tech business models
A year back, I would have said, "You just launched a website, and you call your company a tech company."
Now, I'd rather say, "You just wrapped some LLMs APIs around your product, and you call your company an AI Startup!"
In short, the landscape has changed, and the substance is the same.
There are some critical requisites before you can classify a company as a tech company.
And keep in mind that this is not about words; it's about substance.
A tech company is fundamentally different from a non-tech one.
How so?
In Business Engineering, I put together a framework to understand the critical components of a tech company.
VTDF Business Model Template
Keep reading if you want to understand how to use the framework.
Value model
It usually all starts with a value model which comprises:
An opportunity: the size of the opportunity will be determined by whether the market exists, whether it's still building up, and its growth potential. From the opportunity, it's possible to evaluate the potential market size (tech companies usually look at TAM).
A problem to be solved: a problem can be practical or go beyond that. Companies like Nike and Coca-Cola focus most of their efforts on demand generation. This also applies to tech business models. Before the iPhone, people didn't know they needed a smartphone in the first place.
A set of value propositions: a company will develop a core value proposition from the above. As it scales, it will be able to satisfy a set of value propositions, which are the glue that keeps together customers and the company.
Mission and vision: as the company develops its various models, it also develops its core beliefs, comprising its mission and vision.
Technological Model & R&D Management
Technological modeling is a discipline that provides the basis for companies to sustain innovation, thus developing incremental products.
While looking at breakthrough innovative products that can pave the way for long-term success.
In a sort of Barbell strategy, technological modeling suggests having a two-sided approach, on the one hand, to sustain continuous innovation as a core part of the business model.
On the other hand, it places bets on future developments that have the potential to break through and take a leap forward.
Continuous Innovation: How do we handle engineering resources to sustain continuous innovation for business model expansion?
The technological model is the enhancer of the product, and it helps merge together the value proposition with the distribution model.
When engineering is done right, it helps bridge the gap between what customers still miss, the product, and the way the product is distributed.
The technological model will help satisfy the need of a larger and larger portion of the market, from early adopters to potential laggards. This will determine the ability of the company to scale up.
In his book Crossing the Chasm, Geoffrey A. Moore shows a model that dissects and represents the stages of adoption of high-tech products.
The model goes through five stages based on the psychographic features of customers at each stage: innovators, early adopters, early majority, late majority, and laggards.
In the technological model, the way R&D is managed to produce continuous innovation (to sustain the linear growth of the business) and breakthrough innovation (to enable the long-term success of the business) is critical.
On the other hand of the technological spectrum, you also ask:
Breakthrough Innovation: How do we handle engineering resources and look into very unusual (first-principle-based) solutions which might open up a whole new business model?
In other words, you handle continuous innovation in a path that leads toward the use of resources in a more linear manner.
You also need to balance this out with some aggressive bets on the future that move non-linearly and which might be the ones that make your business model obsolete in the foreseeable future.
Placing these bets is critical to ensure you might have a sense of when your business model is becoming obsolete.
You might say, "why do I want to do that?" Well, because if you don't do that, someone else on the market will do that.
So better to take the chances (in the future) to kill your own business model and yet open the way to new incredible opportunities, or someone else will simply do that for you!
For the sake of it, it's always crucial to leave some pockets of breakthrough innovation (10-20% of the company's resources toward this goal!).
Distribution Model
Distribution, Marketing & Sales: How do we reach, frame, communicate, fulfill and sell the product to the right audience?
The distribution model helps to bring the product into the hands of customers.
The company can leverage engineering, marketing, sales or all of them to make the product fit with the market via its distribution.
That is why, based on what problems the product solves and for whom, it will have an organizational structure more skewed toward engineering and marketing, engineering and sales, or perhaps a mix of the three.
Other things like partnerships and deal-making are also part of the distribution model.
Financial model
Financial Model: How does the company make, and spend money? Is it profitable? And how does it manage its cash for future growth?
In corporate finance, the financial structure is how corporations finance their assets (usually either through debt or equity).
For the sake of reverse engineering businesses, we want to look at three critical elements to determine the model used to sustain its assets: cost structure, profitability, and cash flow generation.
The financial model is what enables the company to keep generating enough cash to sustain its operations, not only in the short-term but also toward R&D and innovation.
And it is made of several components:
Revenue model.
Cost structure.
Profitability.
And cash generation and management.
Revenue model
Revenue modeling is a process of incorporating a sustainable financial model for revenue generation within a business model design.
Revenue modeling can help to understand what options make more sense in creating a digital business from scratch; alternatively, it can help in analyzing existing digital businesses and reverse engineer them.
Cost structure
The cost structure is one of the building blocks of a business model. It represents how companies spend most of their resources to keep generating demand for their products and services.
The cost structure together with revenue streams, help assess the operational scalability of an organization.
Profitability
From how the company generates revenues and its cost structure, profitability will be determined.
When the revenue model isn't yet efficient enough to cover up or sustain the cost structure in the long-term, there is when we have a lack of profitability.
At the same time, it might happen that a company is profitable but it lacks cash, given its overall financial model.
Or it might happen that a company has no profits, or very tight margins and yet it generates a continuous stream of cash.
That is why it's critical to look at the next element.
Cash generation and management
The cash flow statement is the third main financial statement, together with the income statement and the balance sheet.
It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing, and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.
Profitability doesn't tell us the whole story.
We need to look at cash management. A company like Amazon have been running at very tight profit margins for years, and yet generating massive amounts of cash, invested back in its operations.
A company like Netflix has been generating good profit margins, but running with a cash negative model.
This isn't good or bad in absolute, but it gives us an understanding of the company's financial mode.
