By Carter Cast and David Schonthal
In the startup world, there’s a golden rule that entrepreneurs live by: Value goes up as risk goes down. As a result, it’s the job of any diligent entrepreneur to remove risk from a venture as quickly as possible.
The same is true for a corporate entrepreneur. In the early stages of developing a new product or service, these innovators should determine the best ways to reduce risk.
Illustration by Michael Morgenstern
Startups often do this in two steps. First, they identify the most critical assumptions about their venture — the one or two beliefs that must be true for the business to have a chance to succeed. These assumptions typically fall within four risk categories: product, adoption, business model viability and execution. Second, startups test their venture’s core assumptions as quickly and resourcefully as possible. The goal is to fail fast; that is, to identify and kill bad ideas quickly so that entrepreneurs can focus on more promising directions. As we tell executives at the Kellogg School of Management, this culture of speed, learning and rapid iteration enables startups to grab share from — and in some cases disrupt — established incumbents.
Let’s take a closer look at how this process works with the four risk categories highlighted above.
Product Risk
What you’re evaluating: Whether you’ve achieved product/market fit.
Key questions: Is your product or service desirable to your target customer? Is there a real problem to solve and, if so, does your solution address it? Is your product feasible to make?
Experiments to run: Test the desirability of your offer by posing questions in the form of prototypes. Prototypes don’t need to be fancy or expensive; they just need to be good enough to answer the questions you are asking. In many cases, this can be as simple as sketches of your solution, screen shots of a yet-to-be-built website or a short video explaining your idea. The key is to get your prototype into the hands of users so you get the answers you need.
Case in point: Wicked Kitchen, a food truck owned by ConAgra, drives around Los Angeles to test new packaged-food concepts with their target audience (urban young-professionals). Prototyping in this way allows ConAgra to witness customers’ reactions to new ideas and iterate quickly based on what they discover.
Adoption Risk
What you’re evaluating: Whether you can access the customers you hope to serve and whether they’ll pay for your product/service.
Key questions: Is there a segment of customers ready to spend money on your product or service? Can you access key distribution channels in order to penetrate the market? Do you know the customer acquisition costs? Do the unit economics of your business indicate a profitable endeavor? Where does your product fall in the market landscape and can it compete with similar offerings?
Experiments to run: Create pilot tests to identify the conditions in which customers will buy, testing your product alongside your competitors’ products. Speak with the heaviest users as well as non-users in your product category; the former will clue you in to issues such as performance expectations, features and technical improvements, while the latter will provide input on topics like purchase barriers and ease of use.
Case in point: Before officially launching in 1999, the senior management team of Blue Nile, an online specialty retailer of fine jewelry, talked to prospective customers to figure out what factors might prevent them from purchasing a diamond solitaire on the Internet. As a result of those interviews, the retailer incorporated services that addressed customers’ concerns, such as hiring gemologists into their customer service department, offering a free, 30-day appraisal for the diamond, insuring the diamond for overnight shipping and providing certifications for every diamond on their site.
Business Model Viability Risk
What you’re evaluating: Whether the economics of your venture point to a business worth pursuing.
Key questions: Do your projected unit-level economics allow enough room for marketing, selling and distribution costs? Can you manufacture the product at scale? Can you ship it without breaking it? Can you gain regulatory approval?
Experiments to run: Early in the discovery process, speak to experts in your chosen industry. They’ve likely seen their fair share of new entrants, and can illuminate specific facets of new businesses that are likely to bring you success or peril. Industry experts can also help you understand various business model constraints you may face in developing your new product. On the financial side, it’s also wise to use a good old spreadsheet to run “if, then” scenarios related to your business model. Approach modeling as if it were a financial simulator and be honest about your inputs.
Case in point: Dollar Shave Club, a startup in the men’s grooming space, has managed to disrupt an established industry by designing a business model that offsets low product margin with low cost of customer acquisition and strong brand loyalty. To test assumptions around customer acquisition cost and conversion, the company’s founder produced and starred in a deliberately provocative (and low-cost) video designed with virility in mind. The video was a huge success with the company’s target market (young professional males), with nearly 20 million views to date.
Execution Risk
What you’re evaluating: Whether you can execute your business model at scale.
Key questions: Where are your biggest risk areas? Is there any place where you have a single point of failure? Where are the weak spots on your team? Are your team members experienced operators? Do they have a track record of successfully delivering similar product/services to market? Are there market/regulatory forces and environmental risks that you must consider?
Experiments to run: This risk is the most difficult to test and is best alleviated by monitoring performance and having clear goals, programs, deliverables and success metrics. Consider seeking outside opinions from advisors to evaluate whether gaps exist in your management team.
Case in point: When venture capitalists invest in startups, they often pay a valuation premium for experience. They look for serial entrepreneurs who are well acquainted with executional challenges, such as finding and hiring talent, organizing and building high-performance teams, creating scalable processes or gaining access to new customers. One of the best ways for entrepreneurs to secure funding is by showing investors that they’ve thought through major executional issues and have a plan to address them.
Throughout this process, keep in mind that fast failure is a success. Every test that doesn’t work teaches you something vitally important. The key is to make sure that you determine the right questions to ask, create tests to answer them, draw lessons from each experiment and then incorporate your learning into future product design.
Learn more about Corporate Innovation at the Kellogg School of Management.
Carter Cast’s 30-year business career includes a variety of manager, director and executive roles in Fortune 500 corporations and multi-million dollar startups. Part of the launch team at Walmart.com, Carter later became CEO of the online platform. Now a partner at Pritzker Group Venture Capital, Carter invests in high-tech startups and coaches management teams. An award-winning entrepreneurship and marketing professor at Northwestern University's Kellogg School of Management, Carter earned an MBA from the Kellogg School after receiving a BA from Stanford University. Carter has appeared in the Wall Street Journal and the New York Times and on Bloomberg, CNN, CNBC and FOX.
David Schonthal is a professor of innovation and entrepreneurship at Northwestern University’s Kellogg School of Management. David serves as the director of Kellogg’s Zell Scholars program – a selective venture accelerator program helping student entrepreneurs successfully launch new businesses. David is a leader in the business design practice at IDEO, an award-winning innovation consultancy. Previously, David was a co-founder of Fusion Ventures, an investment and advisory firm focused on growing technology startups in early-stage development. He was also a director of strategy and venture development at Tavistock Life Sciences, a private investment firm. David has also held numerous leadership positions at startups in the technology and life sciences sectors.
