The Worst Business Model is the One You’ve Never Created

Your Business Faces a Strong Risk of Failure

Depending on the country you're in, and the report you read, young companies fail all the time. There's a bit of debate on whether the rate is 50%, 66%, 75% or 80%. But you know what's not up for debate? What's not up for debate is that a majority of new companies end up dying within a couple years.

In the US and across the globe, we're seeing a rise in entrepreneurial endeavors. Whether it's a three-person product company, a single-person service company, or some hybrid, people are quitting large corporations in droves and doing their own thing.

The problem, of course, is that if our data tells us that most of these efforts will result in failure, shouldn't we do more to prevent it?

The Two Problems We Find Regarding Business Failure

And that's where things get tricky. Because if you read enough articles, you'll discover two things to be true:

1. The rate of failure changes all the time, depending on which article you're reading.

2. The reasons for failure make great listicle articles. You know, “5 reasons why companies fail.”

In fact, a quick survey of articles and I found this:

20 Biggest reasons why startup companies fail 

5 Reasons 8 out of 10 companies fail 

The 7 Pitfalls of business failure 

Top 6 Reasons new businesses fail 

6 Reasons your small business will fail and how to avoid them 

The list goes on… (See what I mean about the two things holding true?)

The Third Problem – The One You Need To Care About

If you read the first article, the most common reason is “No market need.”

What that translates to is that they couldn't create a business that had enough customers that were willing to spend enough money that would generate enough revenue to outpace their costs.

In the Forbes article, the fifth reason was an “Inability to nail a profitable business model….” In the article after that, it was also the fifth reason, “Failure to plan.”

The second reason in the Investopedia article was Business Plan problems, and in the last article, it was reason number four: “Unprofitable business model.”

The third problem, the one you need to care about, is easy to say and hard to get your head around – your business model.

Why Business Models are Challenging

It's fun to call yourself the CEO of your one, two or three person company. It's not nearly as fun to sit in front of Excel and create formulas in a spreadsheet.

But a business model isn't a spreadsheet. A business model, in simple terms, is a plan for how you make money.

If it's that simple, you're thinking, why does it rank in the top of every list of reasons why companies fail?

Because we're all do-ers. And do-ers like to do. Not slow down and plan.

And it's not just planning. It's data collection to validate the hypothesis that's embedded in the plan. Because if things aren't lining up, you'll eventually end up where a lot of other folks do – in failure.

A plan is nothing more than a hypothesis. But some people talk about their business without even that much.

An Example

Imagine we're having a conversation and you tell me this:

I plan to sell online courses to people who want to run membership sites.

Not enough info to make it a hypothesis.

Your Market

First, I ask you to tell me about the market segment you're going after. We chat for a bit, and you can now be a bit more specific.

I plan to sell online courses to budding entrepreneurs who want to launch a fitness membership site to enhance their existing revenue streams.

Now you've told me the “who” with more detail. These are people who are focused in a specific market, and you even know it's people who already are making money in other ways. This is going to be an investment they make to make even more money. That tells us we're not looking at the low end of the market.

But it's not enough.

Your Product

Second, I ask you tell me more about your pricing. It is another refinement of your segment, but also a telling way to think about your business' products. Are we talking yearly fees? Monthly fees? One-time fees?

I plan to sell an online course for $499 (a year) to fitness gurus to help them spin up an online membership site that will add another revenue stream to their existing business.

Now I'm clear about your product. It's an online course – with a yearly fee – targeted in helping get a professional additional revenue in the fitness space.

This is almost fantastic. But it's still not enough to call a hypothesis (at least that we can monitor and evaluate).

You (and your Costs)

So now I push deeper, I want to know what it will cost you to put this all together. After all, our goal is profit, right?

A small aside, this advice only works if you're trying to actually make money.

What will it cost for you to do this? It's even better if you can break it down per customer, but that's not that easy because you'll have a lot of fixed costs.

But when we finish, we have worked out the main costs. In our example, we came up with:

Hosting & SSL – $500/year
Tech Products – $1000/year
Tech Support – $1000/year
Video / Studio – $1500/year
Email / Marketing – $1000/year

So our total is $5,000 a year. Honestly, that's a tiny amount of money to invest in a company that wants to make money online. But this is an example, so let's just go with it.

What we know is that this infrastructure should and will be able to support tons of customers. So after a certain number of customers, we'll break even. We even have an idea of when that will occur.

At $499 per customer, we think we only need 10 customers.

But that's when I'm going to ask you if you want to make any money, or just cover your costs. And that's when we decide you'd like to make $10,000 a month from this.

So that means our goal is more like 20 (or 21) customers signing up monthly.

So now you tell me this:

I plan to sell an online course for $499 (a year) to at least 20 fitness gurus a month to help them spin up an online membership site that will add another revenue stream to their existing business.

Your Distribution

This is so good. It's so much better than most people. But guess what? It's not enough.

Because this hypothesis has the revenue side and a tiny bit of the cost side of things. But we haven't talked about distribution.

How do you plan to get your course out there to people? In this case, because it's an online solution, it's another way to think about marketing costs, or your cost of sale.

Are you going to offer an affiliate program? If you do, and you pay people 30% of the course cost, guess what? You need more than 20 signups a month. Because 30% of the money we thought was going to our pockets is going to our marketing channel.

So now you look at me and tell me,

I plan to sell an online course for $499 (a year). I'm using several affiliate channels (at 30%) to help bring in at least 30 fitness folks a month that want to start their own membership site to increase their revenue and revenue streams.

And that, my friends, is a business model and a hypothesis that can be tested.

Sure, it won't generate 30 signups in month one. But we know the target. And we know what to measure to see if we're getting close. And we know the levers we can change to test what might get us better.

Our Goal is Profit – As Early As Possible

The problem that most companies face is that they ignore this level of rigor early on. They don't build a workable and testable hypothesis, which means they don't do the hard work of defining the levers they can control.

In our example, we have a lot of ways we can adjust, right?

– We might switch to a monthly charge instead of yearly.
– We might switch from 30% to 50% in affiliate payouts.
– We might switch our target market (fitness).
– We might switch our market segment (high-end).
– We might switch our price (lowering or raising it).

But we know the levers. We see them clearly because we've looked at:

– Our Segment
– Our Product
– Our Costs
– Our Distribution
– Our Staffing

And we've rolled them all into a hypothesis that we can measure and evaluate.

And this is why I tell anyone who wants to start a new business that the most important thing they need to do is create, and validate, a business model.

In fact, I even gave a talk about how you can score your business models because each one of those switches mentioned above creates a new business model. And not all business models are created equal.

But the worst business model is the one you've never created.

 

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Chris Lema

Chris Lema

Chris Lema is the CTO and Chief Strategist at Crowd Favorite. He’s also a daily blogger, a public speaker, and product strategist.

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