Business Model Architecture To Consider When Starting a New Business

Updated: Sep 7

In addition to the problem you seek to solve or the opportunity you choose to pursue and the product or service you offer, one of your key decisions as a founder is what business model to employ. This week, we’re sharing a high-level overview of business model architecture to consider when starting a new business so you can make the best decisions from the start. We will get more granular over time.

Your business model is essentially your blueprint that outlines how the product or service you intend to offer reaches customers, and how value is created and monetized. More specifically, your business model provides the framework for how your company:

  • selects its ideal customers following thorough customer discovery

  • defines and differentiates its offerings within the market it operates

  • establishes its scope, and tasks it will do

  • configures and optimizes its resources

  • goes to market

  • creates utility and value for customers and

  • ultimately generates reoccurring revenue and profits.


Here’s a handy business model framework from Stanford’s Idea to Market Program that provides a clear visual representation that you can adapt for your pitch deck or use to frame key areas of focus in team meetings:




Product/Offering - Type of Business (blue)

What do you offer or sell?

This is a combination of the company structure and output that defines the core value creation mechanism for the business. It establishes the conditions around which all other interactions and decisions will be based.


Customers/End Users (red)

To whom do you sell?

These are the end users of your product or service that realize the value created and make the utilization, consumption, or purchase decision. These are stakeholders that determine product-market-fit which we will focus on next month.


Access/Customer Acquisition (orange)

How does the product reach the customer?

These are the methods used to reach, acquire, and maintain customers that define the objectives for marketing, and market positioning. Customer acquisition establishes the basic mechanisms for the customer touchpoints around how customers learn about the product, access or acquire it, and experience the value you've created.


Partners/All stakeholders that impact the business (gray)

Who else is involved in the process?

These are all entities that are directly involved with the value creation mechanism and customer touchpoints. These include channels, manufacturers, regulators, market influencers, system integrators, resellers, etc. that can help scale customer acquisition. Efficient customer acquisition is key to building your business.


Transaction/Revenue model (green)

What is a typical transaction and what are the unit economics?

This is the clear plan that defines how to sell the product or service in order to generate revenue. It establishes the overarching framework for business cash flow, the sources of cash generation, and the margin structure for each individual transaction. Unit economics become increasingly important over time to reach profitability.

And when you put it all together, this is how a functioning, profitable business should flow:




Partners and stakeholders develop and create the offering, then, via access initiatives like marketing and sales, get the offering in front of potential customers who then purchase the offer so money can flow back to additional product development and ultimately through to the partners and stakeholders of the business.


Simple enough, right?



Put simply; most business models will fall into one of four general categories that I outline below. Within each are a myriad of business models and types across industry sectors:


Four Primary Business Models


1. Business-to-Consumer (B2C) aka Direct-to-Consumer (DTC)

The B2C or DTC business model refers to commerce between a company and an individual consumer, i.e. when you buy a book from Amazon, buy Impossible burgers from Whole Foods, or subscribe to Netflix, Bark Box or ro. These are all vastly different businesses with different business models but all are BTC.


2. Business-to-Business (B2B) or Enterprise

B2B or Enterprise refers to any commerce between two businesses. When Deloitte or Salesforce sells to another large corporation, a SaaS (software as a service) sells to another SMB (small- to medium-size business), when Apple sells MacBooks to Ford, or a wholesale textile company sells to a fashion label, these business models are B2B.


Some brands operate as both B2B and B2C. For example, Apple sells its products directly to you and me as well as to other businesses as mentioned in the example above.


3. Consumer-to-Consumer (C2C)

The consumer-to-consumer business model is when a consumer sells a product or service to another consumer. For example, when someone sells used furniture on letgo, or sells crafts and jewelry on platforms like Etsy and Shopify. Individuals often begin selling on existing online marketplaces and then start their own online stores when they've built up enough brand awareness. Sometimes, they sell via both channels.


