Building Competitive Advantage through Business Model Thinking.
Swiss based Alex is a gifted communicator and the author of 'Business Model Generation' – a book about business models that has sold over 120,000 copies. (Why? Becasue it is extraordinarily good).
Fast Company Magazine named Alex's book one of the Best Books for Business Owners in 2010. Below he talks on how to implement this practically in your own business.
Don't forget, registration for BoS 2012 is open now. We hope to see you in Boston October 1st-3rd 2012 and the first EARLY BIRD DISCOUNT tickets run out on March 30th. Save $900 on full registration.
Confirmed speakers this year include Professor Noam Wasserman, Jason Cohen, Mikey Traft, Adii Pienaar, Joel Spolksy, Peldi, Paul Kenny, Bob Dorf, Dharmesh Shah and others who spend their lives at the sharp end of software businesses around the world.
Watch the video here or skip below to see a full transcript of the talk.
Ok what an inspiring morning. I mean Clay has always been an idol to me in thinking and the research and a lot of what we are going to talk about is built on that & then Jason, in all honesty ,I mean that is really going to push us, some of us who try to be more honest. So let's be honest, who is tired now and attention is going down and getting a bit hungry, hands up, ok[ laughs] Ok this is what I call the death slot of speaking right[ laughs] and I always get placed before lunch I think its bit unfair but[ laughter] now one of the reason is probably because I will actually get you to do things, so it would be tortured to listen to me for an hour so I am going to get you to work and I am going to get you to work on this method that is published in this book called Business Model Generation.
Now I thought it would be interesting to start with the story of the book, did things differently and I think it connects very well with the theme of truth because we co-created this book which means lets write this book with other people out there and when we do that everything that we pushed out of the content was visible and say, ‘this is crap’. It is very easy to write a book, publish it and if people say it is crap it is never going to affect you. We actually went out there and people said, ‘this does not work in reality, this is not how it works in a company’, so that was really fun process.
So let me go into the book for a second just this whole story of the book because I think it is going to introduce the idea of business small innovation we are going to talk about very well. So I did research on business model and I wrote a PhD on the topic and the title was called I have to check this, ‘The Business Model Ontology Proposition in design sign approach’. So much to truth. You get a PhD for a title like that but if I say Ontology in this room it may fly particularly with those who are more into the technical detail but business people, like we all are, also would runaway. So we thought let's take this and turn it into a book which is more accessible. We don't use the word ontology, it is banned. So I thought a couple of years after people were using it I thought I want to write a management best seller and that was very naive because basically, if you see the industry of books, I will start with this to get into a business small thinking, they actually have one million books published every year in English. It is pretty competitive industry and if you take business books eleven thousand are published every year. So guess what? Nobody was waiting for our eleven thousand and first book and we wanted to write a management best seller. How naive can that be? Even worse in that this is a declining industry, twelve percent are disappearing. If you can visualise that, I mean going up in flames and we had the idea of writing a management best seller. When I say ‘we’ it is my co-author who was my former PhD supervisor. I actually said we need to turn this into a best seller, he was a bit more modest. It may also be I am bit more crazy and that's why I didn't stay in academia.
Now what did we do? First thing we did, we changed the product, and we actually tried to do everything different from business book because I think business books are quite broken. They are hard to read, they are long, they are fat, they are sometimes theoretical not practical. So we made a book, it is very visual. We did product innovation. We hired a designer who designed books. It is an extremely different book. You can have it in your bag, I am not doing [laughs] a sales pitch here & some of you have already looked at it. Now why did we do it? Because we thought that it would fix part of it which is broken in business book is that to convey ideas you would need visuals, particularly if it is a topic as complex as business models. That was the first part, now would a publishing company have taken a book like that, what you think? Visual book, different from what exists, very expensive book, would a publishing company jump on this, we are unknown, not from Harvard, not from Stanford. There is no chance, no chance of a publishing house taking a book like that and some of them regret now, ok, why is it? Because they have certain ways of doing things certain tradition, certain roots, they have always done it like that, it is very difficult to change. So what did we do? We said, ‘well we are going to change the business model, we are actually going to self publish.’ Self publish has a little bit of distinction too. We saw good things differently. We will co-create as I said, we asked people to join us. That is not revolutionary, for business books at that time it still works. What we also did was we said you probably have not heard of me before[laughs] particularly then and I have come to say, ‘hey I am going to write a management best seller. Have your name in a book.’ It is going to be, something is going to change management. How? Thinking is being done in business models. That's sound interesting. Ok or could be. Actually we think we are doing so good that we want you to pay us twenty four dollars. So I need your credit card information, you have never heard of me before, you are going to give it to me?[laughs] Actually a hundred people signed up very quickly because we gave them something, we did our market research to understand what they really wanted. People wanted to be part of something bigger, they wanted to participate in a community that discusses business models, they wanted to join some kind of movement.
