Why We Need To Embrace Complexity

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One of the hobbies we’ve (rediscovered) since the start of the COVID-19 pandemic has been making Lego sets. 

Since none of the Legos were organized, we would take our big box of Lego mixed with several sets from Star Wars to basics, a Lego instruction guide (luckily we saved all of those), and started to build. 

It is a very tedious process – great for situations where you have to stay at home- where we would go step-by-step in the instructions looking through the big box of blocks looking for the right pieces. 

We’d discover pieces from old block sets, and of course the oddly detached arm or head from the Lego characters (don’t ask why).  

As we progressed, there were a fair number of times that required improvisation – right block but wrong color. 

We did not have “perfect” sets, so we had mechs that had only one arm or an AT-AP that had blue legs. We’ve slowly amassed a collection of Lego sets of incomplete figures and sets. 

Getting it right is complex. What we were building is complex. To build what we wanted to create takes a lot of input and instruction to get there. 

Complexity is good and we should embrace complexity. 

 

Complexity Makes Us Unique

In many of our conversations with founders, the question is often centered on getting to point A to B faster. It’s about what’s the answer. 

The actual answer and the reality for most is the achievement of the “10-year-old overnight success”. 

Building success is complex and requires knowing what pieces are needed, how to manage those pieces, and to do that well over time, which often means many adjustments and changes along the way. 

This is because solving hard problems is complex. 

If we use venture capital math (see this great video by Hustle Fund co-founder and partner Elizabeth Yin for a great guide on VC math), 90% of the companies in the average VC portfolio are destined to fail. This is built into the investor’s model. 

Money helps, but even the investors putting money into your company expects most to fail.  

The real jewel is not in eliminating complexity, but in understanding how to navigate and take advantage of complexity. 

This was the beauty of the Apple iPhone, a pair of Allbird shoes, and email marketing software by Mailchimp. None of these products or services is easy to make or deliver. 

The ease of use for the end-user should not be confused with making removing complexity. Quite the opposite. This adds another level of complexity that when done right, adds to the moat of competitive advantage these companies aim to create. 

 

Complexity Is The New Normal

If COVID-19 has taught us anything it’s that change can happen in an instant. Whole economies, human movement, and interaction can be shutdown without warning. 

It also taught us just how resilient our businesses are, and in many cases what is needed to make our businesses more resilient – if not thrive – in the future. 

As our society and economy begin to slowly reopen how we adapt to this new normal will depend on how we adapt to the complexity of the new rules of the game. 

How businesses operate, interact with customers, and grow will evolve. In many instances, businesses will no longer be recognizable to the world before the pandemic. 

We are quickly moving from simple adaptation to the swiftly implemented shelter-in-place rules, to looking to the foggy future to determine what’s next for our businesses. 

This starts by understanding shifts in our inputs.  

 

Shifts In Inputs 

In our world, we think of inputs as the drivers of decision-making. 

How well we collect, understand, and assess improve the decisions we make. This is true with how products are made, what markets to enter, and how we price and monetize our products. 

This is not an easy process, and many will do little if any at all to sufficiently collect the inputs needed to make necessary decisions. 

In the new normal, it is vital to understand how these inputs have changed for our customers not only in their personal and professional lives but also in the context of our products and services. 

Learning whether the customers we believed were our “ideal” customers is still valid. If so, then what do they expect to change in how they consume our products and the perceptions they have for our category. 

While there is much higher-level evidence for what is shifting in the market – such as the acceleration of work-from-home and eCommerce spending – what is less clear for many businesses is what does that mean to them and what decisions to take. 

Take for example a VR software company we were asked to advise on for their pricing strategy. With shelter-in-place, more people were consuming digital media more than ever and demand for more content was as high as it has been in recent memory. 

There was pent up demand for more and new. Yet when this company conducted customer research, they found that more than 45% were not willing to spend more than $5 per month for a new premium VR software the company was looking to launch. What happened? Didn’t the pandemic create pent-up demand? 

This research led the company to reconsider who really is their customer. They re-evaluated what components of their offer – both the basic and premium software packages – needed to change to align with the needs and willingness to pay of those customers. 

