the startup report getting the value equation right
TRANSCRIPT
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THE STARTUP REPORTGetting The ValueEquation Right
With Bryan Franklin Jennifer Russell
MIND MONEY MEANING
California Leadership 2013
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THE STARTUP REPORT
Getting The Value Equation Right
What Youll Get In This Report
A Detailed Description Of The Startup Value Equation A Method For Evaluating The Solution To Your Personal Value
Equation
Guidelines For Constructing A Well-Formed Offer A Script For Interviewing Potential Customers About What They
Value
Short-cuts To High Value Offers How To Calculate Your Costs Accurately (When Youre Not A Math
Wiz)
Ways To Avoid The Most Common Pitfalls Of Startup Entrepreneurs
Are You A Startup?
If youve started a business, but you havent yet reached a level ofprofitabilitiy that sustains a competitive personal income for you and anyother founders, you are in the Startup Phase.
The word Startup has been co-opted by Silicon Valley to refer to a specifictype of technology Startup that usually involves massive growthpredictions, a global product strategy, heavy backing from venture
capitalists, and a young founding team of super-genius technologists. Thatrepresents only about 10% of startups in the U.S.* The other 90% ofStartups are self-funded businesses based on an interest, a skill, or anopportunity that are trying to grow quickly and safely.
Similar to the infant phase in human development, the Startup Phaseinvolves vulnerability and requires special care and attention. Mistakeslike spending too much money and failing to set and meet customerexpectations can be fatal. You probably experience a lot of urgency around
growing your business as quickly as possible, but because you are
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managing so many variables, its not clear what you can do to make thathappen.
If youve already established a predictable and reliable method ofgenerating leads, converting those leads to customers and then fulfilling onthe promises you make, you are reallyin the Sustainable Phase and notthe Startup phase. Look for the Sustainability report, Creating a marketingcrank.
*Small Business Association, 2013
Getting The Value E quation Right
In Startup mode, you really have one incredible urgent job: To get out ofstartup mode! And the only way to transition from Start up mode tosustainability mode is to get the value equation right for your business.
The value equation determines the kind of business youll have, how easy itwill be to get new customers, and how fast youll grow. Youve gotten the
value equation right when your customers are happy to pay you more thanit costs you to deliver value to them, because the value they are getting ismuch greater than the price they are paying to you. Simply put,
VALUE > PRICE > COST
For example, if you are starting a wedding photography business, thesolution to your value equation is the value that people place on gettingtheir wedding pictures taken, say $5000, which is more than you charge
them to do the job. Thatsaround $2500, which in turn is more than it costsyou to take their pictures and deliver them in a manner that satisfies theirdesired value, say $1500.
$5000 > $2500 > $1500
Of course, its not enough to know how much a customer values weddingphotography. Your true value equation is based on how much your
customer values wedding photos taken by you. This is why everyentrepreneur must find their own value equation. You can follow general
guidelines created by the others in your field, but ultimately your valueequation is yours alone.
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Its like quora.com for plumbers but with ubers business model(this isnt even an offer what the heck is the customer getting?)
Write down your offer. Then read it back and compare it to the examplesof wellformed offers and poorly formed offers. Which group does it mostclosely resemble? Keep narrowing it down until it sounds and feels justlike the other well-formed offers.
Once youve settled on the promise and the process youre offering, you canstart to find out how customers value what youve got and how much it willcost you to provide it.
Now youre on a scavenger hunt, looking for all the different people whowant to take advantage of your offer, or ways that you could make good onthe promise, and all the different ways you could deliver it.
Fig. A Look For The Overlap
In each circle, there are things that do not overlap with the others.Customers are willing to pay for parking tickets even though they dontwant them. You can afford to offer a small bag of rocks to your customers,but they dont want to pay for that and they dont want it either.
There is also a world of things that customers want that they are not willing
to pay for. Most people want a full-time gourmet chef, but less than .01% ofthe people are willing to pay for it. Most people want to fly private jets
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rather than commercial. Most men want a movie theater in their home.Most women want a 1000 sq ft shoe closet. But again, very very few arewilling to pay for them. Even many of those who could technically afford
these things are unwilling to justify their costs.
Based on this, it is not enough to ask a potential customer if they want whatyou have to offer. You also have to know if they value it enough to buy.
How Do You Measure What Someone Else Values?
Have you ever had a salesperson ask you How valuable would it be to you
to solve this problem? You probably have difficulty coming up with a good
answer to that question, because it causes a conflict in your mind.
Lets say you wanted to buy a cast for your broken arm. If the doctor asked
you, How valuable is it to you to be able to use your arm again? Of course,
its priceless! But does that mean you are willing to pay all the money you
have for that cast? No, of course not.
It can be challenging enough to discern exactly what value you place on
different products, services, and experiences. Add to that the differences in
how different people see the world and approach their lives and you can
imagine the challenge of understanding what someone else values.
So how can you measure it?
Customer Value Interview Script
There are a few questions that are easier to answer than the classic
salespersons approach and give you a lot better sense of how someone else
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values your offer. Talk to people who are qualified to be your customer and
explain your offer to them. Then ask them these questions:
1. Whats the main value you expect to get from my offer?2. What price would you not pay for this offer because its too high?3. What is the lowest price at which you would still rather keep your
money than get the benefit of the promise?
