What is a Business Model and How Do You Make One?

Business models outline a business's revenue stream and summarize how it will operate. A business model is not to be confused with a business plan. The latter is a physical document or report that outlines the business's high level strategy and financial projections over several years. Business plans tend to follow a single format, while business models often come in very different forms depending on the business and industry.

Why Do Business Models Matter?

Business models are crucial, as they help the business owner visualize how their business will create value for itself and customers. Also, they help provide a structure and framework that a business can use, making it easier to apply for things like small-business financing. Having a well-defined business model also serves as a sanity check for the viability of a company for a given market. Finally, business models make it easier to write thorough business plans, as those tend to be more detailed descriptions of how a company will execute on its business model.

When applying for either debt or equity financing, the lender will evaluate your business model and plan. It's a best practice to be prepared to explain the ins and outs of both when under evaluation. The more your preparation shows, the more likely it'll be to have your business funded. Any business that fails to properly explain their model or plan is immediately labeled as a risky investment, meaning lenders will potentially want increased collateral or ownership in exchange for the financing they provide.

What is a Business Model Canvas?

A business model canvas is a standardized and lean template for businesses of all types to use. It's usually a single visual document broken up into different sections. We've listed out all the sections below in what we feel is the order of importance.

  • Value Proposition: This is the centerpiece of both your model and plan. If you don't have a differentiator, your business will not succeed. Every decision you make and every action you take should go toward furthering your value proposition.
  • Key Partners: Detail out your current and future partners. What's your motivation to partner with them? What's their motivation to join you? Use this to really reconsider the importance of partnerships.
  • Key Activities: Based on your value proposition, what're the highest-priority action items you need to take? Why're those specific actions so important?
  • Customer Segment: Who are you targeting and why?
  • Customer Relationship: Are you planning on interfacing with customers on a regular basis? Do you plan to build any sort of a relationship? How is your planned relationship strategy helpful to your business?
  • Distribution Channel: Now that you've identified your customers and what kind of relationship you'd like to have with them, how will you get your goods and services to them?
  • Key Resource: What are the resources you'll need in order to make all of the aforementioned strategies and actions possible? Why is each resource so important and necessary?
  • Cost Structure: How much does this entire plan cost?
  • Planned Revenue: Wrapping it all together, how much do you realistically project earning in pure revenue?

Types of business models

A business model canvas isn't the only type of business model you can put together. In fact, there isn't one standardized template that a business model needs to follow.

There's nothing that says your business model needs to stay static for the duration of the business's lifetime. A flexible plan can sometimes be even more useful as a business launches. No matter what business model you choose, it is always in your best interest to continue to refine and optimize your model. Here are some examples of business models:

Manufacturers: Manufacturers produce products from raw materials, selling to distributors or directly to end consumers.

Freemium Model: Freemium businesses offer basic services for free but offer premium services for additional charges.

Distributor: Distributors typically purchase products from wholesale manufacturers and sell those products to end consumers.

Franchise: Franchise models involve taking part of an existing business model to leverage an existing strategy and product. Franchise businesses can range from restaurants to retail.

How to make your model as successful as possible

All business models will be most dependent on both revenue and costs. A successful model is one with higher gross profits (revenue - cost of goods sold). As long you find ways to increase your gross profit, your model is theoretically improving. With that in mind, you don't need to constantly find ways to increase your sales or revenue. In fact, reducing your costs can be just as effective.

Company A vs. Company B:

Let's say company A and company B both have identical revenue streams and costs. They're both pizza shops. So they both have a revenue stream of $100,000 and total costs of $80,000. They're both experiencing a gross profit of $20,000.

Company A decides that it wants to try to boost its revenue so it launches a marketing campaign that nets $15,000 in additional revenue for the duration of the campaign. Company B, on the other hand, decide it wants to reduce costs by choosing different suppliers for its raw materials and effectively reduce its costs by $30,000. In this scenario, Company B improved its model at a greater degree than company A because it increased its gross profit by $15,000 more.

Mistakes to Avoid When Forming a Business Model

There's no one single correct way to write a business model, but there are some common mistakes you'll want to avoid.

Don't rush the business model

As a business or startup owner, you likely have a million different things to do and not enough time in the day. However, you don't want to rush your business model or your business plan. Both are opportunities to think through the strategy of your business and capture it on paper. Without these in place, it's tough to have an internal reference that can guide your company in its growth stages.

The quality of your model will be directly related to how much time you spend on it. Of course, you don't want to spend so much time on this that your entire business comes to a halt, but we recommend thinking this through so you don't just jump from task to task.

Don't let it collect dust

The last thing you want to do with your model is complete it and leave it off to the side. The business model is designed and meant to be flexible and continually updated. Don't spend a ton of time carefully thinking through the model only to toss it aside. Use each version to learn from mistakes and get a general sense of what trends your business is following.

The best business model is one that accurately captures your projections and your strategy and is a reliable resource to strategize around.

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