Nobody ever plans to launch a failed start-up, to devote months, years, or even decades of his or her life to a company that ultimately dies, that can’t create, market, and sell a profitable product.
Fact: over 90% of all start-ups fail (Proof: 1, 2, and 3).
There are various reasons for this but in most cases it comes down to:
the company building a product for a non-existent market (i.e., there is insufficient demand),
failing to manage its cash flow properly (often utilizing a revenue model that simply doesn’t work),
ineffectively adapting to market changes,
not growing quickly enough,
and/or being led by a founder who eventually burns out.
So what do seasoned entrepreneurs — those who have a track record of launching ultra successful companies — know that founders of failed start-ups don’t?
Among the many potential answers, there is one that many seem to underestimate: the first steps you take toward creating your start-up will ultimately determine whether it succeeds or fails.
What you do in the earliest days of your start-up could make the difference between launching the next million- or even billion-dollar company versus merely becoming one more failed start-up amongst the other 90% lost to history that nobody remembers.
Having worked with countless startups at Appster, we found that, at its core, the creation of a successful start-up consists of five crucial steps.
The specific focus of your company, the exact problem you’re trying to solve, the particular market into which you’re entering, the product you’re intending to build as the solution to the problem, and the economics of your business model all must be decided upon and figured out before you start building your company.
Our 5-step process for successfully launching a profitable start-up looks like this:
1. THE FOCUS
What is your company fundamentally about?
“What should I work on?” This is the most important, and hence the very first question you should sincerely ask yourself when thinking about the possibility of creating a start-up.
The focus of your company is similar to the foundation of a building: whatever subsequent layers you build will depend heavily on the foundational structure supporting them.
Only a solid structure/focus can support a strong building/start-up.
Consider the following diagram:
One of the most crucial aspects of creating a successful start-up is determining the ideal intersection between your abilities (skills), your interests (passion), and what you can get paid to do (money).
Time and again, founders who build prosperous start-ups refer to the basics of this diagram as representing the core of their successes. Virtually every top entrepreneur out there has found an effective middle ground between interests, skills, and capacity for monetization.
Take the example of Steve Jobs: he loved design (passion), was a great marketer and product manager (skill), and always managed to successfully combine his abilities and interests with what was super hot in the market at the time (monetization), whether it was personal computing, personal audio in the form of MP3 players, 3D movies, or the mobile revolution.
So, how do you put this information into action?
Take out a pen and some paper right now, and get to work on answering the following questions until you have thoroughly addressed each of the three key elements:
Passion: What do you want to do with your future company? What do you enjoy doing most? What excites you and keeps your interest for hours on end?
Let’s be clear about the importance of passion: passion is absolutely crucial to building a successful business but it is not the be-all and end-all of everything.
In fact, passion as such is often overrated and its significance overestimated. In most cases, real passion develops as you begin to accumulate success. Thus, when thinking about the focus of your company, don’t concentrate entirely on things you’re most passionate about at this very second but instead include areas of interest that have the potential to give you a sense of satisfaction and accomplishment over time.
List out as many of your passions as possible and then move onto the next domain.
Skill: What are you really good at? What are your unique talents or abilities? What can you do better than others? Are you a skilled designer, programmer, salesperson, all-around hustler? Something else?
You might not currently be the very best at one or more of the things that just popped into your mind but you undeniably possess a number of special skills, talents, and bits of knowledge with which you have the potential to excel within the start-up world and within business more generally.
Again, write out as many of your abilities as you can.
Money: Having determined your key passions and listed out your talents, you now need to ask yourself two further questions? One, can you connect these interests to these skills so as to potentially create a successful business, one that solves an identifiable problem? And, if so, then, two, is there sufficient market demand to eventually generate profit? In other words, is the market big enough?
Answering these questions about market demand and earnings will force you to distinguish business and non-business skills and passions, therefore allowing you to zone in on the specific interests-abilities pairings that have potential to earn money.
2. THE PROBLEM
What is the existing consumer pain/need?
Venture capitalist and billionaire Vinod Khosla said it best: “Any big problem is a big opportunity… If there is no problem, there is no solution, and no reason for a company to exist… Nobody will pay you to solve a non-problem.”
Before you launch any sort of product or service, you must determine the specific problem suffered by your customers that your company will seek to solve.
Painkillers or vitamins?
Vitamins promote good health slowly and gradually: they can help you feel better over time by preventing you from becoming unwell in the first place.
Painkillers stop unwanted and uncomfortable symptoms immediately: they can help you feel better by stopping the pain and hence solving the problem right now. The best companies are painkillers, not vitamins.
