Understanding LinkedIn Business Model

In the post titled, ‘Understanding Business Model Fundamentals’, we learnt why do we need to understand business models and how to visually represent a business model using the ‘Business Model Canvas’. In this post, we will try to understand LinkedIn business model using the Canvas.

LinkedIn is the world’s largest professional network. As of 31st March 2012, LinkedIn had 161 million members in over 200 countries. LinkedIn helps the professionals stay connected with each other by creating and managing a professional identity and building a professional network. LinkedIn has implemented a Multi-sided Platform, which offers different solutions to different categories of users.

LinkedIn provides the following categories of solutions to its network members for free: An ability to manage professional identity using tools such as Profile and Profile Stats; An ability to build and manage professional networks using tools such as LinkedIn Connections, Invitations, and Introductions; Access to knowledge and insights using tools such as LinkedIn Groups, Network Updates, News, Answers etc.

LinkedIn is a good example of a Freemium business model. While the core offering is free for its network members, premium offering comes for a price. The premium offering includes tools such as LinkedIn InMails and Profile Stats Pro. The users can upgrade from a basic account type to Business, Business Plus, or Executive account types. The premium account types provide access to the premium offerings.

LinkedIn platform induces the same-side network effects among its members. This helps in growing the network through word-of-mouth or connection-request-emails. As the average number of member connections grows, the strength of the network improves. The more the network becomes strong, the more attractive it becomes to the users on the other sides of the platform. The users on the other sides of the platform include Recruiters, Marketers & Advertisers, and Developers.

LinkedIn offers LinkedIn Corporate Solutions, LinkedIn Jobs, and Subscription products to the Recruiters. LinkedIn Recruiter is their flagship hiring solution to find, contact, and hire candidates. Self-service postings help recruiters to post and manage job opportunities. LinkedIn Referral engine helps organizations leverage their employees network to find qualified candidates. LinkedIn provides job recommendations to its members over Job You May Be Interested In (JYMBII) section of a member home page. LinkedIn offers Talent Basic, Talent Finder, and Talent Pro as subscription products to recruiters and hiring managers. LinkedIn offers Job Seeker family of products – Job Seeker Basic, Job Seeker, and Job Seeker Plus – to its members to stand out to recruiters and hiring managers.

LinkedIn marketing solutions enable marketers and advertisers to reach their target audience. LinkedIn Ads is their self-service product to target advertisements to specific members based on their profile information. Advertisers can setup and manage multiple campaigns and continuously monitor clicks, impressions, click-through rates, and average cost-per-click. LinkedIn Ads for Enterprise product targets larger advertisers that receive dedicated account management and get access to additional marketing solutions such as Display Ads, Custom Groups, Sponsorships, Whitepapers, and Recommendation Ads.

LinkedIn provides a set of open APIs and embeddable Widgets to the developer community. These APIs and Widgets provide access to the content in the LinkedIn database and help the developers build third-party applications leveraging LinkedIn data.

LinkedIn revenues come from 3 key revenue streams: Hiring Solutions, Marketing Solutions, and Premium Subscriptions. For CY 2011, these 3 streams represented 50%, 30%, and 20% of total revenues of $522 Million. LinkedIn sells Hiring and Marketing solutions through field sales organization and through their website. The Premium subscriptions are primarily sold online. Field Sales organization comprises of direct sales force, agencies, and resellers. While online channel is characterized by lower average selling prices, the offline channel is characterized by longer sales cycle, higher average selling prices, and longer contract terms. During CY 2011, Field sales contributed 55% of the total sales, whereas online channel contributed 45% of the total sales.

LinkedIn business model can be represented over the business model canvas as follows. Click the image to see it on Full Screen.

As discussed earlier, LinkedIn drives almost half of its revenues from Hiring solutions. Here, LinkedIn competes with established online recruiting companies such as Monster+HotJobs, Careerbuilder, and Indeed.com, talent management companies such as Taleo, and traditional recruiting firms. Then, there are companies new to the recruiting industry such as BranchOut, which offers a Facebook application for finding jobs and recruiting employees. In a span of less than 2 years since its launch in July 2010, BranchOut has grown into largest professional networking application on Facebook with over 25 million registered users and 400 million professional profiles. With over 3 million jobs, it operates the largest job board on Facebook.

How big, you think, is the threat of BranchOut to LinkedIn? In case Facebook decides to acquire BranchOut, then how big the threat can become? On 3 May 2012, LinkedIn announced acquisition of Slideshare, a leading professional content sharing community, for $118 Million. How acquisition of Slideshare is going to help LinkedIn boost its revenue growth and overcome the threat from companies such as BranchOut?

Comparing Facebook and Google Business Models

In our previous blog posts, we represented the business models of Facebook and Google over the Business Model Canvas. The Canvas diagrams are reproduced below for your convenience. Please click the link to the blog post, if you want to read the details.

Understanding Facebook Business Model

Understanding Google Business Model

In this post, we will attempt to compare the two business models using Gurley’s Test. Please refer to the post ‘Assessing a Business Model Attractiveness’, if you want to understand the 10-point criteria that we will be using to compare Facebook and Google business models.

