The Left Brain / Right Brain “Business Model” Theory

On 14 Oct., 2015

We’ve all been there. You are passionate about your idea, you get excited about its potential, the product, its features, your co-founders… making the world a better place. Everything seems to be moving in the right direction and then, investors and other entrepreneurs ask you casually “and… how are you going to make money?”.

The Left Brain / Right Brain “Business Model” Theory

Raise your hand if you are an entrepreneur and at some point faced this question “What is your business model”?

We’ve all been there. You are passionate about your idea, you get excited about its potential, the product, its features, your co-founders… making the world a better place. Everything seems to be moving in the right direction and then, investors and other entrepreneurs ask you casually “and… how are you going to make money?”.

Your immediate point of call is Google naturally. Go ahead, type “Business Models” in Google, I dare you. Talk about losing your altitude - from excitement to ‘huh?’, ‘say what?’. It’s challenging enough creating a pitch deck, a 1-pager or an executive summary but trying to both understand what a business model is and how to write it down is almost considered a dark art.

Well, here are the good news, I’m going to give you the secret to deciphering what it is that you need to do to get your business model developed and documented in a way that is both easy to do and easier to understand.

I’m kidding about the ‘secret’ part of course :-) Allow me to introduce to my The Left Brain / Right Brain “Business Model” Theory.

My Left Brain / Right Brain “Business Model” Theory

Roger Wolcott Sperry, a neuropsychologist and a 1981 Nobel Prize Winner for his split-brain research. He coined the notion that the right-brain is best at expressive and creative tasks whereas the left brain is considered to be more responsible for logic, language and analytical thinking.

A Business Model can also be divided into two parts as well, the more creative and conceptual side, the right-brain and the more analytical and detailed side, the left brain.

The Right Brain Business Model

Similar to a top-down approach, defining a business model starts from the top, the more high-level and slightly conceptual level.

The best way to conceptualize and capture the thought process and iterative development of the business model is by using one of 2 best of breed tools. These tools are the Business Model Canvas and the Lean Canvas.

BUSINESS MODEL CANVAS

The 1st model is called the Business Model Canvas or BMC for short and is based on the work done by Alex Osterwalder and Yves Pigneur. This canvas captures the key 9 essential components that make up the business model.

 

The canvas provides a well thought through process for nailing the product / market fit. This is achieved by the unique structure of the canvas. If you draw a vertical line straight in the middle of the canvas, you will have 2 sides: the left side which addresses the Product components and the right side which addresses the Market components. The canvas is split right in the middle where the Value Proposition is formed.

Here is what every section in the canvas means:

·         Strategic Partners / Key Partners - Key partners, key suppliers, key resources acquired from partners and key activities partners perform

·         Key Activities - Key activities our value proposition, distribution channels, customer relationships and revenue streams require

·         Key Resources - value proposition, distribution channels, customer relationships and revenue streams require, e.g. intellectual, human, financial

·         Value Proposition - The actual value we deliver to our customer and the problem we’re solving, e.g. characteristics include newness, design, brand/status, price, cost reduction etc

·         Customer Relationships - The type of relationship each customer segment require, e.g. personal assistance, self service, communities, co-creation etc

·         Distribution Channels - How does the business plan to reach its customers

·         Customer Segments - What customer segments will receive the value we create and offer?

·         Cost - The most important costs in the business, the costs associated with the key resources and key activities

·         Revenues - For what value are our customers willing to pay? How would our customers prefer to pay?

Creating the canvas is done in a certain order, ensuring you build on top of more important components. Working this way allows you to focus and elaborate on each item separately.

1.      Value Proposition

2.      Customer Segments

3.      Channels

4.      Customer Relationships

5.      Key Activities

6.      Key Resources

7.      Key Partners

8.      Revenue Streams

9.      Cost Structure

 

LEAN MODEL CANVAS

This canvas was created by Ash Maurya, as a more problem-focused alternative. I personally have found that the Lean Canvas is easier to grasp for beginners and makes a bit more sense. Quite often, when working with entrepreneurs, I was told that the Business Model Canvas is a bit confusing and some of the content in a few sections appear to be overlapping.

Both canvases are great tools to get the process started. I recommend starting out with the Lean Canvas and working your way from there. This canvas replaces 4 sections with a more problem-solution theme.

