Chapter 4: Developing an Effective Business Model PDF

Chapter 4 Developing an Effective Business Model Opening prOFile her campus media executing on an established business model and preparing for the future Web: www.hercampus.com Facebook: HerCampus Twitter: @HerCampus I f you’re a female college student and are looking for an enrichin...

Chapter 4 Developing an Effective Business Model Opening prOFile her campus media executing on an established business model and preparing for the future Web: www.hercampus.com Facebook: HerCampus Twitter: @HerCampus I f you’re a female college student and are looking for an enriching experience, you might consider plugging into your college campus’s Her Campus chapter. Her Campus is the number-one online community for college women. Written entirely by 4,000-plus college journalists and supported by a dedicated staff at its Boston headquarters, Her Campus features national content learning ObjeCtives on style, beauty, health, love, life, and career, supplemented by local After studying this chapter you should be content from 250-plus campus chapters across the world. In addi- ready to: tion, Her Campus offers slideshows, videos, memes, gifts, quizzes, giveaways, e-commerce, a daily e-mail newsletter, and social media 1. Describe business models and discuss their importance. communities. It’s like nothing else available for college-aged women. Her Campus was started in 2009 by three Harvard University un- 2. Identify and describe the two general types of business models—standard dergraduates: Stephanie Kaplan, Annie Wang, and Windsor Hanger. and disruptive business models. The women met in 2007 while working on a separate Harvard pub- 3. Explain the components of the Barringer/ lication. In the nearby photo, Stephanie Kaplan is on the left, Annie Ireland Business Model Template that entrepreneurs can use to develop a Wang is in the middle, and Windsor Hanger is on the right. In January business model for their firm. 2009, Kaplan, Wang, and Hanger entered the i3 Innovation Challenge, a business plan competition held on the Harvard campus, propos- ing a national online magazine for college women, with student chapters at colleges and universities across the United States. After the business plan received the Harvard Student Agencies Investment Award, Her Campus was born. The award secured na- tional attention, along with free office space for a period of time. Her Campus, the flagship site of the company, which is formally named Her Campus Media, features a vibrant online magazine, with feature articles targeted toward all aspects of college life and survival. The website is divided into six cat- egories: style, beauty, health, love, life, and career. The content is wholesome and upbeat, and speaks to the daily challenges, concerns, dilemmas, and triumphs that college-aged women experience. In addition to a staff of full-time editors, design- ers, and managers working at the company’s Boston headquarters, Her Campus is represented by students at 250-plus college campuses. These campuses are known as My Campus chapters. Each chapter has a president/editor-in-chief, and a staff of volunteer correspondents who develop feature articles, photos, and other content specific to their particular university. Her Campus also has a team of national con- tributing writers who “pitch” articles to run on the Her Campus national website. The 111 112 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS local chapters compete to reach certain levels of distinction within the Her Campus community. The highest level is the Pink level. To reach the Pink level a local chap- ter has to demonstrate flawless writing and formatting, update their site every day, post several times a day on social media sites, host events, and reach 40 percent of the undergraduate female population on their campus. An example of a local chap- ter, the My Campus chapter at the University of Central florida, is available at www. hercampus.com/ucf. Toward the end of 2014, Her Campus was receiving approxi- mately 3.5 million monthly unique visitors, 15 million monthly page views, and was operating with 20 full-time employees. of paramount importance to Kaplan, Wang, and Hanger from the outset was developing an effective business model for their company. The company’s core com- petency is developing compelling content at a low cost and displaying the content in an attractive and accessible manner. The 4,000-plus local chapter correspondents are all volunteers, who write for Her Campus to obtain experience and hone their journalistic skills rather than make money. The same applies to interns in the company’s Boston headquarters. The company’s mission is crystal clear: to produce, on a daily basis, the “Collegiette’s guide to life.” The word “collegiette” can’t be found in the dictionary, at least not yet. It’s a word made up by the founders of Her Campus to describe the women in their target audience. According to Stephanie Kaplan, a collegiette is “a col- lege girl who is on top of her game—strategically career-minded, distinctly fashionable, socially connected, academically driven, and smartly health-conscious, who endeavors to get the most out of her college experience on every level.” In early 2012, Her Campus received a trademark on the word “collegiette” from the U.S. Patent and Trademark of- fice. Her Campus is now the only company that can use that word in a business context. on the revenue side, Her Campus’s business model focuses on connecting com- panies with college females. The key to making this work is Her Campus’s unparalleled access to college-aged women. Part of their business model is native advertising, or sponsored content. The way sponsored content works is that Her Campus will run an article that is sponsored by a brand and that promotes that brand to its audience. This arrangement allows brands to connect with Her Campus’s audience. Her Campus’s client list includes victoria’s Secret PInK, new Balance, Pinkberry, and many other national brands. Her Campus also generates revenue from other types of advertising and sponsorships, which is often visible on its website and additional platforms. other revenue generators include product sampling and on-campus and event-based mar- keting programs. In regard to expansion, Her Campus is steadily increasing its number of My Campus local chapters. It is also interested in overseas markets. In late 2013, Her Campus acquired HerUni.com, a similar online magazine for college-aged women in England. The acquisition of HerUni.com will strengthen Her Campus’s presence throughout the United Kingdom. The company is also thinking about broadening its audience to include men, including the possibility of a His Campus site. The founders would have to think carefully about how that possibility would affect their current busi- ness model and future prospects. In this chapter, we introduce you to the concept of the business model. A business model is a firm’s plan or recipe for how it creates, delivers, and captures value for its stakeholders.1 Business models are foundational to a firm’s ability to succeed both in the short and long term, especially when it is the first one to introduce a new product or service to customers.2 Dropbox, for example, has what’s referred to as a freemium business model. It offers its customers a free account with a set amount of storage  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 113 space, and makes money by selling premium accounts with more capacity. Dropbox could charge all of its users a monthly fee based on the amount of storage that they use, but that’s not its business model. Its business model is based on the belief that by introducing users to its service through a free account, it will ultimately sign up more paid users. To further illustrate what a business model is, the Savvy Entrepreneurial firm feature focuses on Quirky, an interesting company that helps bring peoples’ inven- tions to life. The feature illustrates how Quirky creates, delivers, and captures value for its stakeholder. t he proper time to determine a company’s business model is following the initial validation of the business idea and prior to fleshing out the opera- tional details of the firm.3 This sequence, which is depicted in Figure 4.1, nicely parallels the chapters in the book. Chapter 1 dealt with the decision to become an entrepreneur. Chapters 2–3 considered the initial validation of the business idea. This chapter deals with determining a business model, while Chapters 5–15 deal with the topics needed to implement a firm’s business model and grow the firm. In this chapter we’ll first discuss business models and their importance. We then introduce and discuss a template for developing a business model. The template, called the Barringer/Ireland Business Model Template, consists of 4 categories and 12 items that make up a firm’s business model. The tem- plate, which can be completed on an 8 ½ by 11 sheet of paper or blown up and placed on the wall, provides a nice visual mechanism to think through and display the elements of a firm’s business model. A critical factor is that similar to feasibility analysis, a firm’s business model should not be completed in isolation. The founders of a firm should “get out of the building” and talk to potential customers as a firm’s business model takes shape.4 This is a facet of developing an effective business model that we stress throughout the chapter. business Models and their importance As stated above, a firm’s business model is its plan or recipe for how it creates, learning ObjeCtive delivers, and captures value for its stakeholders. Glance ahead to Figure 4.2, 1. Describe business