On Business Models

When you are in fundraising mode, investors ask you a lot of questions. Some are pretty clever, but most of them are pulled directly from the startup playbook: where do you see the company in 5 years, how do you define success, all the metric related stuff, network effects… it’s a never ending list. But there’s one I’ve always struggled to answer: how do you protect yourself from other competitors, or the romantic version, what's the unique trait about your company that makes you the most likely to succeed.

The reason why I’ve struggled to answer this question is because I’ve been framing it the wrong way. As an engineer, when it comes to protection, I’ve always thought of technology: understand the problem better than your competitor, build an amazing product around these assumptions and wait for the customers to come.

This assumption, though, defines an ideal scenario where the product or the technology is not constrained by any other factor. But the truth is that there are constraints all over the place: money, operations, resources, providers… Protecting yourself only with technology might be possible to a point, specially if you own patents or any kind of intellectual property. But if you don’t, technology is still key, but it is definitely not enough. You’ll need something more.

When investors ask for defensibility they are implicitly asking for an unfair advantage. What do you know, others don’t, that will make your company succeed at the end. They are trying to look beyond technology and understand if you’ve already studied the end game.

Investors don’t care much about technology, anyway. Some of them (pretend to) don’t even understand it. They don’t see it as an end by itself (hint: it is not). They only want to know if you have looked beyond the technology and truly understood the problem from all the possible angles.

I had a hard time understanding this. Every time I was asked about the entry barriers I started to ramble around our technology, our product vision, the clever implementations on the backend… But they always asked something like… “so anyone could do it, right?” and I was like “yes… but we will be miles away when that happens, because our road map…” They stopped listening when I said “yes” because they were not expecting a technical answer.

I learned it hard way: technology is not an end by itself. It’s the support function of something bigger: your business model. Only when business model and technology work together towards the end goal, your incentives are aligned, then you are onto something.

But building a business model that stands out and protect you from competitors is not an easy task. Most of the times, the creativity involved in the process comes from being an insider first. You can hardly innovate in any area if you don’t fully understand how the industry works in the first place.

So in order to break into a particular market and build a business model that your competitors won’t be able to catch up with, you have to study the market first. There are two ways to do that:

  1. Having worked in the industry for years - a.k.a. being an insider[1].
  2. Being naive enough to start a company in the space and learn the hard way.

Of course, at iomando, we chose the latter. We entered the access control industry with our new technology pretending to wipe the market in a snap. We knew nothing. The problem is that we build the product for a market that somehow we unrealistically pictured in our minds. We didn’t even considered how the market was shaped before us and we just assumed our product would fit right in. And we couldn’t be more wrong.

Our software based solution was clearly the best shot we had to create the holly structure that would set ourselves apart from our competitors. Not technology, not a feature, but a strategy that tapped into those characteristics in order to build something our competitors couldn’t catch up with.

After realizing that our "build it and they will come" approach would not work, we distilled the unique traits of our technology, and discussed how we could tap on them to create something our competitors could not replicate. It’s a tough exercise.

In our case, our main uniqueness was a solution based on software, instead of hardware. This characteristic both defined and limited us when it came to build a sustainable business. But it was clearly the best shot we had to create the holly structure that would set ourselves apart from our competitors. Not technology, not a feature, but a strategy that tapped into those characteristics to build something our competitors couldn’t catch up with.

With that in mind, we designed a business model, that today still holds true.

Our product is composed of 3 blocks.

  1. Electronic device hooked in the access.
  2. Cloud infrastructure to manage the access control.
  3. Mobile app to access the place.

We knew we depended on the distributors to sell our product among small customers. It was the infantry, the entry point. But they wanted to be greatly commissioned for each sale, that was the lever that incentivized them. Because of this, we fully shifted the profit associated with each sale to the hardware side. We did it because each sale implicitly brought an installation and a hardware unit with it. This way distributors benefit from a huge markup of every hardware sale plus the installation cost.

Moreover we could lower the price of the electronic unit due to our production scale and the efficiencies we have built around it. And on top of that, we deliberately sold the device at a cost, because we would get the revenue from the service in the future, passing all the initial margin to the distributor and making it even more attractive than our competitors. This way, our distributors were highly incentivized to sell our product, because they saw more revenue coming in from each sale.

What I just described is the low margin business running on the bottom line, but clearly we are not making a living out of it. It is the SAAS we are building on top of it that drives all the profit. Every time a distributor installs a device in a customer space, the device automatically connects to the internet and ties back the customer to our backend. This is what enables our customer to make use of the cloud based service and the mobile apps. The customer is ours, and also is the possibility to deliver a great service and earn a subscription service that could endure for a long time. But this is totally up to us.

It’s a great business because we are running two independent, but interconnected, business at a time. And the software side is really interesting, because it is high margin, recurrent, and potentially expandable with new offerings. But it is also risky. If we deliver a bad experience, the customer will cancel, and we will be left out with nothing because we didn’t cash out the early hardware sale. Therefore we are also extremely incentivized to build a great product, because for us, keeping one customer is worth the same than a new one.

This double edged model, that both incentives distributors to push our hardware and forces us to keep working on having the best product, is the reason that fuels our business, what set us apart. This is also the story I tell investors every time they ask me for the question.

To keep on with the story you can check out the iomando series, or you can also look for other blog publications about iomando, mostly about product design, business strategy or company culture.

[1] Update on 2015.06.25. The news that Andreessen Horowitz was investing in a hair extension business was the ultimate proof that being an insider matters.