Business Model Evaluation

Business model evaluation involves analyzing a company's business model to assess its viability, sustainability, and potential for profitability by examining key components such as value propositions, customer segments, revenue streams, and cost structures.

This article builds upon Business Model Exploration, so I highly recommend reading it first.

Assessing Business Model Quality

Now that we've defined the components of a startup business model, let's recognize that founders want to do more than just map their business models to Diamond-Square Framework. They want to intentionally design valuable business models, the most valuable business models possible, in their quest to solve a customer's problem.

So, what makes a valuable business model? We just learned two elements that can aid in the growth of your startup: network effects and positive, self-reinforcing flywheels. Before we explore the other aspects of valuable business models, it's important to understand the different types of business models that exist in Startupland.

There are few ways to characterize the types of business models you will encounter. Folks will talk about B2C (business to consumer), and B2B (business to business), and perhaps even B2B2C (business to business to consumer; in other words, you reach customers through businesses or channel partners). Those are shorthand ways to define who your customer is and your go-to-market method to reach them.

Another characterization that will be mentioned in business model descriptions centers around startups' pricing models. There are three main types of pricing models. The first is advertising-based, such as Instagram or Facebook, where the customer is both the end user and the advertiser who is trying to reach a targeted audience. A second common pricing model is transaction-based, where a company might get a percentage of the transaction volume going through their platform. Two-sided marketplaces, like Uber or Airbnb, are examples of transaction-based, where the company receives a cut or a take of the total transaction volume. Another common pricing model is subscription-based. There are two flavors of this pricing model, B2C subscription-based services, such as Netflix, which charges monthly, or B2B subscription-based models, which are often referred to as Software as a Service, or SaaS. Amazon Web Services and Salesforce are good examples of companies with a SaaS business model, charging an annual fee for access to their service. Subscription and SaaS business models will often start with a layer of free service to entice the user to try out the product, and then a SaaS fee for premium services. This model is known as a freemium model. Dropbox is a good example of a company that has a freemium model, allowing users up to some GB of free file storage before charging a month for more storage.

Your selection of your business model and the profit formula underlying it is a critical aspect of the startup journey and can make or break your startup idea.

Plastiq is an example of a B2C, transaction-based business model because it works directly with customers to fulfill transactions.

Let's now assess how to evaluate the quality of a startup business model and determine what aspects might influence its potential for success. As noted, using the diamond-square framework gives you an outline of the elements that comprise a startup business model. We will not focus in detail on the Square portion of the framework. Instead, we will go deep on the Diamond so that you have the skills you need as a founder, joiner, or investor to build or evaluate a venture's core operating design.

Let's discuss the questions you should be asking yourself to evaluate the quality of the diamond portion of a startup's business model.

For CVP - Customer Value Proposition, ask: is the value proposition a must-have, compelling one and not just a nice-to-have? Is it 10x better than any competitive offerings? Once the customer uses the product, is it very difficult to switch away from it? That is, are there high switching costs or a sticky relationship?

For GTM - Go-To-Market Strategy: do they have the right mix of direct and indirect channels to educate, support, and distribute the product to customers in a repeatable and scalable fashion? Is there a flywheel or a tight viral loop, such that successfully acquiring users results in even more users coming onto the platform? Can organic demand be created? That is, do they have to pay for every user? Or can they acquire users organically, without having to pay for them?

For PF - Profit Formula: will the venture earn substantially more revenue per item sold as compared to its cost of acquisition and production? That is, does it have high gross margins?

For T&O - technology and operations: to deliver the actual product, is it capital intensive or operationally complex? Are there economies of scale over time, such that you can be even more profitable as you scale?

And then, stepping back, it's important to consider the individual startup within the larger ecosystem of Startupland. So, are there opportunities within the ecosystem that will support the growth and success of the startup? There are three important criteria to consider as you judge the quality of a business model:

  • Network effects and positive flywheels, as mentioned earlier. Does the product become more useful and valuable to customers as more of them use it? And as the business model is in motion, does it self-reinforce and build momentum on its own with little or no friction?
  • Waves or trends - are there secular trends or waves that may propel this startup to success in this current moment, such that the burden of creating a market doesn't rest solely on the startup's shoulders? In other words, is there a strong answer to the question: why now? Why should this startup succeed at this moment? What secular momentum can they benefit from as compared to other moments?
  • Ethics and impact. Evaluate the ethics and societal impact that your startup will have if it's wildly successful to ensure that its success can be enduring and sustained. What positive impact or systemic change will your startup create if it becomes pervasive?

