Finance / Investments · January 12, 2022

How To Identify A Business Model Of A Company

Introduction

A business model can be defined as a methodology a business or a company is in existence for it to generate profits for an infinite duration. A model of revenue generation that can sustain itself to remain in business, handle the expenditure and keep the share holders content.

There are times where a company offering services to general public, can have a business model just focusing on B2B models. Or a company deal with a particular product that generates no income from its doings but still a profitable business on paper. It is very important for investors to identify the business model of the companies before betting on them.

Here are some ways in which you can analyze the business model of a company

The demand for the value the company offers

The demand and supply are the basic economy for any business. A good product with no demand is of no value and cannot sustain in the long duration. The demand for the product can be analyzed by actually studying the behavior pattern of the user, the change in behavior and the probable change in behavior.

The demand for the product today many not be the same tomorrow. This changes from time to time from change in habits of people. A company should also be in a position to change its business model to adapt to this change. In this way they can stay relevant to the market and their consumers.

Researching about the product / services of the company

The main motive of a good business model for long term is the product / services it has to offer. A company with great marketing but bad product may sustain for a short duration. But a company with good product an no marketing may grow slow, but it is bound to be accepted by the consumer in a larger time frame.

For example, Tesla is a electric car manufacturing company. The company has so far spent no money on its advertising, but the kind of product it has to offer is justified with the demand it carry’s today.

Researching about the quality of the product can derive crucial information about the business model of a company in its true form.

Understanding valuations in terms of per user

This approach is mostly applicable for B2C (Business to Consumer) type business model. How much is the minimum fee a single user is liable to pay for the services and what is the potential for the business to increase its per user numbers. This can be another way to quantify a business model, to check for the the average revenues the business can make.

We can understand this using Netflix as reference. The company charges Rs. 199/- from each user every month. This data gives a clear picture to the investors as to how much revenue it can generate by studying the demand for entertainment, the targeted audience and the growth potential of user base.

Other sources of income

There is a difference between a standalone profits and consolidated profits. The standalone profits are made from the revenue generated from founding company. Wherelse, the consolidated profits are the revenues generated from other chain companies, sub companies, investments, third party consultancy etc.

Let us consider Zomato. It is a food delivery service. But do you know it also provides consultancy services to restaurant owners as to what food is popular in a particular location or the target valuations one can achieve by setting up a restaurant. This is a one of a kind service as it helps the restaurant owners what food chain generates better revenue.

Zomato is able to provide this because they have a data of some users, their behavior, what preference do the customers have and how much their are willing to pay. A good business model needs to focus on generating more that one source of revenue. Understanding the different sources gives an overall gist of the entire business model of the company.

Predicting the future potential ways to generate revenue

The future is coming to us as fast as we can imagine. A good business model needs to cope up with not only its competitors but also future proof itself from ongoing changes. One needs to understand the technology behind the company and the business behind it.

Take an example of Zerodha, an online discount brokerage service started in 2010. Back in 2010, no body was prepared to take trading of stocks on a palm of their hands. But with due course of time, things have got different. Zerodha must not have started off as a profitable business, but with future proofing, it has made a mark in the fin tech sector.

Idea the company is focusing on

The idea behind establishing the company talks a lot about the business model of the company. An idea can be related to what change it is making in the company or change in the behavior of its consumers.

CRED can be a classic example of this. The company started with an idea to simplify credit card payments for its users so that they do not default on delayed payments. This was a free service offered to its users for no money in exchange. Then how did the company manage to raise huge funds if the company didn’t have any business model?

The idea of CRED is to collect data from people. The CIBIL score is a crucial data that tells about the loan repayment ability of the consumer. CRED can now ventured into either providing loans to these users or either sell this data to third party business.

They didn’t make money from its users, but instead has a different revenue stream altogether.

Reading the annual report of the company

The profit and loss statement shows the clear picture about the revenue and expenditure of the company. The P&L statements comes with a set of annexures that show the source for all the revenues made by the company, the various expenditures it has incurred to sustain the business and the overall taxes paid on the profits.

The sources of revenue can be a good picture to analyze the business model of the company. this can also be a quantitative approach to gauge the business model and its sustainability in the future.

If the business is incurring more expenditure than the revenue generated, it means that the company has incurred a loss in that financial year. Does it mean that it has a bad business model? This is again debatable, because the company can be in a growth stage and does not focus on the profit aspect in this course of time.

A good example for this can be Amazon. It is an online store company, where it delivers products to its customers to the comfort of their homes. This is a great business model for the company, but the company has not yet started making profits.

Conclusion

Sometimes it gets a bit tricky to understand a business model of a company. Simply because, the business starts off with one agenda and carry’s itself to have a revenue stream in a much different way in the future. One needs to know that we are in a generation of data. Always remember, price is what you pay and value is what you get.

Also read: How To Calculate Price To Earning (PE) Ratio Of A Stock

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