Why is validation so crucial for startups? Looking at roughly 50 startup pitches per month, I frequently come accross startups which are in the midst of the Validation stage, seeking investment for the Growth stage. Oftentimes, there are misunderstandings on the purpose & meaning of 'Validation'. Below are three simple steps to make startup idea validation more efficiently & effectively.
For startup idea validation, an MVP is the smallest version of a product with just enough features to being able to test it in the market. It reduces the risk of wasting a lot of time and money on developing a technology or product that nobody actually wants. Instead, entrepreneurs are able to get real feedback from real customers as early as possible, which accelerates learning about the product and its features. MVPs are by far less expensive than developing the actual product. Quite often, startups in ideation stage are looking for funding to develop their technology, and in most cases, the attempted development goes far beyond an MVP. MVPs should come at very low cost, with manual technologies, and only the key features offered – however, those should be well thought out and a pleasure to use.
There are countless examples on how today’s successful companies first tested their MVP. Uber initially started with an extremely simplified mobile interface, only used by the founders and friends. To gain access, you had to email one of the founders. As the list of users grew, Uber launched their beta version to a small group of people in 2010, which only connected drivers and iPhone owners, and enabled credit card payments. In the case of Dropbox, their idea of an easy-to-use file sharing tool would have required months of development even to be tested. Instead, they chose to create a simple explainer video before actually starting their development. After putting it on their website, they had 75 thousand subscribers in no time. Key purpose of any MVP is to use it for subsequent market and growth validation.
According to CB Insights, ‘No Market Need’ is by far the most common reason startups fail (42%). The good news is that it is entirely possible to answer the question of market need early on, before having invested a lot of time, effort and money into a startup. How? Key is that entrepreneurs are eager to challenge their solution and find out if potential customers actually like it! If there is no actual MVP available, like in the above case of Dropbox, entrepreneurs are able to validate the Interest their solution generates. The bigger the excitement, the better. It is e.g. possible to set up a Google ad to see how many people are interested and sign up for a beta version. An actual MVP, like in the case of Uber, allows market validation to a bigger extent than interest, and can also validate the Adoption rate & Stickiness of a solution. E.g. How regular is it used? Do people continue using it after some time? How many percent drop off and discontinue using it, and how fast do they drop off?
If the solution doesn’t stick, or there’s not even an initial interest, there is another good news: Market validation done in an early stage leaves room for changes – be it the business plan or the product or service. Often, a business concept will need some changes along the way, but the earlier the fundamentals are set right, the better. Before money is raised for growth, any entrepreneur should be sure that the potential and targeted customers actually like the product or service. Once money is raised for growth, the clock is ticking, and the focus will be on achieving the growth-milestones – at that point, finding out that the solution does not fit the market, will be fatal.
Assuming potential customers like the new solution, and the startup is even able to get some initial traction. At this point, many entrepreneurs know that they might have hit something great, and they are excited to go to the market and grow the business into something big. Latest at this point, it is enormously important that entrepreneurs set and plan their KPIs. Being different in every business, I won’t go into detail about the sort of KPIs, but would like to emphasize on two areas: How much will it cost to reach one customer? And how much value will this customer bring? In the industry, those two KPIs are known as CAC (Customer Acquisition Costs) and LTV (Lifetime Value of a customer). The underlying mathematics are simple. LTV has to be greater than CAC. The general rule of thumb is that LTV should be around 3 times the CAC. (This calculation is also possible if you don’t plan to generate revenue from your users, but through other channels – because each user or customer is of a certain value, depending on industry and business model). A common found challenge is that a new businesses product or service is priced at RM10, but it costs RM100 to gain one customer. There are numerous ways to improve on this calculation on both sides, a higher LTV or lower CAC. Sometimes, this calculation will scale over time.
However, it is important to improve on it as much as possible during the validation stage. It is a common scenario that startups are raising funds for Growth, namely Marketing, without having validated their growth strategies. Before ending the validation stage, and before moving into growth, entrepreneurs should have tried several ways to acquire customers, and should know the most efficient way. Entrepreneurs have to keep records of all the different Customer Acquisition strategies and costs. By improving this on a small scale, the impact in the growth phase can be maximised. This way, wasting of resources on the less efficient growth stages can be avoided, and spending can be more targeted.