CB Insights lists having a flawed business model as the fourth most common cause of failures for Tech start-ups. Nineteen percent of CEOs of failed companies attribute a flawed business model as a cause of their lack of success.
What does a flawed business model look like? Simply put, a flawed business plan does not allow you to make enough revenue to cover your costs and deliver a decent return on your investment.
You might select the wrong revenue model or get your pricing strategy wrong. Your manufacturing processes may not be ideal. Possibly your distribution strategy lets you down. Whatever the cause, with a flawed your business is not destined to make a profit.
It’s possible to have a great value proposition that your customers love but still go out of business, as was the case with a company called Desti. Desti was an online travel app launched in 2011. It was able to raise $2 million over two funding rounds. Desti used artificial intelligence to help its users plan their trips. A user would enter their preferences into the app, Which would then find hotels, restaurants, and other location-specific details based on data and reviews found online for the selected destination. It would then offer the most suitable choices based on the user’s criteria. The app received positive feedback, the users appreciated the suggestions it provided. The problem? Users ended up booking their trips on other more trusted sites. Desti was a newcomer in a sector that had several giants such as TripAdvisor and Lonely Planet who also offered travel advice and booking services.
The flaw in Desti’s business plan is that they were not able to find a way to translate their advice into a revenue-generating business. They needed a model that would have made it much easier for their users to book via Desti, compared to going to another travel site. I wonder if a sort of Amazon “Buy now with one click” might have provided a hook. The user selects their chosen suggestions provided by Desti and then books them all with one click.
The news for Desti was not all bad. The company was bought by Nokia who planned to use Desti’s powerful search engine technology in its mapping platform. A very different application for its original intended use.
In a similar manner to Desti, Sunrise also failed to monetize its offering. Sunrise was a calendar app that was able to connect users and calendars from different providers using different web and mobile devices. Using Sunrise users could access calendars from Gmail, iCloud, and Microsoft Exchange with the goal of simplifying the use of calendars and planning events. The app had good reviews. The problem is calendar apps are hard to monetize and the barriers to entry are low. Sunrise had a solid value proposition; it was a native app, that is one that is available from Apple App Store or Google Play, that could integrate seamlessly with other applications.
But it is hard to compete with free. In his book “Predictably Irrational” Dan Ariely describes how free distorts our decision-making. In this case, Sunrise’s calendar could save us time and provide features that enhance our productivity. However, it cannot compete with the less powerful calendar we use because the one we use is free.
As Desti had, Sunrise was able to find a buyer, they were purchased by Microsoft in 2015.
Use the link above to buy Dan Ariely’s book on Amazon. As of March 14, 2023 the Kindle version was available for $1.99.
To effectively monetize your product or service you need to understand what features your potential customers really care about, and how much they are willing to pay. This requires going out and talking to potential customers. In last week’s posts, a case study into the causes of failure of an online dating company, I quoted Lean Startup guru Steve Blank who tells entrepreneurs to “get out of the building” and conduct customer discovery interviews before they start product development. It is good advice. Unfortunately, many entrepreneurs do not follow this counsel. They develop a product, market it, and set a price, based on a simple formula like cost plus. They hope this will generate profits, but they have little solid evidence for this assumption. And worse many use a set-it-and-forget-it approach to their pricing strategy, never reviewing their price in light of results in the marketplace. A better approach is to get inside your customers’ heads even before you start to design or code. You can then develop their product or service around what the customer is prepared to pay.
All business models are built on assumptions and often those assumptions are flawed.
Nespresso, the now incredibly successful combination of a Nespresso machine and gourmet coffee capsules nearly went bankrupt because of a flawed assumption. The development of the Nespresso system was led by the company’s R&D arm with little discussion with the marketing group. Although it looks simple, all you do is fill the tank with water, drop a capsule in the holder, press a button and hey presto you have a great cup of coffee. In reality, it is a three-stage process. First, the coffee is wetted, to make it expand, then air is blown through the coffee to make pathways for the water to flow through, then finally water is pushed through the capsule at the right pressure and temperature to extract the ideal cup of coffee. This requires a sophisticated and expensive piece of machinery. And the capsules, at launch, were not cheap.
Nespresso was set up as a separate company in June 1986. Nespresso reasoned that the office market would be less sensitive to these costs compared to the home or individual consumer. The system was initially launched in Italy, the home of the world’s largest drinking expresso population. By the end of 1987, there were causes for concern. Only half the Nespresso machines that had been produced had been sold. Without machine sales, the market for capsules would be limited. The machines proved to be temperamental in the field, maintenance, and services costs were higher than expected. Lower revenues and higher costs are not a recipe for success.
Nespresso hired an external executive to head up the division, Someone who could think outside the Nestle box. The new hire thought that there was potential, albeit untested, in the household market. There were some trials and tribulations along the way but as is now known the decision to switch target markets was an immense success.
Being fortunate enough to have worked in Europe, North America, and Asia I want to touch on a mistake that is sometimes made by multinational companies. That is to assume overseas markets behave the same as their home markets. History is littered with examples of companies that made this mistake. From Home Depot in China, Starbucks in Australia, Disney in France to Walmart in Germany. If you are thinking of taking your company overseas, contact me to receive my notes from IBGR Season 5 when I looked at many of the aspects you need to consider before taking your company abroad. You can also use that site to set up a 30-minute discovery call with me on any topic of your choice.
If multinationals staffed with intelligent and highly paid professionals get business models wrong, how can you be sure that your business model makes sense?
The answer is to make sure your story makes sense and that your numbers are credible. And are the story and the numbers consistent? If your story is clear and the numbers work then it is likely you have a working business model.
Do you remember Quincy Apparel which I discussed during our first case study in week 2 of this season? Their financial projections did not stand the credibility test. Quincy planned for a 20% return rate from customers versus an industry average of 34%. Their projections for Gross Margin were 57%. In a few minutes on the internet, I learned that the industry average in 2014, two years after Quincy launched, was 37%. EBITDA was expected to be over 30%, again the industry average in 2014 was 12.5%. Their actual gross margin in the month before they closed was 25%. We all want to believe that we can do better than industry averages, after all, averages include some pretty mediocre businesses, not a bit like ours. We tend to forget averages also include some stellar businesses that are humming like well oil machines. Especially when you are starting out, and do not have the advantages of scale, it’s unlikely you will exceed industry averages. Be conservative in your financial projections until you have solid evidence that you have found the key to profitability.
A company called Priceline Warehouse Club believed that by acting as a broker for millions of consumers they could reduce their user’s grocery bills and make a profit themselves Consumers would say how much they were willing to pay for, say, peanut butter. They could not select a brand, only a price. The Warehouse Club would approach peanut butter producers with an offer, reduce your price by 50 cents and we will buy a million jars. The business failed because companies such as P&G and Bestfoods just were not interested. They had spent millions building up a brand image and the Warehouse Club was training consumers to buy on price alone.
Ensure your business plan is not flawed by ensuring the story of your business and your financial numbers tie. Regularly review your pricing and product strategies to ensure you are delivering value to customers. With these simple steps, you will achieve success.
Why Start-Ups fail 