Types of Business Models (VCE SSCE Business Management): Revision Notes

Types of business models

A business model is the plan a business implements to generate revenue and make a profit. It outlines how revenue will be generated, how expenses will be incurred, and describes the key components and functions of the business. Selecting the right business model is crucial for maximising the chances of business success. An original or unique business model can become a competitive advantage for the business.

Australian businesses can choose from several types of business models depending on their objectives, resources, and target markets. Understanding the features, advantages, and disadvantages of each model helps business owners make informed decisions.

Online business models

An online business conducts its activities via the internet without requiring a physical presence. Online businesses have become commonplace across virtually every sector of the economy, allowing businesses to reach customers, promote products, and widen their customer base through digital channels.

Seven main online business models

1. Direct to consumer (merchant model)

This model involves making direct sales to consumers via the internet instead of operating a physical bricks-and-mortar store. The business sells products directly through its website, cutting out traditional retail intermediaries. Amazon and most retail operations use this model, offering convenience and often lower prices by reducing overhead costs.

2. Advertising model

The advertising model involves a website providing content either free or for a fee to attract users. Advertisers then pay the website to promote their products to these users. Payment can be structured in several ways: per impression (based on the number of advertisements displayed), per click (when users click on the advertisement), or via a fixed monthly or annual cost. Facebook is a prominent example of this model. Services such as Google AdSense and BuySellAds act as intermediaries, helping businesses add advertising to their websites and connecting advertisers with suitable platforms.

3. Affiliates model

This model rewards website owners every time a user clicks on a promotion featured on their site and subsequently purchases a product. The affiliate earns a commission on successful referrals, creating an incentive to promote products effectively to their audience.

4. Brokerage model

Businesses using this model act as agents that bring buyers and sellers together. They may function as transaction brokers or create marketplaces where transactions occur. Brokerage refers to the activity of buying and selling foreign money, shares in companies, or other goods and services. eBay is a well-known example of this model. Revenue is generated by charging a fee or commission on each transaction completed through the platform.

5. Subscription model

This model requires users to pay a recurring payment or subscription fee to access the website's content or services. Media outlets such as News Limited (Herald Sun) and Nine Publishing (The Age) use this model, charging readers for access to premium content.

6. Information model

This model involves charging users for specific information accessed through the website. Some digital academic journal libraries charge per article downloaded, for example. This model works well when the information provided has high value and is not readily available elsewhere.

7. Community model

These websites build communities of users who interact with each other through the platform. Examples include blogs and chat sites. Revenue is generated through charging subscription fees or soliciting donations from users who value the community. Wikipedia is an example of this model, operating primarily on donations from its user community.

Advantages of online business models

Online business models offer several significant advantages:

• They provide easy and instantaneous connection with customers, suppliers, and other stakeholders. The business can effectively operate 24 hours a day, reaching a worldwide market without time zone limitations.
• Promotion and marketing are usually cheaper and can reach a wider global market compared to traditional advertising methods.
• Costs and overheads are significantly reduced. There is no need to pay rent for physical premises, and overhead costs such as utilities and insurance are substantially lower.
• It is easy to monitor competitors' pricing and adjust prices quickly to remain competitive in the market.

Disadvantages of online business models

However, online models also present challenges:

• The costs of planning, designing, securing, and maintaining a professional e-commerce website are considerable and require ongoing investment in technology and cybersecurity.
• Customers may be reluctant to purchase online because they cannot physically handle or try products before making a purchase decision.
• The sense of trust and authority associated with a physical bricks-and-mortar location is lost. Establishing a trusted brand name is more difficult without a physical presence, track record, and history of face-to-face customer interaction.

Impact of COVID-19 on online business

The COVID-19 pandemic significantly accelerated the growth of online business models. Global e-commerce sales reached $4.5 trillion in 2021. More than 30% of Australian shoppers tried new brands, and over 20% tried new retailers and online shopping websites since the start of 2020. Nearly half of small businesses in Australia pivoted their approach in response to the pandemic, with a distinct shift towards online operations to maintain market share. Even as retail sales increased by 9% year-on-year from July to December 2020, time spent at home accelerated the decline of bricks-and-mortar stores and the growth of e-commerce.

Bricks-and-mortar business model

A bricks-and-mortar business has a traditional physical presence involving stores, offices, or production facilities that customers or clients actually attend. This contrasts with businesses that rely primarily on an online presence. A bricks-and-mortar model typically offers face-to-face customer interaction, which remains valuable for many types of businesses and customer preferences.