Painkillers are start-ups that solve serious problems quickly and effectively: the customer wants the painkiller right now because he or she has a pain that needs to be fix; he or she doesn’t care whether the painkiller looks nice, has an appealing logo, or might work at some point two or three months from now.
Google is a painkiller: without Google’s 24/7 availability and its ability to return search results within fractions of a second it would be a real pain to find something on the web fast.
Your company must function as a painkiller, providing a product or service that solves a market problem today, not a vitamin that might help in some way at some point down the road.
Is the customer pain monetizable?
Monetizable customer pains are pains so significant that sufficient numbers of customers recognize their existence and are willing to pay money for solutions. On a pain scale of 1–5, a monetizable pain is a 4 or 5, i.e., it needs to be addressed now.
Unless you can discover and respond to a specific monetizable pain, every other activity involved in being an entrepreneur (from design and development to marketing and testing) really doesn’t matter: whatever you end up building, people won’t pay for it unless it solves one or more of their pains.
How to validate your pain?
Having an idea of the specific market(s) and area(s) of business in which you intend to launch your start-up, the next step is defining your problem hypothesis, i.e., devising and testing what you believe to be the core problem to which your business will respond.
To test your monetizable pain hypothesis, you need to:
Find a sample of customers
Survey them in person (preferable) or via e-mail (less preferable); and
Evaluate the results.
In order to gain as much valid insight as possible, you need to acquire brutal honesty from your focus group. This means that rather than enthusiastically pitching the participants your ideas and trying to sell them your specific pain hypothesis you ask open-ended questions designed to let the respondents speak freely and pressure-free. You might ask questions such as:
What is the hardest part about x [i.e., some given problem] ?
Tell me more about x. What happened the last time x occurred?
Why was that experience so difficult?
What, if anything, have you done since in an effort to solve this problem?
What solutions, if any, are you currently using? What do you find unsatisfactory about them?
How do they need to be changed?
Where to find customers for feedback?
Finally, where do you find such potential customers for this kind of focus group feedback? Use all the resources available to you! Try your existing email lists, online forums/message boards, social networking and micro-networking sites, Reddit, Linkedin, Quora, Meetup.com; or even go to Starbucks and offer a free coffee in return for an opinion.
Just be sure to your avoid friends and family as you’re virtually guaranteed to receive biased feedback from people with whom you’re already familiar.
3. THE MARKET
Can you build a real business?
Alongside identifying the focus of your company and zeroing in on the specific problem that it will solve, it’s essential that a market for the solution you intend to create actually exists.
Entrepreneur, investor, and software engineer Marc Andreessen insists:
“The 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” (source).
(We have an entire blog post dedicated to the importance of creating the minimum “viable product” that Marc mentions above — click here to read the article).
So, how do you determine whether a market really exists for the focus of your company and the problem you intend it to solve?
Calculate your market size
In order to confirm the existence of a market for your product, you need to calculate your annual market size (AMS). The AMS refers to:
The total number of people who will buy your product per year
The price point of your product
This formula reveals that in order to generate a high annual revenue (e.g., $1 billion in sales), you need a large number of customers, a high price point, or both.
To get an idea of the market size, follow these steps:
Research press coverage on the market: try to look for articles quoting authoritative market research agencies such as Gartner or IBIS; read SEC filings and Wikipedia (be sure to validate the authenticity of sources used); Google Books can also be quite helpful.
Create a back-of-the-envelope basic estimate of market size, collecting relevant statistics and figures (e.g., via Google search) as necessary.
Further validate the estimate using modern analystics tools, including Google Trends, Google’s Keyword Planner and Facebook’s Advertiser Tools. Utilizing these applications will give you the ability to determine how strong the demand is for your proposed solution.
To properly calculate the size of your specific market, make sure you avoid unjustifiably generalizing your statistics. For example, if you’re starting an e-shop for women’s apparel and there are 150 million women living in the U.S., it should be clear that your addressable market size is definitely not 150 million! Rather, you’d need to determine how many women (of the particular age in which you’re interesed) shop online, how many shop for the specific style of clothing you sell, and so on. You need to dig deep in an effort to determine the exact preferences and buying habits of your target population.
Suppose you’re building a tool for equity futures traders, one that allows them to program their own trading algorithms.
There are 10 million total traders but, as we just saw above, this doesn’t accurately represent your addressable market. A closer look reveals that out of those 10 million traders only 2.5 million are active traders, with the remaining 7.5 million engaging in less than one trade per month.
So, there are 2.5 million potential users of your trading tool. Another look shows that only 1 million of these potential users have sufficient programming skills to use your product. Of course, you’d need to conduct a survey amongst the traders in order to determine this number (try Google Surveys, for example).
