Tuesday, October 20, 2009

Capital deprivation and startup strategies

One of the most important uses of capital is in discovering new markets. With a sufficient pool of capital, new markets can be quickly discovered, probed and exploited; the viable markets invite a rash of competing companies, and unviable markets are neglected and wither.

In India, most companies are severely capital-deprived. With the increases in FDI in recent years, this has changed for the better, but the process of market discovery is still slow and, by and large, left to large companies.

This capital deprivation is one of the reasons that a few large companies are spread across many unrelated markets in India – for example, the Tatas in broadband (Tata Indicom), mobile (Tata Docomo), power distribution (Tata Power in Mumbai), and even electronics retail (Croma).

One of the best features of the American economy is that capital is available to both small and large companies – small companies often doing the work of finding new profitable market niches, and going on to become (or selling out to) larger companies.

In India though, the lack of capital means that most small companies have to think constantly of ways to survive before it becomes possible to sustain the company through cash flows from their primary product.

Some markets require large amounts of capital before it can be said with any certainly whether they are viable or not. In the book "Founders at Work", the founder of Tivo – probably one of the more disruptive products of the last few decades – mentions that it took about $500 million in funding in its first few years. This is an unimaginable amount of money for a small company (or even a medium-sized) company in India to spend, although in the case of Tivo at least, I think the jury is still out on whether this is a viable market or not.

The example of Amazon – which spent several years taking investor money before it turned profitable – is also well known.

These examples – of large capital expenditures before a market is proven – are unlikely to repeat themselves in India since the pool of capital is limited, and flows mainly to large companies. Large companies are typically conservative about exploring unproven markets, since there are multiple internal constituencies that have to be convinced before such projects are green-lighted.

Given this situation of capital scarcity, especially for early stage companies, what is the best strategy for startups to survive?

One is, as mentioned above, to copy products that have worked somewhere else. These have the nice property that you know that someone, somewhere, is willing to pay for that product, and it is also fairly clear how much money is needed to produce it. Companies following this strategy have to be careful that the original product itself won’t be available in their target market before they are ready. For example, making an Indian version of Facebook at this point is probably a poor bet, since the original product has considerable traction. Countries such as China or Germany that have language barriers have seen domestic knockoffs of popular international Web applications before those products were localized into their domestic languages.

Another strategy is to bootstrap the company by doing work for hire. This is a well-established path, and intermediaries like Elance, Rent a Coder and oDesk make it possible to get contract work that (at least in theory) can pay for the salaries of the people working on the "real" product.

In practice, I believe it is all too easy to become a full fledged outsourcing company, and lose sight of the original product. This is fine as far as it goes, but a service company lacks the advantages of leverage that a product startup naturally has. (See my previous post for more on this.)

An additional option, which I believe more and more companies in India will adopt, is to conceive and develop a product in India for the international market.

While examples of US companies that develop their entire product in India while targeting the US market are now commonplace, these companies are typically American companies with American (or Indian-American) founders.

Companies created by Indians in India have traditionally focused on the market at their doorstep before venturing abroad. In some cases, especially for technology products, the Indian market may take several years to become large enough to support Indian startups. In such cases, it makes sense to target global markets side by side with, or sometimes even before, the Indian market.

This "global from day 1" attitude is probably most evident in companies from Israel, as well as other small European countries that lack a large home market. For products where the Indian market is more similar in size to, say, Belgium, than the US, it may make a lot of sense for Indian companies to think international from the start.

[This post is authored by Abhijeet Vijayakar - founder of Nunook Interactive Pvt Ltd, a game startup in Mumbai and Chennai. Nunook is currently developing BrainNook, India's first online, educational virtual world for kids, parents and teachers. In a previous life, Abhijeet developed 3D graphics engines (and games) at Electronic Arts in the San Francisco Bay Area. He highly recommends not succumbing to capital deprivation syndrome.]

Monday, October 5, 2009

Get Customers First and Then Write a Business Plan

from Wil Schroter's BIGGER Blog - Go BIG Network

If you’re thinking about starting a company, please don’t write a business plan. Stop, put the keyboard down, and step back. You’re wasting valuable time.

