Two tests to see if your business model works. Telling a good story and adding up the numbers.

February 2nd, 20106:07 am @ f3 fund it

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Two tests to see if your business model works. Telling a good story and adding up the numbers.

In 2002, Joan Magretta published a very interesting article in the Harvard Business Review titled “Why Business Models Matter”, this was right after the internet bubble burst and your everyday investor was keen to stay away from anything and everything that could in any such way be associated with the dot com boom, the term “business model” was one of these and the sheer sight of a “business model” ran shivers down people’s spines.

However, Joan made a very good observation, this was that a “good business model begins with the insight into human motivations and ends in a rich stream of profits”, and whether dot com companies were here to stay, one could not disagree with the fact that human motivation will lead to some form of behaviour, in this – one that leads to purchases. Which is in the end a business model.

Telling a Good Story

Creating a business model is like telling a story. Take the example of J.C. Fargo, the president of AmEx who in 1982 during a European vacation identified the need for the travelers cheque.

The story associated with the business model was easy peasy for customers to grasp. For a small fee, the traveler could buy a secured against theft product that was convenient as it was widely accepted. On the other side of the table, AmEx was a trusted name, and businesses happily accepted the cheques, as more businesses accepted the cheques, and more individuals used them, more businesses would subscribe as not to stand on the sidelines and get in the game.

As for AmEx, well, we don’t have to go into details, but surely the equivalents of an interest free loan from customers and the nearly risk free nature of the business (customers always paid in cash), made this one of AmEx better business ideas.

But what’s all this have to do with business models? It’s simple really, a business model represents a better way of conducting something, improving on the current alternatives, it may offer value to a group of customers, or it may revolutionize processes until someone else revolutionizes those processes. In the end it tells a story about how something can be done better than it is now.

Doing the Math: The Numbers Test

Does it add up? Are your profits more than your losses? What is your burn rate? How long until you’re out of the red? Will my customers buy my product or service? Changing something and making it better is one thing, there have been millions of Euros, Dollars, Pounds, Yen or whatever currency you’d like to use, thrown at project that were simply put unsellable. These projects had great technologies behind them, they were innovators in their fields, they were new and something truly special, but they flopped.

Why? Because no one bought them, many were simply too expensive, i.e. various online grocers who’d bet that consumers would pay more for the same jar of jam if it could be delivered to their home, or in the 1980’s when Sears decided it would give its customers the option to purchase financial products. Why anyone would purchase an investment to add into their portfolio while shopping around for a car tire is beyond me, but hey, the exec’s thought it’d work. It didnt.

The moral of all this is basically, 1. Tell a good story, see if there’s a need and reason to develop a product or service you’re thinking about developing, who will your customers be, and will everyone involved benefit, and 2. will it be profitable based on a series of critical what-if assumptions focused on your business and product.

And if after all that, you’ve still got a green light. Well… then it’s time to think about scalability and strategy.