Is Your Start Up Idea Gold or Goop?

Is your business idea an undiscovered gem, or a flaming dumpster fire leading you to your doom. Here’s a quick rule to help.

A lot of entrepreneurs ask me to look at their business ideas since they know what I do for a living. Some are gold, some are meh, most are flaming dumpster fires. It stinks to tell people when their ideas are smoldering rubbish, so most VCs don’t and just politely decline or ignore bad business pitches. Although the full content of our upcoming accelerator/incubator, Sputnik ATX, is still in stealth mode, I’d like to share a quick rule you should apply to any business idea that you want to pursue. It is specific to answering the question:  will anyone buy this? A question that is obviously important to everyone except the tunnel-visioned entrepreneur who doesn’t value his equity.

So, would be entrepreneurs, let’s take off our blinders and have an honest conversation about your product and service, and more specifically, the benefit it provides.

I’m hoping you already read my post about consumer surplus. If not, read this first. I’m going to use a lot of those terms here. Because if you’re going to get someone to buy your stuff, you had better generate a ton of consumer surplus first.  Assuming that your idea and business plan can generate value (consumer surplus), you still may have a lot of trouble finding people who want to buy it because the switching cost still exceeds the marginal benefit.  Say what?

Switching costs are what economists call any expense related to stopping the use of one product and service, and beginning to use another. Switching costs may include disposal fees for the old junk, training for new stuff, hardware upgrades, software patches, the time it takes to buy/train/learn the new item, and pretty much anything else associated with the new thing to consume or use. Sometimes these can be quite high.

For example, why do we all keep using Facebook when there are surely other social platforms out there? Because the switching cost includes getting all our friends to switch to the new platform (good luck with that) and also includes information loss when we miss out on posts from our friends still on Facebook or they miss out on ours since we now use some loser platform they’ve never heard of. That switching cost is sufficiently high enough that we don’t switch to Loserbook.

But what if switching has a lot of advantages?  The advantages of switching are called the marginal benefit. This is the increase in value we get from switching to a different product or service. For example, if you stop eating at Chipotle and start eating at Qdoba, you get the marginal benefit of free guac at Qdoba (yes, you read that correctly). You also get the added option of queso at Qdoba, and hey, who doesn’t like queso!  While this is a good place to add another marginal benefit, not playing the intestinal fortitude lottery at Chipotle, I’m going to restrain myself. Suffice to say that there are some serious marginal benefits of eating at Qdoba versus Chipotle.

Now, if you want to create a new company and provide a new service, you need to provide your consumers a product where the marginal benefits exceed the switching costs in a manner that is obvious and as big as possible.  The larger the cap between benefit and cost here, will greatly influence how quickly people will make decisions to consume your new product/service.

One of the worst products to do this, of all time in my opinion, was the Apple Newton. I can pick on Apple, because they’ve made a lot of smart product launches where marginal benefit kicked the life out of the switching cost, but not on this one (thank you John Scully, I couldn’t have written this without you). Newton was a stinker. For those unfamiliar with it, Newton was a hand-held device that kept digital notes for you. That’s it. You wrote on it, it recognized the handwriting if you used its funky letter system and it converted your writing to digital text. It was also expensive.  It cost $699 when launched back in 1993.  That is roughly several gazillion dollars today (in Zimbabwe).

You don’t have to be a rocket scientist to know that $700 is a lot to pay for a notepad that only recognizes its own weird version of shorthand. The Newton made you pay an awful switching cost for something that you already had in a simpler, easy to use format and could buy for fifty cents at Walmart. So what happened? People kept buying notebooks that worked great, and the Newton died.

Remember how the Segway was going to revolutionize foot traffic?  Yep, switching cost exceeding marginal benefit.  There are more. Microsoft Bob?  You betcha! Google Glass?  Check! The idea graveyard is littered with expensive examples of how brilliant people created incredibly complex and expensive solutions to problems with little benefit beyond what the market currently provided.

Now, Steve Jobs returned to Apple (hurrah) and we got the iPad. It could still be used to jot stuff down, but it also pretty much ran the whole universe. The increased benefit of zillions of apps, made the switching cost paltry compared to the massive benefit provided and, viola! People buy them up the wazoo.

So, if you want to avoid betting your life savings, and that of your investors (me) on something that will never catch on, please do some product soul-searching to see if the benefit your start-up provides is sufficient to cover the cost to customers when they switch. Remember, marginal benefit must massively exceed the switching cost -iPad, not Newton. Of course, you still have to do a lot of other things right to succeed, but this is a biggie so get it right.

Author: Joe Merrill

I'm a VC in Austin, TX.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s