We will take each of the 10 criteria one-by-one. We will try to give scores to both the companies based on the information available in the public domain and our knowledge/understanding of the companies. In case you think that we are missing some key aspect, please feel free to bring it out in the comments section. We will give 1 point if the criterion is fully satisfied, 0.5 points if it is partially satisfied, and 0 points if it is not satisfied at all.

1. Sustainable Competitive Advantage.

Google is a dominant web search provider with over 66% of search market share. As per Analyst estimates, Google has over a million servers that process over a billion search requests every day. Google has invested billions of dollars in building huge data centers across the globe. The resulting economies of scale and economies of scope provide a sustainable competitive advantage to Google over new market entrants and existing players.

Facebook is a dominant social networking site with over 845 million users at the end of 2011. Facebook aspirations are even high. They aim to connect all global Internet users – more than 2 billion in number. Facebook strategy is to design social products and enter into partnerships that drive engagement levels of these users even further. Facebook has built a multi-sided platform (MSP) with strong network effects. These network effects and Winner-Takes-All (WTA) dynamics of MSPs provide sustainable competitive advantage to Facebook.

Both the companies have very strong Research and Development capabilities and lead the market through Innovative products. It is very difficult for a new company to enter into web search or social networking services market and beat Google or Facebook in these markets. So, we can give 1 point to both the companies on this criterion.

2. Presence of Network Effects.

Though Google search product serves multi-sided markets, it doesn’t induce network effects because it doesn’t enable interactions between the users on the two sides. Online advertisers benefit from having a large base of search users, but it doesn’t lead to network effects. However, with the Android product, Google has been able to create cross-side network effects between mobile users and mobile developers. Google is also betting big on Google+, its social networking service. Google+ claims to have over 100 million users in less than a year. It is yet to be seen how Winner-Take-All (WTA) dynamics will pan out between Google+ and Facebook.

Facebook is benefiting from very strong network effects since its inception. Facebook benefits from the same-side network effects between the Facebook users. Facebook also benefits from the cross-side network effects between the developers and the users.

We can give 1 point to both the companies on this criterion.

3. Visibility/Predictability are highly valued.

Both the companies are dependent upon online advertisements for their revenues. Google earns over 96% of its revenue from advertising, whereas Facebook earned 85% of revenue from advertising in 2011. Both the companies have self-serve auction-based Ad products and a “long tail” of customers. This makes modeling or predicting the future revenues of these companies little difficult, as compared to that of product companies.

While both the companies don’t disclose and won’t disclose the following statistics, they can help with some visibility/predictability of their future revenues: How many customers (advertisers) they have? How the number of customers has increased over time? What is the average revenue per customer? What are the revenues from mobile advertising? How they are increasing over time?

As we move more and more from an offline to an online world, both the companies are going to benefit in a big way. We can give 1 point to both the companies on this criterion because their revenues are not going to go down anytime soon.

4. Customer lock-in/High Switching costs.

Both the companies are focused on Lifetime Value (LTV) of the customers. Both the companies are trying to lock-in users with their data in form of emails, photos, videos, documents, and blogs. Google has over 350 million users using Gmail. Over 250 million photos get uploaded on Facebook everyday. Over 4 million businesses use Google Apps for Business. Over 4 billion videos are streamed on Youtube everyday. Facebook has over 100 billion friendships. Both the companies have achieved data lock-in with their users. We can give 1 point to both the companies on this criterion.

5. Gross Margin Levels.

Facebook has higher gross margins than Google. In fact, they are amongst the highest in the Technology Industry. Google gross margins have been improving over years. They also provide enough room for high operating and net margins. We can give 1 point to both the companies on this criterion.

6. Marginal Profitability calculation.

To check whether higher revenues are translating into higher profit margins, we can compare the revenue growth with the operating profit growth. Higher operating profit growth would mean higher marginal profitability.

Over last 5 years, Google operating margins have remained between 30-35% range. For Facebook, operating margins were negative during 2007-08, reached a peak of 52% in 2010, and then declined to 47% in 2011. Google’s revenues and operating income grew at same pace at 23% CAGR from 2007 to 2011. For Facebook, it is not possible to calculate CAGR number because its operating income was negative during 2007-08. However, Facebook operating margins are very healthy and are higher than Google. We can give 0.5 points to both the companies on this criterion.

7. Customer concentration.

Both Facebook and Google have a “long tail” of customers. Both of them are not dependent upon any single customer for their revenues. Both of them have implemented self-serve auction-based Ad products. This makes customers “price accepters” than “price demanders”.

Though Zynga accounted for 12% of Facebook revenues in 2011, Facebook revenues are not highly dependent on Zynga. Moreover, Zynga also needs Facebook for its revenues. Both of them are into a long-term relationship. For Google, no single customer or group of affiliated customers contributed more than 10% of revenue during last 3 years.

We can give 1 point to both the companies on this criterion.

