N&B Hadzima - Business Models - nutsandbolts.mit.edu

Business ModelsBusiness Models

Joe Hadzima(MIT S.B., M.Sc. in Management; J.D. Harvard Law)

Senior Lecturer, MIT Sloan School

President and Co-Founder, IPVision, Inc.

[email protected]

January 2019 The Nuts and Bolts of New Ventures © 2019, Joseph G. Hadzima Jr., All Rights Reserved

The Fire Hose

• “Getting an Education at MIT is

like taking a drink from a Fire

Hose.”

• We are going to throw a lot at

you. Different views of the

topic. Your Job/Our Job:

figuring out how it applies to

You.

• Goal: Not just help you with

your current venture BUT to

enhance your Lifetime

Entrepreneurial Skills


Why Care About Business Models?


• iPod Gen 1 - 2001– 4” x 2.43”– LCD screen– Circular Pad– 5gb – 1,000 songs– $399

• Rio MP3 Player - 1998– 3.5” x 2.5”– LCD screen– Circular Pad– 32-64mb 30 minutes of songs– $200

TopicsTopics

• Goals: Help you with your Business Model

– Get you comfortable thinking about Business Models

• Business Model Canvas – One Approach

• Chesbourgh – 6 Components

• Lean Startup – Finding Your Business Model

• Business Model – more examples

• Business Models and Valuation

• Business Model Implementation


The 3 WhysThe 3 Whys

• Why This?– Why is this Idea Worth Pursuing or Investing In?

• Size of Market? Problem Worth Solving?

• Why Now?– Why is this the Right Time to Do This?

• Convergence of Opportunity and Solution

• Why This Team?– Why Do I Think These “Guys” Will Win?

• Experience

• Business Model


BUSINESS BASICSBUSINESS BASICS

• It is a Really Simple Concept ….. (whether you are

doing a Web 2.0 company, a biotech company, a clean techventure or a non-profit social developmental company):


• Create Value

• Capture/Harvest Some of the ValueCreated – so you can do it Again

This is the Business Model


• What is a Business Model?– What does the Business Do?

– How the Business Makes Money doingthese things

• Examples:– Google

• makes money with PPC advertising.

– CableTV• buys content wholesale, sells retail.



• Another Definition?

– (def): The method by which a firm uses its resources (cash,technology and people) to offer its customers better valuethan its competitors and make money doing so.

– It tells:

• What Value You Create

• What Portion of the Value You Can Capture

• By Looking At:

– Who Pays for the Value Created

– How Much and How Often

– What it Takes/Costs to Deliver the Value


A

B

Business Models – Simple and Elegant


Business Models – Simple and Elegant

January 2019

Simplicity is The GoalSimplicity is important. It reveals how well you understand your

business. If you understand it well you can explain it simply. Mostoften it can be simplified. If it can't then probably you don't yet

understand how you are going to make money or capture value.

Millau Viaduct France– World’s Tallest BridgeThe Nuts and Bolts of New Ventures © 2019, Joseph G. Hadzima Jr., All Rights Reserved

Broadcast Radio Model(WWW - World Wide Wireless)

Broadcast Radio Model(WWW - World Wide Wireless)

Costs

– Transmission Equipment

– Receivers

– Providing Content

Business Model Alternatives?


Pay-by-the-message (e.g. telegraph) One-time Fee on Receivers Tax on receivers (subscription) Advertising

Broadcast Radio Model(Business Models Evolve)

Broadcast Radio Model(Business Models Evolve)

1897 thru World War 1

– British Marconi – wireless telegraphy/telephony– Military Use in WW1 – gave rise to trained people

Radio Corporation of America (1919)– Alliance of GE (key patents on transmission), AT&T (key patents on vacuum

tubes), Westinghouse and United Fruit– One to One or One to Few Communications model – competition with submarine

cables• Fee for Service Revenue Model• 25 cents/word to England ($3.25 in 2018 dollars), RCA charged 30% less

Broadcast Stations (1922)– Amateurs, speculators, nonprofits. Little regulation. 576 stations by end of 1922– Spurred growth in radio receivers– Retailers sponsored stations

Broadcast Networks– National Broadcast Company (NBC) 1926 - Shared/Syndicated Content– Ample audience size and advertising dollars (Two sided Business Model)


A Business Model Problem:A Business Model Problem:

• Existing Product: messy, semi-toxic process used inoffices.

• Your Technical Solution. Avoids the use of chemicalsand special materials. Benefits: Quick and Clean

• Prevailing Business Model: Razor/Razorblade model.Sell machine at below cost and make up the differencewith high margin supplies.

• Your Problem: Your machine is 6-7x more expensiveand your supplies are about the same cost as existingsolutions. So existing manufacturers aren’t interested inlicensing the technology.


Business Model Case Study: XeroxBusiness Model Case Study: Xerox

• Xerox Model 914: electrophotography process that avoids the use of wet chemicalsand special paper. Benefits: Quick and Clean

• Prevailing Business Model at time: Razor/Razorblade model. Sell machine atbelow cost and make up the difference with high margin supplies.

• Problem: Model 914 was 6-7x more expensive and the supplies were about thesame cost as existing solutions. So existing office machine companies weren’tinterested in licensing the technology.


• Business Model Adopted: Xerox marketed Model 914 directly.Leased at low cost and charged a fee for more than 2,000 copiesper month.

• At time average business copier made 15 - 20 per day (300 - 400/month)• For success the number of copies made would have to increase substantially

• Result: the ease and convenience of using Xerox coupled with a modelthat encouraged usage resulted in a huge increase in copying, leadingXerox to a 41% compound annual growth rate for over a decade

Business Model Case Study: CytycBusiness Model Case Study: Cytyc

• Pain Point Addressed: Poor sensitivity of cervical cancer screening– real pain point - up to 30% false negative error

– cancers were missed – who did it affect? Patient most, provider somewhat, payor - not at all

• Cytyc Insight: Looked at the entire “Thin Prep” process and recognized thatsample collection contributed more to errors than cytologist fatigue andmisreading

• Problem - US Healthcare system conundrum. Purchase decision maker IS NOTbeneficiary of value. Influencer of decision maker is data from studies of usewhich is dependent on adoption which depends on reimbursement

• Solution - Innovate in the Value Chain. Rethinking how to charge thereceiver of value in a market where intermediaries control access andreimbursement

– Insurers reimburse for PAP smears so patients have never paid for nor made decisions on whatproducts are used

– Physicians were sole decision makers on labs to use and labs controlled what manufacturers’products were used


Business Model Case Study: CytycBusiness Model Case Study: Cytyc

• What Cytyc Did: Provide physicians a form to give patients explainingsimply:

– 25% of cancers are missed by the testing your insurer will reimburse.

– There is a test that improves accuracy dramatically and we make it availableto patients for $25.

– Please sign this form to opt in or out of this test.

• Result:– Physician wins - reduces liability and looks “up to date”

– Patient decides value

– Payor gets info for coverage decision

• Bigger Picture– Became an accepted way to introduce innovation prior to proof of cost

effectiveness

– Same technique used to introduce 3D mammography


Summary So FarSummary So Far

• iPod – partly technical but mostly businessmodel

• Broadcast Radio – model evolved basedon advancement in technology adoption

• Xerox – financial model enabled adoptionand growth

• Cytyc – value chain disruption needed


TopicsTopics

• Goals: Help you with your Business Model– Get you comfortable thinking about Business

Models








Business Model GenerationBusiness Model Generation


From Business Model Generation by Osterwalder et al.January 2019 The Nuts and Bolts of New Ventures © 2019, Joseph G. Hadzima Jr., All Rights Reserved

ValueProposition

Customers&

Channels

ActivitiesResourcesPartners

EconomicsCosts - Revenues


• Some of the Models DiscussedUnbundling Business Models

Long Tail Business Models

Multi-Sided Platforms

Free as a Business Model

Freemium Model

Open Source – a version of Freemium



Unbundling Business Models (Mobile Telco – focus brand & customer)

Customer Relationship

Product Innovation

Infrastructure Management

Long Tail Business Models (eBay, early NetFlix)

Selling Less of More

Niche Products

Needs Low Inventory Costs and Strong Platform to reach Buyers

Multi-Sided Platforms (Video Games, iTunes)

Bring together 2+ distinct but interdependent groups

Valuable to one group only if other group present

Platform facilitates interactions among groups



Free as a Business Model (Gmail, Skype)

