Finding your ideal niche
The biggest error in planning may not be spreadsheet calculation error. Or cost estimation. It is most often missed assumptions about the market, the competition, the speed of adoption, or other critical metrics you’ve researched, or selected, or even just guessed at to create your plan.
Where did you get the data to drive your assumptions of market size or market share? Most entrepreneurs quote a resource for market size, but fail to then take the next step to eliminate all parts of that market unreachable by the company or product. For example, if you supply software to the chip design industry, do you segment your market into digital and analog users, into high end or inexpensive buyers, and into which languages or platforms users demand or request?
It’s easy to find someone to quote a size of market estimate. I became something of my industry’s source for such a number when I carefully catalogued the 160 players both domestic and international, estimated revenues from knowing the number of employees or installations for each (which were often public knowledge or stated by those companies.) I then created a gross domestic and gross international annual market size estimate for my industry’s products. No-one challenged this number, and it became an unattributed source of the metric for market size for years. Perhaps there was no other way to project the size of that market. But many decisions were made within my company walls, and surely by competitors, based upon those numbers.
[Email readers, continue here...] Then there is the famous entrepreneur’s statement about market share: “All I need to sell is one percent of the total available market to make this a rampant success.” We call that the “gloves in China” syndrome when analyzing assumptions within business plans. Without a trace of how the business will get that one percent, the entrepreneur confidently shows that this is all it takes to make us all rich. Even if the total number of annual units in a market is known, the leap to a percent of that market without a specific plan is often a fatal one.
And these are just two of the many assumptions that underlie any business plan. At the very least, all assumptions should be driven by numbers separately listed in an “assumptions section” of the planning spreadsheet, allowing the reader to manipulate those assumptions to see the various outcomes, and challenge the numbers for the benefit of all who have to defend them.
By David Steakley
This week, David Steakley returns for another bite at the corporate apple, with just the right amount of tart comments that will keep this document legal for now. Read on! - DB
How do you judge a company’s prospects, if a corporate business-to-business sale has to be your game? If your company’s market is huge corporations, how do you convince investors you can crack the market, and how do you deliver?
To answer this, you have to understand the challenges of getting paperwork signed and checks issued, in a big company. You’ll notice I didn’t say “the challenges of selling,” because this is seldom the crucial challenge. I am assuming that you have an awesome product or service which cleverly solves some tough problem and promises to deliver solid ROI for the buyer.
Just to be up front, as an investor, I am allergic to companies which rely on making potentially huge sales to corporate clients. The corporate B2B sales cycle produces a harshly binary outcome: either the company dies while waiting for a corporate client to sign the paperwork and remit the funds, or else it delivers gigantic outsized sales with relatively little effort.
[Email readers, continue here...] I routinely see prospective investments which rely by their nature upon selling to corporate customers. I have learned through bitter experience that little can be predicted from analyzing the company’s product or service. Of course, you’d think the company has to have a useful, valuable, or somewhat unusual product in order to be successful. But, from a standpoint of efficient analysis of the company’s prospects, this is not the place to start.
Big corporations are just slow to act. The time needed for decision increases as a factor of the number of people involved in the decision process. The number of people involved in the decision process varies as a factor of the amount of money involved, the number of places in the company affected by the transaction, and the duration and contractual obligations of the commitment.
I have found that the predictor of success is really extremely simple: tell me the name, phone number, birthdate and favorite brand of scotch of the senior corporate executive who is going to be your first customer, and tell me how much he is going to pay you in the next twelve months. Now, I am not saying you have to sell only to scotch drinkers, but you get my point: the predictor is your intimate knowledge of people you already know who need your product, want your product, and who know and trust you to the point that they will work hard to overcome the obstacles of closing the deal.
In other words, you have to have inside agents. You have to know, find, create, recruit, whatever, senior corporate executives who will relentlessly and stubbornly perform the unnatural acts required to close the sale.
Occasionally, I have seen success with companies getting started by using channels, i.e., other companies which are already providing or selling some product or service to your customers, who will tuck your product or service into their bag of tricks in return for a slice of the revenue. But it is very, very difficult to get a new product started this way. Once you’ve established the product, and the channels can be persuaded that your product provides them with relatively easy incremental revenues; channels are a fantastic way to scale your sales effort without fixed costs.
The great advantage of the B2B market is the potentially huge size of revenues from just one sale. Those revenues tend to be very durable, as quite often, you are getting your offerings wired into the DNA of the customer.
