[DAY 2] Refining the Business Model and Naming the Baby

[DAY 2] Refining the Business Model and Naming the Baby

Note: This is Day 2 of a 10 Day series on building a new online startup from idea to launch. You can find the previous posts here:
[Day 0] Let’s Build an Online Startup in 10 Days
[Day 1] Creating a Value Proposition for Our Idea

 

Today’s business model part turned out WAY longer than I planned it to be. But for me it is a very challenging and therefore interesting discussion, that’s why I included it here. Hopefully you can find some value in it for evaluating your own ideas and the business model behind them. If you’re short on time, skip the parts “Contradicting Logic in the Idea”, “What Needs to be Adjusted in Our Business Model” and “A Long-Term View on Keeping Users Around”. Also, I moved the part on the Lean Startup tools we’re going to use to tomorrow’s post.

Today we will focus on the discussing and slightly adjusting the business model for our startup – and giving it a name. What I’m covering today:

  • “Customer Acquisition Cost” and “Customer Lifetime Value” and why they are important.
  • Common business models and revenue models startups (and established businesses) use.
  • Why do we need to adjust the business model for our idea and what is the adjustment?
  • Naming the Startup
  • The Core Principles as a Guideline for Product Development

 


After yesterday’s post, there was a lively discussion on Reddit, which got me thinking about a few things concerning the business model. Initially I planned to explain the business model today. Now I’ll add the changes to it that resulted from yesterday’s discussion.

But before I do that, I’ll explain why it’s important to try and keep customers:

Don’t Lose Money on Getting Customers

Experience and various studies have shown that it is much more expensive for companies to acquire new customers, instead of focusing on keeping existing ones. (I think the general consensus at the moment is that it’s about 5 times more expensive.) That’s mainly the case because you have almost no marketing costs for customers that are already with you.

Companies are starting to realize that and shift accordingly. Case in point: Just go and call your phone company right now. Say you’ve been a loyal customer for X years, yet new customers get all the fancy offers. Ask them what they can do for you. Recently, someone in my family scored a new phone and an additional tablet like this, for free!

But back to the topic: As part of evaluating your business, you should ask yourself the following questions:

  • How much does it cost you to acquire one new customer? (this is known as “Customer Acquisition Cost”)
  • How much value does one customer generate over the entire time with your company? (that’s known as “Customer Lifetime Value” or CLV)

 

If your customer acquisition cost is higher than your customer lifetime value, you’re in a very bad spot. You actually lose money with every additional customer you get.

In this equation, don’t forget that there is also an overhead (this can be technology, employees, rent and all other costs that don’t have directly to do with acquiring customers), which has to be paid for from your revenues.

Now, there’s basically two ways to increase customer lifetime value:

  • Generate more money per customer
  • OR Keep the customers around for longer

 

(Note: Keeping customers around for longer only works, if you actually get recurring value from them (e.g. they pay you every month or you have constant ad revenue from them). If your customers only pay you once, then from a financial standpoint you would actually want to DEcrease the time they spend with you. I doubt this is a very good strategy though.)

 

Contradicting Logic in the Idea

Now, the problem that was pointed out to me yesterday lies exactly in this logic. In our idea, once a customer found his job, he doesn’t have an incentive to stay on the platform anymore. This means that the main focus of the company in this situation will be to constantly acquire new customers, as the old ones aren’t staying. (This is 5 times more expensive, remember?) Also, the customer lifetime value would presumably be quite low, as a customer doesn’t stick around for very long. Not a good mix.

And this is where it gets very tricky: When coming up with the value proposition for the company yesterday, I said that the underlying problem we’re trying to solve is to help the customer getting a job. This means to fulfil our promise, we’d have to focus on getting our customer the best job as quickly as possible. Now this is exactly where the proposed business model has a flaw. From a financial standpoint, we should actually try to keep the customer around for as long as possible to increase lifetime customer value. Again, not a good mix.

This actually robbed me of a good part of my sleep last night. But on the other hand, I’m already grateful for posting this series online, as otherwise I might not even have started thinking about this paradox and how to solve it.

What are we going to do about it?

To understand the adjustments I’m planning, we need a general understanding of what business models and revenue models are and in what form they exist. These two terms are often mixed up or used interchangeably, but I see them as two separate things.

 

Common Business Models

Keep in mind this is a high-level simplification. Especially in the case of revenue models people tend to get very creative, so there’s always new stuff to discover.

The business model describes how your company intends to capture value. This sounds abstract and it is. But essentially the business model is the mix of the company’s structure and revenue streams, explaining how it’s supposed to make money.

The Linear (or “Pipe”) Model

This is the most traditional model where a product or service is offered to a customer, usually (but not always) in exchange for money. Think Netflix, Spotify, app developers or online stores.

