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A Familiar Phone Call
Matt called me last Sunday. He started by telling me that he had “The best business idea ever.” I laughed. Over the last 20 years Matt has started something close to 100 conversations with me in the same way. And, to be fair, I’ve used that opener with him more than once. It has become something of a running joke with us. Not every one of those ideas turned out to be “the best idea ever.” I wouldn’t put more than a handful of our ideas during this run into the great category. Most of our ideas were decent, and many weren’t very good at all.
Over the years, we have become efficient at vetting our ideas. This one was dead shortly after arrival – interesting but with huge upfront capital expense in a mature industry. After our call, I got to thinking about exactly how we go about deciding if a business idea is a great one or not. We may not be the world’s foremost authorities on vetting new business ideas, but you can’t argue that we have a lot of practice. Here are a few techniques to help you determine if your business idea is “pure gold, Jerry” or not worth the paper which it probably isn’t even written on.
Step 1 – The Default Analysis
When most people hear a new business idea, they immediately ask themselves if the product or service is a creative one that they would consider buying or using. The analysis centers around how unique the idea is and whether or not the evaluator would be a potential customer. Matt and I aren’t any different – our minds immediately run off in that direction.
We all use our own frames of reference to perform this initial screening. For most people, their frame of reference is only their lives as a consumer. This accounts for the overwhelming number of consumer-oriented ideas your friends have pitched you over the years. No, I don’t know your friends and I’m not psychic. But, I’m confident I nailed that one. The exchange goes something like this:
“Hey, wouldn’t it be great if there were an airline that had a big lounge onboard and played [insert your favorite show/program here] on big screens the whole time?”
[pause, thought, smile] “Darn right. Brilliant. What a fantastic idea!”
This very subjective and basic level of analysis is normal – we all perform it and it’s worth something more than nothing. The problem is, the approach is far from rigorous and it’s fraught with bias. Whether or not I’d personally buy or use a product doesn’t tell me much about the value of an idea. As statisticians are fond of saying, you and I are each a sample size of one. This first level of analysis is entirely centered on the quality of the concept in a vacuum. It rarely includes questions and challenges that begin to determine if the idea can be monetized and how easy it would be to translate the idea into an actual business.
Those of us who consider brainstorming and analyzing business ideas to be the perfect pastime eventually learn to apply a slightly more objective lens to the analysis. Matt and I spend a lot of time watching and discussing what and why other people are buying. What’s going on in the market? What are the purchaser motivations driving the hot products and services? What are the trends? The goal is to be more objective and, over time, our knowledge of what’s going on in the marketplace and why people act increases and hopefully this leads to better decisions about which ideas to label “great.” At this stage, we spend somewhere between an hour on the obvious also-rans to a few days on the ideas that end up having legs. Most of our ideas die at this stage of the analysis. But, a select few – perhaps 15%-20% – prove worthy of deeper analysis.
Step 2 – Is the Idea a Great Idea for a Business?
Most of our ideas don’t make it through Step 1. Those that do are in for the considerably more objective analysis that comes with Step 2. Here, we are aiming to determine if the great idea is a great business idea.
Profit: The Default Measure of Business Success
What exactly do I mean when I talk about determining if the idea is a great business idea? Ideas are everywhere and there is no shortage of great ones among them. But, for a great idea to be a great business idea, you need to be able to monetize it.
Most people measure business success by profits. Sure, you can choose to pursue other goals. I am a huge advocate of the recent changes in corporate law allowing for hybrid for-profit / socially conscious organizations such as public benefit corporations and low-profit limited liability companies. I wish more businesses would pursue goals other than pure profits. But, the universal measuring tape for business success remains profit. Investors still want profits or a path to profits before they commit their money to a new idea. That great idea you have may not be one that drives bottom-line profits.
Another problem could be that the idea requires too much upfront capital to justify the risk, given the limited potential upside. Or, the market might not be ready for the idea. Food and product delivery startups are all the rage these days. My wife is hooked on Instacart for groceries and we love Favor to get our pizza delivered even though our go-to pizza place doesn’t handle delivery itself. However, these companies aren’t pioneers in the delivery space. Back in the late 90s Webvan and Kozmo raised piles of venture capital dollars to bring on-demand delivery to the masses. Both companies flamed out in spectacular fashion. While there were lots of reasons for their failures, at least part of the reason was that these companies were trailblazers, pushing on-demand delivery to a public that wasn’t yet clamoring for it. Most business strategists and investors will agree Webvan and Kozmo were great ideas. But, they don’t appear to have been great business ideas for that time and place.
Questions to Ask
Some of the questions we ask when determining if the great idea is a great business idea include:
• Would people pay for this product or service?
• How much would they pay?
• What are they currently buying that’s similar?• Is this product or service different enough to make a splash in the market? [The answer needs to be yes.]
