Tl;dr: Your startup business model needs to work. That model needs to pass the numbers and narrative test if you are to have a chance to ever make a profit
Here’s a question for you. Do you want, no need to be successful? Are you working crazy hours and things just not quite sticking? Do you get emailed back from investors when fundraising, but barely more than a meeting?
If so, this blog is for you. Something is missing. Something important. Do you want to know what it is?
We’ll go through what “it” is so that can maximize your chance that you aren’t wasting your youth, and will actually bank serious cash!
Fair warning. This is a long blog. It’s filled with learnings. Not sure you want to put in the time to really learn? Here is what some founders have responded after it. Even printing it out.
Everything is amazing!
We live in an amazing epoch. Every day you experience a small miracle. Even a few decades ago, things you take for granted daily would be viewed as totally insane or even magical.
Where am I going with this?
Have you ever walked out of McDonalds and smiled? I just did.
I wanted something fast to eat, so I walked in, paid 2 euro and got a double hamburger which was eaten by the time I was back to my desk. I ate cooked food in under 5 minutes.
Do you know how crazy that is? Think about it. McDonalds is constantly able to churn out consistent ‘quality’ with almost no downtime.
It made me think of a movie called “the founder” which you have to watch if you haven’t seen it already. Why?
The movie kicks off with Ray Croc AMAZZZED by how the McDonalds brothers churn out food. I mean no one had ever seen something like this! It’s normal to you now, but it was a genuine process innovation of the food business model.
So, in a sentence, what’s amazing about your startup business model?
Don’t think, say it!
Mutter it under your breath quietly so people don’t think you are nuts.
- How have you innovated in your business model?
- Is the innovation in desire or process?
- Does it pass the narrative and numbers test? What are your key assumptions?
If you had to think you have a real problem.
I’m copying x business in America, it worked there (read: VCs gave them cash a few times) so presume they thought about it and it will work for me. #Fail.
You don’t know your business model. But you are about to.
The importance of business models
Inspired by the blog post I wrote yesterday on direct to consumer, I’d love for us to spend some time thinking about the importance of startup business models and how innovation and one other absolutely critical factor (I’ll tell you it in a minute!) will make or break your business. Why?
Well, trust me. I’ve talked to hundreds of founders and invariably end up digging into the fundamentals of their business (aka business model) after about 5 minutes. Why? Nothing else matters! Also, in 99% of the cases the fundamentals are not there, and no thought has ever really been spent on them. So that’s what we end up talking about.
This. Is. Crazy.
Yeah, I thought not. But here’s the amazing thing!
You can greatly increase your odds of success and scale the very peaks of industry by just getting your fundamentals right (and then working your ass off).
But watch out, this is really advanced stuff. It’s not going to be easy, but have you ever heard of a dumb founder who made it big? I haven’t.
Next to the picture of the definition in the dictionary, is a paragraph on how amazing their business model is. That’s what I want for you.
So what is a startup business model?
If you’re confused about what a startup business model is, that’s cool!
In the past, there was a lot confusion about what business models meant and so it even got a bad rap in the 2000s.
Michael Lewis challenged this negative perception when he wrote that the term business model is being routinely invoked during the dotcom boom “to glorify all manner of half-baked plans.” Though let’s face it, to some extent it was true: a company didn’t need a coherent strategy, special competence, or even customers… all it needed was a interwebs startup business model that promised massive profits um, sometime in the future, once we figure what to do with ‘eyeballs’?
A business model is a story how your startup works.
Read that again.
It answers VCs, your parents and Peter Drucker’s age-old questions:
- Who is the customer?
- What does the customer value?
- How do we make money in this business?
- What is the underlying economic logic that explains how we can deliver value to customers at an appropriate cost?
This is a less graphical foundation of Osterwalder’s startup business model canvas, which I think is overly simplistic, but everyone is told to use it, so why fight it. Well, if you haven’t studied business it’s probably a really useful tool for you to build a foundation of your knowledge.
But to make things really simple, a startup business model consists of two parts:
- How you make something
- How you sell something
Innovation is in how you make something or sell something better than before, or ideally both!
So back to the story telling analogy…
Creating a startup business model is a lot like an orgy. Just kidding. Got you excited there didn’t I. Dirty fecker.
No, it’s like writing a new story. You know the old adage that real artists steal… well, all new stories are variations on old ones. All the same. Titanic, whatever. Some Greek dude probably died in a boat too when a girl hogged the floaty thing. Smart ideas in this blog- all had by someone else and stolen by me, probably. Therefore, all business models are variations on what has been done before.
Now to be a little more technical, “done” refers to the value chain, something that underpins all businesses, even for those that didn’t get an MBA and think chain is a retail store. Btw, the value chain is the image above I defaced with two colourful boxes.
We already mentioned the two things startup business models consist of.
- How you make something: This is everything to do with rolling up your sleeves and making something. The design, purchasing, manufacturing, all of it.
