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Business Modeling for Startups

Experienced entrepreneurs understand that the business model always precedes the business plan. In fact, a convincing business model is often all that is needed by a savvy entrepreneur to make the commitment to pursue a fast moving opportunity. Conversely, a business plan takes several months to put down on paper during which the window of opportunity may shut. For this reason, entrepreneurs who need to be agile and fast moving place more importance on formulating the business model than on writing a business plan.

Almost everyone talks about business models these days but only a minority truly understands what they are. Even the academics disagree and contradict one another when it comes to formulating a definition. So let’s review some of the research into business models.

The Business Model as a One Page Diagram

The business model is defined by some as the profit engine of the business. It is where the rubber meets the road, so to speak. The business model is normally distilled into a diagram on a single sheet of paper showing the following elements of the proposed venture:

1. how and where the business acquires cash from customers,

2. how it uses its cash (tracks cash streams from clients and customers to the business and through the business to its suppliers),

3. how products and services flow from suppliers and the business to clients and customers in the reverse direction and, finally,

4. it shows how the business connects (through sales and marketing channels) with its clients and customers.

If you get the business model right, then the harder you work, the more money you make. If you get it wrong, then the harder you work, the more money you lose.

As stated above, the business model should be a one page diagram summarizing how the proposed venture will fit into the value chain between customer and upstream suppliers–if any–and create the value added which will result in profits being made.

Once the business model is properly planned, the next steps will be facilitating a secure foundation with funding, business insurance, and resources.

The Components of a Business Model

In their paper, The Role of the Business Model in Capturing Value from Innovation, Henry Chesbrough and Richard S. Rosenbloom present a basic framework describing the elements of a business model. They list the following six components of the business model:

1. Value proposition – a description the customer problem, the product that addresses the problem, and the value of the product from the customer’s perspective.

2. Market segment – the group of customers to target, recognizing that different market segments have different needs. Sometimes the potential of an innovation is unlocked only when a different market segment is targeted.

3. Value chain structure – the firm’s position and activities in the value chain and how the firm will capture part of the value that it creates in the chain.

4. Revenue generation and margins – how revenue is generated (sales, leasing, subscription, support, etc.), the cost structure, and target profit margins.

5. Position in value network – identification of competitors, complementors, and any network effects that can be utilized to deliver more value to the customer.

6. Competitive strategy – how the company will attempt to develop a sustainable competitive advantage, for example, by means of a cost, differentiation, or niche strategy.

A good business model draws on a multitude of business subjects, including economics, entrepreneurship, finance, marketing, operations, and strategy. The business model itself is an important determinant of the profits to be made from an innovation. A mediocre innovation with a great business model may be more profitable than a great innovation with a mediocre business model.

Should you use it? Find out.

Continue reading about business models.

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