Guide

What is a business model?

A business model defines your value proposition, identifies growth potential, and sets a path towards profitability.

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Business model definition

What is a business model? Ask a dozen people and you’ll get a dozen different answers, but here are the basics: a business model explains why customers would choose you, what they’ll get from you, and how you’ll make money from that exchange.

Components of a business model

Your business model can help you clarify and sense check your business strategy, and set your path to success.There are several components to address when creating your business model:

  • Value proposition: This is the unique value that your business offers to customers. It’s what sets you apart from your competitors and why customers will choose you over other businesses.
  • Revenue streams: The different ways that you’ll generate revenue. This could be through the sale of products or services, subscriptions, licensing, or advertising, to name a few.
  • Cost structure: The different costs associated with running your business. This includes costs of production, plus business expenses like rent, insurance, utilities and marketing.
  • Target market: The group – or groups – of customers your business is trying to reach. It’s important to identify and understand their needs and preferences.
  • Customer acquisition: Methods that your business uses to attract and retain customers, such as advertising, social media, or word-of-mouth referrals.
  • Channels: The different ways your business delivers products or services. This could be through a physical store, an ecommerce website, or a mobile app.
  • Key resources: Resources your business needs to operate successfully. This could include physical resources such as equipment and facilities, or intellectual property resources such as patents and trademarks.
  • Key activities: Tasks your business needs to perform to operate successfully, such as product development, marketing, or customer service.
  • Key partnerships: Partnerships your business will need to establish in order to operate successfully – with suppliers, distributors, or other businesses in the industry for example.

The difference between a business model, a business plan, and a revenue model

  • Your business model gives you an overall understanding of your business: how it delivers value to its customers and generates profits for its owner/s.
  • Your business plan is a more detailed blueprint for starting and running your business. It includes things like goals, marketing strategies, financial projections, and how you'll manage your business on a day-to-day basis.
  • Your revenue model focuses specifically on how you'll earn revenue. It explains the different ways you'll get paid for your products or services (such as through sales, subscriptions, or advertising) and how much you’ll charge.

Common types of business model

Some of the most common types of business model include the service-based model, the retail model, the ecommerce model, and the subscription-based model. Each has its own set of advantages and disadvantages, and choosing the right one depends on the nature of your business and the needs of your customers.

Within each model, you’ll add the extra details about your target customers, products, costs and so on that make the model unique to your business.

Service-based business model

The service-based business model is a popular choice for freelancers and small service-based businesses. With this model, you offer your skills and expertise to clients in exchange for a fee. This could include writing, graphic design, consulting, or any other service you specialize in. This model can be fairly easy to set up and run, with relatively low operating costs.

However, be mindful that your earning potential may be limited by the number of hours you can work at any given time. Some service businesses get around this by charging a flat fee instead of an hourly rate. With a flat fee, you agree on a set amount that customers pay, no matter how long it takes you to complete the work. As you become more efficient and productive, you’ll be able to finish the tasks in less time, allowing you to earn more.

Retail business model

The retail business model is useful if you're selling products directly to customers. With a retail business model, you sell a product for an agreed price, often (but not always) receiving payment before you release the goods. It's perfect for opening a physical store, an online shop, or even a combination of both. Hospitality businesses also use the retail model.

A retail business model offers the potential for high sales volumes and the opportunity to establish your brand presence in the market. It allows you to create a personalized shopping experience and build relationships with your customers. Note that this business model often requires a physical space, which can involve high rent and operating costs, as well as the challenges of inventory management and potential competition from larger retailers. Depending on the industry and location of your business, you may be required to guarantee the product, accept returns, or provide after-sales support. Additionally, the retail industry can be influenced by factors such as seasonal demand and changing consumer preferences, requiring adaptability and continuous efforts to stay competitive.

Ecommerce business model

The ecommerce business model is another popular option, particularly for businesses that sell physical or digital products. With this model, you create an online store or platform where customers can purchase your products directly. This model has the advantage of making your products available to customers around the world and can provide a steady stream of income. Keep in mind that competition in the online marketplace is high, which means you’ll need a strong marketing strategy to stand out and attract customers.

Manufacturing business model

A manufacturing business model is all about creating and producing your own products to sell to customers. It's a great choice if you have a unique product idea and want to bring it to life. By using a manufacturing business model, you have control over the entire production process, from sourcing materials to making the final product. This allows you to ensure quality and customize your offerings to meet customer demands.

The benefits of a manufacturing business model include the potential for higher profit margins – if you can sell directly to customers – and the ability to scale your production as your business grows.

However, it's important to be aware of some of the challenges, such as the upfront investment in equipment and machinery, the need for efficient supply chain management, and risks associated with inventory management and product development.

Subscription-based business model

The subscription-based business model is becoming increasingly popular. With this model, customers pay a recurring fee to access a product or service on a regular basis. This could include meal-kit delivery services, streaming platforms, or software-as-a-service (SaaS) businesses. This model can provide a reliable source of recurring revenue, allowing you to forecast revenue more accurately. However, you still need to focus on acquiring and retaining customers, and you may encounter challenges in managing recurring payments and customer service.

Choosing the right model for your business

Different business models have different sets of advantages, so make sure to choose one that aligns with your needs. For instance, a service-based business model might work well for a freelance writer. But a service business could also adopt a subscription model. An ecommerce business model might be better suited to certain types of retail which don’t require a product to be highly personalized – but it wouldn’t work for custom-tailored clothes. You may find there are one or two business models used more widely than others in your chosen industry.

It’s also important to evaluate who your customers are and what they want. This will help you determine what kind of business model will best serve their needs. Understanding your target market will also help you determine your unique selling proposition (USP), which is what sets your business apart from your competitors.

Speaking of competitors – analyzing their business models can also help you choose the right one for your business. By doing this, you can find out what's working for them and what isn't, and use this information to help you make an informed decision.

Test your business model

Once you've decided on a business model, it's a good idea to test it out. You can do this by offering a free trial or beta test to a small group of customers. This will help you identify any issues and make adjustments before launching your business.

Writing a business model isn’t a ‘one and done’ exercise

It's important to remember that creating a written business model is an ongoing process. It's not a one-time task, but a living document that evolves as your business grows.

Your business model should reflect the changes happening in the market, the needs of your customers, and your own goals. By keeping your business model up to date, you can adapt to new challenges and seize opportunities to achieve long-term success.

Disclaimer

Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.

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