Refining the Business Case

By David H. Williams

This article picks up where we left off last month. To refresh, as developers heard at the last two CTIA meetings, and is the mantra of every carrier and venture capitalist when talking about LBS, it is absolutely critical to know the business case of your application if you are to have any hope of it being accepted and/or funded. Since the business side of the LBS equation can be somewhat foreign to many developers, LBS360.NET has started a series of articles to help developers in this area. Last month's article provided an overview of the first two steps in articulating the business case: articulating your value proposition and sizing the market. This month we build on that foundation, with refining the business case and developing the business model.

Refining the Business Case
Continuing with our pizza delivery application, there are now several new questions to be answered about the size of our potential market, including the following.
  • Of the total number of possible places of business/drivers, what percentage would even be interested in your concept?
  • What would the average place of business be willing to pay (per driver "seat") for this application?
  • What competitors, either direct (e.g. other similar LBS applications) or indirect/substitutes (e.g. PC application that automatically prints out directions as each order comes in) can you expect? What percentage of the market would they have/hold?
  • How many potential customer can you reach, and how quickly?
Let's look at these questions individually.

Of the total number of possible places of business/drivers, what percentage would even be interested in your concept?
Regardless of how good the application is, there will be some portion of the market that won't buy anything like it no matter what. Many people don't like change and many are fearful of technology. Some will know their market so well that there is little need of further assistance. Some have long-time drivers that they know and trust. What percentage of the possible market does this "knock out" before you even get started?

The 80/20 rule is a good rule of thumb here - reduce the possible target market by 20%. It has been proven many times in marketing (and other) history. But apply this rule last.

What would the average place of business be willing to pay (per driver "seat") for this application?
The answer to this question will of course be an assumption, but you need a sound understanding of the pizza business that is supported by market research.

It is essential that you understand what the market will bear. It will confirm your value proposition - at the end of the day, it comes down to money. And it will protect you against critics of your idea who don't understand the business. AND it will specifically drive how you articulate the value proposition in your marketing.

You will need to understand the cost of each driver in terms of wages and benefits (if any). How does it translate to cost per pizza? What is the average time to deliver a pizza? What do the end customers (e.g. the people eating the pizza) value - and in what order? How could your application influence those dimensions? What might be some creative ways to appeal to the owner manager (see next section - developing the business model)?

In the final analysis you will need to apply a dollar value to the per delivery person number. Is it $5/month per driver (re: equipped wireless device)? $2? $10?

What competitors, either direct (e.g. other similar LBS applications) or indirect/substitutes (e.g. PC application that automatically prints out directions as each order comes in) can you expect? What percentage of the market would they have/hold?
There are two elements in answering these questions. One: what mechanisms are currently being used by pizza businesses to manage their drivers? They know their business better than anybody, and assuming delivery is a critical dimension, what tools are they using right now? Who is providing those tools, and what are they working on? (If delivery is not a critical dimension, then your business case is already in trouble.)

In addition, there are legions of people always thinking about "a better mouse trap" in or out of the market in which you are interested. What are they thinking about? Trade publications are a great place to gain this understanding, as vendors are always talking about "what's coming."

How many potential customer can you reach, and how quickly?
You've answered the three questions above, based in facts, assumptions and common sense. This fourth question is where common sense often deserts otherwise very intelligent people looking for approval for their concepts. Is it 10% market share in Year 1, 20% in Year 2, 50% after 5 years? Few businesses, and none in technology-based businesses (other than Microsoft), achieve such market penetration. This question poses the greatest peril to entrepreneurs and new business developers alike - an overambitious, or worse, an outrageous estimate of market penetration, will ruin your credibility with investors and executives. The best rule of thumb is this: make your estimate; cut it in half; cut that in half; cut it in half again; then find someone you trust to be objective to look at your estimates. If they don't laugh (the proverbial "laugh test" of business cases), then you have done a good job with respect to revenue.

Developing The Business Model

One of the biggest issues companies face with LBS is how to charge for it - e.g. the revenue portion of the income statement, also known generically as the "business model," though a truer definition of business model includes the cost/expense side of the income equation and investment/ROI of the balance sheet. This section provides an overview of potential (revenue) business models, and describes which types of applications should be considered for each business model. Cost estimation, to be discussed in a future issue, is very specific to the applications, market, and market strategies involved.

An example of possible business models is shown in the diagram below for the residential real estate industry. It shows a variety of possible models that, from top to bottom, show a decreasing level of service with a decreasing level of cost to the buyer.

Residential Real Estate Business Models
Traditional - Seller pays a commission, typically 5% to 6%, of the sale price. The commission is divided among the agents for the buyer and seller and their brokerage firms. Examples: Century 21; RE/MAX
Discounted Commissions - The seller's agent typically receives a 1% to 2.5% commission and the buyer's agent 1% to 3%. Examples: ZipRealty; Foxtons
Fixed Fee for Service - Fixed prices for a menu of services, purchased separately. Services include listing homes and negotiating contracts. Examples: Help-U-Sell; Assist-2-Sell
Rebates - Cash or gift cards for using a participating agent. Agents share part of the commission with the buyer or seller. Examples: RealEstate.com; Monstermoving.com
For Sale by Owner Listings - These are now supported by companies that provide supplies and advice for people who sell their own homes. Services include listings on websites and magazines. Supplies include yard signs.
(Source: E911-LBS Consulting)

A critical note for LBS businesses: the LBS business model needs to be application-specific; the business should not attempt to apply a one-size-fits-all business model to LBS applications and their target demographics, or even generalize within a category of LBS applications.

