Innovation in Startup Business Models

4/5/12

In our industry, it’s not uncommon for entrepreneurs to become so mono-focused on the novelty of product innovation that they forget to innovate equally around their business model.

In my estimation, a disruptive business model is at least as important as disruptive technology.

As an investor, the perfect scenario for me is a disruptive technology wrapped in a disruptive business model, targeting a new market opportunity or underserved target segment. That’s the perfect storm.







But too often, the business model is left to the end, as an afterthought. Of course, as market observers, we’ve heard countless examples of superior products that failed to capitalize on the market opportunity that was their due. We’re almost conditioned to understand the implications of this. Still, the problem persists as business models fail to generate the attention they deserve.

As a continuation of my series of lectures at the Harvard Innovation Lab, I explored this topic with a roomful of aspiring entrepreneurs. I offered the following recommendations:

1. Be disruptive, create a dilemma

Don’t simply recycle someone else’s business model. That’s squandering an opportunity to change the game by defining new rules in your favor. In redefining a category, your overarching goal should be to cause someone else to have an innovator’s dilemma. Take the conventional and look at its inverse. Turn established business models inside out. You rarely win by following the pack, so figure out where the incumbents are vulnerable and exploit that as the basis for taking market leadership. For example Google gives away tools with powerful utility because their interest isn’t selling technology; it’s collecting data as the basis for an advertising business model. This has been highly disruptive to players like Microsoft whose original business model was licensing software. Facebook is repeating this model, disrupting other online players who can’t compete with “free” and even “better” as they collect rich data profiles to monetize.

2. Identify your C.O.R.E. differentiation

As you think through how you can disrupt the status quo, do so by identifying your Capabilities Of Really Exceptional value. What is it is that makes you exceptionally valuable? Think hard about this one. It’s the foundation upon which you’ll build your business model. Is it software? Services? Or perhaps it’s data or content generated by your community or even a process you’ve crafted? For Facebook, it’s data. For Yelp, it’s user-generated content. Perhaps like Red Hat or Acquia, which is one of my portfolio companies, you’re selling services on top of open source software. Identify your core value, why it’s profoundly better than incumbents or alternatives and, finally, how you’ll monetize and use it as a competitive weapon for unfair advantage.

Once you’ve defined your core, identify multipliers and levers to help accelerate and economize the proliferation of your value proposition.

Multipliers for rapid market expansion

Multipliers help you drive revenue, reach and coverage, which is vitally important when you consider amortizing and then profiting beyond the cost of customer acquisition. Take a close look at the P&L of a traditional software company and you’ll notice something potentially surprising: On average, sales and marketing expenses are 2X research and development in a steady state model.

That’s why it’s so important to find multipliers that will help you drive revenue at the lowest possible cost. Examples of this include freemium or tiered pricing that allow you to seed the market with a low- or no-cost offering as the basis for paid conversion over time.

As one basis for making products more digestible and achieving tiered pricing, I use a technique that I call “Russian doll packaging.” Here, your base product is free or nearly so to encourage viral adoption. As you build a community around the free version, you can convert to paid usage by upselling and cross selling paid “editions” layered on top of the free version.

Aligning with well-established technology stacks can also become a multiplier when you’re filling a conspicuous gap in a high value and acknowledged way. It not only can complete a “whole product,” but done correctly, this sort of strategic alignment can create dramatic pull in the market, putting you in a position for multiplied growth.

Underpinning all of this is the necessity for what I call “SLIPPERY products”: Simple, Low or no initial cost, Installs easily, Proves value quickly, Plays well with others, Easy to use, ROI is obvious, Your customers can’t live without it. Slippery products grease the skids for end-user adoption, which can dramatically reduce customer acquisition and retention costs.

Levers to drive down costs

Levers help you reduce time, cost and resources to deliver your value proposition. Open source (OSS) and other co-creation models are great examples of leveraged business models. Here, you sell value, often in the form of services, support and perhaps commercial add-on products, on top of a core product that is built and maintained by the community. Red Hat is the classic example of a company that has built a franchise around the Linux open source community and a billion-dollar business around this model. Acquia is following a similar path around Drupal open source community and, with cloud services as their multiplier, in the social publishing space.