So basically people join very quickly, we raise the price fifty percent because we wanted to keep this community small, we raised the price fifty percent – what I call inverse pricing. People still joined, the more we increased price the more exclusive it got, people still joined and three days before sending the book to the printer we didn't have a publisher. We asked for two hundred fifty dollars and people still joined because they wanted their name in the book. Now do you think a publishing company would have done that, these experiments, opening up and doing this individually? No of course not, and they regret today because the results are pretty impressive. It was a top ten business book last year and many airports you can find it but more interestingly it has gone to the furthest corner of the world. South Africa, Australia, Antarctica, I don't know[laughs]. Nobody thought we could have an impact, but we did because we did things differently, because we tried, because we experimented and it is mainly because we changed the business model. Now ‘business model’ is a word we use very often, never ever use the word ‘business model’, never. You would be the fourth person in the world. Nobody here [laughs] Ok. So we use it all the time.
Let me do little exercise with you, it is what I call the ‘buzz group’ with your seat neighbor. I want you to just quickly introduce your business model to your seat neighbor, vice versa. In two minutes explain what your business model of your company or software company is. Ok, two minutes lets go, what's the business model of your company[discussion].
So just wanted you to quickly interact on the topic of business model, right so you all explained your business models, you all used the word ‘business model’. So let's do another little experiment for about one minute, if you use the word you know what you are talking about. What I want you to do is in groups of two to quickly define what you actually mean by business model. This word that we use all the time, you just explained business model. What goes in a business model, how would you define a business model? Take two minutes in the same group of two and just figure out what you mean when you say the word ‘business model’, what's behind it, what's the concept, what goes in there? Ok, one two minutes lets go, what's a business model?
Ok let's see this together, let's see this together. So what's a business model? Who can tell me what a business model is? There is no right wrong because you all use the word. So what's a business model in your opinion?
S2: A way to make money.
S1: A way to make money. Any other definitions? Ok what goes in a business model when we discussed a business model what components did we describe?
S3: What a company does? How it competes? How it makes its living?
S2: What a company does? How it competes? How it makes its living? Another couple of concepts like competition also. Anything else how do you describe business model?
S4: Why are you going to be profitable?
S5: Sales Channel.
S1: Why are you going to be profitable? Somebody said sales channel, what else did we mention?
S6: How an organisation thrives?
S1: How an organisation thrives? Ok perfect, anything else other concepts, yes.
S7: The model of how you create long term value.
S1: The model of how you create long term value. Yes I have the mike but it is too fried out, Ok one two last ones, yes.
S8: Why you do what you do and why others should care.
S1: Ok why others should care. Did you all describe these things when you all were describing your business models, these different concepts that came up? I asked this question all around the world, everywhere, then I get people to sketch out what they think, they mean with business models and there is no right or wrong. There is no natural science here but what you get is actually, many people mean something else.
You know this concept of tower of Babel? [laughter] You know, where everybody has different languages? This biblical concept? Well, basically it means this we use this word a lot but we all have different mental models, something profit, something channels, something may be a technology or operations. We actually don't speak about the same thing, some overlap. Profit often, product probably goes in there, some people speak about customers who their targets are but we don't speak about the same thing. How does a meeting look when you get your team together and you talk about your business model, you don't start with the same mental model or the same language, how is that meeting going to look? Or when you explain the business model to the person you were talking to before after ten minutes you get a blank stare they still didn't get it, they got may be the product but the business model not very clear. Basically what you get is this. You get these meetings where very smart people have conversations but you get these blank stares, have a good conversation.
