In part one of this series, we began to incubate your idea, validated that customers actually existed, that they were willing to engage with numerous components of your business model and, that you have something that differentiates you from your competitors (i.e. your Competitive Advantage).
We did this by testing your initial hypothesis about your product, your customers and numerous other components of your potential business model. We then captured the results and begun to make decisions off of the data we captured.
We now know that there is enough desire in the market for your product or service to validate further time, effort and capital being spent.
This was stage one of Design Doing.
But, what we don’t know is whether or not there is a really solid business that surrounds your product. There’s no point putting years of your time and plenty of your (and maybe other peoples’) capital into something if it’s unlikely you will ever see a return.
There are still a lot of unknowns.
It’s time to focus on stage two of Design Doing, Business Model Validation.
And, this means we need to begin focusing more on the numbers.
What we need to achieve over the coming weeks, months and years (but ideally either of the first two) is a concrete understanding of your costs vs. revenues.
Is this a sustainable and therefore scalable venture?
Can we acquire customers cheaply enough to cover all of our costs and deliver us a sufficient margin?
Can we create systems to ensure our business model is repeatable and more easily executable?
Are there enough eyeballs in the market with the bandwidth for our product?
Who are the incumbents we will be taking these eyeballs away from? How will we do it without breaking the bank?
These questions go on and on.
Malcolm Burrows from Dundas Lawyers says that one of the often overlooked issues at this stage, is considering the effect of scaling the business model on the contracts required. For example, if you need to add a co-founder, what exactly do they have to do and what do they get in return?
Clearly this wasn’t designed to be easy, but the reward might be worth it.
Part of the good news at this stage is that you’re already familiar with testing hypotheses, capturing data and then using that to power your next moves.
Testing the commercial viability of your venture is no different. It just requires measurement of different metrics, and these metrics will show up in your accounting package (e.g. Xero. MYOB, etc.). At this stage, it’s a good idea to seek sophisticated appraisal from an accountant to ensure the process, and therefore result, is correct.
Here’s an example of a test you may conduct during this phase.
If you’re a SaaS (Software as a Service) business you’ll typically want to acquire a customer for 1/3 or less of your customers Lifetime Value (LTV ).
If you aren’t familiar with SaaS metrics see here.
Know your numbers
So, in this example we’ll set the LTV at $300, which means you’ve got maximum of $100 to play with in order to acquire that customer (CAC – Customer Acquisition Cost).
Keep in mind, at this stage, the $300 we set will likely be based on a hypothesis you’ve generated from the tests conducted in phase one. This is especially true if you have very few customers, and haven’t had them all that long. You’re going to have to test the hypothesis of LTV and CAC, as well as your channel and messaging hypothesis continuously during this phase.
Remember, most of this is still unknown.
Drue Schofield from 4Front Accountants says it’s critical to know and review these numbers back-to-front, as any movement down, even a small one, can have a serious effect across your GP (Gross Profit), and more importantly, your cash flow.
For instance, an LTV of $300 across 10,000 customers that moves downwards by only 5 per cent could result in lost revenue of $150,000. The effect, therefore, on GP could be catastrophic as the costs probably did not change!
Define your hypothesis
So, what we need to do is generate a hypothesis that may look something like this:
- Our LTV is $300.
- We believe we can consistently acquire a customer through Google Adwords for $100 or less.
- Based on our cost structure, this would be a desirable CAC and deliver us the long-term revenue and profits we need to scale.
In essence, this can be reduced to an equation.
Create your test, as well as pass and fail metrics
The test you conduct to validate your hypothesis may look something like this:
- We have three different content fillers for our Adwords campaign and a total of $2000 to spend.
- We expect that 200 people will click one of our three ads and be directed through to our landing-page (this is the Click Through Rate or CTR).
- Out of those 200 people, 20 (10 per cent*) will sign up.
- We will consider this a pass if 20 or more people sign up to our SaaS product.
- We will consider this a fail if less than 20 people sign up as it would mean the CAC is too high.
For more on Google Adwords campaigns go here.
Or for an alternative testing platform check out QuickMVP.
*It’s probably important to note that in reality, a 1-2% conversion is considered decent.
Capture the results
For this particular test, say 200 people clicked the ad and were re-directed to the landing page you created. However, only 15 actually signed up.
This definitive result (although only a very small sample) means that your test failed. This means that you need to iterate the content of the ad, the value proposition, the channel, the metrics, or somehow the LTV before continuing.
It never ends
This is only a very simple example. Ideally, the process will be much more definitive than this. However, the concept of generating a hypothesis, creating a test with clear pass and fail indicators, conducting that test and then measuring the results is applicable throughout the entire incubation phase of your venture.
In fact, as we’ve previously identified, a business model is never complete. So, the process of continuous validation and optimisation will be present from the day the business starts and continues even when you’ve got as much cash in the bank as Apple.
It’s important to note that acquiring customers, or ‘channels’ is only one component of your business model. The process of validating hypothesis around the commercial viability of the entire business model will need to be completed before you can definitively move to the next phase.
This process takes time and most startups don’t reach the final phase of Design Doing as it hasn’t been able to identify a way to deliver the entire business model that is both replicable and highly scalable.
“It may be that alternative legal structures could assist to create scale by for example considering master licenses or Franchisees,” says Burrows.
This isn’t necessarily to imply failure, however part of the beauty of testing hypotheses and trying to build your startup from facts is that if you are destined to fail (not enough customers, can’t attain product market fit, too expensive to enter the market etc.) you’ll fail quickly and won’t waste half of your life.
So, what’s next?
Well, if you’ve got this far then you’ve successfully validated that each component of your business model is viable commercially, is easily replicable and can be delivered at solid scale if given the opportunity.
You’ve got a good product, as well as a highly functional engineering and product development organisation. You also likely have a solid sales force, marketing team and know your customers, partners and suppliers inside out.
This is good news because, you’re going to need all of that.
But of course, you’ll always be incubating certain components of your business model because a business model is never complete!
This is the time to say hello to long-term cash flow forecasts, organisational structure and operating plans, because you need to get out there, spend money, acquire customers and do your absolute best to take the market with the business model you’ve validated.
Stay tuned for part three where we talk more about Business Model Scale and getting you listed on the NYSE!
(Image source: Bigstock)
