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What Exactly is a Business Model? - Vivek Wadhwa

Everyone in the tech world talks about business models. But I’ll bet that if you quizzed a random sample of these people, you’d find that they really don’t know what a business model is. I did just that with my students at UC-Berkeley. Most raised their hands, and MBA student Blake Brundidge’s attempt to answer the question was a valiant one—but none of them really had a clue.  The only one who got the answer right was Lionel Vital, a Stanford student gatecrashing my iSchool class.

The reality is that a business model is like the old saying about teenage sex: everyone talks about it all the time; everyone boasts about how well he or she is doing it; everyone thinks everyone else is doing it; almost no one really is; and the few who are are fumbling their way through it incompetently. (Yes, I know things have changed.)

I’ll tell you what a business model is, in case you are quizzed by your investors.

But first, let me answer the big question that is surely on your mind: what is a Stanford student doing at Berkeley? It may be that our classes at Berkeley are much better than those at Stanford. That is probably why Lionel approached me at the beginning of the semester and begged to be allowed to audit my class. To Lionel’s credit, he scored better than any of the Berkeley students. So perhaps some Stanford kids are a little smarter, but Berkeley students get better education? I know that our students certainly have a lot more fun. You just have to visit the campuses to note the stark difference.

Now let’s discuss business models. Sorry, the teenagers reading this will need to get their sex education somewhere else. I teach only entrepreneurship and globalization.

Step one in building a successful business is to learn what products or technologies your customers really need and are willing to buy. This is an iterative process that I explained inthis piece. The vast majority of technology startups fail because too few customers buy or use their products. So don’t underestimate the importance of validating and testing your ideas.

Developing the right product is hard. But what is harder is building a good business model. Fortunately, there’s nothing magical about a business model. It’s simply the nuts and bolts of how a business plans to generate revenue and profits. It details your long-term strategy and day-to-day operations.

Entrepreneurs put together elaborate business plans showing optimistic market-share projections. Even 1% of a billion-dollar market seems lucrative, right? Wishful thinking is great, but when it comes time to create your business model, you need to be realistic. The challenges differ from industry to industry, but here are seven basic components of a business model:

1. Reaching customers. Ralph Waldo Emerson famously said, “Build a better mousetrap, and the world will beat a path to your door.” The reality is that even if you did, no one would find you. Even when you know who your prospects are, it’s usually difficult and costly to reach them. You have to find them via the Internet and e-mail, or the old-fashioned way—through broadcast media, print ads, direct mail, telemarketing, or references or by cold-calling. And these potential customers are not likely to be waiting to hear from you and may not respond to you. So be sure you know how you are going to find and reach them.

2. Differentiating your product. You think you’ve got the very best solution, but so does the other gal (or guy). There’s always competition, whether you realize it or not. Smart marketing executives know how to develop unique product-positioning strategies that highlight a product’s true value. You need to thoroughly understand the competition and effectively communicate the unique advantages of your product.

3. Pricing. One of the most basic decisions you have to make is how much you’re going to charge for your product or service. Giving your stuff away is the way to go on the web, but remember that you still need to figure out how you are eventually going to make money—you can’t make it up on volume. Start by understanding how much customers value what they’re gaining from you. Then you need to estimate your total costs, analyze the competitive landscape, and map out your long-term strategy. For your company to survive, your product’s price must be greater than its overall cost.

4. Selling. Persuading customers to buy a product that they need is one of the most important skills an entrepreneur must learn (read It’s All About Selling for Survival). You’re going to be selling at every juncture. So you have to understand what it takes to close a deal and put together the necessary sales process. And this process has to be perfectly conceived. Be sure you test your selling strategy as you would your product.

5. Delivery/distribution. This is easy on the Internet. But for big-ticket items, you usually require a direct sales force; for mid-range products, distributors or value-added resellers; and, for low-priced items, retail outlets or the Internet. It’s different in every industry and for every type of product, but you have to get this right. Your products need to be designed and packaged for the channel through which they will be distributed to customers.

6. Supporting Customers. In addition to teaching customers how to use your product, you need to ensure that you can deal with defects and returns, answer product questions, and listen to and incorporate valuable suggestions for improvement. You may need to provide consulting services to help customers integrate and implement your products. If your product is a critical component of a business, you may also need to provide 24/7 onsite or web support.

7. Achieving customer satisfaction. The ultimate success or failure of a business depends on how much it helps customers achieve their objectives. Happy customers will become your best sales people and buy more from you. Unhappy customers will become your biggest liability.

All the pieces have to come together like a jigsaw puzzle in your business model. The good news is that you don’t have to start from scratch when formulating it. You can give yourself a head start by learning from competitors and other markets. It is not only the successes that provide valuable lessons; it is also the failures.

You can innovate as much in your business model as you do in your products. Be prepared to evolve your innovation strategy as you gain experience and as your market changes. Like your products, it will probably take several versions to get your business model right; you get better with practice.