8. Major partner dependencies.

To increase the engagement levels of its users, Facebook has partnered with content companies such as Netflix, Hulu, Spotify, and Washington Post providing online movies, TV shows, music, and news respectively. However, Facebook is not dependent on any single partner.

Google has partnered with content companies that are referred to as Google Network members. Google helps Advertisers extend their Ad campaigns to these Network member websites through its Adsense product. Google shares Ad revenues with these websites in turn. Google gets nearly 30% of its Advertising revenues from the member websites. In addition to the Adsense arrangements, Google has product distribution partners to bring traffic to Google websites. The traffic acquisition costs from distribution partners represent 10-12% of the total cost of revenues. However, Google is not dependent on any single partner for its revenues or traffic acquisition.

We can give 1 point to both the companies on this criterion.

9. Organic vs Heavy Marketing spend.

Both the companies are very well known Global Brands. Both the companies serve multiple audiences: Users, Advertisers, and Developers. So, both companies run different marketing programs for different audiences to achieve different marketing objectives. Both the companies spent nearly 12% of the total revenues on Marketing and Sales in the year 2011. We can give 1 point to both the companies on this criterion.

10. Growth.

Facebook revenues grew from $153 million in 2007 to $3.7 billion in 2011 at a 4-year CAGR of 122%. Google revenues grew from $16.5 billion in 2007 to $37.9 billion in 2011 at a 4-year CAGR of 23%. During 2007, Facebook revenues were 1% of Google revenues. During 2011, Facebook revenues were 10% of Google revenues.

Clearly, Facebook has grown much faster than Google over last 5 years. However, if we take a look back into Google’s early years, its numbers were better than Facebook numbers today. Google was founded in September 1998. Facebook was founded in February 2004. In its 4th year of operations, in 2001, Google revenues were $86 million. By 2005, Google revenue reached $6.1 billion at a 4-year CAGR of 190%.

Whether we consider the base effect or not, Google’s current CAGR of 23% is also a pretty good number as compared to the Industry. So, we can give 1 point to both the companies on this criterion as well.

Summing up,

If we sum all the points up, we will see that both the companies scored 9.5 of 10. The scores are represented over the Canvas as follows:

We believe that both the companies are very promising. Both of them have a big mission that they are after. Google’s mission is to organize the world’s information and make it universally accessible and useful. Facebook’s mission is to make the world more open and connected. These missions are driving scale and innovation in these two companies. The global online advertising market is big and will expand further. These two players are in a good position to capitalize on the global opportunities.

What is your opinion of using this approach to compare the business models of two companies? Does the reasoning help you in judging which company has a superior business model? It is not meant to be an investment guide. But, using the 10-point criteria, you can achieve a better understanding of a company’s business model.

Additional Reading

 

Understanding Facebook Business Model

In the post titled, ‘Understanding Business Model Fundamentals’, we learnt why do we need to understand business models and how to visually represent a business model using the ‘Business Model Canvas’. In this post, we will try to understand Facebook business model using the Canvas.

Facebook is the leading Social Networking Site (SNS) of the World. Facebook mission is to make the world more open and connected. Facebook has built a Multi-sided Platform (MSP) that serves different customer segments with different value propositions.

Facebook helps Internet users stay connected with their friends, families, and colleagues. It helps them discover and learn more about what is going on in the world around them. It helps them express themselves by sharing their opinions, ideas, photos, and activities. Facebook provides a number of products, free of charge, to its users. These include: Timeline, News Feed, Photos and Videos, Messages (Email, Chat, Text Messaging), Groups, Lists, Events, Places, Subscribe, Ticker, Notifications, and Facebook Pages.

Facebook had 845 Million Monthly Active Users (MAU) by the end of 2011. The following statistics are further illustrative of Facebook size and scale: 100 Billion friendships; 250 Million photos uploaded every day; 2.7 Billion Likes and Comments per day.  More than 425 Million MAUs, nearly half of Total MAUs, used Facebook products on Mobile. With so many users using Facebook on a regular basis, it has become an attractive destination for advertisers and developers alike.

Facebook offers a unique combination of reach, relevance, social context, and engagement to the advertisers. Advertisers can engage with users based upon the information shared by users such as Age, Gender, Location, Education, Work history or specific Interests. Facebook offers advertisers an ability to include social context in their Ads. Social context highlights a user’s connections with a brand or business. Businesses can also create Facebook Pages to engage with interested customers and simulate an ongoing dialog with them.

Facebook offers development tools and APIs that enables developers to easily integrate with Facebook. Developers can use Facebook platform to build apps and websites that are more personalized, social, and engaging. Facebook offers developers Open Graph API and Social Plugins that developers can use build different user experiences, including Apps on Facebook, Desktop Apps, Mobile Apps, and Platform-integrated websites. At the end of 2011, more than 7 million apps and websites had been integrated with Facebook. Facebook offers developers an online payment infrastructure that enables developers to receive payments from the users in an easy-to-use and secure environment.

While advertisements remain a key source of revenue for Facebook, the contribution from payments is increasing consistently. Payment revenues increased from nearly 2% in 2009 to 15% in 2011. Ad revenues contributed 85% to the total revenues in 2011.

