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Is it Easy for Your Customers to Leave You?

Your business model’s strength depends not on barriers to entry, but on barriers to exit. Here’s how to assess it.
COLLABORATORS Rita Gunther McGrath
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You’ve heard of barriers to entry, but it’s barriers to exit that determine the strength of your business model, according to Rita Gunther McGrath, a professor at Columbia Business School.

What’s an exit barrier? Simply put, it’s the combination of factors preventing customers from leaving. “In general, business models that create exit barriers, for which there are switching costs — which are not transactional and which to some extent lock customers in — tend to be more attractive than those in which the opposite conditions apply,” writes McGrath in her article “Finding Opportunities in Business Model Innovation” in the European Financial Review.

So how can you assess your model’s lockdown power? McGrath provides a 10-step diagnostic (see the table “Scoring Business Model Attractiveness,” at the bottom of this post). For each step, the model receives a grade of one through seven, for a total score of 10 (highly vulnerable business model) through 70 (vulnerable business model). Step two, for example, asks for a grade based on where your model falls between two polar statements: “The model is based on individual transactions which must be repurchased each time,” and “The model is based on a series of transactions (such as subscriptions or long-term contracts) which are subject to renewal.”

If your model is closer to the first statement, you’d score it a one or two. If it’s closer to the second statement, you’d give it a six or seven. Somewhere in between, you’d give it a three, four, or five.

To demo the diagnostic, McGrath uses the business model of Groupon, the much-hyped daily-deals website. Graded on the two statements just mentioned, Groupon does not fare well: “The model is based on individual transactions,” McGrath writes. “Users do not subscribe to Groupon; rather, each payment is transactional. That’s a 1.”

In other categories, Groupon does better: “The model does build a form of relationship, but not an embedded or particularly sticky one. Let’s say that is a 4,” notes McGrath. “There is modest impact on the customers’ experience, as it could mean a new discovery or affordable items. Let’s say a 4.”

All told, Groupon nets a 36 — just short of McGrath’s preference for a score over 40. “There are several elements of the model that do not create stickiness, loyalty, or a barrier to competitive imitation,” she concludes. “As customers grow more sophisticated, more numb to the idea of a daily e-mail which may or may not offer them something they want, and competitors come up with more fine-tuned offers, Groupon’s model shows some vulnerability.”

Use Rita Gunther McGrath’s 10-step chart to assess your business model’s level of attractiveness. Choose a number between one and seven for each statement, and add up your score. A score below 40 would be considered vulnerable.

THE PLUS

You can read McGrath’s full article — which also addresses the subject of business model innovation — in the European Financial Review.

For the record, she’s not the only critic of Groupon’s business model. “While Groupon’s model is simple, it isn’t sustainable,” observes Panos Mourdoukoutas in Forbes.

Wharton marketing professor David Reibstein is another skeptic. In an interview on the Knowledge@Wharton site he says, “The Groupon business model works better during a recession than it does during a vibrant economy. . . . As the economy picks up and there is less excess inventory, the availability of supply will go down. The willingness of the merchant to offer deep discounts will go down. The business proposition to the customer will be less attractive if [the item or service being offered] doesn’t have the same deep discount.”

On the flip side, Fred Moran, an analyst at The Benchmark Company, is a believer. You can hear his take in a clip on CNBC.com under the heading, “Groupon Business Model More Powerful Than Street Realizes.”

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