Published at Innovation Excellence, December 27, 2012 (http://www.innovationexcellence.com/blog/2012/12/27/four-rules-to-snap-judge-a-new-venture/)
As an angel investor (in multiple angel investor networks, from Silicon Valley to Dallas), as an evaluator for the North Texas Regional Center for Innovation and Commercialization, and as the Vice President of Corporate Strategy and Business Development for Interphase Corporation, I analyzed multiple businesses for investment and acquisition purposes in the last 20+ years of my profesisonal career. In 2009 alone I suspect I reviewed more than 600 different businesses. Obviously, you need to develop “snap judgment” capabilities, that allow you to quickly, in less than a minute, develop a “gut feeling” for whether a certain business is a good investment or not. Many have developed different criteria, and even my own criteria has evolved over the years.
Here is the current set of criteria I’m using. It is by no means provided here as a guide and I am not claiming that this set is better than anybody else’s set. But it works for me. It is made of four components (questions):
Is it different?
The new business, technology, business model, has to be different than anything else in existence. It has to differentiate itself meaningfully. Not marginally. The difference has to be substantial. Once I identified how this is different, I check the different values that it provides compared with competing offerings (whether directly competing or substitute products or services). This is where “480mbps over 1.5GHz spectrum using OFDM” (technical difference) becomes “higher throughput data” (value difference). Not only advantages need to be listed. Disadvantages should be listed too. By the way, there are cases where one difference could be an advantage in one scenario, and a disadvantage in another. Keep reading…
Now it is time to list the potential users of such product or service. Most of them are easy to identify, as they are the same users of the directly or indirectly competing technology, products, or services. However, some are not easily identifiable, as those are users that could not be served by previous offerings at all, and thus were never considered users. Those are typically where the market disruption occurs. To find those, you must ask yourself “who else can benefit from this?” For each one of those users, indicate whether they care about every differentiated feature, how much, and whether this differentiation is a positive or negative for their specific use. For example, let’s say that you just invented a new engine that is quieter than any existing engine. If you look at military applications, where stealth is important—this would be an important positive differentiator. In the radio controlled airplane market, on the other hand, this is actually a negative, as the hobbyists are looking for authentic (many times—WW II era) sound. A quiet engine is a negative differentiator… The result of this question needs to be an identification of the customer (customer segment) who really cares about the differentiation of the product or service, and to whom this product or service is ten times better (10x) than anything else in existence. Let me be clear—I would never recommend investing, acquiring, or entering a business where the potential customers see 10% benefits at best. This is not really differentiation. However, we need to be careful when discounting a technology that delivers 10% performance improvement, if those 10% cross a utility line that represents a 10x value improvement for the customer (by allowing something that could not have been done before, when technology was 10% worse). The improvement needs to be considered from a customer value perspective. Not from a technological parameter perspective.
Why me and not them?
What is the competitive advantage that you have? Plenty was written about this topic, with one of the masterpieces being Porter’s five forces model. Do you have any advantage over the competitors (current and potential)? You need to be very pragmatic when answering this question. Don’t allow for biases. In one meeting of an angel network one of the presenting companies was asked “why can’t a competitor enter this market as quickly as you did?” and the answer was “this is not something that two guys in a garage can build”. So we continued and asked the entrepreneur “how much work was invested in the development of your product?” to which he replied: “the three of us worked for a year on this!”. So, it took three guys in a garage. Not two… Still not a compelling enough entry barrier for fast followers. The second part of the “why me and not them?” question is the sustainability of the competitive advantage (sometimes referred to as “sustainable competitive advantage” or SCA). How can you make sure that your competitive advantage is sustainable in the long term, and not only until revenue needs to start? Patents (if they are really good ones, and I will not discuss here what constitutes a good versus bad patent, although I certainly hold passionate opinions no the topic) can provide that. One of my favorite approaches to SCA is “vectors of differentiation” (as described in McGrath’s “Product Strategy for High Tech Companies”), where you continue to develop your products along a certain committed, differentiated value adding vector, and stay ahead of your competitor. The question of a “first mover advantage” (FMA) often comes up. Is being first good enough? Suarez and Lanzolla (2005) in their article “The Half Truth of First-Mover Advantage” claimed that FMA can exist the most when the pace of both market evolution and technological evolution are slow, and less (or none) if they are fast. I wanted to just add my opinion on price-advantage. To me, a price advantage is one of the trickiest forms of competitive advantage, and could only be claimed the the company really (be very pragmatic about that!) has a structural cost advantage that cannot be immitated by competitors.
How do I turn it into a business?
Finally, if the product or service is differentiated, and it delivers 10x value to a customer, and you can do it while preventing others from doing the same, the last question is: how do you make money off of it? What is the right price? What is the cost? What is the investment required to generate this revenue? When will it break even? When will it return the investment? What are the risks (development, market, others)? How does the return on investment (ROI) from this business compare with other alternatives (such as risk-free investments)? All first three questions could be answered positively and enthusiastically, but there is still no profit in this business. Unless you want to start a non-profit. Unfortunately, I’ve seen many for-profit business ventures become non-profits. Unintentionally…
image credit: internationalplaythings.com