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