March 2004

Growth Challenge: Business Models
Getting to Liquidity

Are six quarters of sequential revenue growth, sustained profitability, and annual sales over $20M all within your company’s reach in the next 18 months? If not, you aren’t alone. Indeed, despite VCs spending the better part of the last 3 years working out their portfolios, more than 5000 venture-backed companies remain, most initially funded during the bubble and many still unprofitable. In this case, misery has a lot of company, and there’s nothing to love about it.

Most private companies have done well enough to keep going but nowhere near well enough to warrant exit at an attractive multiple. And with too many emerging businesses using similar approaches to pursue many of the same, increasingly demanding customers, there will be few if any destiny-changing-effects from the incremental improvements in the economy, spending, valuation or funding that we are now seeing.

Business models need to change. Tune, transition or overhaul them.

For many companies, getting to a liquidity event will likely require fundamentally changing the business model. If you run one of the (too?) many companies in the security software or storage equipment or Internet services or optical components or WiFi chip or electronic design automation or (fill in your sector) space, you know how strikingly similar your competitor’s overall approaches are to yours, despite what you pitch to your customers, investors, and employees and regardless of how much you would like to believe your business is truly different.

If you’ve made it through the last few years, you’ve undoubtedly tweaked your business model somewhat just to survive, considered major changes you’d like to adopt in the model during a more stable market, or had board members encourage you to consider models that worked well for some of their other companies. The reality is that as companies develop and markets change, business models also need to change — either tune them, transition them, or overhaul them. The worst thing to do is charge forward committed to your existing model despite your company’s decaying, stagnating, or even incrementally improving position.

How best to change your model? First, identify and analyze several options that could fundamentally change your business in one or more of its defining aspects. The framework below lays out key questions and dimensions that can guide your thinking. Then, test and prioritize the most promising options. Finally, develop and implement a strategy to grow your business around your improved model.

Business Model Framework

Here are some of the more interesting options that companies are pursuing these days to break out of the pack and jump start their revenue and profit growth:

• Customers — Who do we serve? Most technology-rich startups realize that they can’t sell horizontally. They need to target verticals or industries to efficiently focus their marketing and sales dollars. However, as we’ve written in previous issues of The Advisor, the best companies are going further, selecting and pursuing highly targeted customer segments as a critical element of their model. Many that offer software or services, for example, segment customers within and sometimes across verticals based on a distinct set of common needs. They then pursue customers in segments only where they feel they can offer a step function improvement in value and can provide that value through a demonstrably superior approach. Because you target only those customers with critical needs and provide a superior solution, your product margins are higher and sales expenses per revenue dollar are lower.
• Offering — What value do we provide? Companies have made progress by shifting from “selling products” to “providing solutions.” Solutions is often a frustratingly vague term, but in this context it usually means selling an interdependent product, service and support offering bundle (e.g., diagnosis, design, deployment, servicing, management, support) that meets the complete range of needs of a customer’s pain point. Network equipment companies have used this model to shift from selling routers or switches alone, for example, to providing design, installation, management and monitoring services along with their equipment. Software companies are also effectively adding consulting and ASP offerings to their product licensing to provide more comprehensive value to customers. Companies employing this model successfully typically have service revenues as large as or larger than their product revenues. A products-services offering provides a steadier revenue stream, higher profit margins, and greater customer retention rate than a products-only offering.
• Operations — How do we provide it? Revenue and profitability breakthroughs in the operations component of the business model have most recently come from outsourced or off-shored product development, increased levels of indirect sales, and leaner and more focused management teams and employees. While these approaches lower costs, the more important benefit is often the increased speed at which companies can get things done. Technology idea to offering, market opportunity to closed sale, and strategy to results should all take less time with innovative operating models. Companies can take full advantage of these and similar approaches by building a distinct competency that enables them to dynamically shift between ever better sources of operational ideas, talent and methods to turn speed into a strong business model lever.
• Advantage — How do we sustainably differentiate? While the bases of competition haven’t changed dramatically over the years, the balance of power among them has. Good management, the old maxim for any emerging business, is more abundant now than ever and seldom a differentiator in the business model anymore since only good management gets funded these days. Technology, while still important as a differentiator in life sciences, has become less so amongst tech and telecom sector companies as those industries mature. Marketing, long a weak sister in emerging growth companies, has gained in importance as we’ve shifted from a “build it and they will come” mentality to a “what do we need to build for them to come” reality. From being able to identify critical customer needs to developing pinpoint value propositions to educating the market to training the sales force to creating excitement amongst both internal and external constituencies, marketing has assumed a more important role in differentiating you from your competitors.
• Return — How do we make money? With the investment excesses of the late 1990s having mercifully passed, emerging businesses are now being forced to make money, make it sooner, and make it on half to one-third the amount of investment they might have received just a few years ago. This has forced a great deal of creativity and has pushed companies, for example, to reduce their fixed costs by employing some of the operations options mentioned above. Offering options like providing services have allowed companies to create a revenue stream earlier and determine which value levers are most effective. Wireless data companies, for example, have determined that being able to integrate their services with the carrier customer is as important as the services themselves. Emerging network equipment and software applications companies have determined that building a relationship with an OEM channel is where their value will be created rather than successfully selling direct to large carriers or enterprise customers.

It’s tough to get to liquidity in the current crowded market of emerging companies. But good options exist to improve your business model and separate your company from the pack. A robust identification of your options, followed by rapid testing and competent strategizing, will put you in a position to hit the growth, profitability and revenue targets needed to reach the liquidity event many will never see.