Test Your Startup Idea

Perhaps the biggest challenge to entrepreneurship is coming up with the idea.  Like many would-be entrepreneurs I’ve been accused of having too many ideas (bubbles) and always popping those bubbles, before they ever see the light of day.  This tendency comes as a result of having experienced the pain of a failed business attempt.  I figured that if I could simulate the business intellectually and see a flaw, then it would be much more efficient to kill the idea then and there, rather than live through another failure.  My goal has been to find a business concept that would stand the tests I throw at it. I’ve created a test matrix that you can
download here, to give it a try.

In an attempt to bring some efficiency to the process, I have compiled all of the wisdom I have accrued through reading and podcasts, and created a series of filters that each idea could be passed through.  Ultimately there is a matrix representing 5 questions for each filter, and for an idea to successfully pass through to the other side, an overall passing score would be required from each filter.

I. Customer Filter

The first step should always be identifying a pain-point that a would-be customer would pay to have solved.  Supply-side marketing has focused upon creating a product and pushing it to consumers but this no longer works.  We must start by identifying a problem.  If the problem is solved in a way that is meaningful to the consumer, they will reward the innovator financially.  And so, all ideas must spring from this and be demand-side driven.   Likewise, we must also identify clearly who the would-be consumer is, how manageable the channel is, and whether the prospective customer has a desirable profile.

Important questions to ask here are:

1. Clear Value Proposition – is the problem valuable enough to the prospect? If asked “what would you give up for this product?”, are they willing to sacrifice anything to have the solution?

2. Clearly Identifiable Customer – The customer must be clearly identified and a “persona” should be created to represent this target customer.  Scaling and optimization should all be centered around understanding this customer.  Thus, a very clear and focused customer must be definable.

3. Lifetime Customer Value (CLV) – A customer ideally is acquired then repeat business occurs thereafter, but this is not always the case.  Considering this variable, what is the total value of a newly acquired customer?  Does it sufficiently overcome the cost of acquiring the customer?

4. Low-Touch Customers – You can either have many “low touch” customers or a few “high touch” clients.  Customers are more efficient to service since they assert less control over process and pricing.  Is this an idea customer profile? Will they accept a simple product or a simplified customization of a product?

5. Segmentable Market – It is much more manageable to start with a small focus, achieve brand saturation, and perfect the model around a small niche, then scale from there.  Is the market something that can be sliced up horizontally, to facilitate this approach?

II. Product Filter

If the idea (“bubble”) has passed successfully through the customer validation filter, the next step is to identify the validity of the product concept.  A few key questions to ask here are:

1. Tight Niche Focus – The concept should be very clearly defined and narrowly focused, like a laser beam.  If the initial idea is to be comprehensive solution for someone, it is too broad.  Instead, start with a core product and iterate the idea until it is validated in the market. Seek to scale horizontally to eventually become the comprehensive package for the identified demographic later, as a growth strategy.

2. No Network Effect – A business such as a social network or a marketplace grow in value exponentially as participants in that network grow.  While this can be a potent multiplier, it is almost impossible to get off the ground without a significant budget. Thus, any LEAN or “boot strapped” business should stay away from any idea involving a network.

3. LEAN-able Implementation – Lean startup methodology suggests marketing early and imperfect products rather than trying to get something perfect before taking it to market.  This way, you can validate demand and profit margins before investing a lot of money in development.  It also affords the opportunity to have users guide you to exactly what the problem is they need solved, and how to solve it. So, is this idea compatible with this methodology?

4. Team-to-Product Fit – Not every team is capable of executing on every idea.  Does the team possess the skills necessary to execute on the idea, or can such a team be easily assembled?  This also has implications for being able to compete effectively in the market place.

5. Inherent Story – It has been said that good salesmen sell a story, not a product; and if you don’t have a story, you merely have a commodity, and will eventually be competed into $0 margins.  Thus it is important to ask if the product concept lends itself well to a story that will engage prospective buyers?  Also, is the product inherently viral, such that they tell their friends or colleagues?  Both these things can have substantial impact on marketing costs, and hence profit margins.

 III. Financing Filter

The next step is to validate if financial aspects of this idea are viable.  Are sufficient volume and margins possible?  What sort of capital and cash flow are required to get off the ground?  The questions to ask here are:

1. Healthy Margins – Before investing time or money, it is critical to have a working model of how much it will cost to acquire a customer, how much to service that customer, and what the profit tolerance of that customer might be, in order to model out what the profit margins would be.  What is the profit per unit of sale?  How does this improve with efficiency of scale?  Is it worth doing?

2. Limited Demand – What is the total possible demand in the given marketplace?  Is there sufficient potential demand that (along with margins) can justify going into business?

