Level 1 CFA® Exam:
Business Models – Introduction
A business model is a company's plan for how it will generate revenues and make a profit. It describes what kind of product or service the company plans to sell, to what customers, through what channels, and at what price. A well-designed business model should align a company's value proposition, value chain, business organization and capabilities, and unit economics. Also business logic is a required prerequisite for a sound business model.
A value proposition are benefits that the company's products or services offer to its customers. The company needs to develop a clear and compelling value proposition to be successful in the market.
The value chain is the set of activities that the company uses to develop and deliver its products or services. The company's business organization and capabilities are the structure and abilities that it uses to develop and deliver its products or services. The company needs to develop an effective business organization and capabilities.
Unit economics is the study of the costs and revenues associated with the production and sale of a unit of a product or service. The company needs to understand its unit economics in order to develop an effective business strategy. The break-even point is the point at which the company's revenues equal its costs.
Features of a company’s business model include:
- customers & market,
- product or service offered,
- distribution channel,
- pricing policy & pricing model.
Customers & Market
A company's customers are the people (in the case of the B2C – business-to-consumer) or organizations (in the case of the B2B – business-to-business) that buy its products or services. The company needs to understand its customers' needs and how they make purchase decisions in order to develop an effective marketing strategy.
The market is the set of all potential customers for a company's products or services. The company needs to understand the size and growth of its target market, as well as the segmentation of that market.
Neither market nor customers are set once and for all. Successful companies expand their target audience and market to increase revenues and profits.
Product or Service Offered
A company’s offer is a specific product or service that the company plans to sell to its customers. The company needs to develop products and services that meet the needs of its target market and customers. Differentiation is the process of creating a unique selling proposition for the company's products or services.
Channels
Channels are the means by which a company's products or services are delivered to its customers. The company needs to select the channels that are the most effective for reaching its target market. We distinguish:
- direct channels,
- intermediary channels,
- digital channels.
Direct channels are channels that the company uses to reach its customers without the use of intermediaries. In other words, the company can use direct channels to sell its products or services directly to its customers.
Intermediary channels are channels that the company uses to reach its customers through the use of intermediaries. The company can use intermediary channels to sell its products or services to its customers through intermediaries such as retailers or distributors.
Digital channels are channels that the company uses to reach its customers through the use of digital technologies. The company can use digital channels to sell its products or services to its customers online.
Direct sales is a direct channel that the company uses to sell its products or services directly to its customers. When the company uses direct sales to sell its products or services it uses its own sales force.
Omnichannel is a channel strategy that the company uses to reach its customers through multiple channels, for example, a customer browses for a product online, buys it, and then collects it from the physical shop. So, we have a mix of a digital channel and a direct channel in this example.
Pricing is the process of setting the price of a product or service. A company needs to consider its pricing power, cost structure, and value proposition when setting the price of its products or services.
Pricing models are a key element of any business model and can vary greatly depending on the products or services offered, the target market, the channels used, and the overall business strategy. There are many different pricing considerations that a company should take into account.
Consideration 1: Company prices vs competition
Premium pricing is a pricing strategy that a company uses to charge a higher price for its products or services. The company can use premium pricing to increase its profits or to differentiate its products or services.
Parity pricing is a pricing strategy that a company uses to charge the same price as its competitors for its products or services. The company can use parity pricing to compete on price or to match the prices of its competitors.
Discount pricing is a pricing strategy that a company uses to charge a lower price for its products or services. The company can use discount pricing to increase its sales or to attract new customers.
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Consideration 7: Ownership or not
There are alternatives to ownership and they include:
- recurring revenue/subscription pricing,
- fractionalization,
- leasing,
- licensing,
- franchising.
Recurring revenue/subscription pricing is a pricing strategy that a company uses to charge a recurring fee for "renting" its products or services. Recurring subscriptions are very popular for digital services but also utilities, telecommunication services, and so on.
Fractionalization is a pricing strategy in which a company sells only a fraction of a product (e.g., co-working spaces) or allows the use of the product at different times by different customers (e.g. hotels).
Leasing is an alternative to holding an asset. Instead of buying an asset (e.g., a car, a machine, etc.), a company leases it from another company that usually specializes in offering leasing services.
Licensing is a pricing strategy that a company uses to charge a royalty payment for the use of its intellectual property.
Franchising is a pricing strategy that a company uses to charge a fee for the use of its business model.
To sum up, the best pricing model for a company depends on many factors, such as the products or services offered, the target market, the channels used, and the overall business strategy. There is no one-size-fits-all model and companies should carefully consider all the key factors before choosing their pricing model.
Many companies use traditional business models used in a specific industry. However, with the development of digital technology, software, new technologies, and innovation, new approaches to business models have emerged. Old ways of distribution or business organization are no longer enough to conquer the market and beat the competition.
Thanks to digital technology, changes to channels and business organization have been possible. The location of the business is no longer that important and lots of tasks can be easily outsourced. Moreover, companies take advantage of digital marketing and network effects.
Let’s take the e-commerce business model. Apart from a traditional direct-sale model, we can also distinguish variations such as affiliate marketing (where you can earn commission on referrals and sales made on other websites), marketplace businesses (which match sellers and buyers of various products), or aggregators (which resell product under their own brand).
Before we go, let’s also mention here crowdsourcing which allows users to directly participate in product or service development and contribute to the product or service.
Finally, nowadays many companies use hybrid business models with digital marketing and the physical distribution of goods.
- A business model is a company's plan for how it will generate revenues and make a profit.
- A value proposition are benefits that the company's products or services offer to its customers.
- Unit economics is the study of the costs and revenues associated with the production and sale of a unit of a product or service.
- Features of a company’s business model include: customers & market, product or service offered, distribution channel, and pricing policy & pricing model.
- We distinguish: direct channels, intermediary channels, and digital channels.
- Omnichannel is a channel strategy that the company uses to reach its customers through multiple channels.
- Pricing models are a key element of any business model and can vary greatly depending on the products or services offered, the target market, the channels used, and the overall business strategy.
- Recurring revenue/subscription pricing is a pricing strategy that a company uses to charge a recurring fee for "renting" its products or services.
- Nowadays many companies use hybrid business models with digital marketing and the physical distribution of goods.