Seven Enterprise Business Models You Need to Know In the Age of Software


Most people never think of technology from an economic point of view. Instead, we focus our efforts thinking about the nuts and bolts of the technology. Tim Chou, a current lecturer at Stanford University, spent his career focusing on Enterprise Technology. He believes that it is important to know a variety of business models to better understand how we can sell to customers. In a talk given at Alchemist, he outlined seven important models of how software companies drive revenue, and offered further insights into the sales process.

Model One: The most typical, yet still extremely effective model: license the software to the user and then charge for support and maintenance. Tim gives the example of Oracle, which previously was a $15 billion corporation with $12 billion coming from support and maintenance.

Model Two: Make your software open source, but monetize the support and maintenance. Tim emphasizes that Red Hat is the only real example of success for this model.

Model Three: Outsource. “I’ll take over your mess and I’ll do it for less.” He explains that the amount of money to manage software is 4x the price so in most cases 75%-100% of the budget is fully allocated for the next year. Therefore, by outsourcing, you reduce the cost structure to purely human labor in China, India, Eastern Europe, etc. However, Tim goes on to outline two major flaws with this model. One, you are unable to maintain a low cost of labor for outsourced labor as workers will eventually want wages that match the workers in Silicon Valley. Two, the primary reason of system failure is human error.

Model Four: Tim explains, “The customer pays for the software and maintenance, while I’ll manage security, performance, etc. for a set price per user per year.” In this case specialization is key. If you can standardize the hardware and software then you can replace human labor with machine labor, crushing cost structures and increasing reliability.

Model Five: You alter the payment terms of Model Four. This can mean paying monthly or by other terms.

Model Six: Every business application company since 1999 has delivered in this model. It involves removing the at-home and at-customer aspect of the model, in order to standardize and reduce cost structures even more. In justification, Tim explains that while operating in model four or five, cost structures can be taken down to about $50 to $70 a user. On the other hand, students of model six can get down to $5 per user.

Model Seven: In reality, Facebook, Amazon, and Twitter are all software companies. What’s different is the way they charge for their service, whether it is ad-based models or embedding it in the transaction. An example is buying a book on Amazon, which is essentially paying for the software. In order to justify that there is an extra step in standardization, Tim argues that Google would otherwise charge around 70 cents per user per year in order to break even for searches. He explains all of their software is extremely standardized so their cost structure is entirely reduced to power (electricity).

Understanding your Customer is Key to Choosing a Business Model

These seven models offer a wide variety of choices to founders—however, in order to know which business model is right for your customers, you’ll need to talk to them! Tim believes in this day and age, we can now target our customers by first knowing who they are instead of just throwing your product out there. We can apply Geoffrey Moore’s idea of Crossing the Chasm to people who will buy into your vision and help you cross the chasm. Tim explains, a lot of the time you can tell if a potential customer is only interested in following the mainstream if they ask, “What is your ROI?” They are not your early investors. They are only interested to see if others have bought. Customers before the chasm are not large corporations, rather, they are individuals.

How do you Sell?

Once you know your customers, the challenge becomes how to sell to them. When broken down, there are two methods of selling. Both methods of selling involve “preciseness:” low and precise selling (e.g. Amazon selling $10 books, movies, etc.), and high but imprecise selling like business software, where you need fewer sales due to high value. The challenge is sitting in the middle where selling price is still high and is still imprecise. Tim makes the analogy of big screen TVs. Just like enterprise sales, there is an education cycle before you buy where you ask friends, read reviews, and do your research. Ultimately, you find that “selling is education and education is selling”.

The challenge is that your sponsor (the guy who thinks what you’re doing is cool) is unable to answer questions to others about your software. Tim explains that the key is the art of storytelling. It really matters who is saying what. Without the right character telling the story, there is no credibility. Stories are a key part of learning as it activates a different part of the brain and your information is more believable.

There are three types of stories: Man versus man, man versus nature, and man versus self. When telling a story about your product, communicate it in 3-5 points, identify the problem, and identify the value of your solution. By comparing the situation before your product to the situation after your product, you create value.

What does this mean?

It is no surprise that in order to sell to customers, you must understand your customers. It is important to understand that while your customers’ ability to use your product relies entirely on how you structure your business model. Their role as a customer lives entirely inside the model you choose to adopt. Therefore, when analyzing your product’s reputation, you can not overlook how your model is structured. By being aware of which business models work and which ones don’t, you can begin to better understand your customers as a whole.

