Business Models in the New Economy - Stanford University





Business Models in the New Economy

Mini-case prepared for Stanford Technology Ventures Program

Trevor Loy (trevor.loy@)

with assistance from Tom Byers and Fern Mandelbaum.

Last revised 12/12/1999

The Mindo Team

Kerri Chang, a senior economics major at Stanford University, gazed out from her table in the corner of the Coffee House. Kerri was waiting for Daniel Jackson and Reza Prajapati, co-founders with Kerri of “” and her partners in the “E-Challenge,” Stanford’s annual business plan competition. Daniel, a co-terminal computer science student, was the technical genius in the group. His work in collaborative filtering algorithms led to the team’s Internet business that recommended web sites to users based on other web sites they liked. Essentially, the technology monitored user activity on a site, looking at where they clicked, what other sites they visited, what they bought, what they read, etc. Based on this activity, the technology could make increasingly sophisticated recommendations for other sites, content, and products that the user might be interested in. Additionally, as the recommendations improved, users began to view them less as advertisements and more as a helpful service.

The “recommendations as a service” quality was ultimately what compelled Reza and Kerri to join Daniel in creating a business plan based on the technology. Reza was a senior art history major who had spent the past summer in a marketing internship with a major e-commerce retailer. While all three team members were talented and Internet savvy, Kerri’s background was the only one with any financial experience. As a result, the team had quickly assigned to Kerri the task of creating the business model for their new venture. Kerri wanted to move quickly, but she had encountered difficulty in defining the best business model due to conflicting results from her initial market research. She had called this meeting to present the various options to Daniel and Reza with the hope of reaching a group solution.

What Business Are You In?

Daniel and Reza joined Kerri with sodas and burritos in tow, and they proceeded to parcel out the food as they began the discussion. Kerri asked the team to recall the lecture from E145, “Introduction to High Technology Entrepreneurship,” during which they had been asked to answer the question, “What Business Are You In?” Daniel’s opinion was that they were in the business of making recommendations to users; hence, a consumer-oriented business which charged those users for the service would be most appropriate. Reza felt, however, that the marketing strategy would be more successful if they were in the business of delivering targeted traffic to business partners; in that case, they should offer the service free to users, and obtain referral revenue from customers. Kerri’s opinion was less clear-cut. She felt that a “recommendation portal” strategy was the best approach, and therefore that they were in the business of aggregating users on their own site and selling advertising to customers who wanted to target those users. As the team members finished their burritos, the conversation continued to go around the table, but no clear strategy appeared.

Business Model Variations

As the group grew frustrated, Reza asked Kerri to outline the various business model alternatives she had discovered during her initial research. “Just lay out all the options, and don’t tell us which ones are more appropriate,” suggested Reza. “We might be able to combine them in new ways and create an entirely new business model.” Daniel concurred. “Remember that Professor Byers covered this in E145. In the new Internet economy, he suggested that business model innovation is as important as technology innovation.” Encouraged by her teammates, Kerri began to outline the various business models she had studied.

“I’ll start with Business-to-Consumer, or ‘B2C’ models,” said Kerri. “Here are the variations I found.”

• Traditional e-commerce. These are retail sites where the business sells a product to a customer, and makes money by selling the product for more than it cost to make the product. A classic example of this business model is E-Toys, the online toy retailer.

• Auction. On an auction site, the business sells its products for a variable price to consumers. OnSale is an example of this strategy. Related to this is Ebay, which brings together third-party sellers and allows them to auction their products to consumers; in this model, Ebay takes a transaction fee from the seller.

• Portals. Sites such as Yahoo! and Excite, both of which were founded by Stanford students, are general media portals which make money primarily by aggregating users and then selling advertising and sponsorships to other companies who want to reach those users. Some Internet companies are also becoming vertical or specialized portals, such as and . They provide content and information that attracts users within a particular interest area, and also sell products within their specialized markets.

• Content. While the Internet has brought about an enormous revolution in the delivery of information, most of that information is free. A few sites, such as and the Wall Street Journal, have succeeded with business models based on charging a subscription fee to consumers for access to the site’s content.

• Services. Many companies provide users with the ability to perform a task. These sites, such as Preview Travel, typically make money by charging a fee for each service.

Reza commented that she was familiar with these business models, having spent time in a consumer-oriented marketing job the past summer. She was beginning to feel, however, that this business plan might be more effective as a business-to-business (B2B) venture. Since she had less background on the ‘B2B’ side, she asked Kerri to continue with her analysis. “Here are the business model categories I discovered during my research,” outlined Kerri:

• E-commerce. Like their consumer counterparts, these businesses, like , make money by selling products to other businesses.

• Auction. These web businesses, such as e-Steel, bring together buyers and sellers of a particular product and allow buyers to bid on goods to determine the current market price. This model is most prevalent in vertical markets where the products are commodities, and the main criteria for users are volume and price.

