4.7 Business models Flashcards
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:
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?
What is the firm’s value proposition to its target customer(s)?
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?
What is the firm’s value chain?
How is the firm organized to execute?
Does the firm have competitive capabilities?
What is the firm’s profitability?
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?
The two key components of a channel strategy
making sales to customers (sales/marketing) and delivering the product or service to customers (distribution/logistics)
An omnichannel strategy
Advances in e-commerce have allowed for this
involves both digital and physical channels.
Price Discrimination
occurs when different customers are charged different prices for the same product or service.
Tiered pricing
discriminates among groups of customers, such as by charging lower per-unit prices to high volume buyers.
Dynamic pricing
fluctuates based on timing, such as lower off-peak pricing during periods of low demand and higher “surge” or “congestion” pricing.
Value-based pricing
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.
Auction/reverse auction models
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.
Bundling
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).
Razors-and-blades pricing
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.
add-on pricing
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.
Penetration pricing
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.
Freemium pricing
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.
hidden revenue business model
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.
Subscription pricing
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).
Licensing arrangements
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
Franchising agreements
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.
Fractionalization
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.
A company’s value chain
the answer to the question of how it executes its value proposition.
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:
- Identify the firm’s key activities
- Estimate the value that is added by each of these activities
- Determine which activities can be potential competitive advantages
Private label manufacturers
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.
Licensing arrangements
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.
Value added resellers
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).
Franchise models
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).
Network effects
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.
