The term “business model” has only been around since the 1990s, so there’s still some confusion about exactly what it means. In short, a business model defines your business’s plan to make money. You can also use business models to your business’s advantage if you know how they work.
In this article, learn what business models are, why they matter for your business, the most common types of business models, and how to choose the right business model for your business.
What Are Business Models?
Business models detail your business’s plan to make an income. The most basic components of a business model answer the following questions:
- What products or services will your business sell?
- Who do you plan to sell to?
- Which marketing channels will you use for your business?
- How much will it cost to run your business?
- How will your business make a profit?
There are a variety of business models you can use, like a subscription business model, freemium business models, retailer business model, bundling model, leasing model, and more.
Understanding business models is useful for both new businesses and established businesses. If your business has multiple revenue streams, you may utilize several business models.
The Importance of Understanding Business Models for Small Businesses
A business model defines how you will create a profitable business. A successful business model allows a business to fulfill the needs of its customer base with an affordable cost structure and competitive pricing. It’s a good idea for established businesses to evaluate their business model to make sure it still holds up to changes in the business environment and the target market needs.
If you want to bring on investors to your business idea, you’ll need a business model outline that shows exactly how you plan to (or continue to) bring in revenue. A detailed business model reassures investors that you have a solid business plan in place.
Additionally, you can use business models to strengthen the foundation of your business and create “virtuous cycles,” which we define below, that allow your business to streamline its revenue-making process.
What Is the Difference Between Business Strategies and Business Models?
A business model and a business strategy sound very similar, but there is a big difference: A business model outlines how your business will make money, while a business strategy explains how you’ll make more money than the competition.
As an example, let’s say you run a boutique clothing business that offers your customers hand-picked items. That’s your business model. When another business that runs on a similar model opens nearby, your business strategy comes in. You’ll need to decide how you’re going to stand out from the competition — maybe it will be through offering discounts, a loyalty program, or adding new products to your line.
While the decisions you make about your business goals make up your business model, the decisions you use to beat the competition make up your business strategy. Your model is more stable than your strategy. It’s likely not going to change at a moment’s notice, but your business strategy might.
Types of Business Models
There are 19 types of business models that companies use as a baseline or template for creating their business’s revenue plan. Any business model innovation outside of these standard models is considered “disruptive.” This phrase often applies to the tech industry but can be applicable elsewhere.
We highlighted some of the most common business model examples below.
1. Product-based business model
A product-based business sells physical items to solve its customers’ problems. This is a business at the end of the supply chain that provides customers with products directly, like your local retailer or bakery. A product-based business model serves as the middleman between manufacturers and customers.
Entrepreneurs looking to finance a product-based business model plan often turn to business credit cards or small business loans. These financing options can provide capital support to build up inventory, sell a new product, or open a brick and mortar location.
2. Service-based business model
Also called a fee-for-service model, it’s as simple as it sounds: You offer a service that your customers pay for. Your business may charge a per-service fee, an hourly fee, a retainer per month, or commission. A freelancer, barber, or accountant could all fit into this business model, as well as a software as a service (SaaS) business.
Small business owners who need funding for the service-based business can also look into business credit cards or business loans. The amount of funding you’ll need depends on your business — a freelancer will likely need much less capital to operate than a barber, for example.
3. Subscription-based business model
A subscription-based business model allows customers to pay a recurring monthly fee to receive ongoing services or products. Netflix and other streaming services are good examples since they provide on-demand movies for customers who pay a subscription fee, as well as business services like Salesforce or QuickBooks. Subscription boxes that mail physical products are other examples.
Small business funding like lines of credit or term loans can be perfect for providing support for startup costs, raw materials, or key resources for subscription-based businesses.
4. Advertising-based business model
To run an advertising-based business, you’ll form partnerships with advertisers and key partners who pay for the attention your audience gives you. This can come in the form of advertising on social media, in a magazine, or the side of a truck. Affiliate marketing is a kind of advertising-based business model, where a business owner receives commission when one of their audience members purchases it.
Working with small business credit card providers can help businesses working in this revenue model to pay for subscriptions that enhance customer relationships, like LinkedIn or Instagram services that make customer connections easier and faster.
5. Distribution business model
A business running under a distribution model will put manufactured products on the market. They’ll use their distribution channels to dispense products from manufacturers directly to the customer. Amazon is an example of a distributor at its core, although they also have many other revenue streams that they have added over the years that makes them a combination of multiple business models.