Facebook is investing heavily into Facebook-owned data centers. This is to support user growth, increased user engagement, and delivery of new products. Facebook data centers currently store more than 100 petabytes (100 quadrillion bytes) of photos and videos. This is going to increase further in the future as users engage more on Facebook. To support these massive storage and computing needs, Facebook custom designed and built their software, servers, and data centers from the ground up.

To increase the user engagement even further, Facebook has partnered with companies such as Netflix, Hulu, Spotify, Washington Post providing online movies, TV shows, music, and news. Their apps help users share what they are watching, listening, or reading with their friends and family.

Facebook business model can be represented over the Canvas as follows. Click the image to see it on Full Screen.

 

Yesterday, on 9th April 2012, Facebook announced a decision to buy Instagram for $1 Billion. Instagram is a photo sharing application that allows its users to apply digital filters to the photos and then share them on different social networking services. The acquisition news is generating lot of buzz because Instagram had no revenues and only 13 employees. However, following statistics of Instagram are impressive: 30 million+ Registered Users; 1 billion+ Photos Uploaded; 5 million+ Photos Per Day; 575 Likes Per Second (~50 Million Likes per Day); 81 Comments Per Second (~7 Million Comments per Day).

In your opinion, how Instagram complements Facebook Business Model? Facebook spent about a quarter of cash they had at the end of 2011 on the acquisition. Was it worth it? Does the Canvas representation of Facebook business model helps you in assessing the acquisition fit?

Assessing a Business Model Attractiveness

In our previous posts, we learnt how to visually represent the business models of different companies using the Business Model Canvas. Our first post, Understanding Business Model Fundamentals, answered why we should study Business Models and how Business Model Canvas helps with the visual representation of a Business Model. Then, we attempted to represent the business models of Google, VISA, and Twitter over the Canvas. In this post, we will learn how to assess the attractiveness of a Business Model from an Investor perspective.

Bill Gurley (Venture Capitalist at Benchmark Capital) wrote an interesting article titled, ‘All Revenue is not create equal – The keys to the 10x Revenue Club’ on 24th May 2011 over his blog at http://www.abovethecrowd.com. In this article, Bill talked about 10 distinguishing traits that warrant high price/revenue multiples and thus higher valuations. These traits are described as follows:

1. Sustainable Competitive Advantage – Here, an Investor is looking for answers to the following questions: Do you know your competition well? What kind of advantage do you have over your competition? Can you sustain it over time? How difficult is it for your competition to provide the same product or service that you provide? Does your business have high barriers to entry?

2. The presence of Network Effects – As per Wikipedia, a network effect is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it. Network effects are present in two-sided markets. Example markets include credit cards, composed of cardholders and merchants; operating systems (end-users and developers); video game consoles (gamers and game developers).

There are two types of network effects: A same-side effect, in which increasing the number of users on one side of the network makes it more valuable to users on the same side; and a cross-side effect, in which increasing the number of users on one side of the network makes it more valuable to the users on the other side. The question to ask is whether your products create Network effects. What kind of Network effects do they create?

3. Visibility/Predictability are highly valued – Investors favor pricing models that provide a high level of predictability & consistency in the future. They would ask you whether your business is vulnerable to the “hit” risk. Do you have follow-on products to your great initial hit?

4. Customer lock-in/High Switching Costs – Investors favor companies with low churn rates of customers and High switching costs. The switching costs can take many forms like Hardware lock-in, Data lock-in etc. How are you creating Customer lock-in with your products or services?

5. Gross Margin Levels – It tells how much leverage exists in the business. Companies with lower gross margins will trade at highly discounted price/revenue multiples because lower gross margins translate into lower net profit margins. You need to answer how your Gross margins compare to that of your competition? If they are high, how will you protect them over time? If they are low, what is your strategy for increasing them?

6. Marginal Profitability Calculation – As per Bill, Investors love companies with scale. Investors will value a company more if higher revenues create higher profit margins, all other things being equal. Marginal Incremental Profitability calculations help Investors understand how well your business is scaling. Investors would ask whether higher revenues translate into higher profit margins for you.

7. Customer concentration – Investors prefer a highly fragmented customer base versus a highly concentrated one. This is because concentrated customers have “market power” whereas small customers are “price takers” in the market. Do you have few big customers or many small customers? Do you have a “long tail” of customers?

8. Major Partner Dependencies – As per Bill, Investors will discount price/revenue valuations of any company that is highly dependent on another partner in some way or another. How much dependent are you on your partners for your value proposition development or for Go-to-Market (GTM) channels?

9. Organic vs Heavy Marketing Spend – Investors love companies where the products/service sales are achieved through “word of mouth” process and the cost of new customer acquisition is low. Lower the marketing spend, the better it is. Does the visibility of your business increases through word of mouth? How your marketing spends compare to that of your competition? What are your Customer Acquisition Costs for new customers? How do they compare to that of competition?

