Business Model – What & Why ?

A Business model is essentially a story that elucidates how a business works. According to Swiss business theorist Alexander Osterwalder, a business model describes the rationale of how an organization creates, delivers and captures value. It shows the various components of a business fitting together and working as one coherent system. It answers the questions- Who is the customer? What does the customer value? How can it be delivered at an appropriate cost?

A business model may focus on improving or changing the way things are done, or it may focus on designing a new product for an unmet need. Moreover, it can focus on creating new needs, like American Express did with Traveler’s check. They recognized the value of safety and convenience for all travelers to foreign lands. People did not have to carry cash with themselves, they did not have to worry about changing their money into foreign currency at exchanges. There was no threat of loss or theft either. American Express used its own image to enhance the credibility and acceptance of the traveler’s check. And it was a huge success back then, because it was based on a solid economic background. The customers paid upfront and encashed the checks alter when they traveled. This turned the cycle of debt and risk on its head. The company virtually enjoyed interest free loans. At times the customers did not even encash the checks!

It is vital for businesses, whether new or established giants, to formulate a feasible and profitable business models. But, it is not imperative that a successful business model will continue to be relevant across time and geographical barriers.  It is needless to say how irrelevant the traveler’s check is now. It is a thing of the past. EuroDisney had to pay the price for being complacent when they decided to expand and operate in Europe without taking any effort to grasp the overall emotion of the new market. They ran the amusement parks exactly in the same way it was done in America, hoping to duplicate the profits. They failed. They failed because they assumed the Europeans to have congruent tastes and preferences as the Americans. It took diligence and prudence on their part to make necessary changes in their model before tasting success in Europe.

Business models fail because either the underlying story does not make sense or the numbers simply don’t add up. There were companies like Webvan which attempted to take grocery stores online, but succumbed to the costs of technology, delivery, maintenance and other overheads. Although it was giving the customers the value of convenience, the customers were not willing to pay premium prices for their daily groceries. This company had a short life spanning from 1996 to 2001. Now let us look at Grofers, a hyper local business in India. It was founded in 2013 with similar offerings in terms of products, services and value, but with a radically different functioning (and eventually, fate). Grofers has gone on to become one of the more successful start-ups. It started small in the metro city of Gurgaon. Gurgaon offered a great clientèle for a hyper local business model because its population consists of working couples, unmarried work force and nuclear families with a single earning member. This clientèle is often short of time or is too lazy to go out for buying grocery. Grofers struck a chord and within few months they were a “Hit Model”. They Started from Gurgaon in December’13 and spread to 26 cities by December’15. The key areas in which Grofers proved to better than Webvan were marketing, appropriately incentivizing the sellers/merchants and also delivering goods to customers at prices cheaper than their nearby grocery stores and providing supplies that the local store might have run out of. It would be a failure to not recognize the revenue the company generates from advertisements as well the funding it has received in the few years of its existence. To an investor, it makes more to sense to put money in Grofers now than it would have to put in Webvan back then. The underlying characteristic variable skewing the balance in favor of Grofers is the demography. There has been a paradigm shift in the demographics as well as the work culture in the last decade and a half, particularly in India. Many things need to fall in place at the correct time for a model to work like in the case of Grofers. I believe Webvan was a bit ahead of its time and could not avoid failure due to hasty planning and poor business decision making.

Business modeling has benefitted from the progress in technology. It has become easier to estimate and foresee the risks and returns. It has even made it possible to understand the impacts of contingencies on the profits and revenues with just a few clicks. But the figures are only as good as the inherent assumptions factored in by the business. A business model can ensure success only on paper. But, businesses need to face the reality of competition and it is the job of strategy to deal with it. Strategy establishes the competitive edge which is essential for survival. A well-formulated strategy can pick up any business model, old or new, and gift a money spinner to an organization. The best possible example is WalMart, which adopted the familiar supermarket model. The idea was simple – customers had to give up on personal service and fancy stores for better prices. WalMart decided to penetrate into all kinds of goods and optimize their stores so as to manage the largest number of people possible. The key strategic decision to open shop in the relatively smaller cities is what made WalMart a success story. The competing supermarkets were concentrated in the big metros, usually at a distance of an hour or so from these smaller towns/cities. People had to travel to enjoy access to the large number of products at the best prices. WalMart, by starting its operations in the smaller towns, bridged this gap. It allowed these small town dwellers to have their own supermarket which was of significant value to them. And WalMart did this while facing literally zero competition. The customers need not travel to the cities anymore, thereby giving WalMart a loyal customer base. At the same time the competitors could not enter these markets and expect to generate any profits because of the small size of the customer base; effectively making it a WalMart Territory. It was a masterstroke by WalMart, envisioning and implementing a strategy on a rather orthodox model.

Sometimes it is difficult to demarcate the line between a new business model and a strategy. Dell is a standout example. The company’s decision to sell directly to the customers was a bold decision; it not only eliminated the middlemen, it also brought the company closer to its customers. This was definitely a new business model, but also gave Dell the competitive edge  companies strive for. Selling directly allowed Dell to offer products at better rates and at the same time stay informed about the customer expectations and market trends. This ensured that Dell did not have any risk to bear the steep costs of obsolescence while staying a mile ahead of its competition at any given point. The competitors were rendered helpless, trapped in their own strategies. They could not afford to disrupt their supply chains and alienate the network of their resellers. What is interesting that Dell had found its difficult-to-imitate competitive edge because of its business model, but important strategic decisions regarding the products, target customers as well as the number and location of stores were still out of the scope of the Business Model. They all formed a part of the Strategy.

Strategy and business model have loosely been used interchangeably but what remains true for any business to succeed is a well-defined business model dovetailed with a unique strategy even if the business does not clearly mark the boundaries between the two. A business needs to be clear about its objectives, set realistic goals keeping in mind the resources at hand. In my opinion, businesses need to revisit the basics and plan to engineer an adaptable business model rather than eyeing to create the perfect sustainable model. Only in such a case can businesses achieve functional and competitive efficiencies & ward off threats of becoming obsolete and irrelevant.

Shashank.

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