For example, for a LBS application focused on navigation aids, a one-size-fits-all business model, focused on usage, could limit the appeal of the application to certain demographics (such as long-distance traveling professionals who use the service infrequently) at the expense of others (such as "Soccer Moms" - high-frequency locally traveling parents). The following provides an overview of business model types often used for LBS.

Basic/Core Business Model

This business model assumes that the services involved are "additive" to the basic service (in a typical carrier's case, wireless-voice-minutes based service) on a "free" basis, either because the service is: unlikely to have a significant amount of existing customers willing to pay incrementally for the service, is seen as an attractive feature for gaining new customers, or will contribute to reducing churn or increasing customer "stickiness."

Examples: Direct Connect (Nextel), AOL Instant Messenger (AIM - before they started including ads).

For non-carrier enterprises, this business case becomes more problematic because the benefit is seen as an intangible that will perhaps improve customer satisfaction or "competitive differentiation."

If the business conclusion is that you cannot charge extra for the location-based service - then recheck it. If it is still the case, the application needs to be reevaluated top-to-bottom. If customers are telling you they won't pay extra for it - then 9 out of 10 times you've done something wrong.

"Traditional" Business Model
This business model assumes a traditional fee for service, born by the customer, not by the carrier (basic/core business model), by the enterprise, or other parties (discussed next). There are numerous variations, including:

Fixed Fee
- (Financially) additive to basic/core services, with the additive service offered at a flat fee (usually monthly) additional to charges of the basic services (example - voice mail, call waiting).

Several variations on this model include:
  • Limited usage volumes. Example: Pre-paid cards
  • Limited usage/supplier participants. Examples: AT&T family plan, MCI friends and family, HMO in-network/out-of-network)
  • Service-tier pricing (different pricing, services or privileges depending on "level" of customer, e.g. platinum, gold, bronze). Examples: Airlines, hotels (Note: this has not been a model successfully used by communications companies.)
  • Affinity programs (rewards programs): Examples: Diner's Club, AX; airlines, hotels club programs
Per Use - Services that are paid for on a per use or "event" basis. Example: Conference calls. This business model can include several components/variations, including:
  • Basic per use - customers charged by # of discrete events, regardless of minutes or users involved,
  • Per use + usage - # of usage minutes +
  • Per use +x setup +x usage +x # of users/ports (customers) - Example: conference bridges.
Other Considerations
The natural inclination for LBS providers will be to use some variation of the traditional business model described above. This model is historically the primary business model for many companies. However, an adoption of a traditional business model for LBS should be considered only for a period of time, for only a subset of location-enabled services, or some similar variation.

As location-based services evolve, they will likely migrate to an advertising or context-based business models (discussed next).

That said, in the near-term (<2 years) of the introduction of most LBS applications, this will probably be the dominant business model relative to location-service deployment. Given this assumption, and the nature of the initial services, companies typically will lead with either a fixed fee or per-use models in the near-term. The question is what variation(s) will be most relevant given those models and the time-frames involved.

Advertising/Sponsor-based Business Model

Analysis by various research firms indicates two-thirds of wireless users would prefer to have some form of advertising subsidize the cost of additional wireless information services (this "conclusion" should be taken with several grains of salt - informal surveys indicate a very low tolerance for any obstacle, including advertising, that adds to any sort of complicated menu navigation process). This research also indicates that one out of every four business listing requests over wireless directory assistance leads to a purchase from the requested business. Wireless services that offer the advertiser a chance to know exactly where the customer is and/or what situation the customer is in and tailor promotional offers that are highly relevant to the wireless consumer are expected to generate high-levels of transactional follow-on, possibly approaching the 25% level of wireless directory assistance.

As we all know, online (wireline) services such as Google, Yahoo and AOL make most of their money from some sort of advertising, whether it's as obvious as a pop-up add, or a subtler "sponsored link" during a search, or even more abstract such as paying for being listed as a member of interest groups (Yahoo liked to do this). Even within a given company's application, business models are in flux. For example, AOL has deliberately reduced or even eliminated its monthly fees for its service to prevent defections to free services, but has now started (somewhat) subtle advertising on its heretofore free instant messenger service, in the form of launching a new browser window when AIM is launched, and adding "bots," or "advertising buddies" like Moviefone to members Buddy Lists (something I find personally annoying, but not enough to block it - yet).

Context-based/Transaction-oriented Business Model

As carriers consider business models for LBS, one of the most significant is a context-based, transaction fee-based business model. These can be either advertising or non-advertising triggered transactions, though advertising-triggered transactions would likely have higher volumes and margins.

There are different ways to define a context-based model. The simplest is using location as the context-defining element, perhaps charging based on what "mode" the user is in, e.g. shopping vs. work vs. home.

This could progress to more complex models such as combining where you are (location) with what you are doing (state), and even when you are doing it - also known as "presence," to enable different context-based business models.

For LBS businesses that plan on partnering closely with a wireless carrier in launching a business, bear in mind that a carrier's financial world revolves around three parameters: new subscriber additions, improvement in average revenue per subscriber unit (ARPU), and churn reduction (loss of subscribers).

Next month we will talk about the "Seven Deadly Sins" of LBS.



Published Friday, December 29th, 2006

Written by David H. Williams



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