Posts Tagged ‘business model’

How to describe and create a business model

Wednesday, October 5th, 2011

Business models fascinate me; how businesses define, reinvent or change their business model is one of the most interesting parts of business strategy.

I recently read an article called Reinventing Your Business Model by Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann, which in my opinion had an interesting approach to describing a business model.

What is a business model?

A business model consists of four interlocking elements that, taken together, create and deliver value:

  1. Customer value proposition (CVP)
  2. Profit formula
  3. Key resources
  4. Key processes

Customer value proposition (CVP)

A CVP is the way you create value for customers, it’s the way you solve a customer’s problem. This element of the business model is by far the most important. Coke’s CVP focuses on its unique flavour that no one else can copy, where as Dell’s CVP is a low-cost, customised computer direct to your door.

Profit formula

The profit formula shows how you will make profits for your company while still providing value to the customer.

  • Revenue model = price x volume
  • Cost structure = Direct costs, indirect costs and economies of scale
  • Margin model = Given the revenue and cost structure how much profit do we make

Key resources

The key resources are assets such as the people, technology, products, facilities, equipment, channels, and brand required to deliver the value proposition to the targeted customer.  This will heavily influence your cost structure.

Key processes

Successful companies have operational and managerial processes that allow them to deliver value in a way they can successfully repeat and increase in scale.

Complementary decisions

You need to make sure that these four elements are consistent and complementary. For example you shouldn’t have a high service CVP and then not invest in staff training and service processes. Conversely for a low-cost provider having fancy offices and labour-intensive processes is probably not the best approach.

Tags: ,
Posted in Featured, General | No Comments »

If you don’t want your unprofitable customers someone else will

Sunday, September 11th, 2011

I am back at lectures today for the start of the second year of my MBA. I am now studying my electives and I have chosen a strategy/ technology track which is where my interests lie.

Today I am starting “Strategies for Fast Track Venturing”, which from the course outline is to study theories and techniques that are reshaping strategic management in fast moving environments. It asks: what are the key factors that determine whether a venture makes money and grows to a significant size?

One of our fist readings is called ‘Bottom Feeding for Block Buster Businesses’. D. Rosenblum, D. Tomlinson and L. Scott (2003). Harvard Business Review March 2003.  There was nothing in the article that most people do not already know but there were some interesting points that I wanted to summarise.

Unprofitable customers are the bane of most companies and a lot of companies actually encourage their worst customers to buy from their competitors.  The authors argue that as customers are scarce this this may be a rash move and that actually you can turn these unprofitable customers into profitables ones.

So how do you go about serving these unprofitable customers? It almost always means redesigning your business model:

  1. Simplify your offering – often a product is unprofitable because it has features that customers don’t want or will not pay for. This also links back to the ‘Reduce/ Eliminate’ from blue ocean strategy which will reduce your costs.
  2. Minimal marketing expenses – serving cost-sensitive customers means you cannot waste money on marketing and should instead rely on word of mouth marketing.
  3. Personal, convenient and pleasant service – often the cost-sensitive/ fringe customers are used to being shunned so good service will be a big surprise. It is also about showing that every customer is valuable.
  4. Careful use of technology – sophisticated technology might not always be the answer, chose the technologies that your customers are familiar with.
  5. Realistic financial targets – low margin businesses require a lot of scale before they are profitable so take a long-term view

Tags: , ,
Posted in General | No Comments »

Do you adapt or redesign your business model for the Internet?

Tuesday, August 30th, 2011

I follow mma, which for those of you that do not know it is a very new sport that has only been popular for about 10 years. After watching UFC 134 at the weekend it dawned on me that its development has a lot in common with the Internet which is a relatively new technology .

In mma the current superstars are those who came from another discipline (such as wrestling or judo) and then learned to be more rounded mma fighters. However there is a new breed of competitor who studied mma from the start of their careers; 18-25 year olds who have been pure mma fighters since their first training session and who are built exactly for purpose.

I see the same parallel with Internet business models, take quickbooks and xero. Quickbooks is a pre-Internet company their desktop software was around long before the Internet. I used their software for years and it was always the same old thing; every few years they discontinued support for the old versions so I had to pay for yet another upgrade, each version looked exactly like the last with no innovation and if you needed any help at all you had to pay for support. Contrast that with Xero which was built from the ground up as a Saas application to be run in a browser, updates are free, there are constantly new features being added, there are no large up front costs (you simply pay a low monthly fee) and the support is not only free it is excellent!  Xero is built for the Internet, Quickbooks is a company trying to adapt it’s model to the Internet.

A pre-Internet company needs to realise that the rules have changed, it seems so obvious but you cannot simply take your old business model and put it online. Established companies have a lot of advantages in other areas e.g. supply chain, distribution, sales, so if they can get the business model right they have the opportunity to make a real impact online.

