Easier said than done. But don’t worry, I’m here to provide you with a method that has helped me in the past. I call this method the “cash-in cash-out business model analysis”.
The typical approach: Defaulting to the Business Model Canvas
During my MBA at Berkeley-Haas we analyzed and designed business models a lot. One of the popular tools used in these exercises is the Business Model Canvas.
What’s good about this? The canvas gives you guidance on what you have to think about. You basically brainstorm each of the buckets, list what you come up with, and you’re done.
The only problem is you’re not really done. I’ve often seen it. People stick post-its on a whiteboard with a business model canvas until they can’t come up with additional points. They assume they now understand the business model. Wrong!
Business model canvases have one major issue: They don’t help you think through how all these buckets come together. It doesn’t help that people try to work around this by using post-its of same colors to indicate revenue stream clusters.
What is needed to provide revenue stream X? And how exactly does the interaction with partner Y influence revenue stream X? Does this network effect create cost for the business?
This is an example of a Business Model Canvas for Amazon.
A better way: Looking at how a company makes and spends money!
That’s where I remember my background in accounting. My favorite accounting professor used to say: “If you want to understand a business have a look at their cash flow statement first!”. A good source for this type of information is a company’s 10-K report which you can typically find in the investor relations section of the company website.
Step 1 - Where the money comes from
Similar to the “revenue streams” bucket of the business model canvas this looks at where the money comes from. Look at different products or business units, different customer groups, different types of payments, partners, geographies, locations, sales channels, etc.
Try to break it out in a way that makes sense for the industry and company you look at. Make it as granular as needed for you analysis - and for the time you have. If the revenue streams are very different in nature, come up with different categories for each revenue stream.
For example, Amazon has a bunch of revenue stream. Let’s focus this example on their retail business: They have revenues from online shopping. There are differences between products: Some are offered by Amazon.com, some by marketplace sellers, some through Prime, and some even are Amazon private label products. This could indicate there are different cost structures behind these revenues.
From here, you can dive into each of these buckets to see from whom Amazon receives money for what.
Step 2 - How it’s been spent long-term
Looking at “fixed cost” - think capital investments or long-term contracts. This is to understand which type of investment the company had to make to provide the revenue streams. Don’t forget to include the support infrastructure (headquarters).
Back to our example, Amazon has to invest in warehouses, logistics, computing infrastructure, marketing, and buildings for their administrative staff. It also has to develop a huge amount of software for their online platform. And in the future, retail stores could add to the offline side of the retail business.
Step 3 - How it’s been spent every day
Now think about payments the company has to make to run its day-to-day operations. Again, go through each revenue stream and think about what’s required to deliver each revenue stream. And also remember to think about the support infrastructure.
In terms of cash going out for Amazon’s operations this would include costs for procuring products sold on Amazon’s website, labor cost of warehouse and logistics staff, electricity and utilities to run the operations, and so forth. Amazon also has to pay for customer support or onboarding and support of partners.
Pay attention to the details: A customer pays Amazon for a product offered by a seller. Now, Amazon divides the received amount up, keeps a portion of the money, and gives the rest to the seller. You could consider this as cost since the margin of the product offered by a seller will be lower than products sold directly by Amazon.
Summarizing your analysis
A good way of bringing your analysis together is by structuring it along revenue streams. Set up a table with each row representing one revenue stream.
Now, add 2 more columns to the table. The first breaking out the long-term cost and the second breaking out the short-term cost by revenue stream. Of course, the same type of long-term or short-term cost can appear multiple times across revenue streams.
Finally, you can visualize your results in the following way. This illustrates how a summary of Amazon’s business model could look like - in this example, revenue streams are separated by products.
Congratulations, you’ve just really understood the business model of your target company - by looking at ways cash comes in and goes out. Remember, you can always go into more detail by breaking out incoming and outgoing cash into even more buckets.
Business Model Canvas advocates will correctly notice that the cash-in cash-out business model analysis doesn’t look at “soft aspects” of business models such as the value proposition or vision of a company.
Indeed, this method focuses on the “hard aspects” of business models. Add the soft aspects if you believe they’re relevant for your analysis. Always keep in mind that what you can see in the cash is “really there”. Looking at cash will help you separate the reality from the possibility, the actual from the forecast, and last but not least the signal from the noise.
In the end, thinking deeply about how money flows through the company will give you a good understanding of a company’s business model. Use the discussed approach and it will help your analysis.