Your Business Model is the Foundation of Your Business Plan
The report of the death of the business plan has been an exaggeration, to paraphrase Mark Twain. Yet, we often read opinions in the popular business press that the business plan is no longer relevant. All you need is a business model, we are told by business gurus.
While there is no consensus on the definition of a business model, most people use it as shorthand for the revenue model of a business; i.e. how does it make money. A business plan, on the other hand, must not only explain a company’s revenue model, but also its overall business strategy: how it acquires customers; how it creates valuable products and services that someone will actually pay for; its go-to-market plan, and its five-year forecast.
In order to be comprehensive, a business model must address the following four key questions:
- How does a business create value?
- What is its value proposition?
- How does it deliver value to a specific set of customers? and
- How does it capture value?
Whereas there have been many attempts at putting all this information in a tabular form, the most successful and commonly used representation is the Business Model Canvas popularized in the bestselling book titled “Business Model Generation”, first published in 2010. The Canvas is made available to anyone under the creative commons license. As a result, it has been widely adopted by businesses ranging from Fortune 500 companies to startups. Most MBA programs use this Canvas in courses on strategy and entrepreneurship.
It is best to consider the business model as a foundation for the business plan of the company. It is the company’s DNA, represented on a single sheet of paper. Its brevity is its key strength. It is also a great strategic planning tool to highlight value-creating processes and to create “what-if” scenarios when discussing a firm’s strategic options.
When a firm has clearly articulated the nine building blocks or “boxes” in the Canvas, it has answered the fundamental strategic questions facing the firm. The individual boxes refer to the four fundamental value questions in the following way:
The three boxes in the top left part of the Canvas relate to value creation.
A business needs a network of suppliers and partners to make it successful because no business can possibly provide every element of a solution by itself. If you are making widgets, you will need parts suppliers. If you are providing services, you will need partners that make the services more useful. Partnerships also reduce the risks inherent in a business. For example, if you outsource your manufacturing, it may be easier to change the production volume and labor requirements more easily than if you owned the manufacturing plant and employed the labor force.
This box describes every activity a firm engages in, to produce its value proposition, i.e. a product or service which someone will actually pay for. The key here is not to get mired in minutia, but to stay at a top level and describe all the activities a firm engages in. For example, a retail store orders inventory, receives it, stocks it, and sells it. A physician’s office schedules patient visits, delivers care on site, and follows up after the visit.
A firm needs key resources to create value. It is useful to think of resources in four broad categories:
- Intangible resources, such as intellectual property, trade secrets, trademarks, processes and proprietary data
- Tangible resources such as physical plant and equipment, office facilities, computers, vehicles etc.
- Financial resources such as seed capital and line of credit, loans and financial assets
- Human resources, comprising the employees of the firm
This box occupies the top center of the business model canvas. It refers to the actual products or services that a firm offers. A value proposition describes the key benefits of the offering in comparison to its main competitors. It describes what job is your product or service doing. In addition, it describes what customer pains you are alleviating, and what customer gains are you are creating. If you are targeting multiple customer segments, you should describe these benefits for each segment. See this article on how to create a compelling value proposition.
In order to deliver value to the customer segments it serves, a firm needs to define its customer segments, choose the appropriate channels to reach them, and define what kind of relationship it wants to have with its customers. The three blocks that define value delivery are:
In order to serve customers effectively, it is best to segment them in one of many ways: segmentation based on demographics such as age or income levels; needs or problems they are trying to solve; or psychological aspects such as fashion consciousness or desire to seek thrills. Trying to be all things to all people is a sure way to go out of business quickly. Once you have described your key customer segments, you also need to define their unique needs or jobs to be done. The greater insights you have into your customer segments and the jobs to be done, the better product or service you will create.
As the name implies, it refers to the conduit through which you reach your customers. You may have direct face-to-face contact with your customers if you own a pet store, or an indirect contact if you are an online retailer. You may reach your customers through distributors or through a direct sales force. Some businesses try to follow an “all of the above strategy,” but the results are variable. Apple is able to create a strong physical presence in key locations via its iconic stores, just like Nike, while also enjoying a healthy online business. Others like Macy’s have been less successful in using physical and online channels simultaneously. Tesla has taken a direct to consumer approach, completely bypassing the traditional automobile dealer network.
A firm must choose what type of relationships it desires with its customers. Will it be short-term and transactional, such as that for an airport kiosk, or long-term such as that for a credit card or mortgage company? The main objective of any business is to get and keep a customer. The kind of customer relationship it develops is directly linked to its long-term profitability. Certain web-based businesses, such as social media networks like Facebook, LinkedIn, or Twitter rely on their customers not just for the advertising revenue, but also for the content they create. These platforms benefit from network effects in monetizing user-generated content.