Looking at similar products in this space would allow you to form an idea of the typical pricing for this market. Let’s say it’s a cost of $500 for an annual subscription to use the program: $500 x 1 million users = $500 million. That’s the most money you could make if you were to win over 100% of the market (an ambitious goal, to be sure).
To gain even more insight, you could conduct a focus group survey similar to the one discussed above (under The Problem) in an effort to determine how many of the traders recognize, and are interested in a solution to, the specific problem/pain around which your tool is focused.
What is your minimum feature set?
Having completing the second and third stages, you should now possess a number of key facts about the monetizable pain upon which you’re focusing as well as some initial ideas concerning how your product should look and function. The next step involves getting more specific about your product by creating a minimum feature set (MFS) hypothesis. The MFS represents the core one or two features for which your customers will pay. It’s essential that you avoid wasting time, energy, and money “perfecting the product” by adding nice-to-have but non-essential features. At this stage you need to focus on the bottom line and save the feature enhancements for a future round of design and development (again, see our article here on minimum viable products).
As French writer Antoine Saint-Exupéry famously said:
Perfection is achieved, not when there is nothing left to add, but when there is nothing left to take away
Discovering the minimum feature set brings with it the incredible power of increasing your flexibility: with fewer features to change, your product will appeal to your customer’s desire for simplicity whilst simultaneously revealing to you the real core of what your users want.
Here are the five steps to defining your minimum feature set:
Develop a minimum feature set hypothesis. Create your hypothesis by considering the major themes that have emerged from the conversations you’ve had with potential users so far, explicitly asking your customers to identify the key problem for which they need a solution (including which issue(s) each feature would address), and simplifying all these bits of information down in order to generate an uncomplicated, straight-forward list of features.
Build a buying panel. Identifying the people who responded to your emails in previous steps, select those most likely to be amongst your future customers and begun compiling a list.
Give your initial product a visual form. Draw up some starting wireframes that give a good feel for the product. You can use tools such as Balsamiq Mockups and Lucidcharts at no charge.
Examples of mockups created with a wire-framing tool:
Do the $100 test. Show your prototype to customers and if you receive inconsistent feedback on whether they’d be willing to use it, which features they do/do not like, and why then try the $100 test: list all the features you are considering implementing into the final product and ask your customers, “If you had only $100 to invest in one or more features of this product, how would you invest your money? Which features would you invest it?” Naturally, customers will select the ones about which they care the most.
Refine, and test the demand for, your product. Test the demand for, and price points of, your product using “breakthrough questions” such as: “What price would be reasonable for this product?”, “Would you be willing to pre-order this product?”, and “Would you be more interested in making a one-time or, alternatively, a recurring payment to use this product?”
5. THE REVENUE
What is your business model? Can you scale it?
With your focus, problem, and product figured out and your assurances that a market exists for your solution, your next step is to calculate whether your business model is capable of getting your product to market, becoming profitable, and increasing in scale.
“Economies of scale” refers to the fact that the bigger your customer base, the cheaper it becomes to produce one unit of your product. For example, if you develop an app and your development costs are $250,000, then a customer base of 10,000 customers would make one of your units cost $25.
A smaller market, let’s say in this case a customer base of 4,000, would necessarily require that you charge a higher price in order to generate the same amount of income. However, the problem with this is that if your competitors offer a much cheaper product then you’re lucky to face difficulties in growing your start-up.
A business must scale — otherwise, it ultimately folds. You need to ensure that your business model has the potential to grow your company over time.
One of the major advantages of developing and selling software is that unit reproduction costs basically do not exist. For instance, you can build an app and then sell as many “copies” of that product as you wish at minimal additional costs to you.
Contrarily, if you sell physical products, such as notebooks, laptops, or window frames, you have to manufacture every single one of them at cost no matter how many individual units you sell to your customers.
Create a simple cash-flow calculation
To estimate your economies of scale, a simple cash flow forecast like the one pictured below can work:
A chart like this also allows you to determine how much start-up capital you require in order to launch your business. Here, you can see that the start-up effectively burns money (the figures in parentheses are negative values) until it finally starts to break even in month 9.
The initial negative cash flow grows to $120,036 and that’s the minimum amount you’d need to stay alive if you were running this start-up.
With these five essential steps taken care of, the next actions involve raising financial capital (unless you intend to bootstrap your company), building your product, achieving a successful product/market fit, and instituting a repeatable and scalable business model.
We will be providing in-depth blog posts on these and related topics in the coming future so be sure to follow our journey on Appster!
Source references: Bud Caddell’s Diagram, B. Srinivasan’s Startup Engineering, Nail it Then Scale It by N. Furr and P. Ahlstrom.