1. Sketch out your business model
The first step to getting to product-market fit is to sketch out your business model. Blank’s students use a business model canvas taken from the book Business Model Generation by Alexander Osterwalder. For each part of the canvas students need to answer a few fundamental questions.
- Value proposition (or product offering).Every business has a value proposition or product offering to attract customers. Google’s value proposition is a fast and relevant free search, with targeted ads and monetising content; Skype’s is free Internet and video calling and cheap calls to phones (Skypeout). What value proposition or product offering are you going to sell?
- Customer Segment (or target market).Every business needs a customer or multiple customer segments to sell to. Skype is used by web users who want to call phones; Nintendo Wii is targeted at casual video game users. What customer segment do you plan to sell to?
- Customer Relationships.A customer relationship refers to how your business will acquire and retain customers. This includes marketing and sales activities, as well as any activities that are used to retain customers, such as customer service. Coca-Cola uses traditional media advertising and excellent distribution to attract new customers and retains old customers by maintaining top of mind awareness. Facebook uses referral emails to attract new users and online advertising to attract new advertisers. How do you plan on attracting new customers? What will each new customer cost? How will your business retain new customers? How much will it cost?
- Distribution Channels.A distribution channel refers to how you will get the product or service to the customer. This may be through a sales force, web sales, and retail stores or through distributors. Kalahari.net uses an online store and a courier company to get the product to the customer. Gillette uses retail stores to sell their razors and blades. How do you plan on distributing your product or service to the customer?
- Revenue Stream.The revenue stream of a business model refers to how the business charges for its products and services and what price the business charges for its product or service. Common revenue streams include: sales of physical goods, rental, subscription fees, licensing agreements, and advertising and brokerage fees. For example, Pick n Pay or Spar make their money from sales of goods, while gyms and golf clubs charge a monthly or yearly fee. How do you plan on charging for your product or service? And how will you price your product or service?
- Key Resources.Key resources are the employees, financial capital and physical resources that a business needs to function. There are four common types of key resources: human, financial, intellectual and physical resources. For example, Makro and Game require employees, all the equipment found in a retail store, as well as all the resources to manage the supply chain. Facebook requires programmers, servers and buildings to run the website. What key resources will your business need to get started?
- Key Activities.Key activities are the essential activities a company needs to create and deliver the product or service to the customer. A newspaper’s key activities would include writing, producing and distributing the newspaper, while Skype’s key activity would be software development. What key activities must your business perform to create and deliver the product or service?
- Key Partners. Key partners are the principal relationships with other organisations that make the business model work. These relationships may include joint venture partners, supplier relationships or strategic alliances. For example, Apple’s key partners for the iPhone include manufacturing companies and App developers. What key partners does your business need to create and deliver the product or service?
- Cost Structure.The cost structure refers to all costs that are incurred when operating the business. When doing projects, costs are usually divided up into fixed and variable costs. What are your business’s fixed and variable costs?
2. Test your business model
Once you have laid out your business model you need to prove the idea will work in the real world. The idea is to have a plan that is based on facts and not guesswork, and to test the business model as quickly and with as little money as possible.
This is best done with the use of learning experiments. And the secret to running a great learning experiment is to ’think small’. Small experiments that are cheaper and quicker to run are generally better. There are four types of learning experiments that can be used to test if your business model will work:
- Interviews: Talking to potential customers, industry experts, thought leaders, suppliers, adjacent competitors and potential partners. This will give you quick insight into the realities of your industry or market.
- Personal selling: Pitching your product or service to potential customers using PowerPoint presentations or a prototype will give you a fair indication of how many potential customers will actually become real customers when the business launches. This process will also give you valuable feedback on how your product or service needs to change to meet customer needs.
- Marketing campaigns: You can test whether the customer will buy your product by running Facebook Ads and Google Adword campaigns to see if people will click on the advert or not. If customers click on the advert in large enough numbers it means there may be a market for your product. If not, time to change your business model.