the Barringer/Ireland Business Model Template. As you can see by looking at models and discuss their the template, a firm’s business model represents the core aspects of its busi- importance. ness. It also describes how the core aspects fit together and support one an- other. For example, three important elements of a firm’s business model are its target market, its basis for differentiation, and its key assets. In Her Campus’s case, its target market is college-aged females, it differentiates itself by focus- ing on six topics that college-aged females care about (style, beauty, health, love, life, and career), and its key assets include 4,000-plus college females volunteering in Her Campus chapters across the country writing articles that they believe other college females will be interested in. This example illustrates a nicely designed business model, at least as it pertains to the three elements mentioned above. Each element supports the others. It’s also a business model that would be difficult to copy. It would take a tremendous effort on the part of a competitor to match Her Campus’s network of 4,000-plus volunteers on col- lege campuses. Figure 4.1 Fleshing out the Proper Time to Initial validation of the Preparation of the operational details of business idea business model the company Determine a Company’s Business Model 114 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS Savvy EntrEprEnEurial Firm Quirky: How One Company Creates, Delivers, and Captures Value for Its Stakeholders Web: www.quirky.com; Facebook: Quirky; Twitter: @Quirky Q uirky is an interesting company. It was conceived by Ben Kauffman, a young entrepreneur who launched his first company when he was 18. Kauffman’s first company, Mophie, designed accessories for Apple prod- ucts. In 2006, Mophie won Best in Show at Macworld vetted by the Quirky community. The most prom- ising ideas are fashioned into products that are sold. By creating this process, Quirky has brought down the barriers that prevent most people from seeing their ideas realized. Quirky has just what a for a modular case accessory system for the iPod nano. good idea needs—product designers, prototype The next year at the same conference, Kaufman and his specialists, manufacturing capabilities, and rela- company did an unusual thing. Instead of bringing their tionships with retailers to get products on store hottest new products to showcase, they brought next shelves. to nothing. Instead, they set up a booth made out of Quirky captures value for its stakeholders via the two-by-fours, and handed out scratch pads to 30,000 profits that it realizes on the products that are people, asking the Macworld community for new product sold. for every product that is sold, Quirky takes suggestions. The sketch that got the most attention, and 60 percent of the revenue and returns 40 per- was repeatedly exposed to the community for improve- cent to the original inventor and the community ments, was a case/bottle opener for the iPod Shuffle. The members (called Influencers) that help shape the product was built, and with this amazing story behind it, idea. To minimize risk, Quirky only fully develops became a hit, selling in 28 countries worldwide. products that have a certain level of pre-sales. This and similar experiences became the inspiration Quirky has relationships with a growing number for Quirky, which was launched in 2009. In a nutshell, of retailers to maximize revenue from the best- Quirky is an invention company that allows people to sub- selling items. mit product ideas (mostly household items and kitchen The attractiveness of Quirky’s business model is that gadgets) that are then vetted by the Quirky community. as the company grows, it can expand into new product The best ideas are selected for prototype development categories. Quirky is also a business that would be difficult and possible sale. It’s become quite a success. over to copy. It has raised over $91 million in venture capital and 550,000 people are now part of the Quirky “community,” as noted above, has over 550,000 people in its network. It and participate in pitching, refining, or voting on product has also built relationships with organizations up and down ideas. The process has created several hit products, the manufacturing and retail supply chains. including Pivot Power (a flexible power strip that bends to fit large three-prong plugs in each outlet) and Crates (modular plastic milk crates used as shelving). Quirky’s products are sold via its website and in big-box stores Questions for Critical Thinking such as Target and Home Depot. The system is a win- 1. Do you think Quirky’s basic business model is sound win for everyone involved. The inventors and community and fair? If you could suggest any changes, what members who help with the product get a cut of the profit. would they be? In 2012, Quirky launched 121 new products—all invented 2. To what degree does Quirky’s business reflect the by ordinary people. attributes of a sound business idea as described in Quirky accomplishes what it does via its business Chapter 2? model. As we noted above, a business model is a firm’s 3. In what other product areas would Quirky’s business plan or recipe for how it creates, delivers, and captures model work the best? value for its stakeholders. Here is how Quirky accom- 4. Think of the challenges in your own life that might plishes each of these key elements: represent a product idea for Quirky. If you don’t think Quirky creates value by allowing ordinary people of something right away, don’t give up. All of us to submit product ideas. ordinary people often encounter problems and challenges in our everyday have good product ideas, but don’t have the lives that might represent the basis of a promising wherewithal to start a company. As a result, the idea. Be prepared to describe to others one of the ideas generally never come to fruition. now, challenges or problems you encounter and how a because of Quirky, anyone with an idea for a solution to the problem could be fashioned into a household product or a kitchen gadget has a product idea to submit to Quirky. shot at seeing the idea become a reality. Source: “How Quirky Uses Technology to Disrupt Manufacturing,” Quirky delivers value by providing an easy-to- forbes, november 1, 2013; “Quirky,” Wikipedia, accessed June 5, navigate process for ideas to be submitted and 2014; Quirky website, www.quirky.com, accessed June 5, 2014.  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 115 general Categories of business Models There are two general categories of business models: standard business models learning ObjeCtive and disruptive business models.5 Next, we provide details about each model. 2. Identify and describe the two general types of busi- ness models—standard Standard business models and disruptive business The first category is standard business models. This type of model is used com- models monly by existing firms as well as by those launching an entrepreneurial ven- ture. Standard business models depict existing plans or recipes firms can use to determine how they will create, deliver, and capture value for their stakehold- ers. There are a number of standard or common business models. An abbrevi- ated list is shown in Table 4.1. Most of the standard business models, with the exception of the freemium model, have been in place for some time. In fact, many of the business models utilized by online firms were originally developed by of- fline firms, and simply transferred to the Internet. For example, Amazon did not invent a new business model. It took the mail order business model, pioneered years ago by Sears Roebuck and Company, and moved it online. Similarly, eBay did not invent the auction business model—that has been in existence for cen- turies. It moved the auction format online. What Amazon.com and eBay did do, however, which is common among successful start-ups, is adopt a standard business model and build upon it in one or more meaningful ways to produce a new way of creating value. Birchbox, for example, adopted the subscription busi- ness model and then built upon it in novel ways. This firm provides its subscrib- ers a monthly assortment of cosmetic and skin care samples in hopes of enticing them to buy full-sized versions of the same products. Its cost structure is low because it operates via the Internet and many of the samples that it distributes are provided for free by companies that want to get their products in front of Birchbox’s unique clientele. The other elements of Birchbox’s business model are supportive of its basic premise. The multifaceted “value” that Birchbox’s business model creates is that it presents products to women that they wouldn’t have oth- erwise tried. Through this model, Birchbox creates two revenue streams for itself (i.e., the subscription service and online sales), and it creates additional sales for the companies that provide the samples that Birchbox disseminates to its sub- scribers. You can read more about Birchbox in Case 6.1. It is important to understand that there is no perfect business model.6 Each of the standard models has inherent strengths and weaknesses. For example, the strength of the subscription business model is recurring revenue. Birchbox has approximately 400,000 subscribers who pay $10 per month. As a result, if Birchbox maintains its subscriber base, it would know that it had a minimum of $4 million in revenue each month. The disadvantage of the subscription business model is “churn.” Churn refers to the number of subscribers that a subscription-based business loses each month. If Birchbox losses 10 percent of its subscribers each month, it will need to