Coming Up With a Winning Business Model
Coming up with a profitable business model is a necessary step before starting a business. However, even an established business may examine its current business model if positive changes can be made. But first, just what exactly is a business model?
Business writers have numerous definitions about what a business model is. It would be helpful to first know what a business model is not. A business model is not a feasibility study. It is nearer in essence to a business plan, although it is not a business plan. Since there is no established definition I would venture to suggest what I believe is the most useful description of a business model. For me, a business model is a formula on how a business will make money on a continuous basis. I use the term “formula” instead of “plan” because it implies something that must be quantified, even if only approximately.
In making your business model, it is important that you pay special attention to the key factors that have the largest impact on profitability. The three factors we discuss below are crucial to almost any business. Your business model must be superior in at least one aspect and have a passing grade on the other criteria.
Product or service offers a significant value advantage. This aspect of the business model is the easiest to understand but is, in fact, the most frequently violated. Too many entrepreneurs start a “me too” business with little or no improvement over the competition. It is so much easier to just imitate a successful business than to invest time and effort to come up with a superior product or service. If you will be going against an established competition, you must have a substantial value added or else people are unlikely to change their habits. You may be thinking what a “significant advantage” is? People have different perceptions of what is significant, and when the difference is in the area of subjective factors like taste, it is even more difficult to make conclusions. As a rough guide, if you have no other better idea for your particular business, you may use a thirty percent difference as a minimum definition of significant.
Sufficient Profit Margins. It has often been stated that you need large profit margins to have a good business model. If it is possible to set prices high without suffering too much sales loss, then it may be a good strategy. However, much depends on the type of product, risk, investment involved, and many other factors. A ten percent margin may be great if you have little risks and investment like in real estate marketing but it would be a lousy mark-up for fashion items that may quickly lose their value. In this matter, a good indicator of sufficient margins in the going rate for that industry. As long as the market is not monopolized, there is strong tendency for margins to stabilize at the appropriate level. One problem with competing with an insufficient margin is that there is no buffer for contingencies. Another problem is that you may actually losing money after factoring all the expenses, like overhead, which are not included in computing the gross profit. Note that one of the most common causes of low profit margins is the inability to source inventory or production inputs at a low price. This is because in most cases, the biggest discounts are offered only to large buyers who can order in massive volume. Because of this, you may not be able to match the selling price of competitors. If your market is price sensitive, then if may not be possible for your business to survive.
Customers that can be reached profitably. You may have a brilliant idea for a product and the market for it may be huge, but it is still very possible not to have a financially feasible way of reaching the customers. There are at least two major reasons why this could happen. The first is when you need to spend a massive amount on a mass media campaign. Even if you may have the cash to advertise, your business may not be extensive enough to absorb the sales resulting from the promotion. For example you may have only a few branches whereas your competitor has hundreds or thousands blanketing the country. A second reason is when there are no marketing channels where you can target your customers. Marketing channels include magazine, television, radio show, etc. where you can show your message to them.
Having an excellent business model gives strong assurance that the business is likely to succeed. Before conducting a feasibility study or business plan, a winning business model must first be found so that you could determine quickly if your ideas have a chance of proceeding to the next level in the planning process.
*Originally published by the Manila Bulletin. D-4, Sunday, September 22, 2013. Written by Ruben Anlacan, Jr. (President, BusinessCoach, Inc.) All rights reserved. May not be reproduced or copied without express written permission of the copyright holders.