 

Tags:
Posted in General | No Comments »

Analysing Betfair’s business model

Wednesday, June 22nd, 2011

Introduction to Betfair

Andrew Black, a one-time professional gambler, and Edward Wray an ex-JPMorgan derivatives trader founded Betfair in August 1999. Today Betfair is the world’s largest international online sports betting company and the world’s biggest betting community.

The company has over three million registered users who bet on sports events and play online games including poker. Betfair is the world’s largest betting exchange handling 1,000 bets a second and completing 5m transactions a day, which is more than all European stock exchanges, combined.

Unique value drivers

1. Peer to peer betting exchange

The key difference to traditional gambling is that instead of betting against bookmakers Betfair customers bet against each other.

Betfair was built on a stock exchange model (similar to Nasdaq) where odds functioned as the share prices.[1] This enables bettors to trade in and out of positions on sporting events, much like trading in and out of positions on stocks. Betfair’s early product was hugely innovative in the UK sports betting markets, enabling people to “lay” or bet against sports for the first time. It also created a new type of gambler that took advantage of market trading dynamics, without needing to have an opinion on the outcome of the sporting event itself.

Of the 2,000 people working at Betfair, 600 are IT engineers.  The exchange technology used by Betfair is proprietary and, as well as being protected by copyright, is the subject of patent protection in various jurisdictions.[2]

2. No risk exposure on bets

Betfair differs from traditional gambling companies in that it does not bear the risk of the bet. It connects punters to each other and then pays out winnings rather than offering odds that it stands to win or lose. It makes its money by taking a commission on any winnings of between 3 and 5 per cent. A small percentage of consistent winners pay a “premium rate”.

This also creates an inherent cost advantage relative to the traditional bookmaker model in the UK. Because a bookmaker takes risk on the outcome of the race, this cost is built into the bookmaker odds offered to the public. Therefore the odds that the public sees on Betfair are more reflective of true market, resulting in most cases, in higher odds.[3]

3. Liquidity of transactions

Betfair says that much of the success of the product is dependent on maintaining high levels of liquidity, a significant proportion of which is generated by Betfair’s sophisticated and high-spending “Heartland Customers”.[4]

Early on Betfair recognised that the key to creating a successful betting marketplace was to improve the chances that any reasonable bet placed, would be matched. In essence, Betfair needed to balance supply and demand the same way that a stock exchange does. They solve this by encouraging volume betting, and marketing to high volume players. As mentioned previously Betfair’s betting exchange enabled a new type of bettor – people looking for arbitrage opportunities. These bettors move large volumes of bets to lock-in a very small profit regardless of the outcome on the race, providing liquidity to the exchange.

The network effects from its leadership provide sustainable competitive advantages.  A highly liquid exchange for bettors is a difficult barrier to entry to overcome, unlike most gambling sites (such as online poker or casinos) that has very few barriers to entry. Creating the critical mass to have an effective betting exchange is difficult and costly, and this is reflected by the almost non-existent competition.

Strengths

  • A near monopoly in peer to peer betting exchanges
  • A growing and cash generative business model (which allows for large dividend payments)[5]
  • An outstanding management team with a track record of operating within a measured and prudent regulatory approach and investing for long-term growth
  • Large and growing online sports betting and gaming market
  • Unique, disruptive Exchange Platform technology. £300m invested on the IT platform since it launched 10 years ago, with a recent major revamp to improve speed and prevent downtime during large sporting events
  • Good relationships with many sporting associations and high profile sporting clubs (such as FC Barcelona and Manchester United FC)
  • The betting exchange provides better pricing than bookmakers, which results in greater levels of customer loyalty and higher customer satisfaction rates.

Threats

  • The regulation and legality of online betting and gaming and varying enforcement[6]
  • Changes to the taxation of online betting or the imposition of other levies, duties or charges
  • Hacking attempts and security related concerns for high profile Internet businesses. Reputation can be severely compromised if security is taken lightly
  • Competing against large established bookmakers such as PaddyPower, William Hill and Ladbrokes
  • Negative publicity about gambling, match fixing and corruption in sport
  • The liquidity levels in the online exchange
  • The importance/ reliance on Betfair’s Heartland Customers (high volume bettors)

[1] Betfair Makes Online Odds on AC Milan, Hillary Clinton, Weather,” Bloomberg News, September 6, 2005.
[2] http://betting.betfair.com/lp/info/about-us.html
[3] Customer satisfaction results from April 2010 TNS UK syndicated case study
[4] Betfair IPO prospectus p.14
[5] The Directors are adopting a progressive dividend policy with a pay out ratio of approximately 20 per cent of profit after tax. IPO Prospectus p.3. At present no dividends are paid.
[6] In 2006 US Congress unexpectedly passed anti-online gambling laws, which caused several companies lose most of their share value http://www.theregister.co.uk/2006/10/02/us_outlaws_gambling/

Tags: ,
Posted in General | No Comments »

Analysing Zara’s business model

Thursday, March 3rd, 2011

Who is the customer?