I did this little sketch in the airplane after reading this book by Dan Roam. You might have read his book 'Back of the Napkin'. This is the new book coming up called 'Blah Blah Blah' because that's what happens a lot when it comes to business models. We don't have good conversations. We just use words but not even the same language when we would actually want to think through our current business model and talk about new future business model we should go beyond the blah blah blah that we do. So this was kind of my idea when I started my research on this topic years back. What would a sheer language look like in order to build better business model and then new business models? How would that language look like?
So that's the introduction to the talk, the fact that we don't have a sheer language so we are going to see three things in the next forty minutes that we have now.
Business model as a better language how could we better talk about business models in order to create better ones and then new ones. It is the first part. Second part is well language is one thing but how do we come up with good may be innovative business models in order to create a competitive advantage, what's the mind set there & we will look at a little bit how designers work. In software we have software designs, a little bit of design there. And the last part is how you test before you build and this is something that comes out of the whole web start up movement with customer development and link start up. How do you apply that to business models? We will quickly look into that.
We start with the first part. We already discussed what a business model is. I will give you an alternative definition, a language to discuss your business model, and then after giving you an example I want you to do it pretty quickly. So we call this as the ‘Business Model Canvas’. This is different from the word I showed initially called ‘Business Model Ontology’. We switched the word Ontology for something more practical – a canvas. What you do on a canvas? You paint. You can make something visually tangible. You can paint your existing business model for better understanding because you just made it visual and tangible. But you can also make new business model if you are a start up or large that wants to create growth engines. To better understand what we are talking about you need to visualise to have a good conversation. So what goes in that language to describe, analyse and challenge the ultimate business model? What goes in there? I give you that the nine building blocks that I would put in there and some of them you mentioned like competition we didn't put in there. We can see why afterwards.
So how do you describe a business model? First you have to describe your customers, who are your customers segments? So if we take New York Times, what are the customer segments of New York Times. Advertisers and subscribers, right? Two very different customer segments, very different jobs to be done. The subscribers or the readers I would call them to be more general because some people don't subscribe at news time right. They want to be informed and entertained. That's their job to be done. Advertisers have different jobs to be done which is reaching audience itself. And for both segments with different jobs have a different value proposition, a fancy word to say a bundle of products and services. For both you have a different one. So if you Google for different jobs for the searchers, then you will have for the advertisers. Both are customer segments. One is a user – does not pay, but you have a value proposition to attract them. Then you want to ask yourself what are the channels are use to reach my segments? In case of the newspaper is it the internet, is it physical news paper, is it the I-pad what are the channels you use? Then once you are doing the business and you know how to reach them, want to ask yourself what type of relationship you are building with them. If you are a private bank you will have a very personal relationship.
So for how much did you sell your last company? [laughs] Four, five hundred million dollars? You will attract a lot of Swiss private bankers and as a private bank, banks will try to build a personal relationship with Jason and your daughter [laughs] there because she is the next generation. If I am Amazon, I probably will not have a personal relationship, to have a long term relationship like the private bank with, what's your name?
S1: With Michel, does Michel have a long term relationship with Amazon, So far yes, it is not transaction, it is long term. Is it personal? No but it is personalized. And those two different choices will have different impact on the business model. Is it going to be personal like key account managers for a software company or is it going to be long term based on automation which also can be personalised. There are different consequences on the business model. And also I am going to ask you how am I going to capture value from what I just created from value. What are the revenue streams? So we take Google, what makes them insanely wealthy as a company? What's the revenue stream? When you say that, you say advertising but you also say what's the particularity that makes them insanely wealthy? The fact that they auction off the search terms. So it is advertising but also the pricing mechanism. So you really want to think of what are customers really willing to pay off and how?
