Six Dynamics of Startup Opportunity

6things

This article was originally posted on Inc.com.

What are the keys to startup success and how can you know if a startup is likely to succeed? A study by Inc Magazine and the National Business Incubator Association found the failure rate to be as high as 8 in 10 businesses, so it is a worthy question to ask before investing significant time and resources into your new venture.

After years of researching this question with Dr Zhang, my co-author from The Smarter Startup , we developed The Startup Opportunity Scorecard. It is a simple tool for evaluating startup ideas against a set of startup heuristics, to ensure you’re accounting for the important dynamics that drive startup success. We’ve defined 18 heuristic principles that are based on generally accepted best practices, and grouped them into 6 major areas upon which a startup is scored:

1. Customer – Always start by identifying a prospective customer and an unmet need or desire, that the market has not sufficiently addressed. What can you provide that is so meaningful that someone will gladly pay you for it? Ideally the customer you identify will represent a market that matches your own needs and ability. If you’re well funded then likely you’re looking for a large scalable problem to solve. If you’re a solo bootstrapping entrepreneur, a less scalable niche opportunity is more likely to bring you success as you can service that niche with a lifestyle business, and not worry so much about getting pushed aside by well-healed competition. Think both in terms of satisfying a need and whether this is the right size market (segment) for you to address.

2. Product – The product you’re creating needs to directly answer the unmet need or desire of your customer. Stay laser-focused on solving that problem and don’t ambiguate the solution with a lot of additional features or messaging that confuse or dilute the value of you’re providing. As you begin to design your product, stay vigilant against anything that could represent a barrier to adoption such high switch costs, a steep learning curve, or a lack of integration with workflows the customer may already be using. The costs (monetary, learning curve, disruption) all need to be low enough that there is still a net value to taking up your solution, compared to the nearest alternative (value = benefit-cost).

3. Timing – Every market has a lifecycle and every opportunity thus has a limited window of time before it expires. In the beginning of a new innovation, markets are easy to enter and a technical solution is the primary challenge – anyone who can solve the problem can find opportunity. Conversely, there is also a risk in being too early to a market since chasing unproven markets can lead to dead ends, or worse, a viable opportunity that will not bare fruit for years to come; a much longer ramp than most startups can finance. The typical startup is best served with a “fast follower” strategy where by you identify new interest by a set of customers that is already occurring but is still early enough that the need or desire for the solution is not yet satisfied.

4. Competition – It is the imbalance of excess competition compared to new customers entering a market that make a mature market turn unfavorable for new entrants – this is the dynamic usually seen in the latter half of an innovation’s lifecycle and why we prefer to focus on newer market opportunities. What we’re looking for is indication of market inefficiency – that a market has not yet sufficiently met the (potential) need or desire for a solution. New or fragmented markets for example, or old stagnant markets that are ripe for disruption. In such a market you’ll have the opportunity to develop a differentiated positioning strategy.

5. Finance – How much up-front investment of capital (sunk cost) will this product require to develop? Do you anticipate large gaps in time between accounts payable and accounts receivable (working capital float)? Both of these scenarios represent financial risk that you need to weigh against the potential benefit you’re anticipating. Every business requires money to get started but the goal should be to minimize the risk / cost where possible, and to weigh those burdens against the potential for returns. Think of this in terms of building an efficient investment machine – our goal is to achieve maximum output (profit) with the minimum possible inputs (risk and cost).

6. Team – If this is competitive warfare, how confident are you that your team can win the battle? Assuming you have limited resources, you should opt out of any battles you are not confident you can win, and preserve them resources for later opportunities. Someone on your core team needs to intimately understand the nuances of the customer you’re addressing, if you are to solve their need or desire. You’ll also want a technical expert on your team who can devise a well-crafted product that answers the need. Consider also whether you have access to favorable sourcing and distribution relationships you’ll need to remain competitive.

With these six dynamics in mind, take a moment to grade the opportunity using the Startup Opportunity Scorecard. Give it an A-F grade for each of the above criteria, using the following scorecard as an example:

startup opportunity scorecard

The power of such a framework is that it provides a holistic vantage point from which you can assess an opportunity before jumping in with both feet, rather than simply following your instincts and succumbing to your own blind spots, or listening to a wise maxim that turns out to not apply to your situation. By going through this process and objectively evaluating an opportunity, you can often identify weaknesses and perhaps even predict the reason your startup will fail, before you begin. If you are able to focus your efforts on only the battles you are most likely to win, then you’re already one step closer to winning the war.