For this company, better inputs helped to reframe the questions that needed asking and re-focused the path the company would need to take. 

This enabled the company to then shift focus to the business model. 

 

Rethink Business Models 

When looking back at past market-shifting events and downturns, are shifts in business models. This includes businesses changing models altogether or for others the creation of new business models. Two prominent examples are the rise of freemium and subscription-based models. 

Market-shifting events create new perceptions of what is essential, and what customers are willingness-to-pay for and how they want to pay. These new realities make it critical for businesses to rethink their business models.

For the VR software company, collecting and assessing inputs during a pandemic raised important questions about the business model they looked to pursue – a new subscription model. 

Pursuing a new business model made sense for the company. The benefits of a subscription model for the company included more predictable recurring revenue, more customer “stickiness”, and a business model potential investors have grown to like. 

Except the company learned their customers did not understand the subscription as it was packaged, and this changed their willingness-to-pay and perception of the price. This insight put into perspective what potential challenges and requirements exist in marketing and converting these customers.  

Changes to the business model will be needed. The new normal requires it. But now we take the complexity of the today, and form decisions enhanced with greater clarity 

 

Reduce Dependencies

In the decisions we make navigating complexity, getting from A to B requires dependencies. 

These dependencies are there assumptions or requirements to move the ball forward. 

Sometimes there are external dependencies such as changing regulations and pandemics. Others are created internally, by businesses. 

How many dependencies does your business have, that are not all necessarily in your control, to move from X to Y? 

Just a few months ago, the playbook to build a growth company was to build an MVP and then raise capital. 

The new normal shifted this goal post, and for many startups, this is a dependency your business may no longer be able to count on. 

Investors are looking for more strength in companies as a business. Is there revenue, real revenue that can grow without a constant refresh of capital? Do customers really need and want to pay for your product? 

Even prospective hires are reevaluating the companies they may or may not join. With instant layoffs at smaller companies and startups, and even the larger scale cuts in well-capitalized companies (see Airbnb), the rules are changing. Stability or a demonstration of future stability (usually by achieving financial independence) is going to be a must. 

Businesses will need to adapt and create even more strength in the organization they build. One of the ways to do that is by reducing how many dependencies your business has to move forward. 

There are potential trade-offs such as raising less capital or growing at a slower rate. But today’s world is forcing leaders to ask, “what are you building, and is it strong enough?”. 

 

Final Thoughts

The COVID-19 pandemic put a spotlight on the challenges ahead of us. Rather than run from complexity, these difficult times allow us to embrace complexity and create new opportunities. 

Those companies that are agile in how they re-examine and re-think their businesses will be better positioned to manage the complexity ahead. 

The rules of the new game have yet to be written, but waiting for certainty and simplicity will quickly dilute any differentiation created to date, and reduce opportunities to accelerate new competitive advantages in the future. 

How are you navigating the complexity of the new normal? What challenges is your business facing managing complexity? Let us know what you think!

 

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Build Your Financial Independence Strategy Map (Part 2)

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TL:DR

  • Achieving financial independence is going to be a core competency and competitive advantage in the coming decade.
  • Startups need to design the map they will use to achieve the financial independence right for their company and objectives. 
  • Working on the core components of financial independence empower startups with greater maneuverability to build stronger businesses and increase their attractiveness to investors and stakeholders. 

In our last post, we discussed the rise of financial independence as an important theme we will hear more about in the coming decade.  Startups are increasingly assessed (and scrutized) as more than a center of innovation, but as a business capable of delivering disruptive innovation and technology. 

That does not mean startups and founders have to go it alone. 

In the second part of our financial indepedence series, we share a guide on the core components to building a financial independence strategy , and how to start making decisions to help you achieve this critical competitive advantage. 

 

Navigate Your Strategy With A Map

For most startups, going it alone isn’t as easy as Prince Harry (who had a tidy trust fund to fall back on) or Princess Meghan (who was an established and capable actress who had her own career prior to joining the royal family). 

Creating a financial independence strategy requires a thorough assessment to form a plan forward. To help the process we outline four important components of financial independence to assess and work towards. 