Before you tackle the corporate market, be sure you understand the challenges of this market, and think carefully about your product design and your sales approach, to reduce the barriers to closing sales as much as possible.
David Steakley, a past President of the Houston Angel Network, is a reformed management consultant. He is an active angel investor, and he manages several angel funds in Texas.
By David Steakley
Our guest insight this week comes from David Steakley, a past President of the Houston Angel Network, and a reformed management consultant. He is an active angel investor, and he manages several angel funds in Texas. Hang on, David tells it like he sees it! – DB
Business plans are interesting. But, as a famous field marshal (1) said, no battle plan survives contact with the enemy. I have found it more important to assess the capabilities of the founding team to react, revise and pivot (quickly change direction), than it is important to assess the business plan. How do you know whether your founder team and your added executives have the right stuff to survive contact with the enemy?
In addition to the ability to pivot, character matters, too. As my kids have commenced driving, I’ve harped incessantly, hopefully to the point of their nausea, on the notion that they should always have in mind that everyone driving on the road is in a massive conspiracy to collide with them, and make it appear that the collision was an accident. “Just assume everyone is trying to kill you,” I say.
I take this approach to angel investing. I begin by assuming that the founders of the company are incompetent, psychopathic, lying con-men and thieves; and I try to convict them of these charges. I ask them innocuous questions, and try to check as many seemingly inconsequential details of their story as I can. Where did you go to school? When did you graduate? In what field was your degree? What was your first job? Why did you leave that job? Where did you grow up? Did you play sports in high school? What are your hobbies?
[ Email readers, continue here...] Faithful in little; faithful in much. If someone will deceive about a small matter, he will deceive about anything and everything. I don’t do business with liars. If I am unsuccessful in proving these charges, then, perhaps the company is a candidate for investment.
I was a partner at a large global consulting firm. We hired literally hundreds of thousands of graduates every year. They had no meaningful experience. The only way to evaluate them was to look for a kind of raw, athletic talent. To help us in this, we adopted a technique which I believe is now universally used, but which was unusual at the time. We called it behavioral interviewing. This technique relies on identifying specific traits and characteristics which one wishes to find, either negatively or positively, and then asking the candidate to tell specific true stories about situations in which s/he would have had an opportunity to demonstrate the traits in question. A lot of the value of this technique relies on the interviewer being extremely aggressive with the candidate about the minutest of details within the story offered.
For the founders of companies in which I am considering investing, I have concluded that flexibility, intellectual nimbleness, and a relentless focus on dispassionate examination of factual evidence of results, are some relatively rare traits with which I cannot ignore. “Tell me about a time when you changed your mind about something important,” I will ask. “Tell me about a time when what you were doing wasn’t working. How did you know it wasn’t working? What was the problem? What did you do?” “Tell me about a time when you screwed up big time. What happened? What did you do?” I will ask questions about the tiniest details of their stories. What were you wearing? What time of day was that?
I have actually had people respond along the lines of “I don’t recall a time when I screwed up.” Or “Sometimes I have been let down by my subordinates and my partners, though.” Check, please!
But, a more common problem is that you find out by detailed questioning that the story presented is not really a true specific story, but a theoretical composite story, which reflects theoretical behavior the interviewee assumes you want to hear about. I don’t want to work with these people. They are trying to tell me what I want to hear, and they do not want to admit the possibility of fault.
I want to work with people who are pleased to discover mistakes, errors, and opportunities for improvement. I will not work with people who hide mistakes, who ignore errors, and who pretend that everything is wonderful. I want to work with people who face the truth.
One of my very
favorite entrepreneurs is the shining example of taking himself to task over errors and missteps, and of a constant vigilant search for how things are going wrong in his businesses. Recently he launched a unit which developed a casual browser-based online game, monetized through micro-transactions for virtual in-game goods. One of the beautiful things about this kind of business is the depth and immediacy of information available about performance and results. So, when something is changed, you find out immediately how the change affects results. This company has been through so many iterations of its model that I have lost track. I love the willingness to experiment, and the perpetual dissatisfaction with how things are going, and the relentless quest for improvement. This guy is going to make me a lot of money, or die trying.
So, focus on the personal traits and characteristics of your team. Things will definitely go wrong. You want to have some idea of how your team will react when that inevitably happens.
