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February 11, 2020

The customer-funded business in 2020

Growth sucks cash, as Verne Harnish, author of Scaling Up, has pointed out. Coming up with a business model that allows for healthy cash flow is critical for any scale-up.

That’s easier said than done, of course. To gain insight into the approaches that are working today, recently caught up with John Mullins, an associate professor of management practice in marketing and entrepreneurship at London Business School. He is the author of The Customer-Funded Business, which challenges the assumption that entrepreneurs must prioritize raising investment capital above all. Here is an edited excerpt from the interview. One of the cash-flow models you’ve discussed that seems very relevant today is the matchmaker model, where companies bring together buyers who have a problem with sellers who offer a solution without ever touching what can be bought and sold. How is it being used most visibly at the moment?

Mullins: eBay was perhaps the pioneer. Now we’re seeing it with car rides from Uber and vacation properties from Airbnb.

The advantage with this model is you can at least get started if you have the skills to build a website and get some early traction for essentially no capital. Then you have a choice: Do I raise a bunch of capital? Or do I grow without outside capital?

The disadvantage is if one side doesn’t really have a problem, you end up spending way too much money, and it’s hard to make the economics work. The subscription model is a perennial favorite for entrepreneurs looking for steady cash flow. How workable is it today?

Mullins: We all subscribe to all kinds of stuff. In a b2b setting, there are lots of subscriptions, as well. Businesses will buy the assets they need. There will be a maintenance contract or service agreement. 

Whether it’s b2b or b2c, the business gets paid in advance in the subscription model. That’s a really nice deal. You have the customer’s money upfront and can use that money to grow the business while providing the service.

However, there’s a downside. What you’re selling needs to be perishable or predictably consumed. If the service being offered isn’t something customers actually need, it is not going to work. You might want new shoes for a little while, but you’re probably not going to stick around as a customer for a long time. Your closet will get full. Some retailers have done very well with the scarcity model, where items are available in limited quantities, yet it doesn’t always work. We’ve seen some flash sale sites fail, for instance. How can retailers use this model successfully? 

Mullins: With the scarcity model, sellers limit what’s being sold both in time and in quantity. The best successful example of scarcity models applied consistently is Zara. Zara has trained the customer by having very strictly limited assortments. They turn their inventory 12x a year. They get paid the day someone buys a dress. They don’t pay their supplier for 60 days. 

The trick with this model is to motivate the customer to buy. That is what Zara does really well. Service businesses are notoriously tough to run, though they’re very common.You’ve discussed the service-to-product model as an answer to this. How can it eliminate some of the challenges?

Mullins: Service businesses are inherently customer-funded. Therefore, they are easy to grow in cash terms. The drawback to many service businesses is when you grow, you have to keep adding service providers. If you are a digital ad agency and get a new client, you have to hire a bunch of new copywriters. From a cash point of view, they’re easy to scale. From an operating point of view, they are difficult to scale. There are people challenges. 

When you take a service business and figure out how to turn something into a product that can be sold without all of the hand-holding, that becomes more operationally scalable. 

There are lots of examples where companies do this. There will be some IT professionals who have a good service and find they can build some software around that. 

If you’re someone who builds a big presence on social media, you can market to that audience. If you don’t have that presence, it can be very expensive to buy ads on Facebook and the like. The trick to this model is getting customers in the room.