At least One substantial Customer Segment continuously benefits

Non-paying customers financed by another part of Model or CustomerSegment

Freemium (iCloud, Skype)

10% of users pay for premium or extra services

Requires low cost for adding users

Metrics: average cost of serving free users, rate users switch to premium

Open Source (Red Hat)

Use Open Source as base to reduce core development costs

Build Trusted Application on Open Source Base

Subscription for vetted releases and support


TopicsTopics

• Goals: Help you with your Business Model– Get you comfortable thinking about Business

Models








Six Components of the Business ModelHenry Chesbrough and Richard S. Rosenbloom


1. Value Proposition

2. Market Segment

3. Value Chain Structure

4. Revenue Generation and Margins

5. Position in the Value Network

6. Competitive Strategy


Value Proposition


• A description of the customerproblem

• The solution that addresses theproblem

• The value of this solution fromthe customer's perspective

Market Segment


• The group to target

• Recognizing that differentmarket segments havedifferent needs.

Value Chain Structure


• The firm's position in the valuechain

• Activities in the value chain

• How the firm will capture partof the value that it creates inthe chain.

Value Chain ExampleValue Chain Example

• Food


SeedManufacturer

SeedDistributor

FarmerFood

ProductManufacturer

Wholesaler Shopper Food Prep

Supermarket - Traditional

SuperMarket


Shopper

SuperMarket

PreparedMeals

Supermarket – Value Add

SeedManufacturer

SeedDistributor

FarmerFood

ProductManufacturer

Wholesaler SuperMarket

Restaurant

Restaurant - Traditional

SeedManufacturer

SeedDistributor

FarmerFood

ProductManufacturer

Wholesaler

Restaurant

LocalDeliveryService

GrubHub

Restaurant – Delivery – GrubHub

SeedManufacturer

SeedDistributor

FarmerFood

ProductManufacturer

Wholesaler

MealPlanning

andPackaging

ShippingService

Family ChefSeed

ManufacturerSeed

DistributorFarmer

FoodProduct

Manufacturer

Wholesaler

Home Chefs – Blue Apron

Revenue Generation and Margins


• How revenue is generated

(sales, leasing, subscription, support, etc.)

• The cost structure

• Target profit margins.

Position in the Value Network


• Identification of competitors

• Identification complementors• e.g., Intel and Microsoft

• Identify network effects that canbe utilized to deliver more valueto the customer.• e.g., Airlines and credit card companies

rewards

Competitive Strategy


• How will the company attemptto develop a sustainablecompetitive advantage?

• How will it use that advantageto improve the enterprise'scompetitive position in themarket?



1. Value Proposition

2. Market Segment

3. Value Chain Structure

4. Revenue Generation and Margins

5. Position in the Value Network

6. Competitive Strategy


TopicsTopics

• Goals: Help you with your Business Model– Get you comfortable thinking about Business Models








The Lean StartupThe Lean Startup

• Entrepreneur’s Vision

• What is Yours?

• Clear Hypotheses – Predictions About What isSupposed to Happen

• Goal: Build a Sustainable Business Aroundthe Vision

• i.e., a Business Model



• Venture Plan

• Begins with a Set of Assumptions

• The Plan is the Strategy given the Assumptions

• Because Assumptions haven’t been proved to betrue

• Goal: Test Assumptions as Quickly asPossible



• Validated Learning

• Systematically figuring out the right things tobuild



• Create Value = Value Hypothesis (Lean Startup)

• Capture the Value Created = Growth Hypothesis (Lean Startup)

• Value Hypothesis• Tests whether a product or service really delivers value to customers once

they are using it.

• Minimum Viable Product (MVP)• That version of a new product which allows a team to collect the maximum

amount of validated learning with the least effort. Remove anything that doesnot contribute directly to the learning you seek.

• Zappos Example• Hypothesis: Customers were ready and willing to buy shoes online

• Took pictures of inventory

• Posted pictures on-line

• Bought shoes at full price if customer bought on-line



• Create Value = Value Hypothesis (Lean Startup)

• Capture the Value Created = Growth Hypothesis (Lean Startup)

• Growth Hypothesis• Tests how new customers will discover a product or service.

