This course includes videos from:
Karan Girotra, professor of operations, technology, and innovation at Cornell Tech
Andrew McAfee, principal research scientist at MIT
Barbara Corcoran, the cofounder of Barbara Corcoran Venture Partners
Nancy Koehn, historian at the Harvard Business School
Note: This course was produced by Big Think. We are pleased to host this content in our library.
Skill Level Beginner
(gentle music) - Companies routinely look at their financial statements, do a financial audit to see the health of their business, really seeing how they're doing in terms of profits. In the same way, companies need to examine if the business model that they've constructed, is that business model healthy? In particular business models get sick, if you might say, for a few different reasons. The industry changes, consumer needs change, or technology enables us providing the service or product in a superior fashion. To ward off against all these contingencies, all of these changes, companies need to systematically examine, if their business model is today relevant or not, or has it just become plain obsolete. And there's a whole host of companies that we can think of, that did not do systematic audits, and ended up being stuck with a business model, which was basically obsolete. The example that comes to my mind, most prominent one, is perhaps Blockbuster. Some of you might recall the days of walking into a video store and trying to buy, trying to rent a movie. That business model was an excellent business model when movies came in these kind of big black boxes or tapes. Today when movies come in a very different format, first with the CDs or DVDs, and then more and more recently, in a digital format. With the technological change, that business model of walking into a store, renting a movie, became basically obsolete. If Blockbuster had done a regular business model audit, to see if this whole concept remains viable or not, perhaps they might have escaped this fate that came to them. (gentle music) The first step to a business model audit, involves understanding where the profits of the firm come from. Traditionally, the profit formula has revenues, how do you get the money in? Costs, and a third element that is often forgotten, which is the risk of these revenues and costs. Together, understanding what your revenue model is, and this could specifically be, do you get money from subscription fees? Do you get money from royalties? Do you get money from direct sales? That's the revenue model, identifying that. Then comes the cost model, is it mostly fixed costs? Is it a lot of variable costs? Is it costs that go up and down with demand, or are these costs, which are static with demand? And that is the cost model. On top of that, the part that is most critical and often under-appreciated, the importance of which is often under-appreciated, is the risk model, within the business model. What are the risks of these revenues and costs? Are your revenues always going to be the same? Or they'll go up and down because of things which are outside your control, exogenous risks? They could also go up and down because of risks you face within the organization. Your employees walk away, that's more of an internal endogenous risk, that's another risk to your revenue and to your cost model. So a business model audit starts with, understanding the revenue model, the cost model, and the risks associated with the revenues and the costs. That's the first step to a business model audit. (gentle music) The next step in a business model audit, is to identify the sources of inefficiencies in the model. Inefficiencies can come from two sources. One, when we make decisions with poor information. For instance, you have to make a decision on how many cars to buy to service a city. Now, when you make that decision, you don't know what the economic growth next year would be, you have no idea how popular your service might be. That's an information risk. You're making a decision with poor information, on the consequences of the risk. Those kinds of risks are prevalent in every business. There's no business that I've ever talked about, that is not exposed to any lack of information, in making these decisions. That's the first kind of inefficiency or risk, information risk or inefficiency, that we need to identify within our business model. The next kind of risk is a little more subtle, it comes not from not knowing what will happen in the world, but it comes from not knowing what other people might do to you. For instance, you are a company which has a supplier. Now, a big risk you're exposed to, is if the supplier will produce components or parts, with the same quality, without using, perhaps not using child labor, without following the kind of standards, that your brand aspires to. The risk exposure to actions from other people in the value chain, is the second kind of risk, the incentive risk in the business model. Identifying both the information and incentive risks, is key to knowing where are the biggest kind of pain points, in your business model, which consequently often end up being the best places to try to improve your business model, or to change the game in the industry. (gentle music)