 

1. Define the strategic intent 

Financial independence – if achieved – is liberating and empowering, but the question leadership teams should be asking is why does your company need and want it? 

There are many reasons why a company strategically chooses financial independence, including controlling how the company will grow and monetize, whether to take external capital (and need to take more again in the future), or set the company up to quickly seize future opportunities. It is vital to understand how the company will look in 2, 5, and 10 years into the future and how this strategy will materially impact the company. 

The other part to this assessment is about execution – to define what it takes – time and resources – to achieve a financial independence strategy. Are there skills, people, product development, capital, or other resources that are required? How will the company acquire what it needs? What are blocks within the company to commit to this strategy?

These are hard questions that require more than soul-searching but a rigorous assessment of known information to drive a conclusion. The goal is not creating absolute certainty of the future, but to envision the pathway to the future your company wants to create.  

 

2. Rigorously design and test the business model

At the core of the financial independence strategy is a defendable and sustainable business model. One of the top 10 reasons for startup failure is a product without a business model. This is a risky way to build a company, and one that takes the company further away from financial independence. 

In our experience, the best business models are rigorously designed and tested. This means creating hypotheses about what business models are relevant to the company’s value proposition and objectives. This is followed by an iterative process of testing, refining and testing again. 

Ideally this process starts from the very beginning, but for companies that are a year or more into existence, tend to use the business model they started with – often adopted from another “comparable” company – and do not work on this. 

No company is “stuck” to their business model, especially if it does not get them onto a path that will lead them to financial independence. What is crucial is that the business model is built around the value delivered to customers and is aimed towards financial independence. Companies can be creative, and draw from outside their traditional industry, as long as they design the model right for their company, product, and customers. 

 

3. (Re)gain pricing power

One of the challenges to a successful financial independence strategy is the loss of pricing power. As value is given away through poor pricing, companies need to offset the per unit revenue loss with increased volume or customer acquisition. This is a challenging (and costly) calculus to manage when pursuing financial independence. 

Companies that are often best positioned for financial independence are those that have strong price management. This includes now the billion-dollar public company Atlassian to designer water bottle brand S’well (with more than $200M in sales), to mainstream companies such as Apple and Netflix. 

Gaining pricing power is not only vital for any financial independence strategy, but creates a unique competitive advantage to do more with pricing to win new markets and customer segments. 

Pricing power is not just the output (price level), but is the pricing strategy and pricing design created to extract the right monetary value, for the right customers. This is a process that market leading companies are constantly working on to master, and one startups can start on right now. 

 

4. Leadership driven, stakeholder supported

Any pursuit of financial independence starts with the leadership team. It can be a leadership team of one or many, but there needs alignment on why a financial independence strategy is necessary and the steps to get there. 

The importance of leadership goes beyond strategy and philosophy, but also in decision-making. Companies are faced with trade-offs, where decisions must be made on deals or opportunities that can impact the pathway to financial independence. A disciplined and aligned leadership team is better positioned to navigate these situations than those where there is fragmented and compromises lead to further complexity. 

In addition to leadership, is the support from other company stakeholders which include team members, investors and advisors. Pursuing financial independence can change the way the company does business, makes decisions, and the results achieved. Having the entire team rallied around the strategic intent is critical. Having the conversation early and often is required. 

 

Final Thoughts

One important theme that will rise in the new decade is the need for financial independence, and the action (or inaction) companies take to adopt and achieve this strategy. 

Growth at all costs is no longer the only way to build companies and create markets. Instead more fundamentally strong companies focused on financial independence are on the rise. This trend will continue as scrutiny increases on companies to not only build incredible products, but to build busiensses that support the development of more products well into the future. 

To ensure companies are better prepared, it is vital that they receive the right support to develop right building blocks.  Like building a company, financial independence is a process, but one that can empower companies and founders to realize the vision they set out to build for years to come. 

 

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The Theme We Will Talk About In The New Decade (Part 1)

theme financial indepedence

TL:DR

  • Growth without pathways to financial sustainability are no longer tenable (and tolerated).
  • Startups need to work towards designing achievable business models that support greater financial independence.
  • Greater financial independence will give entrepreneurs longer horizons and maneuverability to build stronger companies.

