What I’m going to share with you today has been for me the most useful business planning tool since the original business model canvas. It’s helped me clarify even the most challenging business models and helped answer every major question about an idea.
But first, some background…
In 2008, Alex Osterwalder introduced the Business Model Canvas to the world. Hailed as a way to quickly create a business plan on one page, Osterwalder and the Canvas became massively popular in the business world. The canvas was proving to be especially useful to the startup world as it was an easy and straightforward alternative to the norm of creating a 100+ page business plan.
Due to its simplicity and ease of use, it also became the go-to tool for the Lean Startup movement. It was used as a way to document a startups initial business model hypothesis and from there you could systematically validate and invalidate each part of the hypothesis.
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Several years later, in 2014, Osterwalder released the Value Proposition canvas which is a companion to the classic Business Model Canvas. This canvas created a more detailed view into the customer segment you were targeting and the specifics of the solution you were proposing.
In 2015 I needed to create a business plan. I was asked to create a business model from scratch for an IOT product in the home automation market. Having been well-studied on all the ways I could create a business plan I started with the simplest thing I could think of – filling out a Business Model Canvas.
As I started filling out the canvas I learned about the Value Proposition canvas and filled it out as well. Now I had two canvases – one for the business model and another for the value proposition that explained my idea.
After I got done with filling out these two canvases I started using them to talk with others about the idea. That’s when something interesting happened…
I started getting questions about my idea that the canvases couldn’t answer. Questions like these:
- What is your overall mission or vision for this business model?
- What will be your unfair advantage?
- What metrics are most important to validating this business model?
And more questions that I hadn’t thought through yet…
The other thing I discovered is I didn’t like having more than one page (now that I had both the business model canvas and the value proposition canvas) to carry around to talk about my idea. I really wanted everything on one page because it was far less confusing to keep all the ideas straight.
I had thought about using the Lean Canvas by Ash Maurya which had some helpful additions such as the problem statement, the unfair advantage and metrics but I still didn’t like that it didn’t have the value proposition elements all on one page.
The other issue I had with it is the confusing way in which you would go about validating each step. The above numbers represent the order you were supposed to go through in validating the business model. I don’t know about you, but I felt like it was looking at a bowl of number soup rather than a clear and easy to understand process for business model validation.
Innovator’s Canvas 1.0 Is Born
Out of these concerns I decided to create my own version of the business model canvas and hopefully address the concerns I had with the others. I wrote a blog post about it in September 2015 titled The Innovator’s Canvas: A Step By Step Guide To Business Model Innovation.
To date that blog post has been one of the most popular on this website. As I started using the Innovator’s Canvas I found it helpful that I could show the value proposition details as well as the brand promise/why/mission behind the overall idea all in one page.
Some of my peers and co-workers started using it as well and felt like it was a meaningful improvement to both the classic Business Model Canvas and the Lean Canvas.
In conjunction with the Innovator’s Canvas, I outlined a series of steps to take in order to validate the business model hypothesis. Below is the approach I suggested at the time:
As I showed this to people the first thing they said was “Why are they out of order?” Though I thought it was easier to understand than the Lean Canvas with its 9 boxes of number soup, I didn’t have a good response. I took it as usability feedback to consider.
Also I started getting additional detailed questions about the business idea such as the following:
- How specifically will your channel work? How will you drive awareness of this product/business?
- What customer problem are you trying to solve in the first place?
- How much money will you make on a gross margin basis for the product?
- How much general and administrative overhead will you need to support the initial version of the business model?
- What are the overall market dynamics like for this idea? What products and technologies are out there now solving this problem?
That’s when the idea for the Innovator’s Canvas 2.5 started to take shape…
Innovator’s Canvas 2.5 is Born
You’re probably wondering why I went from Innovator’s Canvas 1.0 to 2.5. Well the truth is that I’ve always made updates and improvements to the canvas and haven’t always written a blog post about them. Hence the versioning oddity.
