Economic Model Series, Part 1: What is a Business Economic Model?
December 8, 2011
This is the first in a series of posts that I am writing aimed at helping entrepreneurs maximize their economic performance. You can find a summary of the economic model series here.
Business Economic Model Defined
A business economic model describes how your business works from an economic perspective. Simply put, it describes how the people and other resources, your costs, perform activities and how those activities stimulate your market to create customers, your revenue. Understanding this relationship from a cash perspective is the key to understanding the economics of your business and is also the key to gaining insights to what you might do differently to improve your economic performance.
A slightly different description is that your economic model is the lens that views your business model from a perspective of how your resources (costs) create customers (revenue).
Why Think About Your Economic Model?
Most entrepreneurs work hard to build a product that has a great product-market fit and then to grow their user/customer base while working to establish their competitive advantage over their competitors. The most valuable companies are built this way, but they are also built with great economic model performance in mind.
Great value comes to great companies, and part of the ultimate definition of a great company is that its economic model works well. They figure out:
- How to become large without a lot of capital being consumed (this is the key to owning a greater amount of your business)
- How to make a lot of money (this is the basis for your financially-based valuation, which could be based on top line, gross profit, or bottom line)
- How to grow their economic results over a long period of time
- How to communicate to and convince others that they are a great company and will have great economic results and growth far into the future (this is the key to ultimately getting a great valuation multiple!)
Not all companies or entrepreneurs are out to build great companies, but every entrepreneur should be considering his/her economic model. Every entrepreneur is different:
- Some want to build a core team or technology, or set of features that a larger company wants and is willing to pay for. If this is the case for your company, you should still consider your economic model as you most likely can build your company in a way that’s more capital efficient.
- Other entrepreneurs will be acquired prior to becoming great companies. If this is the case for your company, then you will want to be able to demonstrate and communicate your amazing economic model and how your acquirer will make a lot of money by acquiring you.
- Still other entrepreneurs want to become large independent (public or private) companies. If this is the case, then build your business with a great economic model in mind!
My next post is on “Why You Don’t Think About Your Economic Model (Enough)?“
If you want to learn more about economic models, keep reading. I would also appreciate any comments or suggestions that you have, as I plan on turning this series into an e-book and I want to make sure that it is as clear and complete as possible.