Now, how do you get the business up and running? It seems as if there’s an endless list of things to think about before you can open your virtual doors. One of the first and most important things you need to figure out is your operating model.
What is an operating model?
An operating model is a description or representation of how a business runs. It includes how facilities, equipment, and software are used, how work is performed, how people are hired, trained, and evaluated in their jobs, and how the business’s product or service is delivered to customers.
The basic operating model is typically conveyed through a one-page visual representation that might show organization charts, workflow maps, and performance scorecards. These aids make it quicker and easier to understand a business’s operations than, say, a thick manual.
What’s covered in an operating model? 5 key elements
There are all sorts of studies and presentations full of pep talk and buzz phrases about how your business can develop an operating model. Once you cut through the verbiage, however, you will find that a good operating model typically has these five elements:
1. Key priorities
This lays out important and measurable objectives and the time frame you expect to meet those objectives. It also details your target customers and the geographical scope of your strategy.
Imagine an ecommerce business that sells bed and bath goods. Its key priorities might be to become a leading online retailer of mid-priced products for the bedroom and bathroom in the US, and to reach $100 million in annual sales in three years.
2. Work processes
This section lays out how work is done in each part of the business and what systems are used in the workflow. For instance, the online bed and bath retailer above would have a work process for the merchandise team that specifies how the team reaches contracts with suppliers and how it would establish systems to manage inventory.
3. Business structure
An explanation of the organization’s structure includes how the business is organized into teams, departments, or functions; how the teams interact and collaborate; and how lines of authority and responsibility are formed.
4. Workforce organization
This is information on the types of workers to be hired, their team or department assignments, and their roles. The model can include ways to increase employee retention, such as opportunities for education and advancement, and explain the corporate culture the business wants to create.
This could range from trucks to hand tools, although in today’s economy it more likely means information technology, such as computer systems, software, telecommunication, websites, and data networks.
Operating model vs. business model vs. business strategy
The term operating model is not the same as a business model, though sometimes they’re used interchangeably. Nor is an operating model the same as a business strategy. Here’s how to distinguish among the three:
- Business model. This describes what the business is and how it will turn a profit. For example, “We’re a coffee retailer that makes money through monthly coffee subscriptions and direct-to-consumer sales.”
- Business strategy. A business or corporate strategy outlines what your goal is for the business. For instance, “We want to become the leader in US coffee retailing.”
- Operating model. The operating model explains how the business will reach that goal. In this case, “We will use a direct-trade buying model, eliminating the need for importers; we will use our subscription model to reduce our risk of holding unsold coffee; and we will invest in brand storytelling to highlight our values.”
A corporate strategy or business strategy typically is big picture and abstract, while an operating model is more detailed, with specific plans for the business structure, production and sales processes, management, and role of each employee.
Because they’re more abstract, business models and business strategies may remain in place longer than an operating model, which is more dynamic and flexible, and subject to change as the business evolves. Companies often think of an operating model in two ways: the current model, reflecting how the business is being run, and a target model, reflecting how it might be run more efficiently, based on analysis by the owners and managers.
Benefits of an operating model
An operating model can help a business in the following ways:
- Organization. A model offers a framework that outlines a business’s structure and use of available resources.
- Measurement. A model provides a basis for monitoring the business’s performance, which helps owners identify strengths and weaknesses. They can then use this information to find ways to improve work processes, control costs, and gain a competitive advantage.
- Roadmap for internal growth. A model can help increase sales, contain costs, and achieve economies of scale.
- Guide investment decisions. The model can guide spending on acquisitions of other businesses and additional facilities.
- Communication. An operating model can help an owner or manager better explain the business’s progress to investors, employees, suppliers and customers.
How to develop an effective operating model
Business owners and consultants often create checklists (sometimes shortened to acronyms) for things they consider essential to starting a business and developing an operating model. One such list is known as POLIST. It stands for the following:
P for processes
An operating model delineates the processes for making, marketing, and delivering the business’s product or service. For example, an ecommerce retailer’s operating model could explain in detail how inventory is managed, and how customer orders are fulfilled.
O for organization
This defines the types of people doing the work, and how they are organized—for example, by well-defined functions and departments, or loose, cross-functional teams.
L for location
Even virtual businesses have a physical presence of some kind. An operating model should specify where people and assets are located, and whether they’re concentrated in central offices and working in close quarters or dispersed and operating remotely.
I for information
Every business runs on information, and one part of the operating model articulates how company technology uses it and shares it. Businesses with specific departments and defined functions may share less information between teams than more loosely organized businesses that emphasize collaboration.
S for support
All businesses need help from administration, payroll and human resources, and customer support. Business partners and suppliers also may serve in support roles, and an operating model should specify how that works.
T for timetable
Trains run on a timetable, and so does a business. For example, an operating model for an online retailer might set a timetable of three days for shipping an order through delivery to the customer’s door. The business also might set a quarterly calendar for planning and budgeting conferences, and monthly reviews of team and employee performance.
Operating model example
PepsiCo is an example of a large multinational company that modified its operating model to increase sales and expand through diversification and digital marketing. Unlike its main rival Coca-Cola Co., which focuses on beverages and has no food or snacks business units, PepsiCo started moving into food products in the 1960s. As of 2022, the company’s food divisions generated almost half of the company’s $13 billion operating profit. The company’s leading brands include snack foods Lay’s potato chips and Doritos, prepared foods such as Quaker oats and Life cereals, and beverage brands including Pepsi-Cola, Gatorade, Tropicana, and Aquafina.
PepsiCo has more pricing power in snacks and prepared foods, where it dominates the industry and has a competitive advantage. The company’s Frito-Lay subsidiary has almost 40% of the US savory-snacks market, six times more than its nearest competitor. Its extensive value chain and distribution system, combined with strong relationships with food retailers and convenience stores, allow it to be more of a price maker in this industry.
PepsiCo also gives its brand and geographical divisions a degree of operating autonomy, in contrast with Coca-Cola’s more centralized model.
PepsiCo uses three distribution channels: direct-to-store delivery using independent bottlers and distributors; delivery to warehouses where big customers can store less-perishable foods and beverages; and using third-party distributors to serve institutions such as restaurants, schools, stadiums, and other venues. This also includes selling directly to consumers through its ecommerce sites Pantryshop.com and Snacks.com, which PepsiCo introduced during the COVID-19 crisis in 2020.
The company bottles most of its carbonated drinks in North America, but uses some independent bottlers, particularly overseas. It operates factories that make Lay’s products and other snacks, as well as Quaker oats and other prepared foods. This requires an extensive supply and delivery chain, with potato and grain growers in North America, as well as suppliers for packaging.
Operating model FAQ
How do you know if your operating model needs to be updated or revised?
Your operating model may need to be updated or revised if your business isn’t hitting its goals. It may also need to be updated if your business has outgrown the original operating model designed when the business was smaller.
How can you align your operating model with your overall business strategy?
Imagine a company that grew rapidly but is now having problems with customer satisfaction and rising product returns, either because customers received the wrong merchandise or they disliked the quality. Low customer satisfaction is a drag on fulfilling the goals of the business strategy, which might include winning a specific share of the market. In this case, the company needs to revise its operating model by updating its order-fulfillment team and sales-processing software, or by changing suppliers for better products.
What role does technology play in supporting your operating model?
Technology plays a central role in any operating model because almost all businesses today rely on information technology to some degree. Without software, telecommunication, and a high-functioning website, for example, a business stands less chance of succeeding.