Category

Feasibility

Does It Pencil?

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More than anything else, the feasibility of a business is determined by its ability to make a profit.  As obvious as that sounds, it’s easy to overlook in the fever pitch of startup excitement.  A quick and dirty way to figure out if an idea pencils financially is to examine three figures – sales price, gross margin, and overhead.

Gross margin is the sales price less cost of goods sold, or how much it cost you to make the sale.  The overhead expense is the sum of monthly fixed costs incurred regardless of sales activity.  For example, suppose you sell pocket protectors for $5 each, and that your cost for each is $0.50.  Also suppose your monthly overhead—salaries, office space, utilities, and marketing—is $9,000 per month.  Your gross margin is $5.00 minus $0.50, or $4.50 per sale.  Dividing the monthly overhead by the gross margin gives you the volume required each month to break even.  In our example, you would need to sell more than 2,000 pocket protectors each month to make a profit.  Time for a quick sanity check – what’s your plan to generate 2,000 sales each month?  Is this realistic?  Are you so sure that you’re willing to bet your future on it?

Show Me the Money

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Talking someone out of their hard-earned money is a great way to determine the feasibility of an idea. In fact, selling is the best form of entrepreneurial market research.  What people say and what they actually do are often drastically different.  As an entrepreneur, you’re the underdog, so it’s natural for people to root for you.  Asking for the sale instantly transforms the conversation from one of unwavering support to objective evaluation and feedback.  No longer are you the heroic entrepreneur that people want to succeed.  Now you’re another annoying salesperson.  As a result, you’re more likely to get honest feedback and objections, which will be invaluable to product development.  If you can’t get a purchase order, then you should try for a commitment in writing that your prospect will eventually pay for the product.  It’s not as good as revenue, but it’s better than nothing.

The icing on the cake is that, by asking for the sale, you might actually land a few paying customers.  The cash flow will be a big psychological boost.  It’s the best evidence you can have to prove to yourself, your family, and potential investors that this truly is a viable business.

Why Won’t It Work?

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When exploring a new idea you have to play devil’s advocate constantly.  It’s too easy to fall in love with your concept and lose track of reality.  A great way to challenge the business concept and question its feasibility is to ask, “Why won’t this work?”  As optimistic as you may be about your chances, take an hour to brainstorm every possible reason that the business could fail.  Write everything down, and then separate this list of reasons into primary (key) risks and secondary risks.  Once you have a polished list of key risks, take it to your advisors and industry experts to see if they agree with your assessment.  At the very least this will be a good opportunity to test how well you know the industry.  The final list is a good gut check – do you feel comfortable with this level of risk?  How do you plan to address the key risks?  How much risk are you really taking on?  A successful entrepreneur is not a risk seeker, she is a risk container.  Is the risk contained enough to take the next step?  If so, insert the risk list into your business plan, add to it when necessary, and always work to minimize your risk exposure.

Create Massive Value

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There’s only one thing you need to know to build a successful company – you must create massive value for your customers.  People and organizations are willing to trade their hard-earned cash for one thing only – value.  Therefore, you must have a deep understanding of what your customers need and how to help them get what they want.  Formally known as the value proposition, there are three main components to value: the benefits gained from using your product, the target market, and the price relative to competitors or substitutes.

Realize that your value proposition is specific to each market segment.  Your target market and follow-on markets likely have different value preferences, and you have to cater to each.  The benefit that gets one customer to buy might create ambivalence in another.

Get to the bottom of all three aspects of your value proposition by asking a lot of questions and listening carefully.  Vary your messaging and see what gets customers excited.  Despite the formal definition, this isn’t academic – what you understand to be your value proposition will become the foundation for sales and marketing efforts down the road.  Nail all three and customers will beat a path to your door.

Vitamin, Pain Killer, or Cure?

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Always think about your product or service in terms of the benefits it provides to its users.  Your solution is much more than the sum of its features.  One way to evaluate your product is to consider how well it solves the pain for the customer.  There are three categories that it can fall into – a vitamin, pain killer, or cure.  Vitamins promise indirect, long-term benefits that address general health or minor problems.  They are nice to have, but they won’t wreck your day if you forget to take them.  Pain killers are the next best solution, which are necessary short-term fixes to pressing issues.  While more of a necessity than vitamins, they rarely solve the underlying issues.  Finally, cures make the problems go away entirely.  Customers’ willingness to pay depends directly on their need for your product.  They’re often willing to pay significantly more for cures than vitamins.  But cures are also harder to establish and defend.

If you expect to get significant traction, your solution should be a pain killer at least.  Then, once established, be on the lookout for ways to better solve customers’ problems to make your product that much more important.