- How you sell something: Identifying customers, reaching out to them and getting their attention, closing a sale and then the actual physical or electronic distribution of it
So basically, you can either make a ‘new’ business model by:
- Process innovation (making): a better way of making/selling/distributing something people already know and use (e.g. Warby Parker, Casper, Ford, Walmart, McDonalds)
- Desire innovation (selling): Creating something for an unmet latent need, or something no one knew they couldn’t live without (e.g. Birchbox, Airbnb, Apple)
Note the ‘direct to consumer’ model is typically a combination of both of the above. Furthermore, most great business models typically innovate across the whole value chain, meaning both points.
But where did this business model thing come from?
Be fortunate you have computers and Excel! Before the advent of the spreadsheet you discovered your business model by accident! You only figured out something worked post hoc.
The term “business model” started being common when IBM, Microsoft and Apple commercialised the PC and spreadsheet. How can you break down everything in your business model with pen and paper? If you have seen our fundraising models, you’d have a nervous break down trying to factor all the variables! Only with the tools and data do nerds get their analytics on! Sexy time.
Furthermore, with spreadsheets thinking developed around areas like the market landscape. With tools and market awareness together, you can finally link assumptions about how people behave to the bottom line- how you make it and how you spend it to make it. Excel and their forerunners made it possible to model businesses before they were launched. That’s pretty nuts, right?
But hang… Be honest, how much thought have you put into yours, so far! And did you only do It because you thought investors would ask 😉
So, now you know where the term business model originated from and why it’s rooted in value, let’s talk about assumptions, the mother of f-ups. These are a big reason why things go wrong…
What happens when you get it wrong?
Your startup business model is a bundle of assumptions you validate over time which are a part of a holistic, central thesis, that if these things hold true we will make money and become profitable. VCs will often develop an ‘investment thesis’ which should really be the same thing.
If your thesis holds up you will succeed. If their investment thesis was correct, they make out like bandits too. But what if your assumptions are wrong? Bad things can happen. And they often do… Let’s look at a case study.
EuroDisney. It was a disaster when it opened. My aunt actually designed all the lighting for it. Super fact.
They opened the Paris theme park in ’92 and did a Rocket Internet on the U.S. parks which print $$$. That means same assumptions… The assumptions that made the US parks work are the same assumptions that will work in Paris. Did their ‘business model’ transfer?
Core to their business model was that ze Europeans will spend the same amount of time and money per visit as yanks do on food, rides, and pointless swag. Or will they?
No. All revenue side assumptions failed like betting a fat kid will win on race day. Our dear American friends like it big and often… The French and other Continental brethren expected to be seated at precisely the same time for lunch and dinner, with German efficiency. So what happened? Facility overload, with long lines of snooty frogs. Eurodisney got nil points (say it with a French accent like you are in Eurovision). It all only worked after a dozen + key business model changes.
This is why Rocket Internet fails way more than you read about. Localisation actually matters. The… business model matters. So, let’s continue on.
How do you know you got your business model wrong?
Business models are a lot like teenage sex: everyone talks about it, nobody really knows how to do it, everyone thinks everyone else is doing it, so everyone claims they know what theirs is
Turns out a startup business model is like an orgy, well at least in a teenagers depraved mind. Or mine. Or both, probably.
Well, you know you messed up when you are desolate and broke! But more seriously, you know a business model does not work when you fail the:
- Narrative test: the story doesn’t make sense
- Numbers test: The numbers don’t make any sense (the P&L looks like a hobo and you smell it like a snarky TC article a mile away)
To explain these, let’s use grocery related examples.
The narrative test
Do you want to play a game?
You know Priceline ‘name your price’, right? Well they tried the same shizzle with soft drinks and failed the narrative test. Well, rather they came up with ‘Priceline Webhouse Club’ which did gas and groceries. You people could pick a price for cola and then Prieline would go to brand conscious FMCGs and say give us 50 cents off and we’ll buy a million of those bad boys!
Um no. Do you know what big companies are like? They spend millions on branding so you buy Coke NOT Pepsi (which is gross- Coke told me so) and now you want them to just buy coke like an asexual Kate Dillon in Billions!? Gosh, dang no!
It’s all very well to think you want to play power broker, but you need the leverage to play this game and the willingness of the suppliers to play too. Why would they allow Priceline to jack their swag and undermine their precious narrative of branding?
Computer (P&G and Exxon) says no.
Having said that. Kayak and co successfully did this to some extent by doing flight aggregation. Amazing.
So, what’s wrong with the narrative? They assumed big brands wanted to play in the sand box with Jimmy. Webhouse would in a Pavlovian sense, condition consumers to buy on price not brand. That’s an epic f-up.
To play power broker like Robert Moses (Big book!) you need to build up the leverage (pricing power) which means having product. You need product to build customer base.
So Webhouse did what Rocket Groupon did and paid for discounts out of their pocket (Well they did at the start with Starbucks).
They threw money around like a P Diddy party and a few hundred million dolla dolla bills later they ran out of cash and investors who believed the story. Sort of like Travis K… too soon?
