Wednesday, November 16, 2005

Dave Pollard Writes: Business Models


Alex Osterwalder and I have been exchanging e-mails on the subject of business models. Alex's blog is devoted entirely to this subject, and the graphic above is his 'business model model', showing the nine 'building blocks' for such models from his synthesis of reading on the subject. The right side of the model is about how the business generates revenue, while the left side is about how it manages costs and hence generates profit.

I've been advising clients and prospective new businesses how to document and evaluate their business model for years, and in my experience there are three types of business models, that organizations look at in sequence:

1. Viability Model: How the idea/project/plan/business will make money, and with which partners. In some cases it is actually about How the idea/project/plan/business will fill an untapped need, and with which partners. Such a model outlines the research that will be done to ensure the value proposition is compelling (i.e. customers want and are prepared to pay for it), that the business has, or can acquire, the competencies and resources needed to deliver it, and that it makes strategic sense for the organization (e.g. it's consistent with their mission and values and does not cannibalize existing business). This model culminates in a go/no go decision.
2. Formation Model: How the idea/project/plan/business will be set up. This model is focused on capital and infrastructure that must be in place before operations can begin: human capital (what people will be involved in what roles), intellectual capital (what knowledge, technology and know-how must be put in place), physical capital (what premises, equipment and supplies will be needed prior to start-up), financial capital (start-up money, and where it will come from), and social capital (organization, alliances and relationships that will drive it). This model culminates in a launch.
3. Operating Model: How the idea/project/plan/business will operate. This model describes the ongoing activities of the organization or project -- what megaprocesses it will entail (e.g. R&D, purchasing, sales & marketing, manufacturing, distribution, service, back office support, and management decision making), what budgets and other resources it will require and use, and what roles will be played by who.

This sequence of models can apply to anything from a simple marketing program to the launch of an entirely new business.

It's been my experience that most businesses put insufficient work into the viability assessment, the wrong kind of thinking into the business formation decisions, and too much emphasis on the details of the operating model, and hence on 'micromanaging' the operations to ensure they conform to the operating plan.

The reason for insufficient work on viability assessment is that it's tedious, and the people who are championing the idea have already concluded that it's viable. That's why in Natural Enterprise I encourage an almost excruciating amount of attention and research on viability up front, tough, shoe-leather-wearing work with potential customers, suppliers and partners until you know that it fits a need, that you have the competencies to fill that need, and that you have some competitive advantage in doing so.

If that time and effort is invested, the whole approach to business formation changes. The people and partners who will play the key roles will already be onside and will have essentially self-selected to play those roles. Much of the start-up capital may come in the form of advances from customers who have already indicated an interest in the product or service, and who have been active partners in its design. The total amount of capital will be less, capital needs will be rather obvious, and may be already forthcoming, if the viability assessment has been done well first.

At this point, I think, trust takes over. You have the right people in the right places. They know what they have to do and how to do it. They're motivated, and focused on the customer. Why do you need an elaborate operating model at this stage? Not only will it be telling people what they already know, it will be getting in the way of them doing their job effectively, by imposing the inevitable standards, paperwork, and approvals procedures. And worst of all, it will discourage improvisational thinking and continuous sustaining and disruptive innovation, and will be contributing to what David Ehrenfeld calls "a society managed to death".
So the business models I have helped develop have been heavy on the Viability phase, creative in the Formation phase, and light on the Operating phase. The hardest part is telling entrepreneurs, before they've laid out a penny but after they've invested a lot of sweat equity, that the Viability assessment indicates they don't have a sound business model. More often than not, that's the right message, and failure to heed it is the main reason for the staggering failure rate of entrepreneurial enterprises.

But giving them that message at the outset is a lot easier than telling them, after spending years of effort trying to make a flawed business model work, and investing their life savings in it, that they should pull the plug.

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