(1) Helmuth Von Moltke the Elder, 1871
By David S. Rose
Described by BusinessWeek as a “world conquering
entrepreneur” and by Forbes as “New York’s Archangel”, David is a former Inc.
500 CEO, serial entrepreneur and the founder of New York Angels. He is the
founder and CEO of Gust, the angel financing platform used by over 50,000
accredited investors in 1,000 angel groups and venture capital funds to
collaborate with over 250,000 entrepreneurs in 95 countries.
Since Bill Hewlett joined with Dave Packard in 1939 to create what is today one of the world’s largest computer companies, there has been an evergreen debate as to who is more important in starting a tech company: the techie or the business guy? Steve Jobs or Steve Wozniak? Bill Gates or Steve Ballmer? Jim Clark or Marc Andreessen?
I propose that it is time to reject the notion of the business man or business woman entirely. The underlying problem is that there are really three different components here, and like the classic three-legged school, they are all essential for success, albeit with differing relative economic values. What confuses us is that the components can all reside in one person, or multiple people. And what upsets people is that there are different quantities of those components available in the economic marketplace; and the law of supply and demand is pretty good about consequently assigning a value to them.
Perhaps surprisingly, the components are NOT the traditional coding/business pieces; nor are they even coding /user interface / business / sales, or whatever. Rather, here is the way I see it, from the perspective of a serial entrepreneur turned serial investor, listed in order of decreasing availability:
[Email readers, continue here...] 1) THE CONCEPT: A business starts with an idea, and while the idea may (and likely will) change over time; it has to be good at some basic level for it to be able to succeed in the long run. How excited am I likely to be when I see a plan for a new generation of buggy whip, or another me-too social network? The basic concept has to make some kind of sense given the technical, market and competitive environment, otherwise nothing else matters. BUT good ideas are NOT hard to find. There are millions of them out there. The key to making one of them into a home-run success brings us to:
2) EXECUTION SKILLS: It is into this one bucket that ALL of the ‘traditional’ pieces fall. This is where you find the superb Rails coder, and the world-class information architect, and the consummate sales guy, and the persuasive business development person, and the brilliant CFO. Each of the functions is crucial, and each is required to bring the good idea to fruition. In our fluid, capitalistic, free-market society, the marketplace is generally very efficient about assigning relative economic value to each of these functional roles, based upon both the direct result of their contribution to the enterprise and their scarcity (or lack thereof) in the job market.
That is why it is not uncommon to see big enterprise sales people making high six figure – or even seven figure – salaries or commissions, while a neophyte coder might be in the low five figure range. Similarly, a crackerjack CTO might be in the mid six figures, but a kid performing inside sales may start at the opposite end of the spectrum. Coding, design, production, sales, finance, operations, marketing, and the like are all execution skills; and without great execution, success will be very hard to come by.
But, as noted, each of these skills is available at a price, and given enough money it is clearly possible to assemble an all-star team in each of the above areas to execute any good idea. That, however, will not be enough. Why? Because it is missing the last, vital leg of the stool, and the one that ultimately–when success does come–will reap the lion’s share of the benefits:
3) THE ENTREPRENEUR: Entrepreneurship is at the core of starting a company, whether tech-based or otherwise. It is not any one of the functional skills above, but rather the combination of vision, passion, leadership, commitment, communication skills, hypomania, fundability, and, above all, willingness to take risks, that brings together all of the forgoing pieces – and creates from them an enterprise that fills a value-producing role in our economy. And because it is this function which is the scarcest of all, it is this function that (adjusting for the cost of capital) ends up with the lion’s share of the money from a successful venture.
It is crucial to note that the entrepreneurial function can be combined into the same package as a techie (Bill Gates), a sales guy (Mark Cuban), a user interface maven (Steve Jobs), or a financial guy (Michael Bloomberg). And that it is the critical piece which ultimately (if things work out) gets the big bucks.
The moral of the story is that, for a successful company, we need to bring together all of the above pieces, realize that whatever functional skill set the entrepreneur starts out with can be augmented with the others, and understand that the lion’s share of the rewards will (after adjusting for the cost of capital), go to the entrepreneurial role, as has happened for hundreds of years.
Creative entrepreneurs find niches for their business that are not full of competitors fighting over the last dollar of margin, or niches that are mature and shrinking in size. They search for areas unexplored, or those covered by companies with less of a vision for quality, service or innovation.
