Developing a Great Business Model
Great business models depend on developing three "green lights," or qualities that help the business succeed: finding high-value customers, offering significant value to customers, and delivering significant margins. Great business models also avoid three "red lights" that can derail a business: difficulties in satisfying customers, trouble maintaining market position, and problems generating funding for growth. The list below outlines key factors in determining whether your model meets each green light and avoids the red lights. Examine your own business to see if you meet the criteria for success and, more importantly, to correct any weaknesses you might have.
1. Acquire high-value customers.
High-value customers doesn't mean rich customers, but customers who meet the following requirements:
- Are easy to locate
- Allow you to charge a profitable price
- Are willing to try your product after minimal marketing expenses
- Can generate enough business to meet your sales and profit objectives
Customers don't necessarily need to be the end users of your product or service. They could be retailers, distributors, catalogs or whomever you sell your product or service to. If your end users or distributors don't fit this profile, you can still meet this requirement by attracting high-value customers through partnerships or alliances with companies in the market.
2. Offer significant value to customers.
There are a number of ways you can create significant value and competitive advantage, including the following:
- Unique advantages in features and benefits
- Better distribution through retail or distribution
- More complete customer solutions through alliances with other companies
- Lower pricing due to manufacturing efficiencies or pricing options
- Faster delivery, broader product line or more customization options
The rise of the internet, outsourcing and, most of all, the increased willingness of companies to partner in creative ways to serve customers has resulted in every industry creating innovation in business strategy. This gives you opportunities, but also makes it imperative that you stay on the creative edge to fend off competition.
3. Deliver products or services with high margins.
Better manufacturing costs due to overseas manufacturing is typically not the clear way to higher margins, as competitors will typically match your costs in the end. Higher margins come from having a product that can be made from an improved process or by having features that provide significant value and allow you to charge more. You can achieve high margins with other tactics, including the following:
- Use a more efficient distribution channel.
- Require less sales support and sales effort.
- Have an industry-leading lean manufacturing process.
- Offer more auxiliary products or other opportunities for revenue without increasing cost.
If you aren't sure of your industry's standard ratios, check out www.valuationresources.com where you can purchase industry reports, or contact your local Small Business Development Center, which you can find at www.sba.gov.
1. Provide for customer satisfaction.
Consider whether it will be difficult--and therefore expensive--to satisfy customers once they buy. Some of the aspects of a business that create high customer satisfaction costs include:
- High warranty costs
- Extensive technical support
- Extensive installation requirement
- Extensive customer service
- Interface problems with other equipment
Customer satisfaction costs, which occur after the sale, are red flags because the costs are typically high and don't produce revenue or profits. If your type of product might have high customer service costs, you need to configure your business to put these costs on someone else, either with partnerships or alliances or by restricting your sales to an aspect of the business that doesn't require customer satisfaction costs.
2. Maintain market position.
A good business model uses its resources to improve its market position, adding new products, features and customers or expanding into new applications. The red flags that indicate it will be difficult to maintain market position include:
- Two or three major customers buy most of your product.
- Major potential competitors control the distribution network.
- Technology changes rapidly and requires high-risk product development.
- There are alternative technologies being developed to meet the same need.
- You have well-funded potential competitors who could quickly move into your market.
Long term, your ability to hold market position is determined by the characteristics of the overall market. For example, a company involved in the semiconductor manufacturing business must adjust and guess right on constant changes in technology to hold market position. Sooner or later they will guess wrong and fail.
3. Fund the business.
Startup costs, operating capital, personnel costs and overhead costs are just a small percentage of the funding requirements for any business. The question is whether the investments will have a high return and whether the business can grow without substantial new investments. Red flags for a business model regarding investments include:
- ROI is less than 25 percent in the first three years.
- Incremental production of products or services requires substantial additional investments.
- Fewer than 50 percent of the investment required will be used in revenue producing areas, such as sales and production.
- Investments have to be made prior to sales commitments.
- Industry as a whole has a poor ROI or poor profitability.
Money is available for the right plan and the right model. You'll find money available if your ROI is right and if you have financial leverage, which means your initial investment will allow you to double or triple sales without requiring any more funding.
Don Debelak is the author of Business Models Made Easy (Entrepreneur Press 2006) and Successful Business Models, (Entrepreneur Press 2003). For more information, visit his website, www.dondebelak.com.