At FLG Partners, our CFOs often support high growth companies facing changing business dynamics, opportunities, and competitive circumstances. Many of these companies, from startups to emerging enterprises, will at some point in their evolution consider a change of business model and many do this on a regular basis. Changes in business models can range from a relatively small modification to a massive pivot depending on the business.
There are multiple reasons why a company might rethink their business model. Instigating factors include (but are not limited to):
- To drive a higher company valuation, for example, a hardware business shifting to a SaaS model in order to tap into a stream of recurring revenue rather than relying on “one-off” revenues from the sale of hardware.
- To drive higher sales by increasing the company’s differentiation vs the competition, e.g., shifting from a broker sales model where revenues are based on a percentage of sales to a direct-sale, marketplace model.
- To introduce a new product into a suite of existing offerings. At one of our consumer electronics clients, for example, we introduced a new insurance product alongside the device by expanding our business model.
- In reaction to significant industry change (such as a change in tax or regulatory policy, economic and structural changes, or other external factors) which create a “pull.”
As a CFO working across both consumer and health technology sectors, both internationally and domestically, I have assisted a number of clients through the decision-making processes about when and why to change business models.
My experience leads me to advocate the following four key takeaways for company teams and boards considering a change in business model:
- There are sometimes good reasons why you should NOT change your business model
- You should always consider the FULL impact, both short and long term, associated with this option
- You need to carefully model different scenarios both before deciding, and then again, afterwards
- You should concisely and clearly communicate your recommendations to stakeholders
When Is It NOT a Good Idea to Change Business Models?
In the intense desire to achieve growth, many companies jump to a change in business model as a solution. But there are in fact, many reasons why a change in business model is not the optimal solution. Changing business models can be very expensive, complex, and disruptive as anyone knows who has been through this type of a transition. If your company is facing tough competitive winds or a high-cost structure where profitability is challenging, you may not be able to afford to execute a significant and complex change of business model. If you are trying to create a more affordable solution, for example to expand distribution or customer markets, you might be better off considering a strategic partnership versus a shift in your entire business model. Good examples of these types of situations include medical equipment companies who partner with leasing partners and schools with student loan lenders. One school I worked with was able to attract 25% more students thanks to embracing more innovative financing solutions for their students along with a new, consultative selling process.
Similarly, if you need to carefully conserve cash, you might think about a billing change vs. a pricing change. A classic example of this is using discounting for multi-year contracts coupled with upfront payments from customers. This is a sales policy change instead of a business model change and is much faster and easier to implement.
Another good reason to NOT change business models is when investors are the primary stakeholders pressuring you to do it, especially when your company is publicly traded, and predictability of metrics is key. Due to the significant impact on company financial projections associated with many business model changes, many public markets have close to zero tolerance for such decisions on the part of the C-suite and board. Even a private company should always have solid data supporting a business model change as the optimal solution. Don’t confuse a situation where your product-market fit is not optimal for a need to shift your entire business model. For example, investors are often pushing SaaS companies to shift to usage-based pricing, but in the latest KBCM SaaS Survey, seats-based pricing still accounts for the majority of respondents’ pricing strategies (41%) vs. 25% using usage-based pricing. And the survey results show that these two metrics have been stable over the past 3 years.
Always Consider the FULL Impact of a Business Model Change
A change in business model has implications for the entire organization and often for third-party constituencies (referral partners, distributors, customers, etc.) Even in the case of just a pricing model shift, the entire ecosystem, from product to manufacturing, from sales and marketing to distribution, needs to adjust to, prepare for, and help implement the change.
The product team, for example, may need to add functionality to support the new pricing strategy. Sales will potentially need new incentive structures, and possibly a different pool of talent as they may need to address different buyers. Marketing will need to adapt to the addition of new channels and partner with new referral sources. Even IT will need to integrate the new pricing methodology into data tracking and performance analysis.
Finance needs to be intricately involved in examining the need for such new systems and ensuring that the company adheres to GAAP rules around revenue recognition and fully understands the tax implications of this change. When I was assisting one hardware client launch a subscription model, we needed to introduce new systems to automate the calculation of deferred revenue according to ASC606. Finally, the finance team will also need to help hold the company accountable against a new suite of benchmarks for both efficiency, productivity, profitability, and growth. A case in point: the gross margin expectations for a SaaS business are quite different than those of a hardware business. The CFO is the key point person in the C-suite tracking all these key metrics to evaluate the full impact of the business model change both over the short and longer term.
Carefully Model Business Scenarios (Both Before and After)
In many cases it is challenging to create the financial models needed to evaluate the potential scenarios associated with implementing a change in business model. This is often because there is limited historical data to use for “base case” and “change” scenarios. For example, you might not have sufficient data to set assumptions about the expected increase in sales volume associated with a given change in price, especially by customer segment. My recommendation here is you need to beware of too much detail in your model, especially in cases where your assumptions aren’t backed up by solid data. These situations can give the illusion of accuracy when they should be just directional for decision makers.
I always like to look at two different approaches to scenario building when addressing a business model change: before the decision and after the decision.
Before the decision to change the model, a CFO needs to support the leadership team through a focused and clear set of take-aways that are focused on the biggest levers to performance metrics. These should be anchored by a comparison to available industry benchmarks so that the team can come to a consensus around a “go/no-go” decision:
- Total addressable market (TAM) and sales revenue
- Gross margin
The evaluation must include the sensitivities of these metrics to various possible upsides/downsides. I like to build a “heat map” showing these visually to the team.
After the decision is made to change business models, the team then needs to understand the full impact of implementing the agreed-upon change. Your team should have agreed on what success looks like in advance of the change. The CFO’s analysis should include a combination of financial and non-financial metrics (e.g., Net Promoter Score, Sales, Gross Margin). These metrics should then be consistently monitored both during and post-implementation, over at least the next three to four quarters, so that the data can reveal the full impact of the change on company performance.
Pay Attention to How You Communicate the Story Behind the Numbers
When presenting your key takeaways and recommendations to stakeholders, it is imperative that you think through each audience and what is most important and relevant for them. You should always focus on the story you are telling more than the raw numbers if you want them to retain your takeaways. Many finance presenters miss this point, but it is so important. Your deck shouldn’t be more than 3-4 pages to report your conclusions, whether before the decision or afterwards. Be concise, ask for feedback, prepare for questions in advance, and document discussions.
A change in business model is a critical pivot in a company’s trajectory, but with the right preparation, analysis, decision making, and careful execution, this opportunity to vault ahead of competitors can mean the difference between an “also ran” and a market leader. If you need help evaluating your options around a business model shift, get in touch with us at FLG.