Everyone in the tech world talks about business models. But I’ll bet that if you quizzed a random sample of these people, you’d find that they really don’t know what a business model is. I did just that with my students at UC-Berkeley. Most raised their hands, and MBA student Blake Brundidge’s attempt to answer the question was a valiant one—but none of them really had a clue. The only one who got the answer right was Lionel Vital, a Stanford student gatecrashing my iSchool class.
The reality is that a business model is like the old saying about teenage sex: everyone talks about it all the time; everyone boasts about how well he or she is doing it; everyone thinks everyone else is doing it; almost no one really is; and the few who are are fumbling their way through it incompetently. (Yes, I know things have changed.)
I’ll tell you what a business model is, in case you are quizzed by your investors.
But first, let me answer the big question that is surely on your mind: what is a Stanford student doing at Berkeley? It may be that our classes at Berkeley are much better than those at Stanford. That is probably why Lionel approached me at the beginning of the semester and begged to be allowed to audit my class. To Lionel’s credit, he scored better than any of the Berkeley students. So perhaps some Stanford kids are a little smarter, but Berkeley students get better education? I know that our students certainly have a lot more fun. You just have to visit the campuses to note the stark difference.
Step one in building a successful business is to learn what products or technologies your customers really need and are willing to buy. This is an iterative process that I explained in this piece. The vast majority of technology startups fail because too few customers buy or use their products. So don’t underestimate the importance of validating and testing your ideas.
Developing the right product is hard. But what is harder is building a good business model. Fortunately, there’s nothing magical about a business model. It’s simply the nuts and bolts of how a business plans to generate revenue and profits. It details your long-term strategy and day-to-day operations.
Entrepreneurs put together elaborate business plans showing optimistic market-share projections. Even 1% of a billion-dollar market seems lucrative, right? Wishful thinking is great, but when it comes time to create your business model, you need to be realistic. The challenges differ from industry to industry, but here are seven basic components of a business model:
- Reaching customers. Ralph Waldo Emerson famously said, “Build a better mousetrap, and the world will beat a path to your door.” The reality is that even if you did, no one would find you. Even when you know who your prospects are, it’s usually difficult and costly to reach them. You have to find them via the Internet and e-mail, or the old-fashioned way—through broadcast media, print ads, direct mail, telemarketing, or references or by cold-calling. And these potential customers are not likely to be waiting to hear from you and may not respond to you. So be sure you know how you are going to find and reach them.
- Differentiating your product. You think you’ve got the very best solution, but so does the other gal (or guy). There’s always competition, whether you realize it or not. Smart marketing executives know how to develop unique product-positioning strategies that highlight a product’s true value. You need to thoroughly understand the competition and effectively communicate the unique advantages of your product.
- Pricing. One of the most basic decisions you have to make is how much you’re going to charge for your product or service. Giving your stuff away is the way to go on the web, but remember that you still need to figure out how you are eventually going to make money—you can’t make it up on volume. Start by understanding how much customers value what they’re gaining from you. Then you need to estimate your total costs, analyze the competitive landscape, and map out your long-term strategy. For your company to survive, your product’s price must be greater than its overall cost.
- Selling. Persuading customers to buy a product that they need is one of the most important skills an entrepreneur must learn (read It’s All About Selling for Survival). You’re going to be selling at every juncture. So you have to understand what it takes to close a deal and put together the necessary sales process. And this process has to be perfectly conceived. Be sure you test your selling strategy as you would your product.
- Delivery/distribution. This is easy on the Internet. But for big-ticket items, you usually require a direct sales force; for mid-range products, distributors or value-added resellers; and, for low-priced items, retail outlets or the Internet. It’s different in every industry and for every type of product, but you have to get this right. Your products need to be designed and packaged for the channel through which they will be distributed to customers.
- Supporting Customers. In addition to teaching customers how to use your product, you need to ensure that you can deal with defects and returns, answer product questions, and listen to and incorporate valuable suggestions for improvement. You may need to provide consulting services to help customers integrate and implement your products. If your product is a critical component of a business, you may also need to provide 24/7 onsite or web support.
- Achieving customer satisfaction. The ultimate success or failure of a business depends on how much it helps customers achieve their objectives. Happy customers will become your best sales people and buy more from you. Unhappy customers will become your biggest liability.
All the pieces have to come together like a jigsaw puzzle in your business model. The good news is that you don’t have to start from scratch when formulating it. You can give yourself a head start by learning from competitors and other markets. It is not only the successes that provide valuable lessons; it is also the failures.
You can innovate as much in your business model as you do in your products. Be prepared to evolve your innovation strategy as you gain experience and as your market changes. Like your products, it will probably take several versions to get your business model right; you get better with practice.
The Business Model Canvas
Developing a business model requires that you identify the basic building blocks of the business model that create value innovation. Alexander Osterwalder's work and thesis (2010, 2004) propose a single reference model based on the similarities of a wide range of business model conceptualizations. With his business model design template, an enterprise can easily describe their business model
- Strategic Partners - In order to optimize operations and reduce risks of a business model, organization usually cultivate buyer-supplier relationships so they can focus on their core activity. Complementary business alliances also can be considered through joint ventures, strategic alliances between competitors or non-competitors.
- Key Activities - The most important activities in executing a company's value proposition.
- Key Resources - They are considered an asset to a company, which are needed in order to sustain and support the business. These resources could be human, financial, physical and intellectual.
- Value Proposition - The collection of products and services a business offers to meet the needs of its customers. According to Osterwalder, (2004), a company's value proposition is what distinguishes itself from its competitors. The value proposition provides value through various elements such as newness, performance, customization, "getting the job done", design, brand/status, price, cost reduction, risk reduction, accessibility, and convenience/usability.