 

Earlier this year, Prince Harry and Princess Meghan announced they were “stepping back” from the royal family. One of their reasons is because they wanted to secure their own financial independence. Across the covers of pop culture publications and UK news outlets, the decision (and the subsequent happenings) shook the world. 

They were not only distancing themselves from public money subsidized roles they had as royals, but wanted to create flexibility and dictate their own path forward which includes where they live, what they work on, who they are accountable for, and how they spend their time. 

For the prince and princess, they wanted to decide their destiny and they knew the pathway to achieving this was securing financial independence. 

 

Shifting Tides

Increasing uncertainty and scrutiny was a theme we highlighted at the start of last year, and throughout the year, we saw increasingly greater scrutiny of startups, their business models, and the rationale justifying their financial viability. 

We had “untouchables” like WeWork get to the brink of an IPO only to find itself withdraw its bid to go public, get devalued, and layout staff. Less extreme events include companies such as Postmates pull back from IPO plans, and a slew of other startups who delayed potential scrutiny of their businesses.

 

Pressure from public markets

Companies such as Casper – which was losing $342 per mattress sold – went public but at third of their private market valuation. 

Other unicorns from Peloton and Slack, have not fared much better as public companies. Part of the reason is new pressure about their financial performance, and defensibility of their business model they otherwise did not face as private companies. 

Yet the challenge to even get to this stage (IPO) these days is unicorn status ($1 billion private market valuation or more). This creates an odd paradigm. To reach the level needed to go public, requires the capital and growth of a unicorn, but the type of business needed to reach that status may not be able to sustain the scrutiny of non-private investors and stakeholders. 

This creates a direct challenge to the defensibility of the business from the value proposition to its business model.

 

Stress on business models

The pressure is not only on companies on the brink of an IPO. The start of this new year has seen even more companies finding themselves re-evaluating themselves as a business, and starting with cost-cutting to ease some of the financial burden of their business model and go-to-market strategy. 

Unicorns such as Bird began reorganizing themselves. They laid off staff and pulled out of markets to rationalize their business operations. Bird competitor Lime also did their own round of cost cutting by laying off 14% of staff and pulling out of 12 markets.

But this business rationalization is not limited to scooter companies. 23andMe, Playful Studio, Oyo and countless more unicorns are also going down this path.

Simply put, many companies have been defending the capital they currently have because of uncertainty to access more capital in the private markets, but fundamentally their businesses are not built to make enough money to sustain itself. So these companies need to make the capital they do have go further than originally planned, and find ways for their business economics to work better for them in the short and long term. 

Marketing expenses are increasingly getting unsustainable. Take Unicorn a scooter startup founded by Tile founder Nick Evans, who had to close down his company due to unsustainable acquisition costs. Evans states,  “Unfortunately, the cost of the ads were just too expensive to build a sustainable business.” They not only closed the company, but did not have the capital to fulfill the 350 orders they did receive from customers for their scooters. 

Popularity shouldn’t be confused for viability. And a core component of viability is, at minimum, a reason to believe there is pathway to financial independence and build a company that is building a business, not just a product. 

 

Positioning For The Future: Financial Independence

With ever increasing visibility and scrutiny on startups, a growing theme we will hear is the need for, and decisions-made to help companies achieve financial independence. 

Does this mean financial independence means profitability? Eventually. 

Financial independence is a process and mindset, as much as an outcome. Being on a pathway to achieve financial independence is a function of the systems and processes created and put in place, led by a disciplined leadership team. 

There is an intentional-ness to financial independence, because it is a goal for leadership teams to work towards. Pursuing financial independence also has significant implications on how the business operates including: 

  • How the business will make money;
  • Expectations on growth (trajectory and speed); and 
  • Resource requirements to scale. 

Ultimately, financial independence means companies have created a business model and path where it can still materially grow and create markets, but also achieve its own profits. 

Financial independence enables companies to have a wider array of strategic and tactical options today and into the future. This includes the resources available to invest in the team, new business and product opportunities, and partnerships. This also involves the capital and investment that must be raised and secured. 

In the end, when a company pursues financial independence they are looking to create scalable revenue and profitability engines that decrease the need to seek outside capital, and the expectations that come from external stakeholders. 

