Are you innovating because of need or inspiration?

Most innovations come from responding to a customer’s needs, or finding a niche where products need improvement or extension.  It is rare to innovate using a blank sheet of paper in a room with bare walls and no other contributors.

A thought exercise

Imagine the room in which several graduate business school student groups have gathered, tasked with coming up with an idea for a business plan competition.  The group starts with a blank sheet, and toils through idea after idea, trying to come up with a product or service that might become the next FedEx.  That is tough work, and not a very productive way to start a process.  Sometimes, the result is spectacular.  Most of the time, this form of thinking produces a plan that requires real work to imagine success.

The thought exercise with injected insight

I’d advise the students to do it differently.  I’d advise them to pick a growing industry.  Then find a short list of users, customers, and consultants in that industry who are known to be advanced in their thinking as demonstrated by their prior work.  Then I’d advise them to visit the CEO.  And ask, “What is it that bothers you most about your operation?”  “What is you biggest problem, other than working capital?” “Where’s your bottleneck in production or sales or development?”  “If you could invent a solution, what would it be?”

Find the pain…

Now that’s how to find pain in an industry.  And yet, few think to use this form of investigation.  Yes, you can argue that probably Fred Smith might not have thought of FedEx if he had just interviewed rail or postal customers.  But maybe someone would have given Smith the bare idea from which he could imagine a much bigger opportunity.

Then remove it

[Email readers, continue here…]   If you have a better way to do something, create something or market something, you have a head start.  But if you’re trying to think of what you want to produce, start with finding the pain in the marketplace, and set out to remove it.

Henry Ford famously said, “If I asked my customers what they wanted, they would have said ‘a faster horse.’”  As a mechanical genius, even that comment might have led Ford to envision a way to provide reliable, fast, inexpensive, mechanical horsepower.  It is the process of leaping from a need to an eloquent solution that creates demand and ultimately success in the marketplace.

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Is it your brilliant plan or your execution?

Mike Tyson: brilliant business savant

“Everybody’s got a plan – until they are punched in the face,” famously stated boxer Mike Tyson.  My experience personally reviewing over three hundred executive summaries each year, all sent to me unsolicited, seems to bear out the truth in Tyson’s statement.

Anyone can build a good – or great – plan.  Investors have to look behind the plan and at the entrepreneur and his or her team, knowing that, over time, most of us have come to the conclusion that it is the execution of the ever-changing plan, not the plan itself that makes a company a success.

Tyson’s insight into the realities of the market

Tyson’s statement also addresses change.  The ‘punch in the face’ is analogous to dealing with the business plan when it intersects with the realities of the market.  Wham!  I can’t recall any of my companies hanging onto its original plan after some level of market feedback.

A personal story of a pivot – Tyson style

We built one of our companies upon forecasted metrics for a specific class of retail consumer base but found that there wasn’t enough money in our universe to pay for the amount of marketing to create that much dedicated traffic to our site.

[Email readers, continue here…]   So, we switched to distribution through partners which already had massive amounts of traffic and concentrated in providing great content and great offers that more than made up for the sharing of revenues. Tyson was right again. “Punched in the face” meaning our plan’s intersection with market reality.

Celebrate our versatility

We should celebrate entrepreneurs and managers who recognize the need to pivot when a plan fails to gain traction in the marketplace. And credit Savant Tyson for the insight

Did we just (once again) bet on the jockey, not the horse?

And most of us who invest in so many companies have concluded that our greatest profits over time come from investments in great management, groups that we are confident are able to execute even on average plans.

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Have you heard? Eyeballs aren’t everything.

Remember when?

Back when we were all trying to figure out the real value of traffic on the web, investors – and acquiring companies – got a bit crazy with metrics used to value acquisitions and investments.  Since in most cases, there was no revenue in many of these companies, all trying to gain market share at any cost, we had to invent the metric to use.  And the most logical one seemed to be “eyeballs” or number of unique monthly users finding their way to the site or registering for the service.

