How to Create a Successful Business Model in a Dozen Easy Steps [Fake advice! Not possible.]

You can’t create a successful business model in a dozen easy steps. The title of this blog post is fake news or, more accurately, fake advice. This blog post will give you real advice instead.

Successful business models can be created with a lot of hard work, creativity, innovation and especially experimentation, but there are no formulas. Fortunately there are best practices. I have written about business models many times before (for example, my Steve Blank and Eric Ries posts), but in this post I will be making my points more with examples than the usual more narrative explanation.

The best place to start is asking what a business model is and how it is best discovered. The best place to start is with a definition. I like the Mike Maples Jr. definition: “The way that a business converts innovation into economic value.” Steve Blank has his own definition that is also useful: “A business model describes how your company creates, delivers and captures value.” In other words a business must create value within the value chain and it must capture some of that value. Sometimes value is created and delivered by an entrepreneur and yet little or no value is captured by the creator. As an example, Spotify is creating lot of value in its value chain but how much value is it capturing? The important point is that a business model that does not capture value is not a successful business model. The concept of “capturing value” particularly important since it requires some sort of competitive advantage. The most common cause of failure is the failure of a business model to have a competitive advantage. In a recent interview Bill Gurley described one critical objective of a business in this way: “What is it that will allow you to protect that business over the long term? That could be a network effect. It could be some kind of scale advantage. But it needs to have something like that.” In the Floodgate Value Stack model I have written about before this is the third layer which they call Business Model Power:

value stack

A business model is discovered rather than precisely planned in advance and then manufactured. A flywheel is often used as a metaphor for this because the business model discovery and maintenance process is based on iteration and feedback. The “build measure learn” process is a feedback loop that never ends as long as the business is in operation. Businesses that stop the business model improvement and maintenance process inevitably die. A paper by Rita McGrath notes:

“In highly uncertain, complex and fast-moving environments, strategies are as much about insight, rapid experimentation and evolutionary learning as they are about the traditional skills of planning and rock-ribbed execution. Modeling, therefore, is a useful approach to figuring out a strategy, as it suggests experimentation, prototyping and a job that is never quite finished.”

Sometimes the discovery process is quick and sometimes it is slow. Sometimes the business model discovery process creates a successful outcome, but very often it does not. Applying the scientific method to the business model discovery process is a proven way to improve and expedite business model discovery. As I said I want this post to be more about illustrative examples than usual, so let’s dive into that process. I decided to pick an example from the early 1990s. Many people have forgotten or do not know that at this time people had no clue about many of the business models that would eventually be created. The big buzz was around the Information Superhighway and services built around television. People might say: “I would have known what was about to happen to business models in the years after 1993.” The answer to that is: “No you wouldn’t.” Businesses whose success seems obvious now did not seem so than. Some of the smartest and best informed people in the world missed these successes completely. Some people got a few things right obviously but even then their views and plans evolved over the years based on feedback. The future in the 1990s and all other periods was discovered rather than predicted. People made a lot of bets in the 1990s and some of them worked out. Some people were better at making bets than others. Some of that was luck and some of that was hard work, perseverance and skill.

One of the best illustrative example of my points is Starwave, a business founded in 1993 which pioneered a number of important internet technologies and business models. The founder of Starwave was my friend Mike Slade, who once said: “The whole concept of Starwave was to take various bets on the future of a wired world.” At that time the “wired world” was the investing thesis of Paul Allen who was Starwave’s primary shareholder. Allen once described his thesis as follows: “We can already see a future where high-bandwidth access to information is cheap, where there is plenty of computing power to manipulate that information, and where most of us are connected. I think the most exciting things happening have to do with content. We have only begun to invent what will be possible.” Wired magazine described this using the hyperbole that typified its writing at the time: “Starwave’s mission is to envision products and services as if bandwidth were infinite and free – in other words, as if there were no technological and financial limits to how titles and services could be produced and delivered.” Slade has described the “wired world” thesis in very practical terms: “Paul’s idea was that the world is going to be connected and we should do something about it.”

The magazine Fast Company described how Starwave’s business was evolved by Slade over the years:

“To their first brainstorming session with Allen, Slade brought eight ideas. The first stemmed from a job he had while in college. Back then, he wanted to be a sportswriter. Working at the local newspaper in the fall of his senior year, Slade would spend hours combing the Associated Press wire for stories and scores. After graduating in 1979, however, Slade changed his mind about sports writing. He pursued an MBA at Stanford and landed a job at Microsoft. But he never forgot those nights reading the sports wire, unencumbered by the limits of a sports section’s page count. ‘I always wanted to do that again,’ Slade said. ‘Everybody should like what I like, right? Of all the things that I could be a proxy for consumer taste on, being a sports fan is one. That was our first idea. We had a bunch of others. But of course the first idea was the best idea. Never fails. Off we went to do things with it.’

Trouble was, they still hadn’t come to terms with a platform. They created a few titles on CD-ROM. That’s the path down which most of the sports world was headed. All the leagues were licensing discs that included stats, video and audio that could be updated online, through dial-up modems. They built a few prototypes for an online site that would be delivered via interactive TV. None of it seemed to lead anywhere. For about nine months, Slade and a staff of almost 100 tweaked and tuned this thing that would deliver a sports wire feed, supplemented and complemented by original content, to home computers. They started negotiating with ESPN about branding it. But they couldn’t figure out how to get ‘it’ to sports fans. ‘We were all dressed up,’ Slade said, ‘with no place to go.’