Which pricing mechanism, is it the standard pricing, is it negotiated, is it an auction because that can make a huge difference. So then you know what value we are creating, for whom we are reaching them, how are we capturing value? Now you want to sketch out what I really need in terms of infrastructure to do that. What are the first key resources? Do I need a server infrastructure, a physical infrastructure, do I need programmers, do I need a brand, a strong brand? Not every company needs a strong brand. Do I need intellectual property, the IP there, is a very strong key resource. What are the key things that you need to do what is on the right hand side. Anyone can ask you; what are the key things I need to do? What is on the right hand side? Do I do research and development, do I have Google apps or not? If I am Google, do I choose marketing and sales? Remember the story from Clay where he tells that lot of big companies in US got rid of everything just to focus on the branding and marketing. What are the key things that you are keeping in the business model to what you have on your right hand side and then what are the key partners you are going to work with. So if you use (?) well you have the choice to build it yourself or build it on the back of Facebook because it may help you to scale faster. And now what are they trying to do, the reverse. They got their scale and now they want to do it alone. So what are the key partners that would leverage your business & once you know what you have? Here on the left hand side in terms of resource, activities & partnerships, very quickly you can sketch out the key costs that you will have in business model. Is there any single concept that is new to you? Off course not. They are pretty straight forward. We tried to avoid any type of jargon but what we wanted to do is we wanted to put this together, to have a concept that describes all the important decisions you will make in your company in terms of business logic.
So this is just a concept let's turn this into a tool where it becomes a canvas work & can sketch out my business model. Let's take away the (?) and turn it into canvas and now I can start putting up poster notes and say who are my customer segments, what am I offering them, well if this is what I am offering them what are the key resource that I need, what are the key activities that I need to perform & at the end of the day I have a simple equation where the revenue stream shave to be bigger than the cost structure but the beauty of it is you put everything on one image, on one canvas, on one slide or on one poster if you doing that on a wall. On a poster that we will do this afternoon with those who are joining my workshop. When you do that you have a better conversation because you just made it tangible. It is a huge cognitive jump moving away from the blah blah blah to sketching it up. Pretty straight forward, isn't it. Let us look at the example, and I use one which is not coming from software. The most important thing I want to leave you with is, after this talk I would like you to open up your eyes to innovative business models in any industry you know. You read an article on a company, you ask your self did they change something in the business model? Could I do that in my software company because it is not like product innovation which is industry specific. You can learn from any kind of business model innovation. Ok.
The one we look at is coffee. First I am going to explain this and then I am going to give it to you to do this. So why coffee? Why should some of the smartest software entrepreneurs in the world waste their time thinking about a business model for coffee? What does it has to do with software? Well we all do drink a lot of coffee, I have got my software start up and because it is a really interesting case from which we can learn a couple of things. One thing that I think is important is that I want you to open up your mind on that. Let me start with a question, I will take Switzerland because that is from where I come from and that's where I have the data. How much do you think the amount of money we pay for the coffee we consume at home? How much do you think that has changed in the last couple of years? This is in commodity business, right? Do we pay 20% less 20% more, what would your guess be? Less, because it is in commodity business. How much less? Double somebody said? Some say double some say less. How much less? Ok without taking the currency interchange, that would be a disaster for my software company I can guarantee you that. How much less, somebody said double, how much less? Half, Fifty percent less, ten times more? Ok what's your name?
S1: Trevor you are pretty close. In Switzerland, and you know we are not known for throwing money out of the window and that's why we have banks[laughter], we pay 600% – 800%more per gram of coffee. And it is not George Clooney who advertises for this brand here which you may see Nespresso. Who has heard of Nespresso, hands up? Nespresso has changed the price of espresso consumed at home. They get us to pay six hundred to eight hundred percent more and Switzerland and a lot of countries around the world. Why is that? Because they invented the espresso machine. But the interesting thing is they did it with different business model. This is the machine, this is the product, machine for those who don't know, a single portion of coffee come in an aluminum pod, you put it in and you press it on top and out comes really good espresso with a cream on top like the Milano and espresso bottle. It is really good. I am honest here, it is really good. It is not just that and I wouldn't ask you how they did it.
Let's do it together because it is important that you actually sketch out your business model than taking a third party case. What's impressive here, are the results. One of the fastest growing entities of Nestle, which is a big food company, the biggest in the world, has average growth rate of 30%. It is pretty good for a big company. If you are a startup company, you start from nothing, you want more than 30%, right? They represent $ 3.2 billion in the US and still have 30% growth rate, pretty substantial. Question is; if we take the business model canvas, what business model did they design around the machine with the pods? What did they do?
