3 ways to kill a business on paper
By KEVIN MUHOVI
It is one thing to take a piece of paper, fold it into an airplane shape, hurl it across a room, and make it fly. It’s quite another to construct an airplane in real life. This might seem like an obvious thing to point out, but this is often what happens when people try to build a business. Because they are so eager to build and test their idea, they often overlook certain elements of the business plan. Then, when they try to make it fly in reality, unexpected surprises or unplanned for events prevent it from getting off the ground. Here are three solid ways to make sure that the business you are building in 2D can stand on its own two legs (or four legs, or 1,000 if you’re building the business equivalent of a millipede) when it goes to market. You want to create a killer business plan, not a business plan killer.
If you can’t make it work on paper, it’s going to be freaking difficult to make it work in real life.
Problem sizing
- Desirability is at the core of any business model. But it’s not enough to simply solve a customer problem with a product/service.
- We often say that innovation is the exploitation of creative ideas. Therefore, the goal is not only to build an amazing product or service that people totally love, but also to create a sustainable business around it. And yes, even for NGOs or social innovations who aren’t in the game to get rich or die trying, it is important to have a sustainable business. You won’t be able to help your target group for long without one.
- You need to make sure that the problem being solved is one that somebody is willing to pay for.
- Understand how much money customers currently spend on solving a problem and do a quick metric of the underlying potential of a given opportunity (ie. Total Addressable Market (TAM) (or total available market)
- How often do customers face this problem? What sort of time, money or other resources are wasted because of this problem. (Give it Larry Page’s toothbrush test)
Growth hypothesis
- Understanding your solution’s growth potential is crucial to determining the viability of your business model.
- If you need 1 million customers to make 10 million in revenue in a market of only 4 million customers, that’s going to be extremely difficult.
- Testing with throughput models can help you gauge the viability of your business and understand whether to pivot and focus on other markets.
- What are throughput models? Conversion funnels that determine how many leads you need to generate in order to secure a certain amount of paying customers. For example, if you assume a conversion rate of 10% and you need 1 million customers to make 10 million in revenue, this means that you need 10 million leads. Ask yourself: are there even 10 million people in the market for your product/service?
- Conversion rates of SaaS (Software as a Service, aka. on-demand software) are notoriously low. Dropbox, for example, has a free-to-paid conversion rate of about 4%, which is considered a really good rate. Spotify, which has a ridiculously high conversion rate of 27%, is considered extremely rare. Like super Blue Moon eclipse rare. Most companies can be happy with a conversion rate of 1%.
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Unit economics
- Unit economics are the bread and butter of a business model. They determine whether you’re getting more value per unit (i.e. revenue per unit) than the variable costs to produce and deliver it. Basically, unit economics establishes whether there is a good balance between what you’re going to earn and what you’re going to spend. For example, on the spending side, you need to consider how much it will cost to sell your goods and how much it will cost to acquire your customer.
- Unit economics are the key indicator of how profitable your business is going to be as it shows you are making enough money per unit to contribute to the fixed costs and eventually break even. This is important for startups since they will have heavy investments up front. Even though they might not be making a profit in the early days, unit economics should show that profitability is possible down the line.
- Research industry benchmarks for the cost of goods sold (COGS) and the customer acquisition cost (CAC). Compare this with your assumptions.
- It’s important to analyze different possible market scenarios to stress test your unit economics. If your CAC increases by 20%, do your unit economics still add up?
- Unit economics are the bread and butter of a business model. They determine whether you’re getting more value per unit (i.e. revenue per unit) than the variable costs to produce and deliver it. Basically, unit economics establishes whether there is a good balance between what you’re going to earn and what you’re going to spend. For example, on the spending side, you need to consider how much it will cost to sell your goods and how much it will cost to acquire your customer.