Understanding Linear Business Model
Traditional businesses follow a Linear business model where in the business manufactures the goods, owns the capital assets used in manufacturing and sell these goods or services downstream into the value chain. For example, Maruti Suzuki manufactures cars in its Gurgaon factory, owns the warehouse in which it stocks them, hires the logistics services to distruibute them to the dealer network, depends upon its dealer showrooms to sell them; invests heavily in marketing and sales, own or franchises the service centers across the cities. Before being able to sell a car to a customer all these business units must be in place at the location of the customer. Each player in these business units derives some marginal profit from the sale. Consider a services business, say, Hospitality. A traveler needs a place to stay and hotels provide this service by renting out rooms to them and compliment this with other services built on top of this basic need. If Holiday Inn wants to serve its customers in Paris, it must own or acquire a hotel property in Paris, hire hotel staff and arrange all the hotel service lines (pantry, housekeeping, laundry, café, cabs, fitness center etc), market it aggressively before it can get its first customer. This has to be replicated for each location Holiday Inn wants to serve in. For each new customer, it needs to own an extra room atleast. So if Holiday Inn owns 214,000 rentable rooms in 1173 hotels across the world. This means on any given day Holiday Inn’s occupancy cannot exceed 214000 and if it wants to have 214001th customer it needs to invest in an additional room.
Consider yet another example- an IT services company which provides software services to enterprises by renting out its employee hours to its clients (most Global System Integrators fall in this category wherein they work on Time and Material or Fixed Price contracts). For increasing the addressable market size it needs to recruit additional employees. So their addressable market size is directly proportional to the number of employees it hires.
All the above are the examples of linear business model or pipeline business where the value flows through the supply chain like a pipeline. The marginal cost of acquiring a customer in a linear business model follows a U-shaped pattern. Consider Holiday Inn’s example, for the 214001th customer it basically needs to add an extra room (if any of the existing property has space for it; if not then it basically needs to build or acquire an additional property not just a room).
Linear businesses buy components to build a finished product or service and sell it to its customers.
Products are Linear
Software Products fall in linear business category where in the company creates the software and sells it to its customers. Most SaaS businesses are also linear businesses. Why? Because the SaaS business builds the software, hosts it on cloud and sells the subscription to use the software to its users. SaaS business are more efficient from traditional software business in terms of the cost of delivery to their customer and their cost of new customer acquisition is also lower.
|Product Company||Make one, sell to one|
|Service Provider||Hire one, sell to one|
|Software Company (including SaaS)||Make one, sell to many|
|Platform||Many make, many sell|
Scaling a Linear business vs a Platform
Platforms scale exponentially and more efficiently than linear businesses by virtue of two key differentiators: Unit economics and Network Effects.
Unit economics specially for digital businesses often include information (data) for which the cost of replication is virtually zero. For example, apps, digital music, ebooks or any other digital information or media can be produced and distributed at zero cost. It may cost $X to produce a song for the first time but to create a copy and distribute it to additional listener requires zero investment. This means that the digital products like music have near-zero marginal cost in economic terms. Unit economics for producing and for distributing digital assets is near zero because it costs nothing to create a copy on a server and download it from there.
Capital or physical assets and people do not scale; Networks do.
Network Effect is the incremental value or benefit gained by an existing user for each additional user who joins the platform. For example, when a new rider joins Uber all the drivers gain in the probability of getting an additional rider. Also, as the additional riders join, they attract more drivers to join the platform due to increase in probability of getting more riders. As more drivers join the platform, it results in reduced wait time for each rider due to availability of more drivers who are ready for pickups; and it also results in reduced cost as more drivers compete for the same rider’s pickup. All this is orchestrated by the platform. Network Effects can be negative as well. When a driver leaves the Uber platform, it reduces the probability of getting a ride for all the riders and increases the wait time as well as cost. When rider faces long wait times or extra costs, it motivates him to leave the platform, spiralling the network effect of lower probability of getting a rider for each existing driver thereby triggering the negative growth.
Platforms attract more Investor attention
Platforms are the foremost choice for any investor and the reason exists in the exponential scale and outreach. Successful platforms provide much better RoI as is evident from the recent much talked about success stories like Reliance Jio which attracted investors and raised US$10.5 Billion from global investors. Jio’s investors include Facebook ($5.7 billion), Silver Lake Partners ($747 million), Vista Equity Partners ($1.5 billion), General Atlantic ($870 million), and KKR’s Asia PE Fund ($1.5 billion). Reliance has diluted about 17.1 percent equity stake in Jio. It all happened during the Covid-19 pandemic times when the whole world was struggling with the lockdowns and near-nil economic activities. Why? Because Reliance Jio owns the Data pipe which is used by 388 Million users (50 million more than USA population) for consuming various services. YourStory has beautifully described the Reliance Jio story, read it here.
Another example is India’s KhataBook which still doesn’t have any revenue stream yet it raised US$60M in Series B. Why? Because it is used by 8 million small merchants in over 700 districts of India. Several promising revenue streams can be built on top of KhataBook platform in times to come if they continue to stay focused on designing their ecosystem correctly.
The Strapla Consulting enables the enterprises in building successful Platform businesses by orchestrating the strategy with apt execution.