Advantages of bricks-and-mortar models

Physical business locations provide several benefits:

• Face-to-face customer interaction is possible, which builds relationships with customers and clients. This personal connection may contribute to increased sales through building a base of loyal, returning customers who appreciate the personal service.
• Customers can see, touch, and try products before making a purchase, reducing uncertainty and potentially decreasing return rates.
• A physical presence with identifiable buildings and locations makes it easier to build a trusted brand. Customers often feel more confident purchasing from businesses they can visit.
• Customers receive instant gratification by taking products home immediately, which also encourages impulse buying as customers browse physical displays.

Disadvantages of bricks-and-mortar models

Traditional physical businesses face several challenges:

• Shopping is less convenient for customers with busy lifestyles or those who live in remote locations, as they must travel to the physical location during business hours.
• There are limitations regarding the customers likely to visit the store, resulting in a limited geographical reach compared to online businesses.
• A wider range of stock can typically be provided online due to lower storage costs, while physical stores are constrained by their floor and storage space.
• The potential market is smaller, and overhead costs such as rent, utilities, staffing, and insurance are substantially higher than online operations.

Combining business models

Clicks-and-mortar businesses

Many businesses that originally traded using a traditional bricks-and-mortar model have since developed and adopted online services and sales alongside their physical operations. Major retailers such as Woolworths, Coles, Myer, and David Jones have done this to maintain competitiveness. These businesses are referred to as clicks-and-mortar businesses—companies that previously traded using a bricks-and-mortar model and have adopted online services and sales in addition to their traditional operations.

E-commerce businesses

Businesses that have never owned a physical shopfront and have always operated solely online are often referred to as e-commerce businesses. These businesses were "born digital" and built their operations around internet-based sales from the beginning.

Social enterprise model

A social enterprise uses a traditional business model of buying and selling goods and services with a view to creating profit. However, unlike traditional businesses, the social enterprise's primary motivation is not to create profit for owners or shareholders. Instead, it aims to use profits to fund or support social causes. Such causes might include:

• Reduction of poverty or social disadvantage
• Provision of employment to disadvantaged groups
• Addressing environmental issues
• Supporting community development initiatives

Many social enterprises do make a profit, but this is not usually their main reason for existing. Profits are reinvested back into the business or donated to charitable causes. Social enterprises differ from charities in that they derive income from business activities rather than relying primarily on donations.

Victoria has approximately 4000 social enterprises contributing over $5.2 billion annually and employing thousands of people. Over 70% of social enterprises operate as small businesses in service industries.

Four main social enterprise models

1. Employment model

These social enterprises provide employment opportunities for marginalised people in society, such as those with disabilities, those facing cultural or language barriers, or any disadvantaged group. The Mildura Chocolate Company uses this model, aiming to increase community awareness and understanding of employees' abilities rather than focusing on their disabilities.

2. Goods and services model

These social enterprises aim to offer alternative products to those considered socially or environmentally harmful. Fairtrade is a prominent example. Other enterprises provide organic food, sustainable products, or ethically sourced goods that align with social and environmental values.

3. Social investment model

These businesses typically operate using a traditional business model, but all profits are directed to a charitable cause rather than being distributed to owners or shareholders.

4. Hybrid model

A hybrid model combines more than one of the above approaches. For example, a restaurant might sell organic foods sourced on a fair-trade basis, employ long-term unemployed people, and direct its profits to charity, thus incorporating elements of the goods and services, employment, and investment models.

Franchise model

Australia ranks second in the world for franchising outlets per capita, with almost 90% of these franchises being Australian-developed. The country has over 1000 franchises and close to 70,000 franchise units that contribute $128 billion to the Australian economy.

How franchising works

A franchise involves a franchisee (the person buying the franchise) paying another business, the franchisor (the owner of the franchise system), for the right to use that business's trade name, products, and operating systems. The franchisor exercises a degree of control over how the business is run, but in return provides assistance, advice, suppliers, and their established reputation.

The franchisee is essentially paying for the right to replicate another business in its entirety. This typically involves:

• A one-time upfront franchise fee
• A royalty payment—usually a percentage of sales revenue
• A regular advertising and marketing fee

In return, the franchisee receives:

• Immediate name recognition
• Familiarity through standardised décor and design
• Reliable and tested products
• Marketing support
• Employee training programmes
• Ongoing support for promoting and upgrading products

Franchise agreement

A franchise agreement is a legal document that specifies the rights and responsibilities of both the franchisor and franchisee. The franchisor retains significant control over franchisees' operations to safeguard their trademark and ensure product quality remains consistent from location to location. For example, any time you order a Big Mac from a McDonald's store, you expect exactly the same form and quality of product, even though each McDonald's likely has a different franchisee owner.

