Recently, a reader of my August column “A Field in Flux” asked me for more details about business models relevant to the retirement income opportunity. As I was thinking about his question, I noticed that a couple of robins had built a nest near my office window.
About a month later three baby robins appeared. A few weeks later they looked like their parents and then they were gone. This made me curious about robins in general — they belong to the thrush family — and their survival rate in particular.
The news was as expected: Robins reproduce at a rapid rate — two broods of four babies per year on average. They also fail at such a rapid rate that they are often used as an example of population dynamics. Failure is pervasive in real life.
This is also a key feature of business models. Most implementations of a specific business model fail. What goes for robins goes for business. Interestingly, the average venture capitalist’s portfolio companies seem to fare just as badly as robins do with a 90 percent failure rate.
The field of formal study on business models is not very crowded. For starters the term “business model” does not have a settled definition. Much of the available research focuses on value-chain analyses. However, a 2005 Working Paper from MIT’s Sloan School of Management — “Do Some Business Models Perform Better than Others? A Study of the 1,000 Largest U.S. Firms,” by Peter Weill and others — breaks new ground.
This paper presents a new typology of business models. This typology is more actionable from a practitioner point of view than the value-chain versions.
The typology is based on finding answers to the question: what does your business do in order to make money? The paper organizes the answers across two dimensions: the types of assets involved (physical, financial, intangible and human) and the types of rights being sold (the right of ownership of an asset, the right of use of an asset, the right to match an asset with potential buyers or sellers).
These rights create four basic business model archetypes — creator, distributor, landlord, broker — that can be arrayed across types of assets to define business models. Fortunately, we do not need to review all the business models. We can limit ourselves to the four archetypes as they apply to financial asset types.
Examples of financial creators include serial entrepreneurs who start and sell other companies. This is the case in this typology because creators significantly transform or design the financial assets that they sell.
Financial distributors include traders who buy and sell financial assets without significantly transforming them. Banks and other financial firms that invest for their own account are included in this business model.
Financial landlords let others use cash or other financial assets under specific and limited conditions. Examples include lenders and insurers. Lenders provide cash that borrowers can use for a limited time in return for a rate of interest. In return for a premium, insurers provide access to their financial reserves if the client experiences well-defined losses.
Finally, a financial broker matches buyers and sellers of financial assets.
Whether you are a financial creator, distributor, landlord or broker, it is useful to specify the tactical sales model that powers your business model. In particular, I have found the following questions very useful in order to understand the sometimes hidden, yet crucial, cash flow/asset/liability profile of specific companies:
o Are you selling the equivalent of a put option?
o Are you taking a toll from the flow of business around you?
o Are you buying the equivalent of a call option?
If you earn a fee but your customer can put the asset back to you, you run the risk that a “black swan,” or low-probability, high-impact event, can put you out of business. In the current crisis some mortgage and variable annuity business models have shown the salient characteristics of selling puts.
A great many businesses take a toll from the traffic that flows around them. Many AUM-based businesses have the salient characteristics of taking a toll. As evidenced by income-tax collectors, highway tolls and AUM-based investment fees, this is a powerful business model.
If you buy a call, you may lose some money every day, waiting for the great outcome, the liquidity event that pays for all the daily losses and more — much more. Entrepreneurial ventures have the salient characteristics of buying a call.
While selecting a business model is important, tactical adaptations are the bread and butter of daily life. Some Retirement Income Industry Association members understand that they are working with an old (investment-focused) business model. Their most pressing need is to find tactical adaptations to make the old model last as long as possible. Solutions include renewed attention to growth areas such as IRAs.
Other members are starting or acquiring new (retirement income) business models. Their most pressing needs are all about planning and execution, including correctly pricing the cost of extinction. Remember the rate of success (or extinction) for start-ups. Not all new business models will work. Not all implementations of the right business model will work either. The important thing is to try and to try again.
There is an interesting parallel with RIIA’s credo “first build a floor, then expose to upside.”
In order to try and try again, you must build a floor that catches you when — not if — you fail, so that you can pick up the pieces and start again. What goes for robins, goes for business. What goes for business, goes for clients. Clients will not always succeed. Not all clients will succeed. We should not be planning for perfection. We should be planning for failure, since it is more prevalent than success.