While the phrase ‘traction’ has typically been associated with tyres, friction and slippery driving conditions, its use is increasingly common in entrepreneurship and venture capital circles. This article explores what it means and how it applies to your business.

Defining Traction

The typical entrepreneurship journey moves through various stages, from idea conception to business plan to execution and then growth (or failure). For most entrepreneurs, the journey is challenging because they need to perform many activities simultaneously while always being conscious that they may run out of money in the near future. To fund this gap, investors often turn to early stage investment, which they are more likely to get if they can prove traction – some clearly identifiable momentum and progress so far.

Investors need to carefully balance risk and return and will be well acquainted with the harsh realities of early stage investment, i.e. that most startups fail. As a result, they will be trawling through the evidence you provide (often in the form of a business plan) to assess whether or not a commercially viable business opportunity exists in which they should invest.

For the most part, investors will need to take a leap of faith with early stage investments, relying on the assumptions contained within your business plan to help them decide whether or not to invest (and if so, on what terms). If you, the entrepreneur, can demonstrate that you have gained some traction, especially by proving customer demand with a record of actual sales, you are essentially reducing the risk for them; factual evidence will always trump assumptions, projections and wild conjecture.

The most persuasive evidence you can provide that your business is worth investing in is ‘evidence of demand’. Clearly if this demand is translated into sales, you have irrefutable evidence that the startup has traction. The greater the sales, the greater the proof.

In terms of the ‘traction hierarchy’, active users and letters of intent probably fall into the next tier, below real sales, finally followed by viewer numbers (on your website). While growing visitor numbers to a website was once a good barometer of the potential of a business, it is no longer considered a valuable proxy. These visitors have to convert to sales and, hence, the focus returns to the one piece of evidence that trumps all others – real sales.

Why is all of this important?

One of the problems entrepreneurs face is that their energies and focus are spread widely, as they can get distracted by the most pressing challenge to hand (regardless of its relevant importance in the bigger picture). There is so much to do and so little time. Hence, they can have an excessive product orientation, focusing predominantly on product design, without really addressing wider concepts such as addressable market size, customer acquisition costs and sales forecasts, etc. Business plans can really help ensure entrepreneurs retain focus. They force you to take a holistic view of your business opportunity. However, not all entrepreneurs embrace the principles of business planning, and even those that do may not have a strong focus on ensuring all activities are correlated with the core aim of gaining traction.

Entrepreneurs need to conclusively demonstrate that there is strong evidence of demand. They need to concentrate efforts on the area of product /market fit, a concept Steve Blank has explored in detail in his book, The Four Stages of the Epiphany. Blank states that the primary role of an entrepreneur is to iterate and test assumptions and hypotheses they have made with regard to customer behaviour and demand until they find a commercially viable business model.

‘Your startup is essentially an organization built to search for a repeatable and scalable business model.’

In other words, Blank is arguing that your primary role as an entrepreneur is to ensure there is a good fit between the product and the market and, if there is, you can gain traction from which you can then scale your business.

There are numerous reasons you may not be gaining traction, the most common being the lack of customer awareness about a new product or company. Nowadays, competition is increasingly intense, and it has shifted from being within a market sector to what is essentially a competition for people’s attention. This issue is particularly relevant to Internet-based startups who assume the old adage, “if I build it, they will come”, will apply. People may simply not be aware of your product. For others, they may find that it does not meet their needs, or there may be switching costs preventing them from testing it.

How do you get traction?

Gabriel Weinberg has written a nice post covering various ways a group of entrepreneurs he interviews gained traction. Essentially he is describing a range of marketing activities his interviewees have used to ‘get the word out’ about their product or service. Of course, underpinning all of this is the fact that the message relates to a core product or service that has to address a market need. In all markets there are key influencers (often media) who are good conduits to your target market. Similarly, there are ‘early adopters’, who are individuals willing to test new products and are not averse to risk.

What is enough traction?

The amount of traction required depends on the risk appetite of the investor. The more traction you have, the greater your ability to dictate terms when seeking external investment. Choosing between competing term sheets is a problem most entrepreneurs would love to have. As venture capitalist Mark Peter Davis declares in his blog:

“..investors want to know that a company can repeatedly acquire customers for $X and generate more than $X in gross profit from each customer”.

However, as he goes on to say in relation to what is enough traction:

“In sum, there are no hard-and-fast rules, but when an investor suggests that you obtain more traction it’s because they still need to be convinced that your customers are going to adopt en masse”.

What to do when you do not have enough traction

For me, modest user adoption cannot be excused because you are still in beta. As stated previously, customer acquisition is the clearest signal that you are gaining traction. If you are not seeing growth, it may be that you need to invest more in marketing, undertake some internal market research or some competitive analysis. The last thing you should do is continue along the same path without understanding why adoption rates are not at the level they need to be. Perhaps you need to pivot what you are doing, or consider a Plan B? PayPal is a great example of one such company that went through numerous iterations before settling on an email payment system. As founder Reid Hoffman described recently:

‘Over the years PayPal has made multiple significant pivots. The company started as a mobile encryption platform. Then it was a mobile payments company. Next PayPal was a combination mobile and Web site payments company. Finally PayPal became an email payments company. Each pivot over the life of the company was the result of rethinking the business but maintaining the vision. The focus was always to become a payments operating system; but the nature of the operating system changed multiple times.’

Summary and Conclusion

In summary, all entrepreneurs need to be aware of the concept of traction and its importance in the context of early stage investment. The best form of evidence you can provide is paying customers who keep coming back and telling their friends about your offering. If you can gain this level of traction (with meaningful numbers) the strength of your hand (when it comes to negotiating terms for investment) has improved significantly, as have the chances of success for your fledgling business.

