Best of Times or Worst of Times for Starting a Business?

Best of Times or Worst of Times for Starting a Business?

In a down economy with high unemployment, many managers are tempted to consider a startup. The current environment is both the best of time and the worst of times for starting a business.

Conventional  wisdom on what constitutes a good startup abounds in Silicon Valley, but some insights about what is likely to work require taking a larger and perhaps longer view of success in business. Let’s start however, with some examples of current conventional wisdom. It’s not a comprehensive startup checklist, but it does cover some highlights.

Example Conventional Wisdom

• Businesses started in tough times do better than those in a boom. (An observation made by many people)
• Semiconductor businesses are too expensive and have low success rates. (Many Silicon Valley venture capital firms have closed down their semiconductor investment groups)
• Internet based businesses are attractive because they have low startup costs. (Frequent venture capital observation)
•  Putting businesses on the Internet that automate previously more labor intensive businesses is a low risk strategy. (Typical venture capital observation)
•  Avoid businesses that large players such as Google, Apple, Microsoft, etc. can integrate easily into. (Often phrased as a complaint that large companies are killing innovation because of their patent portfolio or pattern of vertical integration)
•  Venture capitalists are a pain in the neck and actually add little value, so avoid raising money if you can. (A invariable complaint of many entrepreneurs)
•  Manufacturing is impossible in the US. (A widely held assumption)
•  If I don’t have a business model, advertising will support my web site. (Frequently heard idea from startups)
•  My idea for a business is unlikely to be simultaneously invented by other entrepreneurs. (Competitive analysis is typically weak with most startups and even worse, parallel startups may have low or no visibility)
•  Starting a business is lower cost than it used to be because of all the open source and free software that is available. (An observation made most commonly by technically oriented founders who downplay the need for marketing, sales and partner development)
•  Bright and inexperienced managers are the only managers worth considering.  (Consider Google.)
•  Content is king and all content has value. (The idea of “long tail” content is that the Internet provides a method for monetizing less popular or low demand content)

As with any conventional wisdom, while there may be grains of truth in such observations, the reality is that gross generalizations are almost always useless. Some people refer to them as a 40,000 foot view of problem. Strategic analysis of an industry or a company is almost always inadequate; one must look at individual opportunities at the level of a product, service, segment or business model (how one makes money).

But macro trends do matter. In starting a business, an entrepreneur needs to be aware of the gross assumptions floating around the business environment, the business zeitgeist. In Silicon Valley, there are some large and often unquestioned assumptions floating around. Understanding these assumption may allow an entrepreneur to “Think Different” about a problem and reduce the probability of direct competition. And reducing the probability of having to compete with lots of competitors is a strong basis for a good strategy. In the past six months, I am continually surprised at how many innovations are being simultaneously invented by diverse people in different locations. It’s a little like the invention of television or the phone, both invented by multiple people at roughly the same time.

Some Useful Observations For Innovators Starting a Business

Supply and Demand

We are still at a very early stage of the digital revolution.  As a result, many of the lessons learned by early innovators are less appropriate today. For example in the early days of the personal computer, there was remarkably little software.  Today, the problem is that for any product category there is often an overwhelmingly wide variety of choice. And not only is there choice, offering vary in their business model. Consider productivity software. You can purchase the leading product category offering, Microsoft Office in multiple versions including a low cost educational version that is available even if you are not a student. Open Office and Libre Office offer free equivalents with only small penalties. Cloud based offerings are available from both Microsoft and  Google and a host of smaller players. 

The key insight is that having a good product is a whole lot different in an environment of scarce software  than it is an environment with multiple offering and multiple business models.

Content Availability and Distribution

As with software, the environment for content is now transformed as well. In the early years of the digital revolution, content was rarely available on the Internet. 

TV programming was hard to obtain and the schedule determined by the network, cable company or satellite company. Today, content is everywhere. Video content is available by subscription, by rental, by purchase, via broadcast transmissions, cable, cable on demand, cable Pay-TV, Internet delivery, physical rental. Again, the equation between supply and demand has altered in favor of the user. And if greater access, more business models and more methods of delivery were not enough, consumer created video represents a whole new category for consuming time.

The same is true for music. Offerings from iTunes, Amazon, Rhapsody, Spotify, Slacker, Pandora, traditional broadcast radio, Internet delivered radio, satellite radio, etc. provide an overwhelming set of choices that did not exist before.

Written content availability is even more diverse today. In a previous generation, few people had access to more than their local paper and the odd national newspaper. The Wall Street Journal, USA Today and the New York Times were typically the only daily newspapers with national reach. Today, a heavy consumer of news can draw upon a range of news sources that would have been impossible without the Internet.