The two boxes at the bottom literally define the bottom line of a firm. They show how a firm makes money, and what costs it incurs in doing so.
A firm must spend money on key activities, key resources, and key partnerships to conduct its business. Costs can be seen as being either fixed or variable, or a combination. Economies of scale can be used to bring costs down, along with judicious use of outsourcing non-critical processes.
This box refers to all the revenue a firm generates. This is where you should get creative about monetizing every activity a customer value. It is no secret that in an automobile dealership, the service department is the real profit generator. Similarly, activities that used to be performed for free, such as technical support, can be a revenue-generating activity if a firm charges for support and does an excellent job.
Business Model as the Foundation of a Business Plan
One can see the business model canvas as the blueprint, or the DNA, of a business. It describes value creation, delivery, and capture processes succinctly. It is fast becoming a “must-have” for startups. Many VCs want to see a startup’s Canvas before they will consider investing in it. I have led business model design seminars for organizations ranging from Fortune 500 companies to startups as well as a professional sports organization. However, the business model is a static document, and it lacks some key elements of a dynamic business environment such as competition and growth models. For building a business narrative, we need to construct a business plan above the business model, which serves as a foundation.
The Business Plan Essentials
The business plan is a narrative that describes a firm’s historical origin, its strategic view, its competitive environment and competitive advantages, its product and services and their evolution over the next three to five years, among other things. A typical business plan for a startup or a single product company should not be longer than 25-30 pages. However, multi-product companies can have much longer documents that describe their business narrative. A business plan must answer questions regarding the problem it is trying to solve, its differentiation and competitive advantage, its revenue model, and its people plan. This narrative includes a historical perspective, as well as a look at the future growth path. Some key aspects covered in a business plan but not addressed in the business model canvas are:
No business operates in a vacuum. In fact, if you have no competition, you will either have some very soon, or you are in a no man’s land that no other business finds attractive. It is important to consider both direct and indirect competition. A steakhouse not only competes with other steakhouses; it also competes with fast food restaurants and food delivery services. Airlines compete with other airlines, but also with trains and automobiles. Television competes with social media sites for your share of screen viewing time.
Competitive Advantages and Barriers to Entry
In order to make above average profits, a firm must deliver superior value compared to its rivals. This superior value can come from either differentiated features such as ease of use or greater functionality, or from lower prices that can lead to greater volume. A superior product or market position creates barriers to entry. It is very difficult to introduce a new consumer product such as cereal to the market because the distribution channel is already stuffed with products from leading consumer companies. Thus, no matter how differentiated your product is, it may never see the light of the day. The Internet has opened a completely new channel to challenge traditional distribution channels. It is interesting to see how the Dollar Shave Club razor has taken the razor blade market by storm, battling giants like Gillette, without any physical retail presence.
A company is defined by the quality of its people. Superior teams often secure funding for seemingly mediocre ideas, because the venture capitalists believe that smart people will figure a better way out when they hit a roadblock, and pivot to a better solution. A key aspect of business planning is explaining how you will build the right team to execute your vision. Your team’s compensation plan is a critical aspect as well.
No one has seen the future, and no one expects your forecast to be 100% accurate. VCs look for the logic behind your numbers. Simplistic hockey-stick shaped growth curves routinely elicit a smirk from VCs. You have to explain the rationale behind each action. Did the forecast go up because you hired new salespeople, or targeted a new segment, or launched a new marketing campaign? It is important to link effects to specific causes. Generally, VCs like to see a three to five year forecast, broken down into quarterly and yearly numbers. They also like to see traditional financial statements such as income statement, balance sheet and cash flow statement, as separate tabs in a spreadsheet. You need to pay special attention to costs. If benchmarks are available in your industry, such as average revenue per employee, or department spending as percent of total revenue, it is important to make sure your numbers are in line with industry norm. If the industry average profitability of a particular segment is 5% of revenue, it will be difficult to convince VCs that your business will generate 50% profits.
The Business Plan’s Three Purposes
A business plan serves three purposes:
- First, it is a dynamic document updated regularly that becomes the guiding light for the firm. You measure your success against the plan to see how well you achieved what you set out to do. It is the foundation of strategic planning.
- Second, it is used to assess a firm’s viability as a sound investment. It convinces the investors that you have thought through all aspects of starting a business, and you have a blueprint to succeed.
- Finally, it is a document to attract key talent to your venture. New employees will want to be assured that you have a plan for success and that you have thought through the key questions regarding how to create a successful enterprise.
To summarize, a business model is the foundation of a successful business plan. One is not a substitute for the other. It may make for a good sound bite, but don’t be tempted to burn that business plan yet, any more than a pilot would burn his flight plan before takeoff.
Related Services: Business Model Design; Business Plan Preparation.