I will give this to you very quickly, then you will work on your business model. So I am showing you this so you can sketch out yours. Well there is a machine and a pod. How are we going to distribute the machine? We are going to sell this Espresso machine through all retail channels possible to households and businesses. 85% here, 15% here and we’ll earn money from one time machine sales but that will go to the partner who make the machines. We don't want money from that because they are going to sell the pods and that's where they make money. 600-800% more than in any coffee manufactures. How does this work? They sell the espresso pods to their own channels, mail order first, then call centres, then espresso.com and you might know about espresso stores now to the same customers here. Which means they build up their own distribution channel. Why would they not use retail as they did up here? Why would they use their own channels? Are they silly because that costs a lot of money to build and it may have a smaller reach than the retail giants that are out there? Why would they do that?
S10: Keep the price high.
S1: Keep the price high, they can control the price. Ok what else? Branding, right. The relationship with customers is direct and not indirect. Captivate the audience. Actually there is one main reason why it makes a lot more sense and as software entrepreneur price was close, margins. They keep all the margin. Why can they do that? Because once you bought the machines, so they pushed the machines to as many people as possible through retail outlets. Once you have the machine you can only use espresso pods. And they are the only ones who sell them. So what does this mean? So there is another important component to business model. If they are the only one who can sell them, then lock in, that's what it is patents right. So here we have money made through the repetitive pod sales but to protect that here in the key resource they need a lot of patents in addition to the large brand and they have a coffee and production facilities. But see at the strategic choice they did here – push the retail, once you got it you locked in and you buy it directly through them. Sounds quite similar to Apple, right? It is a similar model. With the music and the iPod you were locked in once you started using it. Remember those phrases – a thousand songs in your pocket. That was product innovation, it was mainly a strategic trap to keep you in there. Same thing with the app store. It is a strategic trap to create a long term relationship so that you can't switch.
So activities to keep it short, business to consumer distribution the first time Nestle actually did that showing to consumers rather than to businesses. When you get to cost production, to business distribution, to marketing George Clooney it’s something which is very expensive to them but throughout the world, except for the US, it is George Clooney who represents the brand? So, interesting business model here. The point I want you to keep in mind is there is a product here and a business model around it. When Nestle started out with Nespresso, Nespresso almost failed – exactly the same machine, same product but different business model. How did that business model look? Who was the inventor who came up with it? The CEO who came up with the first business model. They want to sell the Nespresso system through a joint venture partnership with a machine manufacturers to offices. The sales force of the machine manufacturer would sell an Nespresso from Nestle to offices. Two things failed here. Offices were not interested and the sales force could not have cared less about this. They didn't care about another product to sell. Nespresso was so close to closing down, the only reason the board kept them alive was that they had a ware house full of ten thousands of machines. So the board said we might well try something else. So they bought in a new CEO from (?) who was in consumer goods and who changed the business model to what we have seen now. It became a success.
So focusing on product, same goes for technology, focusing on product to technology is not enough. You want to build a competitive advantage; you need to think beyond it. In this case it was difference between success, between success and failure. So we need to take into account the business model much much more. Now they are going on a new business model around a new machine which is focusing not only on espresso but cappuccino which they consider different market and here they have come up with to turn us men into perfect fathers [laughter] which is the Babynes machine & they are still searching for the right business model for putting it. You have thirty seconds, you have formulaic perfect milk coming out. Thirty seconds. Five in the morning, you know the difference between thirty seconds and ten minutes.
We are going to distribute the canvases now in groups of two, each of you is going to get a canvas and each of you has this little chart, this is actually post-it notes on steroids. What I want you to do now is sketch out your business models. I will show you how to do it. I will give you some ground rules. So before you start talking, some ground rules. Listen to me while it is distributed this. Now I want Michel and Judy… are going to sketch out each other's business model, so Michel is the understander – the interviewer. Michel's task is to understand Judy's business model. So what is Michel going to do? He is going to ask Judy what are your customer segments, your most important customer segment, so Judy is going to give a couple and you are going to put up these.
