In 2010 I've written 36 blogs covering topics and areas of interest to entrepreneurs and investors. The focus is that of an investor looking for the least risky investment propositions to place his hard earned cash, time and experience for a good return. But what did the readers of these missives think was most enlightening?
The eighth recommended slide in the series of ten key pitch slides is all about business models. So what is a business model? How does your business model make money? Advertising, freemium and a brokerage fee? That’s three of seven models… do you look wise or confused?
There are a limited number of business models (only seven) so it is a quick exercise to apply each to your business to see which would work most effectively. Each model has a different cost base and different end price to the consumer while the product/service cost will remain constant (since it is independent of the business model). The product cost plus the business model cost define the lowest cost that you can sell your product for that business model.
The evidence you have presented to date will provide an idea of the price consumers are willing to pay to use your solution to solve their problem. Investors will be looking at the difference between the willing price and lowest cost: the greater the difference (or margin) then the better is your proposition since the resulting profit can be distributed to share holders, employees or re-invested in the business to cut costs further, test other business models or create new product.
Now let’s look at the range of business models available:
- Product/Service Sales. Your company creates a product or service that it sells it to customers perhaps directly or through a chain of wholesalers and retailers to the final recipient. Examples of direct sales include the “Freemium” model (e.g. Dropbox) where a minimal service is provided (for users) with a paid upgrade to a much better service (for customers) but this can alarm investors because there is always a danger of never making money. Both Avon and Amway have a pyramid model where the customers are also the retailers. And there may be some personalisation or customisation provided (e.g. Nike, Dell) to the customer by the manufacturer.
- Brokerage Fee. This is a model where your company acts as a middle man taking a clip of the money paid by the customer to the supplier – for example ebay, Uber, Credit cards. The danger of this model is that once the customer has identified a supplier through the company they may by-pass the company in the future (reducing future clips to zero).
- Lending / renting / leasing. Here your company provides a product or service for a particular time at a given rate. Examples include car rental and leasing property.
- Subscription fee. A flat or tiered fee is charged to the customer who then receives a product or service at a regular interval. For example the Dollar Shave Club, magazines, virus scanning services and newspapers.
- Usage fee. Your company provides a marketplace or service and charges a rate dependant on usage (but not the value of goods transacted by your customer). Examples include AirBNB and Amazon Web Services.
- Advertising was a very popular model in the early days of the internet. This is where your company sells the right to display someone else’s message on their property. Examples include Google, Sports Coverage, and Newspapers.
- Licensing / Franchising. Your company provides a product or service which customers pay a fee to use. Typical licensing examples include Patents while franchising includes the Post Office, Pizza Hut and MacDonalds. As a licensor you will invest money to provide additional intellectual property while as a franchisor you will have a complex arrangement stating exactly what each party brings and receives from the engagement.
Once established, you may use more than one business model (for example MacDonnalds owns many restaurants and franchises others). Their strategy may be to use secondary business models to expand in markets that are significantly different or are considered marginal.
If you present more than one business model at the outset you are in danger of appearing indecisive, not understanding your market sufficiently or be clutching at any possible revenue stream. That is a dangerous proposition for an investor’s cash so it is vital that you robustly identify your ideal business model and articulate why it will work for your business.