The first improvement I wanted to make was putting the customer segment and revenues on the left side of the page so you would see those first. That would mostly fix the issue of having out of order items on the canvas. This was effectively version 2.0.
Then the second improvement I wanted to make had to do with showing more detail around the economic model of the business. I’ve seen too many startups fail simply because they didn’t have a clear understanding of the fundamental economic assumptions in their business model. My goal was to be able to refer to the canvas and quickly and easily understand each major financial assumption. To me, just having boxes for cost and revenues wasn’t sufficient detail to truly understand the economic assumptions behind a business model. Adding these elements ultimately became version 2.5.
In my MBA program I remember learning from our managerial accounting class that the simplest formula to use to understand the fundamental economics of any business was:
Revenue – Variable Costs – Fixed Costs = Operating Profit
I thought about this equation over and over and tried to imagine ways it could be visualized on a canvas. That’s when I started thinking of the essential elements of the canvas as stacks of boxes that sit above those elements in the equation. Above the revenue is the customer segment, the problem they’re trying to solve and the job to be done. The revenue side was easy because I already had a stack of boxes that made sense above it. Revenue essentially represents what the customer is willing to give up at any given time in order to get that job done.
When I started thinking through the rest of the canvas I realized pretty quickly that it would all need to shuffle around a bit in order to make sense. But the possibility of making a much clearer connection between elements on the canvas and the fundamental economics of the business model became really exciting to me.
From a variable cost standpoint I split it out as follows:
Variable Costs = Channel Cost + Cost of Goods/Services Sold
For the fixed costs I changed the wording to match more closely what I figured most business owners refer to it as – General and Administrative.
Then the last element was Operating Profit which I changed to “Value Creation” because that’s the assumption you will be making regarding how to actually make money in order to sustain the business model.
So to summarize the following are the elements I landed on:
|Original Equation||New Name||Business Model Group|
|Revenue||[same]||Customer / Problem / Job to be done / Pains / Gains|
|Variable Cost A||Acquisition & Support Costs||Channel / Support|
|Variable Cost B||Cost of Goods/Services||Solution / Product / Pain Killers / Gain Creators|
|Fixed Costs||General and Administrative||Business Structure / Key Resources / Partners / Etc.|
While adding the details of the economic model was helpful I still felt like something else was missing. In every business plan I’ve made I’ve always had to address the overall market dynamics including the competition, technology, customer trends, etc. Because of this I decided to include those elements as well and bundle it all up into a version 3.0.
With this as my new theory of how to generally structure the canvas I then went to work on designing the new canvas. Below is what I came up with:
Innovator’s Canvas 3.0 – The Latest
In this version of the Innovator’s Canvas I’ve organized the content as follows:
- Customer and Problem to solve
- Support Structure
- Economic Model
- Market Environment
Below is an example of the Innovator’s Canvas 3.0 with these themes overlayed.
To download a free PowerPoint version of the Innovator’s Canvas 3, click here.
Part 1: The Customer
The first, and most important part of the canvas, is the customer section. In this section you write down your assumptions about the customer including:
- E.g. Age, income, location, beliefs, interests, culture, etc.
- Problem Statement
- The primary problem they face that you want to solve
- Job to be done
- The fundamental outcome they are seeking
- The pains associated with getting that job done now
- The gains they have expressed they would like to experience
Part 2: The Solution
Once you’ve detailed your assumptions about the customer you can then move on to writing out your assumptions about the solution:
- Mission Statement
- The big picture of what your business does and why
- Value Proposition
- How specifically you plan to solve the problem your customer faces
- Product or Service
- A description of your proposed product or service
- Pain Killers: How you solve the primary pain your customer faces
- Gain Creators: The extra value your solution provides over existing ways to solve the problem
- Cost of Goods/Services
- The cost to make or provide each product or service
Part 3: The Channel
Once you have documented both your customer and your solution, it’s time to think through the channel by which your product (or service) will reach your target customer.
