Fast growing companies fail when they run out of cash before they’ve had a chance to prove they are a sustainable business.
A startup company tests a simple hypothesis: will enough people pay a fair price for its product such that it can cover product cost, corporate overhead and profit? This test needs to be proven before the company runs out of funding options. The business model is the proof of the hypothesis: how a company can sustain itself long-term.
Valid Business Models
While there are many different ways to make money, ultimately it comes down to two strategies:
1. Premium. High margin, low transaction volume (think luxury automobiles). Value is generated by maximizing the amount of cash from each individual sale.
2. Commodity. Low margin, high transaction volume (think grocery store). Value is generated by maximizing the number of units sold.
Emerging companies need to stick to one model. This is much easier said than done. Every customer we work with wants the premium business model. They need the cash. The problem is that many companies become so hungry for revenue that they’ll do anything for it. The most popular tactic is discounting, which is the exact opposite of a premium strategy. While it may deliver short-term results the long-term cost is high – it’s very hard to raise prices because it is so easy to comparison shop.
How to Evaluate Your Company’s Business Model
Successful companies employ a “test and pivot” strategy where they go to market with a basic offering, then tweak it as the market gives them feedback. We recommend simple, low cost tests to validate one to three objectives. For example, if you want to test a subscription offering, put it on your website and measure who clicks on it. After the click send the user to a landing page saying that you are collecting a list of people interested in the subscription and serve up a form with data you want to collect. You will likely see a lot of people leave the page but those that fill out the form are truly interested and will likely be your first customers. Of course, track the metrics on the landing page!
Your objective with this strategy is to prove out the specifics of your model: who is buying from you, what should you charge, how much does the product cost, etc. These kinds of tests enable a sustainable business model to form that can increases sales, profitability and cash flow.
What You Can Do
Review your most recent profit & loss statement. Start by reviewing sales by product to see where performance is lagging. If sales are flat, look at which products are not performing and find out why. If you can’t find a good reason, then eliminate them quickly and replace with something else.
Next, look at your cost of goods sold by component. Are margins where they should be? You can benchmark your company’s performance to your peers. Know where you stack up against them.
Finally, review your operating expenses. Focus first on your sales & marketing expenses – are they reasonable as a % of net sales. Also review your compensation & benefits expense. Does it seem reasonable for your business?