10. Growth – The faster you are growing, the larger your future revenues and cash flows will be. As per Bill, High growth also implies a company has tapped into a powerful new market opportunity, where customer demand is seemingly insatiable. How your business growth compares to that of your competition or your Industry? Are you growing faster than or slower than your Industry?

Different Investors can add more criteria to the list above. But, we would restrict ourselves to these 10 criteria to test the attractiveness of different business models. These criteria force us not only to analyze the financials of a company but also to look at a firm’s position in the context of an industry. These criteria will also help us gain a better understanding of different businesses and industries.

We would be using these criteria to test the attractiveness of different business models. So, let us give a name to these criteria. Since, Bill Gurley first outlined these in his article, we will refer to these as ‘Gurley’s Test’.

These 10 criteria can be visually represented over the Business Model Canvas as follows. The visual representation will help us easily remember these 10 criteria. In the upcoming posts, we will apply Gurley’s Test to different businesses and see how they score.

Please click the image below to see it on full screen.

 

Understanding Google Business Model

In the post titled, ‘Understanding Business Model Fundamentals’, we learnt why do we need to understand business models and how to visually represent a business model using the ‘Business Model Canvas’. In this post, we will try to understand the business model of Google using the Canvas.

Google is among the leading Technology companies in the World. Google is most popular for its Search engine, which helps Internet users get useful results in response to their queries. Google maintains vast index of websites and helps users search different types of content such as Text, Images, Audio, Video, Blogs, News, and Maps through its products. Gmail is another very popular product of Google, for free email services to the users. Google provides social networking services to its users through its Google+ product.

Google provides its services to the Internet users for free. Google makes the revenues from Advertisers who are interested in reaching out to the online users. Google helps them create text-based Ads through Google Adwords – a self-serve auction-based advertising program. These ads appear next to the search results. Most advertisers pay Google on a Cost per Click (CPC) basis, which means advertisers pay when users click their Ads. Google helps advertisers extend their Ad campaigns to the Google Network members’ websites through its Adsense program. Google Network members get a share of Ad revenues in return. Google provides Display Advertising services through DoubleClick advertising technology. Display advertising comprises of video, text, images, and other interactive ads. Display ads appear on Youtube, Google Finance, and Google Network member websites.

Google has developed Android – an open source mobile software platform – that can be used by handset manufacturers to install on their devices and by developers to create applications for mobile devices. Google provides Chrome browser for web browsing. Google is working with several OEMs (Original Equipment Manufacturers) to bring computers running Chrome OS. Google serves the Enterprise market through hosted web-based applications called Google Apps. Google Apps include Gmail, Google Docs, Google Calendar, and Google Sites. People need a browser and an Internet connection to use the Google Apps.

Google has developed a Global Sales and Support infrastructure with specialized teams across different industries. Google multi-product sales force sells campaigns that include Search, Display, and Mobile advertising. Google helps most of its customers with a self-serve approach and tries to bring automation where possible. Google has built a global support team to help advertisers and Google Network members to get the maximum value out of its offerings. Google sales team focus on building relationships with largest advertisers and leading Internet companies.

Google business has 4 key costs elements: R&D, Data center operations, Traffic Acquisition, and Sales & Marketing. Google invests heavily into R&D to create new products and improve existing products. Google is estimated to have over 1 million servers in data centers around the world that process nearly 1 billion search requests every day. Google has invested heavily in these data centers and managing their operations continue to be a key cost element. Traffic acquisition costs comprises of money paid to the Google Network websites under the Adsense program and to the distribution partners who distribute Google Toolbar and other products or drive traffic to the Google websites. Google Sales & Marketing costs include the cost of managing global sales and support teams as well as advertising and promotional expenditures.

Google generates over 96% of its revenues from advertising and this has remained true for last several years. Though Google has evolved its Search offering, got into Mobile space, trying to get into Operating systems, and has build offerings for the Enterprises, any of them has not yet resulted into major revenue streams. Apple, on the other hand, earned 70% of the revenues from products (iPhone and iPad) that didn’t existed 5 years ago. Can Google do that? Can Google innovate its Business Model so that 50% of revenues in 2017 will not come from advertising, but from Google new value propositions in next 5 years? In your opinion, what can be the new revenue streams for Google?

Google Business Model is represented over the Canvas as follows. Please click the image to see it on full screen.

 

 

Understanding Banking Business Model

In the post titled, ‘Understanding Business Model Fundamentals’, we learnt why do we need to understand business models and how to visually represent a business model using the ‘Business Model Canvas’. In this post, we will try to understand the business model of a Bank using the Canvas.

A Bank has broadly two types of customers: One who deposits their money with the bank and one who borrow money from the bank. The banks are a kind of an intermediary between the depositor and the borrower. The business model of a bank is very simple: Offer lower interest rate to the depositor and higher interest rate to the borrower. Make the money from the interest rate differential.

People whether salaried or businessman prefer to keep their money with the bank. It is a better option than keeping it at home because this helps them earn interest income. They trust the bank with their money and believe that it will always be available when they need it. The same people in a different situation would want to borrow money from the bank. The banks offer them the money, but at a higher interest rate.

