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June 22, 2021

4 mental models to turn your business profitable


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A mental model is a technique used by many entrepreneurs to foster a better interpretation of the relationship between certain aspects of life. In its simplest definition, a mental model is a framework of how something works.

The best thing about mental models is that they are like a guide that you can follow to make better decisions, solve problems and have a clearer perception. This is also extremely beneficial for businesses. With the help of mental models, you can incorporate structures and frameworks that will result in more optimized outcomes. Even though there is no perfect mental model, each business can utilize them to reduce time spent making decisions. They’re able to visualize very complex problems and develop an action plan.

Some of the most efficient mental models are those that can be applied to everyday life. You’re able to evaluate problems better by simply starting to think better.

If you don’t use any mental models for your personal projects or for your business, there are usually two ways that you continue with your work: 

  • You continue with the current momentum, without asking any questions or analyzing your current work, or

  • You put your instincts to use, where your past experience and everything you’ve learned so far helps you guide your work. 

While this second is somewhat of a better approach, there is so much more you can do with your business by developing your own mental model that guides every daylife. 

Don’t believe us? Let’s look at 4 mental modes and how they’re used by successful businessmen like Elon Musk and Jeff Bezos. 

The First Principles Method

One of the most prominent mental methods to simplify complex systems is The Method of First Principles. The way this method works is by focusing on two questions:

  • How can you solve a problem in the most efficient way possible if you started from scratch? 
  • If you didn’t take into account all of humanity’s past attempts to solve this problem, what would be the best approach you can take if you looked at its fundamental principles? 

The way Elon Musk harnessed the power of The First Principles Method for SpaceX is by looking past decades of rocket improvements and re-evaluated spaceflight from the very beginning. They first started by looking at underlying engineering principles to figure out how to build a rocket in both a cost-efficient and power-efficient way. Then, they worked from those principles to build the world’s most efficient rocket. 

SpaceX was able to use a very simple mental model to navigate a very complex system, and at the same time, they were able to drastically improve it.

So how would you be able to implement this mental model for your business and future projects? 

Well, there are a few questions that you can ask about every project:

  • What kind of a project is it? Is it a relationship, a business, a product, or something else with multiple components relying on each other?

  • How efficient is this system?

  • If it isn’t as efficient as you want it to be, what are the basic principles underlying this system?  

  • Are you able to start from these basic principles to design a better system?

With The First Principles Method, you would be looking at the basics of a system and developing a better approach that works for your business.

The Amazon Flywheel

One of the world’s biggest e-commerce sites prides itself on using a very productive mental method. Jeff Bezos uses the Amazon Flywheel to maximize its profit and keep the business rolling. 

This mental model works by using the snowball effect. There is a lot of work that needs to start it rolling, but as soon as it starts going it gains momentum and rolls faster. The only difference between a snowball and a flywheel is that a flywheel doesn’t have to stop. It can continue rolling until someone or something puts a stop to it. 

Amazon has created a flywheel by harnessing economies of scale to lower its cost structure. This way, customers get lower prices and a larger range of products. These lower prices attract more customers and direct them to the website, generating more traffic. In turn, more sellers are also attracted to the website, bringing an even larger range of products. And the wheel continues to spin on and on, creating the giant Amazon that we all know today. 

Other companies that use this flywheel mental method for their businesses are Google, Facebook and Walmart. 

Source: Amazon

The Network Effect

Another mental model that is used by one of the most successful businesses in the lodging sector, Airbnb, is the Network Effect. In economics and business, any additional user of products or services contributes to the increase in value of these products and services. 

This mental model is quite important in various industries, mainly because in our daily lives we use a plethora of goods and services. In doing so, the network effect is able to harness the power of “virality” that these bring. For example, telephones and social media are among the most powerful products that utilize the power of the network effect. 

For a Network Effect to work, a business must be able to provide a shared resource that increases its value every time a new person begins to use it. Startups usually use this mental model, as it helps them grow quickly and become profitable in the process. 

They usually follow three steps: 

They focus on a group of people or things

  • They design a platform for connecting this network that is also highly customizable
  • They enable parties on the platform to exchange their resources, usually on a marketplace

Startups that are driven by the Network Effect mental model usually link this group of people or things in a way that creates new incentives for any member of these groups. The product or service that the startups provide, therefore, is usually a platform or marketplace where members can act on these incentives. 

These platforms become more valuable when more people use them. They focus on the consumer's life and habits, so the more people there are on the platform, the more exchanging opportunities that are available. 

If we look at Airbnb, they’ve found a way to connect people and products across the world. It’s now worth about $30 billion. They even claimed to have 4 million listings in over 191 countries in 2017. This came as a result of the platform's accumulated number of guests since they launched in 2008 - 200 million guests to be exact. 

It’s been said that Airbnb formalized the concept of crashing on a friend's couch. So the question that their platform is determined to answer is: What if this relationship between host and guest can exist between anyone?

And this question is also the fundamental one in the Network Effect mental model. 

With each added user, the platform increases in value. And as a result of this mental model, users will promote the platform all on their own. They talk about it to their family and friends, they share it on social media or even write about it in their blogs. The platform begins to become a “self-fulfilling” business that will only continue to grow. It is why even today people always consider booking an Airbnb for their lodging.

Source: Immutable

The Circle of Competence

Charlie Munger and Warren Buffet are the masterminds behind the Circle of Competence, another mental model that is worth mentioning. It’s crucial for businesses and individuals who want to know where they can make financial investments. 

This mental model focuses on limiting places where you can make these investments, usually based on someone's own understanding of investing and past experiences. This model, however, can actually be applied in many areas of life. In its most basic sense, the Circle of Competence helps you understand where your strengths lie and then make you stay within that area.

For example, the Circle of Competence is the subject area where your skills and expertise are the most effective. In turn, these areas are known to you and you are able to better navigate your way through this area and make better decisions. 

What is important to keep in mind, is that the size of the circle doesn’t really matter. What matters is that you’re able to stick to it successfully. 

Warren Buffet even said: 

"Know your circle of competence, and stick within it. The size of that circle is not very important; knowing its boundaries, however, is vital."

In terms of investments, it’s encouraged to focus your time and attention within your own circle of competence, and then invest your wealth into that. This is exactly what Buffet and Munger have been doing for years (and continue to do so), which has made them among the most successful investors in history. They don’t branch away from the things that they know, which has made their firm, Berkshire Hathaway, more than $700 billion in assets. 

This mental model is considered one of the most valuable strategies for individuals and businesses to have success and wealth. With the Circle of Competence, you keep your investments and decisions always backed up with knowledge and experience. You can then work on expanding that circle, but if you continuously work within it success is almost always guaranteed.

Some Food for Thought

All four of these mental models are among the most success-proven ones in a long list of mental models. 

Whichever one you choose to use for your business or project will help you make better decisions, increase value and profit and help build a better foundation. But you don’t have to choose only one. If you are able to utilize multiple mental models at the same time, it will only benefit your business more.

Each mental model tackles one way of looking at life, so the more ways that you’re familiar with, the better you can work with them and use them to your advantage.

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