Business model: What makes a good business model?

What is the definition of a business model and why is it important?

A business model describes how your company can create added value for its customers and keep a portion of this value as profit for itself. The challenge is often to establish a uniform definition of a business model. This can include many aspects, for example

• Manufacture of the product
• Marketing
• Sales process

A good business model is specifically geared towards a market and a target group. It comprises the main components and benefits of a business model, which will set you apart from the competition and ensure your long-term success. In addition to constant value creation, you should also consider how you can minimize risks and costs.

If we take this further, it is also logical that business models are not static and uniform. You can and should evolve it over time so that it can keep pace with constantly changing market conditions and customer needs.

What are the characteristics of a good business model?

The development of a business model that adapts to changing market conditions is of great importance. There are certain characteristics that indicate the long-term success of a company. We take a closer look at the most important characteristics and provide suitable examples.

1. customer loyalty due to switching costs

The principle is simple: if a customer expects high costs when changing a solution, the likelihood of switching decreases.

If you expect higher costs if you want to switch, this may deter you from switching. Conversely, you can also use such switching costs for your business model to strengthen customer loyalty.

Example 1: Digital cameras

Expensive objects and accessories that only fit the original manufacturer's camera create replacement costs. Customers must take these into account before buying a competitor's product.

Example 2: Search engines

If you are considering changing your default search engine, there may be an emotional cost to switching. You will first have to get used to the new browser and adjust.

2. economies of scale and cost distribution

Economies of scale help to make your business model more efficient and profitable. With an increasing number of customers, for example, you can automate and improve processes. As a result, the production volume also increases. By spreading the costs over a larger number of customers, the costs per customer decrease and your company can achieve a higher profit margin.

If you don't want to keep the profit, the products can also be offered at a lower price. This can in turn stimulate demand and increase the overall success of your business model.

Example: Software

You only have to develop software once, but you can then sell the product as often as you like. If you only have one customer, the costs are high. However, if you sell it to two customers, the costs are halved - and so on. Software is therefore predestined for economies of scale.

Example hardware:

Solar modules have been getting cheaper for decades. This is because the price falls by 25% if the global production volume doubles. This is due to economies of scale. The entire value creation process becomes more effective. From the extraction of raw materials to the use of materials and the production process. By doing things more often, we learn.

Source Fraunhofer

3. recurring income

Revenue is recurring if it occurs regularly and predictably. Digital business models can create stable and predictable revenue streams by relying on recurring payments. Subscription models, for example, offer a stable source of income and allow your company to plan for the long term.

Example 1: Digital streaming

Whether in the field of music, entertainment or news - streaming has become indispensable and has largely replaced many traditional services such as radio, TV and newspapers. Most services offer monthly subscriptions.

Example 2: Fresh food on a subscription model

Food deliveries are becoming increasingly popular. You can have dairy products, vegetables or ingredients for individual dishes delivered to your home on a regular basis.

4. income before expenses

Another sign of a good business model is if you can generate revenue before your product is even manufactured. Business model innovations can help to generate revenue before expenses by changing existing business models or diversifying into new ones. This principle is also known as make-to-order production (abbreviated MTO) or build-to-order production (BTO) and also avoids overproduction.

Example 1: Automotive industry

The automotive industry began by collecting money from customers and only then producing the cars "to order".

Example 2: Computer

Some computer manufacturers work according to a similar concept. Their success is based on the fact that customers configure and pay for their devices before they are manufactured. Michel Dell has become one of the richest people in the world precisely by applying this principle.

5. let others do the work

Many successful business models enable the "crowd" or customers to take on part of the value creation instead of having to manage the effort themselves. These business models use customer contributions to create additional value.

Example: Social media

On social media such as Facebook, Twitter and Instagram, users create the actual value through the content they upload themselves. Platforms such as Airbnb also involve their customers very closely in their processes and thus use this quality feature.

