How to not start the wrong business
Building a business is hard...
Dear friends,
Building a business is hard…
However, you want it to be hard for the right reasons. You want the “we are growing too fast” kind of hard. Not the “why are my customers not coming back” hard.
Although there are some pretty smart people out there (who seemed to have figured it out), no one has a blueprint. There are no guarantees.
Instead, what the best founders do is find ways of stacking the odds in their favor. One of those ways is to choose their market with care.
What business school tells you to do (i.e. what not to do)
The first advice we hear is “do what you are passionate about”. Although passion is important and sounds great, it is terrible advice in reality. I might be super passionate about helping college students invest in real estate, probably not a thriving business.
The other most common advice founders get (and investors give) is to focus on building a great product.
In my view, most founders tend to overemphasize the importance of a great product only to run into a brick wall called distribution (market). As it turns out, building a product and getting that product into the hands of thousands of customers are two very different things.
Consequently, the startup graveyard is full of product driven companies.
A perhaps even sadder story is startups finding themselves, after initial break-out success, suddenly treading water at a decent size but unable to continue to grow sustainably or turn a profit. They are stuck and unsure why.
The point is – it doesn’t matter how great of a product you have, or great of an operator you are, if you choose the wrong market. On the flipside, if you manage to pick the right market, you can make tons of mistakes and still succeed.
Market > Product
So, how do you pick the right market? Funny you should ask. I don’t know. I cannot tell you what the right market is for you. However, I can probably tell you what the wrong market is. Look out for these three indicators.
CAC / CLTV
Every business starts out with a CAC of zero and a relatively high CLTV (thanks, friends and family). However, as you start growing you will see these two metrics converge, squeezing your margins and limiting your growth options. If you are skilled, you can augment each metric or delay the convergence somewhat, but you are still limited to the growth equation of your market.
Choosing the wrong market is like choosing the wrong sport. Doesn’t matter how athletic I am or how much I love the sport, being 174cm tall myself I am probably not going to be an NBA star anytime soon. Choose the wrong market and your success will be…let’s say, limited.
Before you start your business, aim for a market with a CAC/CLTV ratio >1:3 and closer to >1:5. With these conditions, you are set up for sustainable growth for the long haul. Avoid markets that do not fulfill this criteria.
Payback time
The second thing you want to understand is the payback time of your market. Payback time is the time it takes for you to recoup your customer acquisition cost. Best in class is 3 months, but you should aim for below 6 months or follow Lenny’s advice. A quick payback time is important as it enables you to recycle your money and reinvest in your growth. Businesses with long payback time are often slower and more expensive to grow.
TAM growth
The last thing you want to make sure is that you are operating within a growing market. A fast growing market will boost your growth, ease the competitive dynamics and leave more room for testing and mistakes.
Final thoughts
Again, operating in the right markets doesn’t guarantee you success. However, it can help you eliminate the chance of you banging your head against the wall for years. There is nothing as meaningless as doing well what isn’t worth doing and time is the most precious resource you have.
And if you are reading this thinking ”fuck, I’ve started the wrong business in the wrong fucking domain”. Meet me at the bar.
Toodeloo,
Carl