Don’t get me wrong, I’m not suggesting that you run aimlessly into the startup abyss. What I want you to avoid is the black hole of planning that most entrepreneurs get into when starting a company. They get sucked into a time warp where a formerly great idea gives way to months upon months of “thinking” about the idea instead of just making the damn thing happen.

If Nobody Buys, it’s Not a Business

The first step, before writing a plan, is to validate the concept. If nobody will ever buy your product, it’s unlikely that a business is ever going to form. Focusing on the product first, and more specifically the customer’s willingness to buy that product, is by far the most valuable time you can spend early in your business.

In addition to validating your concept, selling the product early allows you to prove some key assumptions in your plan before you begin writing it. For example, wouldn’t it be helpful to know what someone would pay for your product before you built it? You would be surprised how much information you can gather from potential customers just by asking them what they would pay for a hypothetical product. “If you build it, they will come” might have worked for Kevin Costner in the movie Field of Dreams, but it’s a formula for disaster in a startup.

The Prototype Company

Sometimes finding out early that your idea isn’t as viable as you thought is a blessing. Instead of spending months writing an elaborate business plan on a completely unproven idea, try putting together a “pre-business plan” that consists of only about five pages that quickly communicates your idea and focuses on the key assumptions that drive your business. These key assumptions are often questions like “Will people buy the product as I’ve defined it?”, or “what will they pay?”, or “how much would it cost me to sell this product?”.

Imagine that the first few months of your business are really more like a great big “prototype company”. Focusing strictly on the sale of the product and proving your assumptions, even on a small scale, will allow you to write a far more comprehensive and viable business plan when you are ready to formalize your thoughts. Additionally, you will be able to make much more accurate forecasts on the business when you get a sense for what it really takes to market, sell and deliver the product.

Your Business Plan is Not an Application for Capital

It’s a common misconception that investors want to see a business plan before they will consider investing in a concept. That’s not entirely true. What investors want to see is that you can demonstrate your ability to sell the product to paying customers. Ask anyone (even yourself) who you would rather invest in – a startup company that is making money without a plan or a business plan that isn’t making any money? Writing long, elaborate papers might have impressed your instructors back in college but it won’t win you any points with investors. They want results, not ideas.

Keep the Plan Simple (and listen!)

Despite what you may have heard, most of the best business plans are as simple as possible. It’s far more important for you to demonstrate that you can solve one market need incredibly well than being able to show you’ve thought of every possible market niche and have included it in your plan. Think quality over quantity.

The process of writing your business plan isn’t to show off how much you know about a concept. The most important aspect of writing your plan is to become a voracious listener. Listen to what your potential customers are telling you they want in a product. Listen to what they are not getting from the existing products. Listen to what investors are looking for in the companies they put money into. Your business plan should read more like a record of all the valuable information you have heard, presented in a meaningful way that makes the case for your company’s potential success.

Put Down Your Pen and Pick Up the Phone

You’re much better served to do your business planning by picking up the phone and asking customers to buy than you are

If Craigslist cost $1

from Seth's Blog

Some things are better when they're not free.

If Craigslist charged a dollar for every listing, what would happen?

Well, the number of bogus listings and repetitive listings would plummet, making the site far easier to use.

The number of scam artists using the site would go down, because it's more difficult to be anonymous when money changes hands.

The revenue of the site would soar, which means that the people running the site could get (far) richer, or fund digital journalism or change the economy of an emerging nation.

Money creates a sort of friction. In the digital economy, magical things can happen when there is no friction. You can scale to infinity. On the other hand, sometimes you want friction.

If you lead a group that allows anyone to join, for free, your group might be large, but it's not tight, it's not organized to make important change. Commitment slows things down in the short run, but ultimately aligns interests.

Startuppable Markets

[Guest post by Abhijeet Vijayakar]

What environmental factors are necessary for startups to flourish?

This question has been examined by several authors, and most have come to the conclusion that a place that looks a lot like Silicon Valley is the natural answer. In other words, take a couple of technologically sophisticated cities such as San Francisco and San Jose, a high-quality university such as Stanford, mix with a generous dollop of military funding, and startups will emerge spontaneously.


(I define a startup as a small company that has the potential to grow explosively rather than incrementally. Every small company is not a startup.)

