In the original newsletter, I put forth the “Venture Investing Expression” below:

✅ Depth of market problem ∝ solution fit ∝ non-obvious insight ∝ traction ∝ business model ∝ market size ∝ go-to-market strategy ∝ team execution potential ∝ status of fundraise ∝ valuation ∝ stage of business ✅

This week’s item is Business Model. 

I will share with you an insight that I’ve observed on business models in the last nine years being in startups. 

According to Alexander O, author of the Business Model Canvas, a business model is a “a representation of how an organization makes (or intends to make) money.” Link is here.

Y Combinator lays out that there are 9 types of business models that 99% of startups fit into. Discovering this content was one of the most helpful “a ha” moments in startups as it brought tight organization to the business model discussion. Link is here.  

It is these nine types of business models that are the artist’s palate of innovation. As you can imagine, with a high number of startup inputs, investors see so many different applications of business models across industries, customers, price points, etc. like the number of permutations of a Rubix cube.

To be honest, some of these thoughts I have held within a mental model for years but have never articulated before until now. So here we go. 😀

✅ Here is what I have found - the startup with the superior business model wins. 

Yet, I will go out on a limb and say that I believe that business models are one of the most underutilized opportunities in startups. ✅

Most of the time, startups attack the market problem head on. Suppose a FinTech startup has identified a market problem for financial advisors. Thus, the logic might go, “We build a product for financial advisors, and we sell to financial advisors.”

👉 What startups often don’t realize is that there are other ways to address the market problem than just head on. 👈

Astute founders look at the problem from all angles. They ask themselves the questions such as:

Market tension doesn’t exist just for your single customer. Market tension is almost never felt in isolation. It exists on a horizontal plane. Choosing the optimal business model is about seeing beyond just the direct customer that is facing the market problem. Many times, there are leverage points in the market that can be uncovered and exploited. 

Specifically, often there are leverage points both upstream and downstream from the actual problem dynamic. Startups can find a wedge and look to manipulate circumstances, align incentives, etc. of the actual problem dynamic. In short, business models are the tools to exploit leverage points in the market. 

Two reasons. First, in a word, defensibility. Defensibility is the ability to hold your pricing power in the market. Alternatives will inevitably come into your space. But a startup that is strongly defensible has the ability to maintain their pricing power, as opposed to a poorly defensible startup who is more of a commodity that needs to flex its price to remain relevant. 

 I see it this way - ✅ Business models are tactics to occupy different amounts of surface area across the problem dynamic. ✅

Typically, but not always, when a startup occupies more surface area of the problem, generally that means that there is more defensibility.

For example, a SaaS play more often than not is the startup selling to the business (the customer). A marketplace, however, often is two-sided (essentially the startup has two customers and is solving for both of their needs). I see this as the marketplace, by solving two customers' challenges, occupies more surface area of the problem dynamic that would be, all things being equal, harder to dislodge by an alternative. (NOTE: More surface area isn't always better. I tend to recommend that startups start with a small amount of surface area, dominate that, and expand from there). 

But more important than defensibility, the right business model is like the antidote that the market truly needs. Remember how we said that all markets have tension, upstream and downstream of the the initial problem dynamic. This is what I believe 👇

✅ In short, the right business model effectively harmonizes market tension among one actor or several actors in the market.  With that harmony comes tremendous market share. ✅

Let me give you an example. 

A startup was developing a product for a segment of people in the trades industry. In the trades, there are many actors in the industry (consumers, trades people, suppliers, original manufacturers, etc.). In the case of this company, the working value proposition centered around the consumer and the solution intended to target the consumer as a SaaS play. Enter Realization #1. When we spoke about the value proposition, however, something important became clear - the consumer was not behaviorally accustomed to looking for such a solution themselves. The typical process was that the consumer would call the trades person to have them do this job for them. Thus, the SaaS play towards the consumer would be nearly behaviorally untenable and likely not gain any traction. Using the power of business models thinking, we realized that the trades person was the one who was getting inundated with customer calls and really needed a way to qualify the customer lead and fulfill the job. In short, the trades person was leaving lots of revenue on the table. We realized that the startup’s solution was much more appropriate for the trades person, not the consumer. In short, the trades person was the main demand driver, but the consumer, although they were more downstream, also played a vital role in the transaction. That was realization # 1. 

Realization #2 was that, furthermore, after looking at the incentives at play between the consumer and the trades person, it seemed that they were misaligned. Specifically, there existed what I call competing market aims. The trades person has scattered availability to do the job but wants the consumer and wants to charge a good price. The consumer doesn’t care as much who does it but wants it fast at a low price. These misaligned incentives were creating constant tension such that even if the SaaS product were somehow to succeed, it would not harmonize the market tension that existed. This discovery led us to believe that with a few tweaks to the product workflow, a marketplace business model, not a SaaS play, could be an optimal way to align the incentives in a way that had not yet been achieved in the market. The marketplace business model seemed to harmonize both of these competing aims, making it possible for each party to get what they want. Best of all, a marketplace taps into the power of network effects as a route to defensibility. In the end, the marketplace business model was clearly superior to the SaaS play originally intended. 

Opportunities abound to look at your business model in a new light. It takes looking and asking the three questions above. Look at the spectrum of the problem, not just the actual problem dynamic. 

I will leave you with a competing market aim to resolve right now - the startup with the superior business model wins.

But business models are one of the most underutilized opportunities in startups. 

Harmonize that.