The Dragons’ Den is one of the more popular business programmes on the BBC, with average viewer numbers in excess of three million . The format is pretty simple – entrepreneurs pitch the dragons (wealthy investors) with their business plan. The entrepreneurs are looking for investment (as well as advice) in return for an equity share in the business. Now in its 9th series, the show has been going from strength to strength. However, what is not always evident is that many of the so-called “successes” often represent bad deals for the entrepreneurs, where they give away too much equity in return for modest investments. This is typically the case in instances where the proposition has already been de-risked by way of existing trading history, letters of intent, sales etc., or where you need the cash to fulfil orders, or to expand.

If you have a serious business proposition (and I use this phrase deliberately, as some entrepreneurs are clearly selected based on entertainment potential), you should adapt a very different strategy in the Den. You should use the opportunity primarily as a marketing exercise where you are in effect pitching your product or service to the British public at large. In many cases it is likely that appearances on the show will result in significant interest afterwards. (Given the BBC recognises this, it is likely they will try and dumb down any overt marketing). Here are some tips as to activities you need to undertake prior to appearing on the show so that you can maximise your return.

1. Ensure your website is up-to-date (and can deal with a traffic spike) and that the phone lines are well staffed. The increase in profile from TV will result in a significant increase in interest in the days following the show.

2. Unless you get an offer from the dragon you target (and on your terms), walk away. While there is definitely a premium to their money in terms of media interest, they will be exceptionally busy investors and may not bring enough to the table aside from the cash.

3. After the show, it is important to use your new-found fame (which may be short lived) to engage with more suitable investors who can provide smart money on more attractive terms (i.e., the cash you need at the equity share you want to give up) as well as access to distributors/ retailers or to key contacts.

4. Use PR to leverage your appearance on the show. All media like an angle, and given the importance of popular culture, an appearance on a “reality” TV show should open many doors. It is good to work on a number of stories to help you gain additional exposure after the show.

5. Undertaking an analysis of the appearance by Ling Valentine (who “entered the den” in February, 2007) would be a worthwhile investment of your time. Ling gives a detailed summary of her appearance on the show on her website and also demonstrates that she is an extremely shrewd business person as well as a great marketer. Explaining her decision (not to take investment), Ling says the following:

“All I could think about was that I could get that cash in 30 seconds from the bank for no equity stake, and that I could not face giving away a third of my business for that, I had a proven business and they had no risk! After the Den I had some regrets, mainly wondering if I had lost out from not working with Duncan and what I had potentially lost from Richard’s end-game expertise, but since my episode aired I have been incredibly busy.”

Indeed, her appearance sparked immediate interest:
“Web visits on the night of the broadcast were over 5,000 people, and the next day it was over 10,000. I spent the whole night trying to stop my server crashing”

In summary, if you have a serious business proposition, where external parties (ideally, customers) have validated it as being serious, you will be better served using the opportunity as a means to raise your profile rather than as a means to raise finance.

Decisions are never straight forward. We all have to make decisions armed with the best information at our disposal at a particular point in time, weighing up the Pro’s and Con’s before deciding on our chosen course of action. However ‘best information’ does not of course equate to ‘complete’ or ‘accurate’ information and many decisions are made under time duress or with incomplete information. On top of these issues, commercial decisions impact a wider group than most personal decisions and these decisions are often deconstructed publically (despite the obvious information asymmetries) unlike most personal ones. There is also a growing tendency for commentators to pre-empt commercial decisions e.g. witness recent media discussions re whether the European office of Twitter will be in London or Dublin . Similarly the ‘losers’ of decisions increasingly attempt to influence the decision seeking reversals . This article seeks to explore these issues in more detail before suggesting some things to think about if you face similar situations to those described below.

Managing Change

Managing ‘resistance to change’ has been a popular academic topic for many years. In 1979, J.P. Kotter and L.A. Schlesinger wrote an article in the Harvard Business Review called ‘Choosing strategies for change’ which sought to offer practical advice to managers dealing with resistance to change. However the concept goes back a little further as the quote from the 15th century Italian philosopher Niccolò Machiavelli illustrates:

“It must be remembered that there is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than a new system. For the initiator has the enmity of all who would profit by the preservation of the old institution and merely lukewarm defenders in those who gain by the new ones. “

What has changed in recent years, however, is that external resistance can now be much more widespread and powerful than mere internal resistance and as a result managers have to make decisions in this wildly changed context. In many ways this change has been driven by the growth of social media which has enabled everyone to have a voice, and anyone with access to an Internet connection an ability to publish.

The Effects of Social Media

Where once people merely consumed products and services they now inform the feature set as active participants in the production as any software developer will confirm. Where once they solely consumed content, they now often add to the narrative with most online publications including commenting platforms enabling anyone to participate in the discussion. While these comments can really enrich the content, they can also often poison it when individuals hide behind a cloak of anonymity and post inappropriate comments or critiscms typically without full disclosure. What we say and do has never been subject to as much scrutiny as it is these days. Similarly the law of ‘unintended consequences’ also has a habit of coming into play when we least expect it. The following represent some recent examples of commercial decisions made where the backlash was very public.

1. Startup Britain

Startup Britain was launched in a blaze of publicity in March 2011. The aims of the website were indeed worthwhile ones, as the website sought to support and advance the cause of entrepreneurship in the UK. However soon after launch, blogs and forums were full of scathing comments ranging from criticism of the features to criticism of Mr Cameron’s involvement. The ‘Create a Logo’ feature was one immediate victim of the backlash and the (foreign) 99designs.com offer was quickly replaced with a link to the (local) DBA homepage .

2. Gap

US clothing retailer, Gap ditched its new logo within one week of unveiling same following an ‘outpouring of comment’ online. Apparently more than 2000 comments were posted on their Facebook page, many of which ‘demanded’ the return of the original, a wish which was duly granted.