Remembering the insanity before 2000

And the numbers were staggering.  Microsoft paid $9.00 per registered user for Hotmail.  AOL paid $40.00 per registered user of ICQ, the early messaging service.  I was the original investor and helped to grow GameSpy Industries, attracted to the fledgling company because of its million users each month, even though at the time there was no monetization to the traffic.

Did the eyeballs suddenly disappear?

But, when the bubble burst in 2000, most of us quickly grew up.  Revenue models became more important a measure than traffic, although market share was and still is an over-weighted part of the value of any Internet-based entity.

Bringing us to today – Viewers or profit?

[Email users, continue here… ]   That is the quandary which entrepreneurs face today in building models for new companies around a web presence.   Great revenue projections from a small user base lead to worries over sustainability.   Low revenue projections but demonstrated (or projected) impressive numbers of unique users lead banks and investors to think that there may be a future method of monetizing the user base that makes the company attractive, even while currently losing money.

I am an investor and advisor to one such “eyeballs” company.

Gaining users at a rate of 50% a month, the company has yet to find a revenue model that will pay for the increased costs of infrastructure needed to support the growth, let alone the fixed cost of operating the enterprise.  And yet, users rave about the service, and spend long durations of time on the site.

Revenue experiments (and failures)

Once we had what we thought was the answer, in allowing for display advertising on these sites. But the competition among sites has overwhelmed available inventory of paying advertisers, greatly reducing the cost per thousand views, and making display ads no longer a preferred revenue source for marginal sites.

We experimented with subscription-based charges – hoping that ours were indispensable services.  In every case, those prototype subscription models failed, as users found free alternatives.  Another of “my” companies had four million free beta gamers registered on the site, but lost all but 10,000 when attempting to charge $9.95 a month for a subscription.

What is the answer? 

Newer forms of advertising have been created to force user views, including pop-ups, pre-roll ads containing video content, and click-through display ads before allowing content views.  Major newspapers and magazines, trying to reinvent themselves, are using the subscription model, as well as all of the above methods in their attempt to become relevant to a new and growing mobile and Internet-focused user base, with varying – but not too satisfying results.

How about charging by the bite (not byte)?

Micropayments, in which services and information are delivered for pennies, requires an infrastructure for collecting, accumulating and billing that is still being experimented with, but showing promising results.

Of course, giants like Facebook, Instagram, and Google have such large eyeball numbers that they can use display and positioning ads to achieve great profits.  Most of us are still searching for the combination of monetization devices that work best for us.  Free sites without and relevant form of monetization will disappear over time, and we will lose services we take for granted today.  It is in the best interest of both Internet users and providers to find an acceptable way to charge for valuable services or information.

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Create a great product – the three-step dance method

Can you create a product in a vacuum?

Creating a new product in a relative vacuum is an exercise in complete trust that you know what’s best for the customer, perhaps even without interaction with such a customer.  It’s probably happened, but not often enough to trust this method as a formula for success.

The three-step dance method

So, I’ve developed the three-step dance in order to help form a repeatable method of how to create a great company from an early idea.

The first step: Involve potential customers early.

Even if you know it all – wouldn’t it be an excellent plan to try your idea out on enough actual or potential customers to measure reasonable feedback?

You can use or discard the information you receive.  We now know that Steve Jobs created several of his products in relative secrecy that became massive industry drivers of change.  The iPad probably would have failed before production, had he used feedback and research from past failures of tablets in any previous form as a guide.  On the other hand, most products or services are created in response to a real or perceived need.  And most of us are not Steve Jobs.

The second step: Take feedback seriously

[Email readers, continue here…]  Making the effort to gather metrics from the field in any form and then ignoring it, takes guts and determination – and in most cases a measure of stupidity.  As I analyze business plans, I usually ask the entrepreneur early in the process whether s/he has tried this idea or prototype or mockup out on potential users.  And if so, what was the response?  And from how many people?  In what related universe?

