What is a “business model”?

Often, when I teach about types and classifications of cost in my management accounting classes, I use the term business model. For example, I might say “whether a cost is fixed or variable, can depend on the particular business model”. But, I am assuming the term business model is well understood. Perhaps it is not, and even when I asked myself what the term means,  I had to do a bit of thinking. So here’s a simplified explanation.

An article in the Harvard Business Review from 2002 describes a business model as “the story which explains how an enterprise works”. This is a deceptively simple definition, but it does capture exactly what a business model is. If I were to ask you what are the essential elements of a story such a Cinderella or The Frog Prince, you would probably says things like characters, what the characters do, when the characters do things, and of course the (moss likely) happy outcome. Using the story analogy, a business needs to ask itself, what is that we do, who are our customers, how much does what we do cost, and will we make money (the happy outcome!). In other words, “what’s our story”  in an economic sense (Read the full HBR article for more detail and examples).

Nowadays, business models have become a bit blurred though. For example, there are so many web-based “businesses” out there who, to be honest, do not immediately show a story which makes economic sense. For example, we now know how Google and Facebook can make money on a business model which changed the advertising world.  But, what about for example Twitter or off-shoots like paper.li. I love the latter, as I can bundle all the twitter users I follow into a daily newspaper, but how can this make money. I am guessing they will introduce advertising, but has this business model already been over-cooked?

I hope this helps you understand what a business model is. To conclude, I suppose the story of what it is a business does has to be infused with accounting concepts. For example, there is not point being the world’s best at something, but costing a fortune to do it.