The depositors and borrowers can be segmented into Retail and Corporate customers. Retail customers are individual consumers, whereas corporate customers can be segmented to small companies, mid-size enterprises, and large corporates.

Banks offer different value propositions to different customer segments. To retail customers, banks offer Home loans, Education loans, Auto loans, and Personal loans. Corporate customers in different industries have different loan requirements. For example, Power sector companies need money to fund power projects. Airline companies need money to purchase airplanes. Construction companies need money for building projects. Before offering them money in form of loans, one critical exercise that banks do is the risk assessment. This is to ensure that they will get back the money, along with the interest, they are lending.

Banks use multiple channels to reach out to their customers. They open branches at convenient locations where their customers can physically meet them. They encourage self-service through ATMs at convenient locations. Banks operate call centers to resolve any issues or queries and to service different kinds of requests. Banks are increasingly leveraging Internet and Mobile channels to offer more convenience to their customers.

In order to reduce their channel costs, banks increasingly look forward to automation. However, they appoint relationship managers to enhance their relationships with their wealthy customers.

The operations of a bank are highly IT intensive. To fulfill their IT needs, banks partner with technology vendors. The technology vendors provide IT solutions in areas of customer experience management, multi-channel integration, business process improvement, loans origination and processing, Risk Management, Business Intelligence, Predictive Analytics etc.

Banking industry is highly regulated by the government. It is very important for regulatory agencies to maintain control over the banks because they are the lifelines of an economy. The control is also needed to protect the depositors against any fraud. One example of a regulatory requirement is the Reserve requirement. It sets the minimum reserves that each bank must hold.

Banks have two key revenue streams. First is the interest income from lenders. Second is the fee that they charge for different kinds of operations. Banks also make money through Credit cards business. We learnt that in the VISA business model case study. Channel costs are the key component of the cost structure of a bank. The interest paid by the bank to the depositors is also one of the important cost structure components.

There exist several different types of banks such as commercial banks, community banks, private banks, state-owned banks, credit unions etc. Some operate within a country’s boundaries, whereas some operate globally. Some focus just on banking, whereas some get into insurance and investment banking businesses as well. Whatever be the case, the basics remain the same.

The basic business model of a bank can be represented over the Canvas as follows. Does the Canvas help you quickly understand how does a bank works? In your opinion, what are the differentiation strategies that banks can use to differentiate their business models?

 

Understanding VISA Business Model

In the post titled, ‘Understanding Business Model Fundamentals’, we learnt why do we need to understand business models and how to visually represent a business model using the ‘Business Model Canvas’. In this post, we will try to understand VISA business model using the Canvas.

VISA business model is very different from a traditional business model. It is not very intuitive enough. Though most of us use VISA credit cards for our payments, very few of us would know how VISA works. In fact, many of us would not even know that VISA is a public-traded company and is listed in the New York stock exchange.

VISA is a Technology company providing global payment solutions to the banks. Its payment product platforms are used by the banks to develop credit and debit card programs for their customers. VISA does not issue credit cards or extends credit to the consumers. Instead, it operates an “Open-loop payments Network” to manage the exchange of information between different financial institutions.

To understand how VISA works, which customer segments it serves, what it offers to its customer segments, and how does it makes money from them, we need to get familiar with few terms. VISA classifies the banks as either Issuers or Acquirers. Issuers issue cards to the cardholders, whereas the Acquirers manage the relationship with the merchants. The diagram below explains what happens behind-the-scenes when a cardholder presents a card for payment to a merchant.

When a cardholder presents a card for payment to a merchant, the payment request is forwarded to the acquirer. The acquirer contacts the issuer through the VISA network. The issuer shares the information on whether sufficient balance is available to carry out the transaction. The information is then routed to the merchant. In case sufficient balance is available, the payment is accepted. Else, it is rejected. The issuer bills the cardholder on a monthly basis. The cardholder pays those bills then.

This is a very simplified explanation of what happens behind-the-scenes. The actual process involves separate loops for Authorization and Clearing & Settlement. VISA also offers several value-added services such as risk management, debit issuer processing, loyalty services, dispute management and value-added information services.

What the above diagram does not tell is how VISA and banks make money in the process. They make money from the transaction fees charged to merchants. To understand how it works, imagine a $100 payment from a cardholder to merchant. In case the merchant fee is 2.4%, the merchant would get $97.60 from the transaction. $2.40 would get unevenly split between issuer and acquirer, depending upon the interchange fee. In case of an interchange rate of 1.8%, the issuer will keep $1.80 and acquirer will keep $0.60. Issuer gets to keep more of the merchant fee because of a higher risk of payment default from the cardholder. VISA makes money on payment volumes, transaction processing, and value-added services.

VISA creates value for all its stakeholders during the process. Cardholders’ benefit because of convenience, security, and rewards associated with card payments. Merchants benefit from improved sales by offering payment method options to the customers. Banks get new revenue streams through card fees, late payment interests, and transaction fee cuts.