• Is this product or service so much different that it requires people to radically change their approach/habits in order to use it? [If yes, tread cautiously unless you have a lot of money – it’s not cheap to create the market for something as the Webvan and Kozmo example above illustrates.]
• Who would this new company’s competitors be?
• Is the industry innovative or stagnant? [If stagnant, the idea has a better chance of success.]
• Do the current players grow through acquisition or organically by building in-house? [Existing growth through acquisition makes for a better business idea, at least a better possible exit.]
• How easily will you be able to communicate with prospective customers?
• Why isn’t it already being done?
I am not so naïve as to believe we ask these questions in an entirely unbiased, objective manner. But, the questions themselves require more thinking and support, which inevitably leads to more informed and objective decision-making. If you are analyzing an idea with a friend or business partner, it will be more obvious to your counterpart when you are married to an idea and have stifled all intellectual honesty. Spend a lot of time with these questions before making any conclusions.
Away With Thee, You Efficient Market Hypothetists
Only ask that last question, “Why isn’t it already being done,” to determine if there is something critical that you are overlooking – a regulatory hurdle, a huge cost issue, etc. This question is often posed by people who use it as a rhetorical question to end the argument about the validity of an idea – “The idea must not be that great or another company would already be doing it.”
It always reminds me of the old joke about the two economists walking across campus when they spot a $20 bill on the ground. One of them bends down to pick it up and the other one grabs his arm and says, “Don’t bother. If it were really a $20 bill, someone else would have already picked it up.”
That’s how we economists (yes, I majored in economics a while back) are trained to think. Modern day markets are fairly efficient. But, markets are not always perfectly efficient and often they are far from it with respect to new ideas and innovations. Companies aren’t doing all sorts of things they could or should be because they are already busy doing all sorts of other things. Few people are sitting around today, doing absolutely nothing and racking their brain for a good idea. Use the question to test if you are missing a major consideration but, barring that revelation, forge ahead.
Think Big: Think Customer Value and Revenue Rather Than Cost and Regulation
At this stage of your analysis, avoid the temptation to get bogged down in pesky operational and regulatory hurdles. Of course, if there is a law prohibiting exactly what you want to do, move on to another idea. But, if the idea just looks like it may be a little challenging to implement or to navigate the regulatory landscape, don’t fear! You may have hit on a winner that hasn’t been pursued because doing so requires hard effort. Guess what? The whole venture is going to be hard work.
Many years ago I was working for a venture capital fund. A company pitched us an idea for an online reputation database. Think of it as LinkedIn with negative reviews and endorsements in addition to positive ones. I remember a couple people on our team were very concerned over the legal liability that could result from users saying defamatory things about one another. That is a legitimate concern. But, it’s not one that should kill the analysis of the business concept’s worth – at least not in the early stages of vetting the idea. The business gets sued a lot? That might be a problem and it might not. The question to ask is whether or not the offering is valuable enough that people will pay a whole lot for it, so much so that the cost of defending lawsuits gets tucked away as a cost of doing business. Know what other companies get sued all the time? The three major U.S. credit bureaus – Experian, Equifax, and TransUnion. People are constantly suing them for posting inaccurate information, which the bureaus just take straight from creditors. Are they in a bad business? No, they are in a great business with huge barriers to entry and the ability to charge plenty for their products and services to cover their legal expenses.
Choose Your Brainstorming Mates Carefully
If you look at a lot of business ideas, it becomes easy to say no to everything. You become quite skilled at being critical. There are always reasons not to do something and reasons why something isn’t perfect.
From February 2013 – May 2014 I was self-identifying as semi-retired. What I was really doing was a little private legal practice, overseeing to a financial services company that was in steady state mode, and looking for great business ideas. I was looking for angel investment opportunities and that one great business idea for me to launch. I realized that as time went on it was becoming tougher and tougher for me to find an idea that met my criteria. Eventually, a good friend of mine told me to stop looking at ideas and just do something, anything. He was right. It was far too easy to become too critical and I was deep in that trap. A critical eye has definite value. The first business idea you ever heard sounded incredible – a “can’t miss.” Really, it was probably awful. Over time, though, you fine-tune your thinking and you become better at analyzing ideas. But, there is a danger of becoming so critical that you can’t spot tremendous opportunity when it’s staring you in the face.
This is an occupational hazard for a lot of professionals. Schedule a company brand audit meeting with a marketing professional and I promise you that you will come away from the meeting thinking your current branding and current marketing company are horrendous. You will hear problem and mistake after problem and mistake. Hand a legal agreement for which you paid good money to have drafted by your current law firm to another law firm for review and you will walk away thinking your current law firm is a bunch of schleps. Nothing is ever perfect and experts can make Swiss cheese out of any idea, website, document, or anything else at lightning speed. These experts are highly compensated for their negativity. At least in the case of the marketing company providing the brand audit, the negativity helps them land business. But, if you overweigh the negative, it’s hard to champion an idea.
