PIVOT OR PROCEED – THE TOUGHEST QUESTION

Dr. Noman Islam

VALIDATING BUSINESS MODELS THROUGH CUSTOMER VALIDATION

• Customer validation is a crucial process in business model development, ensuring that key data, hypotheses, and financial metrics align with customer needs.
• This presentation will guide you through the customer validation process, highlighting key data to review and metrics that matter.
• By validating business model hypotheses, you can make informed decisions about pivoting or proceeding with your business model.
• Customer creation and scaling are essential components of a successful business model, and we will explore these topics in depth.
• Through a combination of case studies and practical examples, you will learn how to optimize your business model for maximum profitability and growth.

PIVOT OR PROCEED: ASSEMBLING DATA FINDINGS

• Assemble a massive amount of hard data from customer discovery and validation
• Review key findings to inform business model decisions
• Ensure data-driven insights support or challenge business model hypotheses
• Identify key metrics that matter in the financial model for validation
• Use data to inform the pivot or proceed decision

VALIDATING BUSINESS MODEL HYPOTHESES WITH DATA

• Verify industry research and customer segments to ensure accuracy
• Review customer feedback and marketing program results to identify trends
• Analyze channel and cost inputs to optimize business operations
• Identify and fill gaps, discrepancies, or anomalies in the data
• Use visual aids, such as a War Room, to facilitate data-driven discussions

CUSTOMER VALIDATION DATA REVIEW

• Review customer feedback from sales report cards to evaluate product enthusiasm and potential sales revenue.
• Analyze market size and market share estimates to understand the target market.
• Examine channel feedback and revenue potential summaries to inform sales strategies.
• Assess pricing, customer acquisition costs, and major product cost changes to optimize revenue streams.
• Study detailed information about the industry, customers, and their behavior to inform business decisions.

VALIDATING BUSINESS MODEL HYPOTHESES

• Review customer-testing results to assess improvements in activation, conversion, retention, and growth activities.
• Integrate learning from discovery and validation into updated hypothesis documents and the business model canvas.
• Examine the intersections and interactions among business model components to identify changes and areas for improvement.
• Use the Business Model Checklist to ensure that all critical questions have been addressed and validated.

VALIDATING BUSINESS MODEL HYPOTHESES

• Assemble data collected in the last phase in the 'war room' for review.
• Use a checklist to walk through business model hypotheses, ensuring factual answers.
• Validate business model hypotheses with quantitative, irrefutable proof.
• Focus on the 'Get/Keep/Grow' Customer Relationships area for web/mobile startups.
• Prove the ability to acquire and activate customers at a cost in line with the cost structure.

VALIDATING CUSTOMER ACQUISITION AND RETENTION

• Customers acquired must demonstrate revenue-generating behavior and stick with the company at expected rates.
• Customer referrals must occur at sufficient numbers to reduce average acquisition costs.
• In multi-sided markets, customers must visit frequently, participate actively, and stay active to generate necessary revenues.
• The Business Model Canvas serves as a scorecard to track progress and iterate on the business model.
• Pivot or proceed decisions are based on results from the validation process, with a focus on predictable customer creation phase outcomes.

KEY INDICATORS FOR BUSINESS AND FUND-RAISING SUCCESS

• Customer Validation is crucial for ensuring business and fund-raising success.
• Reviewing Business Model Hypotheses and Their Interactions helps identify potential pitfalls.
• Focusing on Key Financial Model Metrics, such as revenue and cash burn, is essential for making informed decisions.
• Metrics That Matter, a new approach to startup math, provides a framework for tracking key performance indicators.
• Using a Physical Channel Model or Web/Mobile Product Model can help optimize business operations and improve fund-raising prospects.

VALIDATING BUSINESS MODEL HYPOTHESES

• Review business model hypotheses to identify key assumptions and risks.
• Use a checklist to validate business model hypotheses and ensure all components are accounted for.
• Analyze the interactions between business model hypotheses to identify potential synergies and trade-offs.
• Consider multiple scenarios to validate business model hypotheses and ensure they are robust and resilient.
• Refine business model hypotheses based on customer validation results and market feedback.

PIVOT OR PROCEED: VALIDATING FINANCIAL MODEL

• Validate the financial model by testing hypotheses with customers and reviewing key metrics.
• Determine if the business is scalable and sizable by analyzing a short list of numbers.
• Recite, adjust, and recompute key numbers about customers, product costs, and revenue growth.
• Focus on the two metrics that matter most: cash remaining in the bank and cash burn rate.