Frustrated by the holdup, one engineer finally suggested that they put the product on the Internet. More specifically, on the World Wide Web. Slade knew the Web, knew it cold. He had been vice president of marketing for NeXT computers, the company Steve Jobs started after leaving Apple in 1985. The Web was created on a NeXT machine. Slade did not think the Web was the answer. It was ‘nerdy,’ Slade thought, and would never catch on beyond the scientists who used it to share their work. It wasn’t going to be a business. And it certainly wasn’t going to be a business until more people had high-speed connections. The engineer insisted they should do it anyway. Lacking a better plan of his own, Slade took the idea to Allen. “I went to Paul and said, ‘We’re going to build this thing on the World Wide Web, because we don’t know what else to do,’ Slade said, recounting the dialogue. ‘He goes, ‘What’s the business model?’ I go, ‘I have no idea.’ He goes, ‘OK.’”

This is classic example of an entrepreneur who knew that he needed to find “core product value” and “product/market fit” before finalizing the business model. Certainly all possibilities were considered such as advertising, subscriptions, licensing, and merchandise, but nothing was set at the beginning of the process. Slade would later say: “There is no single plan or model for doing business on the Web because there is no business — yet.” He added on another occasion: “Our strategy was to get out ahead. And run like hell.”

Eventually at least several business models would emerge. Most importantly Starwave cut a deal with ESPN that included:

“Placement of the ESPNet Sportszone name on the crawl that it would run at the 28- and 58-minute marks of every hour. Glover presented a rate card that showed Starwave was getting most of its money back in advertising on ESPN. In the deal analysis, Allen valued that as zero. ‘I have no idea what this is worth,’ he told Slade. Few did. ‘Turns out it was worth everything,’ Slade said. ‘The first people to run a crawl of a Web site that you were supposed to go to was us and ESPN.’ They made their debut on April 1 with an event at the Final Four in Seattle. Digger Phelps chatted up Allen at the launch party. Starwave gave out 15,000 browser discs at an ESPN booth at the convention center. Starwave never turned a profit on ESPN during the five years of the deal, but it became the bridge toward a larger relationship with Disney, which eventually bought Starwave. Along the way, the two companies charted a course for dot-com success.

It didn’t always proceed smoothly. The first time ESPN tried to sell advertising space on the site, the pitch tanked. Glover went to companies offering six charter sponsorship positions for $1 million each. For that, they’d get … well, to be honest, Glover hadn’t a clue. ‘We were laughed out of the room,’ Glover said. ‘Here, most people haven’t even heard of the Internet. And we wanted $1 million. Needless to say, we didn’t even get close to a sale.’ They did finally sell what some say was the first sponsorship deal on the Internet, to Gatorade, for $25,000. ‘And that was huge,’ Glover said. With the sports ubersite launched, Starwave and ESPN had a template in place. They would pay to develop and operate sports sites, in exchange for a cut of the revenue they brought in. They offered the same deal to each of the four major leagues and to NASCAR.”

To close this blog post it is worth thinking about is happening when a new business model is created. Nick Hanauer and Eric Beinhocker make important points here:

“A capitalist economy is best understood as an evolutionary system, constantly creating and trying out new solutions to problems in a similar way to how evolution works in nature. Some solutions are ‘fitter’ than others. The fittest survive and propagate. The unfit die. The great economist Joseph Schumpeter called this evolutionary process “creative destruction.” And he highlighted the importance of risk-taking entrepreneurs to make it work. Thus, the entrepreneur’s principal contribution to the prosperity of a society is an idea that solves a problem. These ideas are then turned into the products and services that we consume, and the sum of those solutions ultimately represents the prosperity of that society. Capitalism’s great power in creating prosperity comes from the evolutionary way in which it encourages individuals to explore the almost infinite space of potential solutions to human problems, and then scale up and propagate ideas that work, and scale down or discard those that don’t. Understanding prosperity as solutions, and capitalism as an evolutionary problem-solving system, clarifies why it is the most effective social technology ever devised for creating rising standards of living…. If the true measure of the prosperity of a society is the availability of solutions to human problems, then growth cannot simply be measured by changes in GDP. Rather, growth must be a measure of the rate at which new solutions to human problems become available.”

P.s., There are many other examples of business model discovery. The paper by Rita McGrath cited once before above (link in the notes) uses Google to make her points:

“Consider a business model category that we take for granted today – advertising-supported Internet searches. Text-based searching has been with us for decades, used primarily by organizations (such as libraries and police departments) equipped with electronic databases. When the Internet began to expand the amount of information available on line, new entrants promised a more organized way for users to find what they were looking for. The business model most early entrants tried was to be paid for the search itself, assuming that was what customers valued. In an early example (circa 1995), Infoseek tried to get customers to subscribe $9.95 per month for access to its search engines. Only later did players such as Yahoo! come up with the innovative idea of giving searches away for free in exchange for giving advertisers access to their visitors – and only later still did Google invent what is still regarded as the best algorithm for ranking web pages among the major search engines, creating a critical mass of searchers that would be attractive enough to advertisers to delivers the huge profits it enjoys today.

Without disparaging Google’s accomplishments in any way, its current success stems from and builds upon the many previous experimental efforts made by preceding companies. Figure 2 illustrates how the experimental process of discovering a viable business model for Internet searching unfolded over a considerable time. Note that the model shifted conceptually as technological possibilities expanded e from transaction to subscription based models, to ones supported by advertising. And note also how the advertising-supported model gives a first-mover advantage to a firm that is able to achieve critical mass, since it becomes more attractive to both searchers and thus advertisers.

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