About the Alchemist Accelerator

Alchemist is a venture-backed initiative focused on accelerating the development of seed-stage ventures that monetize from enterprises (not consumers). The accelerator’s primary screening criteria is on teams, with primacy placed on having distinctive technical co-founders. We give companies around $36K, and run them through a structured 6-month program heavily focused on sales, customer development, and fundraising. Our backers include many of the top corporate and VC funds in the Valley—including Khosla Ventures, DFJ, Cisco, and Salesforce, among others. CB Insights has rated Alchemist the top program based on median funding rates of its grads (YC was #2), and Alchemist is perennially in the top of various Accelerator rankings. The accelerator seeds around 75 enterprise-monetizing ventures / year. Learn more about applying today.


Do Pivots Matter?

                                                              There’s a sign on the wall but she wants to be sure
                                                           Cause you know sometimes words have two meanings
                                                                           Led Zeppelin – Stairway to Heaven

In late 2013 Cowboy Ventures did an analysis of U.S.-based tech companies started in the last 10 years, now valued at $1 billion. They found 39 of these companies.  They called them the “Unicorn Club.”

The article summarized 10 key learnings from the Unicorn club. Surprisingly one of the “learnings” said that, “…the “big pivot” after starting with a different initial product is an outlier. Nearly 90 percent of companies are working on their original product vision. The four “pivots” after a different initial product were all in consumer companies (Groupon, Instagram, Pinterest and Fab).”

One of my students sent me the article and asked, “What does this mean?”  Good question.

Since the Pivot is one of the core concepts of the Lean Startup I was puzzled. Could I be wrong? Is it possible Pivots really don’t matter if you want to be a Unicorn?

Short answer – almost all the Unicorns pivoted. The authors of the article didn’t understand what a Pivot was.

What’s a pivot?
A pivot is a fundamental insight of the Lean Startup. It says on day one, all you have in your new venture is a series of untested hypothesis. Therefore you need to get outside of your building and rapidly test all your assumptions. The odds are that one or more of your hypotheses will be wrong. When you discover your error, rather than firing executives and/or creating a crisis, you simply change the hypotheses.

What was lacking in the article was a clear definition of a Pivot.  A Pivot is not just changing the product. A pivot can change any of nine different things in your business model. A pivot may mean you changed your customer segment, your channel, revenue model/pricing, resources, activities, costs, partners, customer acquisition – lots of other things than just the product.

Definition: “A pivot is a substantive change to one or more of the 9 business model canvas components.”

Business Model
Ok, but what is a business model?

Think of a business model as a drawing that shows all the flows between the different parts of your company’s strategy. Unlike an organization chart, which is a diagram of how  job positions and  functions of a company are related, a business model diagrams how a company makes money – without having to go into the complex details of all its strategy, processes, units, rules, hierarchies, workflows, and systems.

Alexander Osterwalder’s  Business Model canvas puts all the complicated strategies of your business in one simple diagram. Each of the 9 boxes in the canvas specifies details of your company’s strategy.  (The Business Model Canvas is one of the three components of the Lean Startup. See the HBR article here.)

So to answer my students question, I pointed out that the author of the article had too narrow a definition of what a pivot meant. If you went back and analyzed how many Unicorns pivoted on any of the 9 business model components you’d likely find that the majority did so.

Take a look at the Unicorn club and think about the changes in customer segments, revenue, pricing, channels, all those companies have made since they began: Facebook, LinkedIn – new customer segments, Meraki – new revenue models, new customer segments, Yelp – product pivot, etc. – then you’ll understand the power of the Pivot.

Lessons Learned

  • A Pivot is not just when you change the product
  • A pivot is a substantive change to one or more of the 9 business model canvascomponents
  • Almost all startups pivot on some part of their business model after founding
  • Startups focused on just product Pivots will limited their strategic choices – it’s like bringing a knife to a gunfight

About Steve Blank

Entrepreneur-turned-educator Steve Blank is credited with launching the Lean Startup movement. He’s changed how startups are built; how entrepreneurship is taught; how science is commercialized, and how companies and the government innovate. Steve is the author of The Four Steps to the Epiphany, The Startup Owner’s Manual -- and his May 2013 Harvard Business Review cover story defined the Lean Startup movement.  He teaches at Stanford, Columbia, Berkeley and NYU; and created the National Science Foundation Innovation Corps -- now the standard for science commercialization in the U.S. His Hacking for Defense class at Stanford is revolutionizing how the U.S. defense and intelligence community can deploy innovation with speed and urgency, and its sister class, Hacking for Diplomacy, is doing the same for foreign affairs challenges managed by the U.S. State Department. Steve blogs at www.steveblank.com.