Moving past early stage and the challenge of scalability 3: some specific standard business models
This is my third installment in a series on building a business for scalability and long-term success (see Part 1: starting a new series and Part 2: what needs to scale? for relevant background and context material.)
I stated at the end of Part 2 that I would at least briefly note and discuss some of the specific business models that are commonly followed, or at least invoked as operational and strategic goals. And I begin that with the bait and hook model that I started discussing then.
• The loss leader product or service offered as bait to draw in customers has to be something that participants in the business’ target marketplace would want to buy.
• This should be something that customers and potential customers would value and at the price point it would be offered at, as bait.
• The products or services offered as hook according to this model also have to be relevant and of perceived value in that marketplace. And perceived savings and value received from purchasing the bait should offer the participating customer enough value as they see it, so that they would be willing to accept the costs, and even any ongoing and obligatory costs of the hook.
I cited by way of example, the hard connection example of computer printers that are sold at wholesale costs or below to draw in customers who then have to buy that manufacturer’s ink cartridges, because they are the only ones that would work in this equipment – in principle. I add that even there, this system creates marketplace opportunity and business model opportunity for entrepreneurs who would capitalize on the profit potential of undercutting the printer and “official” cartridge manufacturers, offering ink cartridges at a profit but at a lower price point.
• These ink cartridge providers could offer lower price point alternatives precisely because they do not make the printers they would be used in too. So they do not have to add in any costs related to printer production and distribution to make an overall profit from total goods and services offered.
• Printer manufacturers do patent their own cartridge designs, but there are always providers and manufacturing centers – countries with different and disconnected patent protection systems that allow this form of counterfeiting.
• And I add that along with having to deal with cartridge counterfeiters and bootleg ink cartridges, there are markets for businesses that refill ink cartridges. And as an arms race, one of the design goals that printer manufacturers strive for when designing the ink cartridges that go into their printers, is that it be extraordinarily difficult if not impossible to refill them with ink once they are depleted of it, and still have them work correctly.
• And loss of business in the sale of ink cartridges, essential for making this business model work for them, means that they have to make any balancing, compensating profit from the sale of their ink cartridges from a smaller number of sales that do not represent the full ink cartridge market relevant to any particular printer model they offer.
• And this serves to at least marginally increase the price point they would have to sell their cartridges at unless they either accepted lower overall profits on their sales made, or they increased the cost and the price point load that they demand on their bait – the printers themselves.
• But one alternative way to make that work would be to convince computer manufacturers to bundle printers that they in turn take on as bait to offer their customers, when they sell complete computer systems. So business model viability and support is spread across supply chain systems and interconnected systems of businesses that succeed where their business partners do.
• And, of course, there are also legal challenges to counterfeiters, and the costs stemming from that, and additional design and development costs in the design and manufacturing arms races with both alternative cartridge manufacturers and cartridge refurbishes who do not have to carry the costs of manufacturing either the printers those cartridges would be used in or the cartridges themselves.
And these points bring me to a crucially important general principle:
• An effective business model is effective because it works cost-effectively for the marketplace that business functions in, and in the face of all of its actual and ongoing competition,
• And because it works through distributed and interlocked systems of costs and benefits, across the supply chains and other business to business systems that come into play too.
• Business model success or failure is always context dependent and context defined.
And with that I turn to consider alternative business models and business models in general, and do so by starting with the fundamentals.
Businesses succeed because they offer their customers something that is at least then and there for them, unique and of sufficient value to them for them to buy. This can mean offering what amounts to an absolute unique value proposition – something that the customer would find significant value in that they could not find anywhere else. Or it could be something that is in some way without competition there and then – the one fast food restaurant that is open 24/4 in an area and that is the only place available off-hours for the hungry, or the only dry cleaner in some neighborhood and that as such is without competition too.
• An effective business model is one that capitalizes on the value sources and especially the unique value proposition sources that a business offers, and in such a way as to maximize their return on investment and profits received.
One alternative to the bait and hook model that has developed with the advent of the internet and online sales is the online store model, as I have discussed in detail in my series: Online Store, Online Market Space (see Startups and Early Stage Businesses, postings 20-33 and loosely following.) An alternative to this, more frequently pursued by bricks and mortar businesses that develop into online markets too, is the bricks and clicks model. This highlights the way a new business model can be adapted and moved into as a business evolves and as it reaches out to capture new sources of opportunity. In principle at least a business that began with a strictly bricks and mortar storefront, could with time move through bricks and clicks to a strictly online business model, and certainly if fixed operating expense reductions and other fiscal considerations made that a most favorable path forward.
A lot of businesses develop around business models that are based on disintermediation and cutting out middlemen. This can mean manufacturers who cut out wholesalers and even retailers too and move into direct sales to the end-user consumer, and this is often a part of a move to online business models. But this can involve a business taking over work previously done by any type of potential supply chain partner. And this is where business models with names like cutting out the middleman and the direct sales model come in.
Some business models are specifically expansion oriented, and an obvious set of options there come from franchise models. Every business model carries with it, its own specific operational and strategic challenges, and citing franchise operations as a working example as to how that works:
• When a company sells off franchise licenses, it has to deal with license holders and a loss of direct control and oversight in the day to day operations of those facilities.
• Quality control can become an issue and certainly where franchise license holders might seek to cut corners to increase profits, with the potential for diminution of overall brand name value that can come from that.
• So new systems of centrally managed quality control over franchise operations have to be built into this system and included in the franchise licenses offered and sold that would not have been necessary for a business pre-franchise model.
There are other models and approaches that I could add to this, and particularly with the advent of online businesses, and the ubiquitous interactive online marketplace and community. But I am going to hold off on discussing more of this at least for now. I am going to start a discussion of analytical tools for evaluating and categorizing business models in my next series installment. Meanwhile, you can find this and related postings at Startups and Early Stage Businesses. You can also find related material at Business Strategy and Operations and at its continuation page: Business Strategy and Operations – 2.
As a note on the terminology I used above:
I referred to there being a hard connection between bait and hook for computer printer (bait) and ink cartridge (hook) because at least in principle, and by design of those manufacturers you should only be able to buy them from the same ultimate sources. And if you buy one from that original source, then even if you make further purchases from other retailers you still ultimately buy the other from that same manufacturer and ultimate source. By contrast, when you buy a loss leader item from a supermarket, you could purchase just that and leave, and do all of your other grocery shopping elsewhere. This represents a soft connection, and the goal of the supermarket in making its bait and hook model work is that since the customer is there anyway, and the other grocery store items they need are too, they might as well shop there – and even if they do not buy anything else from their shopping list at discount. So you have a dichotomy of models with:
• Hard representing situations where once you buy the bait you are in effect locked in for purchasing the same business’ hook, and
• Soft representing the situation where you as customer would still have sourcing options, but circumstances dictate that they would still buy the hook from the same source often enough to make this business model cost-effective.
According to this, alternative sourcing at to what should be the hook, softens this transaction process. And cost-effectiveness and achievable return on investment depend on what percentage of next step, hook sales go to the original business, and whether they seek to pursue a hard or a soft connection bait and hook model.