Over 90% of startups fail, there are variety of reasons for it but in most cases it’s either the company building a product nobody wants to pay for, a small market, revenue model that doesn’t work or simply a founder burn out.
When starting a startup the first steps you take towards it are the most important. The idea you pick, the problem you will try to solve, the market you’re going into, the product you want to build and economics of your business model all have to be nailed before you start building a company. Here is the 5 steps framework we developed for you, to make sure you get it right:
1. The Focus
What should you work on?
What should you work on – this is the first and most important question you should ask yourself when thinking about starting a startup. It’s like a foundation of the building – whatever you build next will depend on it. It’s same in this case.
Look at the diagram below. I have heard many founders who built successful startups referring to what this diagram represents as the core of their success. Just think about the top founders, they all found a middle ground between their interest, skill and monetization.
For example Steve Jobs loved design (passion), he was a great marketer and product manager (skill) and he always combined it with whatever was the hottest market at the time (monetization), whether it was personal computing, 3d movies, mp3 player revolution or mobile.
So take a pen and paper and work on the following for as long as required:
Passion: What do you want to do? Think about what you enjoy doing? Passion as such is often overestimated – in most cases real passion comes with the success so don’t just focus on things you’re most passionate about right now but focus on areas of interest that can give you a sense of satisfaction. List as many as possible.
Skill: What can you be the best at? Are you a good designer, programmer, sales guy or hustler? You may not be the best at it right now but there are some skills and areas of knowledge you have the most potential to be great at.
Money: So you know what you’re good at and what you would like to do, the first question to ask here is: can this be turned into a business? If it can, the next question is: Is the market big enough to make money with it? Eliminate non-business skill/passion pairs and let’s move on to next steps to find out about the money part.
2. The Problem
Find a big, monetizable customer pain
We have already quoted Vinod Khosla on this topic several times, but since repetition is mother of all learning here it is again: “Any big problem is a big opportunity. If there is no problem, there is no solution, and no reason for a company to exist”.
Painkillers or vitamins?
Best companies are painkillers. Painkillers are startups that solve some serious problem, you don’t care whether the painkiller looks nice or has an appealing logo, you need it because you have a pain. For example Google is a painkiller – without Google it would be real pain to find something on the web fast.
Is the customer pain monetizable?
Monetizable customer pain represents a pain so significant that enough customers recognize the pain and have money to pay for the solution. On a pain scale of 1-5 it would be 4 or 5. Unless you discover a monetizable pain that you can satisfy, all the other things that entrepreneurs spend their time doing (development, marketing etc. ) don’t matter at all, because whatever you build they won’t pay for it.
How to validate your pain?
You already know which markets and areas of business you would like to start a startup in. The next step is defining the problem hypothesis. Frankly make some opinion about which areas are problematic or painful for customers. To test your monetizable pain hypothesis, you need to
- Find a sample of customers
- Get out of the building and meet them (or email if you can’t)
- Evaluate the results
In general you should focus on brutally honest learning. That means don’t pitch your ideas, don’t sell them your pain hypothesis and ask open questions. Something like this:
- What is the hardest part about [problem context] ?
- Tell me more about it. / Can you tell me about the last time that happened?
- Why was that difficult?
- What, if anything, have you done to solve that problem?
- What solutions are you currently using? / What do you hate about them?
You may ask yourself now, where do I find customers: research them and email, try forums, social networks and micro-networks, Reddit, Linkedin, Quora, Meetup.com, go to Starbucks and offer a free coffee in return for an opinion. Avoid friends and family – you won’t get unbiased feedback here.
3. The Market
Can you build a real business?
Many people consider solving a pain or execution the key to a startup success. An alternate view comes from Marc Andreessen:
“Personally, I’ll take the third position – I’ll assert that market is the most important factor in a startup’s success or failure. Why? In a great market, a market with lots of real potential customers, the market pulls product out of the startup. The market needs to be fulfilled and the market will be fulfilled, by the first viable product that comes along. The product doesn’t need to be great; it just has to basically work. And, the market doesn’t care how good the team is, as long as the team can produce that viable product.”
OK so you know your business focus and now you have a problem to solve. The next question is: is there a market for it?
