Using the Customer Development framework to validate a new or emerging business model helps streamline the process.
What we want is proof points and evidence to push ahead in order to minimize risks and maximize returns.
The following post outlines Customer Development Model by Steve Blank, and adds some commentary in at the end about how to use the Business Model Canvas/Toolkit as part of this process.
The nature of finding and discovering a market and customers guarantees that you will get it wrong several times.
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Yet there are several considerations to keep in mind while going through the innovation process that help to make the process less painful and keep expectations in check:
- ideally, we want to keep cash burn low while in the process of validating customer demand (for a startup) or testing a new value proposition (for an existing company) and buy as much runway as possible for potential failures
- the process is non-linear and therefore requires trial and error, meaning that being too presumptuous with financial projections can lead to unreasonable expectations
- Customer Discovery and Customer Validation are the most arduous, time-intensive phases, but once through those, Customer Creation and Company Building can happen rapidly
The company doesn’t build its business teams (sales, marketing, business development) until it has proof in hand (a tested sales road map and valid purchase orders) that it has a business worth building.
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Customer Discovery
TL&DR – Get out of the ‘office’ and talk to customers
An important insight is that the goal of customer development is not to collect feature lists from prospective customers, nor is it to run lots of focus groups. The job of the customer development is to see whether there are customers and a market for the product that vision.
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Product meet vision. Vision meet product.
Having a vision towards the future can count for a lot, but a lot of innovations emerge from those who are working in nitty-gritty industries who discover a problem plaguing the industry today and develop a simple and straightforward solution.
That’s why Customer Discovery is necessary.
The goal is to match the product to the vision and confirm the need(s) of prospective customers relative to the demand in the market (business model).
There are strategies and tactics to achieve this, but the basic premise is listening to customer demands and relaying those back to the core product development/design team(s). If a large percentage of startup capital is blown on a product that nobody wants, it may be impossible to recover from that type of loss, which is why this phase is so important.
Ideally, Customer Discovery leads to at least one or two paying customers at a decent amount, or in absence of payment some kind of LOI (Letter of Intent) or Purchase Order.
Customer Validation
TL&DR – Create a Sales Roadmap
Positive words and encouragement are nice, but cashflow is better for any business. That’s why after going through what is potentially a very frustrating and lengthy process of Customer Discovery, Customer Validation is the beginning of ‘scale’ to reach a sustainable business model.
We know intuitively that getting one or two paying clients in the Discovery phase isn’t going to be enough to lift up the whole business model, but getting several multiples of that likely will be.
If, and only if, you find a group of repeatable customers with a repeatable sales process, and then find that those customers equal a profitable business model, do you move to the next step.
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The goal here is to start to generate tangible evidence that the business model you have created will in fact work (or not!) at the projected cash burn rate.
In essence, customer discovery and customer validation corroborate your business model.
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There is an art to this phase because this is where details really start to matter, such as pricing, channels, and other elements related to the product or service. Margins and relevant information to CAC (Customer Acquisition Cost) are foundational to the success of any business model; therefore, choosing to ‘validate’ in any market that is low-margin or requires massive scale in numbers may require a lot more work than something that is high-margin and requires a much smaller customer base to succeed.
Customer Creation
TL&DR – Hit The Gas
Assuming the business model has been validated and the general margin/ARPU-CAC-LTV argument checks out on a marginal basis (ie. the company is not losing money on a per customer basis when factoring in Customer Acquisition), then it is time to pour money into reaching more customers.
The specific strategy to ‘Hit The Gas’ and reach new customers will be dependent on the characteristics and dynamics of the market.
Some startups are entering existing markets well defined by their competitors, some are creating new markets where no product or company exists, and some are attempting a hybrid of the first two, resegmenting existing market either as a low-cost entrant or by creating a new niche. Each of these “Market Type” strategies requires a very different set of customer creation activities.
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There are some product-market strategies that require ‘dominating a niche’ while others are more mass market. Of course, within this context, there are huge differences between B2B (Business-to-Business) and B2C (Business-to-Consumer) markets; therefore, there is no ‘out of the box’ way to approach this, each company’s context will be different.
Don’t forget about the dreaded ‘Chasm’ that must be crossed as a company starts to hits its stride in a new market.
Design for ‘Crossing the Chasm’ – Medium
A lot of the strategies to tackle ‘The Chasm’ are inherent to the Customer Development framework, such as listening to users, adapting to consumer sentiment shifts, changing the positioning in the brand, etc. All to say, the sales and marketing strategy will likely need to be flexible enough to shift relative to consumer demand.