Ground rules: you don't ever write over a canvas, that's a crime, you use post-its. For each element you use a separate post-it. Why is that you use separate post-it? No bullet points are allowed on post-its just like slides because you can take them away again, because Judy might make up her mind again. Oh That's not very important. You can take it away. More important: once you sketch them all out, once you have your business model existing, you start off thinking what if this could change, what if a customer segment is disappearing maybe in two years? Customer segment does not exist, what is the consequence on the channels, may be you can take some channels away. You can start playing with this. So I give you eight minutes. Judy; her task is to only explain. Michel is doing all the work. Judy can just lean back give all the information to Michel. You got the post-its, you got the canvas. Eight minutes to sketch out the business model. Let's go.
Let's see this together. Did anybody see my magic marker? I left it somewhere while explaining. Oh here it is. So basically this one you can get it for free at the internet at the address her, so I like to giving stuff away for free so you can find canvas there. It is made designed for big posters. To follow, to be fully transparent I am actually helping this little start up in Germany with these things. So we are affiliated. With these be careful; take one, if you take two they won't stick as well. If you take one then these are the best things you have ever used even better than post-it notes. Actually it is very powerful but you need to be bit delicate.
Lets continue together, I know it is bit short but basically it was very easy to do, very straight forward to do –not too complicated. Try to avoid any kind of jargon. What happens when you do this and actually in the software company, where you work with enterprise clients who can help you to pretty quickly sketch up your business model of your client's to design better products for them, you basically move beyond this because what you are going to have is a negotiation on any sticky you put up on the visual poster or little canvas that you have with you. And you will get to a better understanding, much clear picture of what you are talking about because you visualise it and because you are clear. So that is the first advantage of doing this for a better conversation.
Still leaves us with little bit of questions about how do we come up with interesting new business models? This is, I think is very important one because it implies a very big change in the way we design business models and we come up with business models and when I say ‘design,’ I don't say design like form, I really mean design for process. Maybe not as software design, even if that is changing quite a bit but like a architect.
Who knows Frank Gehry? Frank Gehry is a pretty famous architect. One of the most famous buildings he has made is the Guggenheim museum. When Frank Gehry was brought in with his team to work on the Guggenheim museum, the mayor said, ‘we have one of the ugliest cities in Spain, the Basque country and we want to change our city through this building.’ That is a pretty substantial task. Is it heavenly or just creative genius that rains down on Frank Gehry's team to come up with something like that? No, it is a very structured creative process where the most important part is multiple models. Multiple sketches of the same phenomena going in every direction, very different alternatives. Frank Gehry will before and after making something, would talk to people, ‘do you like this, like this, more like this, ok, ok?’ The next meeting he is going to come back to you with this. ‘This is what you wanted.’ Next meeting he come back and says, ‘does this look good, what you are going to tell me?[laugh] It has nothing to do with what I showed last week. What is it that you don't like?’ So Frank Gehry and his team explored alternative models in parallel to figure out what best the best is going to be. It is not about multiple models or prototype to refine, it is to find the best one, to find how could the design mature?
What does that means for us? It is actually the same things for business models, is that we often fall in love too quickly with our business models or we go for the most traditional one in software rather than taking time to work more like architects, where they will say for a sketch, it is a first sketch. What if I gave away my product for free? What if I have a business model without fixed cost, just with variable cost? What if I had a business model where I worked together with my biggest competitor? What if I had a business model doing this and that? So exploring alternatives very quickly will allow you to find better ones. Don't go for the obvious solutions. Try to explore, remember Nespresso, the Nespresso example. The right business model is the difference between success and failure. And in some cases without the right business model you are actually not able to commercialize the product or a value proposition. It is not about losing time. By doing this you will find better business models. Thinking through alternatives just like for a graphical user inter phase you might explore different possibilities again. You want to explore different pricing mechanism, subscription, auction and so on. This is really important because it will lead us to better solutions.
