This article is part of a series about going from “I’d like to start a business” to having a small start-up running, and beyond. If you haven’t read the previous articles, I recommend you do so by going to the first one, which includes a small table of contents.
In the previous post we saw how to validate your idea or, in other words, how to find out if once your product is out on the market somebody will care about it (besides your mom). The thing is, your product having potential customers is just one side of the coin; we still have to see if we can turn that product into a profitable company. This article deals with that analysis.
Following this series logic, we don’t want to write a 100 pages business plan, especially because a business plan is just a bunch of hypotheses that will hardly survive the first interaction with reality. For example, we can write that we will have a supplier of certain characteristics or that clients will follow some particular behaviour when buying our product. But guess what… those are just hypotheses that need to be validated (or rejected) in the real world. At this stage what we need is a minimum business plan with two goals:
- understand and validate the fundamental hypothesis of our business,
- find out as fast as possible if we can turn this into a profitable business and
- have an actionable plan that will guide our actions in the next months.
To build this plan we will use two tools: a Google spreadsheet and something called business model canvas. This framework developed by Alex Osterwalder will help us give our business model a solid structure and validate the hypotheses that conform it. In the link above you will find an excellent video explaining the canvas. Or even better, go to www.leanlaunchlab.com and sign up for an account: it will let you use a virtual canvas where you can manage all validation proces. Let’s get to the plan point by point.
1. Value Proposition
We began to cover this point in the last post. We said the value proposition is the reason why somebody would buy what we’re selling. We could say that the value proposition is the foundation of every other aspect of our potential company. It is important to remember, however, that what we did in the last post was only a first instance of validation: until the first sale nothing is said. Not even until sale one thousand. It’s something we have to keep an eye on constantly, never forgetting what’s the “pain” we’re trying to alleviate, and how our solution creates value.
2. Market Sizing
The next issue to tackle is the market size. Does our product have the potential to achieve one sale? A thousand? Several millions?
Let’s measure it. Go to your spreadsheet and create a new sheet named “Potential Market”. What we want to do is to estimate the potential market for our product and for that we will build a model. Ideally, we would find that information readily available and organized online, but that won’t usually be the case, so it’s a good thing to be able to calculate it by ourselves. Let’s go to the example of the basic t-shirts (and lets imagine we will be selling them in Argentina). The first step is to find out how many people we could reach. We could start with 40MM argentines and start trimming. Only men: 20MM. Those who live in large cities: 10MM. Those with a high income level: 500kl. Aged between 20 and 35 años: 125k. This is a very rough estimation, done in two minutes, but you can always get more accurate numbers. And even if you don’t, you can always estimate them! Now, how many t-shirts will each of these persons buy on average per year? Say 2… and that’s it, we have a potential market of 250k a year. Obviously we need to adjust the market share… let’s apply a 2% and we get 5k t-shirts a year. Another approach would be to find sales figures of our future competitors and start from there. Anyways, every business is unique and there are lots of ways of estimating a market size, so just think your variables and start playing!. Oh, and don’t forget your friend Google, it has more information than what you think it does.. you just have to ask ;)
3. Revenue Model
The revenue model is a key ingredient. In the case of an existing product, such as our shirts, it’s pretty clear that the model is “I give you a t-shirt, you give me money”. In this case we would possibly rather focus on pricing. But in other business we might need to work with other models, or the model itself might be one of the innovative elements of the startup. An interesting example of this is Manpacks (they sell personal men items on a monthly subscription). Some common models are:
- Marketplace: to get supply and demand together, charging a fee or commission to one or both parties. Examples: Open Table, Ebay.
- Advertising: to generate huge volumes of traffic and monetize it via ads. Examples: Facebook, Streema.
- Subscription: a service is offered in exchange of a monthly or yearly fixed fee. Examples: Shopify, KISSmetrics.
- E-commerce: in this case, we sell goods through the internet, charging for each sold item.
Being clear about the model you are going to adopt is of uttermost importance when it comes to making financial projections and finding out if this can be a profitable business.
4. Customer Acquisition Strategy
With an interesting market and knowing where revenue will come from, we should start asking ourselves how we are going to acquire customers. It is usually tempting to think that we can start with a few friends and that word of mouth will magically create a millionaire business, but it would be catastrophic to give way to said temptation; not only because this will hardly work, but also because it will become extremely difficult to project growth… the famous “build it and they will come”. Even though there are ways to accelerate or slow down viral growth, it’s something relatively hard to adjust. It is then of the greatest importance to understand what’s our motor of growth, how’s it going to work and how far we can scale it. For example, using Facebook Ads we can do solid projections[1], it’s scalable and very measurable… if you manage to get good CPA’s[2]. Here’s where you have to work: try to discover as soon as possible what’s a reliable strategy and how far it can take us (e.g. we might be getting astounding results with a certain keyword on AdWords, but the quantity of queries with said keyword… is finite!)
5. Basic Financial Planning (Costs & Income)
For the time being we want to focus just on three questions: how much will it cost to acquire each customer, how much will it cost to produce the product/service we’re selling and how much money we’ll get from each client. We got a first estimate with the experiment performed on the last post[3], and we will sharpen that number in following posts. The cost of the product should be relatively easy to find. Just get out of your room and knock some doors, or put a price to the time you will spend coding. Lastly, but not less important, is pricing. Pricing should be completely independent of the cost structure. It’s an important point, though we won’t cover it today. The goal here is to answer these questions: is our price reasonable? Can we achieve the cost level we are projecting? Is this costs and revenue combination resulting in an acceptable margin?
6. General Projections
Having an idea of the total addressable market and with reasonable estimations (or by now, fairly precise ones) of how much money will we get from each unit sold, we can start measuring the real opportunity size: what profits can we squeeze per month? Per year? Having understood our customer acquisition strategy, we can go ahead with projections and understand at what rate we can grow, what costs this will entail and what we need to do to achieve it. This information should be enough to know if this is a promising venture and if we want to move to the next step (which we’ll cover in the next post).
7. Key Resources and Partnerships
Without doubts, your business will require some key resources and partnerships (e.g. suppliers and distribution). Who are they going to be? At what cost/quality? Are they willing to do business with you? This is something you need to validate, so get out and start talking to them.
8. Gantt
Getting into such venture will require of us a lot of resources, and probably one of the most elusive of them is time. A Gantt chart is basically a timeline of all tasks we need to complete, usually grouped by function (product, marketing, etc), showing which of these tasks we need to accomplish in order to get to the next one. It’s a very powerful tool to understand what we have to do next, where to focus and by when can we expect to achieve each milestone. I highly recommend you name one of your spreadsheet’s sheer “Gantt Chart”! You can read more here.
And that’s it. As you may have noticed, these are not all the building blocks of the business model canvas, but those which I consider more important to cover at this stage of the process. I strongly recommend you to complete the whole canvas and keep track of it.
In the first post we talked a little bit about ideas and how to generate them, in the second one we saw how to find out if our idea might be of some value for anybody and today we started to explore if we can expect to turn that idea into a profitable company.
Meanwhile let us know! ¿What other steps do you think are crucial when it comes to find out if you can turn your idea into a profitable business? ¿Can you think of other tools to share with us?
In the next article we will cover how to build a first prototype and what to do with it. See you then!
[1] With these tools we can estimate beforehand the cost of each acquired customer, our potential reach, etc.
[2] We covered this concept in the last post.
[3] This number isn’t totally precise. To begin with, what we did was a single page site, where the user has as the only option to submit his or her email. When we have a complete site, the process of getting to the final purchase will be longer and will have more friction. That will probably worsen our estimate, but it’s something natural.