3. Zipcar

Following Zipcar’s $50m IPO in April, some critics argued that the institutional investors had significantly under priced the deal. “Zip Car’s IPO Underwriters Just Screwed The Company To The Tune Of $50 Million” screamed the headline in a post on Business Insider by ‘Editor-in-Chief’ Henry Blodget .

Other examples where there has been significant ‘public outcries’ include; Spotify’s recent decision to cut back their ‘Freemium model’ limiting the number of free plays the user can listen to , and the unveiling of the London Olympic Logo which some commentators described as ‘puerile’ .

How to deal with a backlash

As the above examples illustrate, decisions made by known brands (in particular) can attract the most intense reactions often from the most unexpected quarters. Here are some things to consider when faced with external resistance.

• Make sure to get impartial independent feedback where appropriate so you can ensure a full sanity check before a launch/ or an announcement.
• Remember you have access to more data than the critics i.e. some of this data is commercially sensitive or is not in the public domain so they do not have the ‘full picture’.
• Some decisions will never be well received, particularly ones where services that have been free suddenly incur charges. Well rehearsed and logical responses can be prepared well in advance.
• Be prepared to reverse your decision when either new evidence emerges after the fact. As British Economist John Maynard Keynes once said in response to accusations he was flip-flopping on some issue: “When the facts change, I change my mind. What do you do, sir?
• You do not have to engage in a dialogue with the public – particularly when faced with criticism from anonymous commentators with undisclosed interests. However be prepared to overturn a decision when faced with over whelming resistance (as distinct from a vocal minority) from fully transparent critics with well argued cases.
• Do not rush to judgment. A backlash does not mean a bad decision. The London Olympic logo was not withdrawn despite the barrage of criticisms it attracted when launched.

In summary, while a more connected online world brings many benefits, there are also many drawbacks. Decisions made at the business level can be subject to scrutiny far beyond the walls of the office within minutes of the decision being made public. While engagement with a diverse audience is to be welcomed, it needs to be on your terms. For the most part the wisest policy is simply to ignore the noise and concentrate on building your business.

[1] http://www.guardian.co.uk/technology/pda/2010/dec/13/twitter-office-london-dublin

[2] http://www.telegraph.co.uk/news/uknews/1553545/Olympic-chiefs-under-fire-for-puerile-logo.html

[3] http://hbr.org/product/choosing-strategies-for-change-harvard-business-re/an/R0807M-PDF-ENG

[4] http://www.guardian.co.uk/money/blog/2011/apr/05/small-businesses-startup-britain

[5] http://www.bbc.co.uk/news/business-11520930

[6] http://www.businessinsider.com/zipcar-ipo-price-2011-4

[7] http://econsultancy.com/uk/blog/7422-spotify-s-new-freemium-a-little-less-free

[8] http://www.telegraph.co.uk/news/uknews/1553545/Olympic-chiefs-under-fire-for-puerile-logo.html

Introduction

While running a small business is very rewarding, it is not easy, yet more and more of us are being enticed into starting a business, encouraged by an increasingly supportive government, which promotes entrepreneurship at every opportunity. This is good news after all; as entrepreneurs innovate, we as consumers benefit as they produce products and services that better meet our needs. Governments benefit through a greater tax take and lower social welfare costs (as well as gaining from numerous other additional benefits arising from the effects of the ‘invisible hand’). Everyone is a winner.

A Key Challenge

However, on an individual basis, a key challenge for most entrepreneurs is dealing with the sheer range and diversity of issues that they have to address when all most want to do is simply, to sell. Their knowledge base must not only span their industry sector but must cover a breadth of functional topics and issues from marketing to cash-flow management to taxation.

While bigger companies will typically have access to this knowledge in-house, smaller businesses do not have that luxury and hence have to rely on their network as well as search engines, blogs, websites and business forums for answers and help.

Social Media

One of the benefits of the growing ubiquity of social media is that information related to pretty much any subject area is available for free on the Internet, making it a lot easier to access than before. The quality of information that is available for free is significant and search costs are exceptionally low, resulting in unfettered access to solutions to your every business problem.
But all is not as straightforward as it seems. Information gleaned from these sources is not without its drawbacks, not least the fact that, for the most part, you do not know who you are gaining the knowledge from. (This was graphically illustrated in the famous Dilbert Cartoon – ‘On the Internet, nobody knows you’re a dog’).

Some of the following issues also apply:

• How can you assess the veracity of the information?
• How do you ensure the impartiality of the content?
• How do you take general advice and apply it to your own particular circumstances?
• What if you rely on information and then act on it to your detriment?

Firstly, taking information at ‘face value’ is rarely a good thing. Consider each bit of advice as a mere data point as you seek to gather information to make a decision. You should also seek out articles supported by facts with clear attribution to source data where you can substantiate claims.

Secondly, it is important to assess the nature of your inquiry, relative to the risks associated with the decision to be made. Information gleaned from a search engine or website is no substitute for ‘paid for’ advice when dealing with legal or taxation matters, for instance. While we have all become accustomed to using search engines for information searches, we must not lose sight of the fact that nurturing a wide network of contacts whom you can call for advice is a better use of your time than surfing the net for solutions to more complex issues.
It is also worth considering the context of the information. Is it on a commercial site where the author has a commercial agenda or is it on an informational site like Wikipedia where the content is curated by a number of contributors? Articles written on branded websites, with full author accreditation (and clear domain expertise), trump anonymous postings on poor-quality websites every time. However, you must remember that, unlike professional advice, there is generally no come back if you rely on erroneous information and you suffer damages as a result of acting on it.
As an entrepreneur you also have to constantly weigh up the costs of a decision and need to become comfortable dealing with incomplete information. As Venture Capitalist Mark Suster eloquently puts it:

“You are constantly faced with decisions and there is always incomplete information. This paralyzes most people. Not you. Entrepreneurs make fast decisions and move forward knowing that at best 70% of their decisions are going to be right. They move the ball forward every day. They are quick to spot their mistakes and correct. Good entrepreneurs can admit when their course of action was wrong and learn from it. Good entrepreneurs are wrong often. If you’re not then you’re not trying hard enough. Good entrepreneurs have a penchant for doing vs. over-analyzing. (Obviously don’t read this as zero analysis).”