I want to know that potential paying customers have been queried using enough information or a good enough model to get a real response worth taking seriously.  Without this, any information received is suspect.  And failure to make use of the information is a red flag for investors.

The third step: Reiterate and return to customers for comments.

Seeking, then analyzing responses allows you to make changes to the plan and product in response.  But what if the changes create other problems for the customer, or miss the mark, or don’t drive these same customers to more positive responses?

The best possible second round feedback should come from the very same people who took the time to review the offering the first time. They have context and should see effort and progress.  Their comments should therefore be more valued than those from first-time respondents.

Summarizing the three-step dance: 

  1. Involve your customers early.
  2. Take feedback seriously.
  3. Reiterate and return to customers for comments.

So, why not design your product using your real and potential customers as consultants?

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Ready, fire, aim. Really?

You’ve surely heard the variations on this theme.  “Ready, fire aim” was popular in the 1990’s, accredited to any of several authors.  I used the term to describe my efforts in the artificial intelligence field, experimenting with new devices, the lisp programming language, and our first trial installations.  It seemed an ideal way to describe a scrappy, entrepreneurial activity.

What happens to careful planning?

So why do so many business authors stress this behavior? Ready, FIRE, aim. What happens to careful planning, sure-fire metrics, quality test scenarios, market research, a good business plan – all in place before pulling the trigger of a new opportunity.

And who is right here?

If you’re seeking investment from anyone other than friends and family, you’re probably going to have to navigate through the exercise of careful planning, documentation and execution.  Investors are a fickle bunch.  They want to know that their money is not just being thrown at an idea that will become a trial by “fire.”

But speed and iterations are attractive benefits

[Email readers, continue here…]   On the other side of the argument is the truth of the claim that numerous iterations in the form of rapid prototypes and execution of new ideas in the field quickly refine the product or service to meet the needs of the customer, and at a far faster and cheaper pace than with careful pre-planning.

Cowboy coding in software and Internet development

In the software and Internet arenas, there is a term for this: “cowboy coding.” Without the need to carefully document the architecture and elements of a proposed application, a single programmer can much more quickly just code, test, and create revised code.  And today, “no code” or “low code” applications can be created much more quickly without careful testing of the integration with cowboy-coded portions of an application.

Either way, without even pausing to document the process internally, no-one can easily take over the job, if for any reason the cowboy coder is no longer in control.  And the result? Typically, we call that “spaghetti code” to signify code that is so often changed that it no longer looks clean and traceable.

Our conclusion to this dilemma

The conclusion is that the best process depends upon the product, its critical core nature to the business using it, and the way in which the entrepreneur approaches the need for outside investors.

Critical components of any operation or business must be carefully constructed, tested and inserted into the operation of the business.   On the other hand, if a new free app has bugs, they can be corrected in the next automatic update, and probably without much customer noise.

So, which is better for you?

Which is better for you: rapid iteration or careful planning?  What is your case for defending your method of creating new products or services?  Have you ever been stung by releasing a “ready fire aim” project into the marketplace?

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Posted in Depending upon others, Hedging against downturns, Protecting the business | 1 Comment

Can you build a company, not just a product?

Some businesses are built around a single idea.   

And sometimes that idea is just too small a slice of the big picture to be interesting to investors.  There was a recent investor event where I was keynote speaker, on stage only after several panels of experts had wowed the audience with their predictions and observations.  One of the panelists made a point that resonated with me.

“Just a button, on a feature, in an app”

She stated that she had rejected the investment being discussed, because in her mind the entire company was “just a button, on a feature, in an app.”  That comment sent me thinking about relevance, about longevity, and about market size for some of these entrepreneurial applicants looking for funding.

Can you envision round two?

So, what is your goal? If you have invented a game that will be marketed as a new app in the app store, have you created enough of a model to create an ongoing company, or just another app that will compete with the millions  already in the store?  Is your game using a unique engine, or series of animated characters, or method of play that will break ground with potential players, inducing them to look to you for more and more unique games over time?  Or higher and higher levels with more purchased items for play?

