A reporter recently asked me what the most interesting thing is that I’ve learned from running Fluency Scores on hundreds of companies in the past two years.
It would be completely understandable if your answer to this question was “how a company makes money.”
Certainly, after observing how investors evaluate the business model when they look at companies, I can see how this definition became normalized.
Investors hear a company pitch their business and do a quick gut check on the Business Model slide. It’s more of a “can I imagine these customers paying this much money for this product”. Yep, checks out. Moving on.
This definition of business model is worthless to founders and investors. It lacks strategic value or clarity around the health or potential of the business.
In building the Fluency Score, a data technology that measures business model risk – like a FICO Score for startups, we had to get really, really clear on what a business model is in order to develop the algorithms to measure it in a standardized way, quantify it, and provide visualizations and analysis of individual companies and entire portfolios.
Here’s a much more useful definition of business model:
A business model is the way a company creates value for their customers in a repeatable, predictable way.
It has three major components that tend present as assumptions until tested and verified in the market with customers:
#1 The company has to be right about the problem they are solving and the customer segment (ideally, a really tightly defined early adopter segment) who experiences this problem.
#2 The company has to be right about the solution they are offering to solve that problem and this particular customer segment’s willingness to buy this solution.
#3 The company has to develop a repeatable, predictable sales and growth process, appropriate for their customers and the solution offered.
These seem so straightforward, don’t they?
These components become even clearer when we recognize that most “businesses” are actually running multiple business models at once.
Tackling two customer segments? That’s two business models because #1 (Problem and Customer) is different for each customer segment. Even if the company is selling the same widgets to both customers, the process for selling, the price points, the methods of bundling or unbundling the solution, and the eventual growth strategy will be different for both of these customer segments. They must be understood and measured separately.
Selling widgets as individual transactions and in a subscription model? Yep. That’s two business models, even if the sales are to the same customers. Different value props, pricing, unit economics, and retention for these two approaches.
Understanding this basic principle of startup development – that each customer and revenue line is a different business model – can help you immediately.
If you’re a founder
You already know that efficiently using your team’s time and resources to grow the business is your number one job. Clearly articulating each business model will help you determine strategic priorities. Perhaps this will help your team focus efforts in one direction rather than being pulled in two or more places.
If you’re an investor
Ask the founders you meet to articulate their business models separately. Each business model requires its own resources, time, talent, and strategy. Small teams with multiple business models represent more risk than teams with focused attention on one or two primary business models. Understanding the extent to which each business model has been validated in the market with customers will also give you a better picture for their traction and potential than the raw numbers on their slides.
If you’re an accelerator or ESO
Helping founders focus and identify their riskiest assumptions is half the battle. They can’t do everything at once and you can help them sort through competing priorities and goals. If your program is time-boxed, helping your companies describe and focus on just one business model during your program will help them make the most progress. It will also help you determine which mentors, experts, and other resources you can provide to help move the needle for them.