Three beautiful business models

Silicon Valley puts tremendous focus and attention around products and their interfaces, interactions, and form-factors. And with good reason because it’s really hard to 1.) distill abstract human wants and needs into actionable insights, and then 2.) productize those insights into apps, websites, or devices. Within the last 5-10 years, the technology component in many classes of products have become more and more of a commodity. In conjunction, the target demographics have expanded from just geeky early adopters to virtually everyone in the world. As a result, companies today compete more and more on design and interface. In fact, the very best products have an essence of aesthetics ascribed to them. They’re elegant and beautiful, and even sometimes get put into modern art museums.

But with one hand that gives, the other hand must take. Behind every product is a business, and in business, someone’s got to pay for something. The aesthetics of product, something you can see or touch, are apparent. However, there’s also something beautiful about business models that simply work. Often times, tried and true old-school business models work the best, and that makes sense because the point of a business (i.e. make more money than you lose, and the greater that difference, the better) hasn’t changed over the course of human history. But modern technology has made certain classic business models much more compelling. Here are three categories of businesses I find especially interesting for today and tomorrow:

 Addiction i.e. stable, recurring revenue with low churn and high virality

The most base manifestation of this business model is narcotics. The drug trade is so compelling that even after over a trillion USD spent on the War on Drugs, countless people killed, and many more locked up, business is booming. Let me be clear here: I’m not saying that dealing drugs is beautiful. I’m simply noting from an academic perspective that the business model behind it has ruthlessly elegant characteristics: consistent and stable recurring revenue, low user churn, and built-in viral mechanism for user acquisition. As long as folks get hooked faster than they can get clean, the business grows.

Translating this into the technology industry, the closest parallel is gaming (especially those monetized through subscriptions or micro-transactions). World of Warcraft, a subscription-based PC game, at its peak was grossing an estimated 810MM to 1.7B a year from its 10MM subscriber base. With mobile taking off and the gaming demographic becoming more casual, the subscription twist has given way to a micro-transactional twist where players purchase small bonuses and special powers to boost their experience in game — sort of like taking a hit of your choice of drug. Some players, the whales, binge and drop thousands on these games. The games of choice today like Clash of Clans and Candy Crush (at peak, both estimated to gross over 2MM in revenue per day) have carried the companies behind them to billion and multi-billion dollar valuations. The economics are great: micro-transactions +advertisements offer consistent, stable recurring revenue; players get caught up and start investing into the game; and of course, the more the merrier, so folks hook in their friends.

 Pre-selling i.e. no inventory risk / no account receivables

There’s a lot of overhead in running a traditional physical goods business. Between coming up with a product idea and delivering it into a consumer’s hands are a bunch of costs. Some of the biggest risks are 1.) projecting out how much of the product to manufacture, 2.) storing the inventory in a warehouse or storefront, and 3.) often for manufacturers and wholesale distributors, collecting on account receivables (invoices).

These risks are mitigated if not eliminated by pre-selling. Only recently though has pre-selling become large-scale viable; the Internet has made it a lot easier to organize people across geography and timezone and bundle up disparate demand. A standout business built on this model is Teespring, a company that makes customized t-shirts, perfect for student groups and other small clubs or interest groups. Teespring knows exactly how many shirts to print, has no inventory risk and minimal storage costs because each t-shirt is already accounted for, and best of all, it’s all pre-paid. The business is only a couple years old, and from what I hear about their annual revenue run rate, it’s a money-printing machine.

 Marketplace

The market-maker middle-man is a classic service, connecting buyers and sellers. Before the Internet, marketplaces to find the right people to do business with were either non-existent or hard to access. For each specific vertical, you either had to be connected yourself, hire someone that could make the right intros, or in more organized verticals, look people up in specialized directories (Aside: Recently, I came across a massive, nicely bound hardcover book published in the 90’s that literally just listed the contact information for the partners and staff of a bunch of venture capital firms. It looked like it cost a lot of money).

The Internet has made it possible to create open, global marketplaces that consolidate the discovery and matchmaking process. This has happened across a ton of different verticals, and the creators of these marketplaces accrue all the economic value that once was spread amongst localized, ad-hoc ones. EBay is a gigantic business around basically consolidating garage sales. Airbnb is another great example that basically consolidates couch surfing.

What’s really exciting to me these days is the same approach applied to finance and lending. Lending is one of the oldest businesses in history, and 21st century iterations of this business like Lending Club are really interesting. The old school financial institutions have a giant spread between the rates they charge borrowers (especially those who’re subprime) and the interest they pay out to lenders i.e. people who deposit money with them. Lending Club sees this disparity and sits nicely in the middle. By being smart and figuring out how to narrow the spread and match borrowers and investors, they make it cheaper to borrow money for borrowers and serve as a better investment for lenders. All the while, Lending Club is making money off fees from both the borrower and the lender and passing through the default risk. A win for everyone!

None of the business models I’ve discussed are really novel, but they’re applied in novel ways using novel technologies. While there’s nothing tangible to call beautiful, the end results are systems that not just work and self-sustain, but work beautifully and flourish. There’s a sweet spot where Silicon Valley product aesthetics + know-how and old school business models collide. Some call it “software eating the world”; I call it beauty coming together.


 Addendum:

Luxury (i.e. Veblen goods) is an interesting business model, but I don’t think it’s future-proof. With signaling goods (e.g. designer clothes, luxury sports cars, art), the more expensive the product, the more desirable it is. Being in a position to taste-make and command premiums to do so is certainly a great place to be.

However, I think this market is in the wrong direction of technology. In pure software, marginal cost of a new unit is zero, while of course for each new Louis Vuitton bag or each new Rolex, there’s costs for material and craftsmanship. But projecting forward into a world with ubiquitous, sophisticated 3D printing, the value of material and craftsmanship attenuate. In this scenario, luxury retailers will have to adapt their business model. And I believe they’re starting to do so already, as they seem to be focusing more on experiential value of the in-shop experience and creating a lifestyle, and not purely focusing on the product themselves.

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