It was an experience I will never forget. Right before the dotcom bubble, I had an opportunity to visit Webvan, a sweetheart of Silicon Valley at the time. Webvan was a hot grocery delivery startup, and many thought it would be what Amazon has become. Touring the facility, it took me about five minutes to figure out that the company was overengineered and overbuilt, in the way many perceive Tesla to be today. Webvan was an epic fail.
Most people assume startups fail because they run out of money. According to a new study by CB Insights, the number-one reason startups fail is "no market need" (42 percent). Running out of capital is second. In other words, you could have a king's ransom and still get cut off at the knees if you don't get your value proposition right.
There are critical decisions every startup needs to make from the beginning:
1. Solve the right problems for the right market.
In my strategy practice I am often amazed by how little entrepreneurs know about their markets.
Know the growth rates of markets you serve. Growing markets are accepting of new competition whereas saturated markets only tolerate entrants who compete on price. Unless you're going to be the low-cost leader, make sure you're launching into vertical markets that have a positive growth rate.
Start with a market-insight study. Every business should talk to dozens if not hundreds of customers to know what problems to solve. They should also conduct value chain analyses to assess exactly what products they should sell, supported by which services.
Do it at scale. If your company cannot achieve enthusiastic mass adoption, it will be hard to gain traction and receive multiple rounds of funding. Testing is critical in building scale. Make sure you take time to model various offers and vet them through market testing.
2. Develop the right bundle of services.
While the need for differentiation is clear, finding uniqueness proves elusive for most. In building your model, consider:
Economies of scope: Startups with limited capital have a hard time deciding on the optimum breadth of their offering. Economies of scope are realized when a company can spread its costs (i.e. for R&D) across the right number of products or categories.
Feature set and positioning: One used to be able to plot a company's position versus competitors on a continuum based on quality and price. Today, niche providers (those who can survive a launch) must have a feature set that resonates. Because customers are often happy with "just good enough," every feature has an opportunity cost.
A product can have too many features that inflate cost but don't magnify perceived value. For example, there's an emerging business model in which recruiters are stripping out many services and delivering candidates to employers for less than $5,000. Test feature sets until you get it right.
3. Embrace value-creating technology.
Among the most fundamental of decisions in the formation stage is which technologies to insource. To develop a technology from scratch can deplete a disproportionate amount of capital and delay launch of commercialization at a time when a company can least afford it. Conversely, developing intellectual property is the pathway to valuation. So, what is a startup to do?
Focus on owning the technology at the heart of your value proposition and outsource the rest. Today's collaboration tools and cloud-based platforms provide access to configurable technologies. One of our ecommerce clients recently had to decide if it would build an expensive online storefront or focus on its proprietary database. It chose the latter because it would be accretive to driving enterprise value.
4. Look for less expensive ways to upset the apple cart.
One of the least expensive ways to bring something new to an industry is to innovate in terms of monetization method. For example, Silicon Valley is ripe with companies moving toward usage-fee pricing models and other ways of pricing products that cut customers' cost and risk.
Don't get romanced by disruption. While disruption is sexy, it's not always practical or even necessary. To disrupt implies competing directly with larger, well-entrenched companies. You may be better off addressing an underserved slice of an industry with commercially available technology.
5. Become a pro at raising capital.
Let's face it; pitching to venture capitals is not for the weary. In such pitches, many entrepreneurs are ill-prepared and can't answer basic questions about why their products matter. To become a pro, build well-thought-out financial models for five years, create a business plan that cites credible market sources, and practice your pitch to ensure perfect delivery. Most importantly, have a financial plan that considers every round you will need from the beginning.