How to effectively validate your startup idea
80 percent of businesses fail in the first 18 months of their life. A sobering statistic for any would-be entrepreneur, if ever there was one. Many of these businesses are started by people who are passionate and energetic, but they fail to appropriately validate their underlying business model. Actually, there are several steps that you can undertake to prevent this fate for your startup. This article provides guidance on how to perform research and validation on your idea in a systematic and comprehensive manner.
Building a start up that takes passengers to Mars may be a very interesting idea but it may not necessarily be the basis for a financially successful business. Most startup businesses fail because they do not appropriately vet and validate their idea. Here are seven questions you should consider as you decide if your idea is A) a viable one and B) suitable for you:
Do you have the skills that your chosen business will demand of you?
What is the specific mission of your business? What problem are you solving and who are you solving it for?
Have you obtained validation from potential customers to prove that there is a market for the product or service you are offering?
What initial resources and investment do you need? Do you have the required funds, or will you need to raise them from other sources?
Will the business be able to earn a profit in a reasonable time? And well before you run out of your invested capital?
What type of competition will you face, now and in the future?
Will you be able to pivot as you adapt to new circumstances and information about your business?
Validating Your Idea
Key questions to help you validate your startup idea
WHAT ARE YOUR GOALS & MOTIVATIONS?
Before you set up a new business, it is essential to consider the demands the business will place on your lifestyle and if those comport with the type of life you want to build for yourself in the long-term. Factors you might want to take into account include wealth goals, family commitments, hobbies, lifestyle choices, your age and your stress tolerance. If you haven’t already done so, you should review our article on different types of startups to better understand investment needs, risk profiles, lifestyle implications, and upside potential before you decide which type best matches with your business idea, your personality, and your lifestyle desires.
For example, are you looking to create a high-growth, highly scalable Silicon Valley start-up? Entrepreneurs taking this route tend to work around the clock for a few years before “exiting,” either by becoming acquisition targets for larger businesses or by going public on the stock market. This strategy offers the highest financial rewards and perhaps the greatest prestige, but also comes with the most risk. Unless you’re already independently wealthy, you’ll also need excellent communication skills to convince business angels and venture capitalists to give you the external funding your business requires.
WHAT PROBLEM ARE YOU SOLVING?
Successful businesses have a well-defined sense of purpose. In a few years, this might form the basis of an inspiring “Mission Statement” on your website. But at the early-stage of your business, it is enough to have a clear and focused sense of the real-world problem that you are attempting to solve.
The happiest, most authentic business owners are those who work on a problem that they care about personally and are able to create a solution that customers are prepared to pay for. The nature of the mission will vary from entrepreneur to entrepreneur. The most important thing is that you are solving a problem that people care about enough to pay you money for.
It is also necessary for you to know who you’re solving this problem for. What is your target market? Are they young or old, rich or poor, sporty or unfit? Rather than trying to please everyone, analyse your mission and your customer segment to develop a very clear understanding of how you will sell to them.
HAVE CUSTOMERS VALIDATED YOUR IDEA?
Eric Ries’ famous Lean Start-up methodology posits that start-ups are guesses at a viable revenue model. In the validation stage, it’s time for you to determine if customers will buy what your business has to offer them. You’ll also gain invaluable insights into what your customers’ offices and workspaces look like and how they shop. Most investors will not give you a term sheet without seeing proof of customer validation.
In order to test your business hypothesis, you’ll need to create what Eric Ries calls a “Minimum Viable Product” (MVP), a version of your customer offering that has the lowest level of complexity required to provide value to your target market. This allows you to test your product idea rapidly and frequently while expending minimal resources, greatly reducing the probability of creating something that no one wants.
What an MVP looks like in practice varies from company to company. If your business produces a technical product, such as a 3D Printer, it will be necessary to manufacture one or more basic prototypes and give them to users for testing. To receive investment from a bank, a fledgling marketing consultancy might be asked to show evidence of one or more existing clients.
Another great way to validate your business idea is to submit it to crowd funding websites such as Indiegogo or Kickstarter. Your friends and family will probably support your venture come what may, but projects that attract significant donations from strangers online are likely to have better potential as a business.
In each of these examples, you’re looking to see whether customers will buy your products or services at the price you set. This is where the revenue model you develop comes in handy. How do you know what price to sell at? A great place to start is to look at the prices offered by your competitors.
WHAT INITIAL INVESTMENT WILL YOU NEED?
