Business model: definition, types and how to create

Published Friday 15 May 2026

Table of contents

• Business model definition
• Components of a business model
• Common types of business model
• How to create a business model
• How to evaluate a business model
• Business model examples
• The difference between a business model, a business plan, and a revenue model
• Choosing the right model for your business
• Track your business model's performance with Xero
• FAQs on business models

Key takeaways

• A business model defines how you make money. It's the plan that connects your product or service to paying customers, covering everything from your value proposition to your revenue streams.
• There are many types to choose from. Whether you're selling subscriptions, running a marketplace, or offering services directly, the right model depends on your industry, customers, and goals.
• Your model should evolve over time. Regularly reviewing your business model helps you spot new opportunities, adapt to market changes, and stay competitive.
• Metrics tell you if it's working. Tracking figures like revenue per customer, acquisition costs, and profit margins shows whether your model delivers sustainable growth.

Business model definition

A business model is a plan that explains how your business creates value for customers and generates revenue. It describes what you sell, who you sell it to, how you deliver it, and how you get paid.

Think of it as the blueprint behind your business. Without a clear model, it's difficult to set prices, attract investors, or plan for growth. A strong business model helps you stay focused on what actually drives profit.

One of the most widely used frameworks for mapping out a business model is the Business Model Canvas, developed by Alexander Osterwalder. It breaks your model into nine building blocks, giving you a visual overview of how your business operates. You'll find those nine components in the next section.

Components of a business model

A complete business model covers nine core components. Understanding each one helps you see how the different parts of your business fit together and where there might be gaps.

Here are the nine components you should define:

• Value proposition. The unique benefit your product or service offers to customers. Your value proposition is what sets you apart from competitors.
• Customer segments. The specific groups of people or businesses you serve. Defining these helps you tailor your marketing and product development.
• Revenue streams. The ways your business earns money, whether through direct sales, subscriptions, licensing, or other methods.
• Channels. How you reach and communicate with your customers, from your website and social media to physical locations.
• Customer relationships. The type of relationship you build with each segment, such as personal support, self-service, or community-based engagement.
• Key activities. The most important tasks your business must carry out to deliver its value proposition.
• Key resources. The assets you need to operate, including staff, technology, intellectual property, and finances.
• Key partnerships. The external organisations, suppliers, or collaborators that help your business function.
• Cost structure. The major costs involved in running your business, from fixed overheads to variable expenses.

Common types of business model

There's no single business model that works for everyone. The right choice depends on your industry, your customers, and how you want to deliver value. Below are eight common types worth considering as you explore business ideas.

Service-based

A service-based model involves selling your time, skills, or expertise rather than a physical product. Consultants, accountants, and freelance designers all use this approach.

It's one of the simplest models to start with because overheads can be low. However, scaling can be challenging since revenue is often tied directly to the hours you work.

Retail

Retail businesses buy products from manufacturers or wholesalers and sell them to consumers at a markup. This model relies on location, customer experience, and effective stock management.

Whether you run a high-street shop or a pop-up stall, success depends on understanding your customers and keeping a close eye on cash flow management.

Ecommerce

Ecommerce follows a similar logic to retail, but sales happen online. You can sell your own products, dropship from suppliers, or offer digital goods.

The lower overhead costs compared to physical retail make it an attractive option. You'll need to invest in a strong online presence and reliable fulfilment to compete effectively.

Manufacturing

Manufacturers produce goods from raw materials and sell them directly to consumers, retailers, or other businesses. This model requires significant upfront investment in equipment, materials, and facilities.

It suits businesses that want full control over product quality and production timelines. Margins can be healthy, but managing supply chains and inventory is essential.

Subscription-based

With a subscription model, customers pay a recurring fee for ongoing access to your product or service. This approach provides predictable revenue and helps build long-term customer relationships.

It works well for software, media, food boxes, and membership services. Retaining subscribers is just as important as acquiring new ones.

Freemium

The freemium model offers a basic version of your product for free, with premium features available for a fee. Spotify is a well-known example, providing free ad-supported listening alongside paid plans with extra benefits.

This approach helps you attract a large user base quickly. The challenge is converting enough free users into paying customers to sustain the business.

Marketplace

A marketplace connects buyers and sellers on a single platform and takes a commission or fee on each transaction. Amazon and Etsy both operate this way, enabling third-party sellers to reach millions of customers.

Building a marketplace requires significant effort to attract both sides of the market. Once established, the model can scale efficiently since you don't hold stock yourself.

Franchise

Franchising allows you to license a proven business model, brand, and operating system from an established company. McDonald's is one of the most recognised franchise models globally.

As a franchisee, you benefit from brand recognition and a tested playbook. In return, you pay fees and follow the franchisor's standards. It's a good option if you want to run your own business with a lower-risk starting point.

How to create a business model

Creating a business model doesn't need to be complicated. Follow these seven steps to build a model that reflects how your business will operate and grow.

