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.
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