Some businesses require a lot of upfront investment, whereas others can generate a positive cashflow fairly quickly. If your start-up falls into the former category, you’ll need to work out how you will handle your finances while you’re waiting for your product or service to gain traction. Typical ways of doing this include bank loans, crowdfunding, venture capital and continuing to work a day job.
As a minimum, you need to create a sales forecast, budgeted expenses, and a cashflow forecast. This will allow you to calculate how long it will take for your business to become profitable. While your business is losing money, it is also essential to keep your “runway” in mind – the number of months you have until your savings or investment capital run dry. A business that fails to “takeoff” (i.e. become profitable) before its runway runs out will have to shut down.
Even if you do not plan to create a formal business plan, it is good idea to summarize your analysis of your financial situation in a formal manner that you can track agains.
HOW WILL THE BUSINESS MAKE MONEY?
If your expenses exceed your income for too long, you will go out of business. You certainly need to turn profitable before your capital runs out. Here are some common ways a business can generate revenue.
Asset Sale: A customer exchanges their money for a finite product such as a piece of fruit or a laptop. After the sale, the customers owns the product and can do with it what they will.
Usage Fee: The more the customer uses your product, the more they pay you. Pay as you go phones are an example of this model.
Subscription Fee: The customer pays for your product on a regular, pre-determined basis, often monthly. Many gym memberships fall into this category, debiting money from the client’s bank account once every month.
Leasing: When a customer is given temporary access to a particular piece of property, businesses enter into leasing agreements. Some companies lease out bikes for a day to enable tourists to cycle without needing to transport their own bicycles.
Licensing: Frequently seen in the music industry, licensing occurs when businesses give customers permission to use their intellectual property in exchange for a fee.
Advertising: Companies like Facebook make money by providing advertisers with user data. Customers can use their services for free, but browsing exposes users to targeted advertisements.
Choose one or more of these methods that seem appropriate for your business idea. You can validate your revenue source and pricing strategy with customers during prototyping.
WHAT COMPETITION WILL YOU FACE?
At the time of writing, traditional taxi drivers are being driven out of business by Uber, a start-up that connects travellers to regular drivers via a smartphone app. As such, it would be a terrible idea to start a new taxi cab company.
Successful business owners are aware of current and long-term trends within their industry. One way you can acquire this knowledge is by visiting online sources such as Springwise or Trendhunter to research societal trends. If you’re opening a brick-and-mortar business, you should know about other neighbouring businesses that may compete for your customers. Similarly, you wouldn’t want to open a high-end retail shop in the middle of an area undergoing economic depression.
In order to ensure that your target market buys from you and not someone else, you will require an understanding of the features, prices, and benefits offered by your competitors and how they compare to your customer offering.
Your research should include looking through the Internet, marketing databases and industry magazines. You might also consider buying goods or services from your competition directly, or putting yourself on their mailing list. Talking directly to your competitor’s customers and finding out what they like or don’t like is also a good way to collect competitor intelligence. Your aim is to understand what your competition is doing so you can do it better. Whether you compete on the basis of product flaws, poor customer service or cost-effectiveness, your “Unique Selling Proposition” (USP) will become the basis of your marketing strategy.
FINE-TUNE AND PIVOT AS NECESSARY
If your initial customers like what you have for sale, they will become early adopters – the lifeblood of a new business. These early adopters can be an invaluable resource for you to further validate and fine tune your business proposition. Interacting with these customers will give your business access to valuable information about their needs. You might even gain a greater understanding of the competition from this process.
As you learn more about your target market, you’ll need to go back to your original definition of the customer problem and update your ideas. These subtle changes in direction are often referred to as “pivots.” A baker might repeatedly hear that his bread is too sweet compared to the competition’s and add salt to his recipe as a result. A towel manufacturer might receive the feedback that his products are too scratchy, leading to a switch to softer fabrics.
Pivoting can sometimes be disheartening, particularly if you’ve spent months working on an idea that customers refuse to buy. But the best business owners check their ego at the door, listen to customers and change direction as needed. The ability to pivot quickly is much more valuable to your long-term success than trying to get everything right the first time around.
Conclusion
The difference between a dreamer and a business owner is a well-laid plan. Successful entrepreneurs learn their target market, validate their business idea and are self-aware of their shortcomings so that they match their skills and lifestyle desires with the needs of the business they launch. Above all, they understand that only those businesses survive that can build a sustainable revenue stream in excess of their costs before their investment capital runs out.