The key insight with content is that the structure of the traditional news gathering industry is unsustainable when supply increases.

Technology Assumptions

Much of Silicon Valley is built on the assumption that the cost of technology will continue to decline. Moore’s Law is used to describe the observation that the number of transistors in a processor doubles every 18-24 months or so. Similar cost curves are seen in other areas of technology such as hard drives, telecom costs, screens, and software tools.

When the cost of a technology keeps dropping, four things happen. 

• First, it is hard to maintain a traditional business model where service is incorporated into the price for free. In some cases, the profitability is so low that sales costs are no longer affordable – which explains the trend towards freemium models, where initial use is free. Make the trial free to reduce the sales cost. You only pay when you reach some threshold of use or activity. Historically when you bought expensive mainframes from IBM, you received lots of service. The amount of free service declined as the cost of computers dropped. The same phenomenon exists with software. Expensive software is more likely to have paid or free support. In contrast, getting support out of Google on their free offerings is a little like looking for hen’s teeth.
• Second, companies need to increase the performance and scope if their offering in order to maintain their profitability. An MP3 player such an iPod may be profitable, but a smart phone which generates several thousand dollars of service revenues is a lot more attractive. Investment in these sustaining innovations represents the past road to success for many product categories.
• Third, companies will tend to over-service customers leaving room for disruptive less capable products and services. Using a netbook, tablet or smart phone for interacting with the Internet provide clear examples of usage where the less capable technology is more convenient, more affordable or merely sufficient. The lower cost of these disruptive technologies will often open up a new group of users that previously would not have been able to afford the offering.
• Fourth, when margins get compressed, vertical integration occurs. Amazon’s launch of its Fire tablet demonstrates this principle. Estimates of Amazon’s manufacturing cost vary between $150 and slightly over $200, but it hardly matters any more to Amazon that the cost of the razor does to Gillette. Both companies look at multi-period profitability and the revenues generated by the initial sale.

The key insight here is that traditional views of business profitability – single period profitability and individual product profitability often are less important that relationship profitability over multiple periods. This is something well understood in financial services where sophisticated banks and credit unions look at relationship profitability. They promote products based upon their ability to bring in relationships that will be gateway products.  It’s a bit like the heroin distribution business. The initial product use leads to more sales.

One implication of this insight is that it increases the amount of capital needed to build a business based upon multi-period profitability. The challenge is that venture capital firms like to keep their investees on a short leash. With wrong venture capital investment group, a startup runs the risk of being put out of business because of the need to iterate the strategy or the time required for frequent fund raising. And with some venture capitalists having difficulty in fund raising themselves, these “short leash” funding strategies can be even more risky than they initially appear.

So What’s the Good News? Why is it the Best of Times?

There is good news.

The first piece of good news is that with the current high rate of unemployment and generally depressed state of the economy, businesses that think differently about how to offer value demonstrate tremendous success.

Fix Customer Costs

Consider Netflix. Netflix is an extremely clever company that understood before anyone else that there is an effective limit to the amount of time that people can afford to spend renting movies. By offering a fixed price arrangement, they create value for customers by fixing their monthly cost. In contrast, many airlines seem to have an innovation department designed to make the cost of flying unpredictable.

The conclusion: customers like businesses where there is no pricing surprise. Competing against a competitor that does not recognize this customer need is likely to be a productive strategy.

Offer Synergistic and Multiple Value Propositions

Consider smart phones. Smart phones, as a product category,  offer a consumer multiple benefits. They are a music player, cell phone, video playback device, still and video camera, low end computer, email device, Internet device, GPS device.

The conclusion: offering multiple values can increase the perceived value of a product and service offering. In the same way that Microsoft offered a bundled productivity package MS-Office, a cell phone is not a cheap purchase, but the cost per piece of functionality is lower than the purchase of individual components.

Simplify Choice and Pricing

Consider pricing. Pricing is a complicated area in most companies. It’s an area where many people have input. There is almost never one person accountable. Pricing specialists vie with the VP Sales, VP Marketing and CFO for influence. What distinguishes a wildly successful company such as Apple is the clarity of its pricing. It’s hard to identify another company that has maintained consistency of pricing clarity over a changing product line. Many have observed that Apple typically offered three prices in the market so that customers were not cognitively confused about their choices. If for example, you wish buy an iPad you face only two decisions: 

1.       Do I want the option of 3G so I connect when outside my home or office?
2.       How much memory do I wish to pay for? 16, 32 or 64 gig?