• Where Does Growth Come From?• New Customers come from the actions of Past Customers

• Primary Ways• Word of Mouth (TiVo)

• Side Effect of Product Usage (e.g. Facebook or PayPal)

• Funded Advertising

• Repeat Purchase or Use (subscriptions)



• Vanity Metrics vs. Actionable Metrics• What We Need to Learn

• What We Need to Measure

• What MVP to Run the Experiment

• Three Engines of Growth• Sticky Engine (e.g. mobile telephone provider)

• Metric: Churn Rate

• Viral Engine (e.g. Tupperware, Facebook)

• Metric: Viral Coefficient – How many customers does one customer“infect”?

• Paid Engine

• Metrics: CPA – Cost Per Acquisition

LTV – Customer Lifetime Value



• Pivot or Persevere?

• Are You Making Sufficient Measurable Progress to Believethe Current Strategic Hypothesis is Correct?

• Or Do You Need to Make a Change (the Pivot)


PivotsPivots

• Zoom-In: Single Feature becomes the Product

• Zoom-Out: Single Feature of Larger Product

• Customer Segment: Value Hypothesis partially confirmed but for adifferent Customer than anticipated

• Customer Need: We are not solving an important problem but we learn ofrelated problems/opportunities

• Platform: We developed a platform others can use

• Business Architecture: High Margin/Low Volume vs. Low Margin/HighVolume

• Engine of Growth: Change Model

• Channel: Direct or Distribution

• Technology: Is there a Better Way to Solve the Problem?


TopicsTopics









Business Model ExamplesBusiness Model Examples

• Subscription business model Magazines, Software

• Razor and blades business model Gillette

• Multi-level marketing business model Amway

• Network effects business model Facebook

• Cutting out the middleman model Pets.com

• Bricks and clicks business model Barnes & Noble

• Loyalty business model Nordstrom

• Servitization model IT Services

• Low-cost carrier business model Jet Blue

Source: WikipediaJanuary 2019 The Nuts and Bolts of New Ventures © 2019, Joseph G. Hadzima Jr., All Rights Reserved

Different Models to Evaluate


Direct Mass Media

Retail Telemarketing/ PhoneSales

Channels, Distributorsand Partners

Trade Shows andConferences

OEM Channels Internet - Web

Two Examples


Direct Mass Media

Retail Telemarketing/ PhoneSales

Channels, Distributorsand Partners

Trade Shows andConferences

OEM Channels Internet - Web

Direct SalesConsumer or Business

Positives:

• High Contact

• Customer Relations

• More Control

• Multi Purpose

• Experts in the Field

Negatives:

• Free Consulting

• Customer may not like Rep

• High Cost

• Retention


Distributors, Channel, Partner Sales

Positives:

• Cost of Sales is Low

• Hands-off Sales

• Exposure in NewMarkets

• Credibility, PotentialSpeed

• Competitive Edge

Negatives:

• Up-front fees

• No Control

• Distant Clients

• Time to Revenue

• Technical Pressure

• Require lots of Attentionand Training


What Business Model and Why?What Business Model and Why?

• Citibank vs. American Express

• Jet Blue vs. Virgin Air

• Wal-Mart (1962) vs. Neiman Marcus (1907)

• Piaget vs. Swatch

• Amazon.com vs. Barnes & Noble


TopicsTopics









Business Models and ValuationBusiness Models and Valuation

• Researchers analyzed 40 years of financial data from the S&P 500

• They grouped companies into Four Business Models:

• Asset Builders: Build, develop, and lease physical assets to make, marketand sell physical things. Ford, Wal-Mart and FedEx

• Service Providers: Hire employees who provide services to customers orproduce billable hours for which they charge. United Healthcare, Accenture, JPMorgan

• Technology Creators: Develop and sell intellectual property such assoftware, analytics, pharmaceuticals and biotech. Microsoft, Oracle, Amgen

• Network Orchestrators: Create a network of peers in which participantsinteract and share in value creation. eBay, Red Hat, Visa, Uber, Tripadvisor,Alibaba



• Network Orchestrators out perform on

valuation, growth and profit margins:

• 2x to 4x higher Valuation

• 38% to 200+% Higher Compound Growth Rate

• Up to 200+% Higher Profit Margins.