The numbers test
Instacart and on demand businesses fail the numbers test. I presume you have heard of a concept called ‘unit economics?’
Groceries and food in general has crappy margins, and for the later, restaurant owners are cheap dick heads (Trust me, Delivery Hero). There’s been attempts for a long time. They raise money and flame out. Remember WebVan? Customers are also cheap and don’t want to pay for service, but expect a lot!
If you have thin margins on your supply side, and cheap dick heads on the other side, how do the numbers add up? Your business model unit economics (numbers) are as broke as MC Hammer. Insert something about CAC/LTV.
Actually, that’s so key. It’s such a SaaS thing, but do you know how to calculate CAC/LTV in ecommerce and what the benchmarks are? I have friends who run really big funded companies have told me they don’t either.
There are frankly grave yards of startups that fail both tests, or didn’t even know they had a pop quiz at all.
BUT. But. If you are not pushing the edge of possibility on the narrative test, you are not innovating. Later in this blog we’ll go through a long list of startups that pushed the bounds on this and you would have said failed the narrative test aka ‘that will never work.’ Only the founders proved you wrong. Note: I had a ready to go burger today 😉
What’s all this about business model innovation?
Glad you asked. Business modeling is the business nerds version of the ‘scientific method.’ You start listing your hypothesis’, and then test the null, revising when necessary. At its core, there’s two main blocks to innovate in, but each of those two blocks consists of a plethora of bullet points.
Now to some extent all business models have been created and utilised to some extent already. Sure there will be an innovation some point in the future, but there is a playbook of building blocks which will always be referenced.
At the end of this blog we will go through some innovative business models. Some are longer than others, because well it’s a lot of writing and you can do a bit of research is something sounds like it should apply to your business ;).
But my point is, how you combine the high level concepts and tweak them to your specific situation can result in powerful outcomes.
Business model innovation is in the specific application to your specific circumstances
- Dropbox utilised the freemium model pioneered by Gillette and subscription model pioneered by all sorts including Charles Darwin to profound results. The business model became the bedrock for their marketing and go to market strategy.
- Tupperware used the Singer franchise and installments business model and added on their own innovation called ‘Tupperware Parties’ and made out like bandits for decades!
Doing simple things really well creates powerful results. Of course the execution is critical, but without their innovative, specific business model, it doesn’t matter.
You need to start at the top of your business and work your way down sequentially. Profit doesn’t come from just getting in the right ball park, traction shows you are. Profit comes from optimising down the funnel. Profits are not important just because they extend your runway and possibly make you fundable, but because they tell you whether your model is working. It’s the ultimate feedback mechanism.
2016 was the year where startups wanted and/or needed to be cockroaches not unicorns. VCs are starting to actually talk about profitability. In the past few days, Suster, Feld and Wilson have all been blogging on the topic (though still loving growth).
You will never be profitable if your business model is not engineered to allow it!
How are you different?
I was chatting with a founder in Myanmar on Linkedin last night who is in travel. He said all the agents are going out of business. So, I asked well then, why is it that you will not too? What’s different… wait or it (Think Barney)… about your business model?
How are you innovating on something everyone already uses (process innovation) so that your business model works?
Now ask yourself the same question. I’ll do a Tony Robbins and do the same thing. ‘Stop this tape and do the exercise!” That guys awesome. If you haven’t listened to his products, you tots should.
Tech is not as important as you think (shock)
Techies love to lord their coding ability over MBAs. The business is the tech. There’s nothing without the product. You can’t launch without it. True… but, business models make technologies transformative, not the other way around. Without SaaS, Salesforce would just be another licensing business but not on a company’s servers. Without the on-demand model, Uber would just be a verrrry advanced taxi dispatcher.
Big businesses don’t innovate, so don’t act like one
The reality is big business suck at releasing the next big thing. You tell investors the same thing when they ask ‘what if Google starts doing this?’ Read the innovators dilemma by Clayton Christianson if you haven’t already. I’m not writing a treatise on corporate business models. But Google does a lot of crappy stuff – think G+, think Google Glass.
But why do they suck. Well let’s ask my friend Clayton.
“The worst place to develop a new business model is from within your existing business model.” – HBS Professor Clayton Christensen
To be a basic bitch, the reason is an iterative improvement is not innovation. You have to use the ‘think different’ quote literally. Peter Thiel was not talking about a little change in Zero to One. It wasn’t entitled ’12 to 18.104.22.168’. You do not demonstrate 10x thinking by improving. You innovate by messing up my fragile little mind. That’s why so many startups get funded which you read on TechCrunch (read snapchat) and think WTF, my cupcake business makes real revenue, bro!
Crazy is innovation. I feel another Jobs quote coming on about rebels…
The other thing
Now, I mentioned ‘the other’ critical thing. Ready for it?
Yeah, duh! Sure, that’s obvious… I think? Right?
No. It’s not obvious. Do you know how many decks:
- Don’t have a slide on timing?
- Don’t actually explain why the timing is right?
But is timing really that important?
