New Delhi Times

Let me explain the worst kind of business you can get in to. I have been through some not-so-perfect business models myself so I can say I have some insight in to this topic. There are three factors that typically describe a business:

1. How much does it cost for me to sign up a customer (cost of customer acquisition)?

2. How much does this customer pay for my products/services (pricing)?

3. How much will it cost to service this customer ?

Looking at the three factors above, its easy to figure out what would be the worst type of business model. It would be a business where signing up a new customer takes lot of time and money, the customer pays little for the services offered and finally it takes a really long time (and money) to actually service the customer.

Now this might look obvious, but it is worth mentioning because most companies actually fall in to this model doing business. This happens as we often look at the above three factors in isolation. The mindset in a startup is that “we need customers at any cost and we got to keep them happy because then they will give repeat business and also refer us to other prospects eventually leading to profitability and success”. In theory, it is practical. In practice, it is often not so simple!

Most companies start out by offering competitive pricing on their products. This is the easiest way to sell because pricing is a quantitative measure and all other things being equal (or too difficult to judge on), customers will choose the cheapest.  At this point, two things can happen – your product has no takers even at a lower price point which is the end of story right there, or you end up signing customers and actually generate revenue. If the latter happens, then you have at your hands the task of servicing  these customers but within limited resources since you are selling cheap. Now, again two things can happen – either you screw up on delivering to these customers which is the end of story right there, or you do manage to service them albeit with a lower margin. The side effect of having started selling at a lower price point is that you can never increase your pricing (worst, you even got your competitors to bring their pricing down!). So now you have a real business which has products, customers, revenues and possibly even profits. The profits are likely small in quantum because the margin per customer is low. So to become a big business, you need lots of customers, or in other words, you need to scale up. Now once more, two things can happen – either you will not manage to sign up large number of customers because your pricing was so low that it left no room for investing in to growth, in which case congratulations, you just ended up with the worst type of business model OR you might actually manage to sign up a huge number of customers. If the latter happens, you would be facing the final test – does your product or service scale up along with the growing customer base? Now, for the last time, two things can happen – your product doesn’t scale up and you end up with unhappy customers forcing you to further lower your pricing leading to ending up with the worst type of business model OR your product does indeed scale up and you end up with lots and lots of happy customers and the best type of business model!

The moral of the story is that it takes only one step in the wrong direction to start with an excellent business plan and end up with the worst kind of business model. From my own lessons, I think we must answer these three fundamental questions before venturing in to any new business:

1. Will the cost of acquiring a new customer increase, decrease or stay the same as our customer base grows?

2. Will the cost of servicing a customer decrease as the number of customers increase?

3. Will there be enough number of potential customers out there to enable us to achieve scale (should the above two questions have favorable answers)?