The Platform Model

A platform is a place where at least two different parties (usually producers and consumers) can exchange goods and services. Think AirBnB, eBay, LinkedIn or Uber.

The “… as a Service” Model

Companies, that offer something as a service. In most cases it’s Software (SaaS), Infrastructure (IaaS) or Platforms (PaaS). Think Amazon AWS or hosting companies like Siteground offering IaaS or PaaS. Think online applications like Dropbox, Basecamp and Trello offering SaaS.

 

Common Revenue Models

A revenue model details how exactly the company is making money from a particular product. A product or company can be based on multiple revenue models. A good example for the latter is Spotify, which employs both the freemium and the subscription models. These are the five most commonly seen revenue models:

Traditional sales

The classic “store” model. Goods or services are purchased in exchange for money.

Ad/Affiliate based model

The user doesn’t pay for the product or service, but ads or affiliate links are displayed. Often seen in mobile apps and content websites like newspapers or blogs.

Freemium or “Pay for Services” model

The user can use a certain part of a service or the entire product for free, but has to pay for additional services. Often seen in web applications, platforms and mobile gaming apps. Think Spotify, LinkedIn or MailChimp. In gaming apps, this model is often referred to as “pay to win”.

Subscription based model

The user subscribes to a service and pays a regular (usually monthly) fee for it. Think Netflix or traditional magazines.

Transactional pricing model

Access to the service is usually free for the user, but he pays every time he uses it. Think PayPal or Uber.

 

What Needs to be Adjusted in Our Business Model

Now let’s look at our idea. The initial idea, described yesterday, can essentially be categorized as a software-as-a-service model, as the plan was to give users access to the job application management software. For the revenue model, I was considering a Freemium model, where the users get a set of functions for free and can purchase more functions if they wish.

But this model brings with it exactly the issues that I have described above. This means we have to reconsider the model here. The questions we’re trying to answer now are the following:

  • How can we keep customers around, even if they’ve found a job?
  • How can we generate more revenue per customer to cover our marketing costs, if customers don’t stick around?

It seems like the second question is a little easier to answer. Multiple people on Reddit suggested going for the affiliate based model. The concept itself is easily explained: A website that would like to have more people visiting their site offers affiliate links or ad banners. We can show our users relevant job ads by placing these links on our website and receive a commission for every user that clicked one of the links. If this is successful this could help pay for the marketing that will be necessary to get new users to use our website.

 

A Long-Term View on Keeping Users Around

While this seems like a viable short-term solution, I was still thinking about the first question a lot. Mainly because the affiliate solution doesn’t really solve the paradox I described in the beginning of the post. The only way to achieve customers sticking around, is to offer them some kind of value after the job hunting process is done. Which career platform is good at this? Exactly, LinkedIn. They do that by focusing on the “social network” part of the business world – essentially connecting people with each other and displaying relevant content like business news etc. We don’t want to build the next career networking platform here, but LinkedIn has shown that it’s possible to keep professionals around, who aren’t in the jobhunting game.

Now, assuming that our average customer has a profile on LinkedIn – what value would convince him to also be on our platform? The application tracking is definitely part of the equation, but as explained above, it looks like we need something else additionally.

So, what is this “something else”? In yesterday’s post, someone came up with an idea: Upselling premium services like cover letter writing. My only problem with this – it’s much harder to scale such a model, as the effort to write cover letters cannot be automated long-term. Therefore, scaling the business becomes much harder. (We talked about scalability in yesterday’s post.)

But based on that input I had an idea early this morning. What if we shift the business model from SaaS to a platform model? A platform where users or professionals help other users in improving and refining their applications including everything that comes with it. I would even take this one step further. People can help build a personal brand for customers. The effect of this would be an expansion of our target customer group. Now we would not only target job seekers, but also people who look to transition from their jobs into a freelance / consulting career. Also, freelancers, who are looking to strengthen or adjust their personal brand would be included.

The problem with this idea? It is a much bigger scale, as it not only involves building online software, but building a community. Therefore, it isn’t something that I think is achievable in 10 days.

 

Adding the Affiliate Model and a Second Step to the Plan

Based on all these insights, I’m adjusting the strategy like this:

  1. Start with the initial idea as a Software-as-a-Service model to validate whether there is any need for a job application management tool. Generate required revenue for user acquisition through affiliate links. (This will be part of the current 10 day series.)
  2. If the SaaS idea is successfully validated, transform from a SaaS to a platform business model, where users can earn money by helping other users out with their applications, their career and so on.

I promised you guys transparency, so I’m going to share an essential flaw that comes with this plan: Even if the initial (SaaS) idea should be validated successfully (which is the plan for this 10 day series), it doesn’t mean that the second (platform) part of the idea will work. These are in fact two completely separate ideas. This means if part 1 works out, but part 2 doesn’t, we’ll have to try and make part 1 sustainable with an affiliate model or look for other revenue opportunities.

