Get started on designing your business model. You’ll learn why you should work with a dynamic business model instead of a business plan, the 9 elements that can be used to describe the business model of any startup or company, and how you can use customer development to verify your assumptions that are inherent in your vision.
What’s a business model? And why should you work with a business model instead of a business plan?
A business model describes the rationale how a company captures value for itself while creating and delivering value for its customers. It has a market side facing the customer, an operations side how you create your products and services, and a business side how you make a profit.
A startup is a temporary organization in search of a scalable, repeatable and profitable business model. At the beginning, the startup business model is just a number of hypotheses, but the startup has no customers and minimal customer knowledge. A company, that is what a startup attempts to become, executes its business model where customers, their problems, and necessary product features are all known.
Startup strategy yesterday: Executing a business plan
Before the lean startup method was introduced, the conventional wisdom was that the first thing a founder must do is to write a business plan – a static document with a series of implicit hypotheses describing the business opportunity, the problem to be solved, the solution that the new venture will provide, and a 5-year financial forecasts. It was basically a research exercise written in isolation.
When the founders successfully raised money with this business plan, they felt compelled and obliged to execute this plan as if it was an operating plan. The implicit assumption was that it would be possible to figure out all unknowns of a new business in advance, before starting to build the product, launching the product or talking to a single customer. We know today that this is wrong.
Startup strategy today: Searching for a business model
Today we know that no business plan survives first contact with customers. The first year in a startup is unpredictable; there is no way that you could put this together in a 5-year plan. So, you first search for a business model, and then you write a business plan with an operating plan and a financial forecast.
This search for the business model requires knowledge on business models and a search process, in order to minimize risk and optimize chances for success.
Elaborate and verify your business model
Use the business model canvas to capture your business model
For the business model, we will use the business model canvas (Osterwalder/Pigneur) to structure our thinking about the elements of a business model.
You’re going to elaborate the market side of your business model, that is what are you building (value proposition) and for whom (customer segments), via which channels your product gets to your customers, and how you can engage customers over the entire lifecycle of the customer relationship.
On the operations side of the business model, you consider what key resources and key partners you’ll need and what key activities you’ll have to perform to create your value proposition and make your business model work.
From the business side you evaluate what revenue streams you can expect, what the business model costs you, and if this points to a business worth doing.
Use customer development to test and verify your business model
For the search process, we will use customer development (Blank/Dorf), or lean startup (Ries), to guide you how to iterate on each element of your business model.
There is no possible way you can have anything but a hypotheses on day one of the 9 elements of your business model, particularly who your customers are and why they would buy from you. You need to get out of the building and do customer development interviews to verify your hypotheses.
First, you capture your hypotheses, then you turn them into facts by talking to customers and business partners, and then you update your business model based on your new insights. You use the business model as a scorecard to keep score of your progress of how much you have learnt.
And when you have found your scalable, repeatable, profitable business model, you move on to executing it.
The 9 elements of a business model
Let’s look at the 9 elements that can be used to describe the business model of any startup or company. At the end of this section you can make your first attempt to document your business model in the canvas.
Value proposition means what product or service are you building, and the related benefits, by which you seek tosolve a customer problem or satisfy a customer need. The value proposition points out that it is not about your product features and benefits. Customers don’t care about your technology. The customers are trying to solve a problem or fill a need. Your technology is just a part of the solution.
Value proposition answers the questions:
- What are you building, and for whom?
- What products and services are you providing? What features do they have?
For whom are you building it and what exactly does it solve for those people?
What jobs are you helping the customer to get done? What pain are you solving? What gain are you creating?
What is the minimum viable product that results from all this knowledge?
In value propositions, you elaborate the value propositions you are going to offer to specific customer segments to achieve product-market fit. You describe your product features and benefits, your minimum viable product and your product vision.
Customer segments – Your startup or company serves one or several customer segments. Your customers do not exist to buy from you. You exist for them.
Customer segments answers the questions:
- Who are your customers? And why would they buy?
- What jobs is the customer trying to get done? What pains do they have, what gains do they seek?
- How does a typical day in the life of your customer look like? How does their workflow look like without and with your product?
- Who uses the product? Who pays for it? Who influences the purchase?
- What’s your customer archetype?
In customer segments, you aim at understanding your customers by investigating jobs, pains and gains. You picture a day in the life of your customer, capture who uses and buys your product, and who influences the purchase. From all that, you create a customer persona or archetype.
Channels – You reach your customers and deliver them your value propositions through communication, distribution, and sales channels. Today we have physical and virtual products that are sold through physical and virtual (web/mobile) channels.
Channels answers the questions:
- How does your product get from your company to the end customer?
- What type of product do you have, is it physical or virtual?
- How will you be selling your products? How will you be distributing your products? Via a physical or web/mobile channel, direct or indirect?
- What channel best fits your product? What does the channel cost you?
In channels, you’re going to decide how your product gets from your company to your customers. You elaborate what channel best fits your product, and what are the channel economics. You choose a channel to start with.
Customer relationships – With every customer segment you establish and maintain customer relationships. These relationships are very different for physical and web/mobile channels. Here you create demand. Visually this looks like a double-sided funnel.
Customer relationships answers the questions:
- How do you get, keep and grow customers?
- How do you get customers into your sales channel and move them successfully through your sales cycle so that they purchase your product?
- How do you keep them for a long period of time after having spent all the money and time on acquiring them?
- How do you grow additional revenue from those customers over time and get referrals?
