Getting The Business Model Right-
Defining The Business Model
Companies and Corporations are the most efficient form for creating and delivering value ever devised by humans. The Business Model shows how they do it-- create value and deliver it to clients and customers. They create value for themselves, their employees, their shareholders, their clients and customers, indeed, all their stakeholders as well as society at large.
1. A Business Plan is typically 20 to 30 pages long. It talks about all manner of things and usually contains financials and projections.
2. A Business Model is at the core of a Business Plan. It can be said to describe how a business creates and delivers value. In essence, the Business Model is discovered by "Suivez l'argent", following the cash.
3. A Business Model is often a diagrammatic description of how a business creates and delivers value. The flow chart or diagram gives you a window into the business.
4. The term 'Business Model' has come into general use in the last four or five years.
5. The Business Model is the kernel of the Business Plan.
6. If you get the Business Model right, the harder you work, the more money you make. If you get it wrong, no matter how hard you work, you just end up losing more and more money.
7. The web has changed everything. It allows you to customize the company's mass offerings.
8. The Business Model pulls together how you create value and how you deliver it. In the Business Model, cashflow is King.
9. The Business Model is a theory of the way the business actually works. A Business Model allows you to systematically make predictions about the business; it allows you to design processes and your offerings by first describing them, then classifying them, then predicting and finally designing them.
10. The business is a system. By following the money, you discover the system (the Business Model).
11. Successful business models have the following characteristics according to Adrian Slwotzky et al (The Profit Zone, 1998): a) profit, b) profit growth, c) controls, d) low asset intensity (or high inventory turnover, or both).
12. Example: By changing the billing formula of a local consulting company from one wholly dependent on billable hours to a mixed system of billable hours, fixed fees and success fees, they triple revenues in three years and double productivity. (The latter was also enormously helped by investment in networking technology). Fixed fees allowed the firm to turn some its services into quasi products where pricing is not related to hourly consulting.
According to John Callahan's model of businesses that provide custom solutions using standard processes, you need to be able to give your clients and customers a mass customized product or service using standard inputs. Many businesses like the Barber Shop of Model A shown below give the client instead a standard service (the haircut) using custom inputs (the Barber). This is an undesired business model.
Essentially, the goal of most entrepreneurs is to create businesses that create value even when the entrepreneur is not there; i.e., while he or she is 'lying on a beach'.
The local consulting company was providing custom solutions (consulting reports) using custom inputs (specialist consultants), which in Dr. Callahan's model is a neutral result. In this type of business, the only way to make more money is to work longer hours-- hardly a way to create value that is independent of the founders!
By changing to a fixed fee pricing model and creating quasi products that are not solely hourly based services, the firm started to move in the direction of providing a custom service with standard inputs- value creation that can become independent of the firm's individual employees and ownership.
13. Here is the 'Barber Shop' Model from Professor John Callahan- the simplest b. model imaginable.
In this model, information flows from the Shop to clients (where the shop is, how much it costs to get a haircut, etc.) and from clients back to the Shop (eg., what type of services are demanded, what people are willing to pay, etc.).
The service is provided to customers and fees are paid to the Shop.
The Barber Shop has certain benefits and costs (revenues and profits versus time and opportunity lost) and clients get cetain benefits and costs (personal grooming versus time spent and fees).
The efficacy of the Business Model can be measured in terms of frequency (of use), trust levels (trust between client and vendor), dependence, continuity and uniqueness. The Barber Shop scores fairly low in all categories except perhaps frequency.
Now what if Dr. Callahan's model was changed- the Barber decides to add a spa so that now the Model (Model B) looks like this:
By introducing the spa, the Barber has developed two types of customers- type 1 customers are the regulars and type 2 are celebrities (local sports heroes, TV personalities, etc.).
Now this model introduces the possibility of differential pricing or differential services. Maybe the local celebrities pay negative fees (in essence, they are paid to come to the spa, appearance fees, if you will, or negative fees) in the hopes that their patronage will lead to more type 1 clients coming to the shop.
Restaurants do this with police officers (the restaurant is perceived to be a 'safer' place) or sports stars- the place gets a certain caché from their presence. It is almost impossible for a local sports star to buy his or her own meal.