recruit 40,000 new subscribers each month just to stay even. This is why companies that feature a subscription- based business model normally offer a high level of customer service. They want to retain as high a percentage of their subscribers as they can to lower churn and avoid the expenses involved with replacing existing customers. It’s important to note that a firm’s business model takes it beyond its own boundaries. Her Campus’s business model, for example, is based on the idea that female college students will form My Campus chapters and voluntarily contribute content to their chapter’s website and the main Her Campus portal. The trick to getting something like this to work is to provide sufficient incentive for partners to participate. In Her Campus’s case, the local My Campus mem- bers contribute because they want to obtain experience, hone their journalistic skills, and build their résumés. Apparently, Her Campus is providing these indi- viduals a rich enough experience that it’s worth their time to participate. Many 116 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS Table 4.1 standard business Models examples of entrepreneurial firms (or types of firm) name description utilizing this model Advertising Business Business model based on providing advertisers access to highly google, facebook, YouTube Model targeted customer niches. Auction Business Currently synonymous with eBay, the auction business model has eBay, uBid.com Model been around since 500 bc. The idea is to provide a platform for individuals and businesses to sell items in an auction format. Bricks and Clicks A business model by which a company integrates both offline Apple, Barnes & Business Model (bricks) and online (clicks) presences. noble, J. Crew franchise Business A business model in which a firm that has a successful product 24 Hour fitness, Panera Model or service (franchisor) licenses its trademark and method of doing Bread, School of Rock business to other businesses (franchisees). freemium Business A business model in which a firm provides a basic version of its Dropbox, Evernote, Pandora Model service for free, and makes money by selling a premium version of the service. low-Cost Business A well-established business model that relies on driving down costs Southwest Airlines, Warby Model and making money by servicing a large number of customers. Parker Manufacturer/Retailer A business model in which a manufacturer both produces and Apple, fitbit, Tesla Motors Business Model sells (online, offline, or both) a product. Peer-to-Peer A model in which a business acts as a matchmaker between Airbnb, getaround, Business Model individuals with a service to offer and others who want the service. Task Rabbit Razor and Blades This model involves the sales of dependent goods for different game Consoles and games, Business Model prices—one good (a razor) is sold at a discount, with the Mobile Phones and Air Time, dependent good (blades) sold at a considerably higher margin. Printers and Ink Cartridges Subscription A business model where the customer pays a monthly, quarterly, Birchbox, Blue Apron, netflix Business Model or yearly subscription fee to have access to a product or service. Traditional Retailer A business model calling for a firm to sell its products or services, Amazon, Whole foods Business Model made by others, directly to consumers at a markup from the original Markets, Zappos price. Can be sold online or offline. companies feature the participation of others as an integral part of their busi- ness models. An example is Apple, and in particular the Apple App Store. As of December 2013, more than 1 million apps were available through the Apple App Store, created by over 262,000 publishers. About 140 new apps are added each day. It’s a win-win situation for both Apple and the developers. The developers get access to a platform to sell their apps, while Apple shares in the revenue that’s generated. Positive scenarios like this often allow businesses to not only strengthen but to expand their business models. As a result of the success of its app store, Apple launched iAd, a platform that allows app developers to sell ad- vertising on the apps they make available via the Apple App Store. Apple shares in the revenue generated by the advertising. Regardless of the business model a start-up is rolling out, one thing that new companies should guard themselves against is thinking that one particu- lar business model is a “homerun” regardless of circumstances.7 In this sense, the issues discussed in Chapters 1–3 still apply, meaning, for example, that the strength of the opportunity must be assessed and the feasibility of the idea must be validated. The What Went Wrong feature nearby draws attention to  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 117 What WEnt Wrong? Peer-to-Peer Business Models: Good for Some, Not So Good for Others p eer-to-Peer business models are hot. Airbnb, Uber, and lyft, three of the most successful firms in the peer-to-peer business model space, are growing and are worth hundreds of millions of dollars. Peer-to- peer businesses act as matchmaker between individuals Ridejoy was a carpooling service that focused on connecting people that wanted to share rides for long distances, such as los Angeles to San francisco. lyft and Uber, mentioned earlier, focus on short rides. Ridejoy experiened early success. During its first year, 2011, its with a service to offer and others who want the service. user base grew about 30 percent a month, with more Airbnb, for example, matches people who are look- than 25,000 drivers signed up and an estimated 10,000 ing for a place to stay (for a day or two or longer) with rides completed. But it didn’t grow fast enough to satisfy people who have an extra room that they’re willing to its investors. In addition, it had competition from free rent. Relying to some degree on smartphone technol- alternatives, such as carpooling forums on college web- ogy’s capabilities, lyft and Uber match people who need sites. Also, some riders started cutting Ridejoy out once a ride with people who are willing to provide rides. The they got to know one another. Instead of paying Ridejoy success of Airbnb, Uber, lyft, and others has captured its 10 percent transaction fee for a trip from Portland to the attention of investors, who are generally bullish on San francisco, for example, the car owner and riders the peer-to-peer concept. Sam Altman, president of Y would just exchange cash among each other instead Combinator, a start-up accelerator, was quoted in a Wall of paying by credit card on Ridejoy’s website or mobile Street Journal article saying “We’re bullish on the sharing app. Ridejoy shut down in the summer of 2013, returning economy (a catchall term for peer-to-peer businesses), about half of its funding to its investors. and we’ll definitely make more investment in it.” neighborrow.com would let people list household Despite the promise of the peer-to-peer business items for rent, such as vacuum cleaners, cameras, model, several high-profile peer-to-peer business have tools, and electronics. The idea was that if you only failed. The failures include BlackJet, a service that use a power saw or a high-end camera once or twice matched the owners of private jets with people who a year, why buy one if your next-door neighbor has wanted a seat on a private jet for a trip, Ridejoy, a car- exactly what you need and would be willing to rent it pooling service, and neighborrow.com, a service that to you for a modest fee. The site got plently of public- allowed people to list household items for rent, such ity when it launched, including a story in USA today as vacuum cleaners, tools, and food mixers. So, what and a spot on nBC’s early morning program, the today went wrong? on the surface, BlackJet, Ridejoy, and Show. It also had thousands of people sign up and neighborrow.com seem very similar to Airbnb, Uber, and list their items. The problem: very few people actually lyft in that they matched people wanting a particular used the service. What the company eventually found service with someone willing to offer it. is that people don’t like borrowing things. In addition, BlackJet’s basic premise was that once a person borrowing an item such as a power drill isn’t typically joined the service, s/he could book a seat on a private an urgent need, so people didn’t tend to think “oh, I jet within minutes for a ride to a desired location. The could get that through neighborrow.com.” Although idea was that BlackJet would sign up a large number they may have read about the company in USA today of owners of private jets, who would let BlackJet know or seen it featured on television, they soon forgot about when they were making a trip. If a seat was open on the the service. neighborrow.com folded in 2011, after a jet, it would be made available to a BlackJet member five-year run. who was looking for a ride to the same destination. for those seeking rides, BlackJet charged a $2,500 yearly membership fee and up to $4,000 per ride. As it turned Questions for Critical Thinking out, there just weren’t enough people willing to pay that stiff of a fee for the service. In addition, a private jet ride 1. Prior to launching their firms, how could BlackJet, isn’t something people need frequently, so BlackJet Ridejoy, and neighborrow.com have better wasn’t an option that was foremost on people’s minds. anticipated the issues that ultimately caused them “If you have to reacquire the customer every six months, to fail? they’ll forget you,” said Howard Morgan, co-founder of 2. In regard to putting together an effective business first Round Capital, in the same Wall Street Journal