Crowdsourcing is another great example. For example, uTest is a company that has leveraged crowds effectively by mobilizing a global community to execute a mobile application test matrix of such combinatorial complexity that it would have been economically infeasible otherwise.

From the perspective of demand generation, viral, inbound and social marketing has changed the game altogether by shifting the economics of marketing through an inversion of the model from push to pull, and therefore outbound to inbound, making marketing more cost effective and powerful when executed well.

Of course, the real magic is getting multipliers and levers to work together, where multipliers like freemium models also provide leveraged selling value through a community of free users who see value in conversion to paid usage tiers. Your community becomes your pipeline.

By thinking through the three aspects of business model creation—identifying your C.O.R.E. value, finding multipliers for growth and levers for cost economies—you’ll have much better odds of building a company that returns value disproportionally to all of its stakeholders.

So, that’s a partial summary of my lecture on business models. I hope you’ll review the slides and please leave your comments here to let me know your thoughts on being disruptive and gaining competitive advantage with your business model.

Michael Skok is a general partner at North Bridge Venture Partners. His investments include Apperian, Akiban Technologies, Acquia, Unidesk, and Demandware (NYSE: DWRE). Follow @

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  • Gil Arie

    A great piece from one of Boston’s (and the nation’s) smartest VCs.

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  • Don Nataros

    Jim Clifton’s book ‘The Coming Jobs War’ chapter 7 hammers this point. A good read.

    • mjskok

      Don,

      Thank you for pointing me to Jim Clifton’s book. You’re right he makes some great points about the importance of business models.

      I really like the distinction he makes between Innovators as inventors and Entrepreneurs as optimists with the determination to get invention turned into adoption. I love the story of Wayne Huizenga as the entrepreneur behind 3 apparently not very innovative ideas, each of which he built to become Fortune 500 companies. This is inspiring stuff.

      The joy of my job is finding ways to bring the mix of these skills into a venture. And better still looking for breakthrough inventions that we can pair with great entrepreneurs, and going after new market opportunities. But if I have to take just one, I’ll pick the great entrepreneur every time. It’s also why our business is always about people first and foremost. We covered some of this at the Harvard session on company formation http://mjskok.com/resource/com… where we discussed building the team that sets the innovators and entrepreneurs up for success.

  • http://www.supplychainventure.com Dave Anderson

    Michael

    You are so right about business models. One of my favorite comments to would-be entrepreneurs is that “I see lots of good ideas, but rarely a disruptive business model”. Tough to have a successful start-up without both.

    • mjskok

      Dave,

      Good to hear. I try not to be prescriptive in my thinking around this, because every situation is different, and indeed there are startups that are successful without disruptive business models. However our job is always to help entrepreneurs find the path of least resistance to their success. In this regard a strong business model can make a big difference.

      And as you suggest if you start with that in mind, it can really help shape everything from your product, to the market you serve and then the way you reach it. In my discussions with students at Harvard I was constantly amazed how quickly the good entrepreneurs connected the dots between things we covered in business models to the session on go to market. See http://mjskok.com/resource/sta…. I specifically saw firsthand how the iteration between these two was critical to the students developing their plans and even going back and reinvestigating their value propositions.

      Looking ahead what’s interesting to see is that I am meeting more and more entrepreneurs whose fundamental premise is not a new technical breakthrough, but instead is a business model innovation. I suspect we’ll see companies like Spotify or Airbnb causing more entrepreneurs to think upfront about the power of their business model in creating game changing companies.

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  • http://www.mjskok.com Michael J Skok

    Don,

    Thank you for pointing me to Jim Clifton’s book. You’re right he makes some great points about the importance of business models.

    I really like the distinction he makes between Innovators as inventors and Entrepreneurs as optimists with the determination to get invention turned into adoption. I love the story of Wayne Huizenga as the entrepreneur behind 3 apparently not very innovative ideas, each of which he built to become Fortune 500 companies. This is inspiring stuff.