It is important to note that financial independence and seeking external capital or investment can coexist. One example where both can be achieved is 1Password, a cloud-based password management platform. 

1Password pursued financial independence since the very beginning. They built a self-sustaining business that was profitable, and remained profit for more than a decade. 1Password had 1 million users, and 50,000 customers paying for their enterprise solution (Enterprise Password Manager) including 25% of the Fortune 100. 

They built an impressive track record, and after 14 years since its founding, 1Password decided to take outside investment ($200M). The decision was strategic and intentional – to help pursue specific growth programs and objectives.

Financial independence is not going to be top of mind for everyone. As stated earlier, this strategy is created and led from the top. This is true for young companies and mature growth companies alike. 

 

What’s Next?

Achieving financial independence will be a core competency of startups in the new decade. Startups will be expected to demonstrate their business acumen more than they have in the last decade. For external stakeholders such as investors, startups building financial independence capabilities today will not only help increase growth efficiency, but will create a stronger portfolio of companies. 

Where do we go from here? 

To help companies evaluate what financial independence means for them, our next article will outline the core components to build a financial independence strategy map and how to navigate the process. 

Is your company on the road to financial independence? How does your company think about financial independence? Let us know what you think! 

 

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Return of the P-Word

The headlines have been rough for growth startups in recent months (insert link about WeWork). 

It has been particularly challenging for growth startups and their investors looking to take their company public. For what were once the darlings of the investment, tech and media worlds, suddenly the music has started to slow, if not stopped (see Postmates). 

In some ways we’ve now reached a peak when you have a twitter battle between a prominent investor and a professor on the merits of these companies’ existence and prospects of survival. It turned ugly (or entertaining depending on your seats) when they started to make wagers online to show “skin in the game”.  

No, this post isn’t a takedown of VCs, WeWork, or any other VC-backed growth company. 

What is rising from these debates is something more subtle and important – a discussion about how businesses are grown and their pathway to profitability or the “P-word”. (Sorry, I know many were expecting me to say pricing, but we’ll get to that) 

Let’s go over how we got here and what to consider when thinking about the profitability question for your business. 

 

How Did We Get Here? 

A big part of the current debate has been around the strength of high-growth companies as a business. The concerns raised ranges from corporate governance, culture, business model and, yes, profitability (or any hope for profitability).

Many of these companies such as WeWork has through capital by investors with a “grow at all costs” strategy. Through this strategy many business fundamentals have fallen by the wayside. Greater scrutiny of how companies have developed as a commercial enterprise, beneath the veneer of technology, innovation or disruption – has been a deeper look into how, if ever, their business model will enable the company to ever make a profit. 

For anyone following how these high-growth startups that did make the leap in the public markets by IPOing has not fared as well as they did in the private markets led by venture capitalists. The price the public market is willing to pay has differed considerably to the private markets. The exception appearing to be those companies with lower profiles but are profitable. 

Despite all the bad rap many VCs and investors have been getting as of late, not all use the same strategies. Many are equal-parts about innovation, growth and basic business fundamentals. 

 

Why is Profitability Important? 

Profitability or at least the pathway to profitability asks some fundamental questions about the company. It looks at how the company is run, and will be run into the future. It’s not just about managing costs, but how equipped (and aware) the company is to capture and defend revenue growth opportunities. 

Pathway to profitability of course looks at price. Many of these companies operate in highly competitive markets with new competitors emerging. To combat this competitive environment, many entrepreneurs engage in unsound business practices such as price cuts and discounts to acquire customers. This possible because investors are willing to subsidize them and this strategy. Unfortunately, the reality is this is not a sustainable strategy to keep customers.

Evaluating the pathway to profitability raises fundamental questions about any business, and whether the business model actually works. It is is incredibly insightful into not only the current state but also where the company will go. That’s why the question around profitability is so helpful when evaluating a business and its leadership. 

 

Ways To Consider The Profitability Question Properly

Consideration #1: Remember, it is your choice, as the founder/entrepreneur, on how you want your business to grow. 