METRICS THAT MATTER FOR BUSINESS MODEL VALIDATION

• Use the Business Model Canvas to organize and track financial model progress.
• Focus on key performance indicators to track business progress, such as revenue, costs, and growth rates.
• Physical and web/mobile channel costs vary widely, so examine metrics three different ways.
• Key metrics for a physical channel include product cost, market size, customer acquisition costs, and customer lifetime value.

KEY METRICS FOR WEB/MOBILE CHANNEL

• Estimate the per-user cost of a user and incremental costs for added users.
• Determine customer acquisition costs, prospect conversion, and retention rates.
• Calculate the market size, attainable market share, and customer impact of referrals or network effects.
• Analyze the basic operating costs of the business and channel costs for selling through the web/mobile channel.
• Derive the burn rate and project when the company will run out of cash.

CUSTOMER CREATION AND BURN RATE GUIDELINES

• Customer discovery should keep the burn rate between $50,000 and $75,000 a month.
• Customer validation shouldn't exceed a burn rate of $100,000 a month, achieved when product/market fit is achieved.
• Customer creation should ideally hold the burn rate to $250,000 a month, as the company builds a team and generates material revenues.
• Assemble all test results to provide a forecast for the coming year, which begins on Day One of Step 3 of Customer Development.
• An analysis of burn rate and revenue can stop the pivot–or-proceed process if the company will run out of money within the year or won't be able to raise enough funds.

EVALUATING BUSINESS MODELS WITH METRICS THAT MATTER

• Metrics That Matter is a new approach to startup math, focusing on key performance indicators.
• It's best illustrated with scenarios, such as physical product sales, web/mobile product sales, and multi-sided markets.
• The approach helps evaluate business models through spreadsheet scenarios, like the EZ Gardener example.
• Metrics That Matter enables entrepreneurs to track cash-burn computations and make informed decisions.
• This approach is essential for validating business models and making strategic pivots or proceed decisions.

PHYSICAL CHANNEL MODEL METRICS

• The Physical Channel Model (Table 6.1) is used to track key metrics for physical product sales.
• This model is essential for understanding customer behavior and sales patterns in a physical channel.
• Key metrics tracked in the Physical Channel Model include revenue, customer acquisition costs, and customer lifetime value.
• By analyzing these metrics, businesses can make informed decisions about pricing, marketing, and product development.
• The Physical Channel Model is a crucial tool for optimizing business performance in a physical channel.

CUSTOMER CREATION AND METRICS THAT MATTER

• The 'friends and family' funded venture begins customer creation with $500,000 in the bank.
• Revenue never scales dramatically, since the market type is 're-segmenting/niche market'.
• There are 11 metrics that matter in this spreadsheet, including total number of units sold and average retail selling price.
• The total retail-dollar sales for the product per quarter can be computed relatively straightforwardly.
• The company's market share estimates and total addressable market estimates should be compared with customer validation report cards.

CALCULATING NET COMPANY REVENUE FOR PHYSICAL CHANNEL MODEL

• Deduct the channel discount (40% of retail price) from gross sales to get net channel revenue.
• Subtract other channel costs, such as advertising and shelf space fees, from net channel revenue.
• NET COMPANY REVENUE is calculated by subtracting sales costs (reps, trade shows) and product costs from net channel revenue.
• Gross sales are reduced by channel discount and other channel costs to arrive at net channel revenue.
• Sales costs and product costs are essential components of the calculation for net company revenue.

CALCULATING CASH BURN AND REMAINING CASH

• Compute costs of 'turning on the lights' at the company, including meager founder salaries, payroll, rent, equipment, utilities, legal, and other expenses.
• Subtract costs from net company revenue to determine cash burn for the period, indicating whether the company made or lost money.
• Start with the initial bank balance and reduce it by the quarter's cash burn to determine the remaining cash at the end of the quarter.
• Cash burn can be reduced by improving customer growth and reducing product-development costs, as seen in the example above.
• A high cash burn rate can indicate a non-scalable business, requiring founders and the board to reassess the business model and strategy.

