Author:
Bruce M. Firestone, Telfer School of Management, University of Ottawa, January 2010.
Introduction
The Business Model (BM) has come a long way in the last few years from a one page pictogram (or flowchart) of the ‘engine of your business’ to a many faceted model that fully describes the ‘engine room’ of the enterprise.
Let’s recall what the basic BM is: your clients are usually on the RHS (Right Hand Side) of the page, your business is in the middle and your suppliers are on the LHS. Typically, products and services flow from left to right—from your suppliers to you where you add some type of value and then through you to your clients and customers. Usually, money flows in the opposite direction: from clients to you and then from you to your suppliers when you pay them.
There is an orthogonal dimension in the model—a marketing dimension, which is where you demonstrate that you can (hopefully) acquire clients and customers in a cost effective manner.
We have also learned that a fuller picture of the enterprise can be formed when you look at least two dimensions deep on either side (and sometimes more). That is, you also look at who the clients of your clients are and who the suppliers to your suppliers are. In this way you may discover new relationships amongst the players and stakeholders and creative new ways to enhance your business. You are now looking at your enterprise as part of an overall business ecosystem and when you cement your place as a trusted part of that ecosystem, your business longevity is likley to increase.
In an earlier article (http://www.eqjournalblog.com/?p=684), I wrote that there are five things that the Internet can do for business models in the 21st Century that were never possible before including:
1. Create custom outputs from standard inputs (http://www.dramatispersonae.org/CustomeOutputsFromStandardInputs.htm).
2. Reverse out the work to clients and suppliers (http://www.dramatispersonae.org/GTBR/GettingTheBusinessModelRight.htm).
3. Embed your enterprise in a networked business ecosystem made up of your clients, your suppliers and yourself plus your clients’ clients and suppliers’ suppliers (http://www.eqjournalblog.com/?p=581).
4. Match making—directly connecting your clients to your suppliers making service industries scalable for the first time ever (http://www.dramatispersonae.org/TheInternetIsEatingAHoleInTheGlobalEconomy.htm).
5. Mass communication planet-wide through social media and other Internet tools at almost no cost (http://www.dramatispersonae.org/EntrepreneurialistCulture/FutureVision.htm).
The more of these elements that you can incorporate in a new or existing model, the more you are likely to prosper.
I want to elaborate a bit more on the implications of match making because it is not a widely understood phenomenon. Service industries are notoriously labor intensive and hard to scale: i.e., more output requires more input in a more or less linear relationship or, heaven forbid, you may even find yourself in a position where your ratio of marginal output to marginal input is less than one. This happens when a service business is too complex to manage effectively as it grows; that is, you find that there is an optimum size for the enterprise beyond which the business should not grow. In consulting, that size is often one person. As soon as you grow beyond a single practioner, your effective earnings may actually go down while the time to produce those earnings goes up. This is not a happy event and explains why you find so many one person service firms in real estate, management consulting, IT consulting, accounting, legal, plumbing, electrical, carpentry, Mr. Fix It industry, roof repair, mechanic, appliance repair, PC repair and maintenance, Network management and so forth.
But let’s look at one industry—the computer repair industry. If you are GradeATechs.com, say, and you view you’re your tech repair and network management specialists as your suppliers (i.e., not employees) and you can connect them directly to your clients through your website and call centre, you suddenly start to see your business in a different light. If clients can come online or phone your call centre to: a) tell GradeATechs.com what the problem is and b) when they are available for a site visit by a techie and your techies can log on and see what work is available for them and what calls they will take, you have reversed out a lot of the work to both your clients and your suppliers and taken the first step in making your service business scalable. When we actually draw up a business model, this match making capability is usually drawn like a ‘brain’ (since that is what, in effect, it is as these systems become more capable) over top of the business with lines linking to it from both clients and suppliers.
The Complete Model
The complete Business Model is today made of the following ten elements:
1. A one page pictogram (flowchart) showing the whole business ecosystem (your enterprise embedded in a network of relationships with clients, clients’ clients, suppliers and suppliers’ suppliers with an orthogonal marketing dimension showing how the enterprise will acquire customer and clients in a cost effective manner.) The business model shown below demonstrates the evolution of business models over the period 2000 to 2010.
From a simple Barber Shop that uses a revolving ‘barber pole’ as its only means of marketing and where all customers want basically the same things at the same price (a hair cut and a shave for $15) to a spa with diverse services and products that mass customizes its offerings and markets through c-list to a-list celebrities, this model has evolved to the point where for the first time in recorded history, a service business can become scalable.
