A business model is:
- A buzzword
- A set of hypotheses for how a company creates and captures value
- The way a company makes money
- All of the above
The history of business models does not stretch back very far. According to Google’s fine NGram Viewer which analyzes published texts, the concept has only become popular in the late 1990s, trailing the term “business plan.”
There are many theories for why this time period spiked the growth in ideas theories and frameworks about business models. The rise in business publications, the rise in entrepreneurship, the need to explain complex ideas inherent in technology becoming a major force in business are all posited as explanations.
I’ll give you my own oral history: as a tech equity analyst scrub in the 90’s, the moment that Netscape went public was a defining and seismic shift in how we all thought about business, models, and technology. We were using spreadsheets to create business forecasts to do our work, and publish our predictions to “the Street” to trade on our predictions. In fact one of the older analysts showed me his grand file cabinet of the time before Lotus 123 and Excel – actual handwritten spreadsheets and analysis of tech ! firms.
Prior to Netscape, we covered semiconductor companies (Intel, AMD), semiconductor equipment companies (Applied Materials, Tencor, KLA), storage companies (Western Digital), PCs and enterprise computing (Apple, IBM), software (Microsoft, SAP) and other high growth public companies. There was a lot of stuff in those business models: equipment, components, machines. Even the software companies used floppy disk drives to distribute in the time before the cloud.
Then came Netscape.
Before Netscape, I had an obscure job. No one knew or cared what I did when I said I was an equity analyst covering early stage tech companies. At dinner parties I was encouraged to talk about something else, or risk boring the guests.
Then all of a sudden, everyone knew about Netscape, and my job was super interesting to people. A taxi driver taking me to JFK for a flight to San Jose asked me if he could get in on the IPO. Netscape was beyond technology – it was an experience that enlivened the imagination and created massive possibilities for what was about to happen. Regular investors were interested in the stock, and wanted to be a part of that history. I was suddently popular at dinner parties (but only for that short blip of time).
Just around the time of the IPO, we created our first official estimates of revenue and profit. I sat looking at my Excel spreadsheet, with all of the potential revenue projections. Netscape was already licensing its software to telecom companies, they were already selling advertising on their popular browser, and they were charging consultancy fees.
Most importantly, Netscape had done something remarkable: long before the term “freemium” was coined, they were driving aggressive usage and growth by giving the browser software away for free to anyone to use and then charging for enterprise fees.
From Netscape’s original prospectus, thanks to Archive.org:
The Company derives its revenues from license fees for its software products and fees for services, which are generally charged separately from software licenses. Product revenues consist of product licensing fees, and service revenues consist of fees for maintenance and support services, training, consulting and advertising space.
Total Revenues. Total revenues were $696,000, $4,738,000 and $11,888,000 for the period from inception (April 4, 1994) through December 31, 1994 (the “Inception Period”), the quarter ended March 31, 1995 and the quarter ended June 30, 1995, respectively.
For the younger folks reading who were born around this time – Netscape was a major change.
The stock was priced to be offered at US$14 per share, but at the last-minute the price was doubled to US$28 per share. On the first day, the trading floor screamed with cheers of adrenaline and greed as the stock’s value soared to US$75, nearly a record for first-day gain. On the first day of trading, the stock closed at US$58.25, giving Netscape a market value of US$2.9 billion, for a company with no profit.
The fact that the IPO was even accomplished proved that there was an appetite for investors to buy into companies that were not yet profitable. Now commonplace as SaaS enterprise companies go public still spending into growth, Netscape was the first of its kind.
As an analyst, it was difficult to estimate revenue, cost, and profit – because of all of the potential scenarios.
It was beyond complicated. What was the realistic growth of continuing to sell to telcos like MCI and Bell Northern? Their total addressable market? What about Digital Equipment Corp and and SGI and customers like them – were they the most likely to grow? How should I predict the growth of that tiny bit of advertising revenue?
I can’t remember those original projections, but I do remember staring at that blank screen of zeros, and thinking that the story would be much more complicated than anything that came before it. We needed a business model theory, not just a financial projection.
I believe that moment in 1995 is when the need for a business model (vs. a business plan) was born.
Business plans were carefully vetted growth projections, and long expository explanations for how the company would grow. We needed a better concept – a way of dealing with the potentiality and the optionality. A way to model the interactive and constantly shifting scenarios.
What is a business model?
Answer: All of the above.
It’s still a buzzword. Academics still argue about the meaning of the term. Essentially it refers to how a company makes money, and business modeling, the verb, has become a practice. Business modeling is the art of testing a set of interlocked hypotheses for how a company creates and captures value.
In the past five years, business modeling expanded beyond the roles of financial types – CFOs, analysts, investors – into the hands of practitioners. Thanks to tools like Alexander Osterwalder’s Business Model Canvas, Steve Blank’s Lean LaunchPad, and Eric Ries’s Lean Startup Movement, entrepreneurs in companies small and large are practicing the art of business modeling to find their path to growth.
Business modeling never ends. Why?
Post script. Back to that Netscape IPO.
The companies all struggled:
- Netscape, the company, saw continued growth but was attacked by Microsoft’s Explorer browser and AOL later acquired Netscape, sunsetting the product in 2007.
- None of Netscape’s top client lists at the time of IPO remains intact as standalone companies.
- MCI merged with Worldcom, went bankrupt, rose again, and was then acquired by Verizon.
- Bell Northern was later folded into Nortel, which also suffered bankruptcy after the dot com bubble collapse.
- Digital Equipment Corp is the case study for Clay Christensen’s disruptive innovation theory. Digital failed to adapt after the personal computer eroded its minicomputer market. Compaq bought DEC in 1998, and then HP later acquired Compaq
But the founders outperformed:
- Jim Clark is now a Yachtsman and philanthropist, after a long career as a serial entrepreneur (Silicon Graphics before Netscape, then myCFO and Healtheon – the subject of Michael Lewis’s book New New Thing).
- Marc Andreesen became the founder of one of the largest and most potent Venture Capital firms Andreesen Horowitz, where he invests in the primary theme: “Software is eating the world” and engages in fiery tweetstorms about the future of technology and businesses.
My lessons learned:
Mastering the art of business models is good for your career.
Business models are best practiced as a method: of testing a set of interlocked hypotheses for how a company will create and capture value.
Put the tools in the hands of the practitioners. The real innovation in business models comes from shared learning and understanding between the entrepreneurs launching a venture, and growing a company. Not just from the financial analysts putting educated guesses into spreadsheets.
How about your personal story? When did you first encounter the business model concept (vs. business plan, or business case)? Does the hypothesis definition ring true for you?