ar- model, what can other peer-to-peer business model ticle mentioned above. further compounding BlackJet’s start-ups learn from the failures of BlackJet, Ridejoy, challenge, there are readily available substitutes for and neighborrow.com? BlackJet’s service. Anyone can book a first-class seat on 3. Spend some time looking at lyft, one of the successful an airline and ride in relative luxury, without having to pay peer-to-peer business model companies mentioned in a yearly membership fee. BlackJet closed in late 2013, this feature. Why do you think lyft has been successful after only about a year in service. while BlackJet, Ridejoy, and neighborrow.com failed? (continued) 118 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS 4. What role do you think the industry that a start-up Halt,” valleyWag, posted on november 20, 2013, available at http:// is in plays in its suceess or failure as a peer-to-peer valleywag.gawker.com/jay-z-and-ashton-kutcher-backed-uber-for- business? Are some industries more receptive to peer- planes-grind-1467083423, accessed on May 31, 2014; Ridejoy (the to-peer business model start-ups than others? Explain blog), posted on December 16, 2013, available at http://blog.ridejoy. com/from-carpool-to-deadpool-ridejoys-startup-journey/, accessed your answers. on May 31, 2014; D. Kander, “lessons from failure: Borrowing Tools Sources: S. needleman and A. loten, “Startups Want to Be the from Your neighbors,” Entrepreneurship.org, available at http://www. next Airbnb, Uber,” Wall Street Journal, May 8, 2014, B4; n. Tiku, entrepreneurship.org/resource-center/lessons-from-failure-borrowing- “JayZ and Ashton Kutcher-Backed ‘Uber for Planes’ grinds to a tools-from-your-neighbors.aspx, accessed on May 31, 2014. this point. Even though the peer-to-peer business model is currently hot, with homeruns such as Airbnb and Uber, utilizing the peer-to-peer business model is not sufficient to guarantee firm success. disruptive business models The second category is disruptive business models. Disruptive business models, which are rare, are ones that do not fit the profile of a standard busi- ness model, and are impactful enough that they disrupt or change the way business is conducted in an industry or an important niche within an indus- try.8 In Table 4.2, we describe actual disruptive business models that were used by four different companies. There are three types of disruptive business models. The first type is called new market disruption. A new market disruption addresses a market that previously wasn’t served. An example is Google and its AdWords program. AdWords allows an advertiser to buy keywords on Google’s home page, which triggers text-based ads to the side of (and sometimes above) the search results when the keyword is used. So, if you type the words “organic snacks” into the Google search bar, you will see ads paid for by companies that have organic snacks to sell. The ads are usually paid for on a pay-per-click basis. The cost of keywords varies depending on the popularity of the word. Prior to the ad- vent of AdWords, online advertising was cost prohibitive for small businesses. At one time Yahoo, for example, required advertisers to spend at least $5,000 creating a compelling banner ad and $10,000 for a minimum ad buy. AdWords changed that. Its customers could set up a budget and spend as little as $1 per day (depending on the keywords that they purchased). Thus, AdWords was a new market-disruptive business model in that it provided a way for small busi- nesses, in large numbers, to advertise online. The second type of disruptive business model is referred to as a low-end market disruption. This is a type of disruption that was elegantly written about by Harvard professor Clayton Christensen in the book The Innovator’s Dilemma.9 Low-end disruption is possible when the firms in an industry continue to improve products or services to the point where they are actually better than a sizable portion of their clientele needs or desires. This “performance oversupply” creates a vacuum that provides an opportunity for simple, typically low-cost business models to exist. Examples here include Southwest Airlines in the United States and Ryanair in Europe. Southwest created its point-to-point, low-cost, no-frills business model as an alternative to higher-end service offerings provided by leg- acy carriers such as United and American. By actually offering what some would conclude is inferior service relative to its competitors, Southwest was able to at- tract a large clientele that still wanted a safe and comfortable ride, but were will- ing to trade off amenities for a lower fare. Low-end disruptive business models are also introduced to offer a simpler, cheaper, or more convenient way to perform an everyday task. If a start-up goes this route, the advantages must be compelling and the company must strike a nerve for disruption to take place. An example of  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 119 Table 4.2 Four Disruptive business Models Standard business model company disruptive business model and description that Was disrupted Dell Direct-to-consumer computer sales model, which allowed Computers that were assembled, consumers to customize their computers shipped to a store, and then sat on shelves until someone bought them. Introduced the notion of buying a computer first over the no customization was possible phone and then via the Web. The customer would configure because the computer was assembled the computer and pay for it before the computer was before the customer bought it. assembled. Delivery via UPS or fedEx. google AdWords (online advertising product) Traditional banner advertising, provided by companies such as Introduced text advertising, which appears to the right or the top Yahoo. Some services required of organic search results, that when clicked takes the searcher a minimum $10,000 ad buy for a to an advertiser’s website or landing page. The text ads could be company to advertise on the Internet. bought for as little at $1. google’s initial customers were small businesses who couldn’t afford Yahoo’s service. Salesforce.com SaaS (Software as a Service) provider of customer Traditional installed CRM software, relationships management (CRM) software which required large licensing fees, provided by vendors such as Siebel first company to offer CRM software as a SaaS product, Systems and PeopleSoft making CRM affordable to small companies for the first time. By moving CRM to the cloud, it also enabled salespeople to access their CRM service anywhere they had an Internet connection. Uber Quickly connects riders with the owners of private cars local taxis and town-car services who are willing to provide rides first company to provide riders with an app that connects them with the owners of private cars who are willing to provide rides. Advantages include: cleaner cars, avoiding the frustration of trying to hail a cab, direct billing via Uber so no money changes hands between the passenger and driver, and Uber knows the location of the nearest driver so pickup time is often reduced. a firm that’s pulled this off is Uber, a 2009 start-up that connects people needing a ride with the owners of private cars willing to provide rides. Uber, which is the subject of Case 14.1, provides a compelling set of features—cars are ordered by sending a text message or via an app, customers can track their reserved car’s location, payment is made through the app so no cash trades hands between the passenger and the driver, and Uber maintains strict quality standards for the cars and drivers that participate in its service. Uber not only offers a cheaper and more convenient way to perform an everyday task (i.e., getting a ride), but has also struck a nerve.10 The taxi industry scores low on most measures of customer satisfaction, so consumers were eager to try something new. Uber also appeals to technologically savvy people, who see a big advantage in using an app to order a ride as opposed to the often frustrating process of hailing a cab. the barringer/ireland business learning ObjeCtive 3. Explain the components Model template of the Barringer/Ireland Business Model Template Although not everyone agrees precisely on the components of a business that entrepreneurs can model, many agree that a successful business model has a common set of at- use to develop a business tributes. These attributes are often laid out in a visual framework or template model for their firm. 120 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS Many entrepreneurs enlarge their business model templates and place them on a whiteboard. This practice provides a means to step back and look at how all the parts of a prospective business model fit together. Helen King/Bridge/Corbis so it is easy to see the individual parts and their interrelationships. One widely- used framework is the Business Model Canvas, popularized by Alexander Osterwalder and Yves Pigneur in their book, Business Model Generation.11 The Business Model Canvas consists of nine basic parts that show the logic of how a firm intends to create, deliver, and capture value for its stakeholders. You can view the Business Model Canvas via a simple Google search. The business model framework used here, the Barringer/Ireland Business Model Template, is shown in Figure 4.2. It is slightly more comprehensive than the Business Model Canvas in that it consists of 4 major categories and 12 individual parts. The 12 parts make up a firm’s business model. The job of the entrepreneur, or team of entrepreneurs, is to configure their firm’s business model in a manner that produces a viable and exciting business. The Barringer/Ireland Business Model Template is a tool that allows an entrepreneur to describe, project, revise, and pivot a business model until all 12 parts are decided upon. Appendix 4.1 contains an expanded version of the Barringer/Ireland Template shown here. The 12 parts are spread out, which provides space for ideas to be recorded, scratched out, and recorded again as ideas morph and change. Feel free to copy and use the template to help formulate the business model for an individual firm. Next, we discuss each of the 4 categories and the 12 individual elements of a firm’s business model. We will refer frequently to Figure 4.2 throughout the discussion. core Strategy The first component of a business model is core strategy. A core strategy describes how the firm plans to compete relative to its competitors.12 The pri- mary elements of core strategy are: business mission, basis of differentiation, target market, and product/market scope.  