In the last eight weeks, I’ve been taking you through the Business Model Canvas. It’s an essential business tool that, when used correctly, can almost guarantee success. Today, I cover the last section of the canvas: Cost Structure. When it comes to filling out this section, you’ll want to ask yourself: What are the most important costs? What costs cannot be managed? What resources and activities can we cost control? These answers are your starting point.
To catch up on the rest of my Business Model Canvas series, view the following links: Value Proposition, Customer Segment, Channels, Customer Relationships, Revenue Streams, Key Partners, Key Resources, Key Activities.
With costs that cannot be managed, sometimes businesses shop key partners but end up in a situation where the partner has too much control. Porter’s Five Forces, the five competitive forces that shape industry competition, are these: the threat of new entrants; the bargaining power of customers; the threat of substitute products or services; and then the bargaining power of suppliers.
The bargaining power of suppliers can become a monumental hindrance. I’ve seen this happen in a two-person coffee shop. They were getting their supplies from a certain supplier and were drowning in costs. I asked them: “Who’s sourcing it? Have you looked for other suppliers?“
There’s this brilliant entrepreneur in Uganda who started sourcing from the farmers in Uganda who weren’t making a living. Coffee buyers were forcing these growers’ prices way down. So this friend of mine approaches the farmers and says: “If you will grow and harvest your coffee like I tell you to do it, I’ll double what the other folk are paying you.” All of the sudden, the farmers are excited because their lives are changed in a second.
Now he’s got coffee shops all over Uganda and is exporting to Europe and the USA. His company is exploding. How did it happen? Well, he decided he was going to manage his costs and also be a blessing to those farmers. He’s got a built-in supplier. Those farmers aren’t going to go anywhere else. He eliminated worrying about the bargaining power of suppliers just by getting out there and finding a people that no one else was helping. Because of that, he has a captive market. Find people you can partner with where your costs can be managed.
It’s important to know the costs of all the business model sections: segments, channels, key activities, etc. And it’s also important to stay aware of the particular core issues in cost structure:
- Economies of scale
- Economies of scope
- Intellectual property protection
Fixed Costs: This is where a lot of people who are starting businesses get in trouble—I’ve gotten stuck here many times. Most of the time your fixed costs are in PPE : plant property and equipment. You just need to work on your ROI. If your fixed costs are too high and you’re not catching up to it, you have a problem.
How does this apply to you as a two-person cookie shop? Some of your fixed costs could be in your commitment to your lease or leasing your equipment. You want to make sure there’s a balance between what your fixed costs are and what you really need to operate on if your fixed costs get to be too high. When you sign long-term leases on property or you actually go buy property, you want to make sure you understand what your fixed costs are beforehand.
All start-ups fail for the same reason – they run out of money. So, choose your business model carefully to match your cash flow. Managing your cost structure is as important, if not more important, than margin in your revenue streams. This is because your margin, how much you’re going to make in revenue streams, is directly determined by your cost structure. So if it costs x to do y, and I’m losing 20% a month, it’s time to come back and look at the cost structure.
So now I’ve covered the 9 segments of the Business Model Canvas. I know it feels like you’ve got a water hose pointing at you right now, but just keep practicing filling this canvas out and you’ll get there.
Follow these links to join the BMG online community:
- Textbook website: http://www.businessmodelgeneration.com/
- BMG Innovation hub: http://www.businessmodelhub.com/
- Alex’s web site: http://www.businessmodelalchemist.com/
- Alex’s tools: http://www.businessmodelalchemist.com/tools
Got any questions about the Business Model Canvas or developing a business model? Let me know in the comment section below! I’ll try to get back to you as soon as I can.
Join me next Monday for more entrepreneurial tips!