Well Bill Gross (who is sort of a big deal) from Idealab did an analysis and found the key commonality of highly successful businesses was……………….. timing. Seriously.
Team is of course important, but what’s a great team with bad timing. It’s like a comedienne with the best jokes in the world that can’t deliver the punchline. Or as Lord Blackadder said “Life without you is like a broken pencil…pointless.”
Almost every huge business you can think of from Standard Oil to Microsoft was born out of timing. Gates had access to University computers as did Jobs. There was just the right tech coming out at the point in time they were looking for opportunity. If they were born in Canada and ten years earlier, would they be who they are today? I doubt it. We might have new maple syrup though.
Nailing your startup business model
You know your business model when you see it like the Matrix; how all the parts come together.
My friend is a founder of Shazam and told me they had a 20 year road map when they started! They’ve been following it. You can hear Hannibal saying “I love it when a plan comes together.”
How far into the future can you see? Bezos famously asked what won’t change? This is a brilliant question that would give the stoic Theil a hard on.
“I very frequently get the question: ‘What’s going to change in the next 10 years?’ And that is a very interesting question; it’s a very common one. I almost never get the question: ‘What’s not going to change in the next 10 years?’ And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time. … [I]n our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, ‘Jeff I love Amazon; I just wish the prices were a little higher,’ [or] ‘I love Amazon; I just wish you’d deliver a little more slowly.’ Impossible. And so the effort we put into those things, spinning those things up, we know the energy we put into it today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it.”
A business model’s great strength as a planning tool is that it focuses attention on how all the elements of the system fit into a working whole.
The two key points there are:
- Focuses your attention
- Fit into a working whole
You are going to spend a lot of time building a successful business. 7 years is the average to IPO. You will also spend a few years doing an unsuccessful business. So you want to know your business model is right starting out. That way you ‘just’ need to execute on the right path. If you are uncertain, you’re going to be distracted and nervous as a heroine addict in remission without Methadone.
“When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it” Jeff Bezos
Secondly, the pieces of puzzle need to fit together. This is SO key. Everything on your value chain needs to make sense, i.e. you pass your narrative and numbers test. Do a Porters five forces analyses to understand the industry landscape, so you don’t get smashed like Priceline (‘Supplier power’).
When you understand your business model as a whole and the market and have the right timing, something special can happen.
Special things do happen, sometimes
The 2000 internet boom was a total shit show, but there were winners! Take eBay as an example. Meg Whitman joined eBay because of “the emotional connection between eBay users and the site.” The user behaviour was indicative of the potential power of the eBay brand, and unlike many interwebs startups starting up and flaming out, simply “couldn’t be done off-line.”
In other words, Whitman knew eBay passed the narrative test in a compelling and coherent manner, with the potential to eventually pass the numbers test.
eBay’s brilliance was in what they didn’t do, not in what they did. What you choose NOT to do can sometimes be as important as what you do do (he he).
The scope of eBay’s activities have a coherent narrative with their cost structure (the numbers test). What does that mean in practice?
eBay is lazy on purpose (A lie I also tell myself). They offer auctions and that’s it buddy!
After an auction is successful, sellers and buyers work out everything including logistics, payment and shipping themselves (though there is obviously PayPal).
- There is no fulfilment and no inventory to mess about with. Their COGS are nothing so their gross margin is huge
- Shipping is on top thank you very much
- There is no credit risk and none of the overhead that is required to support all that jazz
Amazon on the other hand built FBA at great expense. Which long term may be smarter, but let’s not get into that.
Recently Zenefits and Auto1 blow my mind in their devious smartness. The whole thing just connects. They are totally brilliant and contemporary. A frequent conversation I have with a PE friend is ‘how can we replicate Auto1 business model in another industry.’ It’s not how can we copy Auto1. It’s ‘how can we apply the brilliant narrative to another problem which will pass the numbers test’.
Hopefully you’re starting to get that when you do something that makes sense, you make money, incur appropriate costs and so make long term profit? It is that simple. But… that’s not the whole story as you are about to find out now.
Business model and strategy are different
Every successful business model is built on a sound business model, whether it was an accident or not, or used an excel sheet or not. But business models and strategy are not the same thing.
The business model is how things fit together so you can win. Strategy deals with how you win.
Strategy deals with competitors and go to market and is time dependent. It’s only worth having a fab strategy if you have a business model as a foundation. And vice versa.
We’re trying to help you win and maybe get funded, so let’s touch on strategy briefly.
It’s cliché, but the startups that are the winners and VCs want to fund are those which are unique, they do something no other startup does in ways that no other business can replicate; they are defensible (aka defensible moat, special sauce etc).
The strategic question is simply ‘how are you going to do better by being different?’ You have to be different as in perfect competition there are no super normal profits.
At one point there were 1,600 Groupon clones in China. I know of at least 5 beautybooking sites in Asia, same for Thumbtack clones etc.
When all startups, with the same business model, offer the same stuff to the same cheap customers by doing the same things, there are no winners. You don’t want to play a game with ‘destructive competition,’ as Porter puts it.