Small business loans can provide enough capital to get a distribution business up and running — and flourishing. Financing can give your business a competitive advantage because they may allow you to afford to add to your inventory and grow as needed, as well as offer lower prices to edge out the competition.
6. Marketplace business model
A business using the marketplace business model provides an ecommerce platform for its customers to conduct business on, like eBay or Shopify. Other businesses pay to use this online ecosystem to sell their own goods and get easier access to new customers and a smoother checkout process.
Business credit cards and small business loans can also work well for a marketplace business to pay for startup costs or customer acquisition costs.
7. Franchise-based business model
A franchise-based business recreate their existing business model in additional locations. A franchisee will pay to get access to a proven business model and setup support, and the franchisor will get part of the earnings from the new location. Restaurants and fitness companies often operate under a franchise business model.
Small business loans can provide necessary capital for a franchise business to ramp up operations as needed.
Additional business models include:
- Pay-as-you-go model, like utility companies
- Brokerage model, like real estate companies
- Razor blade model, like razor blade companies that require ongoing purchases of replacement parts)
- Reverse razor blade, like Apple selling a high-price iPhone upfront and then low-cost apps
- Bundling model, like telecommunications companies that sell internet and phone services
How to Choose the Right Business Model for Your Small Business
The best business model for your business depends on your individual needs and goals. First think through who you’re planning to sell to. The model you choose depends largely on your target customer segments. If your target market is moms who are too busy to shop for clothes, opening a retail store might not make sense. Your target customers may prefer a curated subscription box, so you’ll want to re-evaluate your business model.
Next, define the problem you’re trying to solve. What you’re selling is the solution to the problem. This could be a physical product (or products), a service, or a subscription. With the clothing business, the problem you’re trying to solve is that moms don’t have time for self-care. To solve this problem, you could make online shopping an option (under a product-based business model), offer styling services (under a service-based business model), or send out subscription boxes (under a subscription-based business model). While you can combine several business models in one business, each of these options would operate under separate business models.
A business model works if it makes sense for your business’s offering and the customer you’re trying to reach — and it’s profitable. You’ll want to test out the business model you choose and evaluate whether it’s the right fit for you.
Getting financing is often necessary, no matter which business model you choose. One of the best ways to increase your financing options is to establish and build business credit. Learn how to establish business credit in this Nav guide.
Avoid These Common Mistakes When Choosing a Business Model
There are a few big mistakes to avoid when you’re picking a business model. According to the Harvard Business Review, you’ll want to make sure that you aren’t looking at your business and the chosen model in isolation — a lot of your success depends on how it interacts with other companies in the marketplace. Not paying attention to how your business model works against other players in your industry only works if you’re the only one (which is highly unlikely, at least for a long time).
Also, you’ll need to make sure your business model lines up with your company’s goals and reinforces itself. Say you have an affordable motel chain that operates using a franchise business model. Deciding to offer high-end breakfast options or luxury bath products, for example, would eat into your profits.
Instead, you’ll want to offer cost-effective products that fit your business model and create what is called a “virtuous cycle.” A virtuous cycle starts with a business decision (giving clients affordable bath products) that supports your business’s goals (to offer low-cost motel rooms to customers) — and allows you to keep your business’s expenses down. Lower expenses come full circle to allow you to offer lower-priced stays.
Businesses can use these cycles to compete with others in their industry by making their own virtuous cycles stronger, making competitors’ cycles weaker by limiting their growth, or using rivals with different business models to form a symbiotic relationship.
Importance of Understanding and Optimizing Your Business Model
Having a deep understanding of your business model and how it informs your business goals will help you make appropriate decisions moving forward. If a business decision doesn’t flow with your business model, it will become apparent quickly. For example, say you run a barber shop on a fee-for-service business model. If your customers are asking for virtual appointments where you teach them to cut their own hair, you can turn to your business model to help you decide. In this case, an additional does fit under your current business model and may be an easy addition to your offerings.
On the other hand, if you’re considering creating and selling your own hair care products to your customers, you’ll quickly see that that is a different business model altogether. While it can work to have two business models inside of one business (and many companies manage this well), you’ll need to understand that the two are separate types of businesses. Having this knowledge will give you the tools to examine how the two will work together and whether you’re ready to add a second business model or not.
Your business model is just your template — it’s up to you to personalize it. And although you won’t want to change it once a week, your business model isn’t set in stone. If your business fails to become profitable, it might be time to choose a new business model. Maybe you move from selling retail products in store to delivering subscription boxes because your target market prefers that. Or maybe you decide to switch from selling physical goods to selling services because the services provide more revenue.
This article was originally written on March 9, 2023.