Tag Archives: Eric Ries

3 Steps for Micro-Pivoting in Startups

Steering wheel of old sailing vesselThanks to Eric Ries, we now understand the term pivoting a company. That is, when we determine that a major assumption we previously made about our company, whether it be about the product, the market, or the competitors, is wrong, we redirect the company making different assumptions.

However, when leading a company, as when steering a ship, there is also a need to implement hundreds of small micro-corrections (micro-pivots) to the path.

Step 1: Determine “Planning” Values for Your Key Measurements

The ability to grow a company is determined by seven key variables (see 5 Steps to Get Your Startup on Track and Stay on Track to learn about them):

  1. Customer Acquisition Cost (CAC)
  2. Sales Cycle (SC)
  3. Average Order Size (AOS)
  4. Periodicity (P)
  5. Retention Rate (RR)
  6. Viral Coefficient (VC)
  7. Viral Cycle Length (VCL)

Let’s assume that you have decided that financial success will be determined by the internal rates of return (IRR) to external investors. The best indicators of whether they will receive those IRRs are if the company achieves its revenue, EBITDA, and EAT (earnings after tax) goals of $22M, $11M, and $8M.

Plan

During the planning stage, you will determine the values for the seven key drivers of company growth that are both feasible and drive the company to financial success as defined in the previous paragraph.  Use software to verify the relationship between values for these variables and financial results.

Step 2: Analyze Your Results Frequently

Each month, calculate the actual values for the seven key drivers of company growth.

  1. Customer Acquisition Cost (CAC). Determine how many new customers were acquired in the past month as the result of your direct marketing and sales efforts (eliminate, for example, referrals; but include new acquisitions through search engines). Divide the money you spent on marketing and sales this month by the number of newly acquired customers.If you have not yet determined a value for SC, but assume it is between 1 and 3 months, you could instead use the rolling average expenditures for marketing and sales over the past 3 months and divide that by the number of newly acquired customers for the most recent month. 
  2. Sales Cycle (SC). For some businesses, SC will be easy to determine; for others not so easy. For example, if you are using a direct sales force, you will be able to calculate fairly easily how long it takes from lead generation to closing a sale.On the other hand, if your sales are more passive, such as online sales, you will only be able to determine SC by plotting changes in budgets and actual sales over a period of many months. 
  3. Average Order Size (AOS). The actual for this is easy to calculate for all businesses. If your customers purchase more often than once per month, just aggregate their purchases and record their average purchases per month.
  4. Periodicity (P). The actual for this is also easy to calculate for all businesses. Just keep track of how often customers return to purchase again.
  5. Retention Rate (RR). When you first start your business, this will be very difficult to compute because a few lost customers could have drastic effects. By the time 1-2 years have passed, you should be able to have a pretty good idea of how loyal your customers will be.
  6. Viral Coefficient (VC). Only two ways exist to compute this:
    • Create a rewards-based referral program so you can keep track of exactly how many new customers are being referred by existing customers.
    • Ask all new customers how they heard about you (this is much less accurate).

Until you do one of these, you will have to assume that VC is zero or you can be optimistic, and keep entering it as a guess every month.

7.  Viral Cycle Length (VCL). Same comments apply here as for VC.

Enter these actual values and see whether they lead to financial results as good as the original results. If you are like most startups, you will find early results disappointing, and will have to decide how long you will wait before executing changes.

Actual

Use software designed for fast and easy financial reporting to identify that the new (actual) values for these variables have created quite different financial results and thus determine whether or not to pivot.

Step 3: Execute a Pivot or a Micro-Pivot

A pivot is executed when:

  • The actuals portend a poor financial outcome
  • You believe that the actuals reflect the best the company can do

In such a case, you may need to change the product, change the target market, change the way you sell the product, find new channel partners, and so on. These are significant pivots.

A micro-pivot is executed when:

  • The actuals portend a poorer financial outcome than you planned
  • You believe that the actuals can be improved by changing tactics, not through major company redirection

In such a case, examine each key driver of company growth and determine what actions you can perform to improve its specific value. Here are some examples:

  1. To decrease CAC:  Change the content or vehicles for advertisements. Change your messaging. Offer better pricing or better promotions.
  2. To decrease SC:  Offer better incentives to the salesforce.
  3. To increase AOS:  Offer quantity discounts.
  4. To increase P:  Offer frequent buyer programs.
  5. To increase RR:  Improve your product’s stickiness. This is the most difficult to improve in the short term.
  6. To increase VC and decrease VCL:  Offer referral programs.
  7. It might be that all the values are sound; you just need to spend more money on marketing and sales during the early stages of the company to “prime the growth engine.”

