10 questions to ask before you believe in a business model

Some business models are inherently more attractive than others, yet investors and other stakeholders often don’t ask the obvious questions. Here’s a checklist that makes sure you are not one of them.

People like to make thinking about business models really complicated. While that can sometimes have its place, for those looking for a quick overview of what makes one model superior to another, this might be a good place to start. Let’s walk through some key questions.

Question 1: Are we able to create switching costs once we have a customer working with us?

Some of the most powerful business models in use today depend on the fact that it is inconvenient, expensive or time-consuming for customers to switch to another provider. For years, this was a fundamental driver of the success model for retail banks – once you have filled out all the paperwork, established your credit rating, set up all your direct deposits and transfers, to do that all over again to work with another financial institution is a real pain, so most people don’t bother.

Network effects are another form of switching cost. Once all my friends and family are on a social network, for instance, to port all that information somewhere else is difficult or even impossible. Facebook (or Meta, or whatever they are calling themselves these days) is a poster child for a company that tries to take advantage of this effect.

Of course, switching costs can be undermined by adroit competitors. The company now known as Wise (formerly Transferwise) undermined switching costs for foreign exchange transactions by making all the barriers involved in Forex unnecessary, eliminating banks’ dominance for many customers. Instead of actually transferring money from one place to another, they broker transactions of funds within geographies, making low-cost, low-effort transactions available to everyone.

Question 2: Are we transactional or relational in our purchase patterns?

Business models that are based on ongoing flows of a relationship of some kind tend to be more profitable than business models that are purely transactional. A fascinating place in which this is playing out today is how food delivery companies, such as DoorDash and UberEats, are creating relationships with customers that are ongoing, on the backs of the restaurants desperate enough for business to yield control of their customers to the digital giants.

Essentially, what the food delivery people are leveraging is that they can form an ongoing relationship with customers through their knowledge of purchasing patterns, existing financial information and ease-of-use – just use one app and you can get everything directly delivered to you whether it is Thai food, pizza or something more exotic.

The squeeze this puts on the restaurants (or ghost kitchens) that provide the food the delivery companies distribute is dramatic. And yet, it’s hard to see how they can avoid the dominance of those digital companies who have delivery infrastructure. Perhaps this is an opportunity to take R “Ray” Wang’s suggestion and have “delivered by Domino’s” become a thing in support of smaller local restaurants. Good for them, good for Domino’s. Hey, are you listening?

Question 3: How interchangeable is our user interface?

Some user interfaces to access a product or service are easily interchangeable. Take ATM machines – once you’ve learned to use one, you can pretty much use them all. Or the QWERTY keyboard – since it became a standard decades ago, everybody uses it so there is no big difference between providers. On the other hand, some offerings have user interfaces that have something about them that causes users, once they have learned to operate them, to prefer to continue to use the one they know.

Take something like the Excel spreadsheet platform. It may well not be the most efficient or effective way to crunch numbers, but once you’ve gone through the trouble to learn how it works, the desire to switch to some alternative platform is muted. Of course, offerings like Google Sheets simply copy the functionality in the same way, reducing the learning cost to switch for new users.

Question 4: Painkillers or vitamins?

This question is inspired by the observations made by David Kidder, of Bionic, that really groundbreaking innovations are major painkillers. In other words, they aren’t nice to have, optional or just intriguing. They solve an immediate, pressing and urgent problem for the people using them.

Cloud based storage service Dropbox, for example, got its start when one of its founders, Drew Houston, happened to be on a bus from Boston to New York, a four-hour ride in 2006. While he was planning to get work done on the ride, he discovered he was missing a critical component – a USB stick with his stored files! That created the inspiration to never let this happen again because documents could be stored in the cloud. The idea was that you would never be without access to mission-critical information again. The company went public in 2018, and today is called “the ultimate tech value stock.”

Question 5: Do we have the opportunity to take advantage of network effects?

This question gets at whether something about the offer increases to the extent that there are more users, more connections or more activity connected to it, making it more valuable as more of these add-ons accumulate. This is the secret sauce behind the popularity of platform business models, in which companies try to match two sides of markets and take a little cut of all the transactions that happen there.

This of course is often given as the reason Facebook has been so successful – users want to be where other users are. Advertisers want to be where users are. Facebook intermediates between the two.

You have to be a tad careful before you enthusiastically believe that network effects will be an all-time fix, however. Uber, for instance, is learning, painfully, that the power of network effects are limited, because the business is confined to purely local areas. There comes a point at which adding more riders or drivers simply reaches diminishing returns. And of course, Uber has come under massive criticism for its other business practices, fueled by generous and seemingly endless flows of investment capital.

Question 6: Once and done, or ongoing problem?

A tricky aspect of capitalism is that ironically you are often better off (economically) treating a chronic problem than you are offering a complete solution to a constituent’s problem. The result is that true cures for problems tend to come at a very steep price, as that is the providers’ only opportunity to make a profit.