Timing is Everything

timing

This article was originally posted on Inc.com.

Timing is everything. You’ve likely heard this said many times before, but a clear explanation of why is rarely forthcoming. And, since timing is so important, how can you identify and take advantage of good timing?

New opportunities typically arise because of new innovation that either inspires or enables others to enter a market. With the web in particular, the enabler is typically a new platform that brings people together and makes it possible for entrepreneurs to monetize those crowds. For example, Goto.com introduced Pay Per Click (PPC) advertising in 1998, which led to an explosion of e-commerce activity. In 2003 Google AdSense brought about an explosion of ad-driven content websites and blogs. In 2007, Facebook created a platform for social apps and companies like Xynga were born. And in 2008, Apple introduced the app store for the iPhone, and Google followed shortly after with the Android store.

If you are an online entrepreneur, this gives you some idea of where to look, but the opportunities do not last forever. Shortly after Overture launched its paid search platform, Google launched AdWords and brought paid search to the mainstream, and the demand for this service grew quickly. Those who arrived early were able to buy traffic for pennies on the proverbial dollar and had a significant opportunity to build a new business. Competition in the AdWords auctions rose quickly however, and it wasn’t long before the costs of traffic exceeded the profit margins for many small businesses.

As for Apple’s app store, there was a clear opportunity for those who were early to provide the interactive content the market was demanding, but within only a couple years the app store had already become congested with excess content and discovery of new apps quickly became a problem for those who were not already established or who were not providing the very best and most popular content. Today, more than 700,000 apps are available in the app store and 50 percent of the revenue is generated by only 25 developers.

The Internet is unique in its ability to proliferate so many new product platforms and ecosystems so quickly, yet those opportunities are equally fleeting. Each of the platforms mentioned has gone from brand new innovation to a mature market that is difficult for new startups to enter, within just four to five years, suggesting the opportunities online move quickly and startups must be able enter the market and scale quickly, if they are to remain in the market for the long term. After all, once the market is mature, the cost of participating will be significantly higher than in the beginning, and only those who have secured the best sourcing, best talent, and distribution options, will have deep enough profit margins to participate.

To illustrate the significance of entering a market early, consider the Innovation Adoption Curve that was introduced by Everett Rogers in 1962. In this model, Rogers describes how the market slowly uptakes new innovation in the beginning but quickly accelerates towards a peak which marks maximum competition, before eventually decelerating once market consolidation sets in. If we assume the entire process of market uptake takes 10 years, that would be consistent with the observation that many of these online platforms go from new opportunity to saturated within four to five years.

In response to this challenge, a young startup might be inclined to be as early as possible in catching an opportunity. This works sometimes, but is not without it’s own risk. Sometimes the great new innovation or platform your betting on never takes off, and if you’re a young startup with limited resources, that can represent a substantial risk. It is also interesting to note that many successful companies were not the first to enter their market either – they’re often “fast followers” who were able to enter the market soon after someone else validated it, thereby avoiding R&D cost and the risk of non-adoption. This is the case for almost every major innovation in Silicon Valley: Google didn’t invent the search engine, Facebook didn’t invent the social network, and Yelp didn’t invent online reviews.

In 1991, Geoffrey Moore added to the Adoption Cure by identifying what he believed was the perfect time to enter a market, something he called the Chasm. He concluded that entering at the cusp of early adoption and early majority was ideal, because the market was sufficiently proven to reduce the risk of investment, but still provided the opportunity to scale sufficiently before consolidation set in on the back half of the curve. If applied to the online platform opportunities, that means we need to watch new emerging platforms closely and if they appear to be gaining traction, then you need to enter those markets within the next 1-2 years after its introduction.

At the end of the day, timing is merely a function of finding the right balance between supply and demand and these are merely techniques for accomplishing that goal. You need to find the sweet spot when demand exceeds supply to make your job easier and provide the runway you’ll need to take off, before a market consolidates. You can afford to get a lot of other things wrong if you get your timing right.

Are We In a Startup Bubble?

Startup Bubble

This article was originally posted on VentureBeat.com.

Have you noticed how many online startups there are again recently? While it’s great for overall innovation, it can create a challenging ecosystem for budding entrepreneurs. I’ve spent more time than I care to remember, evaluating various businesses, looking at models, and seeking opportunities where I could compete. Invariably no matter what idea I find and no matter how niche or arcane it is, it’s likely there are already more than a handful of competitors already in the space.