Using a canvas like this not just a sketch, existing business model but to imagine possible alternatives. That is very very powerful. I have a little case study here but we won't have time to work on it. So we are going to switch to the afternoon session, the workshop and all that. But now I’ll leave you with two things, the first one and you know this from customer development by Steve Blank and the Lean Startup Movement Eric Ries, we need to test before we build. Why is it? Give me one example from the product field. Who has ever heard of this or used it even? Who has heard of flow TV? Have you used it? Actually I read an article about it. I don't know, read an article in Financial Times, the FT. It said Flow TV is floating out its product after a year of existence and they lost a bunch of money in the process. Flow TV allows you to watch TV throughout US on mobile network. How much money they lost in the process? Very expensive, they actually lost eight hundred million dollars. So that's a eight hundred million dollar business mistake. The product worked perfectly fine but there were no customers. They didn't test their business model. Lucky for them the managers they sold a spectrum license for one point two billion dollars[laughter] but I am not sure if he wanted to do business like that. So basically what it means first talking about business models, well even with the smartest people in the room with the best task that you can get it on paper everything you do inside the building to use the customer development terms well, it is nothing else except for a set of hypothesis or just simple guesses. But still you can develop better business models by thinking about recurring revenue thinking about switching cost but you still don't know if it is going to work, it looks great on paper. This was an eye opener for me when I started working with Steve Blank, who has heard of Steve Blank? He is the bible in the Silicon Valley together with Eric Ries’ book which builds actually on customer development. You can test business models before you can actually build on & that is very important. Basically it means getting out of the building talking to customers and testing every component of business.
You can think this in terms of layers. This is your best guess, you sketched it out with your team as a start up or company creating a new business area. Then you want to figure out the second layer what are the most important underlined hypothesis that have to be true, the customer has a budget to pay, that the pricing mechanisms are right, that the technology can work, the partners will agree, blah blah blah. So you figured out what are the key hypotheses and then you want to start testing them one after the other. So you don't fall in same trap as Qualcum in Flow TV. You can test your business model before you build it. Search phase is really important and building means hiring expensive sales force, putting the structures or organisation structures implies. You can do that before.
Do you have a little patience for a last thing before lunch? I will show you one more thing actually I had to lend a I-Pad from somebody because I lost mine in Parris in train. So if we can switch to the I-pad now. This is a product demo only. I will show it because I think it really advances the way we think about business models. This is not a sales pitch because basically this is a small product of what we want to build it over time, it is just a brick of the software company we are trying to build. Here is a tool box called business mall tool box where you can design a business model and I leave you with a one minute demo, just show you where we are going with business small thinking. I will create a new canvas here and we will sketch out the business model for this app. Let's just say that this is a app, we can sell it to entrepreneurs like yourself and some of you might be consultants in the room. What's a channel to sell an app, a business app is the app store. Let's say I am going to sell this app – so app sales, this is doing nothing else than what we can do on paper. Will it get interesting if I can play with around with revenue estimations? On the upper left hand corner we have a calculator, switch on the calculator and it say how many entrepreneurs are there around here who could be interested. Let's say thirty thousand. How many consultants, with the market size how many consultants would be interested? Thirty Thousand. And now let's do a quick estimation, I will choose revenue stream, so I can immediately choose here type of revenue stream. I am selling you an app, but since I am selling it to you through the app store, which is not a sales, what do I have to do? I have to pay Apple, right? A pain for anybody here who is making apps. So sales minus transaction cut of the app I will sell it to entrepreneurs. How many can I reach here? Let me see fifteen percent, how many times are they going to buy, it is an app? They are going to buy only once, how much does it cost? Twenty nine dollars, how much do I pay to apple? 30%. So immediately I can say I am earning a hundred and thirty and I have to pay thirty nine thousand to Apple. This is not going to cover the development cost for something like this. So I need to play with the business model.
So let's do something else, let's do a web app. I will change the colour here because it is a different value proposition and if I have a web app I am independent off Apple. So again I can choose the web and I am going to sell it to consultants because consultants have a different job to do be done from entrepreneurs. Consultants want to work with their customers and they want o sell it over years and years. They want to create revenue. So if we are on the web selling to consultants and they want it again and again, what I can do in terms of revenue stream, rather than selling it, I can do subscription. Ok, straight forward. Now let me choose this revenue stream subscription for a web app to consultant, I will use the same numbers – 15%, let's say they are going to pay me $9 per month and immediately you can see, that changes quite a bit. So we all know subscription makes more money than selling but when you have this you can throw in your business model figures you can play around with your business models very quickly without opening a spread sheet. So prototyping businesses models, doing this very rapidly in a meeting to sketch out ideas is going to become incredibly important in the coming years. If we can switch back to the screen and say thank you very much for attention before lunch.