THE BUSINESS MODEL- WHAT VCs LOOK FOR: 4KTA
Date: Tuesday , July 03, 2012
Naveen Bisht is a serial entrepreneur and Board Member, Chair – Programs, The Indus Entrepreneur (TiE ) and member of TiE Angels Steering Committee, based in Silicon Valley, California.
As an entrepreneur and advisor to startup companies, I have learnt a lot from more mistakes than I can write about them in an article here. A number of these lessons shape my thinking on advising and working on new ideas and startups. I believe that you need to keep trying and keep trying until you succeed. It's better to fail than not try at all. When you are feeling down as an entrepreneur, remember the quote from Vinod Khosla, Founder of Khosla Ventures, "Our willingness to fail gives us the ability and opportunity to succeed where others may fear to tread". Like most of the topics these days, you can find lots of information on this topic on internet. In order to assess funding a company, venture capitalists (VC) assess risk factors using founders and management's background, market opportunity, competitive advantage, barriers to entry and possible exit strategy. Now for assessing business models, it will depend upon the market focus of the company. The metrics are so different for a consumer internet company vs. Software as a Service company (SaaS) vs. network infrastructure vs. mobile vs. a consulting services company. I will attempt to provide here a different perspective with my four key takeaways (4KTA) to help you through the business model that VCs are more likely to be interested in. These could be useful in most of the scenarios. A number of points are also based upon discussions with one of my VC friends Raj Gollamudi, Investment Director at Omidyar Network and co-founder of BlueStream Ventures.
1. Unit Economics – What it means is that you need to determine the life time value of customer against the cost of customer acquisition. The revenue generated from a customer needs to be more than the acquisition cost for the customer. One of the most common causes of failure in startups is that entrepreneurs are too optimistic about acquiring customers easily once they have built their website, product or some service. The cost of customer acquisition analysis needs to be done thoroughly and understood. Essentially, you need to answer these questions. Can you find a scalable way to acquire customers? Can you monetize these customers at a significantly higher level than cost of acquisition? Are you focusing on cost scale or revenue scale? Are you helping your customer drive more revenue or enable cost savings? VCs tend to like revenue enhancing value propositions. It is easier to make a return on investment (ROI) case and also, public markets typically reward growth.
2. Scale – What it means is whether your business can scale. If so, is it a linear scale or a non-linear scale? The scale affects the balance between cost of customer acquisition and monetization of the customer. The factors that drive this balance need to be considered. Some of these factors are viral or network effects, free or freemium, inbound marketing, open source, free trials, inside sales, channels, partnerships, field sales, upsell, cross-sell, scalable pricing, high churn rate, and low customer satisfaction. For instance, in case of people intensive services companies, revenues are proportional to the number of people servicing the customers. These are not scalable business models especially in developed countries since people costs are quite high. Some of these models have worked well in early stages of developing economies like China, India and others. However, as these countries continue to grow at a high GDP rate, the people costs keep creeping up and hence, these models become non-sustainable. VCs like business models where the company can scale non-linearly in a friction-less manner with high velocity. For instance, for consumer internet companies, could you leverage the power of Facebook, Pinterest and Twitter's massive user base and platforms? Could you use Facebook Opengraph APIs to create network effects for your application with millons of users? In addition, could you use the power of these platforms to find interesting ways to monetize the users?
3. Focused Application Launch – You need to target the market segment with a focused application and it needs to be the best in the market with an underlying architecture that could extend into a platform as company grows and succeeds with the entry product. There are so many successful examples of this strategy such as Microsoft starting with operating system for personal computers and then expanding into office productivity and other applications. Similarly, most recently Facebook starting with closed campus social network and building a stronghold there before opening the platform to outside applications such as gaming as popularized by Zynga and others.
4. Leveraging Existing Platforms and Infrastructure – The compatibility with existing infrastructure or platforms already in an enterprise is quite important otherwise the customer is not going to try your product. The companies have already invested lots of capital in the current solutions and are not going to rip them off for a completely unproven solution from a startup. You need to provide a solution that will fit into the existing infrastructure seamlessly and provide a path to the future with the newer technologies and emerging industry standards with a magnitude of order value addition to existing solutions. Do not expect the customer behavior to change with your solution, no matter how revolutionary it is. Finally, educating a customer with a completely new solution can be an expensive affair.
In summary, my four 4KTAs to keep in mind are unit cost, scale, focused application launch and leveraging existing platforms and infrastructure while building business models for your startup.