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March 20, 2021

What Is Business Modelling?

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‘Business Modelling’ is a somewhat ambiguous term that could be framed in several different ways depending on the type and stage of business you are modelling. While there is no official business modelling process, we look at some of the tools and concepts that help create a better view of what a certain business does (or could) look like.

The below post is a very simplistic, illustrative example of how the topic works conceptually. It is meant for educational purposes and is not specific to any business or brand in-particular.

If we start from the core of what a business model is:

“a business model is defined as the rationale of how an organization creates, delivers and captures value.”

Strategyzer

Then ‘business modelling’ is essentially mapping out the value flows for a business, one that is either currently operational or is expected to be in the future. By mapping out the flows of value within a certain business, you begin to be able to zone in on specific metrics/analytics that help more clearly define strategies.

The Canvas

The Canvas creates a framework to help visualize the ‘Key Components’ of a business model. Starting in the centre of the Canvas with the Value Proposition, you have Customer Channels and Customer Relationships that map towards the key Customer Segments of any company. On the bottom right side of the Canvas is the Revenue Streams. The bottom left side of the Canvas deals with Cost Structure that underpins the business from a very high-level viewpoint. You also have the Key Activities and Key Assets that are linked to the company’s strategy, along with any Partnerships that are formed. These four blocks form the left side of the Canvas and deal with the cost/investment side of the company.

The main benefits of the Canvas are to create a structure that enables shared language among participants and pattern recognition when you start looking at multiple canvases/models together.

Financial Model

‘Financial modelling’ is another area that is tricky to define. Most people associate financial modelling with a set of numbers that outline the future expectations of a certain company which can be used to raise funding. The problem with modelling strictly for this purpose is that the financial model usually ends up being designed to match the story in the pitch deck; it will typically show runway growth and future profitability and fail to highlight the mechanics of the how business model works functionally.

An obvious example is to focus on glossy Income Statement metrics like Revenue growth without an understanding of Gross Margin, Customer Acquisition Costs (CAC), etc. Profitability itself can be a misnomer as most early-stage/high-growth business models should be optimized for Cashflow Metrics (ie. Operating Cashflow/Free Cashflow, etc.) and not purely Profit (EBITDA, Adjusted EBIT, etc.). In the context of business modelling, the financial model should help first to map out the way the business model itself works – through categorization of revenue/cost data into easy-to-analyze buckets – which can then be used to develop strategies to optimize the business model.

Analytics/Metrics

Once we have a Canvas and Financial Model – even rough drafts – a batch of Metrics/Analytics start to surface, of which some will be more important than others. A lot of times these can be hidden by the glossy ‘top-line metrics‘ that we talked about earlier linked to certain elements like sales growth and revenue growth.

The most commonly talked about business model metrics/analytics are usually referred to as ‘Unit Economics‘ and typically refer to ARPU (Average Revenue Per User), CAC (Customer Acquisition Cost), AOV (Average Order Value), etc. But as we have discussed in Loyalty Metrics, example, there are typically certain Power Laws that apply to a business in relation to 80/20 (ie. 80% of the business is driven by 20% of the customers) or repeat buyers (as we see in the Farfetch business model). These types of ‘hidden metrics’ are usually more important, as they can often lead towards simpler strategies to optimize the model. In any case, whatever they end up being, usually 2 -3 Analytics emerge from a sea of data as the most important to help optimize the performance of the business model.

Innovation in ‘Context’

Business modelling helps put ‘innovation’ in a certain context. Some companies may be pre-revenue and want to understand how the business model looks in order to strategize on the best path forward with their team/investors/etc. Other companies already have a business model and are testing some form of innovation and trying to understand the potential impacts across their current business lines. Whatever the situation is, the concept of business modelling helps clarify the key dimensions of the model and stress-test core assumptions.

Overall, business modelling can help businesses – current and future – optimize and adapt with changing market conditions, and create less risk of being caught flat-footed as those conditions change. There is no official ‘business modelling’ process, it usually requires a mix of tools (as shown above) and an analytical approach in order to highlight the key dimensions of a business model.

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