• Exchange. Similar to the auction model, companies in this category, such as Chemdex, bring together buyers and sellers; however, instead of an auction process, they create an exchange which lists fixed prices. This usually works better for non-commodity markets where the buyer’s main goal is to find and purchase exactly the right specialized product.

• Infrastructure. Infrastructure companies provide the technology tools used to enable business activity. In the online world, this category includes companies like Cisco, Broadvision, Vignette, and NetPerceptions.

• Professional Services. These companies often combine a consulting and service organization with a tool and technology development group. For example, USWeb/CKS develops large scale web sites and generates money from both technology development and consulting fees. Bigstep does the same thing for free, but generates revenue from taking a cut of the e-commerce transactions handled on the site.

• Services. These companies provide a service for businesses, such as (which aggregates corporate shipping efforts) or Netcentives (which runs marketing and loyalty programs for a business). Companies in this category typically make money by selling those services to businesses either on a per-use, licensing, or periodic-subscription basis.

• Application Service Providers. Also known as ASP’s, these companies take software that was traditionally stored on a hard drive and run on local machines (such as accounting software like Quicken) and provide it via a web server instead (such as ). Users of ASP software usually pay a service fee on a monthly, annual, or per-use basis.

• Content. Many companies develop content and then license or sell that content to other businesses. This category includes companies like , which develops information about company workplaces for use by job recruiting sites. provides digital mapping and location service to other web sites.

As Kerri concluded her outline of B2B models, Daniel looked lost in thought. The other two urged him to share his train of thought with them. Daniel began, “Well, I’m primarily a technical guy, so I’ll leave it to you two to make the final decision here. But, I was just thinking, while I believe your categories exist in some ideal sense, I can’t think of a single real web business which fits nicely into those categories. It seems to me that almost every Internet company has a mix of revenue components.”

Reza picked up from the end of Daniel’s sentence and continued his thinking. “Maybe we ought to look not only at the overall business model types, but also at the various revenue component types which can be assembled to create the overall business model.” She turned to Kerri. “Do you think you could briefly sketch out what some of those components are?” Kerri nodded. “I can certainly put a number of them down.”

• Commerce. This is simply revenue derived from selling products.

• Service. Similarly, this is revenue collected from selling a service.

• Advertising. This is revenue collected from showing an ad, or “impression” on a web site – regardless of whether the user responds to the ad or not. Advertising is typically charged on a “CPM” or cost-per-thousand-impressions basis. The average CPM in July 1999 was about $30; i.e., about $0.03 per page impression.

• Click-through. This is revenue collected when a user actually clicks on a banner advertisement to go to the advertising site. A site might collect $0.50 for each click-through, which is much higher than just advertising revenue; on the other hand, click-through rates are extremely low, averaging 1-2% of impressions.

• Sponsorships. In response to poor click-through rates, many web companies, especially portals, have moved to sponsorships. In this case, revenue is collected from a sponsoring partner whose logo appears on the relevant section of a web site. For example, Yahoo! Sports might be sponsored by Nike. Sponsorship fees can be structured as a lump sum or on a per-impression basis.

• Affinity. Many sites earn revenue by making recommendations or providing relevant links to products, services, or content. For example, many specialty sites provide links to related books at . In this case, shares 5-20% of any resulting transaction revenue with the referring site.

• Data mining. Information about user behavior is valuable to a variety of e-commerce companies, and many web sites sell information (in aggregate form, usually) about their users’ behavior and preferences for a lump-sum or monthly fee.

• Transaction Fees. In cases where the web site serves as a market maker that enables a transaction to take place, the site usually generates revenue by taking a cut or a flat fee from each tranaction.

• Development Fees. Most technology development companies, such as web site developers or tool providers, charge the customer an up-front development fee which can be quite substantial.

• Subscriptions. Subscription fees have become popular for specialty content sites (such as financial information) and also for marketplace sites like Ebay, where sellers pay a subscription fee to be a part of the online marketplace.

• Per Use Fees. These fees include large one-time payments, as well as “micropayments,” which are very small payments (e.g. $0.01) charged for access to content or services. Application Service Providers use per-use fees, as do some content and archive providers.

• Float. Using the float to support a business model has become increasingly popular in the Internet era, due to the efficiency of electronic transaction processing. In this case, sites colllect revenue before delivering services or goods, thereby earning revenue from the interest on the collected revenue. Online gambling sites use this tactic, as do retailers such as , who pay for the books they sell almost 2 months after collecting the sales fee from the consumer.

As Kerri finished her discussion, the team members sat back and sighed a bit. “I never knew there were so many different ways to structure a business,” commented Daniel. “This is harder than I thought.” Reza nodded and smiled. “That’s also why it’s so exciting!” The group laughed. “We’re going to be here all night,” said Kerri. “ Why don’t I go order some coffee, and then let’s get to work on defining the right business model for our venture.”

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