VISA captures value through the following revenue streams: Service revenues from banks for their participation in card programs; Data processing revenues for authorization, clearing, settlement, and transaction processing services; International revenues from transactions where the cardholder issuer country is different from the merchant’s country.

In order to create the value, VISA has built a global processing infrastructure consisting of multiple synchronized processing centers. These centers are inter-linked and are engineered for redundancy. Managing these payment networks is a core part of VISA operations to ensure a safe, efficient, and consistent service to the banks, cardholders, and merchants.

VISA is a great example of a “Multi-sided Platform” business model pattern. The platform induces “cross-side” network effects. More the cardholders use VISA, more the merchants will accept it and vice-versa. Since merchants are on the ‘money side’ of the platform, VISA focuses its marketing efforts on the cardholders who are the ‘subsidy side’ of the platform. VISA sponsored FIFA world cup in 2010 and will be Olympic sponsor through 2020. This marketing focus helps VISA in building a strong brand and attracting more consumers.

All the aforementioned discussion is captured on the business model canvas below. Does the Canvas help you quickly understand the big picture of VISA business? Who do you think can threaten the strong business model of VISA?

 

Understanding Twitter Business Model

In the last post titled, ‘Understanding Business Model Fundamentals’, we learnt why do we need to understand business models and how to visually represent a business model using ‘Business Model Canvas’. In this post, we will try to understand Twitter business model design using the Canvas.

Twitter is one of the most popular Social Networking Site (SNS) and Micro-blogging platform in the world. It enables its users to share text messages with a length constraint of 140 characters. These messages (aka tweets) are publically visible, by default. Any user can subscribe to tweets from other users by following them. Users can tweet through Twitter website or Twitter clients and apps for desktops, tablets, or smartphones. The following video (from Twitter early days) explains how it works:

While Twitter started as a service to enable an individual share short updates to a small group, it is now being used for a variety of purposes by different set of users. Some users use it as broadcasting medium to broadcast their own thoughts or the content they want to share. Some users simply sign-in to listen to experts or celebrities or brands, whom they like and admire.  Some use it to discover what other people are saying about their topics of interests; while some use it to follow content publishers to stay informed on the latest.

Businesses are also using Twitter in several ways. Content and Media companies are using Twitter to drive traffic to their websites. It is being used by e-commerce and local businesses for deal promotions. Some businesses are using it as a customer service channel; while some are using it increase their brand awareness and monitor their brand perception. Some non-profits are using Twitter as a fund-raising channel as well.

Twitter started as a service in 2006. It gained immense popularity in 2009-10. As on 8 Sep 2011, as per Twitter official blog, Twitter had 100 Million active users. More than half of them logged in each day. As on 26 Jan 2012, as per Twitter official blog, 1 Billion tweets were send every four days, which means 250 Million tweets were shared every day.

With so many users connected to the platform and using it on a regular basis, it is becoming an attractive destination for the advertisers. Unlike other SNS websites, Twitter hasn’t yet started offering the option of ‘Display Ads’ to the advertisers.  Instead, it has provided them with the following innovative ways to reach the users:

  1. Promoted Accounts – Businesses can scale up their follower-base through Promoted Accounts product. The promoted account appears in search results and within the ‘Who to Follow’ section (powered by Twitter’s account recommendation engine). Promoted Accounts are offered through Cost-Per-Follow (CPF) auction, where a business is charged when a user converts into a follower.
  2. Promoted Tweets – Businesses can promote key messages through Search Results to the non-followers of their account. Promoted Tweets can also be targeted at followers of a business or at the users having similar profile to that of a follower. Promoted Tweets are offered through Cost-Per-Engagement (CPE) auction, where engagement is defined as click, favorite, retweet, or reply of a promoted tweet.
  3. Promoted Trends – Businesses can leverage Promoted Trends product to scale conversations and build mass awareness. Trends reflect hottest topics of discussion during a moment. They appear next to a user’s timeline. Promoted Trends appear at the top in the Trends section.

Twitter is an example of a multi-sided platform. Twitter has built an App ecosystem. Twitter offers APIs that help developers build third party apps. Twitter for Websites (TfW) allows easy integration of twitter into websites with Tweet and Follow buttons. Search API allows a user to query Twitter content and find tweets meeting a search criterion. REST API allows access to core Twitter objects such as timelines, status updates, and user information. Streaming API provides real-time access to Twitter firehose. It helps developers with data-intensive needs.  As per Twitter official blog on 11 July 2011,

“Application developers play a fundamental role in helping people get the best out of Twitter. As an ecosystem, we’ve just crossed one million registered applications, built by more than 750,000 developers around the world. This is up from 150,000 apps just a year ago.  A new app is registered every 1.5 seconds, fueling a spike in ecosystem growth in the areas of analytics, curation and publisher tools.”