Finally, it is worth remembering that general information is subject to cognitive biases, and accredited sources used in support of the arguments may be from wildly different contexts from the one in which you are attempting to apply your learnings.

Relying on academic management literature for guidance can be a fickle business. For example, while “first-mover advantage” was once lauded as the optimum strategy for market entry, it was shortly displaced by its close cousin “second-mover advantage”. The thought went that the “second mover” could learn from the mistakes of the pioneering entrant who was likely to run out of money while trying to educate the market. Of course, some of these initial pioneering entrants did not run out of money and ended up dominating their space, thus striking a blow for advocates of being a “second mover”.

For “first movers” there are a number of poster boys, like Twitter, the micro-blogging platform, which has become so dominant that successful market entry by a direct competitor would be difficult to comprehend. The launch of the iPad created the tablet market, which did not exist prior to its launch but has since been flooded with entrants. For some cash-rich entrepreneurs, with the pockets, vision and patience of someone like Steve Jobs, the lack of a market is an opportunity rather than a problem. However, in the majority of cases, there may be no competition because there are structural reasons why a market does not exist (such as a lack of demand or a market size that is currently too small to serve profitably). In other words, the entrepreneur may simply have misread the opportunity!

For “second movers,” you can generally enter the market without the cost of the first mover. A subsequent entrant can study the incumbent when deciding how to design and position their offering. After all, imitation is the sincerest form of flattery. Competition also helps from a marketing perspective – trying to educate and attract a market on your own is a very costly exercise. However, in some cases the first mover is so dominant, subsequent entry would not be advised.

In other instances market entry is not always so easily defined. A recent example from the U.S. is the almost simultaneous market entry of Gowalla and FourSquare, both location-based social networking sites. These were soon followed by Rummble, and a host of others.

For entrepreneurs the lessons are clear – there are different things to be aware of when you start your business, in terms of market entry. If the market does not yet exist you need to ensure you have deep pockets as marketing is likely to be extremely costly. You also need to be confident that you are not ‘misreading the opportunity’.

In the majority of cases, however, it is likely that there will already be a player in your space. In many ways, starting up in a competitive environment is a good thing. Competition sends a strong signal; demand exists, and a market is being established to meet this demand. After all, this removes one of the biggest issues entrepreneurs face – will there be demand for my product or service?

The reality is that competition is increasingly intense in most industry sectors. The growth of the Internet has also lowered the barriers to entry, given its ability to provide relatively cheap access to much greater audiences without the costs associated with physical outlets. The key is to recognise that competition has benefits (as listed above) and is a “fact of business”. If you offer a more compelling value proposition and have an effective marketing strategy in place, you can compete effectively. Potential entrants must not be dissuaded from entering competitive markets, but rather should focus on the elements they can control so they can target a niche they can profitably exploit.

When I am asked about measuring small business performance, my first inclination is to quote Lewis Carroll. In Alice’s Adventures in Wonderland, Alice comes to a fork in the road and asks:

“Would you tell me, please, which way I ought to go from here?”

“That depends a good deal on where you want to get to,” said the Cat.

“I don’t much care where–” said Alice.

“Then it doesn’t matter which way you go,” said the Cat.

In other words, if you do not have a plan for where you want your business to get to, performance measurement does not matter much!

Management dashboard

Small businesses come in various guises and hence it is difficult to generalise when it comes to individual performance management. Metrics (also called Key Performance Indicators or KPI’s) can range from Software as a Service (SaaS) businesses focusing on Lifetime Value (LTV) and churn rates, to hotels measuring occupancy levels and average room yields. However the old adage holds, ‘What gets measured gets managed’, so it is important to have some metrics in place. A good starting point would be to try and understand what are the typical metrics that define success in your particular industry. After that, it’s a case of adding some additional metrics to the mix to ensure that all bases are covered. The following represent a list of some of the more common elements that can make up a “management dashboard” which combine to help you manage performance. Of course, some may argue that profitability should be the main bellwether as to the performance of a small business. While there is merit in this view, it is better to use a combination of metrics which all support the primary goal of trading profitably while growing year on year. This way you have early warning systems in place, as an assessment of profitability based on financial statements can take some time given the reporting time lag.

It all starts with a plan

Creating a simple business plan is vital for all small businesses regardless of whether the business is looking to raise money or not. Planning is essentially about having the foresight to plot and manage your own future, in stark contrast to reacting to accounting data with its emphasis on past performance. While business plans have many purposes, they are not often associated with performance measurement, despite the fact they are a very useful tool with which to measure performance. By committing your thoughts to a business plan you can ensure that you (or your team) know what the priorities are, what activities need to be done, who needs to do them and by when. A business plan brings a lot of transparency to the business with accountability in the form of names, actions and dates.

Cash-flow management

Careful management of cash flow is a fundamental requirement for all businesses. The reason is quite simple–many businesses fail, not because they are unprofitable, but because they ultimately become insolvent (i.e., are unable to pay their debts as they fall due). If you are a “cash-only” business, you can bank the income immediately. However, if you sell on credit, you receive the cash in the future and hence may need to pay some of your own expenses before that income hits your account. This will put a further strain on the company’s solvency and hence a well structured business plan will help you manage funding requirements in advance.

