When I was less than a year old, my parents would time me as I arranged blocks to fit in the given shapes—I was very fast. Naturally good at pattern matching, I was able to learn (or rather memorize) the multiplication table in kindergarten.
Business models are my passion. I love to study them, think about them, work on them, dissect them, and try to make them multiply. A business model is just a series of levers or blocks. Read enough case studies and the patterns and trends will emerge. For the most part the patterns are finite, however sometimes a new business model combination comes along such as “Uber for lawncare,” unlocking new value. This is what we call innovation. For this reason, I strongly believe every product team should include someone who understands business modeling.
The key components of the business model (the levers or blocks) include:
Throughout my professional career, I have been involved in every aspect of the business model to a certain extent. For the most part, this diverse skill set makes me unemployable in a world that is always looking for subject matter experts! I will never be the VP of Marketing or the VP of Engineering. I’m a generalist, or in the words of Emilie Wapnick, a multipotentialite.
I will walk you through my informal methodology to help expand your thinking on business models and transform your innovative ideas into revenue. My methods are similar to popular approaches like Harvard Business School Professor Michael Porter’s Five Forces Model and Strategyer’s Business Model Canvas. I encourage you to explore these time-tested tools. I offer a unique, simple twist that may help you improve your ability to attract investors and succeed in the market.
First, I take a business idea and I visually input all the levers I mentioned above into an imaginary Excel spreadsheet. Yes, you read that correctly, the spreadsheet does not exist. I do this in my head. The two financial metrics in the spreadsheet I visualize are revenue and costs of goods sold (COGS). For each metric, I ask a series of questions:
Revenue: This is how much money the business can make, and a lot of different factors come into play.
What is the product offering?
Is there market validation either through minimum viable product or competitors?
How easily will I be able to acquire customers?
What is my go-to-market strategy?
Is there a positive K-factor? ("What the heck is a k-factor, Jeanette?" Look here.)
Will I need a large workforce (sales team) to grow?
Will I benefit from partnerships and how easily will I get these partnerships?
What will I charge?
Will people be willing to pay for what I charge?
By asking a series of questions, I can get a good snapshot of the overall financial viability of the business proposition. It will also help me determine whether this has the potential to be a fast growing company that will make it attractive to investors.
COGS: These are costs directly related to selling goods or services. These costs are variable and incremental. For example, labor wages and benefits, hosting costs, third-party software fees, office equipment, sometimes utilities and anything you can attribute to selling. There is a debate whether to include hosting costs, but if every time you add a customer your hosting costs increase, then you should include in COGS. If not, then you should include hosting costs in General Expenses with the other fixed costs. Here is a tip: assume a percentage. Do not try to break this down at first. Eventually, you will want to dig deeper into the numbers but for mental math, use a percentage.
The average COGS for a traditional business is between 55% and 85%. Each industry has a different average COGS percentage. How so? Over the years, analysts on Wall Street have studied how each industry performs on average. New entrants are held to those standards. (This is why I feel Wall Street doesn’t know how to value high tech companies, and tech IPOs have been struggling since the late 1990s). For software-as-a-service (SaaS) companies, COGS can get pretty low—variable costs are not proportional to revenues. That is why SaaS is one of my favorite business models to implement.
You can mentally gauge your gross profit margin. If you assumed a COGS of 60%, what this means is for every $1 you make, you spend 60 cents on COGS, giving you a gross margin of 40 cents.
Secondly, I iterate on this a few times (still in my head). For example, I recently had a customer development meeting with a new client, and my first thought was “Oh no, not another marketing platform!” But as I spoke about the pain points, I realized there was an opportunity for differentiation. In my mind, I was able to iterate both on the business model levers and the two financial metrics, particularly as it related to go-to-market strategy, customer acquisition, and retention rates. In a 30 minute conversation, I helped the entrepreneur extend the company’s value proposition by offering a better product at a competitive price.
I am not suggesting that you should build a company or launch a product solely based on business model considerations. The customer pain point and market opportunity should always be first in mind. However, by learning to appreciate financial metrics, and understanding the fundamental components of a successful business model, you can improve your ability to secure financing and to transform your idea into a profitable, growing business.
To learn more about how Dialexa approaches problem-solving for our customers, including our software development process, click the image below.