When you implement a series of micro-pivots, use graphs.as shown below.

 Graph 1
 Graph 2
 Graph 3

These will show how your incremental improvements to actual values for the seven key drivers of company growth are driving the company increasingly toward the predicted fifth-year revenues, EBITDA, and earnings after tax, as a function of time.

These seemingly small but very important adjustments have the power to right the ship and set your business back on the course for success.

Alan DavisDavis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books.

5 Steps to Get & Keep Your Startup on Track

If you plan your startup’s growth appropriately, you can use the identical process to keep your startup on track after you launch.

The ‘Get on Track’ Process:

1. During planning, select values for 7 key drivers of your company’s growth.

Tracka. Customer Acquisition Cost (CAC): For those new customers that you attract as the result of your marketing activities, how much does it cost you per customer?

b. Sales Cycle (SC): How many months transpire between your expenditure of marketing dollars and the acquisition of new customers?

c.  Average Order Size (AOS): How much revenue do you expect to generate each time a customer makes a purchase?

d. Periodicity (P): How often will each customer make a purchase?

e. Retention Rate (RR): What percent of existing customers will remain customers at the end of each year?

f.  Viral Coefficient (VC): How many people will each existing customer attract and successfully convert into new customers? This is a one-time conversion; once a customer refers this many new customers, we assume they no longer refer more new customers.

g. Viral Cycle Length (VCL): How many days will transpire between customers becoming new customers and their referrals becoming new customers?

Note that when planning your company, some of the above (e.g. VC and VCL) will have to be just guesstimates . . . and that’s okay.

However, you should be able to make somewhat more intelligent guesses on CAC and SC based on the type of business and the kind of marketing and sales you expect to conduct. And P and RR values should be much easier to estimate from the beginning based on your business.

2. Before you launch your company, verify that the estimates you’ve selected for the 7 key growth drivers will result in a successful company.  That is, there must be significant revenues and profit, and solid returns for all shareholders to be considered successful. If not, adjust the values until the company becomes successful.

3. Launch your company.

The ‘Stay on Track’ Process:

  1. Every month, compare your actuals to your planned values for the 7 key growth drivers. Enter actual values for CAC, SC, AOS, P, RR, VC, and VCL into your plan.
  2. Verify that the actual values for these 7 key growth drivers still result in a successful company – i.e., significant revenues and profits, and solid returns for all shareholders. If so, you are on track! If not, you must change your strategy.

Change Your Strategy

Based on which key growth driver you want to affect, different strategic changes are in order. Many options exist in every case, but here are just a few ideas:

  • To decrease CAC and SC:  Improve your understanding of the target market. Hone your advertisements to the specific pains of your target markets. Focus on the benefits rather than features of your products.  Offer better pricing or better promotions to increase close rates.
  • To increase AOS:  Offer quantity discounts. Improve your product.
  • To increase P:  Offer frequent buyer programs. Improve your product.
  • To increase RR:  Improve your product’s stickiness.
  • To increase VC and decrease VCL:  Offer referral programs, especially ones that incent both the referrer and the new customer. Make products so exciting that they create a buzz. Add features that increase your product’s value to customers.

As you can see, these seven key growth drivers are not only fundamental to planning your startup, they are also fundamental to keeping your startup on track. Not all are easy to estimate, but you can at least determine in the planning stage what values you must achieve to be a viable company.

Once you launch your company, not all seven are easy to measure, but as you progress, they will become easier. Drive your engine towards success!

Alan DavisDavis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books.

“On Track” Photo courtesy of Clare Wilkinson (Creative Commons)

Why Every Startup Needs a Financial Plan

Assumptions are Important

money-down-the-drainHaving a financial plan for your startup is based on a simple concept. It says “If these assumptions prove true, then these financial results will occur.”

In other words, a financial plan is the place where you determine whether or not your business idea could possibly result in financial success.

To start a business without a financial plan would be like sailing out of port in a sailboat with no navigational tools and no idea where you are going. In the case of the sailboat, your life would be at risk. In the case of a startup company, any money or time you are about to invest is likely to go down the drain.

Notice that I am not saying you need to have all the facts before you launch your company. But you need to at least document the assumptions you are making about the business and verify that if those assumptions end up being valid you have a viable business.