- Customer Relationships - To ensure the survival and success of any businesses, companies must identify the type of relationship they want to create with their customer segments.
- Distribution Channels - A company can deliver its value proposition to its targeted customers through different channels. Effective channels will distribute a company’s value proposition in ways that are fast, efficient and cost effective. An organization can reach its clients either through its own channels (store front), partner channels (major distributors), or a combination of both.
- Customer Segments - To build an effective business model, a company must identify which customers it tries to serve. Various set of customers can be segmented base on the different needs and attributes to ensure appropriate implementation of corporate strategy meets the characteristics of selected group of clients
- Costs - This describes the most important monetary consequences while operating under different business models.
- Revenues - The way a company makes income from each customer segment.
The above building blocks are visualized in Osterwalder's Business Model Canvas:
Seizing The White Space
If you are a new business startup, or an existing company still trying to find its way, I highly recommend that you read Seizing The White Space: Business Model Innovation for Growth and Renewal by Mark W. Johnson.
The Necessity For A Grand Vision or Mission
I often site the need for a company to establish a grand vision or central mission for the business. This is the foundation upon which business models are built and take root. Mark Johnson did not address this in the above videos, but I believe it is very important to establish a grand vision or central mission before developing a business model. If your grand vision or mission statement and business model are not congruent then something is wrong. Steve Jobs established a grand vision for Apple by developing the Digital Hub Strategy, a subject I wrote about in a blog post dated October 6, 2011 and mention quite regularly in many of my blog posts about Steve Jobs and Apple.
According to Steve Jobs the personal computer would become the Digital Hub for the Digital Lifestyle, an emerging digital trend driven by the internet and an explosion in digital devices: digital camera's, videocam's, portable music players, PDA's and DVD video players. The PC would serve as a Digital Hub that would allow consumers to store, share and playback digital images, music and video files.
In the following video, Steve Jobs introduces the Digital Hub Strategy at MacWorld 2001. That was the key moment in history that defined Apple's purpose and the basis for its present business model. The Digital Hub Strategy accounts for the overwhelming string of successful consumer electronics products, including the iPod, iPhone and iPad.
Blue Ocean Strategy
I also recommend that you read Blue Ocean Strategy by W. Chan Kim and Renee Mauborque.
Companies have long engaged in head-to-head competition in search of sustained, profitable growth. They have fought for competitive advantage, battled over market share, and struggled for differentiation.
Yet in today’s overcrowded industries, competing head-on results in nothing but a bloody “red ocean” of rivals fighting over a shrinking profit pool. In a book that challenges everything you thought you knew about the requirements for strategic success, W. Chan Kim and Renée Mauborgne contend that while most companies compete within such red oceans, this strategy is increasingly unlikely to create profitable growth in the future.
Based on a study of 150 strategic moves spanning more than a hundred years and thirty industries, Kim and Mauborgne argue that tomorrow’s leading companies will succeed not by battling competitors, but by creating “blue oceans” of uncontested market space ripe for growth. Such strategic moves—termed “value innovation”—create powerful leaps in value for both the firm and its buyers, rendering rivals obsolete and unleashing new demand.
Blue Ocean Strategy provides a systematic approach to making the competition irrelevant. In this frame-changing book, Kim and Mauborgne present a proven analytical framework and the tools for successfully creating and capturing blue oceans. Examining a wide range of strategic moves across a host of industries, Blue Ocean Strategy highlights the six principles that every company can use to successfully formulate and execute blue ocean strategies. The six principles show how to reconstruct market boundaries, focus on the big picture, reach beyond existing demand, get the strategic sequence right, overcome organizational hurdles, and build execution into strategy.
I would read Blue Ocean Strategy because it represents a new paradigm for developing business strategy.
What is Blue Ocean Strategy? Ten Key Points
- BOS is the result of a decade-long study of 150 strategic moves spanning more than 30 industries over 100 years (1880-2000).
- BOS is the simultaneous pursuit of differentiation and low cost.
- The aim of BOS is not to out-perform the competition in the existing industry, but to create new market space or a blue ocean, thereby making the competition irrelevant.
- While innovation has been seen as a random/experimental process where entrepreneurs and spin-offs are the primary drivers – as argued by Schumpeter and his followers – BOS offers systematic and reproducible methodologies and processes in pursuit of blue oceans by both new and existing firms.
- BOS frameworks and tools include: strategy canvas, value curve, four actions framework, six paths, buyer experience cycle, buyer utility map, and blue ocean idea index.
- These frameworks and tools are designed to be visual in order to not only effectively build the collective wisdom of the company but also allow for effective strategy execution through easy communication.
- BOS covers both strategy formulation and strategy execution.
- The three key conceptual building blocks of BOS are: value innovation, tipping point leadership, and fair process.
- While competitive strategy is a structuralist theory of strategy where structure shapes strategy, BOS is a reconstructionist theory of strategy where strategy shapes structure.
- As an integrated approach to strategy at the system level, BOS requires organizations to develop and align the three strategy propositions: value proposition, profit proposition and people proposition.
Red Ocean Versus Blue Ocean Strategy
The vast majorities of companies, regardless of industry sector, compete in "red oceans." They are basically competing based on the rules established by their industry sector. Many of them are me-too competitors. We are seeing this in many of today's industries including mobile devices (cell phones, tablets and digital music players) and consumer packaged goods. In some industries commoditization has began to set in. I have seen this in smartphones, tablets, PV solar panels, toys and consumer packaged goods.
The differences between red oceans versus blue oceans become clearer when you compare them side-by-side like in the above chart. Blue Ocean Strategy requires a whole new different way of management thinking about establishng business strategy.
Courtesy of an article dated January 8, 2011 appearing in TechCrunch