But even creative entrepreneurs are often trapped inside the box of their experience. Recently in a discussion of this very subject in a roundtable of CEO’s, one CEO reminded us of the Titanic tragedy. She stated that those in charge during the last hours aboard had options probably never considered that could have saved many more lives, given the limited number of life boats available. She listed several, including pulling up the teak floorboards and throwing them overboard along with the deck chairs and dining tables, all to be used for floatation. It made us all think that we had never considered such solutions when contemplating that disaster after the fact.
[Email readers, continue here...] With that challenge, we turned as a group to discuss how CEO’s could make a culture of thinking outside of that restrictive box of experience. We considered adding questions to the interview process that could bring surprising answers from a job candidate, pointing to a creative thinker that might complement the team.
We challenged ourselves as a group to think of answers to problems that a writer of fiction might create, unconstrained by conventional thinking. We worried over the fact that we may have hired people in the past that fit our image of the proper addition to our core staffs, people with similar experiences and training, constrained by the same experiential thinking as ourselves.
And we left that meeting each more willing to search for talent to help us and our enterprise find creative alternatives that would challenge us, expand our product, marketing, sales and process abilities beyond the constraints of our present definition of our company and its core.
It is a rule that early stage managers should find, protect and grow the core business, finding resources wherever possible to service that core in the form of variable expense, to be added to or shed at will as the company finds its niche and establishes a pattern of growth.
From administrative services supplied by personal assistants located in India, to designers and producers of prototypes in China, to call centers managed and located in the Philippines, there are efficient, well organized solutions for virtually every process needed by a company to surround its core.
In earlier college business administration courses, professors often touted the advantages of “vertical integration,” the process of bringing all production from raw materials through the finished product under one roof. With the advent of worldwide seamless communication and cheaper skilled labor available through virtual relationships, that old school thinking no longer holds, even for the largest corporations capable of performing all operations in house.
[Email readers, continue here...] Henry Ford located his auto plant near the river so that his steel mill could cool the raw product and feed the plant across the property. And in the 1960’s, I created a vertically integrated record manufacturing plant where raw materials came in one door and finished record albums out the door of the same building. It was considered the most efficient possible organization at that time. But it proved impossible to shed overhead during downturns. Labor and downturn cash flow issues and management distractions contributed to offsetting the positive effects of such a practice. I doubt Ford would organize his plant that way today, and neither would I. There are far too many alternatives that serve to protect the business during downturns, give management alternatives and provide superior results when not at the core of the company’s offering.
Consider your core. It is the one skill, process or advantage you have over your competition. Then think of all the things you do to surround that core with people and assets that complete the company and allow you to release your product or perform your service.
Now consider how many of those surrounding assets and services are really necessary for you to perform in order to protect and grow your core. For most small and medium-sized businesses, there are lots of wheels spinning around the core that take up the attention and resources of management, but add little or no value to the core of the business.
These are new times, enhanced by our global ability to find resources anywhere on earth to complement the core of our business. And most often, the companies supplying those services are much more efficient at doing so than we could be because of their experience and advantages of scale, and the cost to us of such services is lower than performing them ourselves.
So – what is your core offering? Are you building it more slowly because your resources and attention are focused around many processes not critical to that core?
Some of us remember things better when given a catchy phrase or rhyme. Here’s one to help you with squeezing the most out of your available resources. It reflects the new reality in our business world, one with little room for mistakes and no room for bloat within our companies.
The first “P” stands for people. The wrong person in a job causes all below or above that person in the production system, that depend upon that person, to operate at a reduced rate or quality of output. And if there are people depending upon the output of that wrongly-placed individual, they too will suffer from reduced resources to complete their jobs. The cost of a bad or failed placement in any position in a company’s critical chain is enormous and goes far beyond the salary paid to that individual.
The second “P” is for productivity. If a good person is failing at the job, it may be because you have not provided the resources necessary for that person to do the job expected. Hire a great sales person then fail to support him or her with a good marketing effort or a properly priced quality product, and that person will be set up to fail, and for reasons you might have fixed.
[Email readers, continue here...] Then there is the third “P” – performance. Like a great orchestra, it takes a skilled conductor to bring the best out of the collective members of the group. You are responsible for the quality of performance that defines an excellent enterprise and assures long life for the company as competition becomes more aggressive and geographically extended.