How does an investor react?

[Email readers, continue here…]   Far too many companies have been created around a button on a feature, and not upon a solution to a need in answer to a void in the market.  Investors have seen this game before.   We match what we see to what has succeeded for us in the past.  And rarely do we see a plan for a single product that is not part of a larger vision and remain interested long enough to ask for more information.

There are exceptions. 

The famously popular iPad throw-away app, “Draw It,” might at first seem an exception, until you dig deeper to find a dense plan around a series of social engagement products planned to follow.   Can you extend your product into a planned series?   Plan to create apps, not buttons, and not features.

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Posted in Finding your ideal niche, Ignition! Starting up | 2 Comments

My dad said: “Never take on a business partner.”

My dad was a smart businessman, even if not formally trained. He occasionally gave me advice that turned out to be more than wise, looking back at subsequent experience and events.  His personal teaching event was a typical experience, as I reflect now upon the tens of partnerships I have counseled over the years.  Most often, one partner remained active as another partner drifted away from the business, no longer carrying the weight anticipated at start-up.

So, what could happen with a partnership over time?

It’s just one – the most prevalent – of the many things that can happen to well-meaning partners after time changes plans, and after the business passes through phases of growth or contraction.  The assumption at start-up is that all partners will carry their assigned weight for the foreseeable future, as percentages of ownership are divided accordingly.

Rarely is there any formal written agreement memorializing these initial expectations and stating the consequences of non-performance or inability to make capital calls when required.  In fact, rarely are issues discussed involving downside protections, even including key-person insurance benefiting the partnership in case of an unfortunate event.  And how about a buy-sell agreement if one partner wants to sell their interest to a third party unacceptable to the remaining partner(s)? How about non-compete agreements?  Non-disparagement clauses?

It is always wise to have an attorney help memorialize a partnership agreement, even if painful conversations must take place to do so.  Here’s an example of what not to do…

A personal story about a partnership gone bad

[Email readers, continue here…]   I recall one very personal situation when I was young, that reinforces Dad’s advice. Through my college years, I managed a phonograph record production and manufacturing business that I created as a senior in high school, using independent contractors in local venues to record tapes from musicals and performances from schools, colleges, churches and organizations throughout the USA and Canada – and then to sell the records to the appropriate audiences.

Partnerships are strained with growth and troubles

The business grew to significant size during my college years, and I informally associated myself with an equally young partner, of course without any written agreement or discussion of downside throughout those years, ceding to him all recording work throughout the large home territory and other helpful technical work. The agreement was that he would retain all the revenues generated from those activities and that I would finance the company and manage it.  We received lots of press, even nationally, as we managed our teenage business.

Changes of circumstance often ignite pressures

A year after graduation from college, I left for six months to serve my active duty obligation in the US Navy, while others – not the partner – took care of accounting and customer relations.

And shortly after I left for my military service, my partner left the company without notice and set up a competing company in my absence, never saying a word to any of us.  I was bitter, but unable to do anything about it, since there was no written partnership agreement.  Luckily, after my return from active duty, my company flourished, even went public later, and his remained a small, one-person operation for the rest of its existence.  But, as they say, everything he learned, he learned from me.

Dad was right, even if I learned the lesson years later.

Have you a partnership story to tell?  Lessons learned to be never repeated? Or do you have a harmonious relationship to recall, one that could even be ongoing?  My friend, Rich Sudek called partnerships “a marriage without sex” and reminded us that we often spend more time with our partner(s) than with our family.

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Posted in Depending upon others, Ignition! Starting up, Protecting the business | 8 Comments

Should you include your sweat equity in a business plan?

Investors love it when entrepreneurs draw little or no money from their startups.  It extends the cash available for research and other necessary fixed costs and gives the fragile, young company more “runway” to get to breakeven.

What are you worth to the business?

