Business model is just a fancy term for “how a company makes money.” Until about 60 years ago, companies simply made or bought things for one price, and sold them for a higher price. If your company functions like that, use the business model section to lay out the unit economics of a sale. Show the sales price of one unit, and the variable costs associated with producing and selling that unit. The price minus the costs is the margin. Comparing the margin to fixed costs, like rent and staff, shows how many units the company needs to sell to break even. That’s also called “break even volume”.
That type of basic calculation, often called a “back of the envelope” analysis, is as important as any sophisticated Excel model. Other back of the envelope calculations might include comparing your break-even level of sales to the sales of the entire market (i.e. market share), or to the sales of leading competitors, to make sure your numbers are reasonable.
Business models have gotten more complicated over time, with innovation. Here are just a few:
When a company’s business model is a bit more complex, it’s important to explain it clearly in the plan. An ad-supported website, for example, generates content (or gets users to generate content), attracts an audience to read/view/contribute to that content, and then sells advertisers access to that audience. “Freemium” websites give away free content also, but charge fees or subscriptions for premium content or services. Marketplaces connect buyers and sellers, collecting listing fees or commissions.
One common mistake is the “boil the ocean” business model. I’ve seen dozens of plans like these, believe it or not. With a straight face, the entrepreneur explains that his or her business will make money from selling ads and sponsorships, selling premium subscriptions, selling market research, and selling merchandise. I’ve seen angel investors shred entrepreneurs with kitchen sink models simply by asking for a few examples of successful companies with all those types of revenue streams.
Another common problem is when entrepreneurs don’t understand the fine points of their own business models. I’ve seen this with entrepreneurs who have never sold advertising, but plan to launch websites supported by advertising and sponsorships. Sometimes they are wildly unrealistic about the pricing of their ads, or the percent of inventory they’ll sell. Other times, they double-count ad revenue and sponsorship revenue.
Yet another common error is to use unrealistic comparables. We’ll explore this more when we discuss financial projections, but it’s also a problem with business models. For some reason, thousands of entrepreneurs seem to think the company they have yet to launch will be the next Facebook, Google or Match.com. I admire their lofty ambitions, but the comparisons can make them look naïve. I’d rather see entrepreneurs model themselves after successful niche businesses started with limited capital.