Major Innovations Stem From One Tweak of Traditional Business Models, says LBS Prof
John Mullins is a professor at the London Business School, where he focuses on entrepreneurship and marketing. In 2003, he released the bestseller The New Business Road Test: What Entrepreneurs and Executives Should Do Before Writing a Business Plan. Mullins and co-author Randy Komisar of venture capital firm Kleiner Perkins build on those ideas in their new book Getting to Plan B: Breaking Through to a Better Business Model. Today, we wrap up our discussion with Professor Mullins (to see the first part of our interview, where Mullins discusses why most successful startups find themselves significantly altering their original business plans, click here).
BNET: So, when it comes time to plan for a new venture, how should an entrepreneur approach developing his or her first crack at a business model?
Mullins: The business modeling process today goes something like this. Step one, you turn on Excel. Step two, you make a large number of naïve assumptions in order to fill in all of the cells. Step three, you tweak the value of those cells, because you don't like the answer the first time, until you get a beautiful "hockey stick" projection. The problem is almost all of those assumptions are pulled out of thin air.
Rather than do that, we suggest people think about the five key elements of the business model and not focus on building spreadsheets with a P&L and a balance sheet and so on.
The five elements of the business model are:
1. Revenue Model
2. Gross margin Model
3. Operating Model
4. Working Capital Model
5. Investment Model
By applying targeted data from the analogs and antilogs to each of those parts of the business model, you can much more quickly get to a sense conceptually if this idea you have is really going to work.
BNET: Do new business concepts need to radically change several of these elements, or can they innovate on just one or two?
Mullins: Maybe the most interesting thing about this framework is that virtually every company we studied in the book made their success by doing something radical on really just one of those elements of the business model. For example, with Apple when it revolutionized the music industry, it was the Revenue Model. For eBay, it was all about the Gross Margin model; figuring out how to enable people to trade things from their attic to another guy's attic. eBay did it at essentially 100% gross margins. An Operating Model embodies all of the costs of selling and providing services other than the direct cost of the goods you sell to your customer. We see compelling Operating Models in the airline industry with Ryan Air in Europe and Southwest in the US. They have figured out how to take all kinds out of the cost structure. Ryan Air is now the largest carrier in Europe in terms of passengers served and they've done this all through their focus on the Operating Model. Costco has gotten it right on the Working Capital Model. They charge us for the privilege of shopping in the store. If you add up all of the $50 fees that people pay, that amounts to two-thirds of their annual operating profit. They don't tie up capital because they function on their customers' money. On the Investment Model, we compare the strategies and business models of Skype and Vonage. Vonage had to buy switches and all kinds of other equipment because in its view, you needed a telephone to make a telephone call. Skype decided to do it PC to PC, so the Investment Model required very little capital. Skype got to almost 7 million users in year one with almost no marketing investment; Vonage got its first 1.4 million with almost $200 in marketing.
BNET: This framework sounds like it would also be a valuable tool for venture capitalists, helping them get out of the weeds in the business ideas they look at.
Mullins: It's interesting you say that. We've written this book for entrepreneurs and other innovators, whether they sit in start-ups or large organizations. These are people who are trying to reinvent something. But we've also written it with the investor in mind. We sent this book to a number of VCs we know and they ended up buying a copy for every member of their firm because these are fundamental ideas the VCs need to wrestle with to truly understand the economics of a business.