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 121 Core Strategy Resources Business Mission Basis of Differentiation Core Competency Key Assets Target Market Product/Market Scope Financials Operations Revenue Streams Product (or service) Channels Production Cost Structure Financing/Funding Key Partners Figure 4.2 Barringer/Ireland Business Model Template business Mission A business’s mission or mission statement describes why it exists and what its business model is supposed to accomplish.13 If © 2014 Bruce R. Barringer carefully written and used properly, a mission statement can articulate a busi- and R. Duane Ireland ness’s overarching priorities and act as its financial and moral compass. A firm’s mission is the first box that should be completed in the business model template. A well-written mission statement is something that a business can continually refer back to as it makes important decisions in other elements of its business model. At a 50,000-foot level, a mission statement indicates how a firm intends to create value for stakeholders. For example, Zynga’s mission is “Connecting the world through games.” Zynga is a producer of social games, such as FarmVille and Texas HoldEm Poker, which can be played through its website and social networking platforms such as Facebook and Google+. Although Zynga’s mission statement is short and to the point, it provides direction for how the other elements of its business model should be configured. The company will focus on games, as opposed to other business pursuits, and its games will be social, meaning that they will be designed to be played with other people. The remaining 11 parts of Zynga’s business model should sup- port these basic premises. 122 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS There are several rules of thumb for writing mission statements. A business’s mission statement should: Define its “reason for being” Describe what makes the company different Be risky and challenging but achievable Use a tone that represents the company’s culture and values Convey passion and stick in the mind of the reader Be honest and not claim to be something that the company “isn’t” basis of Differentiation It’s important that a business clearly articulate the points that differentiate its product or service from competitors.14 This is akin to what some authors refer to as a company’s value proposition. A company’s basis of differentiation is what causes consumers to pick one company’s products over another’s.15 It is what solves a problem or satisfies a customer need. When completing the basis for differentiation portion of the Barringer/ Ireland Business Model Template, it’s best to limit the description to two to three points. Also, make sure that the value of the points is easy to see and understand. For example, ZUCA (www.zuca.com) is a backpack on rollers. It was designed by Laura Udall as an alternative to traditional backpacks when her fourth-grade daughter complained daily that her back hurt from carrying her backpack. The ZUCA has two distinct points of differentiation: It relieves back pain by putting backpacks on rollers and it is sturdy enough for either a child or adult to sit on. The company’s website frequently features photos of kids sitting on the ZUCA seat, which anyone could imagine might be handy for kids waiting for the school bus. These are points of differentiation that are easy to grasp and remember. They are the reasons that some parents will choose ZUCA’s product and solution over others. Making certain that your points of differentiation refer to benefits rather than features is another important point to remember when determining a firm’s basis of differentiation. Points of differentiation that focus on features, such as the technical merits of a product, are less compelling than those that focus on benefits, which is what a product can do. For example, when Laura Udall introduced the ZUCA, she could have focused on the features of the product and listed its points of differentiation as follows: (1) is pulled like a suitcase rather than worn on the back, (2) includes a sturdy aluminum frame, and (3) is available in six colors. While features are nice, they typically don’t entice someone to buy a product. A better approach for Udall would have been to focus on the benefits of the product: (1) relieves back pain by putting back- packs on rollers, (2) is sturdy enough for either an adult or child to sit on, and (3) strikes the ideal balance between functionality and “cool” for kids. This set of points focuses on benefits. It tells parents how buying the product will en- hance their son or daughter’s life. Target Market The identification of the target market in which the firm will compete is extremely important.16 As explained in Chapter 3, a target market is a place within a larger market segment that represents a narrower group of customers with similar interests.17 Most new businesses do not start by sell- ing to broad markets. Instead, most start by identifying an emerging or under- served niche within a larger market.18 A firm’s target market should be made explicit on the business model template. Her Campus’s target market is active college females. Zynga’s tar- get market is online game enthusiasts. A target market can be based on any relevant variable, as long as it identifies for a firm the group of like-minded customers that it will try to appeal to. For example, Hayley Barna and Katia  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 123 Beauchamp, the founders of Birchbox, wrote the following about their com- pany’s target market: From the start, we’ve always said that our target market isn’t a specific demo- graphic, but instead a psychographic—we believe that Birchbox appeals to women of all ages and backgrounds as long as they are excited to try new things and learn through discovery.19 This type of awareness of a firm’s intended market, and the people who are the most likely to respond positively to a firm’s product or service, is helpful in build- ing out all the elements of a firm’s business model. For example, targeting women of all ages and backgrounds who are excited to try new things and learn through discovery requires a certain set of core competencies (we define core competen- cies in the next section). It requires identifying and hiring people who have the ability to build anticipation and can locate partners and suppliers that have ex- citing new products that appeal to all age groups. If Barna and Beauchamp had instead identified Birchbox’s target market as females ages 16–31, and left the “try new things and learn through discovery” part out, a different set of core com- petencies may have been needed for Birchbox’s overall business model to work. The same philosophy applies across the business model template. The target market a firm selects affects everything it does, from the key assets it acquires to the financing or funding it will need to the partnerships it forms. Product/Market Scope The fourth element of core strategy is product/ market scope. A company’s product/market scope defines the products and markets on which it will concentrate. Most firms start narrow and pursue adja- cent product and market opportunities as the company grows and becomes finan- cially secure. As explained earlier, new firms typically do not have the resources to produce multiple products and pursue multiple markets simultaneously. An example is Dropbox, the online data storage company profiled in Case 2.1. When Dropbox was pitching its business idea, a challenge it had was that it was solving a problem that most people didn’t know they had. There were ways for people to transfer files from one device to another, such as USB memory sticks, e-mailing files to yourself, and so forth. Dropbox’s solution was much more elegant. Its service allows users to create a special folder on each of their devices, and sync and store data across devices. Dropbox completely solved the problem of working on a file on one device, such as an office com- puter, and then not having it available on another device, such as a laptop at home. When Dropbox launched in 2008, it had a single product—its online data storage service. The initial market it pursued was tech-savvy people in the Silicon Valley. Since then, Dropbox’s market has expanded to all computer and Internet users; the firm now has 200 million customers. But for the first five years of its existence, it stuck to its initial product, preferring to continually im- prove the quality of its online data storage service rather than developing new services. It wasn’t until 2013 that Dropbox added a second product through the acquisition of Mailbox, an e-mail processing service for mobile devices. Recently, the firm announced a third