3. Limited Resources – Are there limited resources that would effect the ability to service the customer? How will this effect the ability and cost of scaling up?  For example, if you are in Fresno and require a large team of talented engineers, scaling might be an issue.

4. Sunk Costs – How much up-front money is required to get things started?   Spending too much money up-front is contrary to LEAN methodology and represents a significant risk to the cash-strapped startup.  Rather than spending a lot of money up-front, it is recommended to use LEAN to introduce an early-stage beta and validate the profit model and get cashflow going, then gradually invest into the product over time.  A healthy cost model would designate a certain percent of revenue for product improvements over time.  Otherwise, external funding is required.  Remember, costs are always 2x what is estimated and revenues ½ of what is estimated in the beginning.

5. Cashflow Requirements  – How much cash “float” is required for this business model?  Some arbitrage models require a significant line of credit .  Is that credit attainable?  And, at what cost?  These risks and costs should be accounted for.

IV. Timing Filter

Timing is often attributed to luck and other fuzzy things that don’t allow an entrepreneur to systematically account for it.  This is unfortunate since timing seems to be one of the most important factors in predicting success.  In fact, in the book Blue Ocean Strategy, Chan Kim asserts that studies by AT&T suggest that looking at management teams, product, process and a host of other factors, were all inferior predictors of success, than simple timing.  Moreover, the book states that a company that is aligned with a larger secular pattern that “rises all boats” is more likely to succeed, than a business that is not aligned with the bigger secular trend.

But what is the right time to jump on a trend?  Companies have failed by being too early and too late to catch the wave, so to speak.  To address this enigma, Rogers introduced the Innovation Adoption Curve theory.  As shown in the graph below, Rogers suggests that the right timing is to hit the Chasm that exists between early adopter phase and early majority.  This allows for a reasonably strong confidence level that the considered wave will build sufficiently as well as it ensures low competition level, and a reasonably large time horizon to exploit the trend, before its momentum dissipates.

Read more here: Market Entrance Timing

To address the timing filter, the following questions should be considered:

1. Secular Trend Alignment – is the idea aligned with a major secular pattern than will help provide momentum?  If not, you may spend a lot of money marketing a concept (and future competitors), not just your product.

2. Recent Innovation Enabler (early) – Is there some recent innovation or technology that now suddenly makes the business model viable, where it wasn’t just a few years ago?  Some VC investors use this as a filter when evaluating businesses to invest in!

3. Market Inefficiency (early) – Is the market still inefficient?  If you look at the stock market, it goes up and down quite a lot each day, which is due to inefficiencies.  These inefficiencies are due to friction and ultimately represent opportunity.  If the market place being considered is too efficient, it is already too controlled and the opportunities are small for a new entrant.  It is better to find a “wild west” scenario where the rules and systems don’t yet exist.

4. Below the radar (early) – If it is still possible to get a business started in stealth mode without fear that the market will solidify before you get to the table, then it’s a good sign you’re still early in the curve.

5. Recent Competition Surge (late) – If there are already signs that a lot of people are rushing to the same place, it may be a sign that the wave’s early majority is currently building and hasn’t crested just yet.

6. Commoditization (late) – If there are already signs of price competition tactics being used in the market, it is a sign the market is already late in the curve, and the opportunity window has closed. Keep in mind that technology is inherently a commodity.

V. Competition Filter

Finally if the idea has passed through all the other filters, we finally ask what the competitive landscape looks like.  Is the market climate suitable for entry?  Questions to ask are:

1. Limited Competition – Is there a limited amount of competition?  Is it possible to segment I a way to really limit competition even further?  Will there predictably be a lot of competition here quickly after you launch?

2. Defensible position – Once a brand is established, is it possible to defend your territory, or are you vulnerable to price competition?  Do you have some sort of story or inherent differentiator that makes you uniquely qualified and your competition inferior?

3. Barriers to entry – Are there important barriers to entry to acknowledge?  Is there something that you will trip on, when you try to enter the market?  Likewise, if you overcome this barrier, can it be used defensively to ensure less competition in the future?  One big issue with SaaS businesses is that there is no barrier to entry and any engineer with a dream can put up a SaaS as a hobby, thus ensuring maximum competition.

4. Team Fitness – Not every team is capable of a fight with a World-Class competitor.  Thus, it is important to assess who the competition currently is and who they will be in the future.  Is your team capable or capturing and defending territory in this climate?

IV. Conclusion

Finally, if an idea (bubble) has survived all of the above filters, in likely is a viable business concept that can be acted upon.  The next step is to create a product positioning statement (don’t waste time on a full business plan that no one reads).  Take this statement and use it to rally around the new mission and execute with LEAN strategy to quickly establish presence and validate the profit model.  Once this is done the hardest part is behind you, and the rest is just execution and optimization.

Neal Cabage

Technologist living in Los Angeles, California.