- Minimum Viable Product: A minimum viable product is a small, cheap product that can be built quickly to find out if customers are interested in buying and using your product. In the case of web start-ups, this may be a page that gives some information about the product and asks customers to pre-register for service. In the case of physical products, this may be a building, a prototype or a small feature version of the product. Doing this will give instant insight into whether people want your product or not.
Learning experiments have the advantage of being low cost, and low risk, allowing you to get a good idea of the potential demand for your product before investing large amounts of money and time. Learning experiments also unearth unforeseen obstacles and challenges that can never be planned for.
3. Improve your business model using real world feedback
Every business model has a number of assumptions or best guesses: unforeseen obstacles, non-compliant customers, hidden costs. As new knowledge comes in from your tests, you need to change and adapt your business model to find what works in the real world.
A number of studies by leading researchers have shown that successful entrepreneurs seldom succeed with their first idea. In one study, Harvard Professor Amar Bhide looked at 100 of the most successful start-ups in the USA and found that 67% of them had radically changed their original business idea before succeeding. It is, however, not easy to fundamentally alter the strategy of your company.
It is often painful and no one likes to be wrong. But the research shows that the ability to change your business model when real world feedback says you are wrong is the mark of a great entrepreneur.
A famous example is Evan Williams, the founder of Twitter and blogger. Both companies were ideas that changed radically. When Williams started Pyralabs, a project management software company, he found that customers were particularly attracted to the note-taking feature.
Using real world feedback, Williams abandoned the project management software idea and launched blogger, which was later sold to Google. Similarly, Twitter was founded as a spinoff of Odeo, a failing podcasting software business.
When developing your business idea it’s important to take note of the real world feedback, and use the feedback to adapt your business model to what the marketplace wants. Adapt and change price points, product features, delivery channels, and marketing propositions until your business idea evolves into something that can become the next big thing.
4. Only start building your business once you have reached product-market fit
Traditional theories of entrepreneurship go as follows. Entrepreneur finds an opportunity, writes a business plan, raises funds, gathers a team and then gets on with the task of building the business, using the plan as a guideline.
This model is fine in the predictable world of known business models, known markets and known products, but in the uncertain world of new ideas, new businesses models, new products and new markets this method usually spells disaster.
Researchers call this type of disaster ‘premature scaling’. A business is considered to be scaling prematurely when it starts spending money on growing the business (ie. advertising, hiring employees, expansion infrastructure) before it has proved all of the assumptions of the business plan.
For example, WebVan, one of the famous dot.com era’s most spectacular flameouts started to expand its operations even though a number of the assumptions in its business plan were wrong. Customers cost more to acquire than originally planned, the customer retention rate was lower than planned and delivery costs were higher.
Even so, the company signed a R7 billion deal to expand by adding 24 distribution centres.
The result: bankruptcy in two years and R5,6 billion wasted. The reason: WebVan started to expand before testing all of the assumptions in its business plan. They scaled prematurely. When you are setting out on your start-up journey, ensure that you don’t start spending money on marketing, hiring and growth until you are sure that all of the assumptions in your business model have been tested and proved, and you have reached product-market fit.
5. Company building
With a proven business model, it is now time for the business to scale. On a graph, this usually appears in the form of a 45 degree growth line. It is time to let the world know about your product. This means launching a PR blitz, ramping up your marketing and sales activities and ensuring that you increase your business capacity to meet the flood of new customers.
By this stage, your business should have found a consistent and predictable way to acquire and retain new customers, while making a profit. However, many businesses fail in the growth stage by not managing the growth process properly.
Three areas must be managed in conjunction with each other: the rate at which new customers are acquired, the capacity to deliver the service and product to the customer and the business’s finances.
Too much investment in capacity and no customers leads to cash flow issues as seen in the WebVan case; too many customers and no capacity leads to angry customers. This is part of the reason Friendster (one of the first movers in the social networking space) didn’t become Facebook.
It acquired too many new customers, more than the site’s infrastructure could handle. The site crashed a number of times, and customers became irritated. The key to successful growth is balancing the rate of customer acquisition with building the business capacity to deliver the company’s products and services.