Looking for startup capital? The prevailing notion is that investors need to know why the startup will be acquired for 10 times its current value in three years.
To be fair, that's probably what most investors want. But they are also probably experienced enough to know that it's far easier to present a PowerPoint slide that shows how much the value of the startup will grow than it is to generate fast enough sales growth to make that promise a reality.
Those pursuing capital for a startup should instead do a really good job of answering this basic question: "Will lots of people pay more for the product than it costs to make it?"
And before answering that one, try to come up with a compelling answer to this essential question: "Does the product solve a real customer problem in a better way than any other product on the market?"
If the answer is no, then it probably won't be possible get people to pay a price that exceeds the costs. But what's the way to really find out that answer?
Do a focus group: a moderated conversation with about five or six potential customers. To run the focus group, you mighthire a moderator who will elicit negative and positive feedback about the startup's product idea.
Assign a person to take notes about who said what so managers can reflect on what happened and telling remarks about whether the company is solving a problem in a better way.
I think focus groups are a simple and powerful way to generate useful insights. Earlier this week, my 29 "Foundations of Entrepreneurial Management" students at Babson College participated in a focus group that led one of my students to remark that she had always thought they were a waste of time until she saw one in action.
I had one student volunteer to moderate and five other students who agreed to act as potential customers. The idea was to have students describe their challenges in waking up in the morning for class and to obtain their feedback on a new product designed to help them do so.
First the moderator asked the students a series of questions designed to uncover whether they might buy the new product. The questions included the following:
Do you have any early classes?
How do the professors respond to your coming in late?
Do you have any problems getting up?
What do you use to rouse you? (The most popular choices were an alarm clock, a cell phone or a roommate.)
What brand is the waking device? How does it work? Is it effective?
Is this pretty standard for other students you know?
Do you sometimes sleep through the alarm?
Would you be interested in a new product that wakes you in a way other than a loud buzz, ring or radio music?
Next the moderator presented a picture of the new product along with a description: The handheld device called a Shake-Up could be could be placed underneath a pillow and programmed to vibrate at the wakeup time.
The moderator then asked the students the following:
What questions do you have?
Overall what's your reaction?
Would you buy a Shake-Up if, say, it cost $7?
If not, why?
The process took about 20 minutes and yielded some powerful insights. First, the potential customers made it clear that morning wakeups were critical and that each person had devised a method, mostly involving the alarm on an iPhone.
One student set three different alarms in various locations of her room that could only be turned off if she rose from bed and shut off each individually.
No students indicated that their method of waking up were broken. None said they would buy the Shake-Up since it did not appear to be a much better solution.
To be nice, some of the students said that they might be willing to try it for free and even buy it if it worked better.
But based on that brief 20-minute focus group, it became clear to all that this company would not be able to prompt customers to buy its product and needed to go back to the drawing board.
This is the sort of insight that an investor would prefer not to finance. Yet I can't think of a faster and less-expensive way to find out whether a startup is taking the right path in developing a product.