By: Michael Whitehouse
As seen on 1000 Angels, private investor network connecting startups with investors, a business model is the one of the most important aspects of a startup when considering investment. There are many different business models out there, but within startup investment there are four which have proven to be effective for others in the project.
Before we discuss this, however; let's highlight an important distinction for any investor.
Business Plan Vs Business Model
In a previous article we discussed what makes a strong business plan to help investors determine whether a startup is ready for an injection of capital or not. But one important point has come out of that discussion – the difference between a business plan and a business model. This is a common mistake, with both often being used interchangeably.
But there is a difference.
A business plan provides the complete details of a startup, what its goals are and how those goals will be met. A business model, however, deals specifically with how a business will make money and nothing more. Both are interdependent, and indeed a business plan will make reference to any proposed business model.
Four Common Types of Startup Business Models
For an investor then to understand how they will make a return on their investment, they must know how a startup is going to generate revenue and if they believe a proposed method will be successful. With this in mind, let's take a look at four business models often associated with viable startup companies.
1. Demand Orchestration: In this model, businesses act as a third party, creating a location for buyers and sellers to interact with each other directly, taking a percentage of any monetary exchanges. Examples of this would be eBay, Amazon, and 1000 Angels. This creates more options for buyers and sellers, with a vast number of individuals and businesses residing in the one place, creating a new innovative marketplace. Demand orchestration may also attract a large user-base which can then be more receptive to first party services and products.
2. Low Prices: Competition is always difficult, but can be even more so when establishing a new brand in an already crowded niche. One business model which can help to counteract this issue is discount pricing. This allows a business the opportunity to attract a large share of a marketplace simply because it is offering its products at a lower price than its competitors. With growth, a company can then develop new products and optimize its service with, for example, faster deliveries and more comprehensive customer support. This model can either be temporary or long term. Once a market share has been grabbed, and trust and demand developed with customers, a startup may then increase its prices without losing too much of its share, increasing profits at the same time. For other businesses such as Amazon, its entire business model is based on having a low profit margin and passing those savings on to customers to continually undercut the market price.
3. Reverse Auction: This business model involves buyers offering a price for a service or product. If the seller accepts then the buyer must adhere to the seller's terms and conditions. This model encourages buyers to feel that they are getting a real bargain, while sellers can have access to a marketplace which is similar to those offered via demand orchestration minus prices being set by producers.
4. Specialty: If a startup can offer a product or service which a small demographic needs and cannot get anywhere else; a premium price can be charged. This results in a limited production to high profit yield. In this situation the marketplace is wholly set by the producer as their product or service is completely unique and in demand by a small demographic. When a larger number of people desire the same product or service, usually other companies enter the market to compete. A startup does not necisarily need a large number of customers to turn a profit, a small number willing to pay higher prices can be extremely lucrative.
A business model is at the heart of any startup project. No matter how unique an investment opportunity appears, it must have a viable way of making money to be worthy of investment, and that is exactly what a business model Provides. It should be remembered that there are many different types of business model out there. The most important thing is to pair the one best suited to a project on a case by case basis.