• Value creation by network reduces

marginal costs and scales faster

TopicsTopics

• Goals: Help you with your Business Model

– Get you comfortable thinking about Business Models








Another View of Business ModelsAnother View of Business Models

Another way of expressing the 6 questions:

1. How Do We Create Value?

2. For Whom Do We Create Value?

3. What Are Our Core Competences?

4. How Do We Competitively Position Ourselves?

5. How Do We Make Money?

6. What Are Our Goals/Ambitions?


From: The Entreprenuer’s Business Model. Morris, Schindehutte and Allen


1. How Do We Create Value? The Offering:

Primarily Products / Primarily Services / Heavy Mix

Standardize / Semi Custom / Heavily Custom

Broad Line / Medium Line / Narrow Line

Deep Line / Medium Deep / Narrow Depth

Access to Product / Product Itself / Bundled

Internal Mfg / Outsourcing / Licensing / Reselling

Direct Distribution / Indirect Distribution / MultiChannel



Another way of expressing the 6 questions:1. How Do We Create Value?

2. For Whom Do We Create Value? Type of Organization: b-to-b / b-to-c / both

Geography: local / regional / national / international

Value Chain: Where is the customer? Upstreamsupplier/ downstream supplier / govt / institutional /wholesaler/ retailer / service provider / final consumer

Market: broad or general / multiple segment/ nichemarket

Transactional / relational





3. What Are Our Core Competences? Production / operating systems

Selling / Marketing

Information management / mining / packaging

Technology / R&D / creative-innovative / intellectual

Financial transactions / arbitrage

Networking / resource leveraging







Image: operational excellence / consistency / dependability /speed

Quality / selection / features / availability

Innovation leadership

Low cost / efficiency

Intimate customer relationship / experience








Pricing and Revenue: fixed / mixed / flexible

Operating leverage: high / medium / low

Volumes: high / medium / low

Margins: high / medium / low








6. What Are Our Goals/Ambitions?

Life Style Model

Income Model

Growth Model

Speculative Model


Business Model - ImplementationBusiness Model - Implementation

Three Levels1. Foundation Level

The 6 Questions – Establishes Your Basic Model

Easily Replicable by Competitors

2. The Proprietary Level Creating Unique Combinations to Achieve Sustainable

Advantage

Not Easily Copied

3. The Rules Level Basic Set of Rules to Govern Operations


Foundation level Proprietary level Rules

Component 1:Factors related tooffering

How Do We CreateValue?

Sell Services Only Standardized Offering Narrow breadth Shallow lines Sell the service by itself Internal Service Delivery Direct Distribution

Short Haul, low fare,high frequency, point-to point service

Deliver fun Serve only drinks Assign no seats/no

first class Do not use travel

agents Fully refundable fares,

no advance purchaserequirement

Maximum one-wayfare should notexceed US$ ___

Maximum food costper person should beless than US$ __


Southwest Airline Example

Foundation Level Establishes Your Basic

Model Easily Replicable by

Competitors

Proprietary Level Creating Unique

Combinations to AchieveSustainable Advantage

Not Easily Copied

Rules Basic Set of Rules to

Govern Operations



How Do We Create Value?


Short Haul, low fare, highfrequency, point-to point service

Deliver fun Serve only drinks Assign no seats/no first class Do not use travel agents Fully refundable fares, no advance

purchase requirement

Maximum one-way fare should notexceed US$ ___

Maximum food cost per personshould be less than US$ __




Component 2:Market factors

From Whom Do WeCreate Value?

B2C and B2B (sell toindividual travelers andcorporate travel depts

National Retail Broad market Transactional

Managed evolutionfrom regional airline toserving 59 airports in30 states

Careful selection ofcities based on fit withunderlying operatingmodel

Specific guidelines forselecting cities to beserved

85% penetration oflocal markets



From Whom Do We CreateValue?

B2C and B2B (sell to individual travelers andcorporate travel depts


Managed evolution from regionalairline to serving 59 airports in 30states

Careful selection of cities based on fitwith underlying operating model

Specific guidelines for selecting citiesto be served

85% penetration of local markets


Southwest Airline ExampleFoundation level Proprietary level Rules




Short Haul, low fare, high frequency,point-to point service




Maximum food cost per person shouldbe less than US$ __


Component 3:Internal capabilityfactors

What Are Our CoreCompetences?

