Should your startup be business model driven?

Zipcar CEO Scott Griffith described Zipcar as business model company. He was likely alluding to the shift  from buying and owning for expected future usage to on-demand rent culture. You likely are thinking isn’t that what other car rental companies do, but I will give benefit of doubt to  Zipcar and interpret this fine granular renting. The essence here is how he saw his venture – as an entity that is business model driven and if I may take it to extreme, a business whose sole purpose is about business model disruption and business model innovation.

There is considerable obsession around business model. When you read advice columns from startup accelerators and their ilk., you will see the chatter on business model canvas, what is the right canvas, business model innovation, recurring revenue, subscription model etc.

In the words of Netflix CEO Reed Hastings I would like to say here, forget the focus on business model and business model driven venture strategy. All this obsession about business model is just plain wrong.

Now that I made by bottom line, let me start over from the beginning by asking

What is a business model?

Most treat business model as just monetization models – Ad revenue, affiliate income, subscription model, pay per use etc. That is only part of the equation. Scamming is also a monetization model but is that a viable business model?  Does the money you take as your revenue represent your fair share?

The correct and complete definition of business model should include first the total value created and then how you get your fair share.

Business model is how you create value for your target customers and how you get your fair share of that value.

If you did not help create value you cannot get your share – well you can but you should not and it isn’t sustainable. Value creation is the prerequisite.

If you look at value creation, the obvious step before that is customers with their unmet needs. You create value through your product or service innovations that fulfill those unmet needs better than any other alternatives available.  If you see customers and their unmet needs as the invariable here then it is not too hard to see that there is no such thing as a business model company. There are only customer driven companies. And if you choose to be business model driven company at the expense of customers and their needs you will find yourself getting disrupted.

Once you established clear value the simplest way to get your fair share is what Instapaper’s Marco Arment said – charge for it. Does this mean there is no need or room for innovations on the second part of equation – the monetization model (what most incorrectly call as the business model innovation)?

Absolutely not. Such innovations should be second order after you have clearly established your customer segment and your value creation innovation. Examples of such monetization model innovations include (but not limited to)

  1.  In the value chain with just you and your customers you can introduce a third (or a fourth) player with each indirect value flows. You create content that is of value to customers, who create value to third parties and you get your share from these third parties.
  2. If customer value realization occurs only in spurts then you can design a subscription model that is aligned with value realization.

But if the job customer hired your product for gets better alternatives and your product gets fired because of that reason then it does not matter how you choose to get paid for the job.

The questions you ask are not

  1. Does by business produce recurring revenue?
  2. Does my product create switching costs?

but

  1. Do customers get recurring value from my product (and hence am I getting a fair share of that recurring value add)?
  2. Does my product continue to improve to stay relevant such that it creates better value than any other alternatives?

Not the shift from you to customers in the second set of questions.

There are no business model companies, only customer centric companies.

Yellow Bananas and Black Model Ts

It is obvious to us now that Henry Ford should have allowed color choice and he would have sold lot more cars. He could have likely charged higher prices over black Model Ts as well. Was this not obvious to him?

Take a look at a present day product that we all consume almost everyday – Bananas. Unless you are a customer of Berkeley Bowl, it is likely you have bought just one variety of bananas. The brands could be Chiquita or Dole but there is only one kind of bananas.

Science Friday has an explanation for this dearth of choice,

… imagine a pipe from Ecuador to your supermarket that can only fit one variety of the world’s 1,000 banana varieties, and that’s basically the way it works.

In order to bring new bananas, you have to build entirely new infrastructure, ranging from plantation to shipping to packing methods and to ways to tell consumers about it.

So why not  do it? The old hands at Chiquita and Dole know only one way of doing things. They are not going to do it. Why not some entrepreneur disrupt the market and import new varieties?

The answer lies in the price we are willing to pay for bananas.

 The banana is the cheapest fruit in the supermarket

They are cheap because the suppliers made a choice to focus their limited resources. They decided to focus their investments and marketing muscles on just one variety.

It is an extremely high fixed cost business – building that virtual pipeline from Ecuador for handling another variety. The result? A split market unless the disruptors can grow the market enough (which is not really disruption).

But can’t they  recoup the fixed costs through higher prices for the new varieties

Unfortunately no. In any new product investment decision, pricing comes first. Given the low reference price set by current bananas how likely will the customer be willing to pay a higher price premium just for the variety? How big will the market be that is truly incremental?

Will the value from variety be clear to customer that they will pay premium for it? What is the additional marketing investment needed to convey the value message?

Even if the value is clear, is there value leakage that bring the value down?  For instance, are their customer behavior changes needed like

One of the reasons is that educational component in bringing the new variety. Baby bananas need to be served much more brown than a traditional Cavendish to taste right. But most people are used to that visual cue the Cavendish gives and so don’t allow them to go brown, and that’s been a real problem in getting people to actually like this variety.

All this capital and resources have opportunity costs – other fruits that can be profitably introduced or other business line altogether. There is no need to disrupt for the sake of disruption if there is no incremental profit.

When is not giving choice to customers is not all bad? When providing choice fail to deliver incremental profit.

 

The Long and the Short of Fidelity and Convenience Traps

In introducing the concept of Fidelity and Convenience Traps, I wrote that traps are where a firm is stuck in when its strategy and innovation are aligned with one factor while the market as a whole prefers another. These traps are a result of relatively stable preference (stable over a longer period of time)  of large segments of the market for fidelity or convenience while the firm’s resources are committed to and tied up with convenience or fidelity.

I also hypothesized that the market’s needs switch between  fidelity and convenience over time. This is not a high frequency switch that happens over a very short period time. The switch happens over a relatively long period of time (1 to few years) and in between switches there is a stability. It is the stickiness of the preference and the slowness of change that cause the traps.

These long run trade-offs are much different from the short run trade-offs we make everyday. These short-run trade-offs do not result in traps. Take for example eating pizza. It is a Friday evening, you and your family of four are considering dinner options. Your children decided it is going to be pizza. On a 0 to 100 scale, rate each of the following options (0 – extremely undesirable, 100 – extremely desirable)

  1. Pizza  delivery from local pizza chain for $25, delivered in 30 minutes
  2. Two frozen pizzas at $5 a piece, that you already have in your freezer, add fresh toppings of your choice. Total time 30 minutes.
  3. Make pizza from scratch, with all fresh ingredients including fresh buffalo milk mozzarella for a total cost of $12. Total time 2.5 hours.
  4. Head out to a highly rated pizza place that serves authentic Italian thin crust pizza in a wood fried oven with all fresh ingredients. Total price $55 and drive time 30 minutes, waiting time 30 minutes.
  5. Head out to local all you can eat pizza buffet place with all standard pizzas made with packaged and frozen ingredients. Total price $28 and drive time 5 minutes with no wait time

You can see that high quality ingredients and  special oven make the pizza very high quality – or high fidelity. A frozen pizza or a delivered pizza are not the highest quality but provide great convenience. There is also the price – that pushes people to til either towards the fidelity or convenience end of the pizza spectrum. The score people assign to these options is referred to as its totality utility. Different people get different utilities from the same option and even for the same person the utilities for a given option will vary with context. The choices are not stable, highly unpredictable and vary over short time periods (even within a week).

In other words different segments of the market, at different times (within a short time frame) switch between fidelity and convenience.  This is the short run cycle and does not represent a stable preference by a large part of the market over a relatively long period of time and hence there are no traps.

Short run cycles do not cause traps, only the long run cycles do.

In the coming weeks, I will write more on modeling the short run and long run cycles.