Make It Feasible

A feasibility study is used to determine the viability of a new business venture.  Commonly called a “business model” by entrepreneurs today, a feasibility study is simply a summary of the key components of a proposed venture.  You will make literally hundreds of assumptions as you move through the six stages of entrepreneurship.  These assumptions are directly linked to your risk of failure.  The more assumptions you make, the higher your risk.  As a result, your top priority has to be to turn your key assumptions into facts as quickly as possible.  Without a doubt, this is the most important lesson in the book – to succeed, turn your key assumptions into facts as quickly as possible.  <Illustration 187>

As you research the feasibility of your business with customers, investors, and partners, you’ll find that many of your initial assumptions were wrong.  This is to be expected – when you’re innovating, you’re venturing into the unknown, which forces you to make guesses about the future.  The essence of entrepreneurship, therefore, is not nailing your business model at the outset.  Rather, it’s adapting to your emerging reality rapidly enough to survive.  You have to be agile and make your business feasible.  Every business has gone through these growing pains.  Startups that can’t adapt are quickly buried and left behind.

This chapter covers the most important feasibility strategies to help you learn, adapt, and make your business feasible.

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Think Like a VC

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When exploring the feasibility of your business, pretend you are the investor.  Actually, it’s not that far from the truth – you are about to invest years of your life, and most likely your net worth, into this risky venture.  You want to be sure this is the right opportunity.  Among other things, an investor will conduct at least a month of due diligence before making an investment decision.  They will ask tough questions, like is the market large enough and growing?  Why will customers buy?  How big is this financial opportunity?  Is this the right management team?  How do they think about the product and industry?  Ask these tough questions (and many more) of yourself.  Does your idea withstand the scrutiny?

If you find this process difficult, find a savvy investor in your area and pitch him.  In addition to great feedback, you’ll be able take a step back and see how an investor would look at your business.

Like buying a house, starting a business is a very emotional process, and it’s easy to lose sight of the fundamentals.  Looking at your business like an investor will help you get into the proper mindset, so you can evaluate the opportunity dispassionately.

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Cash is More Important Than Your Mother

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Cash is king.  The cash dynamics of your startup are often a make-or-break aspect of your feasibility study.  There are two sides to cash, what you take in, and what you pay out.  The two should be evaluated independently.  Since cash coming in is usually a distant dream at a company’s founding, focus on the outflows.  To illustrate the point, consider your sales cycle, or how long it takes to sell your product to potential customers.  There are some businesses with months-long sales cycles.  Imagine the cash implications of this long sales cycle—you have to cover the overhead for months while your team is burning cash, struggling to close sales.  There are a bunch of similar cash management activities that are easy to overlook but crucial to feasibility.  Bad assumptions here can bury your business.  Take each assumption in turn, consider the cash implications, and project out your cash requirements.  How much cash do you burn before you get to breakeven?  Adding up the monthly losses will tell you how much money you’ll need to build the company.

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The Price is Wrong

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In the early days of a startup, entrepreneurs have a tendency to make pricing their products or services much more complicated than it needs to be.  Fundamentally, the price you charge is a function of value and competition.  First, consider what kind of value you create for the customer.  If it’s an enterprise, this should be a Return on Investment (ROI) calculation, or the amount of money you can save a company when it uses your product.  Consumers are more complicated, as they value intangibles like luxury, status, brand, and entertainment value.  Once you have a rough idea of value, use competitive and substitute offerings to triangulate a potential price range.  Then consider where on that price range your product fits best.  One great tactic to help uncover price sensitivity is to interview potential customers and ask them if they would use your product if it’s free.  If they say yes, then ask if they would purchase it for an outrageous amount (such as $1 million).  More often than not, your customer will say something like, “Of course not, there’s no way I would pay more than $150 for this.”  Bingo, you’ve got your price!

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CLV >= 2 * CAC

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Now that you know the acquisition cost of new customers you can compare that to the Customer Lifetime Value (CLV).  The CLV is the total amount of money that an average customer will pay you.  For example, if you charge $30 per month for your service and the average customer is retained for 10 months, your CLV is $300.  If CAC > CLV, you won’t be in business very long.  If CAC = CLV then you won’t make any money on these sales, and again, you won’t be in business very long.  This strategy might make sense in the short-term to build a customer base, but it’s not sustainable in the long run.  The best situation, and a metric to work towards, is for the CLV to be at least double the CAC (CLV >= 2 * CAC).  This cushion gives you the ammo you will need to expand your marketing efforts and sustainably build a solid customer base.  Obviously, the more cushion the better.  These metrics will be hard to know with any certainty before you launch, so make educated guesses and monitor your progress closely.  The bottom line is that you don’t have a feasible business if it’s too expensive to reach your customer given your prices and margins.

