Lesson 2: The Business Model

Types of business ownership

Before exploring business models and innovation, you need to decide what type of ownership structure will be best for your startup. Below is a brief explanation of the common business ownership options. 

  • Sole Proprietorship: You are personally responsible for all business obligations.
  • Partnership: You and one other person are responsible for all business obligations.  Each of you own the company’s profits and debts.
  • Corporation:  A corporation has owners (shareholders), but it is managed by its employees, who take direction from a board of directors. This company structure provides the highest level of legal protection. Should you be sued, you will not be personally responsible for damages. Paperwork and records must be kept up to date for legal reasons.
  • Cooperative: This is a business owned and operated by true equals, run democratically by its members. The owners often refer to their business as a group, collective, or co-op. For example, food stores, bookstores, and other retail businesses are usually cooperatives.
  • Franchise:  This is a company that has created successful business operations and concepts and then sold the rights to other companies. You benefit from a franchise, as it removes a lot of the risk, and the business is able to expand.

McDonalds, KFC, and Col’Cacchio are good examples of business franchises.

What is a business model?

Once you have chosen the ownership structure most appropriate for your business, you need to define your business model. However, before we begin, let’s look at the difference between a business plan and a business model.

Throughout this course, we have seen that entrepreneurship is comprised of many different elements that link together, like pieces of a jigsaw puzzle. 

Management guru and renowned author Peter Drucker asked two questions years ago: “Who is the customer?” and “What does the customer value?” A business model helps us answer these questions, as well as many more. 

A business model is one of the many components that help you develop a business plan – it provides all the essential parts that help you formulate a plan to present to investors or the rest of your team. We will discuss business plans in greater depth later in this module, but for now, let’s review what a business model is, and what it is not:

A good business model is essential to every successful organisation. However, before startup founders or managers of existing large organisations can start applying the concept, they need to understand the mechanics of it and the underlying rationale for business models in today’s business world.

The term “business model” is a relatively new concept that gained prominence around the time that people started using personal computers and spreadsheets. Before, businesses would plan by using a single forecast. They may have done some pre-assessments, but in reality, the way they explored different business scenarios was fairly rudimentary, only occurring after the business had been established and lessons (good or bad) had been learned. 

Spreadsheets have changed this process. Businesses are now able to analyse different approaches by adding or deleting line items and seeing what the overall effect might be. With just a few taps on their computer’s keyboard, they are able to play with pricing scenarios and distribution costs, among other options. Computer spreadsheets provide a way for organisations to model different behaviours of a business before they launch. However, the work shouldn’t stop after a business model has been defined; constant refinement is at the heart of business modelling. 

Many businesses have failed to adjust and tweak their business models as they go along. Their failures helped them refine their business model process and provide a lesson for us all. 

What does this mean for startups?

For aspiring entrepreneurs, developing a business model forces you to think about every aspect of the business and understand what your real value proposition is, what key resources you need, as well as how you will generate revenue.

In the past, if you told someone what industry you were in, they would understand exactly what your company did, since all players in a particular industry had more or less the same business model. Today, companies in the same industry may have very different business models and may generate as much, or more, revenue from an area of that is closely linked to their actual core business. 

For example, McDonald’s is one of the world’s largest fast food restaurant and, while they generate large amounts of revenue from the sales of their meals, their income is also from generated from leasing property out to their franchisees.

For more information on choosing the right model for your business, read this article.

Types of business models

Today, numerous different business models are in use, as companies attempt to strategically outwit each other. Often the type of business you’re in will determine the business model you develop or follow. Let’s take a closer look at the various types of business models:

– Manufacturer: A manufacturer takes raw materials and creates a product. A manufacturer can also assemble pre-made components into a product and may sell directly to end-consumers or to another business that acts as the middleman. 

For example, Dell Computers can be considered a manufacturer because it assembles its computers from parts made by other companies.

– Distributor: A distributor purchases products directly from a manufacturer and resells to retail outlets or to the public. 

For example, a car dealership that sells new cars would purchase vehicles directly from the manufacturer and sell them to the general public.

– Retailer: A retailer purchases products from a distributor or wholesaler, and then sells to the public. Some retailers have a physical shop or chain of shops, while others have opted for the online route. 

For example, Shoprite or Edgars are more traditional retailers, while Spree, Superbalist and Takealot are online retailers.

– Service business: A service business provides either a professional or personal service to a client. This type of business can be either “high touch” or “low touch”, depending on the type of service offered. Most often, a service business relies on a relationship of trust with the client. 

For example, a firm of accountants or lawyers offers professional services, while a hairdresser or personal trainer offers a personal service.

While most businesses fall into one of the basic categories above, the following are subsets of the basic models and offer slightly different ways of doing business.

– Franchising: Instead of creating a new brand, franchising is the practice of using another organisation’s business model, which has already been successfully developed. The franchiser sells the rights to run an outlet in a particular location to a franchisee, who pays ongoing royalties. 

Franchising is particularly popular in the restaurant industry, with McDonald’s, Ocean Basket, and KFC being a few examples.

– Bricks & Clicks: This refers to a company that conducts business both offline (bricks) and online (clicks). This model allows the user to order products online or to visit their local, physical store, providing the flexibility to do business on- and offline. 

For example, while having physical stores, Cape Union Mart also reaches consumers in areas where it does not have outlets through its online presence.

– Freemium: The Freemium business model is popular and common on the Internet. The model offers a basic service to consumers for free, such as 30-day free trial, while charging for premium services such as add-ons or advanced services. As such, customers can access your service for free and decide if they like it before making a purchase. 

Freemium services are a great way to build relationships with customers and establish the foundation for future transactions. One of the greatest advantages to a freemium strategy lies in its ability to be a marketing tool for your service, which helps early-stage startups scale by attracting a user base without costly ad campaigns. 

For example, Spotify’s free version has ads between songs, while the premium service allows you to listen to music without interruption.

– Razor blade model: The razor blade model has evolved over the years to mean any business practice where a company offers a one-time product, usually at little or no cost, that is complemented by another product, which the consumer is required to make repeated purchases of. 

For example, razor blades, printer cartridges and Nespresso’s coffee pods.

– High touch: A high touch business is a service business that requires human interaction. This is more of a customer-centric model in which interpersonal relationships have a major impact on the sale and retention of the customer. With this business model, customers place trust in the business and often have a sense of partnership with a company. In a broader sense, any trust-oriented or relationship-driven business is high touch. 

Examples of high-touch businesses include professional services such as consulting and financial companies, as well as personal services, such as a dentist’s office or hair salon.

– Low touch: A low touch business requires minimal involvement or assistance from employees in selling a product or service. As a customer, you are buying the product or service, and don’t place much value on the individual selling it to you. An advantage of this model is that the cost of acquiring customers is low, since you do not have to hire, train and maintain a sales team with high-level sales and customer service skills. 

An example of a low touch business would be a hardware store.

These are just some of the many business models in use today. As an entrepreneur, you must design a competitive business model and continuously innovate and adapt to gain and sustain a competitive advantage.

Developing the right business model requires the same diligence as designing the right product or service. However, the approach and skills required are different. We’ve learned about different types of business models and why they are necessary. In the following section, we’ll examine what goes into the planning and development of business models and the skills needed to do so.

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