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What is a Business Model Anyway?

The concept of a business model is a difficult one for many entrepreneurs to grasp. Simply put, it’s how you are going to make money. Of course, you are going to sell your product and/or service to customers, but exactly how? At what price? Are you going to use social media? Are you going to have 10 skews of products/services or 50? How are you going to divide your sales? By product? Market? Both? These are all elements of your business model that must defined before you successfully launch your business…and/or ask for money to do so.

The real key to long term success comes from understanding the various components of your business as well as possible, and better than your competition: Problem Definition, Solution Definition, Opportunity/Market, Competitive Advantage, Business Model, Culture/People/Structure, and your Business/Financial Plan. While none of these are more important than the other, defining your business model as early as possible is a plus.

The key attributes of your business model include defining your: revenue streams and the pricing for each; solution costing; solution delivery methods; profitability; Key metrics (KPI’s) and investor ROI. Let’s review each of these in more detail starting with revenue streams and pricing.

Revenue streams are one of the things that can differentiate two businesses in the same market. How you define where you are going to get your income from, which markets, which products/service levels, etc. needs to be defined early so you can test your assumptions and pivot accordingly. It is something you really cannot fully define without actually selling product, but before then you need to start making and testing your assumptions. For example, I worked with a small snack shop/restaurant. They sold things over the counter for people to take out, sit inside (they had two tables) or sit outside (they had two more tables).

The first thing we realized was they could support more take out customers at a lower overall cost than those who sit down and take up the tables, so others can’t. It was a volume thing. In addition, here in Phoenix it gets too hot during the summer to sit outside most days), but traffic was much higher during the cooler season so having outside tables doubled the capacity. But when we modeled the financial projections, we started with 3 revenue streams, all with the same pricing but with different volume assumptions throughout the year and different cost assumptions. They also had items that had to be prepared and others that were purchased and resold. They also sold a bunch of coffees and teas. We ultimately broke up the three revenue streams by the menu with pricing and volumes accordingly.

In other business types you may have wholesale or bulk customers, versus one-time retail purchase customers that you market to and price differently. Or you may have repeat customers versus one-time that you plan to reward with discounts. You may have product that you sell singles at a higher per-item price than multiple sales, say a package of 20 items. How will you define your revenue streams? The answer to the question is not a trivial exercise as it ultimately will drive things as tedious as how you set up your accounting system to collect sales/volumes and what the make-up of your sales/marketing teams will look like.

Costing each of your revenue streams and your overall solution is another non-trivial exercise. As outlined above the costs for each revenue stream may vary based on things like volume, stocking versus just-in-time, the amount of labor required, the amount/type of marketing required. For example, SEO on-line marketing can get very expensive, but full-time sales people can be a bigger burden to handle from the start when benefits and other costs are considered. What will your balance be and how will that impact the cost of each revenue stream? You may use an outside sales force for one product/service, inside sales for another and on-line for yet another. Or you may outsource it all and need to cost accordingly. You also need to look at what your costs of fulfillment will be? How will you take orders, package them and deliver them? Will packaging include your logos or be generic? How will you invoice your customers and collect their cash? What research and development will go into each product, or will it be spread across all products equally? What type of buildings will you need? IT structure?

I can go on, but you should get the idea. You need a very detailed dive into what all of your potential costs will be to produce, deliver and support each product and your overall business. I prefer a line-by-line income statement level look at each cost and how it relates to each product revenue stream. Going back to the snack shop example, they had some products in a refrigerator that cost more and perished faster than other products and we needed to understand those dynamics in relationship to potential costs. Having product that required manpower required different costing than the products that were simply resold.

If you do a good job of defining your revenue streams and costs, you will have the necessary information to define your profitability. By putting together, a detailed set of financial projections you can define your profit on a per item basis, per product line basis, per market basis and overall. You then will have the information to define not only potential investor return on investment (ROI), but a range of potential values for equity purposes.

Knowing these data points is one of the biggest keys to your long-term success. Why? Because if you do it correctly you will have a very well-defined set of Key Performance Indicators (KPI’s), or metrics that you can track and use to ensure you are meeting your goals. I tell clients all the time that revenue and costs are NOT their key performance indicators, nor are margin or even profitability. Well, profitability is key as it defines return on sales, investment, equity, etc. However, my point is that it is the more tedious things that are not obvious and are your true KPI’s. Like how long people sit at those two tables at the snack shop and whether or not the assumption for that built into your pro forma financial projects are correct. Something like measuring the number of people who sit down during each shift versus those that take-out is a real key performance indicator. Learning your real KPI’s is extremely important as those are the things that you need to watch for long term success. The sooner you get a handle on your KPI’s the better you will build-out your plan to ensure you keep a close eye on them.

Your challenge this week is to list your revenue streams out and ask yourself, how much do you really understand about each of them? What is YOUR business model?

Mitchell Bolnick – The Excel Consulting Group