The fourth “P” is for process. How to get your offering from development to market? How to stage and tune a production line for maximum quality and output? How to penetrate an established market with a groundbreaking new product, but on a limited budget? All these are process questions, often faced by management when seeking success.
All of us have limited resources and must deploy them effectively to gain the most possible ground in the marketplace. Like a chain with four links, no one of these can be weak and allow us to succeed in our endeavor. Focus and attention must be paid to each to strengthen the chain. Over time we will explore these issues more deeply using the “theory of constraints” (TOC) method of looking into your physical and financial roadblocks.
The four “P’s”: People, productivity, performance and process.
Which of these four P’s is your weakest link? What can you do to rethink, reinforce and redirect resources and remove roadblocks to the success of that link and enhance your whole organization?
Professional investors laugh when they hear an entrepreneur state, “We have no competition.” That statement has killed more investment deals than almost any other. It is a failed litmus test for the entrepreneur, even if the plan is for a totally new device or service that could take the world by storm. Well, come to think of it, this is especially true in such an instance.
The statement shows a lack of research or previous thinking that is a red flag for investors. Whether the entrepreneur has not been able to find companies doing “something like” the plan, or s/he has not considered the most obvious killer of new ideas – doing nothing, it is a faux pas that should never be allowed to happen.
Doing nothing is the main competitor for most products and services, whether a compelling new idea or a seasoned product long proven to be effective. Remember that the buyer must commit resources, money and time, toward the purchase of your product, and even if the product repays its investment in a few months, there may be issues you know nothing about that make no decision the right decision for this and perhaps many buyers.
[Email readers, continue here...] Consider the state of the economy. Perhaps buyers cannot obtain attractive financing in the current market. Maybe there is advance knowledge of new technologies around the corner that makes any decision today a risky one. It could be that a larger competitor has met with its customers, promising to extend its product line into this very niche. There are thousands of variants of the theme, where no decision is the right decision.
So, do your homework especially well by putting yourself into the minds of your potential customers. Widen your search to include companies with products peripheral to yours, where extension of their product would seem logical, especially if you plan to be successful early in making sales into their market. If you are raising funds, list “do nothing” as a viable competitor in your slide deck. If you are training your sales staff, work especially hard on responding to emotional and factual counters to a final close of a sale. Practice overcoming the potential objection long before standing in front of investors, customers or even your board. After all, fooling yourself should never be an option.
In the creation of a new enterprise, there are five principal risks to be addressed by the entrepreneur. Professional investors will probe these five risk areas and make the decision to invest based upon comfort with each. So it is important for the entrepreneur to identify, address and mitigate each of these in order to increase valuation and decrease the risk of ultimate loss of the business.
First: Product risk. Is the product or service possible to produce at all, let alone economically enough to compete in the marketplace? One way to mitigate this is by using early money to create a prototype, to perform market research, to complete the first generation of the product, or to deliver the service to a satisfied customer.
Second: Market risk. Are you ahead or behind the market with your product or service? Will the public respond in numbers to buy, license or rent your offering? This risk can be mitigated by finding a customer willing to purchase as soon as a proven model is completed, and willing to state this in writing. Another is to gain the support of a core vendor who is willing to offer special extended terms to the company as its investment in creating the product in a finished state. A third demonstration of overcoming market risk is by holding controlled focus groups and gathering information from unbiased potential customers supporting the acceptance of the product or service.
[Email readers, continue here...] Third: Management risk. A great idea often fails from the inexperience or inability of management to bring the idea to market. Similarly, great management often can manipulate an original idea or business plan into one much more attuned to the market, adding tremendous value that might have been lost sticking to the original plan. This is sometimes labeled “execution risk” addressing whether management can create and run the company producing the product acceptable to the marketplace.
Fourth: Financial risk. Any new enterprise is at risk if there are not enough resources to get the company to breakeven, which is a proxy for stability. If a company truly needs five million dollars to get to breakeven, investors that provide the first million are greatly at risk of the company failing to raise the remaining capital or of subsequent investors valuing the company at a lower price than the first investors, causing a “down round” in which the early investors are punished for taking the first risk.
And fifth: Competitive risk. If there are high barriers to entry with such protections as patents, long development time already spent or contracts with the major potential customers, then the risk of a competitor with more resources jumping into the frothy pool and taking advantage of the demand created by the company is minimized.
Reduction or elimination of one or more of these risks increases the valuation of the company and certainly improves its chances of survival and growth.