Fine-tuning Your Business Model After Launch
When a startup is launched, its initial business model is often unproven. A large part of the challenge in taking a company from its humble beginnings to a successful firm lies in the process of discovering and fine-tuning a repeatable business model from the founders’ original innovation or insight. As the founder or business owner, your capacity to adjust, adapt and innovate as your learn about your customer’s needs, marketing environment and overall industry dynamics will be a key factor in determining the success of your startup. The process of fine-tuning the business model of a startup after its launch is the subject of this article.
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While a large company is focused on optimising a proven business model, the main task of an early-stage startup is to search for a repeatable model that it can subsequently scale. Startups do this in every department through an iterative process of fine-tuning, involving frequent contact with customers and rapid learning from failure. Business owners should try to understand their chosen customer problem as rapidly as possible, before selecting appropriate metrics to test how well the solution their company provides is received. These metrics might include simple notions like revenue and margins, but could also involve less well-known jargon like SGA:sales ratio or ARPU. If efforts to fine-tune a business model prove unsuccessful, entrepreneurs should pivot to a different, but related idea. Pivoting is stressful and time-consuming, but preferable to going out of business altogether.
Startup vs Large Company
The mindset required for running a startup is very different from that required for a more established company.
Where larger companies are focused on executing and optimising well-tested strategies, the very definition of a startup is a new business that is in search of a business model. One of the most important tasks of an early-stage company is to experiment with several business models, pivoting and adjusting until a profitable and scalable model is found. Since nearly everything is built from scratch in a startup, this long, challenging process of fine-tuning can apply to all aspects of the business: from sales and marketing through to product development and recruitment. In the process of transforming the initial innovations into a viable business model, the final model may look very different from the original intentions of the founders. Facebook famously started life as a way for college students to rate the attractiveness of students of the opposite sex.
The objectives of a startup in its early life is to grow by acquiring customers and clients, adding to product capabilities, increasing revenues and hiring staff. Companies that do not grow into a profitable model will ultimately go out of business. The majority of growth happens once a company has broadly settled on a repeatable business model, which is why fine-tuning is so important. For companies that do find a scalable model, this growth can be very significant; Uber’s revenues from car-sharing activities increased 38x between 2013 and 2015. By contrast, larger companies are driven to optimise the client relationships, business processes and products that they have already built and sold successfully. Rather than scaling a new business model from scratch, a company as large as Hertz achieves growth primarily through optimisation of its existing operations or by acquiring smaller competitors.
The process of fine-tuning a startup business model is one that is inherently more risky than the optimisation of an established company. Running out of money, losing clients, trying business models that don’t work: there is so much that can go wrong in a startup that founders have to possess a certain amount of courage to start at all. The optimisation of a larger company is less risky, because those that manage the company typically have more money at their disposal and already know that their business model is viable.
Entrepreneurs that successfully navigate the path from startup to established company apply three general principles to their search for a repeatable business model.
In an environment in which financial resources are scarce, entrepreneurs need to learn as much as possible as quickly as possible in order to avoid going out of business. Businesses often learn more from failure than success; this necessitates a certain amount of risk-taking and comfort with failure. Former McKinsey consultant and product management expert Donald Reinersten’s Principle of Optimum Failure Rate posits that a fifty percent failure rate is usually the optimal for generating useful information that the business can use to grow. More specifically, businesses stand to learn the most when they take the largest risks. This might mean A/B testing two different product designs, as opposed to merely choosing between different background colours for the company blog. In order to learn about the deficiencies of their value proposition as soon as possible, startups are encouraged to release a “Minimum Viable Product” (MVP): the leanest version of the product or service that customers are willing to use and pay for. Even if many aspects of the MVP are not accepted by customers, businesses that brave market feedback consistently learn faster than the competition.
Focus on customer retention
Over the months in which a startup is working towards product/market fit, it is essential to focus on customer retention. A company that manages to keep existing customers happy is a business that is moving towards an proven business model and an established place in the marketplace. To demonstrate that retention through customer satisfaction is more important than mere revenue, consider the value of a customer who buys a subscription to a video streaming service, never uses it, and forgets to cancel. That customer might be contributing to revenue generation, but he or she is hardly an enthusiastic user of the streaming service who keeps coming back to use it. If it has several such customers, the streaming service itself might well be financially solvent without ever knowing if it has a scalable business model or learning about customer needs. One way of fine-tuning its business model might be to not include customers who don’t use the service after a month or two, in the retention analytics so that the company knows that customer retention is solely contingent on providing a fantastic user experience and not a result of user apathy.