But when forecasting the ultimate viability of a business, many times an entrepreneurial founder uses a low, unsustainable salary rate for him or herself in order to show early breakeven.  And that is the quandary for investors.  If you had to replace yourself with a professional hired to duplicate your skills, what would you have to pay in salary and incentive today?  That amount is almost always higher, much higher, than the amount budgeted for the entrepreneur.

A “messy” solution

[Email readers, continue here…]   You could start by charging more for your executive salary, then paying out less in cash, accruing the rest into a payable amount due to you in the balance sheet or plan.   But that is a messy way to demonstrate that you are taking less than market wages from your company.  Ultimately, the accrued difference will amount to a large enough liability that several things could happen, all of them negative.

What would the IRS think?

The IRS could see that you are not paying yourself interest on the accrued debt, and consider it invested capital, eliminating your ability to repay yourself in the future. Worse yet, the IRS would then consider the accrued amount to be taxable income upon which no tax was paid, since the accrued labor as an investment has value that was not accounted for from previously taxed earnings.

Another “trick you might use – wrongly

Or you could voluntarily convert the loan into stock with a single journal entry and a stock certificate. But the tax effect would be the same if audited – you would owe tax on the booked value even if not paid in cash.

What is the solution?

The solution is to explain to potential investors that you are projecting under-market wages for yourself or the founder(s) for a period of time, perhaps until breakeven, and then  to agree with them that you will move to market rate at that time.

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Posted in Ignition! Starting up, Raising money | Leave a comment

What is your biggest error in company planning?

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.

Sources for your data

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?

TAM, SAM, SOM? What is your market size?

You could be fooling yourself with market data.  Are you trying to estimate TAM (total available market?)  That’s likely to be completely unreachable for you with almost any amount of resources. And yet, some plan their futures upon a percentage slice of this, rather than…

SAM (Serviceable available market) which is is closer – the market you might be able to reach in your future and service effectively.  And finally, there is the SOM – serviceable obtainable market, the one most likely to fit your planned resources and capabilities.

My story of creating a number for market size

[Email readers, continue here…]   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.

The “Gloves in China” syndrome

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.

Create an “assumption section” of your plan or spreadsheet

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.

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What’s the most important thing in a young business?

Cash is everything to a new business. 

How many times do we have to say this?  The days of being able to trust that there will be an investor or lender on the other end of a call or email whenever needed ended with the 2000 and 2008 bursts of those respective bubbles.  It’s entirely possible that Amazon could not be created and funded today with its planned seven years until profitability.  (It actually took Amazon fourteen years to reach profitability.)

Cash from investors at the early stage?

Early stage investors who take a chance on new businesses, often now plan their investments around the notion – or hope – that they can fund one or two rounds to lead the business to profitability.  There is no longer a guarantee that VCs and later stage investors will be waiting at the run-out point of the angel money to pick up and grow the company.

Business plans often focus upon accrual not cash profit

[Email readers, continue here…]   Business plans that I see often show three to five years of projections, demonstrating profitability at the end of so many months of operation.  Most every one of these uses an accrual basis for determining breakeven, never attempting to predict the cash impact of capital investment, slow collection times, large deposits upon leases, and other major items that consume cash.

Profit gains without additional working cash?

Worse yet, most show rapid gains in revenues but do not account for the extra cash it takes for working capital to grow the business at the rate projected.  If a business takes an average of sixty days to collect cash from the time it invests in the product with costs of inventory or labor, then shipping and billing, then the business will need increased working capital to pay its expenses including payroll while it waits for the cash to come in the door.

Change your projections to focus upon cash

Recast your projections using cash, not accrual, as the measure for planning. An accrual statement is nice to produce.  It confirms that the business is capable of ultimately throwing off positive cash flow.  But only accurate projections of cash by the week or month as appropriate will assure the survival of a business in a rapid growth cycle, or even a startup raising just enough to make it to breakeven.

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Posted in Growth!, Ignition! Starting up | 1 Comment