The spa engenders increased trust levels, frequency, dependence and adds more uniqueness-- patronage has become less sporadic. Maybe that is why we see so many hair salons today offering spa type services today; makes sense doesn't it?
Clearly, Model B opens up more (pricing and services) possibilities and is a better business model. The modern economy is all about providing more options for your clients and customers and greater differentiation amongst your products and services.
14. In constructing your business model, identify the players and the actors. Identify the relationships between them, the information flows, the product and service flows and the money flows.
15. In every business, there are 'secrets' to success. Things that the experts do that may never be verbalized or written down but are essential for success in that industry. The Business Model should help you find out what those 'secrets' are.
16. In Dell's business Model, their secrets are deceptively simple- Dell's Business Model is a) make-to-order, b) cash arrives (i.e., they are paid) before the product is build or delivered.
17. This is the 'pixie dust' that makes their business model work so that a college drop-out (Michael Dell) can build the biggest PC manufacturer on the planet. The differentiator is the pixie dust. "We need an algorithm that will show where the pixie dust is!" Professor Tony Bailetti.
18. Amazon's pixie dust is their use of their relational data base: "Do you want to see what others who bought this book are also buying?" Obviously that is an up sell pitch for Amazon but also an incredibly useful research tool for harried university professors who can put the millions of Amazon customers to work for them doing research.
19. A Canadian University's pixie dust is its monopoly power to confer degrees.
20. Dell's is as described above- making money before ordering any inventory or production.
21. For most people, their 'pixie dust' is simply having a J.O.B. (stands for Journey of the Broke) that pays them every two weeks.
22. Walmart's pixie dust is simply automated and integrated inventory management (integrated with POS systems)- having suppliers send (directly) basketballs to Nashville and hockey skates to Kanata in the right quantities and at the right times.
23. Cisco's pixie dust is outsource everything.
24. The NHL's pixie dust or the NFL's is the right to grant local hockey or football monopolies.
25. The Corel Centre's (and the Sens) is outsource everything except for key customer and sponsor relationships and hockey management.
26. The mini office business pixie dust is in its pricing- lower rents by moving many operating costs to a facilities charge. "The basic rent for the office is $600 monthly. Oh, by the way, there is also a facilities charge for telephone answering, your office furniture, the meeting rooms, etc. of $110 monthly." People only remember the basic rent number.
27. A local hotel with 55% occupancies was going broke in the mid 90s. They kept on lowering prices for their rooms and suites (down to as low as $59) and occupancies kept dropping. (A hotel needs an occupancy rate of at least 70% to survive). The owners did a survey of guests to see what the market could tell them. Their guests ranked price as a very important factor in their decision to stay at the hotel. See the flaw? They obviously needed to survey people who didn't visit their hotel. (Other hotels at the time had occupancy rates of 78% plus and room rates of $129 to $189.) They needed to study that part of the universe of their market that did not visit their hotel and find out why. Then they learned that almost 50% of in bound traffic (most of it tech and gov't related) was female and booking agents shied away from the hotel because of the perception that it was cheap and dangerous. They raised prices to $119 and within 12 months their occupancy rate was within striking distance of the industry average- they had both higher prices and more volume!
28. There is something 'magical' in most businesses that allows them to really make money.
29. The Business Model is important so that you don't have to find out what it is by trial and error alone. You can try and err for a 100 years and not get it right so a Business Model is pretty much essential in the sense that it brings system and process to your search for a viable, profitable and growing business.
30. Tony Bailetti sums it up this way:
business model = advantage x cash engine x passion;
where:
advantage = What are we the best in the world at?
cash engine = What is the price/cost equation that drives our economic engine?
passion = What are our core people deeply passionate about?
Example: if advantage is 0, you do not have a business model. Same if passion = 0 or engine = 0.You have a winning business model if advantage is high, engine is high and passion is high
Notes and comments based on a lecture by Professor John R. Callahan, Carleton University, October 1, 2001 by Dr. Bruce M. Firestone, Ottawa, Canada.
Getting the Business Model Right