There are tradeoffs for any decision you make as a business leader. Being aware of how you want your business to grow will define the commercial strategy you pursue. This will define what pathway, if any, to profitability your company will or will not have. 

Those founders such as Katrina Lake of StitchFix, Eric Yuan of Zoom, Ethan Brown of Beyond Meat created innovative, high value companies that are profitable. 

For those who believe you can not achieve unicorn scale and be profitable look at the incumbent in WeWork’s market – IWG. It’s possible, but it takes leadership to steer the ship in that direction. 

If you are raising capital, this why the best investors always recommend founders to do as much due diligence on the investors they are seeking funding from. Everyone has their own definition of growth and success so understanding and making an informed decision is critical. 

All this requires asking yourself the hard questions. This is both empowering and frightening at the same time. Many entrepreneurs are stuck in a chicken or the egg game, where they need capital to launch or grow, but may want to grow more slow and steady. 

 

Consideration # 2: You need to build the right business model for a pathway to profitability.

There is no cutting corners on the building the right business model. It takes research and rigor to determine what model will best position your company for growth and profitability. 

One of the most common realization companies face early and often is most customers don’t want to buy their product.  This is usually a product of the data they are collecting, but more importantly the data they are not collecting. 

To make better decisions on the business model, this means collecting the right information about the right customers. You need to know what elements of your product is delivering the most value that customers are willing to pay for. You need to know what is not working in your business model, and what to build (or not) build to achieve the optimal value exchange (you give them your product, and they pay you for it). 

When you are not looking at the right customers, they are making you focus on the wrong things. So when you do invest in marketing or branding, you are making a decision on two unrelated things; which can be a costly exercise. 

 

Consideration # 3: Pricing matters.

When most founders think about profitability they look at two big metrics – revenue and cost. Except when they think about that revenue figure they only see one side – volume. 

It is often taken for granted that revenue is made up of volume AND price. This means there are two powerful levers companies can use to influence revenue and therefore your pathway to profitability. 

In a survey we conducted of more than 100 startups from pre-seed to growth stage (Series C and later), only 31% were highly confident their prices reflected their customer’s willingness to pay for their product. In the same survey, more than 45% stated they were unsure whether their customers are willing to pay more for their product. 

This is a lost opportunity for companies looking to build or accelerate their pathway to profitability. But it still remains one critical thing they can do today to change course. 

 

Consideration # 4: It’s harder (and more expensive) to create profitability using a model not designed for it.

The challenge to pivoting towards a profitability mindset is both structural and psychological. The structural challenge is that the team and the way of growing has increasingly been engrained in the way of working. Targets and incentives have been designed around this. 

When the goal has been to grow month-on-month 100%, but due to a shift in the business model or go-to-market strategy, growth “slows” to 70%. Is that bad? How does the team and stakeholders react? 

That’s when the psychological forces kick-in. As founder and CEO of Bird – the unicorn scooter startup – Travis VanderZanden says, “I’m an ex-growth guy, and sometimes it’s painful for me”. 

Profitability is slower and at times, feels like more work. It’s easier to find ways to fill all the seats in a restaurant, until you realize you made no profit and have no money to pay your suppliers and staff. In the long run, the work to install earlier components for profitability will pay off. 

 

Consideration # 5: Creating (and achieving) a pathway to profitability creates a buffer to any economic downturn.

It goes without saying that when your company makes money – profit – it will put you in an enviable position in the event the economy goes south and what was more plentiful capital starts to get harder to come by. 

More important, as an entrepreneur, you have the confidence in knowing you have a business model that can self-produce resources (read: money) needed to weather more difficult economic climate. 

 

Final Thoughts

I recognize that these views may be a less popular perspective. It asks hard questions about the company and the foundation on which it is built (or being built). 

Many of these questions have not been answered or attempted to be answered. 

But more and more companies are facing the reality that no profits or no reasonable pathway to profitability is a difficult proposition to sell. This is true for startups that have raised billions, as it does to the new startup looking for its first customers and investors. 

There is increasing scrutiny to not only the innovation and product you are creating, but scrutiny of ultimately what you are trying to build: a for-profit commercial company. 

Profitability does not mean stifling innovation and disruption. Profitability means living another day to disrupt through innovation. 