2. A spreadsheet that shows the value proposition for a single customer or client. That is, you understand and can demonstrate in a clear and concise way how your new enterprise/product/service/division creates either lower costs or higher revenues (or hopefully some combination of both) for one customer. (For an example of how to demonstrate your value proposition, go to: http://www.eqjournalblog.com/?p=73. I did this to help a number of residential REALTORS I work with. The spreadsheet is at: http://www.ottawarealestatenews.com/ValuePropositionFSBOVersusAgency.xls.) Essentially, negative cost selling happens when you understand your customer’s business almost as well as they do. (For more about negative cost selling, refer to: http://www.eqjournalblog.com/?p=425).
The corollary here is that you should insist that your suppliers provide you with their value proposition too. Why should you expect less of your suppliers than you do of yourself?
3. A second spreadsheet is required that provides you with a financial model of your enterprise. Having done quite a bit of work in the field of urban economics, it has always amazed me that most cities, for example, don’t have a financial model that can tell them what the fiscal implications are of one more resident or, for that matter, one more firm locating in their town. Most cities have budget processes that are a mess. I produced a financial model for a backorder domain name service that you can safely download from our server at: http://public.sheet.zoho.com/public/profbruce/backorderdomaincorpfinancialmodel. From this model, the firm can see what impact each additional client has on the top line of the firm. The firm is also able to test the sensitivity of its top line to changes in the success rate of backorder capture, changes in its COGS (Cost of Goods Sold) and other variables.
Your value proposition for your clients and their impact on your business (which is measured in your financial model) are mirror images of each other. We complete the business ecosystem when your suppliers provide you with their value proposition and you also insist that they have a financial model of how your business impacts them. Why should you care if your supplier’s have a workable financial model? Well, the long term viability of your firm depends in part of a stable supply chain and it won’t be stable if your suppliers are failing on a frequent basis.
4. You should score your business model using our Business Model Scoring Test: http://www.dramatispersonae.org/BusinessModels/BusinessModelScoringTest.htm. You can compare your score with some major firms that we ran through the test a few years ago at: http://www.dramatispersonae.org/BusinessModels/BusinessModelScoring.htm.
5. One of the themes we return to often is that your enterprise will not be successful unless it can acquire clients or customers in a cost effective way. This is just as true of NGOs, Not-For-Profits or Charities. (It is also true that these types of enterprises also need to have complete Business Models including a financial model, its value proposition and the other elements described here—no one likes to give money to a charity, say, that burns up a lot of the funds they raise in administration. They need to be efficient too.) If your new enterprise requires heroic efforts to land clients, you won’t be around long and all the good things you planned to do will just not get done. So Guerrilla Marketing (and now Social Marketing) have to be part of your business model. You can test your GM using another online tool we developed: http://www.dramatispersonae.org/GuerrillaMarketingAndFinance/BMGGuerrillaMarketingTest.htm. Your GM Test score should also form part of your BM.
6. Having a great business model without the ability to execute is not very useful. That is, execution counts/ideas by themselves, even great ideas, are not enough. Take the online ECQ Test to find out more about your entrepreneurial ability: http://www.dramatispersonae.org/ECQTest/ECQ(ns)TestAuto.htm. Show your score in your overall Business Model too.
7. If you need to run Super Bowl commercials before you can get your first client, your new enterprise is unlikely to be successful. Similarly, there are business models that do not easily lend themselves to entrepreneurial startups. Perhaps they need enormous amounts of capital that simply can not be raised by entrepreneurs. The focus here is on enterprises that can be bootstrapped/self capitalized. So the business models we are looking for use Bootstrap Capital to start their new enterprises. VC-funded startups are excluded from consideration here. Hence, you need to show where the capital is coming from and how you are going to self-capitalize your business model. Read more at: http://www.eqjournalblog.com/?p=45.
Here is an example of a home building business that was started for $500 and is, eight years later, doing about $30 million in volume per year. Now it’s true, Best Homes 4 U (not the real name of the startup) got started by doing what is essentially a ‘consulting’ type business: they built decks, fences, gazebos and did small renovations and additions to begin with. But even there, the two Founders (Bill and Josh, not their real names) knew they needed a Bootstrap Capitalization model.
For example, if they got an order for an $8,000 deck, they would take a $4,000 deposit upon signing of their Agreement with the homeowner. Then they would take two progress payments of $2,000 and $1,200 during construction leaving only $800 to be paid when they completed the job. Furthermore, they arranged trade credit from a lumber company (with 30 day terms) to give them more room to breathe (so to speak).
