You can’t succeed in business without an operational model that delivers value to customers at a reasonable price, with an underlying cost that allows you to make a profit. There are no “overrides” – for example, businesses don’t thrive just because they offer the latest technology, or because everyone wants to be “green, or because their goal is to reduce world hunger.
I expect that should seem intuitive to all entrepreneurs, but every investor I know has many stories about startup funding requests with major business model elements missing. The most common failures are solutions looking for a problem, lack of a defined market, and giving away the product.
There are dozens of sources to help you construct your business model, and a good example is a recent book by venture capital investor Elizabeth Edwards, simply named “Startup,” which is really designed as a handbook for launching a company for less. I support her assertion that a business model consists of at least the first seven of the following ten basic elements:
- Value proposition. What is the need you fill or problem you solve? The value proposition must clearly define the target customer, the customer’s problem and pain, your unique solution, and the net benefit of this solution from the customer's perspective.
- Target market. Who are you selling to? A target market is the group of customers that the startup plans to attract through marketing and sales their product or service. This segment should have specific demographics, and the means to buy your product.
- Sales/Marketing. How will you reach your customers? Word-of-mouth and viral marketing are popular terms these days, but are rarely adequate to initiate a new business. Be specific on sales channels and marketing initiatives.
- Production. How do you produce your product or service? Common choices include manufacturing in-house, outsourcing, off-the-shelf parts. The key issues here are time to market and cost.
- Distribution. How do you distribute your product or service? Some products and services can be sold and distributed online, others require multi-level distributors, partners, or value-added resellers. Decide whether the product is local or international.
- Revenue model. How do you make money? The key here is to explain to yourself and to investors how your pricing and revenue stream will cover all costs, including overhead and support, and still leave a good return.
- Cost structure. What are your costs? New entrepreneurs tend to focus only on product direct costs, and underestimate marketing and sales costs, overhead costs, and support costs. Test your projections against actual published reports from similar companies.
- Competition. How many competitors do you have? No competitors probably means there is no market. More than ten competitors indicates a saturated market. Think broadly here, like planes versus trains. Customers always have alternatives.
- Unique selling proposition. How will you differentiate your product or service? Investors look for a sustainable competitive advantage. Short-term discounts or promotions are not a unique selling proposition.
- Market size, growth, and share. How big is your market in dollars, is it growing or shrinking, and what percent can you capture? Venture capitalists look for a market with double-digit growth, greater than a billion dollars, and a double-digit penetration plan.
Investors will want to understand your business model very well and very early. They don’t want to hear your customer sales pitch, which naturally avoids any discussion of how much money you intend to make, and how many customers you expect to convince. Giving that pitch to investors will only frustrate both you and them.
A viable and investable business model is one of the first things you need to highlight in your business plan. In fact, without a business model, your startup is just a dream.