Business Models

In the past most startups occurred because a new technology had come along that would provide solution to a problem that could not be solved previously. (As an example, an unmet need was the pain of creating and editing documents. The solution was word processing, and the technological trigger that made this possible was the availability of low cost personal computers.)

However more recently there is a different phenomenon occurring. Instead of technology innovation being the driver for startups, it is more frequently business model innovation.

The business model innovations fall into two categories:

  1. Brand new business models being created because of the Web which don’t resemble any previous businesses. Examples of these would be companies like Google, PayPal, Gilt, OpenTable, SurveyMonkey, Second Life, eLance, 99Designs, etc. These businesses leverage the incredible power of the web to acquire customers at a low cost, with interesting new ways of monetization.
  2. Areas where there were already existing businesses, where new business models are disrupting the landscape. Examples of this are eCommerce (Amazon disrupting bricks and mortar retailers),  Open Source (e.g. JBoss disrupting an existing market dominated by BEA WebLogic and IBM WebSphere), and SaaS (e.g. Salesforce.com disrupting a market dominated by Siebel and others).

The purpose of this section is to look at the variety of new business models that are being developed, as this appears to be the area of innovation that is leading to some of the most exciting startups.

In many situations a business model breakthrough will have been created by one company and applied to a single area, and there will still exist considerable opportunity for that same business model innovation to be applied to other areas. As an example, Salesforce.com pioneered the SaaS business model, but only applied it to CRM. There are now many other application areas where the SaaS business model could be applied to create new businesses.

Business Model Failure

It is also useful for entrepreneurs to understand what business models are not working well, or are less attractive, so they can avoid those.

After my exposure to literally several hundreds of startups, I have begun to realize that one of the most common causes of failure in the startup world is that entrepreneurs are too optimistic about how easy it will be to acquire customers. They assume that because they will build an interesting web site, product, or service, that customers will beat a path to their door. That may happen with the first few customers, but after that, it rapidly becomes an expensive task to attract and win customers, and in many cases the cost of acquiring the customer (CAC) is actually higher than the lifetime value of that customer (LTV).

The observation that you have to be able to acquire your customers for less money than they will generate in value of the lifetime of your relationship with them is stunningly obvious. Yet despite that, I see the vast majority of entrepreneurs failing to pay adequate attention to figuring out a realistic cost of customer acquisition. A very large number of the business plans that I see as a venture capitalist have no thought given to this critical number, and as I work through the topic with the entrepreneur, they often begin to realize that their business model may not work because CAC will be greater than LTV.

Also if you would like to have a capital efficient business, I believe you will find that it is important to recover the cost of acquiring your customers in under 12 months. Wireless carriers and banks break this rule, but they have the luxury of access to cheap capital.

This topic is discussed in more detail in this section: Why Startups Fail.

The Essence of a Business Model

A simple way to focus on what matters in the vast majority of business models is look at these two questions:

  • Can you find a scalable way to acquire customers
  • Can you then monetize those customers at a significantly higher level than your cost of acquisition

There are some businesses such as marketplaces where there are additional components to take into consideration. However thinking about things in such simple terms can be very helpful.

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It is also very useful to look at some of the factors that can help drive the balance of the model:

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The sub-sections that follow from here look at these factors and also discuss new and interesting businesses models.

Specific Business Models

Further thoughts on these drivers and specific business models are explored in the following sections:

With more to come…

Acknowledgements and Thanks

I would like to thank the management teams at HubSpot, JBoss, and Gail Goodman of Constant Contact who greatly contributed to my learnings in these areas.

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  • http://reecepacheco.com reecepacheco

    Having gone through this process with my startup, this is a well communicated message and all entrepreneurs should give it serious consideration from the start.

    Excellent post, David.

  • http://www.darrenherman.com dherman76

    Nicely communicated.

  • avlokkohli

    Great article. Another example of a “brand new business model” is Mint.com. Their innovation was making money through lead-generation (whereas the market leader Intuit was making money by charging users)

  • http://www.forentrepreneurs.com David Skok

    Agreed – yet another very good example.

