Benchmarks & Definitions

The Chilli Value Test ™

By The Chilli analysts

As an entrepreneur, you may have a 'Eureka' moment - that point in time where you have a great idea that may generate your fortune. Before you proceed to write your elevator pitch and your business plan, it's good practise to validate your business idea, to see if it will form the basis of a sustainable business. The Chilli Value Test ™ is a framework to help flesh out your thought process, strengthening the idea as well as preparing for the creation of the business plan and the due diligence from potential investors.

1. What problem are you solving?

2. What value are you adding?

3. Is the market big enough and growing?

4. How will you make money?

5. Barriers and paths to entry

6. Competition

7. Validating your idea

8. Overcoming customer inertia

9. Risk analysis - don't be surprised!

10. Key ingredients for a business plan

Summary

1. What problem are you solving?

You must be clear on the kind of problem you are solving. There are two categories. Are you putting out a fire? Are you solving a burning need, like the example of Cisco, who solved the problem of routing email across networks of incompatible bridges, hubs and routers?

Or are you making life easier, cheaper and faster? An example of this is the microprocessor, which allowed the mass production of computers and advanced consumer applications, such as games, set-top boxes, etc.

Startups are best focused on addressing well-defined problems. Avoid anything that is akin to a black hole that will drain your limited resources. Large companies have the advantage of resources and economy of scale. In contrast, the greatest advantage a startup has is its speed and agility in decision-making. A startup can make and execute a decision much more quickly than a large organisation.

2. What value are you adding?

If your solution is to be noticed, it should ideally address some kind of major problem. If it is a minor annoyance, you may find that people are quite happy to live with it, or may have a workaround.

How big is the problem? Can you quantify your value in terms of time, cost or speed? If your value is in terms of time to market, quantify it in terms of man months. Ultimately, it must be a tangible advantage, if you are to convince the ceo, cfo or vp of a potential customer.

It is important that you provide both a competitive advantage and a cost reduction (see 'Overcoming customer inertia').

3. Is the market big enough and growing?

Is this feast or famine? Growing markets can afford new players, and even market consolidation allows exit via merger and acquisition, making it attractive for investors. However, if the market is small with several competitors, you will find it hard to survive on reduced margins. If it is a market with one or two customers, you will find that they have a degree of monopolistic/duopolistic power over your business, and a cancelled order could kill your company. It is important to ask yourself whether this market is a growing niche, and how long it will remain so (see 'Competition'). If the area you are addressing is a commodity, beware the resources required for marketing and promotion - commodity products and services are the realm of the large enterprise - not the startup.

4. How will you make money?

Billion dollar estimates are not credible. Markets of that size consist of customers in different geographies with requirements so varied that they consume the product or service in different formats, rendering it impossible for one company to service them all effectively. Look at other companies in your niche - check their annual reports. Add up their annual sales into that segment, and that will give you an idea of the market size.

It is advisable to identify the niche that you can service, and determine who the customer actually is - many startups make the mistake of selling to the wrong part of the chain. Selling into a market is not quite the same as selling to a customer. So determine who your customers are, and how many there are in your chosen niche. Are there less than ten customers? Perhaps more than ten? Or is it a consumer mass-market proposition that will require much greater resources and indirect channels to market?

What will be the average selling price (asp)? What is the target customer's budget - can they actually afford to pay for it, and will they pay for it? Many startups pick the wrong kind of customers - check their financial viability first. It is best to stick to tried and tested business models. Will your business be based on licensing and royalties, services or unit product pricing? How many do you have to sell to reach your revenue targets? Remember that businesses sell products and services to customers that pay. Anything else is a charitable concern.

What is the sales cycle involved? You may have to allow sufficient time to start the relationship, allow an evaluation, then use of your product/service in a real project, before the project hopefully reaches volume production, turning into revenue for you. Markets with very long or complex sales cycles are not well suited to startups with limited budgets. Examples of such markets are the automotive industry as well as government tenders. However, such markets may provide an opportunity to partner with an organisation that already sells into that space (see 'Barriers and paths to entry').

5. Barriers and paths to entry

Section 1 emphasises the importance of well-defined markets. Many markets are vertically-integrated, with users, specifiers, operators, etc. Examples are the mobile phone and pay TV markets. What is the specifying authority for the market niche you are addressing? Is it a standards body or trade association? Is it a network operator or a regulatory authority? Does your product or service need approval?

Is the required know-how to address this niche freely available, patentable or proprietary? You should start identifying potential partners, that can provide you with access to specific sales channels, complementary technology and/or products and may even open up new markets to you. This is a very important point as you should aim to have some 'unfair advantages' to protect your niche from the attentions of others.

6. Competition

If you have no competitors, it may be because there is no market for what you are doing! It is important to remember that you are competing against companies, NOT products. You should investigate a company's financial and human resources, the skill set of their management team, their product/service portfolio, r & d/manufacturing capability and ownership of a channel, segment or strategic relationship.

