Startups and banks learn a lot from one another. A key piece of advice that we deliver to startups is to articulate their Business Model Formula (BMF). Even for the earliest startups, putting your BMF down on paper is crucial to understanding the business you are trying to build. Your Business Model Formula is not your business plan, your strategic plan, nor your pitch deck. It’s something much more powerful.
Your BMF is the logical expression of how your business will turn value into more value. For a business to succeed and become sustainable, it must do this:
The BMF is the logical representation of how YOUR COMPANY’s black box turns $1 into $3. A simple BMF for an early-stage SaaS company might look like this:
This mythical startup spends $50 to acquire a customer who will subscribe for $10 per month, and it will cost $2 per month to deliver that revenue. The average customer will remain a customer for 15 months, meaning this company turns $50 into $120, or $1 in $2.40 (ignoring the time value of money here).
When a very early-stage startup goes through this exercise, the numbers are mostly being made up out of thin air. Without validation, at scale, this formula is purely academic with lots of wishful thinking. Not only could the numbers change, the tactics could change, the strategy could change, even the entire company could pivot. Even so, it’s still incredibly useful to build your Business Model Formula. Here’s why:
1. You are looking for your repeatable, scalable business model. With your BMF, you will see where the assumptions, hypotheses, and leverage points are in your business model and you can identify which elements need to be derisked in which order.
2. You need to align the entire organization to consistent metrics that ensure everyone is solving the most important problems and working in the same direction. This only happens if everyone’s KPIs tie directly to the BMF.
3. Your formula will encompass the entire business and allow you to go deeper and deeper into how your business works. This makes it easier to perform analyses and experiments to continue improving your BMF.
4. It will make every decision easier to make, including product, strategy, and personnel.
5. You’re a startup, so in all likelihood you aren’t profitable. You will need to convince investors that you can be someday and will be able to turn their investment dollars into a much larger increase in enterprise value.
Your Business Model Formula is the Rosetta Stone for your business. Figure yours out immediately to maximize the performance of your company.
Banks need their Business Model Formulas too.
Banks are much more complex than your average early-stage SaaS startup. Banks service retail consumers and business customers. They offer deposits, loans, and investment products. They have wealth divisions and underpin fintech partners. They need to maintain a healthy balance sheet and comply with countless regulations.
These complexities make it difficult for banks to develop their own Business Model Formula. They get in the way of bank executives who strive to lead cohesive organizations, pursuing the same north star. Failure to establish your BMF, leads to inaction because banks will undervalue critical, interconnected aspects to their business. It leads to the position that most banks are in right now: desperate for deposits.
It's much easier to blame your deposit constraint on the macro environment, current rate situation, the credit union down the road, or fintechs than to dive deep to truly understand your organization’s position. Banking is increasingly competitive and requiring greater attention to detail. Not on the incremental improvements to the things banks have been doing for centuries, the detail that requires much more attention is the Business Model Formula.
What might the Business Model Formula tell us about banks and how they operate? The basic bank business model is simple: take deposits, loan them out at a higher rate, and get repaid. Banks have a great focus on their balance sheet because their deposits and loans must remain in balance. That focus on balance sheet comes in sacrifice to the important element that prevents attention to the BMF: customers.
Customers have different deposit, spending, and loan behavior, so customers will engage with the bank in wildly different manners. One customer may only use a bank for a small sliver of their financial activity but may still be more valuable than another customer who has their entire financial life with that same bank but has a much smaller net worth. A wealthy retail customer will be far less valuable than nearly every bank small business customer.
Banks understand these facts very well, but they don’t always think through the lifecycle of acquiring and servicing these customers the way a cash-starved startup might. This leads banks to focus on “more profitable” small businesses and deprioritize retail customers. These decisions may be made using false premises that create MORE long-term bank risk because they misunderstand how their business works. Focusing on one segment that has historically been more profitable, while ignoring the segment that built your low cost of funds, leads to new customers that generate less incremental profit for you. Your narrow focus is, ironically, getting your business out of balance.
The issue is the improper focus on “customer profitability.” Banks go through the customer profitability exercise to understand which customers are the most valuable, who to give the most care to, and who to “quiet quit.” This is incredibly valuable for customer service people to maximize retention, but it’s the wrong exercise when determining where to focus your growth.
Your BMF gives you the true indication of how well your engine functions. It will show you how much you pay to get a customer, what the average customer contributes in deposit value, transacting value, and borrowing value. Tracking against your BMF will enable your organization to evaluate strategies and solutions against your current operational performance, creating better apples-to-apples comparisons. You’ll be equipped to make more robust decisions about opportunities rather than just coming to a decision based on cost and vibes.
To succeed, startups must exhibit operational excellence, even in their earliest days. If banks want to continue succeeding in this increasingly competitive financial market, they will need to exhibit an even greater operational rigor. Take the first step and write down your Business Model Formula.
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