A company’s profit-making strategy is its business model. It specifies the products or services that the company wants to offer, its target market, and any estimated expenditures. Business models are essential for all companies. They assist new and expanding businesses to attract investment, recruit talent, and motivate management and personnel. Existing firms should revise their business plans on a regular basis, or they will fail to predict future trends and obstacles. Investors use business plans to analyze firms that they are interested in.
IMPORTANT FACTS
A company’s primary strategy for conducting business successfully is its business model.
Models often contain information such as the items or services that the company intends to offer, target markets, and any projected expenditures.
Pricing and expenses are the two levers of a company model.
As an investor, while examining a company model, evaluate if the concept makes logical and whether the economics stack up.
Recognizing Business Models
A high-level blueprint for running a profitable firm in a certain market is the business model. The value proposition is a critical component of the business model. This is a description of a company’s products or services and why they are attractive to consumers or clients, preferably articulated in a manner that distinguishes the product or service from its rivals.
A new enterprise’s business model should also include expected beginning costs and finance sources, the organization’s target client base, marketing strategy, an analysis of the competition, and revenue and expenditure predictions. The strategy may also include chances for the company to collaborate with other existing businesses. An example of this is a business model for an advertising firm, that may identify advantages from a referral relationship with and from a printing company.
Business models that enable them to meet the demands of their customers at a competitive and sustainable cost create successful firms. Many firms change their business models on an ongoing basis to suit changing business circumstances and market needs.
When considering a firm as a potential investment, the investor should learn how the company produces money. This entails investigating the company’s business model. To be sure, the business model does not reveal all about a company’s potential. However, an investor who knows the company strategy will be able to make more sense of the financial facts.
Particular Considerations
Many businesses make the error of underestimating the expenses of financing the firm until it becomes profitable while developing their business plans. Counting the expenses of a product’s debut is insufficient. A business must continue to operate until its revenues surpass its costs.
The gross profit of a firm is one method analysts and investors assess the performance of a business plan. A business’s gross profit is total revenue less the cost of items sold (COGS). When a company’s gross profit is compared to that of its primary rival or industry, it reveals the efficiency and efficacy of its business plan. However, gross profit alone might be deceptive. Analysts are also interested in cash flow and net income. That is gross profit minus operational costs, and it indicates how much actual profit the company generates.
Pricing and expenses are the two fundamental levers of a company’s business plan. A corporation may increase its pricing and locate goods at a lower price. These approaches result in an increase in gross profit. Many experts believe that gross profit is more essential when analyzing a company strategy. A healthy gross profit indicates a strong company model. If spending is out of control, the management team may be to blame, and the issues are fixable. As this implies, many experts feel that the finest company models can run themselves.
When analyzing a company as a potential investment, learn how it produces money—this is the firm’s business model.
Business Model Types
There are as many different sorts of business models as there are different types of businesses. Traditional business strategies include direct sales, franchising, advertising-based businesses, and brick-and-mortar storefronts. There are also hybrid models, such as enterprises that mix online shopping with brick-and-mortar shops or with sports leagues like the NBA.
Within these broad categories, each company strategy is unique. Consider the shaving business. Gillette is willing to offer its Mach3 razor handle for free or at a reduced price in order to secure repeat consumers for its more lucrative razor blades. The business approach is based on giving away the handle in order to sell blades. This business model is known as the razor-razorblade concept, but it may apply to any company that sells a product at a severe discount in order to offer a dependent one at a much higher price.
Business Model Criticism
Former Harvard Company Review editor Joan Magretta believes there are two key aspects to consider when evaluating business strategies. She claims that when company models fail, it’s because the narrative doesn’t make sense and/or the statistics don’t add up to profitability. 1 The airline sector is a wonderful location to search for a business model that has lost its luster. It covers businesses that have sustained significant losses or even gone bankrupt.
For many years, major airlines such as American Airlines, Delta, and Continental developed their companies on a hub-and-spoke model in which all flights were routed via a few large airports. The business strategy generated large profits by assuring that the majority of seats were full the majority of the time. However, a competitive business model emerged, making the main carriers’ strength a burden. Low-cost carriers such as Southwest and JetBlue shuttled flights between smaller airports. They avoided some of the operational inefficiencies associated with the hub-and-spoke concept while driving down labor expenses. They were able to lower pricing as a result, which increased demand for short-distance flights between cities.
As these upstart rivals lured more customers away, the incumbent airlines were left with fewer passengers to sustain their massive, wide networks. The situation was exacerbated when traffic plummeted precipitously in the aftermath of the September 11, 2001, terrorist attacks. 2 To fill tickets, many airlines had to offer even further discounts. The hub-and-spoke business model was no longer viable.
Business Model Examples
Consider two rival business concepts in which two businesses rent and sell movies. Both companies generated $5 million in sales after spending $4 million on their movie inventory. This indicates that each firm earns a gross profit of $5 million less $4 million, or $1 million. They all have the same gross profit margin, which is computed as 20% of gross profit divided by revenue.
Changes have occurred over the years with the rise of the internet. Instead of renting or selling physical copies, Company B intends to stream movies online. This adjustment has a favorable impact on the company model. The license payments remain the same, but the cost of storing inventory is significantly reduced. In reality, the shift saves $2 million in storage and delivery expenditures. The company’s new gross profit is $5 million minus $2 million, or $3 million. The updated gross profit margin is now 60%. While, Company A fails to update its business strategy, resulting in a decreased gross profit margin. As a consequence, its sales begin to decline. Company B isn’t even earning more money, but it has changed its business approach, which has resulted in significant cost savings.