Understanding Business Model

Fundamentals
This post attempts to answer the following 3 basic questions on business models: What is a business
model? Why do we need to study business models? How to describe a business model?

Business model is a term that is very loosely used in our day-to-day conversations. Business
managers often use this term, without a complete understanding of it. When they use the term
business model, they are either referring to the revenue model or the operating model. But, business
model is much more than that. Before we start discussing business models, let us discuss what a
model is and why do we build models.

A model is a simplified version of something. It is the scaled representation of a real object. The real
object can be much larger or smaller than the model representation. Models are often discussed in the
field of architecture, where we build models for buildings and other physical structures. Models not
only help in the process of planning and construction of new structures, but also in the understanding
the design of existing structures. Models are also used in the field of engineering to showcase the
design of physical products such as automobiles, aircrafts, rockets, railways, and ships. The goal is
simple: Increase our understanding of the real world objects while eliminating the unimportant details.

While physical models resemble the real world objects they represent, there exist schematic models
and mathematical models that are more abstract than a physical model. Schematic models provide a
pictorial representation of conceptual relationships. Diagrams, Charts, and Blueprints are examples of
a schematic model. They help us avoid costly mistakes. They also help us in asking “what if”
questions.

A business model is a kind of schematic model that helps us gain the complete picture of an
organization business from a high-level perspective. A business model is a framework that helps us
understand how different entities of a business come together to create value for customers. These
entities may include Marketing, Sales, Engineering, Manufacturing, Production, HR, Finance, IT,
Administration, Partners, and Suppliers. A good understanding of business models can help managers
in these different entities with the following:

1. Quickly gain the big picture of the business. Understand how different pieces fit together.
2. Develop the business models vocabulary. Learn to speak the language of business models.
3. Develop a shared understanding. Conduct high-quality discussions and meetings among
inter-disciplinary teams.
4. Think beyond product/service innovation. Consider innovation in different facets of
business.
5. Bring structure to the innovation thought process.

In Architecture, any physical structure consists of several building blocks that need to be assembled to
build the structure. For example, a building has stairs, elevators, electricity system, water system etc.
Similarly, a business model has several components that need to be defined to understand a business.
 Several scholars have attempted to define the basic components and have built different frameworks
using those components. The following papers discuss the attempt of those scholars:

 ‘The Business Model: Theoretical Roots, Recent Developments, and Future Research’ by
Chirstoph Zott, Raphael Amit, and Lorenzo Massa. IESE Business School – University of Navarra.
Spain.http://www.iese.edu/research/pdfs/DI-0862-E.pdf
 ‘Understanding business models‘ by Erwin Fielt. Queensland University of Technology,
Australia.http://eprints.qut.edu.au/41609/1/Business_Service_Management_Volume_3_Mar2011
_Understanding_Business_Models_Final.pdf

Dr. Alexander Osterwalder – A Thought Leader in the field of Business Models Innovation – has
authored a book titled, ‘Business Model Generation – A Handbook for Visionaries, Game Changers, and
Challengers’. As per Dr. Osterwalder, a Business model is defined as follows:

“A Business Model describes the rationale of how an organization creates, delivers, and
captures value.”

As per Dr. Osterwalder, a business model can be described through 9 basic building blocks. These are
listed as follows:

1. Customer segments: Who are the group of customers?

2. Value proposition: What is the offer for each customer segment?
3. Channels: How to reach each of the customer segments?
4. Customer Relationships: How to relate with customers over time?
5. Revenue streams: How to earn revenues?
6. Key resources: What assets are required to run the business?
7. Key activities: What are the important activities/processes?
8. Partner network: Who are the key partners and suppliers?
9. Cost structure: What are the important costs?

These 9 basic building blocks can be shown visually using a diagram called ‘Business Model Canvas’.
Please watch the video below explaining the business model canvas.

[Link to Video]

A good understanding of business model canvas is essential before the understanding of business
models of different companies. This is because it visually demonstrates the inter-linkages between
different elements of a business model. The canvas is very practical and easy-to-use. The canvas
helps in generating new ideas by asking few key questions. Please visit the following link to download
the business model canvas and learn those key questions.

http://www.slideshare.net/Alex.Osterwalder/business-model-canvas-poster

The different components of business model canvas are explained in the beginning pages of ‘Business
Model Generation’ book. The first 72 pages of the book can be downloaded for free from the following
link. These will help in a better understanding of business model canvas.

http://www.businessmodelgeneration.com/downloads/businessmodelgeneration_
It addresses the following questions. What is a Model? What are different types of Models? Why do we
build models? What are the benefits of a Model? What is a Business Model? Why should you learn
Business Models? What are benefits of a Business Model? How a business model is different from a
business plan?