POTENTIAL BUSINESS MODEL CHANGES AND GROWTH OPPORTUNITIES

• Consider dramatic changes to the business model for significant impact on future growth prospects
• Explore overseas markets as a potential growth opportunity
• Capitalize on the company's modest success by expanding product lines
• Develop new products to take advantage of brand credibility and channel relationships
• Invest in product development and marketing to scale the business

VALIDATING BUSINESS MODEL HYPOTHESES

• Review business model hypotheses to identify key assumptions and risks
• Use a checklist to validate business model hypotheses and their interactions
• Analyze financial model metrics to ensure they align with business model hypotheses
• Consider multiple scenarios to validate business model hypotheses
• Iterate on business model hypotheses based on customer validation results

WEB/MOBILE SALES MODEL KEY METRICS

• Revenue comes from three channels: web sales, mobile sales, and appstore sales.
• Cash burned or made during the period is a critical metric for financial health.
• Cash remaining at the end of the quarter is essential for future growth and operations.
• The business operates in three distinct channels, requiring 17 different numbers to create five key metrics.
• Drilling down into supporting details is necessary to understand discrepancies in key metrics.

CALCULATING REVENUE FROM WEB AND MOBILE SALES

• Direct web unit sales are calculated by tracking the number of web app downloads from the company's site.
• Gross direct revenue is obtained by multiplying the number of units by the average selling price of $30.
• Customer acquisition cost is calculated by multiplying the average cost of $6 by the number of solid units.
• Net web revenue total is determined by subtracting the customer acquisition cost from the gross direct revenue.
• Direct mobile unit sales are calculated using the process described in EZ Gardner metric #1.

CALCULATING NET REVENUE AND CASH BURN

• Calculate units sold using the channel method outlined in EZ Gardner unit sales #3.
• Multiply channel units sold by the retail price of $30 to find channel gross revenue.
• Subtract the app-store fee of 30% from channel revenue to find total net appstore revenue.
• Add direct web revenue, direct mobile revenue, and net channel revenue to compute total net revenue.
• Subtract product/product-development costs and current operating costs from total net revenue to find cash burn for the period.

EVALUATING BUSINESS MODEL PROGRESS AND OPPORTUNITIES

• Review the latest business model canvas to identify game-changing growth opportunities.
• Analyze customer acquisition and retention strategies to increase revenue and profitability.
• Assess the impact of potential risks, such as delayed app-store approval or low sales from the $4 incentive.
• Explore ways to optimize staff costs and reduce cash burn, while maintaining business growth.
• Consider revising the year two plan to be more ambitious and aligned with business goals.

PIVOT OR PROCEED: DECISION MAKING

• Customer validation results inform the pivot or proceed decision
• Business model hypotheses are reviewed and refined based on customer feedback
• Financial metrics are analyzed to determine the viability of the business model
• Key performance indicators are used to track progress and make data-driven decisions
• The decision to pivot or proceed is based on a combination of customer validation, business model hypotheses, and financial metrics

VALIDATING BUSINESS MODEL HYPOTHESES

• Review business model hypotheses to identify potential flaws and areas for improvement
• Use a checklist to validate business model hypotheses and ensure all components are accounted for
• Analyze interactions between business model hypotheses to ensure alignment and consistency
• Identify key financial model metrics that impact business model hypotheses
• Refine business model hypotheses based on customer validation findings and data analysis

MULTI-SIDED MARKET EXAMPLE WITH AD-SUPPORTED MODEL

• A multi-sided market example where the product is free to users, generating revenue from advertising and email list sales.
• The company offers its product to users for free in exchange for receiving two emails per week from advertisers.
• Product-development cost is heavy at first but declines over time, with product costs being practically zero due to digital downloads.
• Revenue increases year-over-year, despite being limited by the market type, promising downstream success.

METRICS THAT MATTER FOR MULTI-SIDED MARKET

• New activated users measure the number of people downloading and actively using a free app.
• New user acquisition cost is the average cost to generate one active user, ranging from $0 (viral) to $6 or more.
• Total active users represent the average active monthly users during a quarter.
• Average page views per user per quarter measure the business health and growth by dividing total page views by total users.
• Total page views per quarter are calculated by multiplying total users by average page views per user to understand advertising-sales opportunities.

CALCULATING REVENUE AND CASH BURN

• Average CPM x 4 ads/page: Calculate revenue per 1,000 pages viewed by multiplying average CPM by 4.
• Total Advertising Revenue: Multiply the number of CPMs available for sale by the 4x average CPM to compute advertising revenue.
• E-mail-list rental revenue: Estimate revenue based on competitive analysis and buy-side customer validation research.
• Total Revenue: Add advertising revenue to e-mail-list rental revenue.
• Cash Burn per period: Subtract total cost centers from total revenue to compute quarterly cash burn.

ANALYZING CASH BURN AND REMAINING CASH

• Calculate cash remaining by subtracting cash burned from the checkbook balance.
• This metric becomes crucial in determining the business's financial health.
• Founders should revalidate every number on the page to ensure accuracy.
• Conduct a worst-case analysis to prepare for potential financial challenges.
• Review channel validation efforts to ensure revenue streams are valid.