Walmart is the best example of a great business model with superior strategy. He didn’t invent the business model, he just had a better strategy.
From the outset, Walton chose a different demographic in a different market, but with the same business model. In comparison, the ten largest discounters from the ‘60s, are all dead. They had the same business model, but the same dumb strategy, focusing on large cities like New York.
In Walton’s own words, his strategy, “was to put good-sized stores into little one-horse towns which everybody else was ignoring.” The nearest city was a four-hour drive away. He bet that if he could match or beat the city-slicker prices, “people would shop at home.”
The ‘special sauce’ investors ask about and no founder ever gets…? Since Wal-Mart’s chosen markets were too small for another big store, Walton landed and expanded territory and no one saw the sense in competing since they would initiate mutually assured destruction. Genius.
The business model of discount retailing has seen lots of dilettantes enter since it boomed in the ‘50s. Wal-Mart won because their strategy differentiated them and their business model was evergreen. Insert Amazon reference again ;).
The deadpool are companies like Kmart that tried to be all things to all people, failing to find a differentiating strategy.
The imperative learning is that you have to have a coherent business model, and contemporary, differentiated competitive strategy in tune to the timing in the market.
You need all parts to win.
I love the story of MySQL pitching Danny Rimmer at Index Ventures and describing his strategy as this:
“i’ll never forget meeting (former MySQL CEO) Mårten Mickos,” Danny says. “he said, ‘the relational database market is a $9 billion a year market. I want to shrink it to $3 billion and take a third of the market.’”
You can read about this strategy here. The business model wasn’t explained, but it’s a brilliant strategy and clearly the timing was right. It’s certainly ballsy and differentiated!
So the questions for you to have lucid answers to are:
- What is your business model?
- How do you innovate in process?
- How do you innovate in desire?
- Does it pass the numbers and narrative test?
- What will not change about your business model in ten years?
- What is your strategy?
- How will you differentiate so not be competed away?
- How do you make money?
- Why is the timing right?
Examples of brilliant business models
If we are still together, you’re probably looking for some inspiration?
There are a lot of brilliant business models. I’ve pulled together a few ones which I think are cool.
I’ve broken them up just for you into 4 buckets. But note these are not mutually exclusive, completely exhaustive. If you work at McKinsey, please forgive me.
The four buckets are, loosely:
- Process and value chain innovation
- Behavioral and industry shifts
- Assumption challenges
- Pricing and distribution
Let’s get into them now!
Process and value chain innovation
This involves some real technical ability, or at least detailed process thought. Central to this is that your business model innovation is able to scale and ideally become all the more valuable as you do. Clearly a prototypical example of this was Fords production lines.
You might discover opportunity here by asking “Why do you do things this way?” What if you actually did x? The immediate response might be “you can’t possibly do that because the goble do dook and the dooda dah won’t…. but I guess if you… Great Scott! It might just work!” It’s sort of what plays out with Scotty in every episode of Star Trekk where he makes magic happen… somehow. You can do the same if you question everything.
Ford – Moving assembly line
Ford innovated with the moving assembly line in 1913. Boom. This allowed the company to reduce its per-vehicle production time and costs significantly, and make cars affordable, such that you could have whatever you wanted so long as it was in black.
What was so nuts?
This assembly line innovation reduced the price of the Model T to $350 from $850. They also churned these bad boys out within 90 minutes, significantly lower than the standard of 12 hours! Eventually it took 24 seconds. That’s bad ass.
Your learning is this. How were cars made? Did it make sense? Why did people move, why didn’t the cars? Why does a person know how to do everything when they can specialise in one thing?
Learnings: Question everything. Interview people in a new industry and ask them how they do things. Ask why three times! If you hear ‘because that’s how it’s always been done’ you have found something. You just need a process innovation. Find a nerd who knows more than you.
McDonalds – production line 2.0
This was the inspiration for this blog. The business model even changed toilet hygiene standards in many continents. Seriously, I grew up in Indonesia for 10 years.
Ray Kroc was a sales guy with a vision. He was selling milkshake-mixing equipment, which he believed in so much, he mortgaged his home to become a distributor. It just wasn’t a big seller. The value proposition was it could make five milk shakes at the same time. He clearly liked efficiency.
As in the movie, Kroc travelled across hitting up stores but didn’t get interest. He heard about two brothers in California called Dick and Mac McDonald. who were using eight of the machines concurrently! Huh?
He drove to Cali to check them out. The brothers made an assembly line-like system and had the procedure down to a science. The idea was to incorporate the assembly line like Ford did into the restaurant business and creating a new vertical called fast food.
The brothers weren’t that ambitious, Kroc was. Kroc made the McDonald’s Corporation, a company dedicated to franchising the restaurant. Franchising wasn’t new (see later), but Kroc did it differently.