product, Carousel, which will be a digital gallery that will allow users to share their entire life’s memories. So in terms of product/market scope, Dropbox has progressed as follows: Launch—Single product/Silicon Valley tech-savvy users 1-2 years into existence—Single product/Growing number of Silicon Valley tech-savvy users and people they told about the service 3-4 years into existence—Single product/All computer and Internet users 5 years into existence—Two products/All computer and Internet users 6 years into existence—Three products/All computer and Internet users 124 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS This example illustrates a well-thought-out and executed expansion of product/ market scope. In completing the Barringer/Ireland Business Model Template, a company should be very clear about its initial product/market scope and project 3-5 years in the future in terms of anticipated expansion. A bullet-point format, as shown for Dropbox above, is acceptable. Similar to all aspects of a company’s business model, its product/market scope will affect other elements of the model. resources The second component of a business model is resources. Resources are the inputs a firm uses to produce, sell, distribute, and service a product or ser- vice.20 At a basic level, a firm must have a sufficient amount of resources to enable its business model to work.21 For example, a firm may need a patent (i.e., a key asset) to protect its basis of differentiation. Similarly, a business may need expertise in certain areas (i.e., core competencies) to understand the needs of its target market. At a deeper level a firm’s most important resources, both tangible and intangible, must be both difficult to imitate and hard to find a substitute for in order for the company’s business model to be competitive over the long term. A tangible resource that fits this criterion is Her Campus’s network of 4,000-plus volunteers. As mentioned earlier, it would take a tre- mendous effort for a competitor to amass a similar number of volunteers. In addition, there is no practical substitute for the work that 4,000-plus volun- teers can do. An example of an intangible resource that fits the criterion is Zappos’s reputation for customer service. Zappos is consistently viewed very favorably for its ability to deliver a high level of customer service that is both difficult to imitate and hard to find a substitute for. Resources are developed and accumulated over a period of time.22 As a result, when completing the Barringer/Ireland Business Plan Template, the current resources a company possesses should be the resources that are noted, but aspirational resources should be kept in mind. For example, it took time for Her Campus to recruit 4,000-plus volunteers. The company may have had 100 volunteers if and when it completed its first business model template. As a result, the proper notation under the Key Assets por- tion of the Barringer/Ireland Business Model Template would have been “100 volunteers” (with the goal of adding 100 volunteers a month) or whatever the exact number might have been. Core Competencies A core competency is a specific factor or capabil- ity that supports a firm’s business model and sets it apart from its rivals.23 A core competency can take on various forms, such as technical know-how, an efficient process, a trusting relationship with customers, expertise in product design, and so forth. It may also include factors such as passion for a business idea and a high level of employee morale. A firm’s core competencies largely determine what it can do. For example, many firms that sell physical prod- ucts do not do their own manufacturing because manufacturing is not a core competency. Instead, their core competencies may be in areas such as product design and marketing. The key idea is that to be competitive a business must be particularly good at certain things, and those certain things must be sup- portive of all elements of its business model. For example, Netflix is particu- larly good at supply chain management, which was essential during the years that Netflix’s business model was geared primarily towards delivering DVDs to customers via the mail. Without a core competency in supply chain manage- ment, Netflix’s entire business model would not have worked. Most start-ups will list two to three core competencies on the business model template. Consistent with the information provided above, a core compe- tency is compelling if it not only supports a firm’s initiatives, but is also difficult  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 125 Start-ups vary in terms of their core competencies. Here, two members of a start-up team are design- ing a new product. The startup’s core competency is product design. Monkey Business Images/Shutterstock to imitate and substitute. Few start-ups have core competencies in more than two to three areas. For example, Her Campus has three core competencies: Creating content of interest to active college-aged females Recruiting and managing a volunteer network Connecting active college-aged females with major brands Similar to the Netflix and supply chain management example, Her Campus’s entire business model would be untenable absent these three core competen- cies. In Her Campus’s case, an added advantage is that its core competencies are, at varying levels, difficult to imitate and hard to find substitutes for. Key assets Key assets are the assets that a firm owns that enable its business model to work.24 The assets can be physical, financial, intellectual, or human. Physical assets include physical space, equipment, vehicles, and distribution networks. Intellectual assets include resources such as patents, trademarks, copyrights, and trade secrets, along with a company’s brand and its reputation. Financial assets include cash, lines of credit, and commitments from investors. Human assets include a company’s founder or founders, its key employees, and its advisors. Firms vary regarding the key assets they prioritize and accumulate. All companies require financial assets to varying degrees. Retailers such as Whole Foods Markets and Amazon rely heavily on physical assets—Whole Foods because of its stores and Amazon because of its warehouses and distribu- tion network. Companies such as Uber rely almost exclusively on intellectual assets. Uber does not employ the drivers that provide its customers rides or own the cars they ride in. It simply provides a technology-based platform that connects people wanting rides with people willing to provide them. As a result, Uber’s key assets are an app, its brand, and the relationships it has with its customers, drivers, and the communities in which it operates. Many compa- nies rely heavily on human assets. The success of Zynga’s business model, for example, relies heavily on its ability to attract and retain a group of game 126 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS producers and programmers who are creative enough and proficient enough to continually come up with online games that are engaging and social. Obviously, different key resources are needed depending on the business model that a firm conceives. In filling out the Barringer/Ireland Business Model Template, a firm should list the three to four key assets that it pos- sesses that support its business model as a whole. In some cases, the ongoing success of a firm’s business model hinges largely on a single key resource. For example, Zynga has historically maintained an agreement with Facebook that provided Zynga a privileged position on Facebook’s platform. In 2013, that agreement came to end, which weakened Zynga’s business model and dimmed its future prospects. financials The third component of a business model focuses on its financials. This is the only section of a firm’s business model that describes how it earns money— thus, it is extremely important. For most businesses, the manner in which it makes money is one of the most fundamental aspects around which its busi- ness model is built.25 The primary aspects of financials are: revenue streams, cost structure, and financing/funding. revenue Streams A firm’s revenue streams describe the ways in which it makes money.26 Some businesses have a single revenue stream, while oth- ers have several. For example, most restaurants have a single revenue stream. Their customers order a meal and pay for it when they’re finished eating. Other restaurants have several revenue streams. They may operate a restaurant, offer a catering service, and sell products at their counter, such as bottled barbeque sauce in the case of a barbeque restaurant. The nature of the way businesses make money also varies. Some businesses make money via one- time customer payments, while others receive recurring revenue by selling a subscription service. Some businesses are very creative in the ways in which they make money. For example, many providers of online games offer the basic game for free, and generate most of their revenue from a small number of us- ers who purchase premium products such as time-saving shortcuts, special weapons, and other features to enhance play. The most common revenue streams are shown in Table 4.3. As noted above, many businesses have more than one revenue stream, primarily to le- verage the value they are creating for their customers. For example, Birchbox has two revenue streams—its subscription service and its online store. For $10 a month, its subscribers receive four to five product samples. If a cus- tomer wants to buy a full-sized version of one of the samples, it is available via Birchbox’s online store. For Birchbox, having two revenue streams makes per- fect sense. The