What is a Startup?

A startup is a team that is best designed to launch—and then iterate upon—a minimum viable product, all in the in search of product-market-fit. If that sounds like a bunch of jargon, it is! A couple of quick definitions are in order.

What is a minimum viable product?

A minimum viable product is the minimum thing you must bring to your suspected customers in order to start getting feedback on whether or not you’re building the right thing for the right customer base. And when I say suspected customers, you probably have hypotheses about who your best customers will be, how much they’re willing to pay you, and how they’re going to use your product or service, etc. These hypotheses are likely wrong. The best startups test their hypotheses quickly and then make the appropriate changes to their offerings in order to ultimately arrive at a valid business model.

To make this concrete, I’ll provide a specific example. When I was at Chicago Booth, one of my classmates wanted to launch an app for making and managing restaurant lists. He let the school know that he was looking for beta testers — and I signed up. In my first meeting with Ryan, he showed me paper wireframes and asked me to interact with his app, as if it were on a smartphone screen. He did this with 20 or so of our classmates, refined his wireframes, tested again, and eventually hired a developed to launch, and then iterate upon, a functioning application. While Ryan’s startup NomWell is no more (monetization is tough!), I personally used it track the 150+ restaurants I had a pleasure of visiting during my two years in Chicago — and I really enjoyed watching Ryan build a business based upon customer feedback.

Similarly, I work with and interact with a lot of CPG (consumer packaged goods) entrepreneurs. They often ask me what to do next after they discover that they have a great recipe. Often times people think that they should go and raise money so that they can produce 10,000 units. That would probably be a huge mistake. Before you decide to mass produce a recipe, produce a small batch at home. Why? Because it will allow you to test quickly, and cheaply, to make sure you’re headed in the right direction. (And then, if you get positive feedback on your small test, produce a larger one either at home or at a local culinary kitchen or incubator.)

These minimum viable products, or MVPs, are the tools that let you test your ideas before you invest a lot of cash (and time) into something that might turn out to be a not-so-good idea after all. And if this part isn’t clear yet, the only people truly qualified to tell you whether or not your idea is a good one are your prospective customers.

What is product-market-fit?

Product-market-fit means that you’ve uncovered something that customers actually want, and are willing to pay for it. (If they don’t want to pay for it, you don’t have a business model yet. You’re not quite there. You need to keep testing.)

Iteration is the name of the game, and it’s how do you get to product-market-fit. You must test, receive feedback, make improvements, re-test, get more feedback, and keep iterating on this process endlessly. (Sidenote: Even established businesses benefit from this process, which is something Ries covers in his latest book, The Startup Way: How Modern Companies Use Entrepreneurial Management to Transform Culture and Drive Long-Term Growth.)

To be clear: A startup is not simply a small business. It is a group of people, or a hedgling organization, seeking a business model. (If you’d like to better understand this process, or maybe even read a whole book on the topic, I recommend Eric Ries’ The Lean Startup.)

Once an organization has achieved a profitable business model, and by some definitions, stopped raising money, it’s not a startup anymore.

What is a business?

A business exists to deliver something that a paying customer wants. While not all established businesses achieve consistent profitability, even with a viable business model (think Amazon!), profitability is ultimately the goal.

The most likely path to profitability is through scale. Scaling means that you’ve taken your product to new customers and/or new markets. It might also mean that you’ve introduced new products to your existing customers. It usually means all of these things. And this process usually takes years.

The basic economics of any business

Revenues are what you get from selling your product to your customers. What it costs to produce that product is referred to as Cost of Goods Sold (COGS). Your revenues, ultimately, must cover your COGS and your operational overhead. Profits are what you have left after you’ve paid for everything else. (In an oversimplified way: Revenues – COGS = Gross Margin. Gross Margin – Operational Expenses = Profit.)

Fun fact! Consumer packaged goods businesses tend to have COGS that scale in rough proportion with revenues; you must produce a good in order to sell it, and while you will likely save money by producing your good at higher quantities, those goods always cost money. They grow at the same time that your revenues do, and unless you suddenly start fetching a much higher price or find a way to make your goods at a much lower costs, your COGS will be proportional to your revenues.

Software companies, by contrast, have an initial upfront investment in their product, and then can essentially print copies at little to no cost that they can then sell to additional customers, resulting in a higher profit margin.

Operational overhead is how much it costs to run the rest of your business: It’s what you pay for salaries, for your marketing materials, your rent and utilities, your liability insurance, etc.

How to achieve (profitable) business scale

Scale is achieved by acquiring more customers and/or increasing the lifetime value (LTV) of each of those customers. If your company sells one billion cookies, you are likely to make more money, and also enough money to cover both your COGS and your operational overhead, than if only sell one thousand cookies. A software company that sells each license for $1000 dollars is more likely to be profitable than a company that sells an equal number of licenses at $10 apiece. Math.

So how do you get there?

Who makes sure you’re building and selling the right thing?

Your product team has to deliver the product your customer wants; but it is likely your sales and marketing team that is in the position to drive sales, and actually gather good customer feedback, at the same time. The process of trying to selling your product to your customer is a feedback loop, in which your customers tell you about what they want, how they want it, and even the words that you should use to communicate your offering. Sales people are close to your customer, and are usually in an incredible position to help you refine your offering in order to match your customer’s wants and needs.

At early stage startups, it is often the founders who are in the best position to execute on and manage this process; but if your startup has grown bigger and/or the founders are not natural or even good salespeople, you’ll need to hire someone to do this job.

Sales is a revenue center, not a cost center

Your sales department, it’s worth noting, is your only revenue center in your business. All other departments — for instance, finance, operations, or HR — are cost centers. They play an important role in the running of your business, and it costs you (a lot) of money to maintain the departments you have hired these employees or contractors to run.

Without sales, you have no revenues, and you only have costs. Not much of a business model.

The secret to scaling your business profitably, then, is to target and acquire the right customers. This makes it the most important function within your business. Who have you hired to do this function, have you hired the right people, and are you motivating them properly? If you haven’t, this is a mistake that’s costing you a lot of revenues, isn’t it?

How to grow and maximize revenues

In another post, I cover one of the ways that you can make sure you’ve attracted and will retain the industry’s best sales people through one of the best tools you have available to you: the compensation plan.

If you think you have hired the correct people, have you structured their compensation plans in a way that truly aligns their behavior with the goals you have for your organization? Learn how to put together a comp plan that will guarantee maximum revenue growth for your business.