Tanks in the cloud: Computing services are both bigger and smaller than assumed

Dec 29th 2010 | from The Economist PRINT EDITION

CLOUDS bear little resemblance to tanks, particularly when the clouds are of the digital kind. But statistical methods used to count tanks in the second world war may help to answer a question that is on the mind of many technology watchers: How big is the computing cloud?

This is not just a question for geeks. Computing clouds—essentially digital-service factories—are the first truly global utility, accessible from all corners of the planet. They are among the world’s biggest energy hogs and thus account for a lot of carbon dioxide emissions. More happily, they allow firms in developing countries to leapfrog traditional information technology (IT) and benefit from advanced computing services without having to build expensive infrastructure.

The clouds allow computing to be removed from metal boxes under desks and in firms’ basements to remote data centres. Some of these are huge, with several hundred thousand servers (high-powered computers that crunch and dish up data). Users pay for what they use, as with electricity. As with electricity, they can increase their usage quickly and easily.

The “cloud of clouds” has three distinct layers. The outer one, called “software as a service” (SaaS, pronounced sarse), includes web-based applications such as Gmail, Google’s e-mail service, and Salesforce.com, which helps firms keep track of their customers. This layer is by far the easiest to gauge. Many SaaS firms have been around for some time and only offer such services. In a new study Forrester Research, a consultancy, estimates that these services generated sales of $11.7 billion in 2010.

Going one level deeper, there is “platform as a service” (PaaS, pronounced parse), which means an operating system living in the cloud. Such services allow developers to write applications for the web and mobile devices. Offered by Google, Salesforce.com and Microsoft, this market is also fairly easy to measure, since there are only a few providers and their offerings have not really taken off yet. Forrester puts revenues at a mere $311m.

The most interesting layer—the only one that really deserves to be called “cloud computing”, say purists—is “infrastructure as a service” (IaaS, pronounced eye-arse). IaaS offers basic computing services, from number crunching to data storage, which customers can combine to build highly adaptable computer systems. The market leaders are GoGrid, Rackspace and Amazon Web Services, the computing arm of the online retailer, which made headlines for kicking WikiLeaks off its servers.

This layer is the hardest to measure. It is growing rapidly and firms do not report revenue numbers; nor are they very forthcoming with information, arguing unconvincingly that this would help their competitors. Amazon, for instance, only reveals that it now stores more than 200 billion digital “objects” and has to fulfil nearly 200,000 requests for them per second—impressive numbers but not very useful ones (an object can be a small file or an entire movie). Rackspace says it operates nearly 64,000 servers globally, but notes that only some are used for IaaS.

This reluctance to share information has inspired analysts and bloggers to find out more, in particular about Amazon. That is where the tanks come in. During the second world war, the allies were worried that a new German tank could keep them from invading Europe. Intelligence reports about the number of tanks were contradictory. So statisticians were called in to help.

They assumed that the Germans, a notoriously methodical lot, had numbered their tanks in the order they were produced. Based on this assumption, they used the serial numbers of captured tanks to estimate the total. The number they came up with, 256 a month, was low enough for the allies to go ahead with their plans and turned out to be spot-on. German records showed it to be 255.

Using this approach, Guy Rosen, a blogger, and Cloudkick, a San Francisco start-up which was recently acquired by Rackspace, have come up with a detailed estimate of the size of at least part of Amazon’s cloud. Mr Rosen decrypted the serial numbers of Amazon’s “virtual machines”, the unit of measurement for buying computing power from the firm. Alex Polvi, the founder of Cloudkick, then used these serial numbers to calculate the total number of virtual computers plugged in every day. This number is approaching 90,000 for Amazon’s data centres on America’s East Coast alone (see chart).

The results suggest that Amazon’s cloud is a bigger business than previously thought. Randy Bias, the boss of Cloudscaling, a IT-engineering firm, did not use these results when he put Amazon’s annual cloud-computing revenues at between $500m and $700m in 2010. And in August UBS, an investment bank, predicted that they will total $500m in 2010 and $750m in 2011.

These numbers give at least an estimate of the size of the market for IaaS. Amazon is by far the market leader with a share of between 80% and 90%, according to Mr Bias. Assuming that Cloudkick’s and Mr Bias’ numbers are correct, revenues generated by computing infrastructure as a service in 2010 may exceed $1 billion.

So how big is the cloud? And how big will it be in, say, ten years? It depends on the definition. If you count web-based applications and online platforms, it is already huge and will become huger. Forrester predicts that it will grow to nearly $56 billion by 2020. But raw computing services, the core of the cloud, is much smaller—and will not get much bigger. Forrester, reckons it will be worth $4 billion in 2020 (although this has much to do with the fact that even in the cloud, the cost of computer hardware will continue to drop, points out Stefan Ried of Forrester).

At any rate, the cloud is not simply “water vapour”, as Larry Ellison, the boss of Oracle, a software giant, has deflatingly suggested. One day the cloud really will be big. Given a little more openness, more people might actually believe that.