product samples introduce subscribers to products that they might not have known about otherwise. If a subscriber likes a particular prod- uct and wants a full-sized version, it is available via Birchbox’s website. The arrangement is good for the subscriber and is good for Birchbox. It provides the subscriber a convenient way to buy a product that he or she just sampled, and provides Birchbox dual revenue streams. The number and nature of a business’s revenue streams has a direct im- pact on the other elements of its business model. All for-profit businesses need at least one revenue stream to fund their operations. Whether additional rev- enue streams add or subtract value depends on the nature of the business and the other elements of its business model. It makes sense for Birchbox to have two revenue streams, as explained above. It also makes sense for a retail store, such as a bicycle shop, to not only sell bicycles (Revenue Stream #1), but to sell bicycle accessories (Revenue Stream #2), offer bicycle repair services (Revenue  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 127 Table 4.3 Most Common revenue streams revenue Stream description Advertising Revenue generated from advertising a particular product or service in a newspaper, magazine, website, or in some other manner. Commissions Revenue generated by bringing two parties together to complete a sale. Etsy and eBay generate revenue in this manner. The money usually comes from taking a small percentage of the sale price. Download fee Revenue generated by allowing a user to download a digital product, such as a smartphone app, an e-book, or a software product. licensing Revenue generated from charging for the use of a protected intellectual property, such as a software product. Matchmaking Revenue generated by matching someone who wants temporary access to an asset or competency with someone who owns an asset or has a competency and is willing to make it available. This is how peer-to-peer networks work. Examples include Airbnb, TaskRabbit, and Uber. Product Sale Selling a physical good—such as a product in a retail store or on a website. Renting/leasing Revenue generated by renting or leasing an asset such as a rental car, a copy machine, or a piece of specialized machinery. Service Sale Selling a service—such as a meal in a restaurant or a car repair. Subscription Service Selling a subscription—such as netflix for DvDs or streaming of content, or Birchbox for lifestyle samples. Stream #3), and sponsor local bicycle races (Revenue Stream #4). In contrast, the seller of a smartphone app may charge a one-time download fee (Revenue Stream #1) and offer product upgrades (Revenue Stream #2). But the seller may stop short of selling online advertising (Potential Revenue Stream #3), fearing that online advertising would detract from the experience of playing the game and lead to poorer user reviews and ultimately fewer downloads. In filling out the Barringer/Ireland Business Model Template, you should clearly identify your revenue streams. Placing them in bullet-point format is preferable. Cost Structure A business’s cost structure describes the most important costs incurred to support its business model.27 It costs money to establish a basis of differentiation, develop core competencies, acquire or develop key as- sets, form partnerships, and so on. Generally, the goal for this box in a firm’s business model template is threefold: identify whether the business is a cost- driven or value-driven business, identify the nature of the business’s costs, and identify the business’s major cost categories. Initially, it is important to determine the role of costs in a business. Businesses can be categorized as cost-driven or value-driven. Cost-driven busi- nesses focus on minimizing costs wherever possible. An example is Warby Parker, the subject of Case 5.2. Warby Parker sells prescription glasses for $95, which is well below the price charged by stores like Pearle Vision and LensCrafters. To do this, Warby Parker’s entire business model is based on cost containment. Its glasses are designed in-house, manufactured overseas, and sold via the Web, eliminating many of the costs associated with traditional glasses manufacturing and retailing. Instead of concentrating on driving costs lower and lower relative to rivals’ cost structures, value-driven business models focus on offering a high-quality product (or experience) and personalized service. Optometrists routinely sell prescription glasses in the $400 to $500 price range. 128 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS The additional value they provide is a wide selection, personalized service select- ing and fitting the glasses, and free follow-on services if the glasses need to be adjusted or repaired. Next, it’s important to identify the nature of a business’s costs. Most busi- nesses have a mainly fixed-cost or variable-cost structure. Fixed costs are costs that remain the same despite the volume of goods or services provided. Variable costs vary proportionally with the volume of goods or services pro- duced. The reason that it’s important to know this is that it impacts the other elements of a firm’s business model. Developing smartphone apps, for exam- ple, involves large fixed costs (i.e., the coding and development of the app) and small variable costs (i.e., the incremental costs associated with each additional app that is sold). As a result, a large amount of money will be needed up front, to fund the initial development, but not so much downstream, to fund the on- going sales of the app. In contrast, a business such as a sub sandwich shop may have low fixed costs and high variable costs. The initial cost to set up the business may be modest, particularly if it is located in a leased facility, but the cost of labor and ingredients needed to prepare and serve the sandwiches may be high relative to the prices charged. This type of business may need a smaller up-front investment but may require a line of credit to fund its ongo- ing operations. Other elements of the business model may also be affected. For example, a business with substantial fixed costs, such as an airline, has typi- cally made a major investment in key assets. A service-based company, such as Blue Apron (the prepared meal delivery service highlighted in Chapter 3), may have few key assets but may have core competencies and a partnership network that allows it to source ingredients, design meals, and reliably deliver the meals to its customers. The third element of cost structure is to identify the business’s major cost categories. At the business model stage, it is not necessary to establish a bud- get or prepare pro-forma financial projections. It is necessary, however, to have a sense of a firm’s major categories of costs. For example, Facebook’s major categories of costs are data center costs, marketing and sales, research and development, and general and administrative. This type of breakdown helps a business understand where its major costs will be incurred. It will also provide anyone looking at the business model template a sense of the major cost items that a company’s business model relies on. Financing/Funding Finally, many business models rely on a certain amount of financing or funding to bring their business model to life. For example, Birchbox’s business model may have looked elegant on paper, but the firm needed an infusion of investment dollars to get up and running. Most businesses incur costs prior to the time they generate revenue. Think of a business such as Pure Fix Cycles, the subject of the opening feature in Chapter 1. Prior to earning revenue the company had to design its product, arrange for manufacturing, purchase inventory, acquire customers, and ship its product to its customers. This sequence, which is common, typically necessitates an infusion of up-front capital for the business to be feasible. Absent the capital, the entire business model is untenable. Some entrepreneurs are able to draw from personal resources to fund their business. In other cases, the business may be simple enough that it is funded from its own profits from day one. In many cases, however, an initial infusion of funding or financing is required, as described above. In these cases, the business model template should indicate the approximate amount of funding that will be needed and where the money is most likely to come from. Similar to cost structure, at the business model stage projections do not need to be completed to determine the exact amount of money that is needed. An approximation is sufficient. There are three categories of costs to consider: capital costs, one-time expenses, and provisions for ramp-up expenses. In  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 129 regard to capital costs, this category includes real estate, buildings, equip- ment, vehicles, furniture, fixtures, and similar capital purchases. These costs vary considerably depending on the business. A restaurant or retail store may have substantial capital costs, while a service business may have little or no capital costs. The second category includes one-time expenses such as legal expenses to launch the business, website design, procurement of initial inventory, and similar one-time expenses and fees. All businesses incur at least some of these expenses. Finally, a business must allow for ramp-up ex- penses. Many businesses require a ramp-up period in which they lose money until they are fully up to speed and reach profitability. For example, it usually takes a new fitness center several months to reach its membership goals and achieve profitability. It’s important to have cash set aside to make it through