Step Five – Circular Business Models
There are many entrepreneurs who come up with new ideas to add value to our life or solve the many problems we are have created. Unfortunately we find that no matter how great these ideas may be many are financially quite unsustainable. A quick review of government statistics will show a large percentage of businesses fail in the first five years. According to Bloomberg, 8 of 10 business fail in the first 18 months and Eric T. Wagner, writing in Forbes.com, offers some very sound advice in ‘Five Reasons 8 Out of 10 Businesses Fail’.
Therefore presenting a business case where a customer will pay a premium for your product over a competitive product because it is “a circular product” is the worst business model. The Circular Economy will not become a reality simply because the products and services in this economy are circular. The Circular Economy and its marketing potential might initially bring you some educated customers in the first years of operations. But over time your business will become successful if there is inherent value to all participants; customer, suppliers, channel partners and the environment.
Establishing a Go / No Go Checklist
Large multinationals like Proctor and Gamble and Unilever have marketing and innovation departments that design numerous new products every week. Product development is not a “once in a lifetime” experience for them. As such they also test various new product / market combinations in the supermarkets. They know that only a certain percentage will be successful. Knowing this, they pre determine strict “go / no go” criteria and they set clear goals and expectations. If you know you will fail in rolling out a profitable product, the best thing you can do is “fail cheap!”
The Go / No Go Checklist¹
- Has the problem or opportunity been stated clearly?
- Is it clear who the requestor is? (do you know how the problem or opportunity has arisen?)
- Have you clearly stated how the expected benefits will be achieved?
- Have you clearly stated the desired end result of the project?
- Is the goal statement specific and measurable?
- Is the goal realistic and manageable?
Are all objectives
- Stated clearly and realistically?
- Written with an end result that is definable and measurable?
- Written with a beginning and an end (that is, they are finite)?
- Are the criteria stated as objectives that are to be accomplished?
Risks and Assumptions
- Have the major risks and assumptions been stated?
- Are the major risks and assumptions and any contingency plans realistic?
- Do the stated risks and assumptions allow stakeholders to assess benefits and costs associated with the project?
Is the project overview statement understandable to an outsider?
Would you plan, implement, and manage the project as stated in the project overview statement?
Are you able to manage this project?
Would you put your career or business on the line for this project?
Return on Investment – Where are the Profits?
Your business and initiatives should make money. Don’t confuse the Circular Economy with philanthropy. There is a reason it is called the Circular Economy: your activities should provide a sustainable cash flow, return on your investments and have the potential to provide you with income to sustain your business.
Sales Recognition and Cash Flow
Your new circular business product will move your company toward a more service based model. This will have an impact on the revenue recognition of these sales. When selling a product to your customers you generate an invoice for the full amount delivered, let’s say $50,000. You have received the money upfront or you give your customers a 14 days payment term.
When the invoice is generated (and the money received) your administration books the invoice as sales revenue. If you sell maintenance or other service contracts, you have either agreed on a prepaid price for a certain period, or (more likely) you send the customer’s monthly or annual invoices. Simple. Let’s say you have chosen a model in which you provide customers access to your products for three years and you supply them with maintenance services as well.
New price of product $50,000
Value of product when returned after 3 yrs $10,000
Product value consumed $40,000
Maintenance services for 3 yrs $17,500
Total value delivered to customer $57,500
Per Month (during 36 months): $ 1,597
After three years you will have the product returned and move it into its 2nd life to generate revenue for you. Do you see the difference between selling a product and selling a service? In the service model your sales revenue in the first year is $19,164 (12 x $1,597) and not $50,000. Your sales revenue model changes. Your business will notice the impact in the beginning. On the longer run it could be more beneficial, but you should realize the transition that needs to be understood from a simple product sales model.
Also make sure you make a cash flow calculation to plan on how to cover for the investments and running costs. External financing of some of these flows might be a solution.
When you have decided that you need external funds to develop your circular proposition you can do this in a couple of ways. The most common way is to make an appointment at the bank. But getting a bank loan is often times the longest route.
You should evaluate your proposition based on: “how much are we going to earn when this proposition is realized and successful.” But banks generally review your business proposition as following: “How big is the risk that the requested amount of money is not repaid”.
Realize that you are the entrepreneur and they are the financiers. These are the roles that have been determined by international regulations and as such you better prepare to provide “low risk” investments. This saves you time, energy and it increases your chance of acquiring the required funds.
Using Future Customers to Build a Low Risk Business Case
You are not the only one with “new ideas”. Rather than requesting high risk funds from investors and banks for a comprehensive roll out of your new product-as-a-service line, first build a low risk business case.
Step 1: Split up your total sales area into little chunks.
Step 2: In the selected area you appoint a (third party) market developer who reaches out to possible customers for your planned services.
Step 3: Customers can be requested to pre sign up for the product-as-a-service at a discounted rate, you can stop once a certain threshold or sales target is met.
Step 4: The threshold is determined by dividing the contribution margin per customer during the contract duration by the total necessary investment to provide the service during a certain period.
Step 5: When the necessary threshold is met and the needed amount of customers have pre-registered, most of the investors are willing to provide the necessary funds.
Basically you transformed your “high risk investment” into a low risk business case. Still you need to convince the investors that you are able to deliver the promised service, but proving a business case by proving the concept with an existing customer base is a very powerful tool to get your business funded.
A Few Tips from the Business Model Canvas
¹ University of Washington Canvas ‘Go/No Go Checklist’ as part of their Introduction to Project Management course
Image: Business Model Canvas copied from ‘Money make the world go round’, FinanCE, March 2016, The Netherlands