Some Startups Forget to Validate a Business Model

Many entrepreneurs work hard on the proof of concept (technical), but skip any proof of the business model (revenue flow). In other words, once they are convinced that the product works, they assume their price, sales channel, and marketing will bring in the customers. These days, the technical side may be the easy part.

Proving the business model requires a different approach than proving the technical concept. For example, one CEO I know gave away his software product to the first ten customers. Customer personnel seemed to like it, and it worked, so he was totally devastated when he couldn’t sell one for a “reasonable” price in the first two months of hard work.

So how do you go about proving the business model? It starts with a customer problem or need, and includes proving the technical concept, but starts earlier and goes much further, per the following key steps:

1. Quantify problem cost-of-pain first. Before you design your new solution idea, gather evidence and estimates of how much money a customer is willing to spend (if any) to solve the problem. Factor in your margin, and you will have an upper bound on your solution cost. You won’t succeed with a product that is too expensive for the market.

2. Prove the technical concept. If the product doesn’t satisfy the need, or it doesn’t work, no business model can work. Start by testing the requirements on real customers, and providing “beta” versions to get real feedback. Iterate and improve the fit until your test customers are delighted, not just tolerant.

3. Use focus groups. Gather some representative customer contacts, and give them your best sales pitch, including price, channel, and support. Then listen carefully to the feedback. Don’t be discouraged if you don’t get it right the first time. Changes at this stage cost almost nothing.

4. Talk to domain experts. Here is where your Advisory Board can help you in finding real people with deep experience in your product domain, and gather some unbiased feedback. Listen to potential angel investors, who have domain expertise, and aren’t afraid to ask the hard questions on pricing and channels.

5. Limited rollout. If you have a physical product, try it in a couple of stores first. If you are on the Internet, try one city. This is tricky, since you have to do realistic marketing to see realistic results, but don’t roll out the big viral campaign yet. Look at product costs, margins, commissions, and other expenses to make sure you still have a bottom line.

6. Get a reference customer. You should descend on that big best customer candidate with everything you have. Don’t give the product away, but make sure he has every bit of service you can provide. He better be so pleased that he is willing to provide a testimonial for your real marketing campaign.

7. Sample trade show or user group. If you use the big “Coming Soon!” sign correctly, people will stop by your booth for a look. Make sure they are real customers, and that they get the whole story (not just a technical demo), including price and channel. Otherwise their feedback has no value in proving your business model.

All this assumes you have done the right job first in assessing competition, establishing the sales and marketing channels, and optimizing costs. I see business plans with a great analysis of competitor’s product features, but competitor’s business models rarely get mentioned.