Perhaps, Netflix, with a negative cash flow model, it has been investing substantial cash in the development of original shows, which are both critical to generate revenue and also essential to its brand's strategy.
Thus, revenue generation, distribution, and marketing come together here.
VTDF framework: Key Elements
According to the VTDF framework, a tech business model can be broken down into four sub-models:
1. Value model (value propositions, mission, vision), to answer questions, such as:
Vision: What's the long-term hard problem you're solving?
Mission: How do you get closer to achieving this hard problem in the short term?
Value Proposition: What use cases do we prioritize, as they are in target with our customers' needs?
2. Technological model (R&D management) to answer questions such as:
Continuous Innovation: How do we handle engineering resources to sustain continuous innovation for business model expansion?
Breakthrough Innovation: How do we handle engineering resources to promote breakthrough innovation for business model reinvention?
3. Distribution model (sales and marketing organizational structure) to answer questions such as:
Marketing & Sales: How do we communicate and sell the product to the right audience?
Product Engineering: How do we enable built-in features that help us distribute the product?
Partnerships: Who do we partner with to expand our audience?
Deal Making: What deals do we close that help us get to our audience?
4. Financial model (revenue modeling, cost structure, profitability, and cash generation/management) to answer questions such as:
Revenue Generation: How does the company make money?
Cost Structure: How does the company spend money to make money? (cost of sales)
Profitability: Is the company profitable?
Cash Management & Generation: Is the company cash positive?
From the balance and mixture of those four elements, a viable business model is built.
VTDF Framework: Real-World Case Studies
Tesla VTDF Framework
Value Model:
Opportunity: Transitioning the world to sustainable energy.
Problem to be Solved: Combating climate change by reducing carbon emissions through electric vehicles and sustainable energy solutions.
Value Proposition: High-performance electric cars, solar products, and energy solutions.
Mission and Vision: To accelerate the world's transition to sustainable energy.
Technological Model:
Continuous Innovation: Regular over-the-air software updates, improving vehicle performance and features.
Breakthrough Innovation: Autopilot and full self-driving capabilities.
Distribution Model:
Marketing & Sales: Direct-to-consumer sales, showrooms, and online platforms.
Product Engineering: Integration of software and hardware for a seamless user experience.
Financial Model:
Revenue Generation: Sale of vehicles, energy products, and software updates.
Cost Structure: Manufacturing, R&D, sales, and service centers.
Profitability: Initially loss-making, moving towards profitability with increasing scale.
Spotify VTDF Framework
Value Model:
Opportunity: Growing demand for digital music consumption.
Problem to be Solved: Providing a vast music library on-demand without needing to purchase tracks or albums individually.
Value Proposition: Stream millions of songs ad-free, with offline mode and curated playlists.
Mission and Vision: Unlock the potential of human creativity by giving a million creative artists the opportunity to live off their art.
Technological Model:
Continuous Innovation: Personalized playlists, podcast integrations, and user experience enhancements.
Breakthrough Innovation: Spotify Wrapped, a personalized yearly music review.
Distribution Model:
Marketing & Sales: Freemium model with premium subscriptions, partnerships with telecom providers.
Product Engineering: Integrations with smart devices, cars, and other platforms.
Financial Model:
Revenue Generation: Subscription fees, ad revenues.
Cost Structure: Licensing music, tech infrastructure, R&D.
Profitability: Focus on growth, with profitability challenges due to high licensing costs.
Airbnb VTDF Framework
Value Model:
Opportunity: Growing demand for unique and affordable travel accommodations.
Problem to be Solved: Connecting travelers with local hosts offering space in their homes.
Value Proposition: Unique travel experiences in local homes, often cheaper than hotels.
Mission and Vision: Helping people feel they belong anywhere.
Technological Model:
Continuous Innovation: Improved search algorithms, enhanced host tools, and guest experience features.
Breakthrough Innovation: Airbnb Experiences, offering tours and activities led by locals.
Distribution Model:
Marketing & Sales: Word-of-mouth, referral programs, and digital marketing.
Product Engineering: Seamless booking process, integration with other travel services.
Financial Model:
Revenue Generation: Taking a percentage of each booking from both hosts and guests.
Cost Structure: Technology development, marketing, customer support.
Profitability: Focused on growth, with profitability challenges due to marketing and expansion costs.
Recap: In This Issue
A solid tech business model is built on four key sub-models: value model, technological model, distribution model, and financial model.
The value model focuses on the long-term hard problem the business is solving, the opportunity in the market, the problem to be solved, and the value propositions offered.
The technological model bridges the gap between customer needs, product development, and distribution. It emphasizes continuous innovation and R&D management to meet market demands, while also aggressively betting on breakthrough innovation, which in the future, might make a business model obsolete!
The distribution model involves marketing, sales, partnerships, and deal-making to bring the product into the hands of customers. It determines how the product is communicated, sold, and distributed.
The financial model encompasses revenue generation, cost structure, profitability, and cash generation/management. It ensures the company generates enough cash to sustain operations and support R&D and innovation.
Revenue modeling helps design a sustainable financial model for revenue generation, while the cost structure and profitability determine operational scalability and financial viability.
Cash generation and management are critical for assessing the liquidity and financial health of the company.
The VTDF framework emphasizes the importance of value propositions, mission, vision, continuous innovation, breakthrough innovation, sales and marketing strategies, partnerships, revenue modeling, cost structure, profitability, and cash generation/management.
The combination and balance of these four sub-models form the basis of a viable tech business model.
Ciao!
With ♥️ Gennaro, FourWeekMBA
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This was amazing. Thanks for a great read!