While this answer is true, I think it focuses on only one aspect of a developing startups, the supply side. In other words, the question is generally posed as trying to find the most nurturing environment to generate startups, while assuming that the environment to consume the product of those startups (the demand side) already exists.

Is this always true? It would seem that the organizations best equipped to meet the needs of the market are large companies that can invest significant resources in market research and product development. And indeed, in most parts of the world this is the case.

Specifically in India, large companies like the Tata and Reliance groups are still the dominant Indian players for most products, from “old school” products like salt to Internet properties like blogging sites. There are few Indian companies that have emerged from the ground up to become big on the strength of their products in the domestic market.

So, what about the demand side? What are the characteristics of startup-friendly markets – markets in which startups can successfully compete with much larger players?

I can think of at least three characteristics:

  1. The markets must be large, or growing rapidly on a moderately large base. Targeting a $5 million market growing at 100% will mean that your startup will have to wait for over 4 years to be in a viable $100 million market. By then, your company is likely to be dead.
  2. The markets must be new, or at least changing rapidly. If this were not so, large incumbents would already have completely satisfied the market, leaving no space for new companies to come in. In developed countries, there are not many startups in the grocery store industry for this reason.
  3. It must be possible to create the products that the market needs with small amounts of capital and high leverage. A low level of capital is typically necessary since startups have only a limited amount of money to prove themselves – usually much less than large companies – before dying. High leverage is the same as low marginal cost — once the product is created, there must be hardly any incremental cost in creating thousands or millions of the same item. Software products are the classic example of low-capital, high-leverage products, and so most startups (not all, but the majority) produce software.

There won’t be many startups in the nuclear power plant industry because of the low capital requirement. Similarly, a single hairstylist won’t be able to create a startup because of the high leverage requirement, no matter how distinctive his style, unless he is able to cheaply pass on the essentials of his style to other apprentices.

One of the reasons in which restaurants like McDonald’s were different from those who came before them is because they were able to distil the essence of their product into an easily replicable (and hence leverageable) process.

How do Indian markets fare on these parameters? Are they startup-friendly?

The good news is that the Indian market for many products is large, and getting larger rapidly as the country becomes richer. As many people have remarked, the threshold of $1000 per capita GDP, which is roughly where India is right now, marks the “take-off point” for consumer spending.

Around this level, a large section of the population has their basic needs taken care of and has disposable income for other products. These markets also change rapidly as new consumers with new preferences enter the “consuming class”. So the first two factors certainly hold for India.

I think it’s the third factor that makes the Indian market challenging for startups. The products that Indians consume, by and large, are not startup-friendly. The market for soaps, TVs and motorcycles is growing rapidly, but these are not products that startups can cheaply make.

Similarly, the markets for plumbing or electrician services are also likely to be growing rapidly (hard data for this is difficult to find), but these are not high-leverage products.

So until Indian consumers evolve to a point where they consume low-capital-cost, high-leverage products (broadly, software) in large quantities, startups will have a hard time succeeding in the Indian market.

Till this happens, it probably does make sense for venture capital firms to behave like private equity investors, and be a source of equity capital for medium sized, non-technology companies.

Although the leverage in these “brick and mortar” sectors is much lower than in technology – indicating that Indian VCs will almost never match the percentage returns of their non-Indian counterparts – the sheer size of those markets makes them attractive to be in.

When will India become a large market for startup-friendly products?

I believe in the very near future. India’s GDP today is roughly where China’s was in 2000, and China in this decade has witnessed a huge increase in both the number of Internet users, and the technology services they consume. Shanda, Baidu, and Tencent are only some of this decade’s success stories in that country.

As the Indian market rapidly turns “startupabble”, their Indian versions are not far away.

[Abhijeet Vijayakar is the founder of Nunook Interactive Pvt Ltd, a game startup in Mumbai and Chennai. Nunook is currently developing BrainNook (http://www.brainnook.com), India's first online, educational virtual world for kids, parents and teachers. In a previous life, Abhijeet developed 3D graphics engines (and games) at Electronic Arts in the San Francisco Bay Area. He is surprised that sushi is not more popular in India.]

Simple tools

Weekend Favs October Four