Wrong Questions –> Wrong Answers

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To determine feasibility, you have to interview a lot of people.  Interviewing, in fact, will take most of your time as you learn about how customers think and what they’d be willing to pay for.  The questions you ask in these interviews will inform your entire strategy, making the ability to ask questions one of the most important skills of an early-stage entrepreneur.

The biggest mistake founders make when interviewing is that they ask “leading” questions, or questions that prompt your audience to respond in a certain way.  When exploring revenue model, for example, a leading question might be, “Would you rather pay one-time up front, or a monthly subscription?”  The structure of this question forces the respondent to choose one or the other when it’s possible that they wouldn’t pay anything.  Leading questions can constrain your interviewees and bias their responses.

Instead, ask open-ended, unbiased question like, “Is this something that you would pay for?”  Try your best to ask open-ended, unbiased questions that result in actionable insights.  If you ask the wrong questions, you’ll get the wrong answers.

Good Ideas, Bad Businesses

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Not all good ideas translate into good businesses.  Many doomed entrepreneurs start their businesses on a whim – they see an opportunity for a one-off product that would make their lives better.  Without carefully considering the business, they immediately set out to make the product, and try to build a business around it.  There’s more to building a thriving business than the idea alone.  Just because you can build something – or make a few sales – doesn’t mean that it’s a feasible business.  Think about everything that goes into creating a successful business – sales, distribution, marketing, product development, manufacturing, and much more.  As important as the idea is, a myriad of those factors all contribute to a business’s success.  Before Groupon became Groupon, the website helped people mobilize and take action.  Great idea, bad business.

Beyond the business dynamics, the idea itself can translate into a bad business.  Most ideas aren’t defensible.  If you get any traction, you can expect a lot of competition, so if you can’t fend off the competitors then you’ll have trouble becoming profitable.

When exploring your idea for a new venture, evaluate it as a holistic, defensible business opportunity, not just a great idea.

Product 1.0 – A Brochure

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Before you build a product, write a brochure.  There are a bunch of benefits to getting early feedback with a brochure instead of a product.  Creating a mock-up or spec sheet takes one-thousandth the time and cost of building an actual product, is quick to change, and results in feedback that’s nearly as good. It doesn’t have to be a brochure – anything tangible that potential customers can see or touch has the same effect.  Mock ups, wireframes, designs, and prototypes can all be used to get the point across in a realistic and convincing way.

The important thing is to be as visual as you can with potential customers.  Giving them something to look at and play with makes it easier for the audience to “get it.”  Words get lost in the abyss.  Images and prototypes are hard to misunderstand.  Suddenly you’re not talking about an abstract idea that your audience is likely to go along with (why wouldn’t they?), you’re pitching an actual product.

Being visual greatly helps you get an authentic reaction and objective feedback, so start with a brochure.

Five Risk Factors

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Startup risks can be divided into five broad categories.  The first risk is the product risk, which addresses uncertainties with the solution itself.  Technology risk falls under this category.  Product risk is high you are trying to build a technology that doesn’t yet exist.  The second category is market risk.  You hope that people will buy your solution, but how certain are you?  Is this an established market that you are re-segmenting or is it an entirely new market?  The third risk is financing risk.  Running out of capital is the number one killer of startups.  Do you have enough runway to get off the ground?  Will you be able to raise adequate financing?  Is it a capital intensive business?  The fourth risk is competitive risk.  If you get traction, your competition will not idly stand by as you steal their market share.  How will they react to your entry?  The final risk is execution risk.  Are you the team to actually pull this off?  How much experience do you have in the industry, or with startups in general?  Do you have a track record of success?

Rate each risk category on a scale from one to ten (one is no risk, ten is monstrous risk).  Once identified, take action to reduce that risk as quickly as possible.  The name of the startup game is reducing your risk to increase your chances for success.

Double Your Worst Case

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Through the process of determining feasibility for your idea, you will explore and analyze every key aspect of the proposed business.  Sometimes overoptimistic entrepreneurs include something intangible in their final analysis – a miracle.  Common examples of miracle planning include things like going viral, astronomical conversion rates, unrealistic financial ratios, or inflated pricing.

Whatever your worst case scenario is, double it.  Count on the fact that your milestones will take twice as long to achieve and expenditures will cost twice as much as you anticipate.  Once your business is operating, react immediately if things aren’t playing out the way you expected. If, for example, you find that your customer conversions are 10% of what they should be, immediately revise your projections downward and reevaluate the business.  Accept the facts as they are, not as you want them to be.

The viability of your business should be obvious, so plan extremely conservatively.  Struggling to make the numbers work is a big red flag.  Conversely, it’s highly encouraging if the numbers still work after doubling your worst case scenarios.  Whatever you do, don’t count on a miracle.