Production/operatingsystems





Highly selective hiring ofemployees

Do Not operate a hub andspoke system

Fly into uncongestedairports of small cities, lesscongested airports of largecities

Innovative groundoperations approach

Independent baggagehandling system

Use of Boeing 737 aircraft No code sharing with other





Highly selective hiring ofemployees

Do Not operate a hub andspoke system

Fly into uncongestedairports of small cities, lesscongested airports of largecities

Innovative groundoperations approach

Independent baggagehandling system

Use of Boeing 737 aircraft No code sharing with other

At least 20 departures perday from airport

Maximum flight distanceshould be less than ___miles

Maximum flight time shouldbe less than ___ minutes

Turnaround of flightsshould be 20 minutes orless




Production/operating systems Highly selective hiring of employees Do Not operate a hub and spoke

system Fly into uncongested airports of small

cities, less congested airports of largecities

Innovative ground operations approach Independent baggage handling system Use of Boeing 737 aircraft No code sharing with other airlines

At least 20 departures per day fromairport

Maximum flight distance should beless than ___ miles

Maximum flight time should be lessthan ___ minutes

Turnaround of flights should be 20minutes or less



From Whom Do We CreateValue?

B2C and B2B (sell to individual travelers andcorporate travel depts



Careful selection of cities based on fitwith underlying operating model

Specific guidelines for selecting citiesto be served



Southwest Airline ExampleFoundation level Proprietary level Rules




Short Haul, low fare, high frequency,point-to point service




Maximum food cost per person shouldbe less than US$ __


Component 4:Competitivestrategy factors

How Do WeCompetitivelyPosition Ourselves?

Image of operational Excellence Consistency Dependability

Differentiation isachieved by stressing: On-time arrival Low Fares Passengers

having a goodtime

Airline than Lovebuilt

Achieve best on-timerecord in industry




Component 4:Competitive strategy

factors

How Do We CompetitivelyPosition Ourselves?



Careful selection of cities based onfit with underlying operating model

Specific guidelines for selectingcities to be served





Component 5:Economic factors

How Do We MakeMoney?

Fixed Revenue Source High Operating Leverage High Volumes Low Margins

Annual profitabilityregardless of industrytrends as a result of: Short-haul routes High frequency of

flights Consistently low

fares Internal

efficiencies

Maintain cost perpassenger mile belowUS$___




Component 5:Economic factors

How Do We Make Money?

Fixed Revenue Source High Operating Lev erage High Volumes Low Margins

Annual profitability regardless ofindustry trends as a result of: Short-haul routes High frequency of flights Consistently low fares Internal efficiencies

Maintain cost per passenger milebelow US$___


Component 4:Competitive strategy

factors

How Do We CompetitivelyPosition Ourselves?



Careful selection of cities based onfit with underlying operating model

Specific guidelines for selectingcities to be served



Component 6:Growth/Exitfactors

What Are OurGoals/Ambitions?

Growth Model Emphasis on growthopportunities that areconsistent withbusiness model

Managed rate ofgrowth

Business Models - SummaryBusiness Models - Summary

• What Do You Do?

• How Do You Make Money?

• Goal: Simple and Elegant

• Reality: Complexity, Uncertainty, Changing/Evolving

• Business Model Canvas is helpful “view”

• Six Components:– Value Proposition– Market Segment– Value Chain Structure– Revenue Generation and Margins– Position in the Value Network– Competitive Strategy

• Business Model Implementation – 3 Levels and Rules


The 3 WhysThe 3 Whys

• Why This?– Why is this Idea Worth Pursuing or Investing In?

• Size of Market? Problem Worth Solving?

• Why Now?– Why is this the Right Time to Do This?

• Convergence of Opportunity and Solution

• Why This Team?– Why Do I Think These “Guys” Will Win?

• Experience

• Business Model


BREAK TimeBREAK Time

• Some Pitches• Some Pitches for Team

• 10 Minute Break• Continue “Team” Discussions

• When We Come Back• Joost Bonsen - “Organizational and People Issues”


Documents

N&B Hadzima - Business Models - nutsandbolts.mit.edu