Just a few years ago, may of the simplest online opportunities were still viable for new entrants with relatively little capital. Today, I see excessive competition everywhere I look, and nearly every niche seems to have at least 1 or 2 well-funded competitors. The other day I was joking with my wife about the issue, and we came up with a business idea (as a joke) that we thought would be a good litmus test — a dating CRM. Afterall, a busy dating pro needs to keep track of all their dates right? (joke). So we looked online, and to our horror, there were several, one of which appeared to be a serious product.

This kind of crowding isn’t what you want to see if you’re about to take a major career gamble.

So why has the market become so congested? Consider what has happened with venture capital investments in Internet startups. Only a decade ago, the expense of getting a startup off the ground was very high. With the cost of servers, and having to write all the low-level code from scratch, it was entirely likely to require millions of dollars to get a company off the ground. As hardware commoditized and foundational software became open source, the cost and time to get off the ground has reduced substantially. Investor Mark Suster wrote an interesting piece on this topic, suggesting that the capital cost of launching a new startup has gone from a million dollars to only $50,000.

I’ve heard it said anecdotally that only 1 in 1,000 Silicon Valley startups would be considered a “success” five years later. A little more promising, I also heard Founder Institute CEO Adeo Ressi indicate that startup success was closer to 3%. I don’t know what the actual number is, but this serves to illustrate just how high the risk is and why the lower cost of investment for VCs is such a good thing. Rather than spending a million dollars on a single business, you can spread that same million dollars across many young startups and significantly increase your odds of reaching positive ROI. That’s why we saw Y-Combinator launch a few years ago to provide early-stage mentorship and $20,000 of investment for college students who want to take a chance on a startup.

The Y­‐Combinator model has proven so successful that it has attracted much more money into the ecosystem and there has been an absolute explosion of startup accelerators across the country, all proliferating the same mentorship + seed capital model. The net result is that you have often multiple tech entrepreneurship factories churning 20-50 out cohorts of new startups every quarter.

With geek now being chic and success stories such as Facebook and Google inspiring movies and careers around the world, the allure of becoming a startup millionaire is today’s equivalent of becoming a rock star. And the Internet has torn down many physical barriers that once precluded other nations from competing. Now you see merchants selling directly from China on eBay, and SaaS companies providing compelling online software solutions directly from India and Eastern Europe. No wonder it feels so crowded!

But let’s focus back on the maturing of capital markets and their contribution to this phenomenon. In the traditional investing cycle, initially, a few investors would reluctantly invest a little money in a company that already had a proven model and track record. With a nearly guaranteed return on investment, they saw healthy returns and confidence built. In the next cycle, more investors observed this success and tried to step ahead of the conservative late-stage investors to get in on the easy money. They accepted more risk and lower returns. This process continued until we had a very mature market in which too much money was chasing too few ideas, all trying to step ahead of one another. And eventually we got to where we are today — money being thrown at every college kid with an idea and no track record. Now imagine what happens with the newly passed JOBS Act, that will make it easier for small businesses to attract angel funding from non-accredited investors, particularly through crowd-funding.

But everything goes in cycles, and I can’t help but wonder if this wave is already cresting. While there’s been opportunity for venture capital firms to spread their risk across numerous startups and increase their odds, doesn’t the proliferation of incubated startups actually challenge the success potential of each one of them? And how long does it take for the aggregate return-on-investment to once again find its historic equilibrium?

It was less than a decade ago that Wall Street was touting financial innovation and Congress was touting easy lending that would make it possible for more Americans to become homebuyers. This, of course, opened up capital to home buyers and investors that created the housing boom and eventual bust. But all it really did was bring more people into the market place and temporarily distort opportunities; a distortion resolved a few years later.

So how long will it take for this bubble to correct? As aggregate returns begin to marginalize and the over-supply of startups begin to cannibalize one another, other investment opportunities such as real estate may become more attractive again and provide healthier alternatives for the early ‘smart money’. The ultimate consequence is going to be a downward leg for a number of years for startups. It won’t be the end of the world, but it will mark the end of an easy-money cycle and a period of exaggerated perceived opportunity.

For would-be entrepreneurs looking to invest in a startup today, it may be worth taking a hard look at whether this is the best time to take the plunge. Isn’t it after all the height of a market cycle when the opportunity looks the best and when everyone is convinced that ‘things are different this time’?