If you have targeted a growing niche, at some point you will attract competitors, who previously ignored it. Identify when you think this is likely to happen. It is of course best to work in stealth mode for as long as is reasonably possible (but not so stealthily that potential customers, investors and partners don't know you exist!)

Can you use any unfair advantages, in terms of product proposition, partner or customers, to establish and then maintain, a rolling lead of 12-18 months ahead of the competition? Remember, a startup's strength is its speed and agility of decision-making.

7. Validating your idea

Get out there and use every moment to test and refine your idea! People love to talk. Read trade journals, pick up the phone. Visit trade shows and meet potential customers, partners and competitors - remember to remove your visitor's badge.

Flexibility is key, and you should be prepared to adapt your objectives, strategy and tactics upon receiving new information, and processing this information quickly will hold you in good stead against your larger competitors, where bureaucracy and filtering mechanisms are at work.

Read, phone, visit, ask open questions and above all, listen. By doing this, you are already on the way to building the relationships that your business needs.

8. Overcoming customer inertia

You must think about your target customers from the outset. As stated in section 4, they must attach a value to what you have, be willing to pay, and can actually afford to pay. Many customers will like you and be happy to invite you back. This may be because you are keeping a bored engineer occupied, or are developing a friendship instead of developing your business, or perhaps they are pumping you for information. In any case, you may not be any closer to a purchase order. As good practise and self-discipline, work out how much it costs you to court your target customers in terms of travel budget, preparation time, travel time, etc.

Spend your time trying to learn how the customer organisation makes decisions. Who holds the budget (signs the cheques)? Who is the influencer, and who will champion your cause internally?

You may feel like encouraging the customer to use your product or service on a trial basis, or provide free support. Try to avoid doing this, except for a special (pre-qualified) opportunity. The danger is that by doing this you set a precedent, which becomes a habit, and this forms a costly legacy that will hamper your organisation's operations and growth. Again, work out how much it costs you to trade with a customer - the cost of customers sold. The time and money wasted on a lost opportunity could have been better spent on pursuing a more worthy prospect.

If a customer already has an existing supplier, beware of the time it takes to change habits. The incumbent supplier has the advantage of an existing relationship (staff on both sides will have 'grown up' together), some track record of delivery and a price agreement. Customers will see a new startup supplier as a potential risk, and conservatism will be in play here. The sales cycle may be long and complex, and it may be better to attack the customer through partnership with an existing supplier or perhaps attack a smaller, but less risk-averse prospect, in order to gain traction in your chosen niche.

9. Risk analysis - don't be surprised!

Remember: anything that can go wrong will go wrong. Your software will be buggy, your chip may need two re-spins before it works properly as a product, rather than just sample silicon. Even if you have a signed a term sheet with an investor, you could be waiting for three months before the funds are cleared in your account.

This is your business, so of all the people involved in working for/with it, investing in it, etc, you are the one who should be least surprised when things go wrong. So prepare for it. Identify the risks and potential solutions.

If the product is behind schedule, can you increase resource, reduce the feature set, or phase the release, without losing your customer?

If a specific competitor has entered your niche, you should have seen it coming. You should have some channel or product advantage.

If your target customer falls through, your sales pipeline should have identified at least one or two more qualified opportunities.

If the customer is unable to pay…..well, this shouldn't happen. You would have selected the right customer, performed a credit check and taken some money upfront! Serious customers would have no problem with this.

If the market takes longer to develop, do you have a plan to generate some revenue in the short-term? If you foresee a funding shortfall, are there any grants, loans or saving you can tap (against visibility of your future revenues)?

Your board will expect you to anticipate things. If you don't have a plan, a less-than-ideal plan may well be imposed upon you.

10. Key ingredients for a business plan

You are now reaching the point where you are ready to start writing your business plan. Contrary to much advice, there is no standard format for this, but there are some standard points that need to be covered, including the market you are playing in, details of the niche you can service, what you will service it with. You will also include some details on how it will be developed and who by, as well as information on your competition and how you will overcome them. You should also include some details on how you will overcome customer inertia and sell into your chosen space. Don't forget background details of the management as well as detailed financials, including a breakdown of overheads, a figure for the revenue required to breakeven, a timeline showing how long it will take (with milestones on the way) as well as an estimate of how much you will burn through in the process.

Summary

After reading the ten points of The Chilli Value Test™, how many could you sufficiently address? If it's under four, then you need to conduct more research. If it's between five and eight, you can start validating your plan, and if it's over nine, you are ready to hit the road. Remember, this is an iterative process. Following this framework will improve your idea and your plan, making it stronger, and in the process, more attractive to potential investors, who will be impressed by your command of the facts and your thoroughness (they are investing in you, not just the idea). Investors expect that you know your market, competition and weaknesses.

Comments on this benchmark/definition? Send an e-mail to Editor@theChilli.com.

© Chilli Publishing Ltd 2003

06SEP2003