Bill and Josh understood the ‘golden rule’: “He (or She) who has the gold, rules.” They ‘got’ how important it is to have cash in the bank. [In fact, entrepreneurs and CEOs of much, much bigger enterprises also understand this. They manage their businesses by basically tracking cash and cash flow using three simple measures: AR and AP at the beginning and end of each month as well as their bank balances at the beginning and end of each month. Cash doesn't lie while accounting statements often confound even the most sophisticated analyst.]
When Josh and Bill were ready to tackle bigger things, they optioned a $2 million piece of property for just $500 from a friendly landowner, stuck a few signs up, created some great house plans and spent a summer pre-selling from a trailer on-site. They got supplier credit from Trade Contractors (drywallers, lumber companies, footing and foundation installers, truss manufacturers and the other 25 or so trades they needed to complete their homes).
That summer, they also pre-sold ten homes, collected $40,000 deposits on each home, signed APSs (Agreements of Purchase and Sale) at an average price of $550,000 per home and then pledged those APSs to their Bank for a LOC (with a LTV (Loan to Value) ratio of 50%) to raise another $2.75 million. They also put a value on their time and effort (to do the designs/do the marketing/do the sales/manage the project and construction) of $400,000.
So instead of sitting around and bellyaching that they needed $8 million in financing before they could even start their business, they went out and used what is essentially ‘free’ capital sourced from the deal flow: from suppliers (who trusted them; e.g., the landowner got paid for his lots only when they sold each home), from launch clients’ deposits, from their clients’ strong credit scores and PBSs (Personal Balance Sheets) which they pledged to their Bank and from their own sweat equity.
Here is their Bootstrap Capital Model for your perusal:
8. To succeed, a startup does not necessarily have to find a never-before-tried-idea. Perhaps the reason it has never been tried is that it is a bad idea. Maybe instead, you decide to tackle an existing industry. But at a minimum you need to have something that differentiates you from existing firms—you need some Differentiated Value or ‘Pixie Dust’. As part of your BM, you need to be able to succinctly explain your value proposition (http://www.eqjournalblog.com/?p=394) and convincingly demonstrate that it contains significant pixie dust (http://www.eqjournalblog.com/?p=9).
9. Another aspect of a BM that will help you make sure that ‘the harder you work the more money you will make’, is the Cash Conversion Cycle. What good is a fast growing business if you go broke in the process? Don’t think that can happen to you? Sure it can if your CCC is too long. Basically, this means that if it takes too long for you to collect your receivables or you have to pay for your inputs too long before you can deliver your product or service, your enterprise is doomed. The entrepreneur’s credo is ‘collect early/pay late’ for a reason. Some businesses grew as fast as they did (like Dell for example) because they took this to heart. Dell didn’t make anything it its early days unless they were prepaid—they kept practically nothing in inventory. Consumers and businesses pre-ordered and pre-paid for their PCs and, hence, Dell had a CCC that was negative—which meant the more they sold, the more cash they had on hand which for a startup is absolutely essential. The CCC is calculated as follows:
CCC = ART + INVT – APT,
Where:
ART is Accounts Receivable at Year End,
INVT is Inventory at Year End,
APT is Accounts Payable at Year End.
You can read more about this at: http://www.eqjournalblog.com/?p=610. The actual calculation of CCCs are surprisingly complex and so I put a spreadsheet online to help you with this: http://www.dramatispersonae.org/BusinessModels/CashConversionCycleMeasurement.xls.
You may prefer using our CCC calculators in your browser, so we also put them up for you at: http://sheet.zoho.com/public/profbruce/cashconversioncyclemeasurement.
10. Lastly, we developed an online tool, the BMG (Business Model Generator) to help you get started. The landing page is at: http://www.dramatispersonae.org/BusinessModels/BusinessModelGeneratorLandingPage.htm and the actual Generator is at: http://www.dramatispersonae.org/bmg/. It seems to work best using IE (Internet Explorer) and, even though I use Chrome for almost everything, I use IE when accessing the BMG. This tool is something to help you get started but I expect that you will take what you have learned by using it and what you have learned here and develop something much better.
Conclusion
Business modeling is a relatively new field of research and practice and will undoubtedly evolve extensively in just a few years. The Internet is having a profound impact on the way we design business models and the way we execute them. I predict that this will continue for a long time yet—the Internet is just a baby and will subsume everything in its path—perhaps even including RL (Real Life) as we are already starting to see technologies that overlay information on the reality we perceive around us. However, if you are able to ‘get’ what we are driving at above, you will be way ahead of the curve as it exists today.
Prof Bruce