There are probably countless ideas that could make incredible businesses and investment opportunities. Often, the excitement of a new idea for an app, product, service, or technology can drive people to found a company based entirely on their excitement. That is not to say excitement is a bad thing, far from it, but it is important to make sure any business idea can do what it is supposed to, at the end of the day that means revenue and profitability.
With the success of user-based platforms like Snapchat and Twitter, many entrepreneurs try to follow suit and focus on users first, assuming that revenue is destined to follow. Several incredibly successful companies have succeeded with this approach, but in 2020 this strategy is generally no longer tenable. Most businesses that approach their product in this way fall apart. Users are not a guarantee of revenue, and that assumes that a large enough userbase exists at all.
Understanding business models and understanding the approach your business will take is critical to mission success. Without a fundamental understanding of how your company will continue to pay the bills not only are you put at a severe financial disadvantage, but you can become over-reliant on investors which will put you in a terrible negotiation leverage position or worse result in your business running out of funds. This can also be met with material stress for you as the CEO along the way.
Understanding Business Models
While the job of every business is to generate revenue (and profits), there are many core monetization models your business can have.
- Product Model (Purchase): The product model is the simplest form of the business model. The simplest model would be something like this: “We manufacture watches for 20$. We then sell those watches to the consumer for 40$.” A business produces something and then sells that product to a consumer for more than they produced. The theory is that a consumer is willing to pay for the hours, skill, and capital needed to produce a given object, as well as the perceived value the product carries
- Product Model (Rental): Some companies rely on the fact that certain products are expensive or cumbersome, and that outright ownership may not be desirable for the consumer. Rental car companies work on this assumption. Users pay a smaller fee to use a product while avoiding ownership.
- Service Model: A good example of a service-oriented business model would be an accountant. When someone pays an accountant, they do not expect a physical product, but rather are paying for the skill and service that an accountant can provide. Many service-based businesses operate with people at their core. The function on the premise that time is money, and that selling your time (or your employees time, with margin) will be profitable and sustainable. The challenge of course with this model is that time is a limited resource which limits direct scalability.
- Advertising/Free to Use Models: This model is what many current social media platforms are built on. The service or product is entirely free to use but is paid for by advertisement hosting or the reselling of user data. Snapchat would not have 360 million monthly active users1 if it was charging everyone a significant fee to pay for server space and app development. Instead, it relies on the size of its user base to draw in advertisers. Companies that use this model also often have advanced data analytics which allows advertisers to optimize where their ads are shown so that they can more accurately target interested consumers. Snapchat is not a messaging company; it is a data analytics and advertising platform that built its user base on messaging.
- Subscription Models: These businesses leverage the fact that consumers are willing to make recurring payments for products and services they consistently use. Netflix thrives on this assumption. Individual consumers would find it prohibitively expensive to own hundreds of thousands of movies and tv shows. Services like Netflix can aggregate all these TV shows and movies and rent out subscriptions which allow end-users to view all the media as if they own it. One advantage that recurring payment models have over one time rental models is that consumers are likely to continue to subscribe since the payments are automatic and small.
Plan for Long-term Success
Rather than jumping into an exciting idea and assuming the money will follow, it is important to check your excitement and make sure it will get to profitability, fast. Sure, some companies have had success with the ‘shoot first ask questions’ later approach, but those stories are few and far between. Perhaps they were saved by an angel investor, got lucky with advertisers, or had enough initial capital to run a deficit for years on end. Chances are almost no business are in this situation.
When it comes time to seek out investors and partners (should you even consider raising money), credibility, confidence, and know-how are key. Understanding where your business works and where it doesn’t, where it stands to make money or lose money, and how this plan will work in the long term are all part of understanding your company’s business model.
Understanding how your business will continue to grow and profit in the long term is critical to not only building investor confidence and increasing your credibility, but also in giving you as much freedom as possible when it comes to running your business. Once you understand how your business makes money taking on capital growth becomes a choice not a requirement. If your business can sustain itself and continue to grow without outside investment, then you have an incredible opportunity to maintain complete control over your company. This allows for you to wait until the perfect investor or offers comes along instead of jumping a subpar offer or working with an investor who has a different vision for the business.
Not only can understanding the business model your company will adopt help to make sure that your idea is solid and worth pursuing, but it can also act as proof to investors and partners that you know what you’re saying.
To learn more about business models look at this2 page on my website.