He kept strict control over his franchises, ensuring consistent business practices and standards of cleanliness. Large investors were not a fan, and the cost of leasing land made them fail the numbers test. So some numbers chap had the idea of subleasing properties to the franchisee. Real estate provided the cash flow needed for more down payments on additional land for growing franchises, and so a virtuous cycle continued (think the float, like we will talk about too).
So what’s the cool learnings here? Firstly, how can process innovations create an entirely new category (fast food) and changing user behaviours? Is there a different way to make money or change your cost structure, by owning the property and subleasing? U-haul doesn’t make the money on the trailers, but in the upsell to insurance and boxes etc.
Key here is the implications on behaviour. What new behaviour can a process innovation enable? You need timing though. Post the war consumers loved new and different. Fast food might have been just what they were looking for. But without a process change that behaviour was not possible.
Warby Parker – Disintermediation of the value chain (cutting out the middleman)
Wharton classmates Neil, Dave, Andrew, and Jeffrey founded Warby Parker in 2010 to create a solution to a simple problem: looking like a hipster is expensive. In other words, spending $600 for glasses is nuts!
They groked the high prices were largely due to concentration of market share by Luxottica, which has 80% of the high-end eyewear. Via licensing agreements, they design and manufacture frames for almost everyone you know: Chanel, Ralph Lauren, Prada, and Armani. They even own brands such as Oakley, Ran-Ban, and Persol. Beyond brands, they also own distribution! They own Lenscrafters, Pearl Vision, and Sunglass Hut, even a vision insurance company called Eyemed.
So screw those guys. They own the industry and have too much too lose. We can use that.
Why can’t you buy something decent for a fair price? Throw in some branding and stories about blind, poor kids in Africa and boom! Ka-ching.
Fast forward and Warby has created a low cost structure by cutting out the middleman. They, tell people at least, that they design frames (avoiding licensing fees), source raw materials, and works directly with manufacturers. Aka buy glasses made in China for a dollar and sell them for $99, maybe do something in the US to avoid import costs.
They explain what they do in more detail here:
“How have you altered your supply chain as you’ve been growing? We’ve expanded the number of suppliers that we work with. We’re meeting with them and talking with them, helping them think through how they scale. Warby Parker has three distribution centers in the U.S. alone. The acetate for the frames comes from a 150-year-old, family-owned Italian company; the frames are assembled in Asia; and the lenses are edged and inserted into the frames in the U.S.
We source raw materials — everything from hinges to screws. We’ve gone pretty far down the value supply chain to create such great quality at such a great price. It’s the same production line. Before business school, I ran VisionSpring — which is Warby Parker’s main partner — and we used to produce our own eyewear. I’d spend a bunch of time in the factories. I went with one of the founders and learned all about the manufacturing process. I had relationships to leverage and hired more people with supplier relationships.
We’ve tried to do our best to over-communicate with our suppliers. They’ve never seen an eyewear brand grow this quickly before. We’re experiencing double-digit month-on-month growth. It’s a lot easier to scale a website than a production line.”
What’s so cool about the business? Direct to consumer with something they already want vastly cheaper for the ‘same’ quality. Find a problem a lot of people have, an industry which is being controlled with artificial competition and a way to offer something similar for an 80% discount and you have something there. Don’t pay anyone to distribute it so you can keep more of the margin. Use heavy branding and you can justify something worth a dollar to have perceived value 100x that. Love these guys.
There isn’t anything new about the business models they applied. They just structured things up to their need. Their strategy was brand and social good based. They also adjusted their business model for branding purposes to jack Tom’s shoes and play the BoGO card (buy one give one).
Dell – Direct to consumers and power of data based decision making
Computers were all sold through resellers. That didn’t make sense. Dell would sell directly to end customers instead. This achieved two things and formed their business model:
- Cut out a costly link from the value chain by going direct
- Get information to manage inventory better than any competitor
Dell got moving at a point in time when the pace of innovation in computing was intense. I mean people talked about ‘will we hit the 1 ghz limit!’ So Dell’s inventory advantage meant it could avoid the massive cost of part obsolescence (i.e. pass the numbers test).
Interestingly, Dell’s business model was also their strategy. Competitors didn’t want to copy them!
If competition sold direct, they would disrupt their existing reseller distribution channel who they depended on. Classic innovators dilemma.
So what’s the key learnings? When you can change the economics of an industry and it’s political suicide to change and replicate, you create a competitive advantage. Going direct to customers enables you to get data which 1/ keeps you relevant and 2/ can powerfully impact your supply chain and procurement procedures.
Dell also used the data to know when to do what. They knew focusing on the high end made sense so they did. It’s only when they got to scale the went downstream to cheaper computers, where the scale enabled their unit economics to make sense.
How can data be key to your startup business model and strategy?
These examples could be put in another box, but I want to illustrate how important timing is. A raising tide raises all ships. You just need to be there at the right time the tide is rising. There is typically a catalysing driver such as the internet to be aware of. Perhaps blockchain is yours? Look out for something that seems a little weird that could potentially have a big impact if things go right.
