BusinessModels.001A friend, Rick Giarrusso, posted an interesting blog a while back.  The title is “Prostitution, Drugs, Pornography, Gambling, and Religion.”    He intended the blog to provoke thought, not to disparage any particular profession or business.   Here’s how the five business models break down. The descriptions are Rick’s. (Rick adds the disclaimer that these are business models, and have nothing to do with the specific products or services being offered.)


Model 1: Deliver a product (e.g. drugs, cars, or computers) 

Profit is not based on the number of people you employ; it’s supply and demand and how much product you can obtain and sell, and at what margin. To sell more product, you need to manufacture or acquire more product.  To make more money, you need to make bigger deals, and at a higher margin.

Model 2: Deliver a Service (e.g. prostitution, law, accounting, or consulting) 

People are billed out by the hour or the project (“trick”). Since there is a limit to how much you can charge for someone’s time, and most of that needs to be paid to the individual contractor, you can typically only leverage up the business by hiring a lot of people. So you are limited by how many people you can reasonably manage. It is difficult to get extraordinary margins.

There is typically very little investment needed to start these businesses. They focus on having highly productive individuals and small teams, but are rarely concerned with broader organizational efficiency, as that is not their competitive advantage.

These firms are typically filled with many people of the same basic “type,” or skill set.  As a result, the firms can become mini “think tanks” for their profession–often representing the cutting edge in both theory and practice.

Model 3: Publish something (e.g.,pornography, books, computer applications, media, or information)

These businesses require a significant upfront investment before they can get any revenue.  But having made the investment, they have very low marginal costs. They do not need to maintain any inventory; if they sell a copy of their product, it does not reduce the number they can sell in the future; they simply sell another copy.

These businesses will often give away a lot of product in order to seed demand–at levels that other businesses could not imagine. Whereas other businesses might use “loss leaders,” or give away perhaps 5% of their total volume, pornography businesses may turn that around and give away 80% or 95% or more of their product, making all of their revenue on the remaining 5-20%.

Model 4: Manage Risk (e.g., gambling, financial services, or insurance)

These firms make their money by understanding risk, by having a large capital base that allows them to lend or invest money, and by providing the services that allow other companies to make financial transactions (thus playing “the house”).
Gambling businesses can grow very, very large in terms of dollar volumes, with a relatively small number of people. However, they require significant care to prevent any one set of risks from swamping the rest of the business.

Gambling businesses often mitigate their own inherent risk by creating a portfolio of risky businesses which balance each other out. Properly designed, the system will have some areas losing money, while other areas make a phenomenal return–often for several years. This is intentional; the areas should be chosen such that different divisions will make or lose money at different times. Unfortunately, it can also create significant tension within the employees, who (following the prostitution model) often want to be compensated for their individual successes. The result is these firms can be somewhat unstable if incentives are not set up properly.

Gambling businesses are concerned with ensuring a steady supply of capital, as well as excellent “deal flow” allowing them to participate in the good bets. They are also highly sensitive to errors; one wrong step can sink the business.

Model 5Self-improvement (e.g., religion, education, gyms, or coaching)

These businesses help their customers improve themselves, but make no guarantees as to whether that help will result in tangible benefits.

There are fewer examples of these businesses than some of the other models. However, they are pervasive. Colleges and graduate schools attract a lot of people each year; these people pay a lot of money for an education which may or may not help them achieve their personal economic goals. Self-help courses and churches also fall in this category. This is not to say that they do not help–just that it is a characteristic of these businesses that there are no guarantees. The evidence is often ambiguous, and thus requires a certain degree of faith.

Is there another business model?

The five models respond to five fundamental needs: products, services, information, risk avoidance, and self improvement. Google is supplying a service, that is, helping sellers find buyers and buyers find sellers.  They make their money providing a search service. Apple is a cross between a product company and a publishing company. They make their money on things like iPads and iTunes. Facebook is a service company. The service is helping people find friends and stay in touch with them. In order to make money they have to help sellers find buyers. I guess buyers and sellers are special kinds of “friends.” LinkedIn is also a service company. The service is helping professionals find jobs and employment recruiters find professionals.

Can you think of a fundamental business model that Rick has overlooked? What is it?

Understanding business models is fundamental to strategic decision coaching. For more about decision coaching see The Collaborative Design Process and Decision Engineering.  For more about where business modeling is going see Is enterprise modeling headed for a shakeup?.

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