REVENUE ESTIMATION IN NEW AND EXISTING MARKETS

• In existing markets, estimate revenue by calculating the startup's market share increase each year, based on incumbent performance.
• For new markets, estimate revenue by using proxies and adjacent markets, considering comparable companies' growth rates and potential reasons for similar performance.
• Early sales success with earlyvangelists does not guarantee fast revenue scaling in new markets.
• Sales-growth curves for new and existing markets illustrate the difference in adoption rates between mainstream customers and earlyvangelists.
• Estimating a new market's size is challenging, but can be approached by analyzing comparable companies and adjacent markets.

REVENUE GROWTH IN A RESEGMENTED MARKET

• Assess the size of the existing market to understand the potential revenue growth
• Calculate the adoption rate of your startup's segment to determine the time it will take to recognize the new product as the solution of choice
• Count only the segment that will switch to avoid overestimating revenue growth
• Consider long-term contracts, service contracts, and sunk costs as hidden barriers to switching
• Understand the demand curve to find the optimum intersection between sales volume and net profit

OPTIMIZING BUSINESS MODELS FOR PROFITABILITY

• Market basket optimization is used to enhance profitability or volume
• Pricing can be used to intersect the economies-of-scale curve
• Forward-pricing can be used to reduce production costs
• Metrics that matter are crucial for making sound business decisions
• Pivot or proceed decisions are based on validated business model results

REVISITING BUSINESS MODEL ELEMENTS BEFORE CUSTOMER CREATION

• Review key business model components to ensure a solid foundation for customer creation
• Consider the implications of a 'go forward' vote on business model execution and accountability
• Evaluate the company's readiness to shift from 'searching for a business model' to 'executing one'
• Assess the potential risks and consequences of a single, focused bet on the business model's scalability
• Double-check the value proposition, product delivery schedule, revenue model, and costs to ensure optimal performance

VALIDATING THE VALUE PROPOSITION

• Re-evaluate the value proposition to ensure it's winning in the marketplace.
• Consider reconfiguring, repackaging, or unbundling the product if the value proposition is not convincing.
• Use customer discovery to develop a new product, configuration, distribution method, or price.
• Modify product presentations and return to Phase 3 (product presentation) to refine the value proposition.
• Pivot or proceed with the business model based on customer validation results.

CONTINUATION OF CUSTOMER VALIDATION

• Consider alternative pricing strategies to increase sales volume or reduce acquisition costs.
• Evaluate the customer-relationships hypothesis for potential freemium or multi-sided alternatives.
• Assess the effectiveness of AdWords efforts and explore alternative channels for sales.
• Determine if partners can deliver the expected revenue growth and explore higher-level business model patterns.
• Revisit the business model checklist questions to ensure a thorough validation process.

PIVOT OR PROCEED: DECISION TIME

• Determine whether to pivot or proceed with the business model based on customer validation results.
• Evaluate the need for radical changes or modest improvements to the business model.
• Assess the confidence level in the business model's scalability and profitability.
• Consider the impact of hubris on decision-making and the importance of reflecting on facts and statistics.
• Separate passion from facts to make an informed decision about pivoting or proceeding.

PIVOTING OR PROCEEDING WITH BUSINESS MODEL

• Customer validation results may indicate a need to pivot or proceed with the business model.
• Pivoting involves revisiting and refining business model components through Customer Development.
• Proceeding requires a predictable and profitable ramp to more customers, revenue, and profits.
• Customer validation is a major milestone, demonstrating a repeatable and scalable sales process and a profitable business model.
• Successful completion of customer validation enables the company to move forward to the customer creation process.

CONCLUSION: BUSINESS MODEL VALIDATION AND SCALING

• Customer validation is a crucial step in determining the viability of a business model.
• By reviewing key data, hypotheses, and financial metrics, entrepreneurs can make informed decisions about their business model.
• Pivoting or proceeding with a business model requires careful consideration of customer validation results.
• Customer creation and scaling are essential for business growth and profitability.
• Metrics that matter, such as key performance indicators, help track business progress and inform decision-making.

KEY TAKEAWAYS FOR BUSINESS MODEL DEVELOPMENT

• Use the Business Model Canvas to organize and track business model progress.
• Focus on customer creation and scaling to drive business growth.
• Optimize business models using market basket optimization techniques.
• Regularly review and revise business model components to ensure alignment with changing market conditions.
• Prioritize metrics that matter to track business performance and inform decision-making.