December 5, 2019
So, what is a Business Model?
The GrowthLab 10 Step Approach to Business Modeling isn’t just about building financial proformas. We believe it’s important to start with strategic marketing, customer segmentation, pricing, and the revenue model. This is the starting point for all of our whiteboarding conversations with new customers and companies.
Turning a company’s story into a series of financial statements is a combination of art and science. The art is the business acumen of interpreting vision and facts into assumptions while the science is a collection of facts, market observations, and financial statement analysis to inform the algorithms and assumptions.
Over the course of our many engagements with customers and helping them articulate their verbal story into numbers, dollars, and grounded assumptions… we’ve distilled our business modeling process down to 10 key steps:
1. It always has to start with your addressable market
You have to know who the customer is, how big the customer base is, and how deep it goes. You need to know the customers that are ready, willing, and able to buy your product or service. Knowing your customer is ultimately going to improve your marketing ROI, either by increasing your conversion success rate or by decreasing the overall customer acquisition cost.
2. Figure out your customer acquisition cost
Your Customer Acquisition Cost (CAC) is, simply put, the cost to the company of acquiring one customer. The cost could simply be marketing, but it can also include sales development representatives (SDRs) or product demos. CAC could also be calculated based on your cost for 1,000 impressions or even your cost per click (CPC).
Understanding your customer acquisition cost will help you better optimize your marketing budget in the context of Step One (Addressable Market). Knowing your customer acquisition cost will then help you better understand how much capital you will ultimately need to raise for your desired market penetration.
At GrowthLab we like to take a simple 3-step approach to understand your marketing investments:
- With your product or service, how many customers could benefit from and access your product or service? This is your Addressable Market?
- With your marketing budget, how many customers can you actually target? This is your Target Market.
- With your conversion rate of leads to customers, how many customers can you convert from leads in your Target Market to customers? This is your Penetrated Market.
Answering these three simple questions will help you define your Customer Acquisition Cost as well as your marketing ROI. Moreover, Step One and Two help you develop some of the most critical assumptions in any proforma build-out or business model.
The above three questions are also applicable to most business models including those who sell through distributors, wholesalers, or other indirect channels. We are big fans of this approach because it is simple and straightforward to understand and communicate to stakeholders.
3. Define your pricing strategy
A pricing strategy is a method or model used to determine the best price for a product or service. Pricing strategy isn’t done in a black box; you must capture the voice of the market (VOM) and the voice of the customer (VOC). In other words, your pricing strategy is based on what a customer is willing to pay for your value proposition? There are a few questions you should ask potential customers as well as yourself. These include:
- Does my product solve a problem?
- Am I replacing a product and improving on its capability?
- Am I consolidating multiple products or services into one?
- Is my product or service inherently so innovative that it doesn’t only solve existing problems, rather it creates a new market?
We spend a lot of time on pricing because it isn’t a discrete input. It is a range of possibilities and it is the basis for your revenue model. More on pricing… below in Step Four.
4. Define the revenue model & understand the revenue drivers
A revenue model is a key component to any business model, as it identifies which source of revenue to pursue. Your revenue model is a function of Step Two (Customer Acquisition Cost) and Step Three (Pricing Model), but also a function of your go-to-market strategy. Your revenue model can extend beyond the scope of just a one time sale to include recurring sales, rent, lease, and “the shared economy” model. In this age of Uber and SaaS models, revenue model innovation has been a driver of turning old school industries into the newest business model.
In this step, you want to stop and think about how you are going to make money; not just how you’re going to earn revenue, but how your company and product will interact with the market to drive value. Your revenue model is so much more than price times volume. It is about how your customer interacts with your product or service and how the customer ultimately interacts with your value proposition.
The beauty of business modeling is that you can attempt to understand the underlying impact to cash and profitability based on multiple and distinct revenue models without putting customers at risk.
5. Understand the cost of your product or service
Understanding the costs of manufacturing your product or providing your services is crucial for building your proforma. In essence, taking Step Four (Revenue) and subtracting it from Step Five (Cost of Goods Sold) generates one of the most important sets of financial metrics: Gross Profit and Gross Margin.
The types of expenses that go into understanding the cost to build your product or provide your service can include direct labor, direct materials, production supplies, factory expenses, warehousing, and shipping. Your cost of goods will likely fall into one of two major buckets: Manufacturing COGS or Service-based COGS.
With manufacturing, it is important to understand that the product build is not just about the components. You have to think about everything from bringing the components together, paying for assembly, packaging the product, shipping, and delivery, etc. All of this is wrapped up into the Cost of Goods Sold for your product.
The second bucket, for service-based businesses, includes some of the systems that are required, the people that provide the service, and travel costs to provide the service. For service-based businesses, in particular, there is no steadfast rule as to what is included or excluded unless you are truly following GAAP Accounting. Our approach is less about rigorous accounting policies and more about understanding the impact of your COGS on your cash flow and where you are making and losing money (see The GrowthLab 4).
