Definition of business model: The way in which a business adds value, creates a product or service and delivers it to the customer.

What is a business model?

A business model is a fundamental description of how a business makes money. It can take the form of a rough plan sketched out on a post-it note or a 200-page document.

What makes business models very interesting is that two companies selling the same product can have a completely different business model.

Business books and entrepreneurship books contain great examples of radically different business models which will challenge you on how you thought all businesses made money.

What might distinguish one business model from another?

A business model could consist of information such as:

Based in the domestic country versus based offshore

Online casinos and gambling websites often have regulatory permission to serve UK consumers but aren’t based in the UK for tax and regulatory reasons. This is an explicit business model choice.

Type of work undertaken by employees versus work outsourced

Some bakeries make all their products from scratch each morning, whereas others buy in their products from a central facility and simply heat them on-premises.

Manufacturing a product versus buying it ready-made

A company needs to decide whether it will physically produce any products itself, or work with a supplier to produce the item. This relates to how vertically integrated the supply chain will be.

Physical product versus digital product

Physical products come with needs such as warehouse, security against theft and staff members. Digital-only products are efficient to deliver, but can be perceived as of lower value by the consumer.

Value product versus luxury product

A company need to have a clear idea of whether they’re serving the low, middle or high end of the pricing spectrum. It’s incredibly difficult to serve each range without completely independent brands, as cheap products reduce the perceive value of a luxury brand.

Fixed pricing versus subscription pricing model

What do the following services have in common?

• Gyms
• Online courses
• ebooks
• Mobile data providers
• Music stores
• Delivery services
• TV & film streaming
• Cinemas

All of these services can be used once for a fixed price or in unlimited quantities if the consumer opts to pay a monthly subscription.

This business model is particularly effective in industries where the incremental cost of providing a user with an additional unit of service is virtually nil (such as digital products).

Individual sales versus selling products as a bundle or package

Amazon Prime is a great modern example of the bundle. Selling different items or services as a bundle is actually a neat way to maximise sales when providing services to a bunch of consumers who have very different preferences.

Other examples include theme parks (where a single entrance fee grants access to a wide variety of rides) and all-you-can-eat buffets, which let you plate up your favourite items.

Open for business during limited hours versus 24/7

In the UK supermarkets have moved from being open from 6am – 11pm to a 24/7 model only recently. This changes the experience for the customer, but also allows the business to operate differently (such as stocking up shelves overnight).

Good customer service versus limited contact points

Some companies make the investment in good customer service and emphasise this as part of their product offering. Web hosting providers – acknowledging that customers are worried about encountering technical issues – make a big point of boasting about the quality of their service.

Other services, such as search engines, are used by millions of users a day, and will occasionally go wrong. But search engines do not offer live support for users because this isn’t deemed necessary and would increase the cost of goods sold immensely.

Active trading versus franchise model

Franchising is a business model where the business makes money from selling a business model, such as a food outlet, to investors who get to own and run their own business in a semi-independent fashion.

The franchisee gets to keep most of their profits, and benefits from a ‘ready-made’ and tried and tested business model.

The franchisor benefits from steady franchisee income (often charged as a royalty on turnover) and doesn’t need to raise much finance to expand the number of sites rapidly, as franchisees contribute the cash needed.

How is the phrase business model used in a sentence?

“Business H has rapidly evolved its business model in response to change consumer trends in how they want to access information.”

“The best consulting books help to guide practitioners through the art of distilling a business model down to its key elements, and then challenging every aspect to see if the business could fundamentally make money in a different way.”

How does the definition of business model relate to investing?

Business models are the utmost importance to value investors such as Warren Buffet, who won’t invest in shares until he understands the business model and management style of a company.

Check out our investing books and investing courses to learn more about value investing and growth investing.