Some small causal structures arise and work reliably in many cases to capture how things change. And businesses in many sectors share completely standard structures. Using standard structures saves a lot of modeling effort, and cuts the risk of making errors. Using standard business-type models reduces effort and risk still more.
How can common structures arise?
I explained in another post, Why theory matters! that our digital twin business models reflect a rigorous 4-part theory of how business systems work. Following that theory gives us a reliable 4-step process to build a digital twin business model
That process starts from the changing outcome we want to understand, and asks “what causes that?” – and we want an answer we can calculate with. For example, many of us want to know why revenue has been rising or falling as it has been doing, and what levers we have to improve revenue growth. So:
What causes revenue? … sales * unit price
then … What causes sales? … customers * sales per customer
“Customers” is a stock, so:
What causes the number of customers at any time? … the number of customers last month plus customers won per month minus customers lost per month
So changes to revenue depend on the customer win-rate, the customer loss-rate, the customers’ purchase rate and the price. So those must be the factors we seek to change if we want to grow revenue. (There are more dependencies to add, of course, like how price affects the other 3 items. And things are a little different for durable products or one-time services).
The standard customers-sales-revenue structure For a simple consumable product, those relationships explain changing revenue – there cannot be any ‘other’ explanation. And that structure can be configured for any case. Here is a screen-shot of the model, with illustrative numbers.
We would go on to ask what further factors cause each of the items above to change, such as our marketing spend, sales effort, service quality, competitors’ price and so on.
But this structure, and its math, is where we start from.
Check out the model at sdl.re/customers-to-revenue-consumables. The model-project includes an example of the model applied to sales and revenue for a retail store.
There are many standard structures – but not too many! Go through the same “what causes that?” process for other outcomes of interest and we find many other standard structures. For example:
… how service quality reflects the balance between customer demand for service and your capacity to deliver it
… how the “quality” of a customer-base (the average revenue they generate) changes over time
… how customers and sales are won and lost between you and competitors
… how quality and reputation drive changes to customer numbers and sales
A relatively limited library of such standard structures is enough to get you started on most common challenges or initiatives you want to tackle.
Complete standard business models
“But my business is unique!” Sorry – but no it isn’t.
Following the 4-step process further, until we have covered the whole of a business system, also ends up finding common structures that apply to any specific business of a certain type. For example, every local table-service restaurant in the world has:
- a menu (its product range)
- staff (to prepare and serve the food)
- tables (its capacity)
- customers, who use the restaurant with some frequency
Of course, the numbers – and how they are changing – vary hugely between individual cases. And the exact relationships between the elements will vary, for example customers’ sensitivity to service or value. But those elements and relationships themselves are common. You do achieve some level of service quality, and that does affect how your customers feel about continuing to use your restaurant.
Then, we can modify such a common model for any additions (e.g. adding take-out service) or variations (a town-centre or highway unit relying on passing traffic instead of a local population).
Similarly, every airline, law firm, construction company etc. will conform with one of a few variations on standard business system structures for their sector.
Save time and be more reliable The benefits we get from the existence of such standard structures and business models are huge.
Clearly, it takes less time and effort to simply configure an already-working model to reflect a specific case than to build that model from scratch.
And because you know the model already works, you will make fewer mistakes!
But – be careful! – there may always be unique features of any case that mean you have to make adjustments. So always ask “Is this exactly how it works in my case“
The standard customers-sales-revenue model described above, and that universal restaurant model, feature in our core course on building digital twin business models. Many other standard structures, such as those for customer-quality, competition and intangible factors, feature in our “extension” classes for dealing with common issues.