The only purpose of a business is to find and retain a customer.
Businesses and business models come in all sizes, shapes and forms. However, at their core all businesses have the same five basic building blocks that drive their success.
Just like DNA, where the same basic building blocks can make up a human being or a mosquito, the five business blocks can create a large company like General Motors or a small corner lemonade store. Once you understand these blocks, you gain a unique and crystal clear insight into the workings of any business and have the tools to ensure the success of any business.
As a venture capitalist, I use these basic building blocks to choose between start-ups that have the chance of making back 20 times the amount of money I invest in them and those that don’t. As a consultant, I use these basic steps to help companies I have worked with increase their customers, revenues and profits by over ten times. As an entrepreneur I use the same blocks to optimise my business and steer it to ultimate success.
If you are working on a start-up or are even out of the gate with your first few customers, understanding the basic DNA of a business could significantly increase the odds of your success.
Every business is based on just five things:
The first block is the most important and is the foundation of any business. All other blocks are built on top of it. If you get this one wrong, everything else you do will fail; this is one of the few certainties in business. It is a description of how you create value and who you create it for.
If you don’t receive a “pass” on your value proposition, there is no point building the other blocks on top of it. Just as in school, depending on what you have in mind as your ultimate destination, you can get by with a pass grade, but it is desirable to have an A. An A is required to become the next Uber or Facebook, but a pass is good enough to be the local Ford dealer. As a VC we are generally looking for A+ value propositions (and A+ founders). But as a consultant often times it is good enough to get our client from a C to a B.
The Value Proposition covers four crucial areas:
Who are you trying to serve? If you earn an MBA or go on a marketing course, you will be talking about segmenting your market and choosing a target market. In reality, it is not rocket science; what you need to know is its potential size, its current size, the amount of competitive activity and the best ways to divide it into two or more easier to manage chunks.
Its potential size needs to be large enough to support the aspirations of the founders and investors in the business. However, it also needs to be segmented such that you can address a small enough niche that you can dominate it within 12 to 18 months, with the capital you have. If you can’t dominate a niche in a relatively short period of time, the odds of success go down a lot.
Your aim in creating a high growth start-up is to build a dominant company in its industry – a Google, a Microsoft, an Apple – the key is to become dominant in your niche when you start. Not to start and hope you can become dominant when you grow up. Facebook started up being the dominant social media site on Harvard and later in US universities, Uber quickly became the dominant ride hailing app in San Francisco.
The next bit of your Value Proposition is the problem you are solving or the need you are trying to satisfy for the target customer. The bigger the problem and the more important it is to the potential customer, the better. All successful businesses are built on solving customer problems, either large or small, or filling needs.
In the business to business space, the dominant problems are around raising revenues, reducing costs and improving productivity. In consumer space some common problems are often around speed (Dominoes Pizza), convenience (supermarkets), health (Beach Body), image (Porsche) or a combination of these.
The solution is what you are bringing to the party to solve the problem. In order to be valuable, solutions need to solve problems or meet needs at least five times better than the current alternatives. Being twice as good is seldom enough.
And finally, what is the unique value that your solution delivers?
Google (search) helps internet users find the information they need faster and more easily than other search engines (when they launched they were in a crowded space of over 100 search engines). Pampers is helping parents keep their babies dry conveniently (when Pampers launched most mothers used terry towel nappies). Of course value propositions have to evolve over time to remain relevant to the target customer.
As a VC, we are looking for five to ten times or more value compared to what currently prevails in the market.
The second block describes how you capture the value you create, or how do you make money from what you are doing. The most basic business model is selling a product, say a magazine, and the customer buys it. It is a one-time transaction and the profit is made in the sale.
The same magazine could be sold through a subscription model, where customers spend a smaller amount, but are compelled to do so every month. So instead of buying your magazine at the newsstand, customers pay for a monthly subscription and have it delivered every month. This is a much more profitable model for the manufacturer; they don’t have to recruit a new customer every week and they save on the news vendor’s margin, and might also be more convenient for the customer. Hence this business model enables you to enhance the value and also capture more of it.
Another common business model is the razor blade model. The value creator sells a razor (or printer) at cost or very low margin and then sells a high margin razor blade (or ink cartridge), which is where the profits are made. There are hundreds of different business models and possibly thousands more that, with a little thought, could be dreamt up. The advertising model, freemium model, franchise model, are just a few.
Choosing or designing a model that is optimal for your business and customer is an important part of your business design that is frequently overlooked by founders.
The third block is how you attract customers to your business. If you can’t attract customers to the business, then you are very unlikely to develop a scalable business. Not having an attraction block means you find customers by cold calling, this can be an expensive process and is seldom scalable, with the exception of very high value and high margin products or services.
There are a few companies in the cookware, encyclopaedia and insurance businesses that have succeeded without having a customer attraction part to their business, but they are the exception. Of course if you are a big ticket business to business like Boeing or Space X then lead attraction is not so important.
For most businesses, to be effective a lead attraction formula must be inexpensive (relative to the price of the product or service), and easily replicable.
Pampers attracts customers through ads in the mass media and sampling to new mothers. When Google started, they attracted customers through tie-ins with ISPs and PR. Because of its 10X value delivery, word of mouth soon took over. A physical retailer may use a shop window or other signage on a busy road or in a mall. A web retailer may use search engine marketing or Facebook ads to attract leads.
Regardless of what it is, the most successful companies have a reliable and replicable lead attraction formula; they also understand the metrics around there lead attraction process and know exactly how much it costs to generate a lead to their business.
Once you have a prospective customer (lead) the next block is how you convert them into a customer.
At Pampers they convert customers at supermarkets where they use signage, shelf displays, in store promotions and other merchandising techniques to get their leads to become customers. Boeing and Cisco use sales people with well planned sales presentations to multiple decision makers. A retailer uses store layout and merchandising. An online retailer has special offers or freemium offers and a well planned closing page.
The final block is how you get your product or service to the customer in a way that you have super fat margins and the customer is extremely happy with the experience. It is only with happy customers that you get word of mouth referrals and you move in to a virtuous cycle of growth, with falling customer acquisition costs.
Once you look at your business, or any business, through the lens of what is its value proposition, ask these questions: How does it attract prospective customers? How does it convert its prospects to customers? How does it deliver the goods or services (i.e. fulfil on its promise)? You are then in a position to take the next steps, which are to ask how well it is doing each step and how can it innovate to improve.
How much it is costing per lead (i.e. the effectiveness of its marketing? Why? What is the percentage conversion (the effectiveness of its sales)? Why? What is its customer satisfaction (its ability to generate positive word of mouth) and the cost of its final delivery (the effectiveness of its operations)? Why?
You are now in a position to design, innovate and improve each area and see how the improvements affect the overall performance.
Of course these five blocks don’t make the total picture of a business. You have recruitment processes, training processes, people management and motivation processes (HR processes), reporting processes, financial management processes, product development processes, etc. But all these processes exist only to serve the five key blocks.
Once you understand your business or anybody else’s business through the core five, you have insight into its competitive strength, its profitability and the key ways to improve performance.