Heavy marketing spend can work, but after several analysis of the CBCV (Customer Based Corporate Valuation) framework and subsequent Business Model Analytics research, we have seen that this only works if CAC stays low enough for LTV (Lifetime Value) to blossom in the mid-term. Churn – or lack of repeat customers – kills a business model.
Paradoxically, CAC tends to rise as competition increases, so it is almost impossible for any company to sustain heavy marketing spend long-term. Therefore, it is best to at least blend Organic with Paid Channels and not be dependent on large advertising budgets to obtain/maintain scale.
Company Building
TL&DR – Bring in The Right Talent
At this point, after the business model is validated and the company has reached sufficient enough scale to become a ‘player in the market,’ it is time to bring in the talent and expertise to take it to the next level.
As we have seen in other research, the lion’s share of rewards in any major market segment skew towards the Top 3 players, so it is important to not simply be ‘happy to have arrived.’ Think about how many flameouts we have seen on the Nasdaq and public markets in recent years, companies who were one day a mainstream brand are now on the their death knell.
Company Building, is where the company transitions from its informal, learning and discovery-oriented customer development team into formal departments with VPs of Sales, Marketing and Business Development. These executives now focus on building mission-oriented departments that can exploit the company’s early market success
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From a finance perspective, things can become a bit ‘wild’ at this stage because key hires don’t come cheap and are expected to generate outsized returns in the very short-term, which sometimes doesn’t work out for a variety of reasons.
Adding a large bracket to the P&L for staff compensation will suddenly change the whole business model and likely require large external financing, which may not be what some companies want. There is nothing wrong with the family business or small company seeking to develop the talent from within; just remember, that one or two key performers can generate 10 – 20X return on their investment in the right position.
In the end, everything in the Company Building Phase will be determined by the conditions of the market and whether the customer base is new (Category Creation) or whether it is a resegmenting of an existing market. The former could require a lot more ‘fresh thinking,’ while the latter could benefit from those who have done it before. The main takeaway from all of the above is that there is no one-size-fits-all approach.
Role of the Business Model Canvas/Toolkit in Customer Dev.
When you look at the Business Model Canvas’s of major companies and successful startups, they kind of make sense. The beauty of the Business Model Canvas’s creation was its use as a communication tool about how to design business models on one page instead of 10-page business plans.
Yet, simply plugging in the dimensions of each part of the model oversimplifies how difficult each step in the process of creating a new business model truly is.
For example, cross validating a Value Proposition with a profitable Customer Segment is a step that most companies never get past.
You can use the Business Model Canvas in combination with the Value Proposition Canvas to aid in the Customer Development process and provide a place to sketch out ideas/ideate relative to the business model as a whole.
The business model is the full picture, but you need to go deep into the weeds with potential customers and spend weeks/months learning, iterating, adapting, and refining any product or service’s value proposition with customers as part of the Customer Discovery and Validation phases.
Yet one insight or piece of feedback in either of these phases could change the entire logic behind the business model and tweak core elements of the financial model out of whack. An example of this could have been certain assumptions of a subscription/recurring business model, which when brought to market proved to be false and blow out the entire logic behind the business model.
That’s why, through the process of Customer Development, an entrepreneur or executive may end up cycling through three or more business models. What you don’t want to do is get too set on one model and push that model onto customers in order to self-actualize customer validation in order to ‘raise capital’ from the 3Fs (friends, families, and fools).
A lot of new business models operate on assumptions about finding investors and raising capital that simply aren’t accurate, and as such will push a model onto a small group of ‘close contacts’ and use that as evidence to raise money from friends, family, (and fools) with promises of a big future payday.
Most startups and new businesses fail regardless, the point of Customer Development + Business Model Canvas frameworks is to fail intelligently and cheaply in the name of innovation if you are going to do so. Creating a fancy Canvas and skipping steps in the Customer Development process can lead to some of the greatest disappointments in history, not to mention debts, frayed relationships, and broken promises.
The Customer Development model consists of four well-defined steps: customer development, customer validation, customer creation, and company building. Each of these steps has a set of clear, concise deliverables that give the company and its investors incontrovertible proof that progress is being made on the customer front. Moreover, the first three steps of customer development can be accomplished with a staff that can fit in a phonebooth.
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What we want is proof points and evidence to push ahead in order to minimize risks and maximize returns. The Customer Development framework and Business Model Canvas are two separate but complementary tools to help achieve this process in a structured, shareable way.