Business Model

Before we can have a coherent conversation about business models and startups, we need to talk a little bit about how “business model” became a catchall catchphrase. Coming out of the dotcom bust, “business model” evolved as the vague term of art used to describe monumental startup failings. You would hear analysts say things like, “Of course Pets.com bombed. Mailing big heavy bags of pet food is a terrible business model.”

The problem with a catchall catchphrase is that it has too many variables baked in. There is no way to know specifically what fundamental business rule is being broken. What exactly is wrong with delivering heavy things? Bad margins? Limits to scalability? Supply chain? The cost of delivery as compared to the value being created? Is there some inherent weakness in the strategy to deliver dogfood to people’s homes rather than sending it to retail outlets to be held in inventory before being purchased and self-delivered by consumers?

Adding to the confusion is the common conflation of “business model” with “revenue model.” The revenue model only includes how a company transacts with customers, i.e., how it makes money. The business model includes much more, like building infrastructure and developing strategic partnerships.

In this chapter, we’ll deconstruct the phrase “business model” from the VC’s perspective. Let’s start with a fundamental definition:

Razor Definition, Business Model:

 The competencies, systems and infrastructure developed by a company to facilitate interactions and transactions within its value network with the goal of creating and redistributing value.

There is a lot to unpack there. Let’s start by focusing on the last portion of the definition, which articulates the goal of the business model: to create and redistribute value. For traditional businesses, this could be reworded into the objective: to grow and profit. It turns out that those two outcomes, growing and profiting, are in conflict, and for venture-backed startups, the latter half of the goal (to profit) may not even be necessary.

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Also covered in this chapter:

• Growth and Profitability
• Path to Exit
• Barriers to Scalability
• Scalability and P/M Fit
• CAC & LTV
• Products vs. Services
• Margins
• Revenue Model