Assessing Business Model Profitability: NPV and VARIM Analysis Report

This report analyzes methods for assessing the profitability of a business model, focusing on two primary techniques: Net Present Value (NPV) and VARIM analysis. The report explains how NPV is used to calculate the stream of income a business will generate and discount it by an appropriate rate, detailing its application in valuing businesses at different stages (start-up, scale-up, and exit). It also highlights the drawbacks of NPV, such as high data requirements and a static notion of value. The report then introduces VARIM analysis, which offers a more dynamic approach by evaluating the value, adaptability, rareness, inimitability, and monetization of a business model. Each component of VARIM is defined, with specific measures provided for each, such as customer satisfaction, flexibility of resources, number of competitors, and rate of return. The report provides an overview of how to assess profitability, and valuation of a business model, offering key insights into making informed business decisions.

19th and 23rd October 2020
Business Model Innovation – Lecture 2 and 3
How do you assess the profitability of the business model?
There are two sorts of methods:
1. Net present value method
2. VARIM analysis
Net present value analysis:
- All businesses will generate income in the future
- One way to value a business model is to calculate the stream of income it will
generate and discount it by the appropriate rate.
- Often the discount rate may be the return investors want to earn
- Otherwise, the discount rate is the present rate of interest
One way to value a business model is to say what is the stream of income it will generate
and discount it by an appropriate rate of return.
It is meant by the appropriate rate of return for the entrepreneur - this could be the rate of
interest charged for capital funds that they may have to borrow to run the business.
For a shareholder or somebody interested in taking a share of the business, it might be what
is the return that they expect.
The discount rate is the cost of borrowing the capital, or it is the rate of return that an
investor may want to earn.
NVP formula:

One very useful application of the net present value is in understanding whether stocks are
over or undervalued.
Using NPV to value businesses:
- Distinguish between start-up, scale up and exit stages of businesses
- Data available in each stage is different
- A company available I. each stage is different
- A company scaling up is easier to evaluate as there is some history of revenues in
firm and industry
- Usually compare P/E ratio or PEG ratio with that of an analogue.
- Valuation quite important at the time of IPO
Drawback of valuation with NPV:
- High data requirements
- Use of analogues – ignores differences between firms (and their capabilities)
- A static notion of value – as it also ignores the role of competition and external
environment
- VARIM offers a more dynamic analysis.
The more data you feed this formula, the better the estimate of the present value. The use
of analogues can help overcome this lack of data. Still, it ignores the differences between
the firm's capabilities and also, of course, the net present value analysis doesn't put any
emphasis on the competition, so it's a very static notion of value, it does not recognise the
role of competition or the external environment.
Valuation of start-up:
- No history of revenues so NPV is difficult to use
- Investors and consumers are arbiters of value
- Investors offers often reveal their valuation through their offer
- If investors pay £y for x% of the business
- We can infer that investor’s valuation of the business opportunity is £100(y/x)
- This can be different from the founder’s evaluation

VARIM analysis of profitability:
Value: Does the business model offer benefits that customers perceive as valuable to
them?
 Can be measured by customer satisfaction and loyalty, reputation/image, market
share, benefits offered relative to competition.
 Quality of resources e.g., founder resources, network effects, reputation
 Quality of activities – use of industry value drivers like location, frugality, low input
prices.
Adaptability: Is the business model – or core parts of it – cost-effectively reconfigurable
or re-deployable to offer benefits that customers perceive as valuable to them?
 Adaptability of resources – how flexible can the firm be with its key resources
 Adaptability of activities- measured by diversity of products offered, new sources of
revenue, perceived level of “improved services”
Rareness: Is the firm the only one that offers the customer benefits? If not, is the firm’s
level of the benefit higher than that of competitors?
 Measures include Number of competitors, Number of substitute products, perceived
advantages of firm relative to competition.
Inimitability: Are the benefits offered by the firm difficult for other firms to imitate,
substitute, or leapfrog?
 Measures include:
-number of imitators
-ease of imitation due to imitability of resources or activities
Monetisation: Does the firm stand to make money from offering the benefits to the
customer?
 Measures include rate of return on assets or measures of profitability; pricing model;
pricing, importance of complementary products, number of customers willing to pay,
cost structure, industry attractiveness and firm’s position

Example: