Small Business Thoughts

Entrepreneurs basically have two options to get an answer on the viability of their product/service before attempting to carve out a new market for it. 

• Spend a lot of money.
• Build a minimum viable offering (MVP) and use it to find the product-market fit. 

The true test of viability isn’t whether or not the product offering works for the intended purpose. It’s also not whether or not you can sell it to a customer. True viability comes down to whether or not that product offering can establish market fit. Markets are tricky things, especially new markets, so the answer isn’t always as binary as many would like it to be. It may take months or even years to determine whether or not product-market fit has been achieved. But the opposite of viable is unsuitable for practical use or purposes. A failed MVP is not true unsuitability because, if you’re willing, the opportunity exists to fix the issues and move on. What you don’t want is an impracticable product, one that will never be viable.

Here are the four reasons why a MVP might never be viable. 

1. Incorrect target market choice. This mistake is the one I see the most and is the hardest to come back from. The root cause is usually the same…in an attempt to make the biggest splash, the company chooses the largest possible target market. In hindsight, this flaw is easy to spot, because the market was chosen only for its potential…the size of its total target market. But the total target market is the last thing that needs to be taken into account when choosing a target market. In effect, when you consider the other three reasons for an unsuitable product, your total target market is pretty much chosen for you. 
2. Incorrect unique selling proposition. All good products solve a nagging consumer problem efficiently and affordably. However, a trap for many product ideas is that they are just solutions in search of a problem. But even once this trap is passed, one of the biggest mistakes an entrepreneur can make is building a product to solve a problem that’s too small. A similar mistake is developing a solution that doesn’t solve a problem broadly enough to warrant a purchase. People like the status quo, and they’re usually comfortable with the devil they know. If you’re solving a small problem or only part of a broader problem, your unique value proposition is off. Your product may find initial traction, especially if your target market is narrow enough, but it may never scale. 
3. Incorrect positioning. Sometimes, the problem involves a combination of both product consumer value and the chosen target market. This error is in positioning. Positioning, in its simplest form, is about nice-to-have versus must-have. A well-built product can always find a few customers who want it. What’s more, a good salesperson can make any product desirable to some folks. But finding fit in a market usually comes down to whether that market needs the product or just wants it. When “want” gets misdiagnosed as “need,” the result is a poorly positioned product. Either the unique selling proposition or the target market needs to be reevaluated, or both. 
4. Incorrect pricing. Pricing is where companies usually start fixing failed MVPs first. And that’s a mistake. Here’s a how-to on pricing in a nutshell:

• The customer acquisition cost (CAC) tells a business how much it costs to acquire new customers. It provides insights about sales and marketing efficiency. A business must know its CAC to understand if the business model can be profitable. CAC equals the amount spent on advertising divided by the number of attracted users. To get to an accurate acquisition cost, be sure to include expenses related to marketing, any commissions that are paid to sales team members for their successful conversions, and any other expenses related to acquiring new customers. Here are some average costs (Shopify 2021 study) to acquire a customer by industry for e-commerce brands with less than four employees:
  • Arts and entertainment: $21
  • Business and industrial: $533
  • Clothing, shoes, and/or accessories: $129
  • Electronics and/or electronics accessories: $377
  • Food, beverages, and tobacco products: $462
  • Health and beauty: $127
  • Home and garden: $129
• The lifetime value (LTV) is the estimated revenue that a business will gain from its customers, over their entire lifetime. It takes into account the average order price, the purchase frequency and the customer relationship length. It offers insights about how a business is performing when it comes to customer satisfaction, loyalty, and trust and measures its efforts in nurturing customer relationships. It also allows for more accurate forecasting and focuses on a long-term approach to customer value. A simple example is: if the product offering price is $15/month and customer uses it for 3 months, LTV is $45.
• LTV/CAC ratio compares the expected lifetime value of a new customer to the cost that it took to acquire that customer. In other words, it allows a business to determine whether the profit made from a customer over their lifetime is worth the expense incurred to obtain that customer. The LTV/CAC ratio is a calculated by dividing the total sales or gross profit made from a single customer or group over their entire lifetimes (LTV) by the cost required to initially convince that same customer or group to make their first purchase (CAC). 
• Pricing determines your LTV.
• Narrowly targeted markets produce lower customer acquisition costs (CAC). Higher unique value propositions produce higher lifetime values. Until the total addressable market, value proposition, and positioning are fixed, pricing is just an exercise in guessing.

Once these mistakes are corrected, the rest is simple math. An LTV/CAC ratio greater than one is a positive indicator of how valuable a company is. The average LTV of the customers is the average revenue per customer adjusted for monthly churn (how many users have stopped using the offering) and gross profit margin. This ratio helps determine how much should be spent on acquiring customers. The higher the business LTV/CAC ratio, the more efficient and effective the sales and marketing are. There aren’t any hard and fast rules regarding what a business ratio should be, and a good ratio may be different for different types of businesses. However, a ratio of 3:1 is generally accepted as a favorable indication of a company’s performance. It shows that the business is doing well with acquiring new customers and retaining existing ones. A lower LTV isn’t necessarily bad as long as the CAC is much lower. A higher CAC isn’t bad when a higher level of revenue is coming in. The ratio of LTV/CAC provides you with a complete picture of your marketing efforts and performance.

it is important that to track LTV/CAC ratio to better understand the business and which direction it should take the marketing strategies as you search for a product-market fit. For more planning thoughts download the ebook entitled “Small Business Thoughts Real-Time Strategic Planning”.

Copyright ©John M. Trenary. All rights reserved.