- How will your target customer become aware of you and your solution?
- How will you explain the benefits of the solution to the customer and answer their questions?
- How will your solution be delivered to the customer?
- How will you provide ongoing post-sale support to your customers?
- Acquisition & Support Costs
- How much will it cost you on a per customer basis to utilize this channel?
Part 4: Support Structure
The next piece of assumptions to fill in has to do with the support structure of the business. This includes:
- Business Structure
- The legal entity
- The owners
- Key Resources
- Human resources, i.e. the team, needed to build and support the business model
- Physical resources needed to support the model (e.g. office space, a new plant, tooling, etc.)
- Financial resources needed in order to support the discovery efforts and create the first version of the business model
- Intellectual property necessary to have a right to practice or protection of the idea
- Key Partners
- The partners needed to create and sustain the model
- Unfair Advantage
- Your unique advantage to making the solution better than anyone else
Part 5: Economic Model
Once you’ve defined the assumptions about the customer, solution, channel and support structure, you have everything you need in order to create the economic model of the business.
- Revenue – Pricing & Frequency
- The price the customer is willing to pay for the solution as well as the frequency of purchase (over a year)
- Acquisition & Support (variable costs)
- The cost of supporting the acquisition and post-sale support of a customer on a per unit basis
- Cost of Goods / Services (variable costs)
- The cost, on a per unit basis, to the business to make the product or offer the service
- General & Administrative (fixed costs)
- The cost to pay for the support of the business over the first year
- Value Creation (profitability)
- The expected operating profit of the business and breakeven volume
Part 6: Market Environment
Once you have documented your assumptions about the business model you are trying to build in the sections above, it’s helpful to also document some specifics about the market in general. That’s where the market environment section comes in handy.
- Market Trends
- General customer trends including changing demographics, behaviors or preferences
- Market Size
- The total number of potential customers who value solving this problem. Also can include the total spend of that market already on solving this problem
- Current Channels
- Primary channels that are used today to deliver comparable solutions
- Current Solutions
- Current products and services being sold today
- Current Providers
- The leading creators of comparable solutions in the market today
- Industry Trends
- Shifts in the industry regarding consolidation, fragmentation, etc.
- Technology Trends
- New technology that provides a runway for innovation
With that information filled out you now have a crystal clear idea of what your business model assumptions are and are ready to move on to the next step of validation.
Below I’ll explain this process from a high level. For a more detailed explanation and to download these materials and more, check out my free video training for innovators called Innovator’s Masterclass. There should also be a link toward the top and at the end of this article.
Validating (or Invalidating) Business Model Assumptions
Having an idea written out is only the first step of creating a new business. The real work begins when you start to validate or invalidate your assumptions.
Below is a graphic that illustrates the typical order of risk in a business model idea.
This represents the areas of the canvas that are most risky to least risky.
- Problem / Opportunity Fit: We have verified a customer segment with a burning problem/need that they are willing to pay to fix.
- Problem / Solution Fit: We have verified a solution to their problem that they would buy right now if it were available.
- Product / Market Fit: We have verified a channel to reach customers for sale and delivery of the solution.
- Business Model Fit: We have verified that the business model can be scaled profitably and sustainably.
The last section on market environment is labeled facts because those data points should not be assumptions. You should be able to fill in each of those boxes with objective facts and move on.
Experimentation Is Key
In his breakthrough book, The Lean Startup, Eric Ries outlined a model for startup success that he called the “Build – Measure – Learn” loop.
The idea of this loop was to quickly and inexpensively take an idea, build an MVP, show it to customers and get feedback/data that you can learn from. Those startups that could go through this cycle the fastest were usually the ones with the highest likelihood of success.
In business model validation, following the Build – Measure – Learn loop is critical. To do so you’ll want to setup and track business model experiments. Below is an example of how I create and track those experiments.