Huffpo and other blogs – Change in traditional print to online ‘blogs’
I’ll make this short as it is obvious. People wanted to read stuff online and for free. Blogs like Huffpo saw that. Companies with physical print either didn’t or did and had too much invested to do anything about it. Huffpo and others innovated with native advertising to monetise.
Learnings: When you see the writing on the wall, use cost structure against people. See what the world will look like and adjust the monetisation of your business model to it.
Netflix – move from physical to digital and power of a virtual cost structure
Netflix gained its initial competitive advantage through a combination of known business models: virtual landlord, subscription and all you can eat. The lack of physical infrastructure and postal integration, no late fees etc offered a clear advantage over Blockbuster.
Blockbuster had an old world strength in it’s physical presence everywhere. But that comes at a cost. With the internet and mail, your margin is way higher! But what do you do when you have invested so much in property. Do you cannibalise it? No, no salary man would do that. Let’s just say Blockbuster did not adapt well to Netflix’s strategy of charging a flat fee for unlimited DVDs mailed to peoples’ houses.
The next great thing was seeing the opportunity in streaming and original content. They took some big risks and it paid off. It’s worth mentioning Netflix saw how much paid content cost them and the endless negotiations with big media, where they had little bargaining power. Solution, make your own.
Learnings: Truly understand what pisses off your customers. What do they hate about the big boys? Offer customers exactly that. But to compensate you need a new cost structure. Figure one which is the exact opposite of them and make your weakness your strength. This is Sun Tzu 101. There’s also more than one way to skin a cat. If you have no negotiation power, no worries, change the rules of the game.
Amazon – People will buy on the internet and growth first revenue later
In the mid-1990s, entrepreneurs and scoundrels were scrambling to find ways to take advantage of the internet. Seriously, no one believed anyone would really use it let alone buy on it! It was a toy.
Jeff started an online book shop that sold a wider collection of books than stores could carry, buying warehouses to hold a vast inventory to direct-to-consumer. By listing books but pulling them from repositories they were also able to have a crazy big offering no one could match.
Next, it takes a long time to build a retail business. But if they could grow fast enough they would be able to create real defensive barriers. So long as investors would back them it wouldn’t matter. Ever since VCs have been pushing growth and not concerned with profits. Well till now.
You know the story so let’s move on. But add the point that this was an internet play. They bet big on the internet and it worked.
Learnings: Your margin is my opportunity. Cost structures matter. If you focus on the basics and do them really well you will do really well. Sometimes it can take a reeaaallly long time to pass the numbers test even when you pass the narrative test.
Now this is my favourite section. It’s good old fashion crazy startup stuff. It starts with this “What if….” And that what if is pretty ballsy. Everyone will think you are dumb or crazy. But man when you get it right! Beautiful. This is really why VCs fund stupid stuff. The stupid stuff can make the biggest differences.
Apple – computer for everyone
Do you want a computer? But what can I actually do with it? Um… The vision to see a computer in everyone’s home when only super nerds were using them, and not for much at that, was impressive.
This really was think different. It was imagine a world… You never know unless you try.
Learnings: Customers may not want what your product can do now, but wonder if they will if it looks a little different?
Airbnb – stay in someone’s bedroom
Staying in someone spare bedroom? Are you nuts. I have friends who play b-ball with the founders and laughed at them when they were asked to invest…
Airbnb is a great example of really challenging conventions and assumptions.
Learnings: If you know there is a fundamental problem in a large market to be solved (accommodation), then eventually you hit on adoption, just because there is a need.
Birchbox – product discovery
Girls like pretty stuff. They find it hard to find more pretty stuff. What if we send them pretty stuff every month and get them to pay for it? We’ll also get the brands to give them to us for free.
It sounds pretty dumb but it worked.
Learnings: Charge subscription and upsell when you can. Understand the problems your demographic faces.
What do you do when competition is insane? Do something different. Priceline did that with the name-your-own-price concept. Vendors bid to meet the prices customers set for hotel stays and air tickets. The names of providers are not disclosed by name which protects suppliers by not associating them with discounts.
The notion that consumers can attempt to set prices is pretty outlandish.
Learnings: In a highly competitive industry there are always ways to differentiate. You need to understand the needs of consumers and the sensitivities of suppliers to get it just right. Anything short will flame out like Priceline did in the case study with coke.
What if I said you could build a $11 billion dollar company by offering group buying on limited time discounts? Mason started with a two for one discount for the pizza shop below their office and sent a newsletter.
It worked because offline retailers have very few marketing options. They haven’t really expanded since the yellow pages.
Learnings: Just try. You will never know if a toy is secretly a golden goose. Understand your suppliers in detail to understand their problems and sell to them
Uber – taxis suck
What if you could disrupt how you moved? We’ll start by doing black cars on demand. Um. Ok. Come back to me when you have traction said investors.
Learnings: Market sizing is complicated. You can’t think just about what you see, you need to think about where it could go to. The market for black cars is small, but the market for transportation is massive. Where there is a big enough problem you will have a real shot in fundamentally creating a paradigm shift. The details matter.
