(Also posted on LinkedIn here).
I’m a big fan of the “Lean startup” movement. Steve Blank, Ash Maurya and others have done amazing work around innovative, startup companies. Two of my most recommended books in this area are The 4 Steps to Epiphany and Running Lean. I strongly recommend every founder read these. Shockingly, most haven’t!
I’ve come across a new breed of founders who are well versed in the lean startup methodology. They understand the importance of customer discovery, a minimum viable product and the power of testing. These are all necessary to build new products.
I submit that they are not sufficient to create a company.
A feature isn’t a product; a product isn’t a business; a business isn’t a company; a company isn’t an organisation.
Here are four additional questions you need to look into before you startup.
1) Are you talking to the right, representative prospects to validate your idea?
I’m a big believer of getting out in the field and talking to customers. Dozens even 100’s of them. It is an order of magnitude better than sitting in your office and pontificating. However, talking to 200 people does not make your idea into a viable business opportunity.
Are these 200 people truly representative of the prospective customer pool ?
Or, is there a selection bias? Perhaps, these are only tech-savvy customers in urban areas or the upwardly mobile. You need to estimate how big is that addressable market over the couple of years.
Secondly, how critical of a pain point is it for these users?
Is it an ongoing pain or a one an infrequent, perhaps even a one time, problem ? In general technology has made people be more open to saying “yes” more often to new ideas. This is the classic Aspirin vs. Multi-Vitamin question that VCs often talk about. While new ideas area interesting, it often takes years to change customer behaviour unless it a dire problem for a large number of prospective customers.
Don’t try to “invent” demand. Find basic human needs and solve them better, cheaper and faster.
Evan Williams, Co-founder of Twitter.
Market creation is hard for a variety of reasons; one of the primary reasons is that the cost of distribution is continually getting more expensive.
Lastly, would customers pay — ideally with money or at least with their time(e.g. Snapchat, Instagram, Google)?
2) Can you get effective distribution of your product or service ?
Human beings and businesses alike are being bombarded with a breathtaking innovations at a rapid pace. However, the amount of time, energy and money they have is limited.
How will you reach a large number of customers whether they be consumers or businesses? Are there existing channels that you can tap into ? Would they be cost effective?
Every innovator believes that their product will have strong word of mouth, virality and/or some kind of network effects? Well, most don’t. For most ideas, esp. in B2C, I would be very dubious if you don’t have strong, organic user acquisition channels to grow.
3) Are the unit economics viable?
So you have a problem worth solving, a solution that’s differentiated and a shot at distribution. Now comes the question about “Unit economics”. The simplest place to start is with your gross and net margin. How much money would you make per transaction (or unit of engagement)? This is not GMV or Transaction Value but the money that your business makes.
The first step for this is to calculate your Contribution Margin, or the money you make per transaction less your variable costs. For most businesses, variable costs are marketing, payment gateway charges, delivery/logistics charges, etc. This does not account for fixed charges for your employees, server costs, etc.
Is your margin or take rate (%) enough to cover your variable costs per unit?
If you are relying on scale to get your contribution margin positive, you are barking up the wrong tree! You may never get there.
4) Is there a large enough profit pool to tap into?
If you’ve gotten this far, you clearly have a problem, distribution channel and business that’s worthwhile.
Is there a large enough market size and profit pool in the area that you are in?
I don’t know about these new valuation metrics, but remember that the only way to value a business that will always be true is: present value of discounted future cash flows
Prof. Bill Sahlman, HBS, Circa 1999
If you don’t have a large enough profit pool, you may build a company with great unit economics on a large enough market but have little discounted future cash flow (e.g. IRCTC — Indian Railways). See Rajan Anandan’s prescient comments on the Indian B2C e-commerce marketplaces.
Now comes the source of capital to build your business. If you are aiming for something big and ready to scale fast, then I would recommend using venture capital (if you can affirmatively answer all 4 of these questions, give us a shout at Prime Venture Partners). However, VC money may not be appropriate or relevant for your business or your approach. Here’s one representative list of questions to ask yourself before raising VC money.
All of this won’t be empirically figured out on Day 0 of a startup. Of course, you will learn along the journey. However, you won’t be able to change the contours of the market or the availability of profit pools once you are 6–12 months into your startup.
It behooves you to spend a few weeks or even months to think through these questions before you commit yourself to a new company!
Guest Post by Amit Somani. He is a Managing Partner at Prime Venture Partners, an early stage VC firm based out of Bangalore, India. Prime invests in category creating, early stage companies founded by rock star teams. Prior, Amit has held leadership positions at Makemytrip, Google and IBM. He is also deeply engaged with the early stage startup ecosystem in India and actively volunteers with iSpirt, TiE and NASSCOM. He tweets occassionally @amitsomani and is trying to become an active, late blooming blogger.