- Step 1: Ask a specific question about the riskiest assumption in your business model. “Our question is…”
- Step 2: State a hypothesis about what you think the answer to the question is. “Our hypothesis is…”
- Step 3: Decide what metrics to track that will tell you whether your hypothesis was right or not. “We are right if…”
- Step 4: Plan and list out the resources you will need in order to setup the experiment. “The resources we need are…”
- Step 5: Write out how you plan to execute the experiment and the procedure you will follow. “Our procedure is…”
- Step 6: Write out the observations you saw during and after the experiment. “We observed that…”
- Step 7: Write out your conclusion by stating whether your hypothesis was valid, invalid or uncertain. Also describe what you learned. “We learned that…”
It’s also helpful to track the time it took to learn each finding as this represent your cycle time through the build – measure – learn loop.
Now let’s move on to running some experiments…
First Risky Assumption: Customer/Problem
The first most risky assumption to validate or invalidate is that you know who your customer is and you believe the problem they face is worth solving. Typically this is the assumption that trips up every idea at first.
“No plan survives first contact with customers” – Steve Blank
The reason this assumption is so challenging is because it’s tempting to think of customers in general or stereotypical terms. Phrases like “millennials,” “homeowners,” “premium car buyers,” “CIO’s,” etc. might sound specific but in reality are far too vague and amorphous to be useful.
In my experience and in working with others who are going through this process the most important activity that you do as a discovery team is talk face to face with customers. Don’t rely on surveys. Don’t rely on consultants. Talk to customers face to face yourself. What you’ll find by doing this is after speaking with hundreds of customers (don’t skimp, talking to 10 customers and calling it good is far too few to actually be helpful) you’ll start to deeply understand the problem you need to solve and you’ll clarify how to segment them. You’ll pick up on clues and commonalities that may not have anything to do with demographics or psychographics but that paint a clear picture of who it is you should be targeting.
You’ll go from saying “millennial homeowners” to “millennial homeowners with a young child where the mother stays at home.”
That’s a segment with enough detail to work with.
Another example is you might go from talking about “premium car buyers” to “owners of 10+ year old luxury 4-door sedans who have started searching online for a new car.”
Another example could be going from talking about “CIO’s” to talking about “IT Directors at Fortune 500 conglomerate enterprises who still use on-premise data storage.”
The point is that even though you wrote out who you think your customer is, it’s likely to change by getting far more specific and useful as you talk to hundreds of customers.
The goal for these initial discussions with customers should be to get to the point where you can accurately predict what they will say. Once you’ve gotten to that point, you usually have enough of a deep understanding of the customer segment in order to build a business model around.
Second Most Risky Assumption: Problem/Solution
The second most risky assumption to validate or invalidate is that your solution idea will actually solve the customer’s problem. This assumption can be tested far faster and cheaper than you might think. The temptation will be to test it after building an elaborate prototype or worse to test it after going into full-scale production.
Rather than spending all that time and money before learning what the outcome will be, the best thing to do is try to simulate the solution for customers in an inexpensive way. If you’re idea is a new smartphone app, create an Invision prototype with a common task flow represented and see what customers think.
If it’s a new piece of hardware, create a 3D print of the object and attach weights to it to simulate look and feel. Tape a phone or iPad to it if it needs a screen and put the Invision app on it to simulate the software experience.
Bottom line is to do whatever you possibly can, as cheaply as you can in order to get feedback from customers about whether or not the solution solves their problem.
Third Most Risky Assumption: Channel
The third most risky assumption is usually the channel to reach your customers. The best way to test this assumption is through channel experiments that utilize real channels to sell and deliver your solution.
For example, if your solution and customer segment lend themselves to this approach, a relatively easy experiment to run is an online ad campaign (either Facebook or Google) that leads to a landing page where you ask people who are interested to leave their name and email. That way when the product is ready you can send them an email about it. This at least helps cover the awareness and sale part of the channel assumption.
Fourth Most Risky Assumption: Support Structure & Economic Model
The next most risky assumption is usually the support structure and economic model of the business. As important as this assumption is to the overall sustainability of the business, it’s still listed as fourth because of the following reasons:
If you don’t know who your customer is…you won’t know what problem you’re trying to solve.
