Business Model as a Disruptor

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If you take away one key message, it is this: the breakthrough technology, the new market discovery, and the disruptive business model together add up to the perfect storm for a startup. You obviously want breakthrough technology, and you obviously want to discover a new market or white space (consumers in healthcare, a new way to get coffee to people). But if that can also become a disruptive business model, that in and of itself is so significant that you have the perfect storm. Nothing is better than being in a place where nobody else is, with a product nobody else has, sold in a way nobody else can. Think of it as a three-legged stool: business model is one of the key legs, but it will not stand alone. If you build a brilliant business model but never identify the right segment or figure out how to lead it to market, it is only a piece of the puzzle.

Here is something I rarely say so emphatically: most of the time I hear founders claim they have an absolute breakthrough product or service, and they do not even think about the other two legs. They believe the better mousetrap will make people beat a path to their door. Not only do I not think that is true, a lot of the best businesses being built right now do not even have breakthrough technology. They are the same kinds of products and services, but they have a fundamentally disruptive business model, and that is what changes the game.

Why the business model matters as much as the technology, in financial terms. Can anyone say why? “Products don’t sell themselves.” Exactly. No matter how good your technology, people do not even know about it, so how are they going to find it? What does it cost for people to find out about your product versus develop it? It is usually double. If you look at a software company P&L, on average about 15 to 20 percent of the P&L is spent on R&D and 30 to 40 percent, in other words double, on sales and marketing. So even with a brilliant product, twice the amount you spend building it gets spent taking it to market, and the business model is about getting multipliers and levers to take that cost out and the revenue up. And the valuation impact is enormous: work we did with Goldman Sachs shows that companies that get their business model right can have literally 5 to 10 times higher valuations than those that do not. Somebody does something smarter in their business model and is worth 10 times more than you. It happens all the time.

Startup Secret: connect the dots as a founder. If you get your business model wrong, you spend more, you take more cash, your ownership goes down, and your valuation goes down. If you get it right, you spend less, you are very cash efficient, you get better valuations, you have lower dilution, higher ownership, and a much bigger outcome as a founder. This directly impacts your bottom line.

Startup Secret: rewrite the rules and create an innovator’s dilemma. Would you rather walk onto a playing field where you have to play by a whole bunch of rules a competitor set for you, or would you rather reorient the whole field, set out your own rules, and let the competitors come figure out how to play by yours? Obvious. And the best business model probably has not been invented yet. Do not take somebody else’s business model and just apply it to your situation, because at that point you are adding very little value. If Red Hat’s Jim Whitehurst comes to tell you how they took a commodity, in fact a free product called Linux (which at the time was way behind operating systems like Sun’s Solaris), and built a business valued in the billions, you will see there was very little truly innovative about Linux as an operating system. What was differentiated was the business model.

Symantec antivirus: giving away the software. I am going to date myself with a story that is well over 20 years ago. Symantec is a multi-billion-dollar company today, but back then our revenue was well under $50 million (probably $20 to $30 million), and we had more than 20 products: add-ins for Lotus 1-2-3, Think C and Think Pascal on the Mac, a database, a word processor. Our best-selling product was Symantec Antivirus for Macintosh, and the Mac really was plagued with viruses in those days. It was a great business. We used to sell packaged software in boxes through retailers, and people paid a lot of money for it as a perpetual license.

We also acquired Peter Norton (known for utilities, disk recovery, backup) and changed the brand from Symantec to Norton, which turned out to be critical. But the real change was the business model. When we brought antivirus to the PC, we had the classic product-marketing debate: “We are number one on the Mac, why not just copy the model, same channels, same perpetual license?” Thank goodness we stopped. At the time there were maybe 100 viruses on the whole planet, and they were coming out faster and faster (today there are tens of thousands). We realized customers do not want software. What do they want? To stop viruses. The value was not in the software, it was in getting the virus definition before it ever attacked your machine. So we flipped it on its head. We gave away the antivirus software (and remember, this was before the web, so giving it away actually cost us money to manufacture and ship), because without the software on everybody’s machines we had no basis to send updated virus definitions. Then we charged a subscription for the definitions.

