Your Business Model: More Than a Pitch

It shows investors precisely how your business will create a profitable niche in the marketplace. Our guest columnist explains

by Gwen C. Edwards

Editor's note: This is the fifth column of a series of weekly Q&As in which entrepreneurs featured in the Women Entrepreneurs Special Report answer questions submitted by readers. You can submit a question for consideration here by writing to nick_leiber@businessweek.com.

Why do investors place so much emphasis on business models? What do they mean?

"What's your business model?" is a common question among investors and entrepreneurs. It's another way of asking the critical questions: How do you plan to engage the market? How do you plan to make money? Do you plan to sell your product directly or through other channels? Do you plan to provide services or manufacture product? Do you plan to charge users, advertisers, or some other party who gains value from your offering?

But the term "business model" refers to more than how you make money. It also covers where you are positioned in your industry. It answers the questions: How do you fit in? Are you disruptive? Are you creating a new way of doing business?

An entrepreneur might describe her business as a new approach to video surveillance, conveying the need, market, and scale of the opportunity—and then jump to a description of her technology's unique intellectual property. That is her pitch—but it's not a description of her business model. She'll still need to explain exactly how her business will engage the market. What role will it have in the distribution or supply chain? Is her business a surveillance-equipment manufacturer, a supplier of unique intellectual property that is embedded in each camera, or a provider of video surveillance services?

A Critical Choice

Depending on precisely what a business has to offer, you usually have many choices on how you want to engage the market. Know that your choice of business model has profound implications on your rate of revenue, the amount of capital you will need, and the competition you will face.

For example, software companies often have to decide if they want to license their software to enterprises and rely on significant one-time license fees and annual maintenance fees, or "rent" the software on a monthly basis. The licensing model translates into a large amount of revenue per sale; the renting model means smaller fees but can readily reach a broader market. Salesforce.com (CRM) is renowned for redefining the software-as-service business model.

And sometimes it is the business model itself that is the essence of the breakthrough idea. Take Starbucks (SBUX). It created an atmosphere for people to enjoy the experience of a special treat. Each outlet felt warm and personal. Customers were invited to order to go, or sit and stay indefinitely. But what made Starbucks a household name? The sheer number of its outlets. Its business model created a stellar retail experience, and then blanketed neighborhoods with that experience. Now consider what the chain would have been if the business model had been to create a unique blend of roasted beans, and sell them in gourmet food shops and retail outlets across the globe. Very different indeed. This is an example of a business model that changed the way we experience coffee.

The Model Is the Means

My own experience in recognizing the importance of a business model involved migrating a telecommunications company from a service business model (that offered to transport applications for pennies per megabit) to a model that would simply license the software to enterprises—so that they could garner the efficiencies over their own private networks. The decision to shift the business model led to a much lower-cost business with much less risk and a clearer break-even point on the horizon. It was not the original intent of the company, but during the lean years (post-2000), this was the only approach that made economic sense.

You may be tempted to choose more than one business model, but you'll be pushed to pick just one—the model you think is most likely to succeed, and give you and your investors a home run! Know that your choice of business model will affect your capital requirements, competition, resources required, types of skills you'll need, and just about everything else about your business. Your decision also tests just how clearly and thoroughly you've thought about your business.

And of course, it's one more make-or-break decision you'll have to make as you lead your company. Make sure you consult with several different advisers, from different parts of the industry you're in or entering, and then be sure to find at least one trusted adviser from a completely different industry—just to give you some out-of-the-box thinking. Be prepared for constantly conflicting advice. Then model the financials—even if you have to hire someone to help you do this. This exercise will prepare you well for the next steps and for discussions with potential investors and partners.

Gwen C. Edwards ran a $400 million networking division of SBC Communications (now AT&T). She is now exploring a new startup after serving as chief executive of Middlewire, a telecommunications company that shut down in 2001.