For example, the wildly high prices of drugs that cure formerly incurable diseases such as hepatitis, reflect this dilemma. Once a patient has been through a regimen, the problem is done and there is no further need for treatment. But the cost of the cure is expensive. One Solvaldi pill costs $1,000 – a 12-week course can run a patient $84,000 and other treatments are in the same range of cost.

This factor is also why increasingly firms are turning to recurring revenue models rather than product sales models to market their offerings. Monthly or annual recurring revenue has become the dominant standard for Software as a Service (SaaS) companies, but even companies that sell physical products have gotten on the subscription bandwagon. All those direct-to-consumer companies selling everything from dog food to mattresses are attempting to take advantage of serving an ongoing problem. But, as I point out in this article, just because you want to think you’re solving an ongoing problem does not mean that you are actually doing so.

Question 7: Transactional or relationship oriented?

This factor gets at all those intangibles that surround an economic transaction. If I’m buying a commodity whose prices are known and transparent, there is no particular need to establish a relationship with the person I am buying from. I just place my order and away we go!

On the other hand, to the extent that the product quality is not easy to ascertain, the purchase is high-risk, or the need for customization is considerable, the quality of the relationship between buyer and seller takes on a larger significance. To the extent that there is an emotional, in addition to a purely economic benefit to the purchase, there is often greater willingness to pay on the part of the customer, and the relationships tend to be stickier.

Indeed, the importance of relationships is embedded in a number of other concepts, such as the lifetime value of a customer and the importance of replacing transactional “funnels” with deeper lifelong “relationships.” Marketing services such as Hubspot have leveraged this idea to create entirely new business models.

Question 8: Does it matter?

Many entrepreneurial businesses have failed when, even if they do make an improvement in the customers’ experience, the improvement is marginal or insufficient to overcome the inertia of simply continuing to do what the customer has always done.

As consultant and tech executive April Dunford proposes, you always need to consider what customers are doing right now to solve their problems. Your biggest competition might well be the intern!

Groundbreaking offerings, on the other hand, make a material difference to what the customer is able to do or the problems that can be solved in a noticeable way. Back to Wise – it is able to offer the equivalent of foreign exchange trading for a noticeably, like really noticeably, lower price than a similar offering by your friendly local bank. The result has been massive customer adoption and substantial growth.

Question 9: The initiative creates a platform for interactions

As the value of products and services becomes subsumed by what R “Ray” Wang calls “Data Driven Digital Networks” the importance of having some kind of platform strategy increases. A standalone offering, while not necessarily a bad thing, doesn’t offer the exponential growth potential of many platform business models.

While today of course we would think of digital giants in those terms, the idea of creating a platform for exchange and interaction is not a new one. Michael Bloomberg, for instance, made his fortune with the creation of the Bloomberg Terminal, providing information for traders at the tips of their fingers. More importantly than the technology, however, were the social interactions fostered by the Bloomberg terminal, making the technology irresistibly sticky for its users, commanding a premium price for Bloomberg and setting the foundation for an information and media empire that continues to operate powerfully to this day.

As one observer noted, “Bloomberg is a great business because it has low churn, and it has low churn because its IM function is basically an exclusive club of approximately 325,000 people whose employers think they are worth at least $25,000 per year above their base salary. Like any exclusive club, if you can get in, it’s assumed that you’re probably worth talking to.”

Question 10: Lone Ranger or co-created?

While the popular imagination just loves the idea of Steve Jobs arriving on a clamshell and single-handedly inventing uniquely desirable products that change the world, such standalone approaches to innovation tend not to work. Instead, the more powerful models today are bringing together communities of participants – users, developers, makers, designers and more – to envision and create new offerings. Once you are part of the community, it becomes very difficult to leave it, particularly if you had a hand in creating key aspects.

And this isn’t just for born-digital firms! Unilever, the consumer packaged goods giant, has long maintained an open innovation platform to encourage outsiders to pitch ideas that might be of use. Most recently, it has launched the Positive Beauty Growth Platform, an internal collaboration between its venturing “Foundry” unit and its Beauty and Personal Care Division. The hope is to start to bring social connections and ideas into the manufacturing of physical products.

Want some help thinking this through?

At my sister company, Valize, we have developed diagnostics to help you think through questions exactly like these. We’re helping companies make an end-of-year push to get ready for new business models and better innovation practices for 2022. Contact [email protected] to learn more.

We’re also launching a series of on-demand, self-paced learning modules for creating customer insight. You can find out about these by visiting this site: https://learninghub.valize.com/

Better to find out the flaws in a busines model early

My goal in helping you work through these questions is to quickly hone in on those places where your business model might be problematic. After all, why not maximize its attractiveness, if you’re going to put all that work into creating one!