Stop Wasting Time on Unviable Business Ideas
Stop Wasting Time on Unviable Business Ideas
The 5-Minute Test to Rapidly Evaluate Your Startup's Potential
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In today's issue, I will show you how to quickly test if an idea is worth pursuing before investing months of effort.
Too many entrepreneurs prematurely rush to launch their product, join an incubator/accelerator, or hit the pitching circuit only to realize months (or years) later that they were chasing too small an idea. They waste precious time, money, and effort -- which could have been avoided if they had sized their idea at the outset.
At the other end of the spectrum, some entrepreneurs create (or are asked to create) fantastical 5-7 year forecasts, which aren't any better. The problem with these spreadsheets is that they have too many numbers that quietly mask the riskiest assumptions in layers of innocent compounding lies.
You end up
creating a fictional model that even you don't believe,
using different metrics with your product team
while defending your fictional model to stakeholders.
This is counter-productive, and there is a better way.
Meet the Rapid Viability Test
The Rapid Viability Test (RVT) utilizes a quick back-of-the-envelope estimation technique devised by physicist Enrico Fermi, famous for making rapid order-of-magnitude estimations with seemingly little available data.
Instead of a traditional top-down approach, a Fermi Estimate takes a bottom-up approach where you start with a set of inputs, roughly estimate them and then test the viability of your idea using these input assumptions.
As long as your input assumptions aren’t off by an order of magnitude (power of ten), the resulting estimate will be accurate enough to make an educated go or no-go decision.
Here's how step by step:
Step 1: Ballpark your Minimum Success Criteria, Not Your Idea’s Maximum Upside Potential (Goal Sizing)
Many forecast models result in fictional plans because they attempt to estimate the maximum upside potential of an idea, like an exit or IPO. The problem with this approach is that you're aiming too far out into the future (5-7 years). It's hard (if not impossible) to see that far due to the fog of uncertainty that clouds our visibility at the early stages of an idea.
I, instead, recommend setting a three-year timebox and estimating your minimum success criteria.
The Minimum Success Criteria (MSC) is the smallest outcome that would deem your idea a success three years from now.
Why three years?
Easier to visualize than five years.
Sufficient time for most products to achieve product/market fit.
Things get much clearer (fog lifts) after product/market fit.
The other common mistake entrepreneurs make is asking how big their idea can get. This is backward because why would you ever want to work on an idea that doesn't hit your minimum success criteria?
A better approach is determining your MSC independently of your idea and testing one or more ideas against your MSC to filter out the most promising ones. In other words, don’t start with an idea and ask how big it could get. Start with your MSC, and ask if your idea can achieve your goal.
How do you set your MSC?
I recommend using an annual recurring revenue (ARR) goal for your MSC.
Why revenue? Because all businesses have revenue which is an excellent measurable proxy for profit, valuation, or impact.
Why recurring? Don’t confuse recurring company revenue with recurring product revenue (like Saas). Every business, irrespective of product type, aims to create a repeatable, scalable business model.
A repeatable business model generates repeatable revenue.
A scalable business model generates growing revenue.
Repeatability is a prerequisite to scalability. So start by modeling for that.
Finally, don't chase three-digit precision. The purpose of this exercise is to ballpark a rough 3-year ARR. I recommend thinking in powers of ten.
Building a 7-figure business is similarly challenging across different product types. But building an 8-figure business is an order of magnitude harder.
When you think 10x, there are only four levels to the game. Pick one.
$100k ARR: Roughly enough to quit your day job
$1m ARR: A small 3-5 person company
$10m ARR: A VC backable business
$100m ARR: A Unicorn or low-margin business
Step 2: Identify Your Customer Archetype (Customer Sizing)
Next, you're going to estimate your annual revenue per customer/account (ARPA) rounded to the nearest power of ten in order to identify your customer (animal) archetype:
These customer archetypes come from a sales/hunting metaphor popularized by Christoph Janz, a VC at Point Nine Capital, in a blog post titled Five Ways to Build a $100m business. Not all businesses aim for a 100m ARR goal, so I generalized Christoph's model to support the different goals above.
Why do we care about customer archetypes? Just as building businesses to a specific size is similarly challenging, acquiring customers of a specific size is similarly challenging.
Identifying your customer archetype helps with rapid estimation and informs your sales and marketing go-to-market strategy. For instance, while you can use a landing page to acquire mice customers ($100/year), you wouldn’t attempt to catch whales ($1m/year) this way.
Step 3: Evaluate Your Beachhead Market (Market Sizing)
With your MSC and customer archetype defined, you are now ready to test the viability of your idea. You evaluate whether your target beachhead (or early adopter) market is big enough to hit your goal.
A beachhead market is the first market you aim to dominate to establish a solid foundation from which to expand.
The ideal is to achieve your MSC goal with a single beachhead market, so you don't have to cross the chasm before product/market fit.
How do you tell if your beachhead market is big enough?
Use the chart below to determine how many customers you'll need to acquire at the 3-year point to hit your MSC goal.
Then test if your market is big enough.
As a general rule of thumb, your total addressable early adopter market needs to be roughly 100x the number of customers you’ll need to acquire to hit your MSC goal.
Here’s why. Most products, irrespective of product type, start with a customer conversion rate between 0.5–3%.
For B2B sales, according to Salesforce, the average conversion rate for MQL (marketing qualified lead) to SQL (sales qualified lead) is 13%. From there, only 6% of SQLs convert to deals. That’s a 0.78% customer conversion rate.
According to various industry benchmarks for SaaS products, 2–10% sign up, 15–50% become subscribers, and 20–40% churn on the first pay period. That’s a 0.6–1.2% customer conversion rate.
For e-commerce sites that have just started, most report a 1–3% customer conversion rate.
Using a Fermi estimate, this is closer to 1% (not 10%). So to acquire X number of customers, you'll roughly need 100x leads.
Now that you understand the steps, let’s apply the Rapid Viability Test to a real-world example.