1. Identify your target audience. Start by defining who your customers are. Consider their needs, pain points, and what they're willing to pay for. The more specific you are, the easier it is to tailor your offering.
2. Define your value proposition. Clarify what makes your product or service valuable to your target audience. Focus on the problem you're solving and why your solution is better than the alternatives.
3. Choose your revenue streams. Decide how you'll make money. Will you charge per sale, offer subscriptions, take commissions, or use a combination? Your pricing should reflect the value you deliver.
4. Map out your key activities and resources. List the essential tasks, tools, and assets your business needs to deliver its value proposition. This includes staff, technology, suppliers, and facilities.
5. Outline your cost structure. Identify your main costs, both fixed and variable. Understanding where your money goes helps you set realistic prices and manage cash flow and profit from the start.
6. Identify your channels and partnerships. Determine how you'll reach customers and which partnerships could help you grow. This might include online marketing, distribution agreements, or supplier relationships.
7. Test and refine your model. Before committing fully, validate your assumptions. Talk to potential customers, run a small pilot, or create a minimum viable product. The Business Model Canvas is a practical tool for visualising your model and spotting gaps before you launch.

How to evaluate a business model

Once your business is running, you need to check whether your model is actually working. Regular evaluation helps you catch problems early and make informed decisions about where to invest your time and money.

Here are the key metrics to track:

• Revenue per customer. This shows how much each customer is worth to your business. If it's declining, your pricing or upsell strategy may need attention.
• Customer acquisition cost. Calculate how much you spend to win each new customer. If acquisition costs are rising faster than revenue, your model may not be sustainable.
• Profit margins. Look at both gross and net margins to understand how efficiently your business converts revenue into profit.
• Customer retention rate. A high churn rate suggests your value proposition isn't meeting expectations. Retaining customers is usually cheaper than finding new ones.
• Break-even point. Know how many sales you need to cover your costs. This gives you a clear target and helps you plan for growth.

If several of these metrics are heading in the wrong direction, it's a sign your model needs adjusting. That might mean changing your pricing, targeting a different customer segment, or rethinking your delivery channels.

Business model examples

Seeing how established businesses apply different models can help you decide which approach suits yours. Here are three well-known examples.

Spotify (freemium)

Spotify offers free, ad-supported music streaming alongside premium paid plans. The free tier attracts a massive audience, while premium subscribers generate the bulk of revenue. This model works because the free experience is good enough to build habit, but the paid version removes friction.

Amazon (marketplace)

Amazon connects millions of third-party sellers with buyers on a single platform. It earns revenue through seller fees, advertising, and its own product lines. The marketplace model lets Amazon scale without manufacturing most of what it sells.

McDonald's (franchise)

McDonald's earns a significant portion of its revenue from franchise fees and property rentals rather than just selling food. Franchisees run individual restaurants using McDonald's brand, systems, and supply chain. This model allows rapid global expansion with relatively low risk for the parent company.

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

These three terms are often used interchangeably, but they describe different things. Understanding the distinction helps you plan more effectively.

A business model explains how your business creates, delivers, and captures value. It's the high-level logic behind how you operate and make money.

A business plan is a detailed document that outlines your goals, strategies, financial projections, and operational plans. It's often used to secure funding or guide decision-making. Think of it as the roadmap that turns your business model into action.

A revenue model focuses specifically on how you generate income. It covers pricing strategies, payment methods, and the different ways money flows into your business. Your revenue model is one component of your broader business model.

In short, your business model is the "what," your business plan is the "how," and your revenue model is the "where the money comes from."

Choosing the right model for your business

There's no perfect formula for picking a business model. The right one depends on your skills, your market, and the resources you have available. Here are some practical considerations to guide your decision.

Start by looking at your customers. What are they willing to pay for, and how do they prefer to buy? A subscription model might suit a service with ongoing value, while a one-off purchase model works better for standalone products.

Consider your competition. If your market is crowded, a unique model can be a differentiator. Combining elements from different models, such as pairing ecommerce with a subscription add-on, can help you stand out.

Think about scalability. Some models, like marketplaces and digital subscriptions, can grow without a proportional increase in costs. Others, like service-based models, may require you to hire more staff as demand rises.

Finally, plan for change. Your business model isn't fixed. According to the UK government's business support guidance, reviewing your business strategy regularly helps you respond to shifts in the market. Aim to revisit your model at least once a year to check it still fits your goals and circumstances.

Track your business model's performance with Xero

Understanding your business model is one thing; knowing whether it's delivering results is another. Xero's cloud accounting software gives you real-time visibility into the financial metrics that matter, from revenue and expenses to cash flow and profitability.

With customisable dashboards and reporting, you can track how each part of your model performs and make confident, data-driven decisions as your business grows. Get one month free.

FAQs on business models

Here are answers to frequently asked questions about business models.

Do I need a business model if I'm just starting out?

Yes. Even at the earliest stage, a business model helps you clarify how you'll make money and who you're serving. It doesn't need to be complex; a simple outline of your value proposition, target customers, and revenue streams gives you a solid foundation to build on.

Can I combine different business models in one business?

Absolutely. Many successful businesses blend two or more models. For example, you might sell products through an online shop while also offering a subscription service for regular deliveries. The key is making sure each model complements the other and doesn't create unnecessary complexity.

What is the Business Model Canvas?

The Business Model Canvas is a strategic tool created by Alexander Osterwalder that maps your business onto a single page. It covers nine building blocks, including your value proposition, customer segments, channels, and cost structure. It's a practical way to visualise how your business works and identify areas for improvement.

How do you know if your business model is working?

Look at your financial performance. If your revenue is growing, your customer acquisition costs are manageable, and your profit margins are healthy, your model is likely on track. Declining metrics in any of these areas suggest it's time to revisit your approach. Regularly reviewing your numbers helps you catch issues before they become serious problems.