It can be a hard pill to swallow, even for the most innovative and well-capitalized companies such as Dyson. Famous for their vacuums and fans technologies, Dyson has been working on a fully-electric automobile and allocated more than $2 billion for development and production. Yet after building a team of more than 500 employees, Dyson has abandoned the plan because it was not ‘commercially viable’. No one would argue Dyson is not an innovator or disruptor. 

While not all components of the business is developed and mature, it does mean the entrepreneur is ultimately responsible for knowing (or getting to the point sooner rather than later) how to build a commercially successful business. 

As history has shown, pathway to profitability is one thing that rarely gets turned around in a good way – or without enormous pain – when the foundational pieces are not developed and managed. 

 

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Fundamentals Of A Winning Business Model

At the core of every successful company is a strong business model.  

Your business model is the blueprint for how your business will make money (or not). But for many companies starting out, not enough time or effort is put into identifying the right business model for their business.

This can turn out to be a very costly mistake.

In a study by CB Insights on the top reasons why startups fail, a top ten reason (coming in at #7) is going to market with a product without a business model. 

It doesn’t have to be this way.

Designing the right business model for your company, product and goals are very much in your control. From our experience working with fast-growing startups to global corporations, we cover core elements to building a successful business model.  

 

What Is A Business Model?

Let’s level set by making sure we understand what a business model is, and is not.

According to John Elkington and Richard Johnson, “business models are what connects technology potential with real market needs and consumer demand”.

Another definition from management theorist Peter Drucker is that a business model is “assumptions about what a company gets paid for”. 

So there are two vital parts to understanding what a business model means for your business:

  • A connection between your product or services and the needs of your customer and market; and
  • A structure that defines your customer’s willingness to pay.

This is important because to build the right business model it will depend on how much we know about our customer, market, value proposition, prices, and financial requirements and resources.  

This requires information – the right information – to help us assess and inform the right business model for our company.

No small task, but all work within your control.

 

Why Your Business Model Is Critical To Your Company’s Success

Entrepreneurs and businesses understand that they need a business model, but too many do not understand what makes a good business model for their business.

A good business model answers core questions about how your business will operate, as well as the viability prospects of the company. A great business model creates a competitive advantage embraced by customers and differentiated to the competition.

Given the high stakes, your business model should not be left to guesswork and chance.  

 

Create and deliver value: How you bridge the gap between your solution and customers

Why your customers need a new product – more specifically your product – is not always obvious. This is especially relevant for new technologies and innovations.

Your business model is the bridge between the solution your company offers, and the needs and willingness to pay of customers. It is how customers make sense of your value proposition and the pathway to acquiring the proposed solution. 

 

Financial viability: How your company makes money

At the core of any business model is how a company intends to make money and profit from its products. The quality of the business model for a company and its product reflect whether enough money will be generated (read: profits) to achieve viability.

The business model also reflects how well the company understands its customer and market, to make a commercial enterprise capable of generating revenue and eventual profits. If the business model isn’t right, this can wreak havoc on the financial viability of your company.

 

Strategy: How your company wins customers and the competition

Too many companies – big and small – have a tendency for a ‘follow-the- leader’ mindset when selecting a business model. This can be an actual market leader with a commanding market lead and is setting perceptions on the value and prices.

Then there is the perceived market leader, where within an industry – often in nascent or technology-driven industries – there are companies competing with one another despite the vast majority of prospective customers don’t know the company let alone the value proposition or pricing competitors.

What this means is there is business model complacency that occur for many companies, leaving potential profits on the table, but also a missed opportunity to differentiate from competition. By creating business models that are like everyone else, there is greater pressure to justify the value proposition and the pricing question of “is it worth it?” – a tall order for many startups and new ventures.

 

Key Components Of A Business Model

Like pricing, a good business model doesn’t start by simply selecting between a menu of models. No, a good business model starts by understanding your customers for your product created by your company. A great business model is designed for the company, it’s customers, and the goals the company aims to achieve.

 

Your value proposition   

Developing an effective business model requires a clear identification of the value proposition and how you can differentiate yourself in an often-times crowded market.