4. Consumer-to-Business (C2B)

Any individual who sells their products or services to a company can be included within this category. When a consumer sells their own products or services to a company, they are often called a “creator” which is usually different than a more traditional freelancer who often does the same work as an employee on a part-time or fixed-term basis through a service agreement without becoming a full-time employee. Influencers are an example of creators who are personal brand builders with large audiences who create content and community that corporate brands want to reach and will pay to get their products in front of targeted consumers. Photographers who sell their photos online as stock images for corporate presentations are another good example of the growth of the creator economy and business model.


Within each of these primary business models are more specific models for early-stage tech companies, which I outline below. It's important to think about what market you're participating in from a business model perspective so that you understand what metrics to track and what investors expect to see. Here’s a rundown:


Enterprise

When you work with enterprises (as a B2B business as described above), you work in terms of contracts. This means it's your predominant focus from which you can frame your metrics.

What are key metrics to track?

  • Number of bookings or customer agreements - the total number of contracts/commitments your company has

  • Total customers - the total number of unique customers that you get

  • Revenue - the money received for providing your services


Enterprise model common mistakes: Confusing “bookings” or customer agreements with “revenue” and implementing contracts when working with the enterprises. A startup hasn’t delivered any services or value unless the contract is fulfilled. Therefore, you cannot report revenue when you haven’t yet delivered any service unless there are aspects to that agreement that involve some kind of work that you get paid for which is not part of the larger core services agreement. Just because you have a LOI or even a signed agreement, unless there is work getting underway or completed and a commitment to pay for that work and the terms of that payment are agreed then don't report it as revenue.


SaaS

This model charges users on a recurring basis (usually monthly or annually) to access software.

What are the key metrics to track?

  • Monthly Recurring Revenue (MRR) — your retention from customers liking the product and agreeing to pay for the subscription each month

  • Annual Recurring Revenue (ARR) — the pace of revenue growth as compared with the absolute revenue number. This metric should be tracked in conjunction with MRR to show the annual comparison of the business when it comes to subscribers

  • Gross Monthly Recurring Revenue Churn (Gross MRR Churn) — how many paid customers are canceling each month? Pay close attention to this metric if you are at the early stage of your business development and don’t have a large group of customers yet;

  • Paid Cost to Acquire Customers (Paid CAC) — this metric is for cases when you decide to experiment with advertising and are ready to pay to acquire users. Many startups including one of my own in the past, teams can start relying on paid media too early in the sales cycle.

SaaS model common mistakes: Don’t confuse ARR and ARRR (Annual Run Rate Revenue). ARRR = ARR + revenue not attributed to a recurring subscription such as deployment fees, training, and other professional services. In this case, you won’t have a recurring revenue business if the users do not like the product and are not willing to pay for a subscription.


Subscription

Similar to SaaS but typically with lower revenue per customer. Examples are LinkedIn, Netflix, and any other company that usually targets B2C and that offers an affordable monthly subscription for every customer. The metrics are generally the same here as with SaaS.

What are the key metrics to track?

  • MRR — users who are willing to pay to receive the full set of features

  • Compound Monthly Growth Rate (CMGR) — quite often, with a subscription-based company, the subscription revenue is smaller so pay close attention to this metric

  • MRR Churn — losing even one or two customers, particularly when you’re early-stage, has a real impact on your revenues

  • Paid CAC — this metric is for cases when you decide to experiment with advertising and are ready to pay to acquire users.

Subscription model common mistakes: Don’t measure CMGR as a simple average — use specific and discrete monthly growth rates. What happens with averages? It makes your growth look good because you had a few spikes. See the warning above about utilizing paid media too early and too often.


Transactional

Businesses that charge a fee (usually for each transaction) each time a customer uses their product. Stripe, PayPal, and Coinbase are examples.

What are the key metrics to track?

  • Gross Transaction Volume (GTV) — this metric shows you that not all the volume of payments that goes through your platform is revenue. If 50 users go through your company’s processing, you will have a large sum of money in total transactions, that’s GTV, but it won’t be your revenue.

  • Net Revenue — money that you’re left with after the transactions flow through your platform; those that go into the company’s bank account.