Pro forma profit and loss

A profit and loss forecast is an integral element of any business plan alongside a pro forma sales forecast and cash flow forecast. These statements are forecast in advance (broken down by month) and represent a reference point for actual data as it emerges. By forcing you to forecast and to document all expected revenues and costs, the process helps you produce a report detailing the likely trading performance for the year ahead. If you are an established small business, this data is easier to arrive at as you can use past performance data as a reference point. While brand new businesses’ lack of trading history makes this process more difficult, it also makes it more valuable – you need some references to know whether your new business is on track. Once you commence trading and have actual real data, it is then easy to undertake some variance analysis (between the forecast data and the actual data) to assess whether or not you and your business are on track. With actual data it is possible to take remedial action before waiting for a full year of historic transactions to emerge, at which point it may be too late. For example, if sales in month one are significantly below the planned level you can make an early decision regarding what actions need to be taken as a matter of urgency (i.e. perhaps bringing costs into line, increasing marketing activities, pivoting the business, etc.)

Google Analytics

If you are running a website it is essential that you are running an analytics package in the background (Google Analytics is one of the more popular free ones). This enables you to gain a real insight into customer behaviour on your website. If you are an ecommerce site, you’ll be able to analyse details like the eCommerce Conversion Rate (ECR) and aim to improve this rate over time. Given that your revenue is essentially a factor of two elements (ECR * Number of visitors), improvements in these two will help you drive business performance improvements.

Peer analysis (ratios)

You can also assess your business performance by measuring some key financial ratios and benchmarking these against results from peers (which are typically aggregated to ensure anonymity). This data is typically compared according to industry codes as determined by the North American Industry Classification System (NAICS) and its predecessor Standard Industrial Classification (SIC). This system helps facilitate peer analysis as companies are grouped according to industry sector. While these systems were well suited to analyzing relatively homogeneous industry groups in the 1930s, I do not believe they are well suited to modern organisations with multiple revenue streams, and disparate business models. However, some small businesses with straightforward, conventional business models may find such data comparisons useful. In summary, measuring performance is an important element for all entrepreneurs and small businesses. However, given the huge breadth of products and services provided, it is difficult to assign blanket metrics. The above will give you some ideas as to the sorts of things to be thinking about and these can be added alongside key performance indicators specific to your industry sector. Once set up it is easy then to keep an eye on these to ensure that your business remains on course.

This is the third of a three-part series. Read Part I and Part II.

A business plan is essentially a more detailed version of your business model. A business plan has been traditionally understood as a physical document, although increasingly this view has changed as business plans have migrated online. The business plan format very much depends on the context and business plans are often verbalised via presentations where a presenter pitches their business plan to an audience. Business models are more likely to take the form of either simple verbal descriptions or one page visual representations which can either be produced before a business plan or as part of the same planning process.

Alexander Osterwalder, co-author of Business Model Generation, agrees with the link, arguing that:

‘..when you have designed and thought through your business model you have the perfect basis for writing a good business plan.’ 

It is also worth noting that there are increasing numbers of business plan critics who argue that their composition is too time consuming and that people need ‘to get building’. Some of this criticism has come from software developers (many of whom are proponents of the Lean Start-up Methodology).  I personally feel their arguments are a little simplistic and that entrepreneurs need to map out a viable business model and a business plan in tandem. I also think that the arguments are more valid in an Internet business context, where it is relatively easy to bootstrap a low-cost website which can be used for feedback and constant iterative development.

If you are looking to build a new business and are about to draft a business plan, you should also spend time working out your optimum business model as well as drafting a visual representation of it.  You can use the following framework to map same. In recent years there has been significant innovation in the range of business models, and some of them may be of relevance to your offering. Finally, it is also worth noting that some business models such as the Internet bubble model have largely had their day. Very few investors will invest in businesses these days that have advertising at the heart of their business model.

Resources

Articles

Reinventing Your Business Model (Harvard Business Review, December 2008) by Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann

No Plan Survives First Contact With Customers – Business Plans versus Business Models by Steve Blank

Free Content as Marketing, Not Business Model by Tim Berry

How Business Models Help Generate Business Plans by Alexander Osterwalder

Virtual Goods: the next big business model by Susan Wu

A New Framework for Business Models (Harvard Business Review) by Mark W. Johnson (2010)

Business Model Innovation –the new route to competitive advantage (IBM)

Books

• Business Model Generation: A Handbook for Visionaries, Game Changers, and Challengers (2010) by Alexander Osterwalder and Yves Pigneur.
• Getting to Plan B: Breaking Through to a Better Business Model (2010) by J. Mullins & R. Komisar
• Business Models for Content Delivery: An Empirical Analysis of the Newspaper and Magazine Industry by Marc Fetscherin and Gerhard Knolmayer (2004)
• ReWork: Change the Way You Work Forever (2010) by Jason Fried & David Heinemeier Hansson
• Harvard Business Review on Business Model Innovation by Harvard Business School Press
• The Four Steps to the Epiphany by Steve Blank  (2005)
• Free: The Future of a Radical Price by Chris Anderson (2009)
• Competitive Strategy by Michael Porter (1980)    
• Seizing the White Space: Business Model Innovation for Growth and Renewal by Mark W. Johnson (2010)

 Tools

The Business Model Canvas is a great outline you can use to map your business model.

Videos

How to Choose a Business Model by Roan Lavery

The New Business Model by Guy Kawasaki

Websites

The Business Model Innovation Hub (Exchange knowledge on business model innovation)

Trendwatching.com (Stay abreast of business model innovations)

This is the third of a three-part series
Part I: Have you Optimised Your Business Model?
Part II: Examples of Well-Known Business Models

This is the second of a three-part series. Read Part I and Part III.

The following are some examples of business models that are used by various businesses. The list is by no means exhaustive and is designed to give you a feel for some of the models that exist (business models evolve constantly).

In many instances, the names can vary as they are not typically universally defined.

The Add-On model

In this instance, the core offering is priced competitively but there are numerous extras that drive the final price up so the consumer is not getting the deal they initially assumed. If you have recently tried to buy an airline ticket or car insurance, you will have spotted that the number of extras you are offered can almost reach double figures!