Zara’s target market is young, price-conscious, and highly sensitive to the latest fashion trends. They have an advantage over traditional retailers because they do not define their target by segmenting ages and lifestyles giving them a much broader market.

They segment their product line by women’s (60%), men’s (25%) and the fast growing children’s (15%) department.
Zara started operations in Spain in 1975, and now operates in 74 countries worldwide.

What is the value proposition?

Fashionable, affordable clothes
Zara’s strategy is to offer cutting edge fashion at affordable prices by following fashion and identifying which styles are “hot”, and quickly getting the latest styles into stores. They can move from identifying a trend to having clothes ready for sale within 30 days (where as most retailers take 4-12 months). This is made possible by controlling almost the whole garment supply chain from design to retail.

Large choice of styles
Zara produces around 12,000 styles per year (compared to the retail average of 3,000), which means that fresh fashion trends reach the stores quickly. A typical Zara’s customer visits the store 17 times a year compared to the average of 3 times per year. This high number of styles also means that the commercial teams have more chances to find a winning style.

Scarcity
By reducing the manufactured quantity of each style, Zara creates artificial scarcity and lowers the risk of having stock it cannot sell.

Scarcity in fashion increases desirability, which means shoppers need to buy quickly as the item may not be available next week.
Lower quantities also mean there are not much to be disposed when the season ends; Zara only discounts 18% of its stock in sales, which is half the industry average.

Prime locations
Zara spends relatively little on advertising (0.3% of revenue) compared with traditional retailers (3-5%), instead they reach their target market by locating their stores in prime town-centre locations.

How do they deliver it?

Most retailers outsource production to low cost Asian countries. In contrast Zara is vertically integrated with the majority of production carried out in owned or closely controlled facilities in Spain. This gives a lot more flexibility and speed however it means higher costs.

Stores place orders twice per week and the supply of finished goods is matched to store demand. Production is then increased or decreased in the flexible production facilities. Demand based production means there is very little inventory in Zara’s supply chain, which results in much lower working capital requirements.

Deliveries typically arrive one to two days after ordering with most deliveries arriving by truck from the Spanish factories. Clothes are then put straight onto the sales floor and are available to purchase.

Business model risks

Just-in-time manufacturing relies heavily on production in Northern Spain. Any weather, labour or terrorist disruption to the area will have a serious impact to sales, as there are no alternative supply centres in Europe.

As production is carried out in Spain where average wages are higher than low cost Asian countries so factory wage costs will be higher than competitors, which will affect margins.

Zara is also vulnerable to financial vulnerabilities in the Euro as most of its cost-base is denominated in Euros.

Finally increased oil prices will affect profits as twice-weekly deliveries means higher transportation costs.

Tags: ,
Posted in Featured, General | 3 Comments »

What is the difference between strategy, business model and tactics?

Tuesday, February 8th, 2011

It’s not easy to explain eloquently the difference between your strategy, business model and tactics, but I heard a really great car analogy recently that explained it perfectly:

A strategy is like being a car designer, your business model is the car and your tactics are the car driver.

Tags: ,
Posted in General | 1 Comment »

Business model innovation in emerging economies

Tuesday, February 1st, 2011

I listened to a talk recently from a senior strategy executive at one of the World’s largest companies. In his talk he lamented that as a firm they were struggling to tap the Chinese and Indian emerging economies and that local competitors were beating them hands down. When we quizzed him about the strategy for emerging countries he said that they sold the same products as they did in the rest of the World but at a cheaper price.

Re-think your business model for emerging economies

Simply selling your existing products cheaper in emerging economies is not enough, you need to re-think your business model from the ground up based on region and local needs. Products should solve problems and you cannot assume that a villager in India has the same problems as a person living in the centre of New York.

See the local problems first hand

I recently read an article describing how a company selling fridges entered the Indian market with disastrous sales. They want back to the drawing board and re-engineered the product and process from the ground up:

They sent out teams of people to live with typical families in India to see first hand what problems they were experiencing, and they found something really interesting.

  • The families were highly mobile (moving house often)
  • They bought fresh foods almost everyday, so they used their fridge to store the evening meal so that it would last until the next day
  • They only needed to chill their foods they did not require high powered refrigeration for creating ice or freezing food
  • They had constant power cuts so they only kept small amounts of food refrigerated

Re-engineer your product

With these insights the company designed a small, lightweight fridge (which could be easily transported) with minimal cooling (which meant cheaper manufacturing) with backup battery power (in case of power failure). With the reduced parts and size the company could sell the new product at $69 which was almost 8 times cheaper than the original price.

Start with your customer value proposition

Once you have your customer value proposition you can decide whether you want to choose a cost leadership model over the differentiation model and then you need to understand the antecedents of these two approaches and build your local infrastructure to support them.

Tags: ,
Posted in General | No Comments »