In customer relationships, you’re going to elaborate how you get, keep and grow customers – how you plan to acquire, activate, and retain customers, get revenues and referrals. You choose your initial strategies and tactics.
Revenue streams – If you’re successful, your activities on the market side of your business result in revenue streams. We distinguish the revenue model from pricing tactics. Arevenue model is the strategy the company uses to generate cash from each customer segment (like asset sale, subscription etc.). Pricing is the tactics you use to set the price you charge in each customer segment.
Revenue streams answers the question:
- How do you make money from your products and services being sold to customer segments?
- What’s your revenue model? What’s your pricing tactic?
- What value is the customer paying for?
In revenue streams, you’re going to elaborate how you plan to make money. You choose your revenue model and pricing tactics. You elaborate what value customers are willing to pay for, what the inner economics of your business model are. Then you match it and consider if this points to a business worth doing.
Key resources are the assets required to offer your value proposition and make the business model work.
Key resources answers the questions:
- What are the most important resources you need to make the business model work?
- In human resources, what kind of people do you need? What do you have to do to get and keep these people?
- What intellectual property do you need to acquire, or protect? What physical assets do you need? What financial resource do you need? How will you fund it?
In key resources, you elaborate what key resources you’ll need to make your business model work. You describe what human, intellectual, physical and financial resources you will need. You consider where you find them, how you can secure them and what they will cost you.
Key activities are the activities you have to perform to deliver your value proposition and make your business model work.
Key activities answers the questions:
- What are the most important activities you have to perform to make your business model work? Is it activities in the areas of production, problem solving, or platform/network management?
- Are you in the “production” business, providing goods and services in high quantity with highly standardized processes?
- Or are you in the “problem solving” business, providing new solutions to individual customer problems?
- Or are you in the “platform/network” business, providing a platform that addresses the needs of distinct customer segments?
- How do these key activities relate to your value proposition? What is or will be your core competency?
In key activities, you develop what key activities you’ll have to perform to make the business model work. You elaborate the production, problem solving and platform/network activities that define your business. You consider how they relate to your value proposition and what is or will be your core competency.
Key partners – Some activities are outsourced to key partners and some resources are acquired from key suppliers. First, you need to ask what you need from them, and why. The partnerships you need today are different from the partnerships you are going to need in a couple of years from now. To get started, you don’t need strategic business development partnerships, because your first customers, early adopters, don’t expect a “whole product”.
Key partners answers the questions:
- Who are the partners and key suppliers needed to make your business model work?
- What key resources are you acquiring from them?
- What key activities do they perform?
- What do they get from you in return?
In key partners, you are going to develop who are the partners and key suppliers needed to make your business model work. You elaborate the key resources and key activities you need from them, and why. Focus on the partnerships you need to get started.
Cost structure – The cost structure results from the other elements of your business model. Here you want to get a good sense of what it will cost you to run your business. When it comes to cost, not only the Euro amount is important, but also the cost structure; it determines your path to profitability and flexibility at scale.
Cost structure answers the questions:
- What are the most expensive cost to operate your business model?
- What are the most expensive activities and resources you need to acquire or build? What are notable get-keep-grow, channel or partnership cost?
- What is the cost structure? What are fixed and variable cost? What has to happen so that you break even? What happens if you scale up or down?
In cost structure, you are going to calculate the cost to operate your business model. You elaborate your most expensive key resources and key activities, and diagram an operations and finance timeline. You consider the cost structure, and what has to happen so that you break even. You choose the metrics that matter for your startup business.
Document your business model
Document a first version of your business idea on the business model canvas. Think of your first version of the business model canvas as the starting point showing the hypotheses that must be confirmed in face-to-face or online interaction with customers.
More often than not, the customers will reject components of your business model. After doing customer development on each element of the business model, update the canvas to reflect any pivots or iterations, highlighting the changes. This becomes your basis for the next build-measure-learn loop.
Do customer development on each of the 9 business model elements
You may have hypotheses on day one on who your customers are, what they’d buy, and why they’d buy from you. You have a preliminary plan how to get, keep and grow customers, how to make money, and how to make your business work from the operations side.
But there is only one way to figure out if you have product-market fit and a repeatable, scalable and profitable business model: By doing customer customer development on the 9 business model elements to test the hypotheses inherent in your vision. Your goal is to turn your hypotheses into facts. You’ll do that by talking to real customers and business partners.
Iterate on each element of your business model with this build-measure-learn feedback loop, or insights cycle:
State your hypotheses
Take your hypotheses and your preliminary choices on strategies and tactics for each of the 9 elements of your business model.
Set up experiments
Don’t just pitch to potential customers, instead try to set up experiments that are able to prove or disprove your hypotheses. Articulate pass/fail tests for each hypotheses.
What’s the MVP you’ll use to test your hypotheses?
What customer discovery interviews will you conduct?
Conduct customer discovery interviews
Talk to at least 10-15 customers and partners to test your hypotheses.
Do customer and partner interviews confirm your hypotheses?
Do they confirm your preliminary choices on strategies and tactics?
Capture and share your insights
Capture your findings and insights, then share your learning in the community:
Your business model with the latest changes marked, and multi-sided markets shown in different colors
On this element Summarize your hypotheses and preliminary choices on strategies and tactics What experiments have you run? What’s the MVP you’ll build to test further? What are metrics that matter?
What did you learn on this element from talking to customers and partners?
Hypotheses: Here’s what we thought
Experiments: Here’s what we did
Results: Here’s what we found Action: Here’s what we are going to do next