In a sense you can see these pricing options as influenced by software interaction design. Good software design typically reduces the number of choices that a user must make and it is typically goal oriented. When you have this limited palette of choices, you are more likely to buy and less likely to worry that you are making a sub-optimal decision. In the smart phone area, Apple’s limited choices make selection of an iPhone far easier cognitively than the bewildering array of Android phones.

In the same way, curated applications on the iPhone platform contrast dramatically with the lower level of quality control on Android apps, where malware has been more of a problem. 

The conclusion: your pricing model can change perceptions and adoption of your product. While pricing may not be sufficient if you have a poor product, having a good product with confusing pricing is a recipe for failure.

Shamelessly Exploit Your Competitors and Their Investment in Technology

Most engineering based startups put most of their initial capital into product development.  While to some extent, this is an understandable approach, it is often not the most effective method of learning about customers and growing a business.

Learning about what customers really value and will pay for is critical. Bob Cooper’s research on new product development success rates suggests three important conclusions:

1.  The strongest predictor of new product success is offering a differentiated high value product.
2.  Value is not homogenous and varies by segment of the market and also by the objectives of the user.
3.  The most common cause of new product failure is inadequate market research and understanding of customer needs.

The conclusion: the upside of the wide availability of products and services is that a startup can choose to license, resell or repackage technology that has been already developed. Honda distributed an SUV by Suzuki as a way of both filling a whole in its product line and learning about the SUV market. The same redistribution option is often an attractive way of learning more about customers and their needs.

This strategy is often an excellent way of entering a market and reducing capital costs. Perhaps even more importantly, it allows the investment of scarce capital into marketing, promotion and sales. And with a track record of customers and revenues, it may be easier to raise money from angel investors and venture capital firms. Even better, if the innovations developed build upon the initial resale relationship, there may be an opportunity to turn a supplier into a distributor.

Some Companies with Platform Strategies Can Be Supportive to Some Small Businesses

Innovation often takes two forms: product innovation and platform innovation. Platform innovation requires the development of partnering relationships with other companies, who must develop applications to run on the platform.

Nokia got into trouble because it generally built superb hardware devices but was weaker on its platform strategy and was forced to ally with Microsoft to catch up with Apple and Android. Companies that offer dedicated devices will increasingly find it hard to compete against more general purpose platforms where software functionality can replace a dedicated device such as a remote at much lower cost. Sonos, the well designed wireless music system offers a remote for its music systems but recognizing the proliferation of iTouches and smart phones also offers a free remote application on the iPhone as does the video streaming box manufacturer Roku.

HP’s recent announcements about its tablet offering demonstrates the importance of having a supporting ecosystem for a platform strategy. If you have a platform strategy, you need to put in place programs to encourage or incent potential partners to adopt your platform.  Without an ecosystem strategy, even the best product is unlikely to succeed.

Ecosystem developers need to ensure that their environment remains attractive. Apple’s current 30% distribution fee is increasingly forcing its ecosystem to develop non-native applications that are browser based to avoid its distribution fees and will over the longer term weaken Apple’s hold on its developers.

The conclusion: large companies need partners to make their ecosystem work. A small company should shamelessly exploit this need and demand significant incentives and help from a late developer of an ecosystem. The availability of cross platform development tools and approaches can also provide greater customer reach.

Marketing Matters and Makes a Difference in Creating Successful Startups

Above all, the biggest opportunity is to remember that marketing matters. It makes a difference. There are at least five reasons why companies should invest in marketing:

First,  understanding your customers leads to better design of a product or service.  Obtaining ongoing customer feedback quickly allows for more rapid iterative improvement.

Second, while building general purpose products would seem to make sense from a product development perspective, customers look for ease of use and solutions that match their needs. Nailing down what customers need and delivering what they need means taking a general purpose product and ensuring it solves the customer problem.

Third, benefits and positioning need to be tailored to specific types of adopters. RIM has been very successful in the enterprise space because it tailored its features (security, bandwidth, central management) to the needs of IT departments managing email to mobile users. Its less successful tablet launch appeared designed for corporate users but was marketed as being appropriate for any user.

Fourth, what customers, prosumers, reviewers and other media report about your product or service is part of the “value” of the product.

Fifth, those who design products understand them too well. They lose their ability to take an outside-in or customer view of the problem. Product designers and developers typically focus on relatively obscure features without quantifying the key benefits the customer may care about. 

Perhaps the most important reason that marketing matters is that in an environment with many competitors, spending money on letting your customer know that your product exists creates more revenues for you than for competitors who don’t let customers know that they exist. Product leadership is not just about who has the best product, it also involves reaching customers.