Refining the Business Model

Business model assessment is useful because it allows founders and investors to analyze each component of a venture’s business model and determine if there may be components that are not aligned. It illuminates the areas where things are not working and where more experimentation or a pivot may be necessary. 

Pivots occur when a founder decides to abandon an element that is not working and try a new approach. Pivots are an essential part of the process of refining a business model and adjusting as a result of your experiments. 

We will learn more about the types of experiments you can run and how to execute pivots in the following articles. For now, let’s learn about a potential pivot Plastiq considered around their target customers.

As Plastiq progressed, it was clear that merchants valued this service because it allowed them to access previously untapped markets: cash-only customers. But, Plastiq’s actual traction and volume of consumer spending - particularly on large purchases - was falling short of their projections.

The team began to wonder: Who is our target customer, and what does their ideal customer profile look like? Have we been focusing on the wrong subsegment? Could there be a different group of customers who would either better align with our GTM strategy or could strengthen our PF?

By analyzing Plastiq company data and reaching out to learn more from customers about how they were interacting with their service, they learned small and medium businesses (SMBs) were a key segment of the market. Not only did they use Plastiq for large purchases, but they also used the platform more frequently than individual consumers. These SMBs valued the ability to pay their vendors on a monthly basis to improve their monthly cash flow.

Note this common pitfall for founders. Plastiq’s initial focus on individual consumers was based on their own life experience as students paying for tuition, but as they got deeper into learning about their customer, they were able to run experiments that unearthed this previously ignored, more compelling segment. 

With this new insight in hand, the team decided they should pivot their CVP to target this new customer segment.

To Pivot or Not to Pivot?

The Plastiq team saw SMBs as their ideal customer profile. Targeting them would increase Plastiq’s profit formula, which would benefit from small and medium business owners’ regular transaction frequency. Also, there was clearly a gap in the market for these business owners that Plastiq could help fill. Given this, Plastiq pivoted to primarily targeting SMB customers.

Making this change would create tension with their GTM strategy unless they adapt their GTM to highlight the value Plastiq provides to SMBs. Marketing to this new segment may require a new set of features, partners, pricing, and even team.

Plastiq’s Updated Business Model:

  • Customer Value Proposition (CVP) - Allow SMBs to pay their vendors on a monthly basis to improve their monthly cash flow in addition to rewards benefits.
  • Go-to-Market (GTM) - Recruit staff and partners who know how to target and market to SMBs and use their knowledge to educate and work with these business owners.
  • Profit Formula (PF) - Update pricing scheme to account for new services they will provide through their website and enable them to still make a profit.
  • Technology and Operations (T&O) - Update product to include more reporting and cash management automation these businesses will require.

Let's reflect on the pivot Plastiq made and its implications.

First, the co-founders adjusted their ideal customer profile from consumers to
small-and-medium sized businesses, or SMBs. They believed this would improve both their value proposition and revenue potential, as this customer segment would use Plastiq monthly, rather than annually.

This pivot then had to ripple through their entire business model step-by-step.

For CVP, a different target customer required a different value proposition. For SMBs that would mean cash flow as well as rewards.

For GTM, reaching SMBs is a very different task than reaching consumers. It would require an adjustment in their sales and marketing approach, including the recruitment of channel partners, banks, and corporate credit card companies who already worked with small-and-medium businesses.

For PF, with a different customer - SMBs and a different product, which included more workflow automation, a new pricing scheme would need to be implemented by Plastiq that is a blend of transaction-based and subscription-based.

For T&O, a different target customer has different requirements and thus needs a different product. In this case, one that provided more reporting and cash management automation.

It all starts with understanding who your customer is. Experimenting and iterating on a precise definition of your target customer and then allowing that definition and the associated value proposition to ripple through all the business model elements is a critical part of the product-market fit journey.

Don't be afraid to pivot and evolve. In fact, embrace these adjustments as evidence of continued refinement as a result of your startup experiments.

Determining GTM Strategy

Now that we've drilled down into the CVP, let's spend some time examining the GTM in more detail.

One lesson that all founders learn quickly is that they have a superpower. No one can sell like the founder. When you're in the jungle phase of a startup's life, remember that the goal is not to maximize scaling, but to run experiments rapidly and maximize learning. The best way to maximize learning in an integrated fashion is for the founder to get out there and personally work to acquire customers.

The founder of Y Combinator, Paul Graham, has a rule of thumb for early-stage founders: "Do things that don't scale". Founder selling doesn't scale,
but it does maximize learning.

Let's learn from Plastiq about how they approached founder selling and how they transitioned beyond it as they scaled.

