An idea, a business license, and a taxpayer identification number may be enough to get many businesses off the ground, but if your goal is to profit and grow, a working business model is an absolute must. But what is a business model? And how do you know what model will make your business a success?
Starting a new business may fill up your to-do list quickly, but skipping important strategic steps can turn a brilliant business idea into a failed venture. A good model ensures that you can continuously provide value to your target customers and gain a competitive advantage.
This article will guide you through what a business model is and the types of models you can employ.
What Is a Business Model?
A business model is the profit-making structure that you use to sell your products or services in your target market. Unlike revenue models, which look solely at your revenue streams, business models take a more holistic approach by explaining how your business generates value overall for target customers — not just how your business generates money.
This value proposition is a distinct part of every successful business model. Through this proposition, your model tells your team and your investors how you’ll drive customers to your business and continue to maintain their loyalty to your product or service. It also shows how you can stand out from other companies.
Beyond your value proposition, your company’s business model will also explain how your sources of revenue can balance out the expenses you expect, including marketing and raw material costs.
Business Model vs. Business Plan
The term that’s most often confused with a business model is a business plan. While both terms are closely related, a business model describes how your company functions in the present, while a business plan describes how your company will develop in the future.
Creating a business model is a must when you’re building out your business plan, but central to your business plan are also your analysis of your industry and financial projections. In this sense, your the model acts as a foundation, while your business plan allows you to see the big picture of where this foundation will get you.
Though a business plan is still crucial when you’re trying to get investors, lenders, and stockholders on board with you, selecting an appropriate model for your business will define its success and potential for success in the long run.
5 Common Types of Business Models
While there is a correct answer to our first question — “What is a business model?” — there’s no one correct answer when asking what model will make a business successful. Different products and services will be able to generate the most profit with different types of models.
In this section, we’ll define some of the most commonly used models, and highlight proven use cases for each.
1. Subscription Business Model
The subscription model has been booming among across many industries in recent years. With Netflix, ClassPass, Spotify, and many other popular brands all finding success in what is now dubbed the “subscription economy,” you’re likely very familiar with at least one company that’s using this model.
Businesses that employ the subscription model earn revenue by charging their consumers weekly, monthly, or annual fees to get access to services or to get products delivered. It’s a fantastic way to drive customer loyalty and keep your cash flow consistent. However, the companies that find the most success with subscription-based models are the ones that consistently provide new products (ex: new movies on Netflix) or everyday essentials (ex: shaving supplies from Dollar Shave Club).
The subscription model is best known as a route that B2C (business-to-consumer) companies take. However, Adobe is a great example of a largely B2B (business-to-business) company using subscriptions to drive revenue. By charging designers, video producers, and other professionals yearly or monthly for an essential software, they continue earning by limiting access for what could have been a one-time purchase.
2. Advertising Business Model
The advertising business model is a type that provides its direct consumers with a free product or service, while making money off of the companies that want to purchase ads on their platforms instead. This model is almost solely used by content-driven brands. These include news organizations, blogs, social media platforms, and mobile game developers.
Of course, advertising has changed a lot over the years, which means the advertising model has changed quite a bit, too. Not all companies using this model solely profit off of traditional ad placements. Some make more money off of native ads, which are made to blend in with other posts on your platform, while YouTube creators may make more money off of brand placements.
This model isn’t limited to content platforms. Social media influencers are a very modern example of entrepreneurs who earn the vast majority (if not all) of their income through ads, even without their own websites.
3. Freemium Business Model
When you use the freemium business model, you offer your target customers limited access to your product or service for free, while charging for upgraded features. The theory behind this is that your users’ loyalty will grow over time, leading to greater desire to broaden their use of whatever you’re selling.
It’s important to note that this free access is provided on an ongoing basis. Whereas free trials are more of a marketing tactic, free limited access is embedded into how your business runs. The freemium model is most often used by software-as-a-service (SaaS) companies, which can easily unlock parts of their software as soon as you make a purchase.
Hootsuite, a social media scheduling tool, is an example of a successful brand that uses the freemium model. If their customers want to manage up to 10 channels on their own, they don’t need to pay. However, if they start to hire on more employees or take on clients, they may end up finding it necessary to upgrade.
4. Franchising Business Model
When you use the franchise business model, you are essentially selling access to your entire brand. Your target customer is someone who wants to sell your products or services with your logo, revenue model, and business processes. In return, you receive a portion of the profits they earn directly from consumers.
This model works best for brick-and-mortar business owners who have recognizable brands that they want to expand quick. It puts the risk of expansion largely on your customer, helping you grow faster without losing money. You can also set guidelines on what your franchisee can do with your brand to maintain integrity.
McDonald’s presents one of the most successful examples of a franchising business model, having expanded throughout the world by selling rights to their food and well-known brand.
5. Manufacturer Business Model
Rounding up our list is one of the most traditional business models around. The manufacturer model is simple: You turn raw materials or pre-made parts into a product; then you sell it.
There are two primary types of customers that you can target with this model. First, you can target consumers directly. For example, if you own an Etsy shop, you may create your own jewelry, then sell and send it directly to a consumer without a middleman. This direct sales strategy is common with companies that have their own e-commerce websites.
A more traditional route to take with this model is selling your product to a distributor. In this scenario, a product (like a bag of chips) gets sold to a specialized retailer (like a grocery store) at a wholesale price. The retailer then sells the product to the consumer at a markup.
To maximize profit, some companies using manufacturer models (like Dell and HP) will sell to both consumers and distributors.
Frequently Asked Questions
Now that you understand the types of models, you can select which one you want to use for your business. Before we let you make your choice, here are frequently asked questions to help you make an informed decision:
1. Is it possible to change my business model over time?
Absolutely. While it’s rare to completely change models, due to the amount of work it can take to change who you’re targeting and how, your business model shouldn’t be viewed as something that’s completely inflexible.
This is especially true for startups and small businesses that are just starting out. If you notice your initial model is the root cause of drops in revenue, don’t be afraid to innovate and restructure as needed. In other cases, you may actually switch to a franchising model due to the fact that your brand is proving to be a success.
2. What is an example of a marketplace business model?
The marketplace business model has grown immensely in the internet age. In this model, your business creates a connection between buyers and sellers, then profits off that transaction by taking a percentage of the sale. Airbnb and Amazon are both great examples of large brands making this model work.
3. Do franchises always have to be brick-and-mortar businesses?
Not necessarily. Most franchises are brick-and-mortar businesses only due to the fact that your franchisee must be granted a market to operate in. However, a mobile cleaning service is a good example of a business that doesn’t have a physical location but could still use the franchising business model, since you can designate service areas to each franchisee.
Know How You Profit
Creating a business model is a crucial part of business planning, as it clearly outlines how you’re making a profit and helps you determine if you’re staying on track. Not every business will find success under the same model, even if you’re direct competitors. However, this is exactly why having a great model can help you stand out.
If you want to determine if your model is working, learn how to calculate profit margin to review your revenue and expenses.
