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In my last paper How Do Venture Capitalists Make Decisions? we looked at how VCs do investments selection and what they think are the main drivers of value creation. I got roasted a bit on Hacker News because the survey did not include the notion of traction, revenue and social proof. In the Hacker News discussion, I answered that revenue and traction were most likely related to business models having this definition from Wikipedia in mind: “A business model describes the rationale of how an organization creates, delivers, and captures value, in economic, social, cultural or other contexts.”
The participant was not satisfied with this answer and he wrote that “I can’t see that traction or revenue are part of the business model, product, technology, or anything else that was mentioned.” That lead me to try to define what the term business model really means and the roots of the term. Indeed, the term business model often encompasses everything from strategy to economic model to revenue model. The authors of this paper try to clarify the definition of the business model terminology and where it comes from.
The Origin of the Term Business Model
While the term was first mentioned in an academic article in 1957, it spread during the emergence of Internet companies in the 1990s. During this period, the term was used to explain still unprofitable but innovative business undertakings dealing with technology, because Internet companies could not be valued based on existing models since there were no precedents. Following the burst of the technology bubble, the term business model started being used for the analysis of all kinds of businesses and not only Internet companies has technology revolutionized the way companies do business in every industry.
Business Model: What it is
The authors build on the resource-based and the transaction cost economics view to define what a business model is. The resource-based view define the firm as a bundle of resources and capabilities, whereas the transaction cost economics view recognizes that resources don’t bring any value to customers, but that value is generated through the transactions made with the use of resources. Thus, they argue that business models represent “a specific combination of resources which through transactions generate value for both customers and businesses.” With the advent of the Internet, transaction costs were reduced in many industries, thus enabling new ways of organizing the resources of a business at a similar or lower costs.
Business Model: What it is not
- Strategy: Business model is a reflection of the realized strategy. As Michael Porter said, strategy defines “how all the elements of what a company does fit together.” Strategy is about building dynamic capabilities to respond to future and existing contingencies. According to the authors, dynamic capabilities are defined as “the capacity to anticipate, shape, seize opportunities and avoid threats while maintaining competitiveness by improving, combining, protecting and, when deemed necessary, rearranging the company’s intangible and tangible assets.” Business models are then bounded by the firm’s dynamic capabilities. In summary, the strategy reflects what the company wants to be whereas the business models reflects what the company is at a given time.
- Business Concept: Business concept is a vague term, it is any conceptualization of business reality, so it can be along the line of a business market opportunity, the products and services offered, a strategic option for evolving the business, etc.
- Revenue Model: A revenue model describes the revenue sources, their volume and distribution. It is an important element of a business model, but only defines how revenue is appropriated and not how a company creates value in its entirety.
- Economic Model: Tool to analyze behaviours and its outcomes in economic terms using economic and mathematical modelling.
- Business Process Modelling: BPR is a graphical representation of how transactions are executed within an existing business model.
As we saw in this paper, a business model is focused on the short-term. Taking the business model in isolation of the company’s strategy is risky as a successful business model will bring its share of competitors ready to eat into the margins by copying the model. Thus, a business model does not paint the complete picture of the business, but merely explain how the various elements work together at a certain moment in time. Managers seeking to outperform their competitors must focus on the following:
- Selecting the right combination of resources and transactions models in the short-term.
- Out-executing competitors with the selected business model.
- Continue developing the company’s dynamic capabilities.
- Redefine the business model with agility depending on the corporate strategy and on the threats/opportunities.