The Advertising model

The advertising model became popular with the growth of radio and TV where the TV stations earned revenue indirectly from people looking to promote services to the audience they attracted, rather than via consumers paying radio and TV stations for the consumption of their TV programmes.

Some Internet businesses derive revenue predominantly as a result of being able to offer advertisers access to highly targeted consumer niches (often in the absence of revenue from selling their goods or services).  So if your website is about a narrowly defined topic, it is likely to attract a highly defined niche audience who could be offered complimentary products or services with a higher probability of success than blanket mass market advertising.

However, this business model is increasingly difficult to justify if it is your main revenue stream. For a start, the landscape is extremely competitive and advertisers are spoilt for choice. Building brand awareness and translating that into site visits is a very difficult and costly challenge. Successes such as Facebook are very much the exception to the norm.

If this model is being considered for your startup, it is worth noting that nowadays most savvy investors ignore ‘vanity metrics’ such as Page Impressions/Visitor numbers and want to understand whether the underlying business proposition is profitable. Examples such as YouTube illustrate how hard it can be to monetise free content even when you have significant visitor numbers. In short, this model is in decline for most businesses.

The Affiliate model

An affiliate is simply someone who helps sell a product in return for commission. However they may never actually take ownership of the product (or even handle it). They simply get rewarded for referring customers to a retailer when they make a sale.  Again this business model has been a huge success given the ease with which the Internet facilitates it.

The Auction model

The auction model is synonymous with eBay, these days, but of course auctions have existed for hundreds and hundreds of years.  The tulip market in Amsterdam is one of the more famous examples. There are numerous different types of auction, from English, to Dutch, Vickrey, Sealed Bid, etc., and they all share certain characteristics: the price of the good is not fixed; each individual assesses the value of the good independently; final value is determined via competitive bids. This business model has become very popular in recent years as the Internet has helped to broaden its appeal.

The Bait and Hook model

This is essentially the razor blade analogy listed above, where disproportionate amounts of the value are captured on components, refills and the like. Anyone who regularly buys ink cartridges for printers will recognise this model where customer lock in and switching costs result in monopolistic pricing on the component side. The mobile phone business also grew rapidly on the back of this model as handsets were often supplied free of charge when you signed up for a contract. Nowadays with SMART phones, such is the level of demand for some that consumers have to pay hundreds of pounds for the phone and in many instances minimum contracts are 18 months.

The Direct Sales model

While direct selling was initially the primary ‘route to market’, production efficiencies coupled with improvements in transportation meant producers could reach a much bigger market and this resulted in the pre-eminence of the retail distribution model for many years.  However the emergence of the Internet as a distribution channel meant that producers could disintermediate costly resellers and sell direct to customers themselves, in effect going the full circle. The PC manufacturer Dell is a great example of a company who is very focused on the direct sales business model.

The Franchise model

Opening a franchise is essentially buying a working business model in a particular industry. You pay royalties for the privilege but get access to a winning recipe, a support network and an established brand. Two famous franchise business models are McDonald’s and Subway.

The Freemium model

This is where the business gives away something for free in return for your personal details so they can then market to you and hope to build up a relationship so that you buy from them in the future. It is typically used in service-based businesses where the lifetime value of the average customer is high and is increasingly popular with Internet services such as Spotify, Skype, or Flickr. Many of these offerings have similar cost structures where the marginal cost of serving an additional customer tends towards zero. The core free offering then acts as a gateway to the paid service. For example, with Spotify, the free version comes with adverts, the paid does not.

The Internet Bubble model

At one point, ‘unique visitor’ numbers to a site had a large perceived value. Many businesses offered free Internet services and businesses were valued on the basis of potential rather than underlying profit and loss metrics. There are still remnants of this today, and some spectacular examples like Twitter.com, where the notional valuation of the company is considerable even though existing revenue streams are negligible.  The actual business model is in effect getting lost in the media hype and proliferating user numbers, and it is more a case of ‘figuring the business model out at a later stage’ than up front. Naturally this is a highly flawed strategy and rarely works.

The Low-Cost model

The low-cost model can be summed up in one word: ‘Ryanair’. This is an extremely well established business model, where the aim is to drive significant volumes of customers (at a low customer acquisition cost) and by charging a very low price. In return, revenue is earned from a whole host of ancillary sources – these include:

• Bank card charges                                                                                           
• Advertising on seats
• Lottery ticket sales
• Flight insurance
• Selling train tickets
• Priority seating
• Extortionate charges for excess baggage, reprinting a boarding pass, etc.
• ‘Preferred car hire rates’

The model is not simply about trying to extract a whole myriad of extra cash from consumers, but also configuring every single aspect of their business model so as to drive out cost. Examples include buying oil futures to manage oil price fluctuations, having destination tourist boards pay for newspaper advertising, having staff pay for their own uniforms and training, and so on.

The Pay as You Go model

With this model actual usage is metered and you pay on the basis of what you consume.  Some mobile phone contracts operate on this basis i.e. the user can buy a phone card which gives them credit. Each call is metered and the credit is reduced as the ‘minutes’ are consumed (in contrast to subscription models where you pay a monthly fee for calls).

The Recurring Revenue model (Subscription model)

With the recurring revenue model, the aim is to secure the customer on a long term contract so that they are consuming your product or service well into the future. Given that the cost of customer acquisition can be high, retaining customers is a primary goal for most businesses. It is also becoming synonymous with ‘subscribing via direct debit’.  Most utilities providers operate under this model. Magazine publishers have also been looking to expand this portion of their business for some time, offering heavy discounts to subscribers (who buy all issues directly), rewarding them over individual discrete purchases (bought on an ad hoc basis from various third parties).

The Somali Pirate Business model!

Business models do not just apply to legitimate businesses as this post, The Somali Pirates’ Business Model by Mark Leon Goldberg illustrates!

