Business Models

The basic elements

A business model has a lot of different components, lots of things need to work, lots of things need to be in place, and much of the details won’t be known until you’ve tried, tested, failed, reflected, changed something and tried again. But it’s important to think about it early on and to plan accordingly. Even if you are just copying what someone else has done it still needs validation, it still needs testing. Perhaps they are not as successful as you think, perhaps the town or street in which your version of their business will operate is slightly different to the others, perhaps times have changed and not as many people want that anymore. The only certainty is that things will need testing.

But you can boil down every business model into three boxes…

(If you listen to business interviews with older founders, you’ll often hear them talk about advice and stories from their parents who would summarise all business by putting bills, receipts and cash into 3 different shoe boxes, if you get that right then you’ll be fine, so lets start there):

Box 1: What you’ve spent today. Costs

Box 2: What you earn’t today. Income / Revenue

Box 3: What you have left over. Profit (or not)

It sounds obvious but lots of people don’t start at the basics and so obvious holes appear in their complicated and elaborate plans. If at the end of the day you are spending more than you are earning then when box 3 is empty the game is over.

Now some people have larger boxes than others, so again be careful about copying someone else’s business model if you don’t fully understand how large their box 3 is.

The concept of the 3 boxes is also the key message behind business cashflow. You might have a really profitable business, but if you have a bill to pay today and no money in box 3 to pay for it then you’re in trouble. An example might be a property developer who is building a house. When they sell the house they might have lots of money coming in, but until that point it’s all flowing in the wrong way and if they run out of money before they are able to finish and sell it, then the game is over.

I heard a story years ago on the radio about a fish and chip shop run by an old couple. The husband did the fish and the wife served the chips. So the story went, every time the wife would serve a customer a big pile of chips, she’d take one and put it back. Saying “this one is for the pension”. Selling chips was her source of income and her source of costs so by taking a single chip back at the end of each day she could sell a portion of chips that had already been paid for, meaning it was 100% profit and went straight into her savings for when they retired. A tiny amount, but over time it would add up to something meaningful. Could she have served slightly fewer chips each time, yes, could she have put her prices up a little, yes. But this was a frequent daily reminder to her about the importance of box number 3, having something left over from every transaction.

Engineering Businesses

Now all this might seem a bit stupid and obvious. But you’d be amazed how easy it is for, in particular engineering and product based, businesses to make a mess of it.

The story usually goes something like this…

You’re working hard on a new product, you’ve got most of it worked out but there’s just a few small details left.

Your sales team (or maybe just the back of your mind) are really pushing, keen to make a sale to prove this has all been worth it, lets close a deal, lets get a customer. Lets make this happen!

So you agree a price with a new customer and boom success is just around the corner. But wait, those small little details left over might be surprisingly expensive. Maybe it takes you 6 months longer (6 months of extra salary) to finish, maybe you forgot to factor in taxes and VAT to your price, maybe some of your suppliers have just changed their prices, maybe you’re buying everything from China in US dollars and suddenly Brexit causes the value of the pound to drop 30%.

Whatever the reason it’s very easy to find yourself in a situation where the profit you thought you were going to make just isn’t there anymore.

This happens to large and small companies so just be careful with jumping to a sales price and closing the deal too early.

So as a business founder, make sure you can articulate how your business will work in it’s most basic three elements. Also for anyone looking to get involved with a business, if they can’t clearly articulate what their costs are and how they make money. Beware!