The Free Money Business Model
Forget Jack and the Magic Beans. This is an entrepreneurial fairytale: You and the Magic Mailbox.
A good idea isn’t worth much to an entrepreneur unless you can find a way to execute, and get customers to pay you for it. So even if you have the world’s best product idea, you need to match it with a profitable model. That’s where our fairytale comes in. It has the happiest ending any entrepreneur can imagine: a simple $10 post office box that fills with cashier’s checks from customers every month.
Now, true, such a thing might not actually exist. Although, if you scrutinize your credit card receipts and find you’re still paying a few recurring bucks or more for services you signed up for long ago but hardly use—that survey website you meant to try and quit or the online dating site you signed up for before meeting your soul mate?—you’ll pick up on what we mean.
Oddly, the best place to find such a thing might be Harvard Business School, where Bill Sahlman, a professor specializing in entrepreneurial finance, describes this kind of Magic Mailbox in a thought experiment as the ideal business model. Setting aside for the moment the question of whether such a “business” would improve the world in some way, there’s a useful guidance in Sahlman’s thought experiment. Imagine if you could build a business in which, for whatever reason, people simply sent you money. What kinds of characteristics would it have?Low levels of customer contact. That’s a good thing, all else being equal, because customer contact costs money.
- Low capital requirements. Stop by the post office once or twice a week, maybe swing by the bank. You’re all set.
- Huge margins.
- Low risk.
Simple, and lucrative. Sign us up. Until we actually figure out how to build a Magic Mailbox, though, its primary utility is that it provides an ideal against which to judge just about any other business model you might consider. Give it a try.
Imagine that you’re Elon Musk, launching SpaceX, a private company that plans to launch rockets up into space. Measure the business model of SpaceX against the Magic Mailbox, and it’s a ridiculously tough venture. Customer contact costs are sky-high (appropriately!). Can you imagine the sales and service effort to convince someone to pay to launch satellites into orbit?
Capital requirements and risk are huge: Just mention that it’s a spaceship company and you’re suddenly talking about many hundreds of millions of dollars. Logistical requirements are severe, and payments and profit margins are largely unknown.
Thank goodness that there are people willing and able to take considered risks like this to achieve noteworthy goals. That said, entrepreneurs often need to walk before they run. Apologies, dear reader, if you actually are Elon Musk, who also co-founded PayPal and Tesla Motors. But for most of us, we’re probably considering a slightly more grounded business.
Let’s consider a few more common differentiated business models, and how they stack up against the Magic Mailbox ideal.
Razors and razor blades
This is such a classic and effective business model that we refer to it simply by the name of the product that perfected it. Razors themselves are usually sold at or below cost. Razor blades, on the other hand—that’s where they get you. Same thing with, say, laser printers and cartridges. So, customer contact costs might stack up against the Magic Mailbox pretty well. Buy the low-cost razor, and you’re more or less obligated to buy the higher margin ones.
This business model has low margins and high risk, as customers can get so much news and information for free on the Internet. (Say, for example, this article!) Up against the Magic Mailbox, it can be a tough sell. The one saving grace might be if you get customers to sign up for long-term deals. Reach the idea of recurring revenue, and it really is almost like having cashier’s checks sent to your mailbox every month.
The more user-produced your product is, the better. Some online models probably spring quickly to mind—YouTube, for example, as well as LinkedIn or Facebook, in which the users themselves produce virtually all of the content. (Or the fantastic comments that you, our dear Reader, might decide to post after this article and contribute to its value.) But these products exist in the non-virtual world as well. When a customer pumps her own gas or checks out his groceries at a self-service cash register, there’s the potential to reduce the cost of servicing each customer—much like the Magic Mailbox.
Sure, the Magic Mailbox is simply a thought experiment. If it weren't we'd probably be at the post office right now. But if you continually compare the models you come up with against this sort of utopian ideal, it just might lead you to a very rewarding business model.
Jon Burgstone and Bill Murphy Jr. are co-authors of the new book, Breakthrough Entrepreneurship.
JON BURGSTONE | Columnist | Professor, UC Berkeley
Jon Burgstone was co-founder of SupplierMarket, acquired by Ariba for $1.1B. He now teaches at Berkeley, where he helped launch the Center for Entrepreneurship & Technology. He is co-author of Breakthrough Entrepreneurship.
BILL MURPHY JR. | Columnist
Bill Murphy Jr. is a journalist, ghostwriter, and entrepreneur. He is the author of Breakthrough Entrepreneurship (with Jon Burgstone) and is a former reporter for The Washington Post.