As the above illustrates there are numerous business models that can be considered and the number is growing on a regular basis. For example in the gaming industry alone, David Perry, COO of Acclaim Games Inc list 29 business models for games that he is familiar with.

This is the second of a three-part series.
Part I: Have you Optimised Your Business Model?
Part III: Business Model vs. Business Plan

This is Part I of a three part series. Read Part II and Part III.

What is a business model?

A business model is a description of how your business intends to operate and make money. At the most basic level, it involves a producer making something and selling it directly to customers at a profit (but this simple model has propagated into numerous diverse models in recent years).

Alexander Osterwalder, co-author of the book Business Model Generation, defines a business model as:

‘… a description of the value a company offers to one or several segments of customers and of the architecture of the firm and its network of partners for creating, marketing, and delivering this value and relationship capital, to generate profitable and sustainable revenue streams.’

The development of a business model is essentially a strategic perspective rather than an operational assessment, and focuses on how you capture value i.e. it includes a description of the value proposition. Deciding upon a business model becomes particularly important as a concept when it is not a simple ‘make and sell direct‘ model and you are looking to create value through a non linear route.

The Business Model – An Introduction

In days of old, business was arguably a lot simpler; you produced something and sold it for a profit, building up a good reputation over time so as to ensure ongoing patronage. Before the industrial revolution most sales were essentially local, and you had a much greater steer on competition, demand levels and pricing. You probably sold your products directly to consumers as the butcher, baker or candlestick maker.

Fast forward 200 years and business has changed considerably. A lot more creativity is needed to get noticed in a time-pressed world (not to mention in making a sale). You are probably facing global competitors, and in many instances a widely dispersed audience who are increasingly difficult to reach in a cost effective manner. As a result, numerous alternative strategies have emerged to get your product to market, safely into the hands of the consumer and business model innovation has become increasingly popular.

“Companies that put more emphasis on business model innovation experienced significantly better operating margin growth (over a five-year period) than their peers.”

Source: IBM Global CEO Survey

Mark Johnson, author of ‘Seizing the White Space,’ agrees about the benefits, arguing that:

“Business model innovation is the key to unlocking transformational growth–but few executives know how to apply it to their businesses.”

In many respects the emergence of business model innovation started with Gillette and razor blades. They worked out that if they sold the razor at low cost, consumers would happily pay for the blades. Given the resultant switching costs and customer inertia, the result was often a lifetime of patronage (despite the fact the initial transaction was a loss-making one for the producer). In essence, by providing something at below the market price (the razor); you can create a market for a secondary product (the blade) upon which you make ongoing profits. A second characteristic of the model was that the mark-up on the secondary products were often disproportionate relative to their cost so were highly profitable for the manufacturer. Anyone who has had to buy replacement ink cartridges will bear witness to this!

A trend in recent years has however been the growth of companies (often Web 2.0 ones) with uncertain business models. Take Twitter, for example:

“Twitter has become an influencer in the way information is shared around the world. But while its immediacy, transparency and simplicity offer answers about all things both newsworthy and mundane, one big question about Twitter has gone virtually unanswered: how it plans to turn a profit.”

Source: CNN article (July 9, 2010)

Of course, the big challenge for the likes of Twitter, Facebook and other social media sites is that attempts to monetise come at a number of costs, often the privacy of the user and their ability to use the service without interruptions from third party advertisers. Monetising a free service invariably degrades the experience for the customer and hence companies need to walk a fine line as Facebook found to its cost in recent months.

Thinking about your business model

If you are an entrepreneur starting a new business, it is very important that you consider a number of different business models as it is possible to derive revenues from a range of different sources at various stages of the product’s lifecycle.

Businesses can also operate hybrid business models. For example, newspapers make their money from a mix of advertising revenue and the price they obtain for the newspaper. As we have seen in London, models can change over time as the value of certain portions of the business increase in value; for example, the Evening Standard newspaper is now given away free every evening (hence relying solely on advertising income to sustain itself). As U.S. Cambridge, U.K. -based entrepreneur Doug Richards proclaims:

‘One may start a business with the idea that one will sell a product to customers only to discover that no one will pay for it, but they will accept it when it is provided for free. When that’s the case, advertisers may pay for the production and distribution of the product.’

In essence, business models are essentially dynamic as new opportunities can emerge at various points on the value chain. Sticking to the newspaper industry, the dominant online business model for many years was free online content supported by advertising. However, the commercial viability of such a model is not sustainable (most sites lose money) and this tactic also results in lost sales as some people substitute a free digital copy for a physical paid one. The Times in the U.K. has recently changed its model to a ‘paid for’ access one – whether they can make it a success is debatable, given the fact so many free substitutes are only one click away!

Uses for business models

1. Starting a new business
If you are starting a new business (particularly an Internet-based one) and are seeking investment, the business model will be an important element of your business plan. Any prospective investor will be very keen to understand your business model clearly i.e. how you intend to generate cash, and whether it appears that you can do so profitably.

2. Innovation and product design
Business model innovation enables you to take a holistic view of the business to assess unique opportunities that exist outside of innovation solely on the product side. Business models also jump industry so it is a good idea to keep a breast of innovative business models you come across (regardless of the context). One simple (yet common) form of innovation is deploying business models from another industry in your own. As Mark Johnson claimed in ‘Reinventing your Business Model’:

“Business model innovations have reshaped entire industries and redistributed billions of dollars of value.”

The low cost business model pioneered by the likes of Irish airline, Ryanair (replicating the Southwest Airlines model) is now becoming more popular in the hotel industry, for example, where costs are being reduced significantly and entire business models are being reassessed. The CitizenM hotel in Amsterdam airport, in the Netherlands is one such example; staffing levels are far below industry averages as customers are forced to self serve.

