New Business Models in these Changing Times (printed in CFO India Magazine, Feb 2017)

WHAT IS EXCITING me the most these days, you ask? Well, we are almost in a renaissance phase in business. The new kinds of business models and value propositions which are showing up are quite stimulating. What’s causing them? Well, what I pay for as a consumer, is changing. I may enjoy a service and not pay for it; an advertiser may pay for it for me, with the hope that I will pay for the advertiser’s product or service some day! Where I paid to buy an expensive product before, I may only pay for a service.   In this context, let me refer to the Circular Economy. This is a concept of industrial economy where manufacturing, product life cycles and services are designed to yield higher productivity from resources and to generate lower waste.    Circular Economy has the potential to radically change business models going forward. The traditional product life cycle starts with elements which go into components which are used to manufacture products. These products are used by a consumer or an entity through its useful life, at the end of which it is scrapped, leading to waste.    

 The Circular Economy attempts to elongate product life cycles and increase the number of cycles of a product. In some cases it generates byproducts which yield further value. This brings a number of benefits, the first of which is to significantly raise the yield from the same set of resources. If a product, made of metal, plastic, silicon, is scrapped after one life cycle, most of the elements would go back to the earth after one use, contaminating the soil somewhere or polluting the air on incineration. There can be a different approach to manufacturing, selling and using a product.   Products can be designed in a way that the core elements can be taken back after usage in one life cycle. The products taken back are re-manufactured, retaining the core elements and design. The re-manufactured products can then be put out in the market for another cycle of usage, perhaps in a different segment, at a different price point. So the same elements, with some additional effort, can be used for a longer time through multiple life cycles, increasing their yield and deferring and reducing wastage. There are several examples of this already.   Peter Diamandis writes in his book Abundance, that there is enough opportunity for the world to provide resources for its entire population. He talks about a number of factors which can make this happen. These include the better usage of resources and information, innovative technologies which will radically change the way we produce and consume, and a world of co-operation which will evolve as there is higher awareness about how we are connected. He writes, “In today’s hyperlinked world, solving problems anywhere, solves problems everywhere.” The Circular Economy approach has many other elements which may lead towards abundance. Say, you have an expensive equipment. You try to sell it to me, promising that it will reduce my consumption of other materials, of energy, manpower resources, etc, over a period of five years. Based on your calculation, I will get a return on my investment in 2.5 years at my cost of capital. Problem is, only time will tell whether I shall achieve this or not. Your calculations are based on assumptions on the cost of each of the resources used, my consumption and the performance of your equipment in the past. Any of these can change.    In a different approach, you could offer me the equipment for usage. You could ask me to share equally with you the savings I have in the consumption of material, energy and other resources, calculated on an agreed baseline. How would you develop this model? One could add on elements to it, like service, annual reset, bonuses, penalties, etc. When I stop using the equipment, you would take it back. You would shed certain parts, service the core, re-manufacture it and put it out in the market again. The equipment can go through a number of cycles this way.    Another kind of circular business model is in Resource Recovery. An apt example is how Walt Disney World Resorts send food waste to a facility to be used as fuel for production of bio gas which is used in the generation of electricity. The waste from generation is used as fertiliser.    Energy is scarce and hence the clamor for renewable energy. A bio ethanol product developed by a company, which produces fuel from agricultural waste, became an additional revenue stream for the company, while addressing the energy problem.   The platform sharing model is another way, which is evolving rapidly. Aggregation of taxi services and aggregation of rooms are well known examples of how expensive assets like cars and houses are placed on a sharing platform on “pay for use” basis. This is extending to manufacturing platforms which are shared and to colocation data centers and software platforms.    The perception of value, of risk and the point at which the value is paid for can shift significantly with these new business models coming into play. In the conventional model, manufacturer makes a product, sells to buyer and buyer pays for the same. But in the new business models, an entity can offer value as a service; he may be paid by the user of the service, or by a third entity which may benefit from the user using the service. There could be an arrangement to share the recovery of resource or the gain from producing another item, like renewable energy.     

  For financial planners, this poses certain interesting issues. When we build the financial models for such business arrangements, the following will need special attention. To validate the projections on whether the market will in fact pay for the services we are proposing, we must build a plan in what I can call, “Steps and Landing” model. Imagine walking up a staircase where there is a landing after a few steps. On reaching the landing, we must assess whether the assumptions are working, before taking the next few steps. We must identify the critical assumptions in the projections and determine indicators; if the assumptions are working then we carry on and if they are not then we pause and correct. This is also called “learning loops”.   Secondly, when we shift from product sale model to pay for service, pay for usage or pay for savings models, we must separate the financing elements in the model.  A pure lease financing model may not be appropriate. The structuring should start from the customer’s viewpoint. The revenue streams should be based on the value accruing to the customer and what the customer would be prepared to pay. We should then determine the margin level and work out the desired costs, with the objective of achieving it with operational and sourcing efficiencies. If it does not work, then back to the drawing board! The desired margin after all should yield the desired return on investments.   In the business models described above, the risks impacting the critical assumptions may be different from traditional business models. Unforeseen activities and costs coming up from time to time may impact the P&L. So the costing and pricing will need tweaking as you move along. This means leaving flexibility in certain parts of the contract. If savings are committed to the customer, there can be a range with a minimum which is not “risky’ allowing for variations above this threshold. Back to back arrangements with input sources and services would mitigate some risks. Equally, there should be enough flexibility in contracts to leverage opportunities to yield upsides, which can be shared with customers or vendors.    As partners to business, I see opportunity for finance folks in working out new models with the changing times. While we must assess the risks and have the most realistic view, we must also think how smarter cost and revenue models can be evolved, mitigating risks, leaving space for opportunities and yielding the desired returns.