If you don’t know what problem you’re trying to solve…you can’t create a compelling solution.
If you can’t create a compelling solution…then you don’t need a channel.
If you don’t know who your customer is and you don’t have a compelling solution or channel to market…then your support structure has nothing to support and there is no need for an economic model.
The other reason the support structure is least risky is because it’s usually the most flexible component of the model. If you need to get more resources you raise money, hire more people, and connect with more partners.
Also as it pertains to the economic model, if you’re idea is constrained from a cost standpoint then you usually have options for cost reductions down the road – especially as you achieve scale with the business.
As an initial test to determine if the support structure is viable, it’s a good idea to calculate an initial breakeven volume. Below is an example of how to calculate this value:
Breakeven Volume = General & Administrative / (Revenue (price) – Acquisition & Support – Cost of Goods & Services)
For example, let’s say you have the following assumptions for an economic model where you sell computers you make out of your garage:
- Revenue (price) = 1500 (per computer)
- Acquisition & Support = 50 (per computer average)
- Cost of Goods = 1200 (per computer)
- General & Administrative = $500,000 (costs to support the initial business model for a year)
Using the above example we can calculate the breakeven as follows:
$500,000 / ($1500-$50-$1200) = 2000 units
This means that with the assumptions laid out in this example economic model the business would need to sell at least 2000 computers in order to breakeven from a proft/loss stand point. For each additional unit sold above 2000 the business would make an operating profit of $250/ea.
Using this canvas you can also calculate gross profit and gross margin. To do so use the following formula:
Gross Profit = Revenue (price) – Acquisition & Support Cost – Cost of Goods
Using the same example from above we get the following:
$1500 – $50 – $1200 = $250
To calculate gross margin (percentage) you can use the following:
Gross Profit / Price = Gross Margin Percentage
In this example the numbers work out as follows:
$250/$1500 = 17%
The next question you might ask is “What is a good gross margin to have?”
The answer actually depends heavily on two things: 1) how fixed cost intensive your business is and 2) your overall business strategy. Some businesses are heavily weighed down by large fixed costs such as airlines which have to maintain an expensive fleet of planes in order to support their business model. These types of businesses usually need high gross margins (50%+) in order to pay for the fixed overhead of buying and maintaining a fleet of planes. Other companies, such as those in service based businesses like building cleaning companies, have very low fixed costs but much higher variable costs. In that case they may be able to afford low gross margins because they don’t need to support a lot of overhead.
Other companies, such as those in software businesses, have both low fixed costs and low variable costs which enable them to become very profitable on both a gross margin and operating margin basis. The downside to those companies is that they can be extremely competitive because of the low barriers to entry.
Additionally, the strategy you choose has a major impact on the right gross margin targets. In my other post on “The Two Business Strategies: Cost Leadership and Benefit Leadership [and Where Michael Porter Missed the Mark]” I outlined two fundamental approaches to a market. The first was cost leadership where you emphasize to customers how low your prices are relative to the competition (usually necessitating low gross margins). The second was benefit leadership where you emphasize how good your benefits are relative to the competition (usually leading to high gross margins).
Ever since using the Innovator’s Canvas 3 I’ve been able to understand various business models much more quickly and cost effectively. The canvas has been helpful in working with partners, both so they can understand our model a little better and so we can understand theirs. And it’s been a great tool for helping organize business model validation work.
If you also find it useful and would like to learn more or download a PowerPoint version of the canvas, check out my free Innovator’s Masterclass Mini-Course. The first video and set of slides is all about the Innovator’s canvas and how to apply it to your business. The other two videos will help you take your idea and validate or invalidate it one step at a time.
To download a free PowerPoint version of the Innovator’s Canvas 3, click here.
Also below is a version of the canvas that has descriptions for each box. Let me know what you think in the comments section!