When you are in the early stages of analyzing new ideas, don’t talk to these professionals and other negative Nellies. Don’t bring your idea to your friends who hate everything. Beware of lawyers – we can be very critical! Instead, bring your idea to the big thinkers. I am not suggesting you run your ideas by non-thinkers, that’s different. Big thinkers can think, but they won’t get bogged down in the granular issues right out of the gate.
Much later, after an idea has made it through the stages we’re discussing today and beyond and you are ready to run with it, bring the idea back to all those experts. Let them shoot holes through the business idea then. That’s the right time to make sure your idea holds water. Their analysis will be invaluable at that point. But, when it comes to nascent ideas, you have to follow the advice Will Smith’s character gives to his son in The Pursuit of Happyness — “You got a dream, you got to protect it.”
Step 3 – So, am I the Right Person to Launch this Business?
If you are looking for a business to launch, your initial analysis is not quite finished. After you have successfully answered the “Is this a good idea?” and “Is this a good business idea?” questions, go one step further and ask yourself “Is this a good business idea for me?”
I keep a Word document with ideas I’ve kicked around over the years. Some of the ideas never made it past an initial conversation, some I took all the way through pitch deck preparation and the creation of a pro forma P&L. There are tons of ideas listed. I would say the majority of them are at least decent business ideas and some are great business ideas. But, most of them aren’t great business ideas for me. As angel investments, with the right management team, a lot of the ideas would have had legs. But, as a company for me to launch, they didn’t make the cut.
How Much Value Can You Add?
There aren’t many things that I consider beyond my ability to understand. However, there is a lot beyond my ability to manage effectively, at least without putting in a lot of background research. It is challenging to manage a company when you don’t really understand what the company does. I don’t mean that you can’t talk intelligently about what the company does. Any sharp person can figure out how to explain at a high level what is going on. But, do you really, truly understand how the product is made or the service is delivered?
Some people don’t care if they really understand those things at the core. The energy and technology industries are rife with CEOs that were never engineers or programmers and couldn’t explain in detail how a well is drilled. They can get by and use the right jargon. And, a lot of times they are talking to industry analysts and investment bankers who would be equally befuddled if they were forced to carry on a conversation with the people that actually deliver the products and services. You see, they don’t really “get it.”
Some years ago I worked for a company that supplied equipment to the energy industry. It was a very simple business. Competitors all had similar equipment and all that mattered to customers was availability and price. In an effort to expand beyond what was essentially a service business that priced like a commodity, our Board of Directors made the decision to buy a company that provided true services related to the equipment. Sure, the business was related – definitely same sector. But it wasn’t long before the long-time executives of our acquiring company were in meetings with executives of the newly-acquired company and not able to decipher what was really going on. Was a deadline missed because someone messed up or does that just happen? Did we underbid a project because we missed something important or were we unwisely overeager in our bidding? Did things arise after we bid that could not reasonably have been anticipated at the time of the bid? What’s really going on?
A good analogy is that managing employees that do something you don’t understand is like trying to monitor the number of hours the hourly repairman is charging you for when you aren’t capable of changing a light bulb. You can’t. At least, you can’t do it real well. You have to choose well and trust who you choose. Sometimes that works and sometimes it doesn’t, but I don’t love being in that position. Maybe this is an issue for you, maybe it’s not. However, there must be certain considerations you have that separate great business ideas from great business ideas for you. Know these considerations and apply them ruthlessly.
Do You Really Want to Do This?
Then there’s the critical question, “Do you really want to run a company that does y or makes x?” I lost track a long time ago of how many business owners I met that loved doing a certain thing and incorrectly surmised that running a company that did that thing would be a blast. Bed and breakfasts come to mind, as do coffee shops. The romantic notion of mingling with happy patrons while enjoying the sweet aromas of the magical caffeinated elixir is quickly replaced with running around ragged bussing tables because a schedule employee flaked out. Alas, reality doesn’t always match the dream.
Putting it All Together
I said early in the article that I’m not claiming to be the end-all be-all on what makes a great business idea. This is a very subjective process, much more an art than a science. I believe it’s a very personal process. Ideas are everywhere. What makes a great business is more than just an idea. Hopefully, this has given you a framework to evaluate ideas. The next time your friend calls you up with the “best business idea ever” you will have the tools to see the difference between a great idea, a great business idea, and a great business idea for you. Before you quit your job to pursue her dream you will have a solid basis for deciding if it’s worth making the leap or not. Here’s to hoping you eventually find that idea, make that leap, and soar.