“We looked at every process to see where we could streamline,” says Michael Levie of the new hotel chain. “Building costs and personnel costs are the biggest outlay for hotels. So we have no reception or restaurant staff. And the construction is modular. Our hotel rooms are designed as fully fitted units that can be stacked one on top of the other. This way, we’ve managed to reduce the construction time to ten months, saving on costs.”

Over time as new technologies emerge inefficient business models get displaced. One good example is the music industry. While the primary driver of the value is the musician, the actual value created is dispersed in numerous directions as the following post illustrates:

Does a CD have to cost $15.99?

(Source: Almighty Institute of Music Retail)

The value dispersion is instructive and hence it is not surprising that digital delivery of music (disintermediating the distributor) would emerge as a more compelling business model. The launch of the iPad and the growing popularity of devices such as the Kindle are also likely to drive the take up of a new digital orientated business models for the book industry.

3. Creating Revenue Streams
As I mentioned in the opening sections some Internet companies struggle to monetize their customer base. Their business model is effectively parked as a trade off to attracting ‘users’. The logic here is simple; if you offer a free service you remove the biggest risk or barrier to new prospects. Once you have significant volumes of users you can then create a business model to monetise this large user base.
Similarly, in the gaming industry ‘free to play’ has been a popular model where users play the games for free but pay to acquire virtual goods be it tools to play the game better e.g. buying weapons or multiplayer access.

4. Competitive Analysis
A traditional means to assess the attractiveness of an industry was to undertake strategic analysis using the methodology prescribed by Michael Porter in his Five Force Analysis. His core argument was that these following five forces determine the competitiveness of an industry and hence its attractiveness:

1. The threat of the entry of new competitors
2. The intensity of competitive rivalry
3. The threat of substitute products or services
4. The bargaining power of customers (buyers)
5. The bargaining power of suppliers

Understanding businesses from a business model perspective can also be extremely instructive as you can build up a narrative regarding how companies perform certain activities to gain a clear understanding as to their strategies. Using this in tandem with Porter’s Five Forces will give you a good sense of the competitive landscape which can then help you decide on the optimal strategy to pursue and also to preempt competitive threats.

About the Author:
Alan Gleeson is the managing director of Palo Alto Ltd, the UK division of Palo Alto Software.

This is Part I of a three part series.
Part II: Examples of Well-Known Business Models
Part III: Business Model vs. Business Plan

Decisions regarding how you finance your business should be taken very seriously as it is one of the most critical decisions you will make at the start-up phase and forms a key part of any business plan. When considering the different financing options, you need to spend some time learning about the conditions that come attached to early stage capital investment.  By far the best way to finance your business is from current cash flow arising from sales but unfortunately this is not realistic for most start up businesses.

A cursory glance through mainstream newspapers indicates that raising start up finance remains difficult as UK banks are simply not lending money to businesses (especially start-ups).  As Luke Johnson of Beer & Partners argues that;

“Angel investors are the only realistic option for these early-stage companies. Currently banks are barely open for business, or tend to offer loans on unattractive terms, so the need for equity capital is greater than ever. What’s more, since current low interest rates give savers such poor returns, more and more angel investors are emerging that have a strong appetite for direct investment in small companies.”

As Luke Johnson indicates, we have witnessed a growth in the number of angel investors seeking to fill this gap seeking to support entrepreneurs through the provision of early stage capital.

In addition, the ongoing success of the BBC programme, Dragon’s Den (where entrepreneurs seeking investment pitch their business plans to a panel of prospective investors), has added to the growing popularity of angel investment as a primary means by which entrepreneurs secure early stage investment in their fledgling businesses.  However I believe there is an alternative more compelling option which is more appropriate for non capital intensive businesses like Internet start-ups- and it is known as bootstrapping.

Bootstrapping

When you bootstrap your business you look to (a) start your business without any external finance and to (b) manage the business with a very tight control on costs. There are numerous benefits to start-ups in avoiding outside investment (particularly at the pre-revenue stage).

These benefits include;

1. Creating a strong cost discipline
2. Galvanizing staff against profligacy
3. Helping to maintain a focus on driving revenues (while controlling costs)
4. Helping to ensure an ongoing focus on innovation.

By ensuring as low a cash burn rate (rate at which a company uses up cash) as is feasible, you increase the chances of your business succeeding. Similarly, without any debt repayments or obligations to shareholders you can afford to be more flexible with your idea (pivoting to Plan B if need be).

Once you have proof of concept and evidence of demand, it is a lot easier to secure financing at considerably more favourable rates if needed.

As Greg Gianforte author of ‘Bootstrapping: The Secret to Entrepreneurial Success’, declares

‘When you’re Bootstrapping, you’re forced to deal with customers and to fulfill their needs from Day One. If you have a lot of external funding, on the other hand, you can be fooled into thinking you’ve already created an actual business just because you’re paying salaries and rent. But you haven’t. You only have a business when you have paying customers. Bootstrappers know this instinctively, and never lose that customer focus.’

US Entrepreneur turned academic Vivek Wadhwa agrees, arguing in his Techcrunch article ‘Ditch the Biz Plan, Buy a Lottery Ticket’

‘My advice for entrepreneurs in industries with relatively low capital costs (like internet/software) is to bootstrap. Of course, you can start by trying raising venture or angel capital when you have just an idea (you never know, you might get lucky); but don’t waste too much time on it. And don’t get discouraged if they [VC’s] turn you down; you are in the majority. Instead, focus on validating your idea, building it, and selling for survival. ‘

In short, bootstrapping is an excellent way to grow your business (particularly an Internet business) as you really focus on the need to generate profits that can be reinvested to drive further growth.

Finally here are some articles that will give you a better feel as to how you can bootstrap effectively:

How to bootstrap your company to profitability by Spencer Fry

The Art of Bootstrapping by Guy Kawasaki

Bootstrapping your way to Success by Alan Gleeson