 

The new items that were swapped in are:

·         Problem - a clear definition of the problem this venture / idea is trying to solve

·         Solution - a clear statement of what the actual solution is. E.g. is it a website, a mobile app, an online call center etc

·         Key Metrics - this refers to the business’ top 1 or 2 KPIs (Key Performance Indicators). It’s critical to keep in mind that every business normally has 1 or 2 top-level KPIs. These are used on a regular basis (normally days, weeks, months, quarters and year, and at times on an hourly basis) to track the growth and sustainability of every business

·         Unfair Advantage - when entering a market, it’s critical to establish a unique unfair advantage. The obvious examples are IP-related assets, e.g. patents, scientists or professors who are part of the core team of the business. Other more modern examples include celebrity associations (see Feex as an example). These provide a hard-to-copy or compete advantage

The order in which to fill out this canvas was slightly changed as well. You first start off with the segments and work your way in through the problem statement.

 

AN ITERATIVE PROCESS

And last but not least - quite a few entrepreneurs don’t realize it - working with these canvases is an iterative process. You start off with a very high-level canvas that addresses multiple segments, and through the process of refinement, you end up with a small subset of canvases, each addresses a specific segment or sub-segment in your ideal market.

 

The Left Brain Business Model

The left brain business model drills down into the nitty gritty of an actual model you would expect to find in a business plan or when discussing it with an investor or a CFO.

But first, let’s revisit the definition of the phrase “Business Model” from the perspective of the left brain. In its pure form, a business model is "A scalable way to acquire customers and monetize these customers at a significantly higher level than your cost of acquisition". So a business model has really only 2 components, the Acquisition and the Monetization. We use the abbreviation CAC to describe the acquisition cost, i.e. Customer Acquisition Cost and we use LTV to describe the monetization component of the equation. LTV means Life Time Value. The LTV of a customer will give us a key metric for evaluating the effectiveness and success of the selected business model or models. More on this later.

David Skok, partner at Matrix Partners, visualized this formula perfectly. He also pointed to a very important goal when creating and monitoring a business model. One must achieve an imbalance between the two components, whereby the LTV is significantly higher than the CAC. This is the only way to build a successful and growing business. See illustration below:

 

CAC - CUSTOMER ACQUISITION COST

Calculating the CAC is easy and is done by using this formula:

CAC = (MCC + W + S + PS + O) / CA

 

Definition of each parameter in the formula is below:

·         MCC = Total marketing campaign costs related to acquisition (Not retention)

·         = Wages associated with marketing and sales

·         = The cost of all marketing and sales software

·         PS = Any additional professional services used in marketing/Sales (Designers, Consultants etc)

·         = Other overheads related to marketing and sales.

·         CA = Total customers acquired

What you will need to do now is create a spreadsheet (preferably a Google Sheet document so you can easily share it) and outline all the above costs in a single column. See example below. Note that in this post I will not drill-down into the mechanism and the specific example mentioned but I will dedicate a post for just that soon.

 

LTV - LIFE TIME VALUE

Next, you will need to add in the LTV figures. The LTV figures are based on time and are normally calculated on a yearly basis. Keep in mind that for an early-stage start-up, you will most probably build out a monthly sheet first and focus on your first 6 months. It’s almost impossible to accurately predict and forecast your CAC and LTV beyond the 6 months mark at this stage.

Below is a simple example of putting both the CAC and the LTV together. The most important metric to track in this sheet is the CLTV/CAC ratio or multiplier (CLTV = Customer Life Time Value and is another way of describing LTV). This gives us the growth ratio of the business. The longer customers stay with the business and keep paying for receiving value, the stronger and more stable the business will be in the long run. In addition, if we are able to show a x3 CLTV/CAC multiplier by year 3 and a x5 to x10 multiplier by year 5, we enter the realm of the ‘Hocky Stick’ growth start-ups and are prime for VC investments or M&A and IPOs.

 

Conclusion

To conclude, a Business Model can be divided into 2 parts, the high-level and conceptual part and the detailed, spreadsheet-driven part. Every entrepreneur needs both and you should always start off with the right side - the canvas side.

As with the split-brain theory which was eventually debunked, the Business Model must have both parts to be whole.

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