In business school, I had the privilege to read, study and analyze 1,600 business cases and as a strategy consultant I had the opportunity to transform several different businesses and industries. Additionally, over the past two decades I have reviewed, invested in, and created hundreds of business plans as an entrepreneur, Entrepreneur in Residence/Venture Partner with two venture capital firms and Chairman of a Seed Capital investment firm. One of the lessons that I’ve learned — often painfully as I look back on my mistakes — is that business models really do matter and have a tremendous impact on the success of any new venture.
What is a Business Model?
A business model is nothing more than the description of how a business works, makes money, grows, serves its customers, etc. Obviously with proven businesses, the business model is easier to comprehend than in many newly designed businesses.
For example, it was easier for everyone to understand the business model of a regular store-front book retailer than it was initially to understand the business model of Amazon.com, although, as it turns out Amazon.com had a vastly superior business model. It was also easier to understand the business model of Hewlett Packard’s computer business in the late-1980’s than it was to envision how Dell Computer might be different, but again, as it turns out, Dell had a superior business model.
Let’s explore both examples to clarify the different business models and to establish why it is important to think this way while you try to improve your existing business or prior to launching or acquiring your own business.
Store-Front vs. Online Book Retailing
In the mid 1990’s the typical book retailer bought a massive inventory of books, stuck them on shelves in a high-rent facility, and then waited for customers to drive to their fully-staffed store, browse for books, and make a purchase. The goal for Amazon.com was to build a compelling, feature-laden website that allowed customers to easily find and order books online within a couple of clicks of a mouse. The different business model of Amazon.com had dramatic, positive cash flow, scalability, and profitability implications. Amazon could grow very rapidly because they got paid instantly by via a customer’s credit card, but negotiated to only pay vendors after 60 to 90 days. This meant Amazon was able to leverage the cash of customers to fund their growth (cash flow). Amazon was able to sell books worldwide without the infrastructure cost of a regular retail chain and once they built the website, there was nearly no incremental cost of serving the “nth” customer compared to the first customer, so variable costs were transformed into lower fixed costs (scalability). And, although it took a while to get to profitability due to the outsized investment required to build a new brand, when Amazon did reach profitability, their profit potential far outstripped the normal razor-thin margins of typical retailers.
Comparing the Booksellers’ Business Models
Check out this quick comparison of a full-year performance (from several years ago prior to the shuttering of many stores) between Barnes & Noble (primarily store-front, although a significant web presence) and Amazon.com (web only). It is clear to see that Amazon.com had a far superior business model.
Corporate vs. Direct Consumer Computer Sales
At the time of Dell’s launch, computer sales of companies like IBM or Hewlett-Packard was focused on the business market with mass-produced machines that were placed in inventory and sold through value-added resellers to corporate customers that valued blue-chip vendors over price, purchased in volume, worked with pre-established credit lines and purchase orders.
Meanwhile, Dell’s strategy was to sell personal computers to the emerging consumer market — which had different needs than the business market — and was under-served by the industry leaders such as IBM and Hewlett-Packard. The Dell offering was to cater to the particular needs of consumers which included convenient build-to-order manufacturing one unit at a time, price-competitive customer-direct sales and a credit card-based billing system.
In this case, the market served required a different business model and Dell was one of the first to figure that out and to capitalize on those differences by developing different capabilities.
Similar to the Amazon example, Dell won big and most large store-front computer retailers that existed at the time of Dell’s launch ended up going out of business.
Analyzing Your Business Model
So clearly, business models matter in terms of the financial performance of the business as well as what customers you serve and how you serve them. So what do you do with this information? For starters, you should think through all aspects of the different business model implications to guide your strategy on improving or developing your own business.
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