This paper discusses the fifth component of a business model, economics. Previous papers have described the definition of a business model1, and its other four primary components: markets2, products3, processes4 and people5. “Economics” refers to the central focus of a business model, its financial model.
A business is fundamentally an economic enterprise, and the primary goal of a business from the perspectives of its primary stakeholders (employees, owners and partners) is to maximize its value (so as to maximize each stakeholder’s share of that value).
Some readers may argue that businesses also have important non-economic goals. In agile strategy however, we make a clear distinction between a company and a business. A company is a human organizational entity, with vision, values and other non-economic aspects. Normally the primary purpose of a for-profit company is to own and maximize the value of one or more businesses, but it can also have other purposes. By contrast, a business is an economic entity – specifically the value exchange between its stakeholders and its customers. In this sense, a business has a single purpose – to make money for its stakeholders by delivering value to its customers.
A business does so by selling a product or service that customers want and will pay for (because the value of the product or service to the customer is worth more than the payment). It then shares that customer payment amongst all the people (stakeholders) who help provide that product or service to that customer.
These people or stakeholders fall into two main groups – those who actually do the work of providing the product or service (employees and partners) and those who provide capital to the business (owners / investors). Most businesses need capital because of the timing of these payments – normally a business has to share the payment with its employees and partners to provide the product or service before it receives the payment from the customer.
This simple description identifies the five components of a business model. The customer is the markets component; the product or service is the products component; the providing of the product or service, encompassing all the activities needed to create, market and deliver the product to the customer, is the processes component; the employees, partners and investors contributing to and sharing in the value are the people component; and the payment and how it is shared amongst stakeholders is the economics component.
This simple description also illustrates how a business is a seamlessly integrated economic engine. The customer you choose determines what product or service you can sell and at what price. The processes you choose (how you will make, market and deliver the product or service to the customer) are dependent on the nature of your products and markets, and in turn determine which stakeholders you need. Conversely, the stakeholders you choose can impact which markets you pursue, which products you offer and what processes you implement. Each of these choices, and all of their underlying details, has a material impact on all of the others, and collectively they determine the economics of the business. To maximize the economics of the business, you need the optimal balance of markets, products, processes and people.
In addition, this simple description illustrates the key elements of the economics component: revenue, costs, profit, investment and funding. The payment from the customer is revenue to the business. The share of that payment that it gives to its employee and partner stakeholders are costs to the business (where “partners” includes all vendors, channel partners, etc.) and the share of that payment that it gives to its owner stakeholders is its profit. The capital it receives is funding, and paying that capital out in advance of receiving payment from customers is investment.
Thanks for sharing such interesting information. Will bookmark for later reading.
Posted by: debbie | 10/13/2011 at 01:22 AM