Founder selling means the founder goes out and sells, and in Plastiq case, they were a small two-man team. It was them - they went out there and sold. And looking back, it was one of the more fun times they had at the company. They were learning things, they were having conversations, and they were making decisions so quickly. It was a wild and fun time, but that meant that they had no other personnel. They were the people on the front lines, they were learning, iterating, building the operations, the product, the technology and the marketing all at once.

In the early stages of a company, there is no one who can sell a product better than the person who thought it up and whose baby it is. Everyone loves their baby. Like, this is the best thing in the world, and you need to have it. That energy, the enthusiasm, and the knowledge is invaluable in those early stages. So founder selling, if you can't sell something as a founder, you're dead in the water because that's the best chance that you've got. You're having those conversations, drumming up interest, it starts somewhere, and you've got to catch that fire before you can get other people contributing to it.

The transition from founder selling to hiring their first sales person was rough. It was due to not having a significant enough product-market fit at the time that they scaled up their personnel. They hired too early. They as founders were able to iterate so quickly and the connection was so close between product and ops that something would come up, and they'd say, oh, cool, we'll have a solution for that by the end of the week.

Their first sales hire was 40 plus, and they wanted someone with experience, who knew what they were doing, who could close the sale and do complicated deals. But as it turns out, a lot of the DNA for sales is that sort of like plug and chug. You know what it is you're selling, and you know the parameters of the deal, that makes money, and you go out there with your target customer and messaging, and you go out there and do it. The individuals that they had hired in the early days, for that reason, didn't have the innovative entrepreneurial mindset that you needed to really continue the path that they had started with founder selling. They were still in that expeditionary phase, and they were hiring people who were not set for that. So that's the early stage, and you learn a lot, and you spend a lot, but hopefully, you can push forward.

So, when it comes to hiring people, look for people that fit the DNA of your company. Make sure you're ready to hire a sales person. Make sure not only you as a manager, are ready and as the organization is ready, but that you as a product and a support staff are ready because sales people, when properly enabled and properly motivated, they can crush it. But without it, you're going to find almost no returns.

Those are some of the common challenges of transitioning beyond founder selling. Founder selling is the first phase of a multiphase go-to-market strategy that allows the founders to progress along what is known as the Sales Learning Curve. The Sales Learning Curve was inspired by the age-old manufacturing learning curve, which states that costs start very high and decrease as sales volume increases. Similarly, the Sales Learning Curve starts at a point where things do not scale and selling costs are very high. That's because a founder's goal during the first phase of the Sales Learning Curve, the initiation phase, when the startup is still "in the jungle", is to learn how to sell and obtain feedback on how prospective and real customers are experiencing the product. At this point in the process, it doesn't matter how efficient your sales efforts are. Instead, it matters how much you're learning.

The next phase, the transition phase, comes when you're beginning to see signs of repeatability in how to sell your product or service. A path is beginning to emerge. Not a perfectly straight and smooth path, more like a dirt road. At this point, you can hire your first sales rep or two, ideally folks who can translate what the founder has learned from their own selling into a repeatable, scalable sales playbook. Recall, that the Plastiq team hired one well-experienced sales leader, which ended up being a misstep. After all, the sales playbook is being sorted out and the selling process is still scrappy and dynamic. More senior people may be uncomfortable with this degree of uncertainty. In this phase, it may be more beneficial to hire salespeople with less experience and more generalist skills, who will bring more flexibility to the role. These types of generalist salespeople may not receive many resources or support from the company. And so they would need to be skilled at not only selling, but also creating the necessary scaffolding to support selling. At this phase, the beginnings of metrics and measurements to assess sales effectiveness can be put in place.

The final phase, the execution phase, is where a larger sales team is hired, and you can begin to focus more formally on the sales formula. This phase feels more like moving along a highway, where you're optimizing for speed and efficiency. Here you can hire a salesperson at the vice president level who is skilled at building processes and keeping the sales machine running. In this phase, larger teams are put in place, perhaps geographically distributed, across sales, marketing, and customer success. This is also the phase where a dollar of investment in sales and marketing yields a precise amount of new business. And that formula becomes repeatable and scalable over time.

The Sales Learning Curve is best suited for B2B sales activities, but can also be adapted for B2C. Even in many B2C businesses, such as Instagram, the actual revenue generated comes from a business rather than a consumer. Another important GTM approach for B2C and B2B businesses is product-led growth, a topic we will cover in one of the next articles.

Wrap Up

Stay tuned - in the next article, we will discuss Business Model Alignment!