4.7 Business models

Question 1

A well-formulated business model does not need to include all of the information that would appear in a business plan (e.g., detailed financial projections), but it should be able to answer the following questions:

Answer 1

What is the firm’s value proposition to its target customer(s)?

What is the firm’s value chain?

What is the firm’s profitability?

Question 2

What is the firm’s value proposition to its target customer(s)?

Answer 2

Who are the firm’s target customers? How does the firm keep its customers?

What product(s), service(s), and experience(s), does the firm offer?

Where is the firm selling? How does it reach its customer(s)?

How much is offer pricing relative to competitors?

Question 3

What is the firm’s value chain?

Answer 3

How is the firm organized to execute?

Does the firm have competitive capabilities?

Question 4

What is the firm’s profitability?

Answer 4

What impact does the firm’s business model have on its revenue model?

What impact does the firm’s business model have on its cost structure?

What impact does the firm’s business model have on its asset profile and financial structure?

Question 5

The two key components of a channel strategy

Answer 5

making sales to customers (sales/marketing) and delivering the product or service to customers (distribution/logistics)

Question 6

An omnichannel strategy

Answer 6

Advances in e-commerce have allowed for this

involves both digital and physical channels.

Question 7

Price Discrimination

Answer 7

occurs when different customers are charged different prices for the same product or service.

Question 8

Tiered pricing

Answer 8

discriminates among groups of customers, such as by charging lower per-unit prices to high volume buyers.

Question 9

Dynamic pricing

Answer 9

fluctuates based on timing, such as lower off-peak pricing during periods of low demand and higher “surge” or “congestion” pricing.

Question 10

Value-based pricing

Answer 10

sets prices based on the perceived value of a product or service to the consumer, which typically requires estimating the opportunity cost of not purchasing

For example, the price of a pharmaceutical drug may be set based on the savings it is expected to deliver in terms of fewer hospitalizations. This differs from cost-based approach, which adds a percentage markup above production costs.

Question 11

Auction/reverse auction models

Answer 11

are used to determine prices for different customers based on a competitive bidding process. Advances in technology have made it easier for companies to use both dynamic pricing and auction-based pricing schemes.

Question 12

Bundling

Answer 12

encourages customers to purchase multiple products or services by charging a lower price than they would pay to purchase each individually.

This strategy is most useful when the products or services are complementary and have high incremental margins and marketing costs (e.g., television and internet service).

Question 13

Razors-and-blades pricing

Answer 13

entices customers with a low price for a piece of equipment that requires ongoing purchases of high-margin consumables. Printers and ink cartridges are another notable use of this strategy.

Question 14

add-on pricing

Answer 14

customers add extra products or services to their orders, either at the time of purchase or after initial product use.

For example, apps may require users to make in-app purchases in order to access additional features.

However, this pricing strategy can cause reputational damage if customers feel that the company has taken advantage of a “captive” dynamic.

Question 15

Penetration pricing

Answer 15

used to quickly establish market share with the intention of charging higher prices after consumer acceptance and scale have been achieved.

This model has been employed by content streaming services because sacrificing margins during an initial phase can be justified in pursuit of the comparative advantage that is conferred by network effects.

Question 16

Freemium pricing

Answer 16

offers a basic level of functionality at no cost in the expectation that users will be willing to pay for premium features or content.

This model is widely used by software and app developers.

As with penetration pricing, the initial revenue sacrifice is justified by the potential for the network effects that come from widespread adoption.

Question 17

hidden revenue business model

Answer 17

based on providing a service at no cost while generating revenues that are not provided by users.

The most common example of this model is providing free media content and generating revenue from advertisers for access to the audience.

Question 18

Subscription pricing

Answer 18

allows customers to access a product or service for as long as they need in exchange for a recurring fee, which may be fixed or variable based on usage.

This model has long been used in the media sector, with customers making regular payments for continued access to, for example, television channels or published content. In recent years, advances in technology have allowed the subscription pricing model to be adopted for wider range of items (e.g., printer ink, razors).

Question 19

Licensing arrangements

Answer 19

permit the use of an intangible asset in exchange for royalty payments.

For example, a children’s clothing manufacturer can license the right to use images of a popular cartoon character on its apparel and pay the trademark’s owner a percentage of sales

Question 20

Franchising agreements

Answer 20

grant a franchisor the exclusive right to distribute a company’s products and/or services within a specified area.

In exchange for payments, the company provides its franchisees with various services, including marketing support.

This model is commonly used in the restaurant industry.

Question 21

Fractionalization

Answer 21

divides a single large asset that consumers would not use entirely into smaller units that suit their needs.

Examples include sub-letting office units, sharing server capacity, and timesharing of vacation properties and private jets.

Question 22

A company’s value chain

Answer 22

the answer to the question of how it executes its value proposition.

Question 23

Investors can analyze a firm’s value chain as the link between its value proposition and its profitability. The key elements of value chain analysis are:

Answer 23

1. Identify the firm’s key activities
2. Estimate the value that is added by each of these activities
3. Determine which activities can be potential competitive advantages

Question 24

Private label manufacturers

Answer 24

also known as contract manufacturers

are specialist manufacturers producing items that are marketed by other firms

Outsourcing arrangements like this have become increasingly common as the global economy has become more integrated.

Question 25

Licensing arrangements

Answer 25

allow a firm to sell products that use another firm’s brand or intellectual property in exchange for royalty payments based on a percentage of sales.

Question 26

Value added resellers

Answer 26

provide key services for the products that they sell.

Firms that follow this business model typically sell products that require specialized installation, maintenance, and repair services (e.g., air conditioning systems).

Question 27

Franchise models

Answer 27

grant franchisees the exclusive right to operate a location of the parent company’s operations in exchange for royalty payments. This model is commonly used in service-intensive industries (e.g., restaurants).

Question 28

Network effects

Answer 28

represent the value that is derived from incremental increases in users, rather than internally generated by firms.

This concept applies to new technologies such as messaging services, social media platforms, and payment processing systems.