this period. operations The final quadrant in a firm’s business model focuses on operations. Operations are both integral to a firm’s overall business model and represent the day-to- day heartbeat of a firm. The primary elements of operations are: product (or service) production, channels, and key partners. Product (or Service) Production This section focuses on how a firm’s products and/or service are produced. If a firm sells physical products, the products can be manufactured or produced in-house, by a contract manu- facturer, or via an outsource provider. This decision has a major impact on all aspects of a firm’s business model. If it opts to produce in-house, it will need to develop core competencies in manufacturing and procure key assets related to the production process. It will also require substantial up-front investment. If a firm that produces a physical product opts to use a contract manufacturer or an outsource provider, then a critical aspect of its business model is its ability to locate a suitable contract manufacturer or outsource provider. This is not a trivial activity. It’s often difficult to find a contract manufacturer or outsource provider that will take a chance on a start-up. As a result, in the Barringer/Ireland Business Model Template, it is not suffi- cient to complete this box by simply saying “Manufacturing will be completed by a contract manufacturer.” The exact name of the manufacturer is not necessary, but a general sense of what part of the world the manufacturer is located in and the type of arrangement that will be forged with the manufac- turer is needed. If a firm is providing a service rather than a physical product, a brief description of how the service will be produced should be provided. For ex- ample, Rover.com, the subject of Case 2.2, is a service that matches people who need their dogs watched while they are out of town with individuals who are willing to watch and care for dogs. The business model template needs to briefly report how this works. The explanation does not need to be lengthy, but it needs to be substantive. For example, an acceptable description for Rover.com is as follows: Rover.com will connect dog owners and dog sitters via a website. The dog sitters will be screened to ensure a quality experience. Customer support will be provided 24/7 to troubleshoot any problems that occur. Pet insurance is provided that covers any medical bills that a dog has while in the care of a Rover.com sitter. This brief statement provides a great deal of information about how Rover. com works and how the elements of its business model need to be configured. This is information that isn’t provided in another box in the business model template. 130 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS Channels A company’s channels describe how it delivers its product or service to its customers.28 Businesses sell direct, through intermediaries, or through a combination of both. Many businesses sell direct, through a storefront and/or online. For ex- ample, Warby Parker sells its eyewear via its website and in a small number of company-owned stores. It does not sell via intermediaries, such as distributors and wholesalers. In contrast, Pure Fix Cycles sells direct, via its website, and also through bicycle stores throughout the country. It utilizes distributors and wholesalers to get its bikes into stores. Some companies sell strictly through intermediaries. For example, some of the manufacturers that sell via Zappos and Amazon do not maintain a storefront or sell via a website of their own. They strictly rely on broadly trafficked sites such as Zappos and Amazon to sell their products. The same holds true for firms that sell services. Hotels, for example, sell their services (typically rooms) directly through their websites and telephone reservation services, and also through intermediaries such as travel agents, tour operators, airlines, and so forth. For example, if you were planning a trip to San Francisco, you could book your flight, rental car, and hotel through Travelocity, Expedia, or many other similar services. In this instance, Travelocity and the others act as intermediaries for the service providers. A firm’s selection of channels affects other aspects of its business model. Warby Parker maintains a simple channels strategy, selling strictly through its website and a small number of company-owned stores. Its price point is low enough that it must capture 100 percent of its margins for itself for its business model to work. In contrast, GoPro sells its cameras through its website, via on- line outlets such as Amazon and BestBuy.com, and through hundreds of retail stores in the United States and abroad. It utilizes intermediaries, such as whole- salers and distributors, to help it find new outlets. GoPro has a value-driven cost structure, so it can afford to share some of its margins with channel partners. The advantage of GoPro’s approach is wide dissemination of its products both online and in retail outlets. Some firms employ a sales force that calls on potential customers to try to close sales. This is an expensive strategy but necessary in some instances. For example, if a firm is selling a new piece of medical equipment that needs to be demonstrated to be sold, fielding a sales force may be the only realistic option. Key Partners The final element of a firm’s business model is key partners. Start-ups, in particular, typically do not have sufficient resources (or funding) to perform all the tasks needed to make their business models work, so they rely on partners to perform key roles. In most cases, a business does not want to do everything itself because the majority of tasks needed to build a prod- uct or deliver a service are outside a business’s core competencies or areas of expertise. The first partnerships that many businesses forge are with suppliers. A supplier (or vendor) is a company that provides parts or services to another company. Almost all firms have suppliers who play vital roles in the function- ing of their business models. Traditionally, firms maintained an arm’s-length relationship with their suppliers and viewed them almost as adversaries. Producers needing a component part would negotiate with several suppliers to find the best price. Today, firms are moving away from this approach and are developing more cooperative relationships with suppliers. More and more, managers are focusing on supply chain management, which is the coordination of the flow of all information, money, and material that moves through a prod- uct’s supply chain. The more efficiently an organization can manage its supply chain, the more effectively its entire business model will work.  CHAPTER 4 | DEvEloPIng An EffEctivE BUSInESS MoDEl 131 Along with suppliers, firms partner with other companies to make their business models work. The most common types of relationships, which include strategic alliances and joint ventures, are shown in Table 4.4. The advantages of participating in partnerships include: gaining access to a particular resource, risk and cost sharing, speed to market, and learning.29 An example is a partner- ship between Zynga, the online games company, and Hasbro, a long-time maker of board games. In 2012, the two companies formed a partnership, which re- sulted in the production of Zynga-themed adaptations of classic Hasbro games. Hasbro now makes a board game called FarmVille Hungry Hungry Herd, which is an adaptation of Zynga’s popular FarmVille online game. The partnership is good for both Zynga and Hasbro. It provides Zynga a new source of revenue and entry into a new industry, board games, and it provides Hasbro a fresh new game to sell to its customers.30 Partnerships also have potential disadvan- tages.31 The disadvantages include loss of proprietary information, management complexities, and partial loss of decision autonomy.32 When completing the Barringer/Ireland Business Model Template, you should identify your primary supplier partnerships and other partnerships. Normally, a start-up begins with a fairly small number of partnerships, which grows over time. One trend in partnering, utilized by all types of businesses, is to use free- lancers to do jobs that are outside their core competencies. A freelancer is an independent contractor that has skills in a certain area, such as software de- velopment or website design. There are several Web platforms that are making it increasingly easy to identify and find qualified freelancers. These platforms are highlighted in the Partnering for Success boxed feature. Table 4.4 the Most Common types of business partnerships partnership form description Joint venture An entity created by two or more firms pooling a portion of their resources to create a separate, jointly-owned organization network A hub-and-wheel configuration with a local firm at the hub organizing the interdependencies of a complex array of firms Consortia A group of organizations with similar needs that band together to create a new entity to address those needs Strategic alliance An arrangement between two or more firms that establishes an exchange relationship but has no joint ownership involved Trade associations organizations (typically nonprofit) that are formed by firms in the same industry to collect and disseminate trade information, offer legal and technical advice, furnish industry-related training, and provide a platform for collective lobbying Source: B. Barringer and J. S. Harrison, “Walking a Tightrope: Creating value Through Interorganizational Relationships,” Journal of Management 26, no. 3 (2000): 367–403. 132 PART 2 | DEvEloPIng SUCCESSfUl BUSInESS IDEAS partnEring For SuccESS Odesk,