  • Monthly User Retention — due to the way transactional businesses function, you’ll likely have a large volume of recurring customers (particularly if you’re price-competitive with other transactional businesses) since your customers are making money each time you get paid. If your monthly retention is low it’s likely that you have other problems with your platform that should be fixed as soon as possible.

Transactional model common mistakes: Try to use discrete monthly growth rates instead of measuring CMGR as a simple average.

Marketplace

A business that acts as an intermediary between two consumers, connecting them to buy or sell a good or service. Examples include Airbnb, eaze, or Booking.com.

What are the key metrics to track?

  • Gross Merchandise Value (GMV) — the percentage of money the company receives from the price of the good a user lists for sale on the platform.

  • Net Revenue — the percentage of the GMV that the company receives in its bank account.

  • Net Revenue Compound Monthly Growth Rate (Net Revenue CMGR) — **Marketplaces are typically B2C companies so the volume of users matters.

  • User Retention — a customer that only uses your platform once and doesn’t come back won’t help your revenue or your company grow.

Marketplace model common mistakes: Blending paid user acquisition with organic user acquisition. If you don’t separate the two metrics, you won’t have a good sense of sustainable growth.


E-Commerce

A company that sells physical goods online. Generally, they manufacture and inventory those goods — i.e. Amazon. With e-commerce, you may make the products, but you can source the products as well.

What are the key metrics to track?

  • Monthly Revenue — because you don’t have recurring purchases, monthly revenue needs to be tracked.

  • Revenue Compounded Monthly Growth Rate (Revenue CMGR) — measures the return on an investment over a certain period of time, and the revenue that comes from it.

  • Gross Margin — the gross profit in a given month divided by total revenue from the same month.

Marketplace model common mistakes: Not accounting for every cost that factors into Gross Profit. If you bought something and the cost is $10, a lot of companies wouldn’t include things like shipping costs, customer processing costs, and payment processing costs. If you don’t include those costs, you’re pricing it wrong.


Advertising

A company that offers a free service and derives revenue from selling advertisements placed inside the free service. Examples include Snapchat, Twitter, and Reddit — basically platforms that are used by a high number of users, which are the most important part of the company — especially for early-stage.

What are the key metrics to track?

  • Daily Active Users (DAU) — the number of unique active users in a 24-hour period, averaged over time. Users who do not come back to your platform are important to understand. You need to know how to keep them there.

  • Monthly Active Users (MAU) — the number of unique active users in a one-month period. How many kept using your platform after their first login.

  • Percentage logged in — users with a registered account that log in and log out over the same 30-day period.

Advertising model common mistakes: Some founders fail to accurately calculate user retention and end up regretting it.


Hardware

A company that sells physical devices to consumers. Examples are Fitbit, GoPro, and Xiaomi. This model is very similar to e-commerce therefore, all the key metrics to track are the same.

What are the key metrics to track?

  • Monthly Revenue — there aren’t any recurring purchases, so simply track revenue per month.

  • Revenue Compound Monthly Growth Rate (Revenue CMGR) — since we are talking about users and tracking volume, and because averages aren’t the whole picture for this type of business, tracking compounded growth is a more accurate measure.

  • Gross Margin — make sure you’re making money on each transaction.

  • Paid CAC — the average money you spend in obtaining a customer. You should always measure this metric, regardless of what business model you have, so you can ensure a healthy ROI (return on investment).

So, how to know which business model is best for you?

  1. Through customer discovery and ongoing testing, understand the true value of your product/service to the customer segment you've identified as ideal.

  2. Demonstrate demand by validating that your product/service solves the problem or fulfills the need you're seeking to solve.

  3. Choose a proven business model in the market for the least amount of effort or invent a new one, which could, in and of itself, be your market differentiator.

  4. Develop your business plan or business model canvas.

  5. Test your sales channels and distribution strategy to determine which is most effective and efficient.

  6. Run more tests, experiments, and potentially, a pilot program.

  7. Gain more customer insights and iterate your business model and plans accordingly.


If you want help refining your business model, join us at the upcoming AMA with Chris Deutsch, register for an Ask an Expert session at the AWS Startup Loft, book a 1:1 call with mentors including Kyle Hermans at Angel Club, or find some great advisors.

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