A business model is the process by which a company plans to make money. Think about pizza chains like Domino’s and Papa John’s. These companies buy their ingredients in such massive quantities that they can sell you a decent pizza for less than it would cost you to make the same caliber of food. Add in some good branding plus an eager set of local franchisees and it’s no wonder that these chains have been so successful.
When building a business model for a start-up, you need to develop solid answers to three key questions:
– What gap in the market have we identified?
– How will our company fill the gap?
– How will we make money when filling the gap in the market?
Since its creation in 1997, Netflix has grown from a start-up to a corporate juggernaut with more than 50 million customers. Co-founders Reed Hastings and Marc Randolph recognized that a huge gap existed between what video stores such as Blockbuster Video offered and what customers wanted. Video stores offered a small variety of movies. When a hot new release came out, many customers were greeted by an empty shelf and became frustrated. And customers hated video stores’ late fees.
Netflix’s founders decided to fill this gap by offering customers flat fee access to a huge selection of videos via mail – keep the DVD as long as you wish, no late fees – and eventually via streaming video. Netflix makes money by charging customers more for a subscription than it costs to fulfill a subscription.
Flat World Knowledge (FWK) offers a very different example. Textbook industry veterans Jeff Shelstad and Eric Frank founded FWK in 2007. These founders recognized that college textbooks are too expensive and they worked to fill this gap by publishing textbooks that students could access online for free. Shelstad and Frank planned to make money by convincing students to purchase upgrades such as printed copies of textbooks and study guides.
Investors bought into this “freemium” business model. In late 2008, FWK secured $700,000 in angel funding. This was followed in 2009 by $8 million in Series A funding from backers such as Greenhill SAVP, High Peaks Venture Partners, and Valhalla Partners. In January 2011, the firm received $15 million in Series B funding led by German media company Bertelsmann AG.
As an author of a FWK business textbook, I had a front row seat as the company struggled in 2011 and 2012 to execute its business model. Simply put, freemium did not work because FWK did not persuade enough students to buy upgrades. Not only was FWK’s initial free online reader a good quality offering, the company made its free offerings more attractive by creating (at considerable expense) an even better second generation free reader. Meanwhile, the company’s marketing programs did not convincingly highlight the paid upgrades’ value added.
My co-author and I tried to advise FWK on how to improve, but our suggestions fell on closed ears. Fortunately, we had negotiated a substantial advance before writing our book due to our concerns about the freemium model.
In November 2012, FWK decided to dramatically shift its business model by no longer offering free online access. Soon the management team was on its way out. While Netflix’s founders had nailed all three questions surrounding a business model, FWK’s Jeff Shelstad and Eric Frank did not figure out how to make money while filling a gap in the market. In December 2012, former Blackboard executive Christopher Etesse replaced Shelstad as CEO. Etesse set out to refine the business model in a way that would provide returns to FWK’s investors. I am rooting hard for him to pull it off, especially since FWK takes the unique step of issuing stock options to its textbook authors.
The incredible success enjoyed by companies such as Netflix, Domino’s, and Papa John’s might make it seem as though perfecting a business model is easy, but the case of FWK shows otherwise. And keep in mind that virtually all companies have some struggles along the way before arriving at a business model that works. Providing solid answers to the three key questions offered above (What gap in the market have we identified? How will our company fill the gap? How will we make money when filling the gap in the market?) does not guarantee prosperity, but it is a necessary step on the path to success.
Disclaimer: The above thoughts on FWK simply represent my opinion; other opinions may vary.