Business Models: what are they and how do they differ from strategy?

Business models, are essentially short stories that tie together all of the key components of a business in a way that clearly conveys how everything comes together to provide value and make money.  Specifically, a good business model identifies who the customer is and what they need, and how the business will deliver value to generate sales that exceed its cost of capital.  Forming a new business model requires one to think holistically and to rationalize all of a business’ components, and as a result can be quite challenging.  Even articulating an existing business model, simply and accurately, can be a very useful exercise for any business owner or aspiring entrepreneur.

History has a lot to teach us.  In business school we often studied from cases that were written by academics and industry subject matter experts, detailing the stories of real companies.  In dissecting the stories, students learn by example of how companies came into existence, defended market share, reinvented themselves, failed, etc., etc..  A particularly memorable one was about American Express, and its creation of the traveller’s check (an extremely successful business model).  AmEx alleviated traveller’s stresses with dealing with cash while overseas by effectively providing them with a letter-of-credit.  For a small fee, travelers could avoid the challenges of traveling abroad with large sums of cash as the checks were only good for the designated user, and were also insured in case they were lost or stolen. Leveraging their brand reputation, they got many merchants to accept their checks, which made them all the more convenient.  As it was, the business model wasn’t exactly exciting.  However, the key underlying aspect of their model was that it was entirely riskless.  The customers paid for these checks upfront, and with cash.  However, they often didn’t use them for quite some time, and some times not at all.  So, AmEx suddenly found itself with the ability to earn interest off of the cash payments before having to cover the checks that eventually got used.  Just as banks had accepted deposits from its customers, in exchange for safety and convenience, while reaping the “carry” (the overnight interest on the deposits), AmEx too was able to make enormous profit off of a very low risk business model that addressed a serious customer problem while leveraging an existing strength of the company.  An old business model, with a minor facelift and a new application.  American Express essentially “disrupted” cash with a new business model that improved upon existing options consumers had for a very distinct problem.

Business Model vs. Strategy

If a business model describes how a company will provide value to customers in a manner that generates revenues exceeding its cost of capital, then a strategy describes how a company will do this better than its competitors.  Many believe that Wal-mart pioneered the business of discount retailing; however, many companies already existed in this space and had been adapting to discount practices decades before the first Wal-mart existed. Wal-mart’s success focused less on business models, and more on competitive strategy, or more specifically competitive differentiation.  By picking rural, underserved communities that were geographically isolated, Sam Walton chose to bring this business to areas that other retailers (discount or otherwise) were not interested in.  Kmart actually preceded Wal-mart and Sam Walton borrowed a lot of the business model aspects from this discounter and others around at the time, too.  However, it was his focus on different customers and different markets that turned out to be the decisive factor and right bet. Everyone else at the time was focused on stores in large metropolitan areas.  Putting large box stores into these small, isolated, rural towns created a huge opportunity to sell regular, nationally recognized brands to a huge consumer base hungry for those items, but with historically limited access to such goods.  By expanding his network of stores across the country in areas like this, Walton amassed tremendous purchasing power with suppliers – further increasing his ability to offer lower prices.  Wal-mart’s tale is a powerful example of taking an existing business model and employing a different strategy through competitive differentiation.

Much has been written about what business models are, what strategy is, and how the two play together.  So much so, that it can be quite confusing to digest all at once.  The table below (by Mark Johnson from his book “Seizing the White Space”) neatly summarizes a lot of distinct business models.  For more on business models, check out this great article that summarizes a lot of the finely differentiated viewpoints from various thought leaders.

Business Models - HBR

(In case you were wondering what’s up with the paper napkin image we selected for this blog post, read this article from 2003 about Dell Computer.  Enjoy!)

 

 

 

 

 

 

 

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