Kickstarter – get people to fund your widget
What do you when a bank won’t fund you and VCs don’t get hardware? Nothing.
What if people would give you money to build something they would love to have?
Learnings: This is an application of the float business model, but rather than the company benefitting directly, the suppliers and consumers do.
Tinder – swipe for love
Match is painful. It’s embarrassing. It’s not cool.
Learnings: Simple can be a business model
Pricing and distribution
This is where you can get really creative and innovative. These are how you turn something that won’t work into wildly profitable. They’re designed to solve a problem in an elegant manner, opening up the market.
Singer – Franchising and installment plans
Isaac Singer was the founder of I.M. Singer & Company who patented a sewing machine, which started appearing in the mid 1800’s. But Singer’s sewing machines could sew 900 stitches per minute. Boom. But… at $120 each, they were out of reach for most Americans.
So they invented the first-ever instalment plan. Now everyone could have a sewing machine and pay for it in instalments. But now, how to sell more?
Yup, franchising. Find business people who were interested in owning the rights to sell Singer’s sewing machines in defined geographical areas and charge them an up-front licensing fee for the right to sell the machines (with the requirement to teach them how to use them in the first place). Licensing fees enabled them to fund more manufacturing.
Learnings: Combine startup business models for a one two knock out punch. Understand that making someone a livelihood by being an independent business owner is a business model. If customers can’t afford your product, what can you do to enable them too?
Tupperware – Direct selling / buying clubs
Tupperware gets its name from its inventor Earl Silas Tupper. Whilst the fantastic plastic was innovative, it’s the distribution which is so incredible. Brownie Wise invented Tupperware parties.
Learnings: Social is powerful. Distribution can be fundamental to your business model.
Charles Darwin (sort of) – Subscription model
Subscription models have been around for a long time. Charles Dickens sold his novels as a subscription. If you consider member dues paid annually or monthly a “subscription” they’ve been around at least since the middle ages. We’ve seen countless flavors of subscription, from newspaper & magazine subscription, gym memberships, premium cable channels, to the “book of the month” clubs popularized after WWII in Europe.
The subscription model is an ingenious business model, reinvigorated in the SaaS industry
Learnings: Get people to pay more frequently without having to keep selling
Gillette- The “Gillette business model”
Gillette is known for offering the razor for free, but selling the replacement blade for a much higher value. Since the razor was offered for free, a market for the replacement blades was created, and it was through these blades that Gillette was able to acquire and grow their revenue. It’s been copied thousands of times.
Learnings: People are cheap. Create an escalation of commitment to access their wallet
Skype/Dropbox/weed – Freemium
Similar to the razor blade model, freemium is equally powerful. Some are convinced that the “freemium” concept was first invented by canny drug dealers who started giving teenagers their first few hits for free, knowing that a certain percentage would return.
I can’t figure out exactly who was the first freemium provider, but it’s pretty bad ass.
Learnings: If adoption is an issue, give it away for free. A % will return that more than cover your COGS
American Express – Travelers check
In 1892, J.C. Fargo, the president of American Express was on a holiday in Europe and found it hard convertible his letters of credit into cash. “The moment I got off the beaten path,” he said on his return, “they were no more use than so much wet wrapping paper. If the president of American Express has that sort of trouble, just think what ordinary travelers face. Something has got to be done about it.” What they did was create the traveler’s check
In exchange for a small fee, travellers bought both peace of mind (insurance) and convenience (ubiquity of acceptance). What was so key though was that merchants accepted the checks because they trusted American Express brand… they also got more customers which is nice. There was also a network effect in that the more other merchants accepted the checks, the more other sellers had to do the same.
What was innovative is the float. Customers always paid cash for the checks. In most businesses, you incur cost before revenue (Start thinking about SaaS). Before anyone buys your beany baby, you’ve got to make it first. The traveler’s check flipped the switch on the cycle of debt and risk on its head. Like the insurance business, people paid for checks long before they used them and so AmEx got what banks also had long benefitted from; an interest-free loan from its customers. And like Groupon, some of the checks were never cashed, which was free money ;).
Learnings: Think to yourself. How can you get interest free loans? How can you benefit from the float? Kickstarter effectively offers this too
Zenefits – come for the tools, pay for the service
This is very similar to the Gillette model.
Zenefits helps companies connect HR systems (payroll, insurance, onboarding, etc.) into a single dashboard. The twist in the business model is that Zenefits doesn’t charge companies anything. Instead, Zenefits acts as an insurance broker and makes money from commissions. It is so popular it was termed anti-competitive.
Learnings: In a boring industry you can mess things up for competitors by 10x the service. Then off ‘upgrades’ which they need anyway.
As Ray Kroc once said, “The two most important requirements for major success are: first, being in the right place at the right time, and second, doing something about it.”
Take the time to truly understand your startup business model and if it doesn’t make sense, steal someone else’s!
If you want help figuring out your startup business model, reach out to us at strategy.50folds.com or email me at [email protected]
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