As Peter Drucker famously says, ”Customers don’t buy products, they buy the benefits that these products and their suppliers offer to them.”

We often take for granted what our product actually does for our customers, leading to business models built on assumptions. Companies that are attempting to disrupt an industry, are particularly prone to this because they hold the belief that the disruption itself is the benefit.

Yet human nature is often resistant to change if not rejects change outright in favor of the familiar. That’s why when you go to the purchase page of some software companies you see a long list of features and benefits – a list made for everyone, and thereby for no one.

 

Your customer

The process of defining the value proposition and the benefit your product aims to deliver, the next question is, “who is the benefit for?”.

In our project experience working with companies from high-growth startups to large market leaders, the question of who is actually the company’s customer is commonly overlooked.

We take a tiered approach to the customer question that is based on the degree of connectedness the customer segment has with your product.

Imagine a series of concentric circles – like the rings of a tree trunk – where each circle gets smaller as you get closer to the center. While in aggregate, all the circles combined represent your desired market, it is those circles closest to the center that care most about your product and ideally, your brand and company.

Defining who those customers are, what they value most and the benefits they need to derive – whether through your product or a different solution – is critical. This enables you to create a business model aligned to your customer; not someone else’s customer.

 

Your pricing

The best companies are pricing experts because one of the most important parts of your business model is the pricing strategy.

An effective pricing strategy maximizes revenue and demonstrates that you really understand how your customers value your offering. The amount of resources dedicated to developing a pricing strategy also reflects how much time a company has spent trying to extract value out of its products. This involves monetizing different aspects of the product to serve the largest possible audience.

More advanced pricing strategies may use tools such as targeted discounts or promotions to increase revenue, and the use of other pricing design tactics. A good pricing strategy that captures the value out of your offering increases the odds that your business will be sustainable in the long run.

 

Your goals and resources

Creating a business model for your customer and company means self-discovery by your company of what it wants and needs to achieve. This can be to maximize revenue. It can be to penetrate the market and win market share. Creating a proxy for success steers how the business model is designed but also make changes as needed.

Creating a good business model also needs to account for resources needed to achieve your defined success. This may mean to make changes on how your company sources materials or talent, how your company acquires customers or shifting the business model.

When companies adopt a business model of market leader or look-a-like company, many input and output assumptions are made often to the detriment of the company. Rather than methodically evaluating inside on what is and is not available, attempts are made to fit their square (the company) into a circle (competitor’s business model).

 

Building The Right Business Model For Your Company

The types of business models available to you depend on the results of your work on the different components outlined above. This means a great deal more time spent on research and discovery as it is on selecting from a menu.

Even businesses that look similar at first glance could have dramatically different business models. Consider video game developers such as Electronic Arts and Epic Games. Electronic Arts have a traditional gaming business model and charge $60 per game up front. Epic Games uses a “freemium” model where games such as “Fortnite” are free to download and gamers then pay for in-game upgrades.

This has proven to be an effective strategy as Fortnite earned $300 million in April 2018, almost six times the first-month sales of EA’s highly anticipated Star Wars Battlefront II. Epic Games’ business model requires the company to engage customers over an extended period of time but Electronic Arts just need to make that first sale. Their respective business models don’t exist in a vacuum and are designed to achieve commercial objectives

It is also important to be mindful of potential pitfalls when building a business model. If the price is wrong, the analysis that follows will be fundamentally flawed. Targeting the wrong customers means that the business model will emphasize the wrong product attributes. Every assumption in a business model needs to be checked and rechecked.

 

Final Thoughts

A company’s business model is a key success factor in both the short- and long-term.

A good business model identifies the core customer, their pain points, and how specific products or services can address those issues. The best and most disruptive companies create not only amazing products but a business model that connect paying customers to their solution.

But success comes not only through the ultimate model these companies chose, but the fact that the model was uniquely their own, for their product and customers.

Business models might serve as a blueprint for a company’s future but those plans aren’t static. Business models evolve over time as companies better understand their customers, the value of their offerings, and their competitive positioning. Evolution doesn’t necessarily mean a complete overhaul. It is a commitment to making actionable adjustments (e.g. pricing, product offering) that meet the needs of the market for now and beyond.

 

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