A Simple Process for Setting Priorities for a Startup Idea

Spoiler: Test the assumption that is cheapest to test first

Warning: This process is a ‘rule of thumb’ and needs to be adapted for every context. As always Context is King.

I’ve used this process (or variations of it) about a dozen times, both when launching my own company and when evaluating new revenue streams in existing businesses. The process is simple but encourages rigor and focuses the business owner on what is important and not on what’s exciting.

There are two goals to the process. The first is to discover flaws in the business idea as quickly as possible and thereby minimize the human and financial capital expended. The second is to maximise the the value of the business as efficiently as possible.

Process Outline

List out the primary assumptions of the business such that if they are all true then the business will meet your ambitions for the company. If you’ve got more than 7 assumptions then you’ve probably gone too deep. What we are after is primary assumptions – note in the below example that there is one primary assumption for customer acquisition, not several secondary assumptions (cost of a lead, conversion rate of leads, cost of sales reps, etc.)

Next order them by how much they cost to test (don’t forget your time is a cost too, it is normally far more significant than the financial capital). Finally, test the assumptions in that order – the cheapest one first, the next cheapest second, and so on.  That’s it, you’re done 🙂

Sample B2B SaaS Startup Assumptions

  1. There are 50,000 potential customers in our target market
  2. Average revenue per customer will be €3,000 per annum
  3. The cost of acquiring a customer will be €2,000
  4. We will be able to build MVP for €50K
  5. Annual retention rate will be 85%
  6. We will be able to acquire 20% of the market in 5 years

Typically there are two or three assumptions that can be tested cheaply and there are always a few assumptions that can’t be tested until you are in business for years (retention rate, market penetration, etc.). However each proven assumption radically decreases the risk of the overall business idea and therefore increases the valuation.  If you imagine that each assumption has a 50% risk factor then every one that you can validate halves your risk and doubles the effective valuation.

Building Product First is Nearly Always Wrong

In the above example the assumption that an MVP can be build for €50K is mid way down the list and this is a fairly typical priority for most startups. It is nearly always significantly cheaper and quicker to test customer acquisition and pricing. Yet it never fails to amaze me the number of startups that decide to build a product before testing the cheaper assumptions.

Imagine spending €50K on a MVP only to discover that customers are only willing to pay 10% of what you’d assumed.  You have now just wasted €50K and a year of your life when you could have tested this with a hundred phone calls completed in a couple of days.

Bring it to the Next Level

It is easy to bring this to the next level by incorporating other factors into the calculation of priorities. Risk level is a good one, where you heavily weight high risk assumption so they get tested sooner.  What you include will depend on your own context but should always be centered on creating a more effective prioritisation that minimises risk and increasing value rapidly.

Increase your Pricing to Increase Your Sales Volume

Spoiler: Because you can spend dramatically more on Sales and Marketing

As I explored in the previous post – very frequently your price is only a very small aspect of the total cost to your customer. For many IT solution is can be as little as 10%. Therefore a increase in your price may not make a noticeable effect on your customer’s cost and therefore the Law of Demand may have a negligible effect in reducing demand for your product, however it can have a dramatic positive impact on your business.

Worked Example

Startup AAA is selling a product for €10,000 and makes 5 sales a month. Startup AAA has a sales and marketing budget of €3,000 for each sale – so they can spend €15,000 a month on acquiring new customers. Startup AAA’s price is 20% of the total cost of ownership for the customer.

If Startup AAA increase their price by a modest 20% to €12,000. This only increases the total cost to the customer by 4% (since price is only 20% of the cost). While unlikely, this small increase in cost may impact on minorly on demand, however the impact of this extra funds has on sales and marketing can be dramatic. In this example the amount spent on sales and marketing can be as much doubled to €6,000 per sale. With the additional resources that this spend allows, sales and marketing should easily be able to increase the total volume of sales.

So price increases disproportionately positively affect your sales and marketing budget (or alternatively profit) while disproportionately minimally impacts on the total cost for your customer.

It should go without saying that price increases like this only apply if your competitive advantage is not price, but then again if you are a startup competing on price then you’ve got bigger problems.

Your Price Does not Equal Your Cost

Its economics 101 that when you increase the price of something the demand goes down (The Law of Demand). Unfortunately, like most 101 courses, this is a partial truth that needs either further study or practical experience to be useful and as the old adage goes – ‘a little bit of knowledge is a dangerous thing’.

No doubt you’ve all seen the law of demand used to justify low prices. It is particularly dangerous to a startup as it can be used as logical proof to an emotional decision to have rock bottom prices. We all fear rejection and we emotionally want to do everything we can to minimise our chances of it. So we tend to lower our price to a level where it can no longer be an issue.  

However for startups your price, no matter what you set it at, is almost never the issue. The problem is your total cost to the customer and price is just one small element of this.  Your total cost is a long list but for most startups the largest cost to the customer is the personal risk to their career of doing business with an startup as opposed a known quantity.

“Nobody ever got fired for buying IBM’. While obnoxious, this 1980’s slogan this hit upon a core business truth – not only are we, as sellers, ruled by emotion (fear of rejection) so is the buyer (fear that their purchasing decision will be perceived as a failure). If the project fails because they chose a startup rather than an established player, even if vastly more expensive, their choice will look unjustified and unnecessarily risky to their boss (and everyone has a boss).

There are many other costs that go into the total cost born by the customer and I won’t go into them at length, but they include evaluation, training, support, change control, hardware etc.. For IT solutions these costs can frequently outweigh the actual price 10 to 1.  A 50% reduction in your price may only represent a 5% reduction in the total cost of ownership. Similarly a 50% increase in your price may only represent a 5% increase in the customer’s total cost.

Remember, as a startup, if you are going to be rejected, it is almost a certainty that it’s not your price that’s the problem – it’s your cost. Even if you are told by the lost customer that its your price, it still probably isn’t. Most people shy away from hard conversations and a potential customer telling you that you are rejected is a hard conversation. In these circumstances people tend to use the easiest way to end the conversation quickly – saying your price is too high is nearly always the easiest.

A final thought: unless you are a commodity, you either have a lot of value or no value. Unless you have a lot of value, your solution will never overcome the other costs that have to be borne by the customer, and you effectively have no value. It’s not a linear scale, its binary.

Next Blog Post I’ll explore how high pricing can increase demand rather than reducing it.