Trade Value, Wealth Control, Complete Challenge
Business is about offering something of value that others need or want so much that they are willing to trade their wealth to pay the price if they can afford it in their budget and its purchase priority order.
Wealth gives you the power and freedom to do what you want within reasonable bounds (more vacations, more business, investing, retirement, research, arts, politics, philanthropy). Being able to do things with your own wealth is the foundation of business and economic freedom, as opposed to forcing others to give up their wealth toward your own goals like an angry mob or totalitarian dictator (even if intended for the common good). That said, there is absolute truth on both ends of the spectrum between "taxation is theft" and "the system is rigged in favor of the rich and those who own the means of production". As an entrepreneur, you will see this dynamic in play when paying taxes, negotiating with monopoly suppliers, and competing with wealthy, mature businesses who cut costs through economies of scale and debt-free operations; penetrate the market with brand awareness and predatory pricing; and front their reputation to land lower-cost and exclusive deals with the common suppliers of each industry.
The great challenge of entrepreneurship is that you have to get everything right. The right idea is vital to hold a path to success. The right marketing strategy is vital to reach the target audience quickly and cost-effectively enough with a compelling message. The right product design is vital to attract and retain customers with competitive quality and long-term brand loyalty. The right partners and employees are vital to avoid decision paralysis, business fragmentation, and productivity loss. The right suppliers are vital to sustain the external ingredients of the business with reliable production, clear communication, and fair terms.
Prepare the idea carefully.
Some ideas try to solve a problem that does not exist.
Some ideas already exist now.
Some ideas have already been tried before.
Some problems have already been solved in a different way.
Some ideas are only possible after certain requirements have matured.
Example: Flying cars cannot enter the mainstream market until a breakthrough in self-driving/autopilot technology combined with either low-power aerial propulsion or high-capacity batteries/fuels.
Dig into the complete cost and risk of a potential product.
Example: In concept, solar panels can help homeowners save money on their entire energy bill every month. In practice, whether homeowners save any money at all is dependent on the lifespan of the solar panel, its performance degradation over time, its average performance in the local climate, and the cost of the entire system (purchase, installation, maintenance, insurance). Additionally, an uninsured system bears the financial and operational risk of equipment failure due to malfunctions and weather damage. With a non-grid-tied system, homeowner activity is limited by the system's average power generation over the long-term and its immediate energy capacity in the short-term.
Compelling business ideas are much more likely to succeed.
Benchmark what is currently available on the market.
A compelling product is much better in overall performance.
Example: Solid state drives are much faster, smaller, and more durable than spinning hard drives. Once SSD manufacturing matured and brought prices down, spinning drives were rendered obsolete for all but cheap long-term storage.
A compelling product is moderately better at a single performance metric.
Example: The used car market has always attracted consumers looking for discounted vehicles. However, consumers flocked to buy new cars when small changes were made to big factors, such as automatic transmission, air conditioning, and power windows.
A compelling product is a bit better at core performance for an important application.
Example: Life-saving medicine that has a 5% better success rate is compelling.
The business model covers the operational structure of the business, its role in the market between customer/supplier/partner relationships, its monetization strategy, and transition plan for the future.
In order to build and run a business you need a complete understanding of its general design, including R&D, operations, accounting, sales, and customer support. The strength of each department depends on its size and individual skills. Early start-ups and small businesses will require you to take on as many roles as you capably can and outsource the rest. Finding a good first business partner can be tricky and full of risk. Hiring a first employee is slightly less risky and quite costly. As the business grows, the communication structure between departments becomes increasingly important. Maturing companies often size up their human-resources (HR), quality-assurance (QA), and legal departments to protect themselves from internal problems, product/service problems, and lawsuits.
The monetization strategy covers how the business generates revenue and profit. Most products carry a one-time purchase price, such as with food at a grocery store. Some software and services offer a regular subscription fee, such as with rent. Some software provides a free basic service and charges for the complete or advanced version. Some services offer a trial period. Fees may be a fixed value or a percentage of the transaction.
A good business model is able to adapt to changes over time in the industry and economy as a whole. A business might have to start with single-purchase monetization then shift to a subscription structure as the market saturates (ex. professional design software industry). A business might have to integrate vast amounts of automation into their operations in order to maintain a competitive price and convenient experience (ex. shipping industry). A business might have to fundamentally alter or pivot its current product to evolve its value preposition with new technologies (ex. movie/game rental industry).
Investors and Fundraising
High-growth start-ups are popularly funded by venture capital investors (VC) and angel investors. These 2 investor types are generally reserved for early-stage businesses that have a trajectory toward an IPO on the public stockmarket or an acquisition by a wealthy company. Accordingly, the businesses that qualify must be headed toward incredible revenue and profit margins. VC firms are known to be ruthless negotiators who try to take large equity stakes in early-stage companies in need of cash. Angel investors are appreciated for their willingness to accept lower yield, sometimes even just graciously expecting to break even. So it is imperative to both avoid getting exploited and avoid meeting generosity with failure. My single key recommendation around fundraising is that you must get as much traction as possible with your own money. It's good for your negotiating position, good for reducing the risk that you'll let your investors down, and good for pushing yourself with a much-needed sense of urgency.