Develop deeper understanding of customer problems
A crucial part of the fine-tuning process is working towards a complete understanding of the problem(s) that you are solving for your customers. During the customer validation phase, you will find many customers that are unwilling to buy what you are offering them, most often because they don’t have the problem you articulated. The sooner and more frequently you have the courage to expose yourself to feedback from real customers by releasing early iterations of your product or service, the faster you will understand what exactly your customers want from you. One good tip is to articulate the customer problem as you understand it as part of your customer acquisition strategy. Split-test different ways of articulating the problem and see which one customers like more. After doing this a hundred of times, you should have detailed answers to questions like:
- Why should customers buy from me and not the competition?
- How much money do customers have at their disposal to spend on my product or service?
- How does my product or service make the lives of my customers easier?
- At what time of day and at what location do customers prefer to shop?
Specific Fine-Tuning Approach
Apart from the core business model, a startup also needs to fine-tune and streamline it operational activities so that they are efficient and aligned with its evolving core business model. For example, if a company decides to change its employment model from an employee-based one to a sub-contractor based model, it need not continue to retain a large HR department.
Sales & Marketing
As a startup’s customer base gets larger, the business should divide customers into different segments and match their marketing campaigns to the disparate demographic segments (e.g. incomes, genders, ethnicities etc). Review the performance of the teams selling to each segment and allocate more salespeople to teams that are understaffed. Keep returning to your understanding of how your customers benefit from your product or service; you may find from talks with customer service staff that customer needs may have evolved over time. With an eye on the performance of your various sales channels, seek to invest more resources in those that are providing the most revenue, while withdrawing from those that are less successful.
Product design and positioning
Product optimisation begins with the release of the MVP. As you start to gain feedback from customers, make minor tweaks to the design in such a way that your offering better reflects customer demand. For example, a sweet shop selling home-made chocolates might find that its customers enjoy eating white chocolate the most, and make changes to its product line by putting more resources into buying supplies of white chocolate and less into dark and milk. A few weeks later into testing its business model, let’s imagine that the same store finds that purple packaging sells at twice the rate of regular black packaging. The owner of the sweet shop would be wise to move production towards purple packaging. Many small businesses lack the courage to experiment with higher pricing, thereby leaving significant sums of money on the table. If the owner of the sweet shop typically sells 1000 chocolate bars per month at $5 per bar, he or she could achieve the same monthly revenue with only 625 bars just by raising the unit price by $3. Any sales after that would mark an increase in revenue.
Customer relationship management
Improve and fine-tune your customer relationship processes and workflows. As you product mix changes, adjust your customer service strategy accordingly. Use technology to provide superior service with a smaller number of employees. Good customer relationship management begins with positive, motivated employees. Once you’ve ironed out any issues among your own staff, encourage employees to listen attentively to customers on social media and the phone, reaching out to those customers who report issues. Implement customer surveys, particularly for long-standing customers, and be sure to include feedback from your own employees as part of your research – employees can be a great source of customer insight.
The fine-tuning of supply chains involves minimising two things: the cost of delivery and the time it takes to get the product to the consumer. Your business may have to experiment with delivering goods by rail, road, sea and air before it comes up with the optimal strategy.
Key Metrics to Track
As you fine-tune your business model, there are certain figures that you and your team will have to track on a daily, weekly and monthly basis in order to see if your business model is gaining traction with users. These figures are your business metrics.
General metrics that might be worth tracking include:
- Average revenue per user (ARPU): If your ARPU is increasing, it means that you are getting more sales from each customer and/or you have pricing power. Note that this tells you nothing about the quality of your sales.
- Customer Acquisition Cost (CAC): The cost of attracting each new customer. This is a great way to track the efficacy of your sales team. Decreasing CACs mean that your sales process is becoming more optimised. You should also be sure to know if your business is able to attract new clients profitably.
- Churn rate: This shows you how well your business is retaining customers. It should decrease over time as you achieve an ever-closer product/market fit.
- Burn rate: How much money do you need to spend every month to keep your business afloat? To avoid going out of business altogether, early-stage companies should know how many months’ capital they have sitting in the bank at any given moment. Burn rate is also an important consideration for external investors.
- SGA to sales ratio: Comparing your expenses on selling, general business expenses and administration (SGA) against your sales revenues gives you an idea of your startup’s operational efficiency. To improve your ratio, consider cutting discretionary spending on sales, marketing and payroll.
