Strategic Execution Part 3.3: Business Model Validation
This blog is part of a series of blog posts on the 6 stages of corporate development with the overview here. In previous blog posts, I explained what strategy is, why it is needed, and how it is developed and executed. In this post, I will outline the third of six stages of strategic corporate development for growth from inception to Exit; mastering the highly differing and even contradictory demands and focuses of each of these independent stages is the key to successfully navigating the entire journey.
The purpose of the Business Model Validation stage is to tune the company and all the processes and core product to set the stage for growth. The previous stages have brought the company to having a product and market micro-niche match in which to sell, with repeatable and scalable revenue, and reasonable customer churn. Without this, the company is a business, but without being able to do all of this without generating sufficient profit to fuel future growth, development, and eventual capital returns, that business is not sustainable. The purpose of Business Model Validation is to update the product and processes associated with that product to a state where the value created for customers and captured by the company can support continued growth. It is at this point, where the company should start being managed by processes more resembling a growth stage company, as referenced in the beginning of this post. The process is to execute micro-niche focused growth and product development, while also performing a series of internal process transformations and associated automation.
Business Model Validation Objectives:
Continued growth and servicing of the customer base, development of the product and sustainment or improvement of pricing and churn rates.
Stand up marketing and sales processes including marketing channels, ideal customer criteria, messaging, toolsets, and content, also including solidification of testimonials and other proof of performance, and finally a sales funnel process and associated collateral, proposal material, and digital tools that may facilitate these processes.
Continue to mature and benchmark as necessary the product management, product development, delivery, integration, training, support, and retirement / closeout processes including all services that touch the customer.
Stand up and evolve internal productivity measures for all organizations and processes.
Step maturation in corporate support processes such as HR, finance, compliance, etc.
Achieve an industry / business / investor appropriate ratio of LTV to CAC as a measure of the company’s success in refining the value produced and captured to support growth.
Usually, a step maturation in governance processes is appropriate and required with the addition of institutional investment.
Business Model Validation Metrics:
The metrics of each stage build on previous stages. Runway, through cash and time management of the team remain a key metric as do the traction metrics of revenue as well the metrics associated with the uptake step model shown in Figure 2. The metrics added in Product / Market Validation remain important including Product Cohort / Complete Customer base churn, Customer Value versus Pricing, Gross Margin and unit economics for the company, Customer Acquisition Cost (CAC) and Life-Time Value (LTV). The company should start tracking the ratio of LTV to CAC. All of the above metrics now solidify as the primary corporate-wide metrics, from which the company’s true Key Performance Indictors (KPI) should be selected (or Key Results Indicator, as appropriate). Added to this set of metrics are metrics that will be highly dependent on the organizational structure and the inherent functional process design of the company. These metrics are time, cost, productivity, and quality measures associated with all of the organizations and other key processes in the company.
Business Model Validation Areas of Consideration:
Business Model Validation is the most ignored stage of corporate development in startup companies. We are all products of our experiences, and there are a class of companies out there (e-Commerce, SaaS primarily) that stand a strong chance of arriving at the end of Product/Market Fit with their unit economics in order. The reason for this is that many of their externally facing and internal processes are inherently software based and efficient to begin with. Another way to look at this is that any efficiencies are generally exposed to the customer and thus take on greater urgency in earlier stages. In either event, failure to perform this stage can doom your company to being an inefficient capital-sucking beast that is not scalable. At minimum, all companies should treat this stage as a criteria-driven non-optional stage that may be performed very quickly.
At this stage, companies tend to start being run as growth stage companies from a strategic planning and execution perspective. Cyclical strategic planning with purposeful strategic projects and continued product experimentation (referenced as product mapping in the Product / Market Validation Stage) are the focus. The projects should be a mix of process standup and improvement across the entire organization. The process should be iterative and prioritized by internal process interdependencies. ROI as a strategic management tool to prioritize initiatives becomes important once the company enters the Product / Market Growth stage. This should be introduced at this stage as part but not all of the priority criteria. Depending on the state of corporate processes, however, ROI may or may not be most important as a measure as some processes and tool introductions are simply not optional and ROI calculations may not be particularly reliable.
There are five (5) key focus areas that start to become important during this stage:
Continued Product / Market refinement
Customer Acquisition Process
Value Delivery Processes including retention
Talent development and retention
Management and Governance
The continued evolution of the product and the understanding of which market niches to which to target the product is an ongoing key focus area from this point forward. This should always include evaluation of the ongoing viability of the product within its targeted market niche. As noted before, I will write a deeper blog post on product and product portfolio management to address the nuances of this process.
Customer acquisition processes include ongoing market sub-niche exploration, demand generation, prospecting, sales, portions of onboarding, and portions of retention among possibly others unique to your product and company. This stage is the first point at which it makes sense to develop a formal sales team, as well as territories or market niches or other means of managing sales conflict. The marketing team should have been seeded during the Product / Market Validation stage, and expanded during this stage. There is a well-proven adage that marketing scale up should proceed sales scale-up so market demand is in place before the sales team attacks that demand. It is also worth recognizing that the marketing team and a seeded sales team are required to develop the prototype sales processes along with the business development team (usually the CEO or other key founder). A part of this process is ensuring a well-developed target customer profile to guide the marketing and sales activity. Another part is building at least a preliminary sales playbook. The company needs to continue to measure Customer Acquisition Cost (CAC) on a unit basis and introduce marketing channel and message refinements, process streamlining, target customer focus, proof of performance, and canned support material as well as automation to start reducing that cost.