Calculate your market size
The annual market size is the total number of people who will buy the product per year multiplied by the price point. To get to a billion dollars in annual revenue ($1B), you need either a high price point or a large number of customers. To get an idea of the market do the following:
- Research press coverage of the market, try to look for articles quoting market research agencies such as Gartner or IBIS, reading SEC fillings, Wikipedia or Google Books can be quite helpful.
- Next, you want to do a back of the envelope estimate of market size, Googling as necessary for any statistics.
- Then you want to further validate this market with some modern tools, including Google Trends, Google’s Keyword Planner and Facebook’s Advertiser Tools. This will give you an idea of how hot the need for the solution is.
To calculate the market size you avoid generalising the market. E.g if you’re starting an eshop for women’s apparel and there are 150 million women in US – that’s not your addressable market! Find out how many shop online, how many shop for the style you sell and go deeper on finding their preferences and you may get closer.
- Suppose you’re building a tool for equity futures traders that allows them to program their own trading algorhitms:
- There are 10 million traders. Is this your addressable market? Well, a closer look shows that out of those 10 million only 2.5 million are active traders while the remaining 7.5 mil. make less than 1 trade per month.
- So you have 2.5 million potential users. Another look may show that only 1 million of them have sufficient programming skills to use your product. You can find this estimate out by running a survey among traders (try Google Surveys for example).
- If you look at similar products in this space you may get an idea of what the typical pricing for this market is. Let’s say it’s $500 for annual subscription – $500 x 1 mil = $500 mil. That’s the most you can make if you win 100% of the market.
- You should go even further and survey those people about the pain you’re trying to solve and see how many recognise the pain.
4. The Solution
Define your minimum feature set
After completing the second and third stage you should have some facts about monetizable pain and an initial idea about how the product should look like. The next stage is to get more specific about the product by creating a minimum feature set hypothesis. Minimum feature set represent the core 1-2 features that your customers will pay for. Avoid “perfecting the product” by adding features – this will make things worse, just focus on the bottom line. Listen to Saint-Exupéry:
Perfection is not when there is anything to add, but when there is anything to take away
Discovering the minimum feature set has an incredible power – it increases your flexibility dramatically, as there are fever features to change, it appeals to customer’s desire for simplicity, but most importantly it allows you to discover the real core of what customers desire.
Here are steps to define it:
- Develop minimum feature set hypothesis: Firstly, look at the key themes in the conversations you’ve had so far. Secondly, ask customers – which is the key aspect they need a solution for, what one thing would the feature solve? Lastly, simplify, simplify and simplify
- Build a buying panel: Go back to customers who responded to your emails in previous section and select the ones who are most likely and relevant to be your next customers.
- Give your initial product a visual form: Draw some initial wireframes that give a good feel of the product. You can use a tool such as Balsamiq Mockups or Lucidcharts for free.
- Do the $100 test: Show your prototype to customers and if their answers are inconsistent try the $100 test: List all features you are considering and ask customers “if you had $100 to invest in any features of this product, how would you invest your money?” Naturally, customers will choose the ones they care about most.
- Refine and test the demand for your product: Test the demand and price points using “breakthrough questions” – “would you be willing to pre-order?” etc.
Examples of mockups created with a wire-framing tool.
5. The Revenue
Can you scale it?
So you have a market and a product, your next step is to do a simple calculation to determine whether a given business is capable of getting there.
Economies of scale means that the bigger your customer base the cheaper it is to produce one unit of your product. For example is you develop an app and you’re development costs are $250k, 10,000 customers would make one unit cost $25. If your market is too small to get 10,000 you need a higher price. However, if your competitors are much cheaper, then you might have a hard time growing your startup.
The awesome thing about software is that there are simply no unit reproduction costs. You build an app and you can sell as many “copies” of the product as you wish and minimum additional costs. If you sell e.g notebooks sets, no matter how many notebooks sets you sell you have to manufacture every single one of them at cost.
Create a simple cash-flow calculation
To estimate your economies of scale a simple cash flow forecast line the one below may do the work. You will also find out how much startup capital you require to get it going. In example below you can see the startup burns money (figures in parentheses are negative) until it start’s to brak even in month 9. The initial negative cash flow grows to $120,036 and that’s the minimum you need to stay alive.
The next steps are raising finance (if you’re not bootstrapping) building a product, achieving a product/market fit and repeatable and scalable business model. We will blog on these topics in coming future so sign up for the newsletter to stay in the loop.
By Michael Ugor