Entrepreneurship, Strategy series

Written on 19 June 2017
By Dr Clare Gately
Professor of Entrepreneurship, EDHEC Business School.
This article is based on her academic research, executive education and teaching and from the practitioners and authors in this field.
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Imagine yourself as a scientist. Your work is built around experimentation, data collection and analysis. Hypothesis are formed which you prove or disprove in searching for answers. The science community is replete with stories of pioneering advances that seemed to happen by chance. Yet on closer inspection, success was attained after a long process of learning, tenacity and open-mindedness. This scientific mindset can be applied to business innovation. The lean start-up methodology, centred around frequent customer feedback and fast iteration bears similar hallmarks to scientific discovery. In developing new products people want, there is no myth or magic. It is an iterative process of trial and error that edges the opportunity closer to market fit.  

Failure, over and over again is to be expected, it is part of learning.  A lean approach to innovation embraces the insights from failure to develop a more robust, customer–centric solution. As Samuel Beckett poet and laureate (1906-1989) noted : "Ever tried. Ever failed. No matter. Try again. Fail again. Fail better". Thus remaining openminded to pivoting away from the original idea and reframing the problem is part of the innovatory process. This process brings surprises along the way. For instance, the American chewing gum company Wrigleys, began as a baking powder company. In the 1890s William Wrigley Jr. gave free chewing gum away with each purchase. He quickly noticed that the chewing gum was more popular than the baking powder product and soon began to manufacture his now iconic chewing gum brand.

In developing new products people want, there is no myth or magic. It is an iterative process of trial and error that edges the opportunity closer to market fit.

Now, more than ever, as innnovation and competition intensifies, businesses need faster time to market. The Global Entrepreneurship Monitor (2016) indicates that total early-stage entrepreneurial activity for European countries notably France, Germany, Spain, Italy is significantly behind that of other innovation-driven economies such as the U.S. and Canada. The lean start-up methodology may provide a solution. It enables businesses to innovate quickly, with lesser risk and build products people are willing to pay for.

The science of innovation demands metrics which can be used to make decisions and respond to customer needs. The metrics of interest will largely be dictated by the businesses stage and business model. However there are four really useful metrics worth tracking for most businesses: 

1. User Interviews: As part of the trial and error cycle, build early prototypes and encourage customers to interact with the proposed solution. The more your hypotheiss and assumptions are challenged, the more insight you gain, the more you learn in designing something of true value. For a service business a simple slide deck or mock up of a brochure outlining the proposed service offering is enough to get customers talking. For a product business, a prototype, 3D print or sketch maybe enough to elicit insight.  Interestingly, eighty five per cent of user problems are discovered after just five interviews. There is little point in wasting time and money in continuing the interview process, it is better to fix what you’ve discovered and test again.

2. Customer Acquisition Cost (CAC): With the rise in internet companies and online marketing campaigns, this metric has become easier to track. Customer acquisition cost is the average amount you pay to acquire new customers.

 

Hence if the total marketing and sales spend in one month was say, €1,000 and ten new customers were acquired, then the CAC is €100. The CAC will be radically different for different business sectors, think for instance of the different costs of acquiring a customer for heavy machinery as opposed to an online music subscription. Once the CAC is known, there are many ways to improve the business’s CAC through customer relationship managment or improving the sales conversion rates.

3. Churn Rate: Churn is the number of customers lost in a given time period for instance per month, year or quarter. This metric is important as the cost of keeping an existing customer is a fraction of the cost of acquiring a new customer. 

 

Say for example you had 1000 customers at the beginning of the month and 50 customers left during the month. Then the churn rate is 5%.  This implies that the average customer lifetime is 20 months.  Monitoring churn rate is a good indicator of how well your business retains customers and how quickly the business acquires new customers. In analysing customer churn, businesses should consider whether the product is truly addressing customer needs, whether a competitor’s pricing strategy is more attractive to customer’s and general economic conditions that influence purchasing patterns.

4. Customer Life Time Value (CLV) : Customer Lifetime Value is the estimated total revenue a customer will generate in the life of their engagement with your business.

For instance if 50 subscribers to a web site pay €8 and 50 subscribers pay €10 per month, then the average revenue per subscriber per month is €9 per month. Say the average customer lifetime is 20 months. Hence the Customer Lifetime Value is: €9 x 20 = €180. For the business to grow and be profitable, a good rule of thumb is that the customer acquisition cost should be less than one third the customer’s lifetime value. For example, if the Customer Life Time Value (CLV) is €600, then no more than one third, or €200, should be spent on acquiring the customer.  This figure is useful in segmenting the market to find customers that fit this profile. 

Taken collectively, these metrics help innovatory businesses make pragmatic decisions and change their behaviour to achieve stronger growth. It is important in so doing that the metric is tracked over time.  In searching for a scaleable business model, metrics matter.

* Sometimes Gross Margin (in a given period) is used too, depending on industry e.ag. For generic pharma products or software where gross margin is close to 0.8/0.85 it is ignored for simplicity.

For further reading:

Blank, S. Why the Lean Start-up Changes Everything. Harvard Business Review, May 2013 pp 1-9.

Croll, A. and B. Yoskovitz. Lean Analytics: Use data to build a better start-up faster. USA: O'Reilly Media Inc., 2013

Fitzpatrick, R. The Mom Test: How to talk to customers and learn if your business is a good idea when everyone is lying to you. Colorado, USA: CreateSpace Independent Publishing Platform, 2014.

Global Entrepreneurship Monitor. Global Report, 2016.

https://blog.kissmetrics.com

Knapp, J.; Zeratsy, J. and Kowitz, B. Sprint: How to Solve Big Problems and Test New Ideas in Just Five Days. New York: Simon and Schuster, 2016.

**Nielson, J, and Landauer, T.K. A Mathematical Model of the Finding of Usability Problems. Proceedings of ACM INTERCHI 1993 conference, Amsterdam 24-29th April 1993.

Olsen, D. The Lean Product Playbook: How to Innovate with Minimum Viable Products and Rapid Customer Feedback. New Jersey: John Wiley and Sons Inc., 2015

Ries, E. The Lean Start-up. UK: Penguin, 2011