What is a Model? A Model is a representation of a real object or situation. It presents a simplified

version of something. A model can be as simple as drawing a house plan and it can be as complicated as
the design of a big building.

What are different types of Models? Models can be classified into 4 categories: Physical models,
Schematic models, Verbal models, and Mathematical models. Physical model look like the finished
objects they represent. A Schematic model is more abstract that a physical model. They provide pictorial
representation of conceptual relationships. Diagrams, Charts, Blueprints are examples of a Schematic
model. Verbal models use words to represent some object or situation. Mathematical models are built
using numbers and symbols that can be transformed into functions, equations, and formulas.
Mathematical models can further be categorized as follows: Descriptive models (merely describe
something mathematically), Optimization models (used to find optimal solutions), Deterministic models
(where the value of the variables is known with certainty), and Probabilistic models (where the values of
variables are not known with certainty)

Why do we build Models? What are the benefits of a Model? A model helps us increase our
understanding the real world systems while eliminating the unimportant details. Models force us to
organize and sometimes quantify information and, in the process, often indicate areas where additional
information is needed. Models help us in asking “what if” questions. Models generally are easy to use
and less expensive than dealing with the actual situation. They help us in avoiding costly mistakes.

What is a Business Model?

Why you should learn Business Models? To achieve a shared understanding of your business. To learn
business models vocabulary so that you can talk and think in the language of business models. To quickly
understand the business models of your customers and partners. Business models help us avoid costly
mistakes.

How business model is different from a business plan? A business plan is a long well-structured
document detailing out different aspects of the business such as Product development plan,
Manufacturing and Production plan, Operations plan, Sales and Marketing plan, Financial Plan etc. This
document is required when you are raising money for your venture through Bank loans or VCs. A
Business model is less detailed. It can be shown via diagrams on a single page.

Explore Further:

 ‘The Business Model: Theoretical Roots, Recent Developments, and Future Research’ by
Chirstoph Zott, Raphael Amit, and Lorenzo Massa. IESE Business School - University of Navarra.
Spain. http://www.iese.edu/research/pdfs/DI-0862-E.pdf
 'Understanding business models' by Erwin Fielt. Queensland University of Technology, Australia
http://eprints.qut.edu.au/41609/1/Business_Service_Management_Volume_3_Mar2011_Under
standing_Business_Models_Final.pdf

References:

http://www.referenceforbusiness.com/management/Mar-No/Models-and-Modeling.html

Business model is a term that is very loosely used in our day-to-day conversations. Business managers
love to use this term, without a complete understanding of it. When they use the term Business Model,
they are either referring to the Revenue Model or the operating model. But, business model is much
larger than that. It covers all

A good understanding of business models can help managers with the following:
1. Quickly gain the Big Picture of the Business. Understand how different pieces fit together.
2. Develop the Business Models Vocabulary. Learn to speak the Language of Business Models.
3. Develop a shared understanding. Conduct high-quality discussions and meetings among inter-
disciplinary teams such as Marketing, Sales, Finance, IT, HR, Planning and Operations.
4. Think beyond Product/Service Innovation. Consider innovation in different facets of business.
5. Bring Structure to the Innovation Thought Process.

Dr. Alexander Osterwalder – A Thought Leader in the field of Business Models Innovation – has authored
a book titled, ‘Business Model Generation – A Handbook for Visionaries, Game Changers, and
Challengers’. The book is gaining immense popularity across the globe. The book has sold over 2,00,000
copies so far. As per Dr. Osterwalder, Business model is defined as follows.
 “A Business Model describes the rationale of how an organization creates,
delivers, and captures value.”
A business model can be described through 9 basic building blocks that show the logic of how a
company intends to make money. The 9 building blocks are described as follows:

1. Customer segments: Who are the group of customers?

2. Value proposition: What is the offer for each customer segment?
3. Channels: How to reach each of the customer segments?
4. Customer Relationships: How to relate with customers over time?
5. Revenue streams: How to earn revenues?
6. Key resources: What assets are required to run the business?
7. Key activities: What are the important activities/processes?
8. Partner network: Who are the key partners and suppliers?
9. Cost structure: What are the important costs?

These 9 basic building blocks can be shown visually via a diagram called ‘Business Model Canvas’. It is
called a Canvas because it helps in drawing of Business Models. Please see the diagram below on how a
Business Model Canvas looks like.