The agreement grants the franchisee an exclusive right to operate the franchise in a specified trading area. The franchisee agrees to pay fees that typically include:

• An initial, upfront franchise purchase fee
• A percentage of sales income each month (royalty)
• A regular advertising and marketing contribution fee

Advantages of franchising

For the franchisee, franchising offers several benefits:

• Significantly reduced risk of business failure compared to starting an independent business, as the model has been tested and proven.
• Avoidance of the franchisor's initial mistakes and learning curve, as systems and procedures have been refined over time.
• Opportunity to access franchisor-provided training in all aspects of the business operation.
• A business system that has been tested and usually succeeded, with established policies and procedures and expert assistance and advice from the franchisor.
• Less responsibility for certain decision-making aspects, as many key strategic decisions are made by the franchisor.
• Established suppliers and the advantages of bulk buying through economies of scale, reducing costs.

Disadvantages of franchising

However, franchising also has limitations:

• The franchise's reputation is judged by the performance of all franchisees. Poor service provided by another franchisee can negatively affect all franchise locations.
• Risk of excessive costs and fees: beyond the initial purchase fee, the franchise owner must pay ongoing monthly service fees and a percentage of revenue, which can significantly impact profitability.

Brief history of franchising

Isaac Singer (1811–75) is credited as the modern father of franchising. During the 1850s, Singer wanted to increase sales of his sewing machines and achieve wider distribution but could not afford to manufacture more machines. Additionally, customers wanted training to use the machines, which retailers could not provide. Singer therefore decided to charge licensing fees to people to sell his machines in specific areas, with each licensee expected to provide customer training. This innovative approach provided capital for ongoing manufacturing.

The modern franchising model flourished in the USA during the 1950s and 1960s. McDonald's, Kentucky Fried Chicken, and several laundry, dry-cleaning, hotel, and rental car franchises were significant players. Within a 10-year period, McDonald's opened 1000 stores, demonstrating the model's scalability.

Ray Kroc (1902–84) is credited as the founder of the McDonald's franchise system. A milkshake mixer salesman, Kroc discovered the McDonald's hamburger store in California in 1954 and was impressed by the business model. He became its licensing agent and recruited franchisees. In 1961, Kroc bought out the McDonald brothers. By 1988, there were more than 10,000 McDonald's franchisees across the USA, and now there are more than 37,000 worldwide.

In Australia, franchising followed a similar pattern. After World War II, car manufacturers such as Ford and Holden established franchise models for retail sales. Petrol companies such as Shell, Mobil, and Caltex established franchise models for service stations. In 1968, Kentucky Fried Chicken (now KFC) opened its first Australian store. Over subsequent years, Pizza Hut, McDonald's, and Hungry Jack's opened their first franchise outlets in Australia.

Importer and exporter business models

Businesses that buy and sell products across international borders operate using an importer or exporter business model. An importer purchases overseas products for resale in their home country, while an exporter sells home-country products overseas.

According to the Department of Foreign Affairs and Trade (DFAT), Australia's two-way trade in goods and services was worth $873 billion in 2019–20, with China, the United States, Japan, South Korea, and the United Kingdom as the top five trading partners.

Reasons for adopting an importer or exporter model

Several strong reasons exist for adopting this business model:

Price differentials between countries

Some products are cheaper to manufacture and assemble in one country than another. Raw materials and labour costs vary significantly across countries, making it attractive to source products from countries with lower cost structures and sell them in countries where higher prices can be obtained. For example, clothing and footwear produced in South-East Asia often cost less than similar items produced in Australia. Importers and exporters exploit economies of scale to maximise profitability.

Differences in quality, reputation, and image

Certain countries have established reputations for particular products. French perfume has a high reputation, and Egyptian cotton is highly regarded in Australia. Conversely, Australian wine is highly regarded in many parts of the world, and Australia is recognised as a source of high-quality agricultural produce and dairy products. This reputation can command premium prices.

Ready availability of goods in quantities

Some goods are not produced in Australia, and others cannot be manufactured domestically at competitive prices. Electronic goods are currently sourced from Asian countries, where they are produced in large quantities at competitive prices. The scale of production in these countries makes domestic manufacturing economically unviable for many products.

Seasonality

Agricultural products are predominantly seasonal. At different times of the year, certain produce grows in specific parts of the world, with many countries sourcing their supplies from those regions. As seasons change, the geographical sources of these products shift. This creates opportunities for importers to ensure year-round supply of seasonal products.

Business opportunities in niche markets

Opportunities arise for niche markets both in Australia and overseas. Entrepreneurs identify and exploit these opportunities. Some established international businesses see Australia as an expanding market and establish operations to capitalise on this potential—for example, fashion retailers H&M, Zara, and Uniqlo have all created a presence in Australia. Similarly, some Australian businesses have expanded overseas, such as Australian surf-wear producers.

Legal considerations

Import and export businesses must be aware of legal requirements and restrictions when moving products between countries. Important considerations include: