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Sunday, January 4, 2015

Top 10 Reasons Why Investors Reject Financing New Businesses



Ever wonder how start-ups find capital to fund their businesses?

A study was conducted by an American research firm to analyze a 10 year historical performance of new businesses opening and businesses closing down. The study reported  that an average of 46.4% of new businesses fails within the 2 to 5 years of operations. From an industry perspective, real estate being the lowest at 30% and technology having the highest at 55%. Some takes a bit longer but eventually closes down.


Also, start-up funding is not as easy at is seems. Based on the same study, roughly 98% of new businesses from young companies are rejected for venture financing. What I learnt is that the reason for such high rejection rate is not satisfying certain criteria.


So if you are in the lookout for investors to finance your up and coming businesses, let me share my top 10 reasons that you should avoid to ensure high probability of getting an investor - or at least spike their interest based on what I learnt from by studying and working in several start-up environment.



Top 10 Rejection Reasons for Financing New Ventures

1. Opportunities that are non-market centric tends to be unattractive opportunities. These are opportunities that are unfocused regarding customer needs. Some of the indicators are companies who have low customer loyalty, a payback to the user of more than 3 years and unable to expand beyond a one-product company.

2. Opportunities that competes in industries that are highly concentrated, perfectly competitive, or that are mature or declining are typically unattractive. Capital requirements and costs to achieve distribution and marketing presences can be prohibitive and price-cutting.

3. Opportunities that have unknown market size with growth rate of less than 10%.

4. Opportunities that forecasts less than 5% market share within 5 years as well as competing in markets with low demand yet high supply.

5. The time to breakeven or positive cash flow is more than 4 years and the ROI is less than 15% - 20%. 

6. There is low value-add strategic importance such as distribution, customer based, geographic coverage, proprietary technology, contractual rights, and the like. 

7. There is no exit mechanism and strategy. Giving some serious thoughts to the options and likelihood that the company can eventually be harvested is an important initial and ongoing aspect of the entrepreneurial process. 

8. Non-attractive opportunities don’t have existing teams that are strong and contain industry rock stars. A team with no proven profit and loss experience in the same technology, market, and service area would most likely result to a poor-performing business. 

9. Founders that are misaligned to the requirements of the business is a sign of poor fit which results to rejection. 

10. The core technology that runs the business has many substitutes or direct competitors.

9:28 PM Posted by Nicco Joselito Lopez-Tan (陳里道) 0

Monday, July 7, 2014

How Calculus Can Help You in Business

Ever wonder why we take calculus during college (with the exception of degrees heavily focusing in the arts)? I remember that most students do not really appreciate this subject due to the 'alien' concept and mind-boggling equations.

Being an engineering student myself, I was a bit confused as to how this subject can help me once I get a full time job. Like any other student, I also asked sarcastically the question - Why do I need calculus? It's not like I'll go to the market and ask for the differential price of a product. Nobody really uses it in real life.  

But as years gone by, and I matured in my chosen field of profession - I realised that Calculus was more than a math subject I need to pass in college. I remember my CEO calling me one time showing me a bell curve graph showing the fluctuation of our EBITDA numbers as we increase or decrease our OPEX. I know, I know... big words! Simply put, my CEO was asking me to find out what metric should we tweak in order to meet that sweet spot to optimise our production cost and at the same time hit our profitability target.

This experience is one of the countless events that forced me to go back to my old textbooks and find a way to answer these crucial questions. And it brought me back to Calculus and the concept of derivatives, limits and functions.

In order to appreciate Calculus and its many applications for business, let me hone this discussion in the topic of derivatives and differentiation. To make it simpler, let me provide a non-standard definition of these two concepts in the context of business administration and management.

A DERIVATIVE is something (a number, a metric, a KPI, etc) which is based  on another source. It is the number or the event that you would like to know given a certain set of information or facts to predict a certain outcome. It is determined only if another variable is present. And the process of finding this Derivative is called DIFFERENTIATION. 

To make sense of this topic, let me give you two cases that I've used  this concepts in reality

CASE 1: Budget Rooms for Rent

Situation: One of the business owners I've helped is an owner of a small apartment for rent for backpackers. He owns 250 rooms across the city and marketing it heavily via the internet and travel agencies. If they rent X apartments then his monthly profit, in dollars, is given by the following equation:

P(x) = 3200x - 80,000 - 8x

Where:
3,200x is the price per room per stay.
-80,000 is the fixed monthly cost to operate the business.
- 8x2 is the recorded rate of the variable cost during operations.

Case Problem: How many rooms should they rent in order to maximise profit?

Some people would think immediately that renting all rooms will be the best case scenario reaping maximum profits. But factoring in cost of operations (both fixed and variable cost), it would be interesting to know if renting out all rooms will definitely be the best possible course monthly for this business owner.

Solution:

We know that the maximum profit is between 0<x<250 range of rented rooms. What we need to do next is to find the derivative of the profit as declared above to get the Critical Points to which we will get the maximum profit. Again, as defined, derivative is something that you would like to know based on other facts (in this case the PROFIT). And we need to differentiate it to get the derivative.

(I assume you know basic differentiation)

P'(x) = 3200-16X
If P'(x) = 0
0 = 3200-16X
16X=3200
X = 200

200 is one of the critical points. Hence the range is between 0<200<250

Substituting these three numbers, we get the following profit per month:

P(0) = -80,000
P(200) = 240,000
P(250) = 220,000

As you can see, renting all 250 rooms produced less profits versus 200 rooms if we factor in operational cost. Hence, the business owner was advice to aim to rent out 200 rooms at regular price in any given month and utilise the remaining 50 for any promotions they would like to do to further increase their earnings.


CASE 2: Cupcakes for Sale!

Situation: Every December, one of my friends sells cupcakes to earn extra during the holiday season. One of her biggest challenge is that after the end of the month, she feels that her total effort in producing the cupcakes versus the money she earns from it is not generating her significant income. She doesn't know what price tiering she would do because her cost increases if she produces more cupcakes.

So, after observing and recording data, we found out that her production cost per day has this function:

C(x) = 2500 - 10x - 0.01x - 0.0002x3
Where:
2500 is her total cost
-10X is her savings since she can produce 10 more cupcakes using the same amount of ingredients
- 0.01xis her savings on electricity
- 0.0002xis her savings on delivery per batch to clients

Case Problem: She wanted to know what would be the rate of change of her cost if she produces 200, 300 and 400 cupcakes in a day in order for her to create an optimal pricing scheme.

Solution:

Same process in the first case, look for the derivative and apply the critical points 200, 300 and 400.

C'(x) = -10 - 0.02x + 0.0006x

C'(200) = $10
C'(300) = $38
C'(400) = $78

As you can see, producing the 201st cupcake will add $10 to her cost, 301st cupcake will cost $38 and the 401st cupcake will be $78.

From this information, she knows that her cost increases every time she increased her production. This made it possible for her to create tiering in her price schemes to cover the increasing cost associated with production.

So there you have it, simple ways you can use derivatives in your business. It has more applications which we can cover in other blog post. If used properly, you can definitely outwit your competition.



11:51 PM Posted by Nicco Joselito Lopez-Tan (陳里道) 4

Tuesday, June 24, 2014

Reconstructing Market Boundaries - How to Develop a New Market

Whenever I discuss marketing as a subject with a few friends or lecture about marketing principles, I always get questions about the pressure of emerging media. Specifically digital concepts and how it affects their existing strategies. Then there is this debate if digital marketing is another form of "market penetration" or "market development" strategy.

Some marketers view digital marketing as a penetration strategy entering an existing market with existing products. They believe that  they are marketing to the same group of people (using digital marketing concepts) with existing product positioning will reap higher results.

While this might be true to some brands or products, what I have observed so far after countless experiments in a live e-commerce platform is far from just penetrating a market.

What I have observed in several digital campaigns being integrated in an entire existing strategy replicates the primary elements of a market development approach strategy. So you might ask what are those elements. Simply put, what I have observed shows the very primary elements of market development - new market, existing products.

Some argues that my definition of "new market" does not apply to the digital realm. Their argument is rooted on the fact that these are same markets but only equipped with gadgets that are able to transact and receive marketing messages.

But as I explore this new media and acquire data-tested results, I firmly believe that market development strategies would work far more better than penetration strategies. My hypothesis for this claim is based on my definition of a "new market" which is:

New Market in the digital space is  based on digital behavior rather than the general demographic profile.

This way, I can increase further our earnings through a more detailed targeting criteria with higher potential of customer conversion.

So the next question is, how do I develop a new market? There's no simple way of doing this but I have used a few frameworks out there that helped me developed profitable market segments. Here are some suggestions that you can test out on your own and see if it works!