Value delivery processes include product development and deployment, portions of onboarding, usage processes, maintenance and support, training, and portions of retention activities among possibly others unique to your product and company. I note onboarding and retention processes as split between customer acquisition and value delivery because there are a variety of process models for performing these functions. There usually is some point in the process there is clearly a transition or subtasks that clearly are one or the other. In most companies I have seen, the processes to perform the value delivery chain are purposeful ad-hocs and hacks designed to get the job done without the development that was not previously affordable or are manual processes that the original team could not spend the focus on automating. The company needs to continue to measure the Lifetime Value (LTV) on a unit basis and introduce process refinements, reformulations, automation, customer and employee training, data libraries and models, and myriad other steps to ensure the customer is receiving the intended value and the company’s cost to deliver that value is appropriately constrained. LTV is a function of value capture per unit per time-period x the number of time-periods a customer may be expected to be retained once on boarded. Delivering value and retaining customers is a key facet of this focus area and should be the first focus of the company. Process efficiency can take a back seat to customer retention, with the tradeoff that to the extent this occurs, the longer this stage will take.
An additional key point is worth making here with regard to the company’s customer base and churn rate as well as LTV. For most companies, as customers as been acquired, the product has also evolved. The product / market experimentation of the Product / Market Validation and Business Model Validation stages may have resulted in customers on boarded for whom the product is not a tremendous fit. These facts can set the company up for future churn, and will likely distort the value of the LTV calculation. Contracts that include longer periods of performance and/or performance guarantees can amplify this skewing. If the product is a SaaS product or the company has another mechanism for synchronizing product in the field, this can address these inconsistencies; for that reason, such mechanisms are strongly encouraged. Non-fit customers can be a larger problem. At minimum, the company should ensure sales into this sub-niche are deceased, the LTV and churn metrics isolated, and internal and external stakeholders informed. In addition to this, the company must choose what to do with these customers; the cost of retention can vary. In some cases, the industry reputational damage and temptation to compromise the value proposition with collateral effects is too great and relationships with these customers terminated. In other cases, the relationship can be used as an opportunity to tune the product to repair the value delivery. Finally, in some cases, the right thing to do is to let the non-fits customers languish and determine their own outcome. These options can be present within the same company / situation and the right decision dependent upon the customer. The situation should serve as a good reminder to practice good product / market hygiene as experiments are concluded.
Customer Acquisition and Value Delivery must be refined in concert with each other. First, together they typically define the entire customer journey with the company and must be holistically tied to each other if the objective is to optimize that experience; and it should be. Second, it is possible that a change in one-area effects the other with regard to information collection, prospect filtering, and even market sub-niche focus.
I will not focus too much on talent development and retention, despite its tremendous importance, as it is an appropriate topic for a future blog-post. The Business Model Validation stage is typically the point where the company will start expanding beyond the founders and their surrounding set of core employees. It is often the turning point where a number of changes happen:
The trade of equity options vs. salary becomes less of a core incentive element
New employees become less jack of all trades and more specialized requiring structure, evaluation, measurement, and more employee-specific HR management
Key core employees, and founders, will start to see their jobs start morphing, often quite rapidly with introduction of management responsibilities, planning, and other skillsets they may not have
All of these changes require an evolution in the way the company attracts, manages, retains, and off-boards employees.
The company usually requires a step-change in professionalization of the management and governance processes. The teams are generally starting to become large enough where there are layers of communication, coordination, and tactical / strategic intent. Further, both employees and external stakeholders will start demanding a higher degree of planning and performance to plan.
The exit criteria for Business Model Validation can include many different factors, but the ratio of LTV to CAC is emerging as a leading indicator of readiness for transitioning into the Product / Market Growth stage. This ratio can best be thought of as the ROI for growing the business. It expresses the expected dollar margin contribution to the company for an investment of a dollar in customer acquisition activity. There are a variety of opinions out there about what this ratio must reach; the most common opinion I have seen for venture-backed companies is 3:1 as a transition threshold; much of the empirical basis of this ratio comes from venture backed SaaS companies with a relatively low process refinement cost and good capital reserves. However, it’s worth understanding that this ratio should continue to grow as the work of refining this ratio continues in Product / Market Growth and for companies that require either greater investment in process transformation or perhaps have smaller capital reserves (in house and in investor dry powder), a ratio higher than 3:1 may be wise. Secondary indicators should also be validated including the presence of known product / market fit issues, sales obstacles, and insufficient team skills or structure.
In the next blog post, Product / Market Growth.
What stage of corporate development are you currently in and what challenges are you facing?
For most companies, the usage of external parties to facilitate the strategic planning and execution process produces superior results. The process typically involves a great deal of information processing that isn’t core to running the business on a daily basis and a facilitator in planning sessions frees up the team to focus on the critical questions rather than the process and can inject highly productive objectivity into the discussion and decisions. If you would like to discuss where your company is in the evolution of strategic planning and execution or would like some assistance in setting up or performing this critical process or just have a question please contact us.