This is like going to the doctor and saying, “I don’t know what the next COVID is, but give me the shot in advance.” Would people pay for that? Absolutely. It was not a nice-to-have, it was essential for enterprises, and they did not care about the software, they cared about whoever had that virus definition first. Suddenly we had a completely predictable, monthly recurring subscription business, because every time a virus came out we knew people would want it and would keep paying. We had our team, mostly in Ireland, staying ahead of the signatures and even predicting them. We took out two competitors within a year (Central Point, PC Tools), they were just gone. It increased the price of our products by 50 percent per seat. And it had nothing to do with technology. Remember, we started with a worse product: the press would literally come to our exhibition stands and say “detect this virus,” and the answer would be “oh, shoot, no.” There was a little company, Dr Solomon’s in the UK, doing a better job with about a tenth of the number of people. Instead of getting into a feature war, we changed the game.

Google Apps versus Microsoft Office (Don Dodge). Don Dodge made the rare move of going from the developer world at Microsoft to the exact same role at Google, so he has seen both sides of a big business model transition. His framing: you have to be disruptive in three areas, technology, business model, and market position, and you have to assume any technology can be replicated within months to years. That leaves business model and market position. Those are hard to copy because they become part of your DNA: how you hire, your cost structure, how you communicate to the market. And a key point for founders: startups can pivot and change their DNA very quickly; big companies cannot.

Microsoft Office had 90 to 100 percent of the market. Rule number one: do not compete head-on, you will lose. Office was the enterprise market, so Google went the opposite way. They started with consumers, then schools and universities (no money but they need the products), then local governments, then small and medium businesses, and only last the enterprise. This is straight out of Clayton Christensen’s The Innovator’s Dilemma (start at the low end, be disruptive, because the incumbent moves upmarket and ignores the low end) and Geoffrey Moore’s Crossing the Chasm (get your beachhead, then creep up-market). Google’s levers: free versus a $500 license (freemium), simple versus complicated (most users only use 5 to 10 percent of Office features), and the 80 percent solution. But the real disruption was the business model. Microsoft could not follow, because to make Office free would have meant giving away $3.8 billion of profit that year, with hundreds of people working on it and thousands of businesses reliant on it. They were attracting users to their platform and monetizing them through advertising, so they did not care about the app revenue. Microsoft watched their stock trade like a dial tone through this period. It did not matter what features they added; the more they added, the more bloat (they came up with Clippy, then changed the toolbars and made everyone relearn it). That is the kind of disruption we want you to come up with.

Mobile: same product, three different DNAs. Apple and Google are apparently selling the same product (iPhones versus Android phones) in very different ways. Apple does consolidated hardware and software integration, a premium product, controls everything, and makes money on hardware (they take 30 percent of app revenue, not 70, so apps drive the platform). Microsoft licenses the operating system, because that is what they have always done. Google gives away the Android operating system for free and open-sources it, because their core DNA is to give things away (search, Chrome, Gmail, Android) and monetize through advertising. At the time Android was around 60 percent and iPhone under 30 percent and growing apart. Is it possible both Apple and Google are winning? Yes, because they are playing different games, and none of them can change their core. On the advertising question (“isn’t it a race to the bottom?”): scale matters in advertising, and Google has scale Microsoft cannot have. Mobile advertising will be completely different from web advertising (I used to work at AltaVista, with blinking-GIF display ads, until Google came along and made search advertising profitable), so it is not a declining market, it is a source of innovation.

Netflix and Spotify. What is their model? Subscription, and a library of content. How do they get value from it? You get pleasure, and they measure that from how often you watch, which translates into data, which drives recommendations, which is why you go back. Recommendations are Netflix’s core; exploration and discovery are Spotify’s core (I am too old to find good music, so I just go on Spotify and ask). Netflix could sell that data for ads, and to date had not, but that changed for a reason: their stock price plummeted when they started losing subscribers and could not compete with all the other services, so they introduced advertising into their model. You do not even realize, when you are watching a movie, that there is a business model behind it keeping Netflix in business. If there is not, they are not sustainable, and they do not get to outlast their competitors and be the surviving winner.