Overall, I see 2 major mistakes happen time and time again from the tendencies and expectations of entrepreneurs and investors. First, entrepreneurs have a hard time balancing their path of growth and their path to profit. New entrepreneurs have a tendency to lean toward making profit, while investors want growth, understandably and often wisely. When companies focus too much on growth, they commit sunk cost into new regions and markets that will not produce a return until much later. This may force the company to be more desperate for cash in the short-term while increasing their total risk. When companies focus too much on profit, they give up on their first-mover advantage, including their early timing for easy market share. This may force the company out of the market as competitors budge in spaciously. Balance is essential. Second, new entrepreneurs have a tendency to waste a lot of money, celebrating their influx of cash and rushed by their pressure to grow. Know that securing investment is indeed a milestone worthy of celebration but by no means is it an excuse to slow down; you can take it easy after you mature the company, achieve sustained profits, and help your investors exit along the way. The value of an experienced advisor can be instrumental in maintaining financial prudence and realism.
Small businesses need to be funded in a more grassroots manner. You always start by investing your own money. Once you have traction you can raise funds from family, friends, private investors, and/or pre-orders. Small business fundraising usually comes as loans because loans have a clear payment schedule and rate of return for the risk assumed by the investor. Small business equity is substantially more risky as the path to return-on-investment and annual yield is precariously dependent on the long-term future of the business. Even private investors who are interested in the long-term upside of equity will often request convertible notes that are loans with the option to convert into equity at a pre-determined ratio.
You really have to consider the perspective of the investor. Generally, they want your business to succeed so they can make money while facilitating a new enterprise that creates jobs and generates value. Specifically, the only way they will be able to make money is if there is a clear exit plan. As an entrepreneur, if you want to develop a good relationship with your investors, you have to think about how you will facilitate a strong financial exit for them while building your business healthily at the same time. Likewise, good investors will try to do the same in kind for you.
Market size is the intensity with which all products within a product category, like toothpaste, are bought and used in the economy. Market size is usually measured as total revenue per year, total units sold per year, and total number of active users. Market size values help predict revenue potential, calculate pricing margins required for profit, and grow operations accurately in preparation for future demand. Market size is closely associated with market share, which expresses the fractional values corresponding to a specific business or product.
Market saturation is the reduction of demand that occurs when a durable product fills the world. Full market saturation causes demand to fall toward the rate of expiration.
Example: Consider refrigerators that last 10 years. The fully saturated demand is an average of 0.1 per household per year. When the refrigerator market was new, everyone was buying. For a population of 100 million households that fully adopted refrigerators over 5 years, the average demand would have been 20 million units per year. But after everyone has a refrigerator, the industry is forced to shrink to an average of 10 million units per year, the rate of expiration.
Market saturation is revitalized by new products with compelling features.
Example: Consider a population of 100 million households who already have a refrigerator. Suppose a new refrigerator is launched with incredible energy efficiency and a convenient transparent door. These features might be compelling enough for 30 million households to buy a new refrigerator even though their existing one has several years left in its lifetime. That said, beware the after-effects of improved durable products that may be better and last longer but correspondingly decrease the long-term demand.
Total Investment Cost
Total investment cost is the full amount of money and time required to bring a business from zero to sustained profits. Sometimes a business may decide to prioritize growth over profits; such a plan is longer and more expensive, but deployed to yield more profit on average over time. Sometimes, rapidly changing industries demand that businesses make major reinvestments to stay relevant and competitive in their respective markets.
Demand validation is the process of checking whether people actually want a given product at the price it is expected to be available. For a new business, demand validation helps measure the interest in a product before extensive time and money are invested into the business. For an existing business, demand validation clarifies the value of potential changes to core business products.
Customer Acquisition Cost and Customer Lifetime Value
After demand validation, you must start the specific calculation to determine if the business can profitably attract new and returning customers. This calculation fundamentally involves the concept of customer acquisition cost and customer lifetime value.
Customers can only be reached with some form of marketing, whether it be a website, commercial, or list of professional relationships. If a radio commercial costs $1000 and brings 1000 new customers who buy from your business, the customer acquisition cost for that marketing channel is $1. If the average purchase of a new customer brings $50 in profit, then the short-term customer value is $50. If the average customer comes 100 times over the long-term, then the average customer lifetime value is $5000. The return on investment for the commercial itself is thus incredible, but the length of the timespan and other costs must be factored in as well for the complete picture. Overall, the short-term and long-term profit per customer must be compared to the cost of marketing and overhead per customer to make a detailed determination of a viable business.