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Buying Customers

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How hard is it to reach your target market?  Do you have to search for customers or will they find you?  The average dollar amount spent to land a new paying customer is called the Customer Acquisition Cost (CAC).  If you hire a salesperson that costs $1,600 each week and she lands four customers per week on average, your customer acquisition cost is $400.  On the web, if you pay for Google Adwords at $2 a click and it takes 30 clicks to get a user to sign up, your cost is $60.  Different market segments vary widely in how challenging they are for companies to reach.  Some audiences are impossible to find, whereas others have obvious and cost-effective channels.  The harder it is to reach potential customers, the higher your costs will be.  As a startup with limited resources, you have to plan your initial targeting carefully because a high acquisition cost can quickly break the bank.  Underestimating the CAC bankrupted eToys, a dot-com company valued at one point in excess of $4 billion.  Try to estimate your CAC up front to see if it makes financial sense.  If you find that the CAC is too high, experiment by either targeting different channels or different segments.  The CAC is a vital startup metric for you to analyze and monitor continuously.

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Growing Pains

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There are a lot of ways to get more customers.  When it comes to evaluating the feasibility of the business, you have to know exactly where this growth is going to come from.  Broadly, these strategies can be split into two buckets, paid and organic.  Relying on organic strategies to grow your customer base is like counting on the lottery for your retirement.  Yes, a few companies take off virally, but most who try crash and burn.  Paid acquisition strategies are a necessary part of business, so understand exactly where your growth will come and why.

Paid

  • Sales team: In-house or outsourced sales people who collect leads, generate interest, and close sales
  • Advertising: coupon books, newspapers, billboards, search engine marketing, and other forms of paid advertising
  • Affiliate networks: Commission Junction, ShareASale, or other affiliate networks that sell your offering on a commission basis
  • Partnerships: strategic partnerships with other organizations that will bring customers (typically for a fee or a share of revenue)

Organic

  • Social media: basic social tactics such as Facebook Like or share via Twitter, or more creative viral campaigns
  • Word of mouth: customers talking to friends and family about your product, advocating your company and its products
  • Public relations: this is coverage by newspapers, television programs, and celebrity involvement
  • Social proof: normal product usage that advertises your product and brings in new users
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If You Build It, Will They Come?

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A fundamental piece of any feasibility study is the customer acquisition strategy, or how you will land new customers.  You should have a great answer to the question, “How are you going to get customers into your store or drive users to your website?”  This is so important, in fact, that it routinely separates the winners from the losers.  Often underestimated, many first-time entrepreneurs (consciously or not) adopt the Field of Dreams mantra, “if you build it, they will come.”  They won’t.  Even big companies like Disney make this mistake.  They launched Go.com expecting the masses to come, but no one showed up.  Just a few years after launch, Disney took a $790 million write-off and shut it down.

Today more than ever there is so much noise and demand for a customer’s attention that it’s next to impossible to stand apart from the crowd.  Having a customer acquisition strategy is one of the most important aspects of your go-to-market plan.  Once you have the broad strokes of a strategy in mind, challenge your most critical assumptions through quick, low-cost experiments that reveal actual conversion rates, customer interest, effective positioning, and competitive differentiation.  Do what’s necessary to get the data, but don’t scale until you have a verified strategy to drive users and get customers.  Having a compelling customer acquisition strategy will give you and your investors the confidence that when you build it they actually will come.

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Get a Haircut

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By now you know that you need to get your product launched as quickly as possible.  It’s easy to postpone the launch, and convince yourself that a polished product will generate more sales.  But the more features you add, the longer it will take to launch, and the more time required to determine feasibility.  Launching quickly will give you the feedback you need to iterate and improve on your initial idea, which will help you create something that people will actually pay for.

A haircut is a great way to boil down your product to only the most essential features.  Start by listing all of the features that are necessary to launch.  Next, take your list and eliminate at least half of the features.  Seriously.  As impossible as this may sound, forcing yourself to eliminate features is the mentality you need to adopt to get to market quickly, win customers, drive revenue, and stay alive.  Don’t get bent out of shape – you’re not killing the features forever.  You’re only putting them on the back burner until customers ask for them.  Imagine all of the time you’ll save, which can now be spent with customers, learning about the right direction to take the product.

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Play Dumb

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The importance of early interviews can’t be overstated.  Hidden in these conversations are the clues you need to piece together your startup puzzle.  These clues will either confirm that you’re on the right track, or save you years of unnecessary struggle.

It’s important to know how to listen when investigating your idea.  The point of interviewing prospective customers is not to impress people with your knowledge or sell them on your idea.  Instead, you need to get candid and honest feedback. Entrepreneurs have a lot of trouble taking off their sales hat, which can result in useless, biased feedback.  If you ask leading questions, you’ll get loaded answers.  Biasing your interviews is one of the easiest and most damaging mistakes you can make.

Turn off your charm and be as boring and dispassionate as possible.  Act as if you couldn’t care less.  The less people think you care, the more likely you are to get honest feedback. You might even go so far as to say that you’re doing some research for a friend.  Play dumb and see what people say.  Let them be the experts and encourage them to educate you.  People will open up and be much more helpful.

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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?