In The Lean Startup, Eric Ries provides us with sound advice for starting a company: State your assumptions and then make many small iterations. For each iteration,

  • Invest as little as possible
  • Build a minimally viable product (MVP), i.e., build something you can show your customers
  • Learn which assumptions are valid
  • Pivot and repeat

Innovation Accounting

As a metric for determining that you are making progress, Ries recommends using innovation accounting (IA). IA is basically checking that assumptions are being verified, the product is progressing toward viability, and the startup is learning – all good things.

Traditional Accounting

I would add just two steps to his advice:

  1. Before you launch, build a financial plan based on your assumptions to verify that financial success is at least possible.
  2. At the end of each iteration, repeat the financial plan to verify that the revised assumptions are still sufficient to support financial success.
 Iteration Ia

A company following the traditional lean startup approach is iterating and “making progress” but it is unclear if it is heading in a financially viable direction.

No Financial Plan;
No Knowledge

 Iteration II

By creating a financial plan, you can learn that the path you are considering cannot result in a great financial result.

Financial Plan Shows Poor Results

 Iteration III

By recreating the financial plan with different assumptions, you can determine that charting an alternative path could result in a far better financial outcome.

Change Path & Financial Plan
Shows Good Results

My advice makes sense only if creating a financial plan is not overly time consuming. The secret is to use a tool that supports automatic generation of financial statements directly from your business assumptions. By doing so, financial planning costs you little but saves you a lot.

???????????????????????????????Davis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and author of six books.

Pivoting Without Blinders: Advice for Startups

HorseBy their very nature, startups are full of unknowns. These unknowns are not the blinders in your startup.  Failing to acknowledge these unknowns and give them a value are the blinders.  It is this that hampers success and slows down your horse.

Entrepreneurs have an obligation to their stakeholders to ensure that assumptions they are making about these unknowns could possibly lead to financial success.

For example, a classic unknown for most startups is the price that customers would be willing to pay for your product.  Your startup needs to document some believable price and then demonstrate that if sufficient customers purchase the product at that price, then your company would be viable.

After you’ve launched your company, many of the assumptions you used will be proven false. You have three choices.  Here are those choices with their advantages and drawbacks:

Stick to your original plan   If the assumption proven incorrect was relatively minor, this is a valid alternative. Otherwise, it is somewhat foolish.

If customers aren’t buying at the assumed price, change the price or change the sales method or change the product.  Do something!  Don’t just decide that persistence is always a virtue.

The advantage of sticking to your original plan is that it is what your original investors expected you to do. The drawback is they would much rather have you pivot than lose their money.

Pivot   In my startup #3, we had always envisioned ourselves to be a product company (and gave many of our services free to our paying customers).

After two years without success, we pivoted to become a services company (and gave our products free to our paying customers). That move made us profitable.

The advantage of pivoting is you explore all viable options for your company. The drawback is that, without discipline, you could explore options forever. One secret is to spend as few resources as possible between iterations.

Learn quickly.  Pivot intelligently.  Determine that each pivot has at least the possibility of a sound financial outcome.

Abandon your startup   This is the most extreme case of a pivot. It comes in two flavors: personal and company.  I did a personal abandonment in one of my startups because I had assumed my business partner was ethical; he wasn’t, and I was out of there!

Company closure is the right move when you have seriously considered every possible direction and each one is either impossible to execute or leads to an outcome without financial success.

The advantage of abandoning your startup is it makes no sense to throw good money (or time) after bad. The drawback however is with a bit of tweaking you might have a perfectly viable company.

Wise entrepreneurs pivot. They modify disproven assumptions, once again assess whether the plan could possibly lead to financial success for all stakeholders, and if not, adjust other assumptions until they are once again headed in a direction toward a lucrative financial state.

As you assess your startup, consider how to pivot your business intelligently:

  • Spend as few resources as possible between pivots
  • Compare alternative directions for your next pivot and select the most viable
  • Do a financial analysis to ensure the new direction could result in financial success

Also consider the benefits:

  • Lowers the risk to you
  • Lowers the risk to investors
  • Raises the likelihood that your company will be successful

Assessing the terrain and making adjustments is the essence of pivoting and of responsible entrepreneurship.

???????????????????????????????Al Davis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and author of six books.

‘Running beauty’ photo courtesy of Tambako the Jaguar (Creative Commons)