- Gross margins: It’s important to have a basic awareness of what sort of gross margin is typical for your industry. If you are hitting your margin targets and/or margins are increasing, it’s a great sign that you are on your way to a repeatable business model. If not, review the other metrics listed here to get a sense of where any issues might lie.
- User growth rate: For businesses that are seeking viral growth, this is arguably the most important metric. More frequently, it is more prudent to concentrate on retaining existing clients, as this gives entrepreneurs better evidence that they are keeping customers happy. See the discussion of customer retention above.
- Percentage of active users: Startups should look for users who return to their product or service frequently, as opposed to those that sign up and then become passive. The former typically spend more and are more likely to recommend your business to friends and family. Precisely how this is tracked will vary from business to business; an app might track how many users use their top three features on a monthly basis.
Your choice of which metrics to focus on will additionally be determined by your industry. For example:eCommerce websites track their conversion rate and the percentage of abandoned carts.
- eCommerce websites track their conversion rate and the percentage of abandoned carts.
- Socially-driven websites such as social media sites or blogs should track the ratio of good content (sharing, collaboration, interlinking of internal webpages, being linked to an external site) versus bad content (cyberbullying, pornography, violent content). They should also monitor the ratio of active users to lurkers.
- SaaS businesses should track CAC, conversion rate and customer retention. They might also consider looking at Lifetime Customer Value.
- Advertising businesses need to look at the efficacy of on-page advertising, the number of pages customers visit per session, and click-through rate.
- Apps are advised to keep a record of how many users are active on a daily and monthly basis, how many users have downloaded the most current version, and how many users have uninstalled their product. Somewhat harder to quantify is the ratio of positive reviews to negative ones.
It is perfectly possible that your business will fall into more than one of the above categories. As well as thinking about your industry, consider how far along your startup is on the path towards a proven, repeatable business model, and review your choice of metrics accordingly:
- Problem validation: Startups in the early stages of ascertaining whether they have articulated the customer problem accurately should make sure that they track conversations with at least 10 customers, preferably more.
- Solution validation: Once you’ve identified a real-world problem that customers want solved, you should track the willingness of customers to pay for your solution.
- MVP validation: Having built your MVP as an initial solution to the customer problem, track how often customers recommend your product or service to their friends and family. This is also the stage of your business’ life at which it makes sense to start keeping records of daily, weekly and monthly users. As you introduce new features to your customer offering, monitor how often these are used.
- Generating buzz: As you focus on acquiring more customers, start analysing metrics like conversion rate, churn and lifetime value.
- Business model validation: The ultimate test of your business model is long-term profitability. A small web consultancy might need to validate this very quickly, whereas investor-backed giants can afford to wait a little longer before worrying about revenues. When you reach this point, track revenue per customer, gross margins and overall revenue.
When Fine-Tuning is Not Enough
Sometimes, fine-tuning is insufficient to fix fundamental flaws in your business model. Companies in this position have two options: pivot or die.
Some examples of companies that successfully reinvented themselves are:
- Groupon, now the world’s largest provider of daily deals at restaurants and retailers, started life as ThePoint.com. This was a site allowing customers to ask people to donate money or do something as a group, but only once a certain proportion of the group agreed to participate.
- Instagram, now a photo-sharing app owned by Facebook, was once a service that allowed users to check into locations and earn points for hanging out with their friends.
- YouTube, now the go-to location for Internet video, was originally a video dating site.
On the other hand, the following companies failed to listen to market feedback and ended up running out of money:
- Rate My Speech was a website that allowed users to submit their public speaking activities for community feedback. The creation of any social site requires a critical mass of users, and Rate My Speech never realised that there was no demand for its service.
- Fastr set out to be Whatsapp for customer service, connecting company representatives with customers via an instant messaging app. Large brands were unimpressed at the idea of appearing side-by-side with lots of other unrelated brands, and Fastr was unable to pivot its technology to a different market before it ran out of money.
- Wattage wanted to empower average consumers to create custom hardware in their browser. There was no demand for this product; investors were uninterested, and the startup went out of business.
Finding a repeatable and profitable business model is the hardest challenge for a startup. Business owners should aim to learn as quickly as possible, retain existing customers and acquire a complete understanding of the customer problem. With these general principles in mind, they should track metrics that are appropriate for their business size and industry, and work towards fine-tuning all aspects of their overall operations. If the business model still fails, the startup may still be salvaged with a timely pivot.