WHY BUSINESS MODELS FAIL
Developing a Business Concept
A business concept is a concise description of an opportunity that contains four essential elements: The customer definition; the value proposition (or benefit to the customer) and the compelling story; the product/service; and the distribution channel or means of delivering the benefit to the customer.
The business concept can be thought of as a type of elevator pitch. Elevator pitch is a term that has been applied to the idea that one has only a few seconds – the time it takes to ride an elevator up to the twelfth floor – to get an investor (or other interested party) to “buy into” a business concept. A few seconds is not a lot of time, so having a clear, concise, and compelling statement of the business concept is important.
In reality, most people, whether they are potential customers or potential investors, don’t have enough time in their busy schedules to give a proposed idea more than a few moments of thought before they decide whether to dismiss it or investigate if further.
Quick-testing the concept
With a preliminary business concept in hand, it is helpful to do a quick test to determine whether a full-blown feasibility study is warranted. Many weak business concepts can be eliminated from further consideration by asking a few simple questions. Answering these questions does not require any research. The entrepreneur can simply rely on his or her own knowledge and on the advice of people who can provide objective opinions.
- Am I really interested in this business opportunity?
If the concept is developed, time and energy will be invested, so it is important that the entrepreneur be passionate about the idea. Many potential entrepreneurs have gone forward with concepts that others suggested, only to discover, after they have spent considerable time, effort, and money, that their hearts weren’t in the business.
- Is anyone also interested?
A business cannot exist without customers or, in many cases, without investors, so it is important for an entrepreneur to determine whether anyone else is interested in the business concept.
- Will people actually pay for what is being offered?
Often when people hear about a new product or service, they express interest – and even excitement. But what are they willing to pay for it? And how much? If they are not willing to pay what it’s worth, the idea may need to be revised.
- Why me?
The entrepreneur must be convinced that he or she is the right person to execute this concept. What unique capabilities and contacts does the entrepreneur bring to the venture?
- Why now?
Why is this a good time to launch this business? Why has no one else done this before/ or, if they have, why did they fail (or succeed)?
Once these questions have been satisfactorily answered, it’s time to progress to the next level: the business model.
The Business Model
Once a business concept is identified, entrepreneurs must address the important issue of how to make money from the products and services they offer. More important, they must determine how the company will create value for its shareholders, investors, customers, and value chain partners.
Building an effective business model addresses all those issues, as well as creating a competitive advantage for the company. One difficulty is that business models tend to change over time as customer needs change, so the challenge is to find a way to sustain the efficacy of the model over time. It should also be protected from imitation, which could turn the company’s products and services into commodities.
Why Business Models Fail
It is not uncommon for business models to fail when they are not carefully conceived and executed. One of the biggest reasons for failure is lack of a compelling story. Business models also fail when the numbers don’t make sense.
Building a Business Model
It is useful to build a business model in stages: Stage 1: Identify the entrepreneur’s place in the value chain. Stage 2: Determine who pays whom, how much, and when. Stage 3: Calculate the impact on the customer in terms of switching costs and learning curve. Stage 4: Identify the revenue streams from the products and services.
Stage 1: Identify the Entrepreneur’s Position in the Value Chain
The first step in developing a business model is to identify the entrepreneur’s place in the value chain. If the entrepreneur’s company is a supplier or producer of raw materials, it will generally be at the top of the value chain and upstream from manufacturers.
Intermediaries, such as distributors and retailers, will be downstream from the manufacturers. Where a company is located is normally a function of its capabilities and the desire of the entrepreneur for a particular type of business. Selling a business concept takes the least amount of investment and requires the least time commitment from the entrepreneur. Conversely, starting a retail business requires a huge time commitment, demands substantial capital, and generally carries with it higher level of risk.
Stage 2: Determine who pays whom
Once the business is located on the value chain, it is easier to recognize who pays whom and to determine costs and pricing. For example, a raw materials producer charges the manufacture $4 per unit; the manufacturer turns the raw material into product and sells it to the distributor for $6. Alternatively, the manufacturer can use an independent sales representative (sales rep), who will find outlets and receive a commission on sales made. Note that the retailer who buys from the distributor or sales rep, typically at least doubles its cost in setting the price to the consumer. This is known as keystoning. Note that as a rule, markups increase as one moves down the channel. This occurs because the cost of doing business increases, as does the risk.
The value chain now illustrates the various markups, which is helpful in determining the lowest price possible for the product. The highest price possible is determined through market research with potential customers. The markups on the original cost reflect profit and overhead for the channel intermediary and are determined by what is typical in the industry. Every product or service has more than one channel option, so it’s a good idea to depict distribution options graphically to compare their effectiveness. Graphing the value chain makes it possible to do the following:
Measure the time from manufacturing to customer on the basis of the lead time needed by each channel member.
Determine the ultimate retail price on the basis of the markups required by the intermediaries.
Figure the total costs of marketing the product. For example, manufacturers have to market to distributors, but to support their distributors they may also market to retailers and even end-users or consumers.
Stage 3: Calculate the Impact on the Consumer
It is important to determine whether the proposed business model will force consumers to change the way they use or find a particular product or service. Will that change benefit customers in a way that they will readily see? For example, many computer users have not switched to the latest Windows operating system because they can’t really see what benefits it offers over the system they are currently using. In other words, the basic functionality has not changed substantially, but the cost to the customer in terms of time and money is too high to warrant switching. It is also important to determine whether the learning curve for the customer will be steep. If customers see that learning to use the new product or service will take some time and require them to change old habits, they will think twice before purchasing.
Stage 4: Identify Multiple Revenue Streams
One of the most important components of the business model is identifying the revenue streams that will flow from the products and services being offered. A healthy business model always supports revenue streams from multiple types of customers and multiple products and services. Relying on one revenue stream from one type of customer is dangerous.
Sources of Opportunity for Business Models
Many opportunities exist for building new and innovative business models. Here are few examples:
- Reposition the company on the value chain. Look for unserved or underserved niches and customer dissatisfaction.
- Reinvent the value chain. Ignore what currently exists and develop a whole new value chain. This is often accomplished by looking at successful value chains in other industries and extrapolating to the entrepreneur’s value chain.
- Redefine value-added. Don’t do things exactly the way everyone else does. If competitors seek out contracts for work from customers and wait for customers to tell them what to do, try learning what customers want in advance, doing the work, and then approaching the customer with a solution.
- Redefine distribution. Find out where the customers are and go there. If the channel contains a lot of intermediaries, consider “selling direct” to save the customer money.
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