    The joy of my job is finding ways to bring the mix of these skills into a venture. And better still looking for breakthrough inventions that we can pair with great entrepreneurs, and going after new market opportunities. But if I have to take just one, I’ll pick the great entrepreneur every time. It’s also why our business is always about people first and foremost. We covered some of this at the Harvard session on company formation http://mjskok.com/resource/company-formation where we discussed building the team that sets the innovators and entrepreneurs up for success.

  • http://www.mjskok.com Michael J Skok

    Dave,

    Good to hear. I try not to be prescriptive in my thinking around this, because every situation is different, and indeed there are startups that are successful without disruptive business models. However our job is always to help entrepreneurs find the path of least resistance to their success. In this regard a strong business model can make a big difference.

    And as you suggest if you start with that in mind, it can really help shape everything from your product, to the market you serve and then the way you reach it. In my discussions with students at Harvard I was constantly amazed how quickly the good entrepreneurs connected the dots between things we covered in business models to the session on go to market. See http://mjskok.com/resource/startup-secrets-pt-4-going-market. I specifically saw firsthand how the iteration between these two was critical to the students developing their plans and even going back and reinvestigating their value propositions.

    Looking ahead what’s interesting to see is that I am meeting more and more entrepreneurs whose fundamental premise is not a new technical breakthrough, but instead is a business model innovation. I suspect we’ll see companies like Spotify or Airbnb causing more entrepreneurs to think upfront about the power of their business model in creating game changing companies.

  • http://siridkellermann.com S Kellermann

    Your article is inspiring and I got some good ideas to chew on for a while. But it is very tech-centric; tell me how these concepts can apply to other types of products and services? Say, for example, the diagnostics or therapeutics markets…

    • mjskok

      That’s a great question. Although I am not personally experienced in those areas, I observe my partners who do invest in this area, like Carmichael Roberts, and I believe that the same principles apply. See his post above.

      For example, almost any market requires one to think through the challenges of development, packaging, distribution and delivery in a cost effective manner. Which of these is your CORE competence? I rarely see companies with more than one or two of these. Most are innovations in one regard or another, such as a new diagnostic device, sometimes they include a diagnostic process or even a manufacturing approach. But few early stage companies North Bridge sees have the distribution reach as a core competence in the highly competitive field of healthcare.

      So in the life sciences world, the Business Model may *need* to come up earlier. For example is it appropriate to manufacture or license your diagnostics? And in the case of products that require clinical trials or long approval processes, just as I suggest in the article, the earlier you make these decisions, the more efficient you are likely to be with your resources and capital, and the more focused you are likely to be on your CORE competency.

  • http://www.mjskok.com MIchael Skok

    That’s a great question. Although I am not personally experienced in those areas, I observe my partners who do invest in this area, like Carmichael Roberts, and I believe that the same principles apply.

    For example, almost any market requires one to think through the challenges of development, packaging, distribution and delivery in a cost effective manner. Which of these is your CORE competence? I rarely see companies with more than one or two of these. Most are innovations in one regard or another, such as a new diagnostic device, sometimes they include a diagnostic process or even a manufacturing approach. But few early stage companies North Bridge sees have the distribution reach as a core competence in the highly competitive field of healthcare.

    So in the life sciences world, the Business Model may *need* to come up earlier. For example is it appropriate to manufacture or license your diagnostics? And in the case of products that require clinical trials or long approval processes, just as I suggest in the article, the earlier you make these decisions, the more efficient you are likely to be with your resources and capital, and the more focused you are likely to be on your CORE competency.

  • Carmichael

    Michael, I agree. The business model topic is extremely relevant to life sciences companies inclduing dianostics, medical device and biotech. Consider the following questions:

    How/where best to get a product initially approved? Should you do clinical trials in partnerships or alone through a CRO? Where to best do manufacturing such that you have GMP products at a cost that is competitive? Do you build a competency in marketing and sales? How do you fund the most expensive parts of the business?

    These are all important questions for a life science company. There is no general “right” or “wrong” answer to these questions in a vacuum; it all depends on the business model of choice. Better to understand the model early– preferably in detail–to navigate accordingly.

  • http://www.facebook.com/horaciopoblete Horacio Poblete

    Disruptive tech innovation needs a disruptive business model. Couldn’t agree more. Ok, so let’s do this. I’ll pay you a dinner when after we disrupt the status quo. :)