  • http://www.barringtonarch.com barringtonarch

    Great post! i recently read Plan B, which is a great resource for creating & testing business models that work! http://bit.ly/bu1vE4

  • http://www.forentrepreneurs.com David Skok

    Thanks for the recommendation. It looks like a worthwhile read.

  • Vashi Mayur

    hmmmmmmmmmm………….Great Information Provided……………….thnks :)

  • Micubogdan

    Hi David. I read some things on your blog.It looks very useful for our start-up.I would tell our story too,but it would just be another letter in the crowd.
    Instead,i would offer our services for free.You can test it to your blog/website and if you are happy, just tell your friends about it.I cannot share a web site with you because we are still in beta. I can send you details ,just ask at micubogdan@gmail.com
    Shortly: we can extremly easy increase the quality and number of sharing and tweets your articles have.Maybe especially you do not need it.But it worth seeing it in action for free.

  • http://www.facebook.com/people/Micu-Bogdan/1317781241 Micu Bogdan

    I have a question about Business model above.Groupon has a field sales,really high rates for clients,outbound marketing.Still,it is the most rapid growing company…Why do you think like this?

  • http://www.forentrepreneurs.com David Skok

    Micu,

    I believe that Groupon is a great example of a new business model that has several breakthrough elements to it. The first is that they leverage social viral effects for customer acquisition. This has been a key factor in the very fast growth in their customer base at a low cost.

    They then use their sales force to dial the vendors to get the deals that are needed to feed that customer base. There is nothing wrong with using a sales force or outbound marketing, provided that the micro-economics at both the customer level, and also at the salesperson level, work out correctly. In their case the micro-economics are highly profitable, so they very much fit the advice that I am trying to convey above.

    The big story behind Groupon is not that they invented a new product to sell to their customer base, but that they invented a new business model to bring the same old product to a customer base. That business model works because the microeconomics at the customer level are terrific.

    I hope this clarifies, and answers your question.

  • http://www.facebook.com/people/Micu-Bogdan/1317781241 Micu Bogdan

    Thanks David.
    I totally agree with you.But i think the real trick here is that Groupon has targeted business in the services areas(like food,spa,etc) wich can afford a High Number of customers-Low Income rate.This would not apply products.
    We just build a platform for group-buying of online products, but the limitations are somehow obvious.We figure out a way to compensate this but again,we turn our eyes to offline markets.

    Groupon helped Offline reach Online fast and easy.It’s like an inbound marketing cake delivery system for offline vendors :).

  • Anonymous

    This is a really clear explanation of business models – suitable for any size business, clearer than a lo of marketing textbooks.

  • Stephanie

    I thought that if I built my website I would just start selling—OH WHOOPS forgot one thing! Nobody knows where to find me!

    http://www.worldstretch.com

    just in case anybody wants any Urban Athletic Wear!

  • http://www.outsource-website-development.com/ outsource development

    Many thanks for theexciting blog posting! I really enjoyed reading it, you are a brilliant writer.  I actually added your blog to myfavorites and will look forward for more updates.Great Job,Keep it up..

  • http://www.realseocompany.com/local-seo-company/ Local SEO Company

    Essential business model innovations fall into two categories which is input here. I’m luckily found this construction view. Thanks for posting. :)

  • http://applereleases.net/apple-iphone-5-release-date-will-it-be-announced-in-june-or-oct-this-year Apple iphone 5 release date

    Fantastic business models.. Great tips buddy

  • http://www.forentrepreneurs.com David Skok

    Thanks!

  • Anjan

    Thanks David. That’s a lot of information neatly put! Helps in relating to highly successful startups.

  • David Alpert

    David, where in your blog do you touch on these other components that marketplaces need to take into consideration? “There are some businesses such as marketplaces where there are additional components to take into consideration. However thinking about things in such simple terms can be very helpful.”

  • http://www.forentrepreneurs.com David Skok

    Hi David, I don’t have any further writings on this topic. Sorry.

  • Facebook User

    David: We’d love your blog. We’d love to set something up with you. We aggregate a lot of business to business events across all verticals — https://www.facebook.com/BusinessVibes -