[2] What is a Business Model Really, Actually?

In a standard startup pitch deck, the “business model” pops up somewhere around slide 5 of 10, so technically it is of middling importance but really the middle of a presentation is when attention is at its lowest and when you want to slide something by your listeners just when they’re about to nod off.

On the one slide usually reserved for the “business model”, we usually learn that the founders plan to go with “freemium” or “subscription” or “platinum level pricing”. Well, OK.

Why “Freemium” is not a business model

When you do a google for articles on “Why startups fail”, and there are many of them, the standard top response is “No market need for our product/service/idea”, hovering around 50% of responses (multiple responses allowed). “Our business model sucked” comes in around the lower top ten, somewhere near “Co-founders started hating each other”. So not really that important, one might think.

Let me give you a different statistic: “Your business model sucks” is the reason why 98% of startups fail. (The other 2% is co-founders sleeping with each other and then realizing that that was not a good idea.) The Business Model Is Everything. It is the engine that drives your startup and without it you can fill as much fuel in your tank as you want and still go nowhere, fast. But the business model is most likely not what you think it is, and certainly not “freemium”.

Freemium, subscription pricing, early bird offers, essentially everything you read on a common “business model” slide are pricing strategies. The pricing strategy is the outcome of a business model, not the business model itself. Why does this distinction matter? Because you will almost certainly get your pricing wrong in the early stages of your startup, and going back to your business model will help you adjust in the right direction rather than just flutter about wildly.

As complicated as possible: what is a business model?

A business model is at its core your expression how you plan to make money off your business idea. Because if cash-in does not exceed cash-out, you’re not a business, and that’s true for Mustafa’s döner stand just as well as the Roman Catholic Church. But “freemium” is not an expression how you plan to make money, it’s something you copped from some other (probably highly successful) startup in the hope that its halo will shine on you too.

A business model is a set of stakeholders, their interests and incentives, and a set of transactions that leave every group of relevant stakeholders better off. In econspeak that’s called a strict Pareto improvement; in bizspeak it’s called a win-win-win. A stakeholder is someone who potentially has an interest in your venture but more importantly holds a resource you need. The most obvious one is cash, but attention has become nearly as important in the new economy as cash. (More on this later.) A relevant stakeholder is someone without whose resource you cannot build a business — you cannot substitute them out.

A transaction, or in some case more generally an interaction, is when two or more people come together and voluntarily exchange what they own. In the old economy those transactions tended to be fairly straightforward: good-for-money, good-for-good, good-for-a-promise-to-pay-money, promise-of-a-good…, you get the picture. New economy deals have a habit to make these transactions much more convoluted (I’ll talk far more about this in future entries), so it is important to think clearly through the premises of your business. For one, money is by far no longer the only currency with which you might get paid. There’s attention, privacy, referrals, what-have-you. In the new economy your users are rarely your customers, and products are rarely ever just simple bags of rice.

OK, but…

To get some sense of order into this complicated mess, your very very very first exercise as a new venture should be to map out your stakeholders. Call this the Stakeholder Engagement Map if you’re so inclined. Spreadsheet or back of an envelope, doesn’t matter. Write down:
+ The group of stakeholders you’ll encounter (don’t forget yourself, your team and your investor)
+ Their wants, needs, desires, hopes, whatever you could supply them with
+ What the can offer you in return
+ Some prominent members of the group, focusing on the ones within your reach
+ Some inkling on how big this particular group might be, and
+ Some inkling how relevant this group is for you.

You will run into a sense of being overwhelmed by all of this very quickly, and wonder if there is an end or a point to this exercise. You will also likely feel a sense of dread that there are many questions you simply can’t answer. Ignore this dread and write something down anyway. You are actively engaging in the important activity called bullshitting.

Bullshitting is the first step to every successful venture.

Bullshitting (or if you prefer a less coarse language: conjecturing) is also the first step to validating your business from Day One. It is the first piece of evidence you bring to the table to determine whether your business idea is valid, and it has two huge advantages:
+ You probably wrote something down from a gut feeling, which is vastly more precise than randomly picking a word from a dictionary or a random number from your pocket calculator, and
+ You (hopefully) realize that this piece of evidence doesn’t cut it.

So if bullshit or conjecture is the lowest-level means of validation, what are the higher levels? There are two more: theory in the middle and empirics at the top. I’ll talk about them in turn, but now it’s most important that you work your way up. So get going on that stakeholder engagement map. It is what will become, in due time, your (poorly named) customer relationship management tool, a.k.a. CRM.