IF YOU CAN'T BE #1, BE THE BEST #2
The first time I heard this phrase was during my master's program where one of my professors said that "strategy" is being the best in your category. It doesn't mean you have to settle for 2nd best but the takeaway for this part is to know what space you are competing and being the best in that category.

ACCEPTANCE IS YOUR STARTING POINT
In order to recreate your market boundaries, you have to start at a product category that is already acceptable. For example: luxury cars, hand soap, instant noodles, etc. These are existing acceptable categories. Before competing directly with accepted categories, understand first how your product will stand out from the rest based on an existing buyer group.

FOCUS ON THE SAME BUYER GROUP
Before enhancing your target market, focus first on the existing buyer groups of the product category you are trying to win.  You can select from the following: it can be the purchaser (i.e. moms buying hotdogs), the user (i.e. kids who loves hotdogs) or the influencer (i.e. best friends of the mom who needs a suggestion for quick bites for her kids).

DISSECTING YOUR COMPETITIVE LANDSCAPE
This is where research comes in. After deciding which buyer group you will focus on, create a list of direct competitors and define their scope of products and services offered. Some questions that will help you identify these elements:

  1. Are there other variants of these products?
  2. What is their product positioning? Who are they targeting and how are they communicating it?
  3. What value added service do they offer?
  4. How often they create promotions?
  5. Is there something intangible that customers considers valuable from the product?
  6. How long is the sales cycle?
  7. How many people buys it from the shelf? Frequency and Recency?

You can even make a matrix of the 4 P's to complete this section. List down the product info in one column, list down the place that it is distributed (include if it has shipping involved), list down how many promotions they did, and what type (i.e. discount, buy one get one, gift with purchase, etc), list down the prices in different channels of distribution.

PRODUCT TRUTH - USUALLY STARTS BY ACKNOWLEDGING THE NATURE OF THE PRODUCT CATEGORY
Once you've identified all the elements in the previous step. It's now time to generate you key takeaways as to how the entire industry looks like and accept its functional and emotional orientation.

Here's an example: Product category: Luxury Cars
Functional truth - these cars are the same with other economical cars because it can take one person from point A to point B. However, the luxury car category boasts of sophisticated design, slightly expensive materials, customized  interiors, state-of-the-art electronics, 24 hours concierge/hotline, free cleaning for one month, and other features like imported leather seats.

Emotional truth - two people will buy this. People who are financially capable and demands them to put on an image of luxury and finesse. These people would most likely be CEOs and business owners. The other is a group of people who aspires to be one of the people described above. That they will do anything to come up with the money to buy the luxury car. But these two groups feels the same emotional orientation, they want to feel special and be acknowledged as a high spender radiating an image of sophistication, class and financial stability.

DEVELOPING YOUR STRATEGY CANVAS - REDUCE, RAISE, CREATE
To reconstruct market boundaries and developed a whole new market, you can use the following strategy canvas developed by W. Chan Kim and Renee Mauborgne in their book - Blue Ocean Strategy. I find this tool very effective in developing a new market.

What you do is to have a functional vs emotional grid outlining the key functions of the product category in the X-axis. Outline all the functions as listed in the previous steps. On your Y-axis, have two  criteria - High Value or Low value. This will serve as the emotional meter. You will mark this based on the offering. Mark it high if its being offered and low if its not.

Here's an example following the Luxury Car product:




You can see immediately which functions you have and you don't have as benchmarked against your direct competitors. 

After mapping out your competitor's functional and emotional positioning, you then layer your own on top of it. From there you will use the RRC framework:

Reduce - decrease or completely eliminate from your product features or offerings
Raise - increase the value of the functions you want to highlight to develop a new market
Create - functions and features you know you can fulfill for the customer that adds value

Taking the example above, you decided to reduce a few features that are not important to the current user base. You raise the features that are important. and create new features that are not yet available to your competitors. Hence, you decided to do the following:



From this graph alone, you can already see your key differentiators and how you can make your competitors irrelevant by focusing on functions that has high emotional value to your target market. 


RECONSTRUCTION BEGINS
After setting on what you will reduce, raise and create in your strategy canvas, this will then help you fill in the rest of your marketing strategy in terms of promotion, communication, distribution and positioning.

Following that will help you target the market you want to attract and therefore help you define the characteristics of this new market.

5:45 PM Posted by Nicco Joselito Lopez-Tan (陳里道) 0