Avoid the business model trap that kills most startups
Finding the right business model may not get you headlines, but it’s critical to building a successful startup. After all, this is how your business makes money. Develop a sustainable business model so you don’t fall into the trap of just surviving until your next round of funding.
When launching a business, it’s easy to get caught up in the excitement of creating an innovative new product or service and marketing it to your target customer. This is only half of the job.
The other half is finding a way to create this product or service so that it brings in more money from sales than what it costs to produce.
This equation is what generates a profit. This is money you can reinvest in your business or take out of the company as your reward for a job well done.
Unfortunately, many startups forget this simple rule of business.
Instead, their business model is to survive just long enough to attract the next round of financing. This is dangerous.
While a new investment might ‘plug some financial holes’, eventually, you’re going have to do more than just sell your dream to bring in new investors.
You will need to demonstrate how your business can generate a profit on a recurring and sustainable basis.
This is what a successful business model does and why I made it Building Block #2 of The Launch Code
Business model basics: product, service, or both?
There are as many types of business models as there are types of businesses. You can be a manufacturer, a distributor, a retailer – brick ‘n mortar or e-commerce – or an agency, to name just a few.
At its most basic level, you have three categories of businesses to consider:
- Product – you can produce a physical product and sell it directly to wholesalers, retailers, or customers.
- Service – you can provide a service that delivers value to customers without ownership of specific costs and risks.
- Hybrid – you produce and sell a product and provide services to support this product on a one-off or on-going basis.
The most common tech startup business models
You don’t need to invent an entirely new business model. Most companies use existing business models and refine or combine them to develop a competitive advantage.
You’ll find lists of up to 50 business models on the Internet. I’ve narrowed this down to the most common business models among technology startups:
- Subscription – you charge consumers a subscription fee to get access to a service. A common method of delivery is known as Software-as-a-service (SaaS). This is when a centrally hosted, cloud-based software is licensed to customers via a subscription plan. Examples: Netflix, Salesforce
- Freemium – you provide basic elements of your service for free and charge for premium features. This is not the same as a free trial where customers get access to a product or service for a limited time. Instead, freemium models allow for unlimited use of basic features for free and only charge customers who want access to more advanced functions. Examples: MailChimp, LinkedIn.
- Marketplace – you allow sellers to list items for sale and provide customers with easy tools for connecting to sellers. Your business generates revenues from fees to the buyer or the seller for a successful transaction, additional services for helping advertise seller’s products, and insurance so buyers have peace of mind. The marketplace model can be used for both products and services. Examples: Ebay, AirBnB, Amazon
- Advertising – you create content that people want to read or watch and then displaying advertising to these consumers. You have to satisfy two customer groups: your readers or viewers, and your advertisers. Your readers may or may not be paying you, but your advertisers definitely are. Examples: YouTube, Facebook
Other common business models include software, e-commerce, digital downloads and franchising.
What business model you choose depends on your business needs and what value you want to create for your stakeholders.
The jackpot: a scalable business model
These business models are among the most popular because they are all “scalable”. This is a word you are guaranteed to hear a lot if you speak to investors.
A scalable company is one that can maintain or improve profit margins while sales volume increases.
This generally means that unit costs – the cost of producing one single piece of product – declines as your business expands.
If you have a scalable business model, you will be able to grow more easily through new geographies and markets. Scalability gives you more flexibility and comfort.
A scalable business model is popular among investors because this means that given the proper management and funding, the business has the chance to expanding exponentially.
Entrepreneurs need to have a definite idea about how scalable their business is. Business models that aren’t scalable are potentially profitable as a small business but can’t grow in an economical way.#
Convert your business model into a financial model
You’ll need to turn theory into practice and apply specific financial figures to your business model to bring it to life.
Business models can be broken into three parts:
- Everything it takes to make something – design, raw materials, manufacturing, labor, etc.
- Everything it takes to sell that thing – marketing, distribution, sales commissions, delivering a service, and processing the sale.
- How and what the customer pays – pricing strategy, payment methods, payment timing, and so on.
For example, if you’re creating and selling a physical product, here are some questions you should ask?
- What is the cost of producing one unit of my product? How does this cost per unit change if you produce one thousand or ten thousand or even one hundred thousand units at once?
- How will I promote and deliver my product to my customer? Will I use marketing, direct sales or some combination of the two to make my target customer aware that my product is available? How much money will I spend on each? How will I physically ship my product to my customer, and what direct costs will this process generate?
- How much will my customer be willing to pay for my product? How much profit do I want to generate from each sale or over the course of a certain period? How much do my competitors charge for a similar product? Do I want to position my product as premium quality for a premium price, or would I rather communicate it as a mass product for everyday use?
Do some modeling to show your best side
In the beginning, you’ll need to make certain assumptions to answer many of these questions. You can rely on these assumptions to create a simple financial model using a spreadsheet like Microsoft Excel.
Remember to plan for both direct and indirect costs. Direct costs are specifically related to producing the item for sale, while indirect costs cover expenses, like human resources and office space, that exist no matter how many products you sell.
When planning your revenues, remember to strike a balance between how much you charge for your product or service and number of customers who will be willing to pay this cost. Your total income will be a multiple of these two figures.
Finally, keep in mind that you will not likely generate a profit from the very start of your business. This means that you will need to include funding in your financial plan to cover your losses until you reach your break-even point, and generate enough revenues to pay for your on-going monthly costs.
Business modelling is a process
Once you’ve completed your first financial plan, you’ll need to update it regularly. You will likely gain more information, like price quotes from outside suppliers or initial feedback on pricing from potential customers, that you can input into your financial model to make it more realistic.
You also be able to experiment with various scenarios, changing your costs, pricing and profit margin until you arrive at a financial model that makes sense.
Get used to doing this type of ‘modeling’ for a while. Finding the right business model will take time as you put all the pieces together to create long-term and sustainable growth.
Interestingly, the term ‘business modeling’ comes from exactly this process.
With the advent of the personal computer and spreadsheet, entrepreneurs were able to experiment and “model” different ways that they could structure their costs and revenues to generate a profit. They could make changes to their business model and immediately see how this change impacted their business model now and in the future.
Stay committed and focused, and avoid the trap of thinking you can build a business by going from one investment to the next. Eventually, you will arrive at the business model that will ensure your company’s future growth and sustainability.
Register for The Launch Code online workshop today!
Do you want to learn how to create an effective business model?
Register for The Launch Code online workshop on July 14-15, and I’ll guide you through this process, as well as, the nine other building blocks of a successful startup.
The Launch Code is a business development framework that combines corporate planning methods with entrepreneurial execution to give you a structured guide to building a startup. My unique approach captures the best of these two business environments into 10 building blocks that explain how to launch a successful business.
Learn more about The Launch Code online workshop and how can you register HERE!