Middle age for startups
A friend of mine has a hardware startup called PowerToad. Typical to any middle-aged startup, they are suffering from growing pains. It is imperative for startups to begin moving from the "sell it to anyone who sniffs at us" phase, to really focusing on just exactly, what type of market you are focusing on
? Those questions are the most salient for PowerToad as they have signed up a number of high profile clients, but as of yet it doesn't appear they are cash flow positive and need just the right marketing and sales effort to make it all happen. This post from Early Stage VC seemed to fit the bill. Jeff if you're reading, take a look.
Business Model, Schmizness Model
The term “business model” has bothered me for a long time. I have always found it to be a glib method of characterizing a company’s relationship with its various constituencies, e.g., customers, suppliers, competitors, etc. The problem isn’t really the concept. The problem is that it’s a complex, multidimensional structure that doesn’t really lend itself to a summary sentence, at least not if you really want to understand the business. Yet it one of those economic terms that has entered the popular lexicon as the rise of business schools in the 1970s and 1980s mainstreamed “businessperson” as a profession (like engineer, doctor, or lawyer).
Wikipedia does a decent job of summarizing the cacophony of ideas that are embodied in the term business model. I won’t recount them here. The reason the question “what’s your business model?” bothers me it that the inquirer often judges the answer based on its parsimony, as though simple is prima facie evidence of good. Occam’s razor applied to business strategy.
I myself will sometimes ask others the question, but I use it to test for complexity, not simplicity. I use it as a Rorschach to see how deeply the respondent has thought about the market and which aspects of the business appear most salient to him or her.
In preparing for this entry, I started to ask myself how do I think about a business model? And how do I test if business models are complete, coherent, and compelling? When I worked at Bain in the early 1980’s the firm then specialized in ‘strategy’ and ‘business definition,’ equally amorphous concepts. (Amorphous is good when you bill by the hour). We used to refer to three tests to define whether two companies were in the same business – similarities of cost structures, competitors, and customers.
So I sat down and drew this little graphic for myself to try and outline the key concepts that seem to appear in the “business models” of companies that I see in my practice. I don’t claim this is complete or some form of ‘ground truth.’ It is a snapshot of the concepts that I most readily gravitate toward when I think about “what’s your business model?” I am sure I have left out huge chunks that will become obvious when I go to my next deal pitch meeting tomorrow.
I am not going to explain every facet. Most of it is self-evident (I hope). However, a couple of things are worth noting. First, at the center are the terms “lever” and “return on equity.” I think of all these bubbles as knobs or levers in the machine that is a business. Not all are equally important, but all are impactful choices that Management has made about the business, even if the choice is to ignore this facet. Second, the objective I want to maximize is return on equity, not growth, not revenue, and not necessarily even market share, though these may be part of what generates ROE.
I have enumerated some of the common choices more for illustration than prescription. I should point out the category of “enterprise asset” because I think of this as a separate objective beyond barrier to entry. The “enterprise asset” is that intangible that is the difference between book value and enterprise value. It is the reason why an acquirer is drawn to the business beyond the NPV of the earnings stream. It is the strategic value or what accountants call goodwill. This box is particularly important in early stage investing, as the exits are so often around acquisition. The business should have a clear definition of its ‘residual value’ to a potential set of acquirers.
Hopefully some will find this useful as a checklist. There is nothing Web 2.0 about this framework. And there shouldn’t be. Business is applied microeconomics -- Web 2.0 or pest extermination (perhaps a poor juxtaposition – I need an editor.) Anyway I feel better for having shared my quick and dirty model of a business model. Thanks for listening.
So, quick, what's your business model, anyway?