Fundamentally changed cost structure due to digital business models

By fundamentally changing its cost structure, your company can significantly reduce its costs and increase its profit margins at the same time. Such changes in cost structures are often the result of innovative business models that change the dynamics of the industry.

Example 1: Aviation

In the aviation industry, one company was able to make a profit every year by making a radical structural change. It only used one specific aircraft model, which was suitable for all pilots.

Example 2: WhatsApp

WhatsApp has built a new business model on an existing idea. This fundamentally changed the cost structure and enabled the company to hold its own against its biggest competitor - SMS at the time - in the long term.

7. protection from competition through patents

There are two options for implementing this feature: Secrecy or patenting.

Example 1: Secret "recipe

Some companies have kept their "recipe" secret for decades, thus securing a competitive advantage. This is the case in the beverage industry, such as Coca-Cola, or in algorithm-driven business models such as Google.

Example 2: Patenting

The pharmaceutical industry in particular loves patents in order to be able to produce its products exclusively for several years.

8. network effect

The network effect always occurs when the addition of new offers or new users makes your business model even more valuable for customers. This has a significant economic impact, as companies can use network effects to adapt their business models and optimize their revenue generation. This allows you to grow very quickly.

This also makes it considerably more difficult for competitors to enter the market. With this quality feature, you not only ensure growth, but also long-term profitability. At the same time, it protects your business model from other companies that want to operate in the same market.

Example: Airbnb

The subletting broker has built up a huge, global network of (letting) tenants. A comparable provider who is only now setting up their business will have a hard time in this market, as no one will be looking for them.

How can you use this for yourself as a product manager?

Thomas recommends reflecting on these eight characteristics of a good business model in your company. It is crucial for product managers to understand the different business models in order to make strategic decisions. To do this, consider the current or planned business model of a product and ask yourself the following questions:

• What would it look like if you were to incorporate the network effect, economies of scale or a subscription model?
• What could you perhaps change or adapt to work according to these characteristics?

Using this approach, you can go through all the quality features and sketch out eight new versions of your business model. You should then consider which of these versions are the most feasible.

Try out the approaches and be willing to experiment! Also ask yourself how you can test possible changes in practice.

The most important facts in brief

A good business model enables your company to remain profitable and competitive at the same time and to stand out from the competition. Business model innovations are of strategic importance as they can ensure long-term success.

Companies should constantly develop their business model in order to be able to adapt flexibly to the market and create added value in the long term.

The 8 quality features will help you to optimize your own business model!

The most frequently asked questions about business models

What is a business model?

A business model describes how a company creates, delivers and captures value. It includes the product or service offerings, target customers, revenue streams, cost structure and the way in which the company operates and achieves competitive advantages.

What types of business models are there?

There are different types of business models. The freemium model offers basic services free of charge, while premium services are subject to a charge. In the subscription model, customers pay regularly for continuous access to products or services. The e-commerce model is based on the online sale of products or services. The marketplace model brings buyers and sellers together and usually charges a fee per transaction. In the advertising model, companies generate revenue through advertisements, which is often used by media and internet companies. The franchise model licenses a successful business model to other operators. In the on-demand model, services or products are provided on demand, often via mobile apps. Finally, the peer-to-peer model enables the direct exchange of products or services between private individuals. These models can also be combined to create hybrid business models.

Business models can be designed, improved and changed using the Business Model Canvas.

Which business model is the right one?

The right business model depends on the type of product or service, the target group, the market conditions and the company's specific strengths. A careful analysis of these factors helps to choose the most suitable model.

When is a business model innovative?

A business model is innovative if it finds new ways to create, deliver or capture value that have not been used before and significantly changes existing market structures or processes. This can happen through disruptive technologies, unique customer approaches or new revenue streams.

What is a business model innovation?

A business model innovation is a fundamental change to an existing business model in order to find new ways to create, deliver and capture value. This can be done by introducing new technologies, tapping into new markets, adapting to changing customer needs or implementing new revenue streams in order to stand out from competitors and achieve sustainable competitive advantages.

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