As a professor of business and management consultant I find myself in a variety of organizations. One of the questions I often ask both senior managers and line personnel is how their organization makes money. Another way to ask the question is to ask for a description of the firm’s business model. In many organizations the answers are a best superficial. In the worst cases the answers are misleading. The answers frequently take the form of describing what the organization produces and sells.
Among more thoughtful managers the answer may reflect the strategy or competencies of the organization: we are rapid innovators in information technology or we deliver premium customer service in the hospitality business. Yet, such answers are inadequate and fail to provide real direction for an organization. The reason is simple. The same answers could be offered by organizations that do not make money, or at least do not make a profit. So, if the same answer applies to organizations that are profitable and those that are not, they cannot really be the answer to the question how does your organization make money?
A useful answer to “how does your organization make money” is a description of the organization’s business model. A business model defines several key dimensions of a business. First, it identifies whom the organization defines as its customer(s) and does so with greater insight than simply who buys the organization’s products and services. Rather the answer should be in terms of the characteristics of customers and the value they obtain from the products and services they buy. For example, a hospitality company might define its customers as affluent travelers seeking luxurious accommodations and highly personalized service. Alternatively, another hospitality organization might define their customers as budget conscious business travelers who seek comfortable accommodations at the end of busy day. These two sets of customers are quite distinct, and the differences have very significant implications for how the organization organizes and promotes itself, how it prices, and the organizational competencies necessary for success. Although both organizations may be broadly a part of the hospitality industry they clearly are not in the same business and make money in very different ways. They will also be perceived as different by customers, or potential customers, which means their brands are different, whether by intention or not.
A second element of a business model is defined by the activities that the organization carries out in order to deliver value to its defined customer base. This includes not only what the organization itself might do but also whom it partners with to serve its customers. Partners include suppliers, distributors, retailers, and service providers, among others. Indeed, a fundamental strategic decision for a business is what activities the organization will do itself and what activities it will out source to partner organizations. As one simple illustration in the context of the hospitality industry, an organization could elect to operate its own restaurant within a hotel property or out source food service to another organization. How an organization organizes its activities and the partners it employs have implications for both the competencies required of the organization and its cost structure.
Also integral to an organization’s business model is how it prices its offerings, that is, what it charges for and how. To continue the example in the hospitality industry the luxury hotel may charge a substantial price premium for a room but also offer an expensive restaurant and catering services that are substantial sources of revenue. The organization focused on the budget business traveler may charge less for a more Spartan room but include a modest breakfast and perhaps a happy hour with free or reduced cost beverages as part of the room cost. Again, these are two very different revenue and cost models.
Finally, a business model addresses how an organization will promote itself and how it will brand and differentiate itself. The luxury hotel may promote self-indulgence and pampering. The budget hotel may emphasize value and comfort. To be effective these messages must be consistent with the other elements of the business model. For example, indifferent staff members are not consistent with a luxury brand.
Successful managers are able to articulate the business model(s) of their organizations. Indeed, every employee in the organization should have an understanding of the business model and how what they do every day contributes to that model. The business model is not strategy, which focuses on how the organization will compete in a competitive marketplace. Rather, the business model is a fundamental statement of the underlying viability and sustainability of an organization. Winning against the competition is important, but making money is necessary to play over the long term. Every successful brand has embedded within it a successful business model. Firms compete using different business models or by better execution of the same business model used by competitors. Thorough and systemic analysis of a firm’s business models, and any given firm may have more than one business model depending on its business(es) and the customers it chooses to serve, should be a routine part of a firm’s annual business planning cycle. Such review can identify opportunities for innovation and suggest times when it is time to change one of more elements of the business model, or the whole business model.
Contributed to Branding Strategy Insider by: David Stewart, Emeritus Professor of Marketing and Business Law, Loyola Marymount University, Author, Financial Dimensions Of Marketing Decisions.
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