I have no hands-on experience with affiliate models so far, so this will be a first for me. I can’t tell you yet whether I’ll be able to squeeze this part into the 10 days, as the first priority is getting the product done.

 

Coming up with the Business Name

Aaaah – my archnemesis – the business name. The number one part of the entire process I constantly keep overthinking way too much. The funny thing is, the more you overthink it, the weirder all the new ideas become. It’s a downwards spiral. I won’t be giving you any creative advice on how to come up with a name, as the process is very unique for every business. (Also I’m really bad at this creative part myself, so why should you listen to me? 😊 )

Here are three key things to ensure when choosing a name:

  • Keep it short and simple
  • Keep it pronounceable (actually say it out loud a couple of times)
  • Make sure a good web domain is still available for it (Use namechk to quickly check name availability for the most popular domains and social media accounts. Afterwards double check the price on GoDaddy – some popular domains are way overpriced. For our purposes, a domain shouldn’t cost more than 15-20 $.)

Here’s the weird stuff I did to come up with a name for this idea (don’t try this at home):

  1. Spent way too much time on random name generators like Naminum, until I ended up babbling random word parts to myself.
  2. Tried to get inspiration online. Don’t do it. You’ll just get more confused.
  3. Went through epic music videos and wrote down cool-sounding words I heard, trying to mash them together. (I’m not kidding, here’s the screenshot and the piece of paper.)

And there it is, on the piece of paper, middle left, the idea that I liked best:

N-ter

Short, (quite) simple, kind of fits the purpose (as in “Enter the company” or “Enter the job market”), domain name available. That’s good enough for now. Startup names are way overrated anyway.

(By the way, I already bought the domain, so none of you guys can pull pranks on me. 😉 But don’t worry, I’ll still dive into the process on how to purchase a domain in an upcoming post.)

 

Core Principles for Making Business Decisions and Building the Product

When undertaking a project like this one I like to think of a few key principles that will guide the way for the upcoming journey, before I establish and test key assumptions or dive into designing and building the product. Think of them as mental models that will make it easier for you to make future decisions. You can always come back to them if you can’t decide whether to go left or right at a certain point.

Why is this important? Quite some time ago I read an interview with the CEO of a budget airline, and he said something along the lines of: “Being the CEO is actually quite easy. Our key strategy is to become the cheapest carrier in the US. So when I’m facing a business decision I only ask myself: Will this initiative help us become more cost effective?”

Reasoning from first principles

This term was popularized by Elon Musk and essentially is about not accepting “truths” that have become popular in society. He provided a great explanation in an interview with Kevin Kelly:

First principles is kind of a physics way of looking at the world. You boil things down to the most fundamental truths and say, “What are we sure is true?” … and then reason up from there.

Somebody could say, “Battery packs are really expensive and that’s just the way they will always be… Historically, it has cost $600 per kilowatt hour. It’s not going to be much better than that in the future.”

With first principles, you say, “What are the material constituents of the batteries? What is the stock market value of the material constituents?”

It’s got cobalt, nickel, aluminum, carbon, some polymers for separation and a seal can. Break that down on a material basis and say, “If we bought that on the London Metal Exchange what would each of those things cost?”

It’s like $80 per kilowatt hour. So clearly you just need to think of clever ways to take those materials and combine them into the shape of a battery cell and you can have batteries that are much, much cheaper than anyone realizes.”

Applying the 80/20 principle

When facing overwhelming design or business decisions, always think: What are the 20% of activities I can do, that provide 80% of the value I’m trying to achieve? This can be applied to so many things and can make you see things in a different light, therefore reducing complexity.

Being transparent and putting the user first

I believe that it’s critical nowadays to put the user first. Users are the ones to provide value to businesses. Without customers, almost no business would exist. For me part of this strategy is to be transparent in what you’re doing and always try to maximise value for the user.

 

Day 2 Summary

If you are following along with an idea of your own, today figure out the following things:

  • Think about how your idea will capture value.
  • Which business model are you choosing? Why?
  • What revenue models are you choosing? Why?
  • Will your customer lifetime value probably be higher than your customer acquisition cost? If not, re-think the first three questions.
  • Come up with a business name.
  • Think about which core principles you will apply to your business.

 

That’s it for Day 2! Tomorrow, we’ll dive into the following topics:

  • Discuss the elements from the Lean Statup method which we’re going to apply to our idea
  • Establish a set of assumptions to test
  • Design the functionality of the actual web application with use cases and user stories

 

Meanwhile, sign up for the email-newsletter and I’ll let you know when the new posts go online!

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