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How Do We Make Money?

Jul 17, 2022
 

You may find the term “business model” thrown around in the boardroom.

In this Savvy Director article, we’ll explore what it means, how it differs from strategy, and what the board’s role is, and what directors need to know to fulfill their role with respect to the organization’s business model.

And if the board you serve is in the non-profit sector, not to worry. There’s plenty here for you as well.

 

What is a business model?

The term business model is one of those things people recognize when they see it but can’t quite define.

In brief, a business model answers the fundamental question, “What business are we in and how do we make money?” It’s a framework for describing the way an organization operates - the way it provides value to customers, and how and by whom that value is paid for in a way that covers costs and makes a sustainable profit.

For a non-profit, it could be a framework for how the organization generates the revenue needed to fulfill its mission or purpose.

Any business model is composed of a number of components – components that include customer segments, products and services, value proposition, cost structure, key activities, distribution channels, suppliers and partners, and resources.

In fact, the term business model first came into widespread use when spreadsheets became common, allowing companies to create models of all those components in various configurations. Of course, there were business models before that, but they were created more by accident than by design.

It’s important that your business model and your strategy make sense when considered together. Confused about the difference? Think of it this way: a business model is a description of how your organization runs, while a strategy explains how you intend to do it better than the competition.

Your competitive strategy might involve improving your current business model, introducing a new business model into an existing market, or taking the current business model into a new market.

 

What is the board’s role?

When it comes to business modelling, most of the work falls to management. The board's role is to oversee it, challenge it, and help ensure that it will lead to sustainable profitability.

If the company is developing a new business model, the board will obviously need to spend time on it – overseeing the various components and how they are configured. Having said that, directors do not need to get into the weeds. Instead, they take a broad view, evaluating how the business model affects the company's infrastructure, and ensuring the company has sufficient resources to get there.

The choice of a business model impacts technology and skills requirements, branding and marketing efforts, and cost structures. To assess the business model from a strategic point of view, the board should work to understand the competitive landscape and to assess the impact on the organization’s risks.  

As a company grows, the board and management need to continue to evaluate whether components of the business model such as distribution channels, technology, and capital are still appropriate.

When new products or services are introduced, the board and management must consider whether they fit the existing business model, or whether changes are needed. Taking new products from the innovation stage to market means that the business model must be constantly revisited.

Successful business models have feedback loops that allow the board to know whether things are still on track or the existing business model is running out of gas. When innovations to your current offerings create smaller and smaller improvements, when your own people have trouble thinking up new improvements, or when your customers are increasingly finding new alternatives – these are all signs you may need a new business model.

Knowing you need one and creating one are, of course, two vastly different things. It’s really management’s job to come up with those ideas. The HBR article What is a Business Model? offers useful suggestions to spark the discussion.

 

What do directors need to know?

As part of a new director’s onboarding, they should get a good understanding of the organization’s business model. Getting answers to the following questions is a great place to start:

  1. What customer problem are we trying to solve?
  2. Who pays?
  3. How large is the target market?
  4. Who are the competitors?
  5. What does it cost to deliver?
  6. What is the marketing message?
  7. How easy is it to stop imitators?

A great tool for understanding a business model in a straightforward, structured way is the “business model canvas” - an organized way to lay out all the parts of the business model - key resources and activities, value proposition, customer relationships, channels, customer segments, cost structures, and revenue streams. It’s a tool that’s equally useful in for-profits and non-profits. 

The business model canvas is a shared language for describing, visualizing, assessing, and changing business models. It’s up to management to create a business model canvas, so there may not be one for your organization. If one exists, it’s a great tool for directors to truly understand the business. Using it can lead to valuable insights that answer the fundamental question, “What business are we in and how do we make money?”

The HBR article A Better Way to Think About Your Business Model offers details for creating a business model canvas. Here’s a quick overview:

  1. Customer segments. The three segments that provide the most revenue.
  2. Value proposition. Products and services – the job you do for your customer.
  3. Revenue streams. The top three revenue streams.
  4. Channels. How you deliver the value proposition.
  5. Customer relationships. How you maintain the relationship.
  6. Key activities. What you do every day.
  7. Key resources. People, knowledge, and money.
  8. Key partners. Partners you can’t do business without.
  9. Cost structure. Top costs.

 

What about non-profits?

If you serve on the board of a non-profit organization, you might be wondering how this Savvy Director article applies to you. Don’t let the term “business model” put you off. While non-profits are primarily mission-driven, they’re also business enterprises. Every non-profit organization is built on an underlying business model that enables its programs to succeed.

As described in the article Transforming Nonprofit Business Models, four core components – revenue mix, infrastructure and expenses, program cost, and capital structure – define the non-profit business model. They’re closely interrelated and each one is impacted by weaknesses or changes in any of the other three.

As with any organization, a non-profit’s business model is not static. The structure and composition of revenues, expenses, and capital evolves over life stages and in response to external events and internal strategy. For instance, economic downturns stress non-profits, leading to doubts about the sustainability of their business models. Seeking a permanent business model is not productive. Instead, monitor feedback loops and – just as in the for-profit world - stay alert to signs that the business model is running out of gas.

There’s not enough space to delve into the topic of non-profit business models in this Savvy Director blog, but if the non-profit world is where you’re building your governance career, I suggest you read the article The Looking-Glass World of Nonprofit Money: Managing in For-Profits’ Shadow Universe by Clara Miller (Nonprofit Quarterly, June 2017). It offers a fascinating look into the challenging realities of non-profit business models.

 

Questions for the Savvy Director

Here’s a list of some suggested questions from the Resources listed below.

  • How scalable is our business model?
  • How can we innovate and change our business model?
  • Does our business model create value?
  • What customer problem are we trying to solve?
  • Is our target market growing or shrinking?
  • What’s our market share?
  • What’s our customer retention?
  • Who are our competitors?
  • Does our business model provide protection from competition?
  • How much recurring revenue do we have?
  • What’s our gross margin?
  • What’s our profit rate?
  • How capital intensive is our business?
  • How do we use switching costs to prevent customer churn?
  • Do we earn money before we spend it?
  • How much of the work can be done by others?

 

And for those in the non-profit world: (adapted from Transforming Nonprofit Business Models)

  • What is our dominant revenue source?
  • How is the availability or stability of that source changing?
  • What other types of revenue can we develop?
  • What are our three largest expense types?
  • How effective are our costs in carrying out our strategy?
  • What are the strengths and weaknesses of our current infrastructure?
  • What could we accomplish with stronger systems and support?
  • What is the true cost of our core programs?
  • What are our largest assets? Are they liquid or illiquid, restricted or unrestricted?
  • What is available in liquid funds to invest in the organization’s future strategies?

 

Your takeaways:

  • A business model answers the fundamental question: “What business are we in and how do we make money?”
  • A business model is a description of how the business runs, while a strategy explains how you intend to do it better than the competition.
  • The board's role is to oversee the business model and decide whether it covers all the important bases and will lead to profitability and stakeholder support and acceptance.
  • As part of a new director’s onboarding year, they should get a good understanding of the organization’s business model.
  • A business model canvas is an organized way to lay out all the parts of the business model - key resources and activities, value proposition, customer relationships, channels, customer segments, cost structures, and revenue streams.
  • Every non-profit organization is built on an underlying business model that enables its programs to succeed.

 

Resources:

 

Thank you.

Scott

Scott Baldwin is a certified corporate director (ICD.D) and co-founder of DirectorPrep.com – an online hub with hundreds of guideline questions and resources to help directors prepare for their board role.

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