Twitter business goal is simple: Increase the number of users using the service. This will help attract more advertisers. While third-party apps help increase website traffic and content usage, Twitter has entered into different kinds of partnerships to increase awareness and drive more users to the service. Here are 4 kinds of Partnerships that Twitter has entered into:

  1. Search Vendors – Twitter licenses full feed of public tweets to search engine vendors such as Microsoft (Bing Social), Google (Google Realtime), and Yahoo. This helps in enabling real-time search and discovery.
  2. Device Vendors – Twitter partnered with Apple to enable deep integration of Twitter in iOS5 mobile operating system for iPad, iPhone, and iPod touch. This means users can tweet directly from Apple apps such as Camera, Photos, and Safari, along with third-party apps such as Flipboard, Livingsocial, and Instagram.
  3. Media – Twitter has entered into partnerships with companies such as Mass Relevance and Crimson Hexagon to help media companies and brands deliver compelling Twitter integration to their users more easily. This can help media companies capture real-time reactions to the important news. Though these partnerships are not major source of revenue, they help in expanding user base. Additional visibility drives further growth for Twitter.
  4. Mobile operators – Twitter has partnered with Telecom operators across the globe to enable users to send and receive tweets from mobile phones using SMS.

All the aforementioned discussion is captured on the Business Model Canvas below. Though we have attempted to capture all important aspects of Twitter Business Model, we might have failed to capture some. What do you think we have missed? Does the Canvas help you quickly understand the big picture of Twitter business?

 

Understanding Business Model Fundamentals

This post attempts to answer the following 3 basic questions on business models: What is a business model? Why do we need to study business models? How to describe a business model?

Business model is a term that is very loosely used in our day-to-day conversations. Business managers often use this term, without a complete understanding of it. When they use the term business model, they are either referring to the revenue model or the operating model. But, business model is much more than that. Before we start discussing business models, let us discuss what a model is and why do we build models.

A model is a simplified version of something. It is the scaled representation of a real object. The real object can be much larger or smaller than the model representation. Models are often discussed in the field of architecture, where we build models for buildings and other physical structures. Models not only help in the process of planning and construction of new structures, but also in the understanding the design of existing structures. Models are also used in the field of engineering to showcase the design of physical products such as automobiles, aircrafts, rockets, railways, and ships. The goal is simple: Increase our understanding of the real world objects while eliminating the unimportant details.

While physical models resemble the real world objects they represent, there exist schematic models and mathematical models that are more abstract than a physical model. Schematic models provide a pictorial representation of conceptual relationships. Diagrams, Charts, and Blueprints are examples of a schematic model. They help us avoid costly mistakes. They also help us in asking “what if” questions.

A business model is a kind of schematic model that helps us gain the complete picture of an organization business from a high-level perspective. A business model is a framework that helps us understand how different entities of a business come together to create value for customers. These entities may include Marketing, Sales, Engineering, Manufacturing, Production, HR, Finance, IT, Administration, Partners, and Suppliers. A good understanding of business models can help managers in these different entities with the following:

  1. Quickly gain the big picture of the business. Understand how different pieces fit together.
  2. Develop the business models vocabulary. Learn to speak the language of business models.
  3. Develop a shared understanding. Conduct high-quality discussions and meetings among inter-disciplinary teams.
  4. Think beyond product/service innovation. Consider innovation in different facets of business.
  5. Bring structure to the innovation thought process.

In Architecture, any physical structure consists of several building blocks that need to be assembled to build the structure. For example, a building has stairs, elevators, electricity system, water system etc. Similarly, a business model has several components that need to be defined to understand a business. Several scholars have attempted to define the basic components and have built different frameworks using those components. The following papers discuss the attempt of those scholars:

Dr. Alexander Osterwalder – A Thought Leader in the field of Business Models Innovation – has authored a book titled, ‘Business Model Generation – A Handbook for Visionaries, Game Changers, and Challengers’.  As per Dr. Osterwalder, a Business model is defined as follows:

“A Business Model describes the rationale of how an organization creates, delivers, and captures value.”

As per Dr. Osterwalder, a business model can be described through 9 basic building blocks. These are listed as follows:

  1. Customer segments: Who are the group of customers?
  2. Value proposition: What is the offer for each customer segment?
  3. Channels: How to reach each of the customer segments?
  4. Customer Relationships: How to relate with customers over time?
  5. Revenue streams: How to earn revenues?
  6. Key resources: What assets are required to run the business?
  7. Key activities: What are the important activities/processes?
  8. Partner network: Who are the key partners and suppliers?
  9. Cost structure: What are the important costs?

These 9 basic building blocks can be shown visually using a diagram called ‘Business Model Canvas’. Please watch the video below explaining the business model canvas.

A good understanding of business model canvas is essential before the understanding of business models of different companies. This is because it visually demonstrates the inter-linkages between different elements of a business model. The canvas is very practical and easy-to-use. The canvas helps in generating new ideas by asking few key questions. Please visit the following link to download the business model canvas and learn those key questions.

http://www.slideshare.net/Alex.Osterwalder/business-model-canvas-poster

The different components of business model canvas are explained in the beginning pages of ‘Business Model Generation’ book. The first 72 pages of the book can be downloaded for free from the following link. These will help in a better understanding of business model canvas.

http://www.businessmodelgeneration.com/downloads/businessmodelgeneration_preview.pdf

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