6. Build an all-star team: The right capability & the right timing
You need to know what people capabilities the business needs along with knowing the timing of when you need to hire each capability. You don’t want to get too deep too fast and be overstaffed. Your HR strategy needs to be tied back to the product development roadmap, sales and marketing roadmap, and overall operational scaling of the business. Your business model should be a framework to help answer the question “What capability and how much of it (capacity) will I need over the next 5 years.”
The key to scaling a business after you’ve started to gain customer traction or you pass the initial product development phase is to focus on your team. We like to see companies start with a small HR footprint and begin to build the hierarchy, organizational structure, and departmental functions; and scale from there.
For a scaling business, it is okay to build the HR framework in your organization as a function of growth (using formulas to drive hiring) versus individual, discreet hires (naming each hire separately). For example, hiring customer support reps based on the number of active customers.
7. Operating Expenses: Focus on scaling…Don’t sweat the small stuff
The important thing about operating expenses is to focus on revenue growth, customer acquisition, and scaling. Modeling operating expenses that don’t power these three things should not consume your time and energy — Don’t sweat the small stuff.
It is vital to remain focused on the big picture. Scaling allows you to stand up and grow your business, so focus the time you spend building OpEx on customer acquisition cost, marketing, physical footprint, R&D, product development, and HR strategy which all need to tie back to our execution roadmaps.
Don’t spend your time dealing with the right formula for bank fees, paper supplies, telephone expenses, etc. If you are finding yourself spending too much time figuring out operating expenses, stop and go back to Step One (Addressable Market).
8. Timing is of the essence…Take the time to manage the timing
Timing is everything, make sure you manage it accordingly. You need to develop a roadmap for each of your functions or departments such as sales and marketing, R&D, product development, customer success, and corporate overhead. These roadmaps define the outcome and respective timing and, therefore, must dovetail with each other.
At the end of the day, a business model is a time series of cash flows and events.
9. It’s all about the burn…know your cash burn!
Understanding the sources and uses of cash in any business is the first step to any capital raising activities. Steps One through Seven are all about the business drivers while Step Eight is about the timing of the impact of those drivers. All the preceding steps ultimately bring us to this point: What are your cash needs?
The cumulative total of your cash burn tells you how much total capital you need to raise. How and when you raise the capital is a function of the stage of your business. In other words, the same three factors from above define how much and when you raise the capital. Thus, it comes down to your product development roadmap, your customer acquisition roadmap, and your operational scaling roadmap.
From this, you can begin to put your capital plan together which includes investor segmentation analysis focused on who you will raise capital from.
10. Go back to step one
Now you understand your cash burn and how much capital you need to raise and when you need to raise it. The tenth step to the GrowthLab 10 Step Approach to Business Modeling is this: Do not “pass go” without revisiting Step One.
So, Step Ten is reconsider your market! Ask yourself questions like do I have enough resources and capital to execute on Steps One through Seven? Do I have enough cash to market to my target market within my addressable market over the next six months? Do I have the right people to execute on sales and marketing strategies? Do I have enough capital to execute on the product development strategy? Is my thought process in scaling operations in sync with my customer acquisition timing?
If you answer, “No,” to any of these questions, you need to reconsider how much capital you will raise and the timing of that raise.
Business modeling is not about simply generating a series of financial statements. Take a stab at the GrowthLab 10 Step Approach to Business Modeling. Give us a call or fill out the form below. We would love to hear your thoughts.
“GrowthLab has provided invaluable tools and advice to Tizra’s management team, helping us scale smoothly and confidently.“
Abe Dane, CEO at Tizra
“GrowthLab earns my highest praise for professionalism and affordability. I have hired them to improve our financial reporting... they were hands-on, patient, and able to move our organization... to an up-to-date and easy-to-use system.”
Christine Earley, Ph.D. Board Member & Treasurer at NAMI
“…well-versed in all areas of finance, providing strategic guidance for early- stage start-up businesses… possesses a great work ethic, deep insights into financial analysis and modeling, and a collaborative approach to his work. An asset to any team.”
Andy Levitt, Founder & CEO at Purple Carrot
“GrowthLab is a tremendous partner for FluidSense. Allowing our core team to focus on engagement and development, while GrowthLab focuses on the financial and bookkeeping aspects.”
Jeff Poole , COO at Fluid Sense
“GrowthLab has provided invaluable tools and advice to Tizra’s management team, helping us scale smoothly and confidently.“Abe Dane, CEO at Tizra
“GrowthLab earns my highest praise for professionalism and affordability. I have hired them to improve our financial reporting... they were hands-on, patient, and able to move our organization... to an up-to-date and easy-to-use system.”Christine Earley, Ph.D. Board Member & Treasurer at NAMI
“…well-versed in all areas of finance, providing strategic guidance for early- stage start-up businesses… possesses a great work ethic, deep insights into financial analysis and modeling, and a collaborative approach to his work. An asset to any team.”Andy Levitt, Founder & CEO at Purple Carrot
“GrowthLab is a tremendous partner for FluidSense. Allowing our core team to focus on engagement and development, while GrowthLab focuses on the financial and bookkeeping aspects.”Jeff Poole , COO at Fluid Sense
FROM THE BLOG