4. What would you expect to pay another company for a similaroffer?
5. Would you expect to pay more than that or less than that to me inexchange for my offer? (And why?)
6. What is the highest price at which buying this offer would occur toyou as a no brainer?
7. What are some ways I could change my offer to make its value toyou more tangible?
This can be a sobering conversation or an enlightening one, or both. We
recommend talking to at least 10 customers and recording the
conversation. The exact words the customer uses to talk about their
situation are valuable for marketing and copywriting key words and
phrases, and you often will hear important things when you play back the
recording that you may have missed in the moment.
Once youve interviewed 10 people who are qualified to be your customer
about what dollar figure they attatch to the kind of promise and process
you plan to offer, you will begin to see a patternfrom different people
saying the same kinds of numbers. The VALUE variable in the valueequation is the average of the answers to question number 3. The PRICE
variable in the value equation is somewhere between the average answer
to question number 4 and question number 6.
Change Your Offer To Lower Risk
Increasing the customers perception of the VALUE of your offer
dramatically increases your flexibility and chances of success. The higher
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the VALUE, the more options you have on the COST side and the more
freedom you have to charge higher PRICES.
During your 10 interviews, youll notice that changing something about theProcess often dramatically changes the perception of VALUE, even though
the promise hasnt changed.
Thats because customers automatically build in risk (or their assumptions
about the chances of success) into their own sense of value. For example,
which is more valuable, $100 cash or a lottery ticket with a chance to win
$100,000,000? You chose the cash (hopefully!) because you are
automatically building into your assumption the fact that the lottery ticket
isnt very likely to provide those winnings.
Your customers do the same thing when they consider your offer which is
whyit is that they value the same offer from different companies and
entrepreneurs so differently.
Think about how your customers view the chance of success with your
product or service. What are the things that you could do to change your
promise or process that would lower the risk of failure and increase the
chance of success, in the customers mind, before they purchase? Those
ideas are going to help you solve your value equation.
Short Cuts To High Value
There are certain universal factors that drive up value. There are dozens of
advanced short cuts to massive Value included in the Mind Money Meaning
System, butif you want a short cut to increasing the VALUE of your offers,there are some basic short-cuts to get you started in Fig. B. For now,
make changes to your offer to make it Higher Value or Highest Value.
Fig. B Short Cuts To High Value
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ForProcesses
ForBusiness
ForTransformation
ForDevices
HighestValue
Done-For-You Get MoreIncome
CustomRecommend-ations
Automated
HigherValue
Done-With-You
DiscountExpenses
EvaluationOr Assessment
Fashionable
Lower
Value
Do-It-Yourself
WithSupervision
Save
Time
Mental
Models Clever
LowestValue
Do-It-YourselfHandle
NecessitesInformation Functional
Calculating Your Costs: The Basics
Once you have arrived at the VALUE your customer gets from your offer,
youve anchored the solution to your value equation on one end.
KNOWN VALUE > PRICE ? > COST ?
The next area to investigate is your cost. For your business to be
successful, include all the expenses that are required to deliver value to the
customers according to your offer.
There are a few different categories of cost, which well cover in order of
most obvious first.
Direct Costs expenses that you pay out of pocket in order to deliver the
value of your offer. If you own a restaurant, the cost of all the ingredients
that went into making the meal that the customer bought are direct costs.
If you run a carpet cleaning business, then the hourly wage of the employee
while they are on the jobsite with the customer is a direct cost. Direct costs
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are variable, because they go up when you have more customers. Some
businesses, like coaching, have no direct costs at all.
Allocated Costs expenses that are related to your business but arentdirect. Overhead expenses such as your accountant, equipment leases, and
printer paper are often allocated costs.
As the name suggests, in order to figure out how much it costs you to
provide your service, you have to allocate some portion of those costs to
each customer. This can be a bit tricky, especially at the beginning, because
its hard to know how many customers you are going to have.
If a software company spends $25 million developing its software, andexpects to have 25 million customers, then it can allocate $1 per customer
in Allocated Costs. But if they guess wrong and end up with only 100,000
customers, suddenly they have $250 in allocated cost per customer, which
is deadly when you were counting on only $1.
In the beginning, assume a 50% utilization rate and calculate your allocated
costs based on that assumption. If you are a massage therapist, the
maximium number of clients you can take is likely 3-4 massages per day, 5
days a week: 20 massages. per week. That would be 100% utilization. 50%
utilization would be half of that, or 10 massages per week. Now, you can
add up all your allocated expenses for the year, say $10,000. If you work 40
weeks per year, thats 400 massages. $10,000 per year divided by 400
massages is $25. That means you have $25 per massage in Allocated Costs.
Heres the formula one more time:
Total Yearly Allocated Costs / (Max Per Week x 50% ) x Work Weeks
Now you have Direct Costs and Allocated Costs, but there is a third
category of costs which is the most important and the most often
overlooked. In fact, it is this third category of costs that is most often
responsible for the faiure of a business.
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You Messed Up Your Numbers: Miscalculating Cost
The third category of costs are Hidden Costs, which are almost never
calculated by Startup entrepreneurs, leading to miscalculating cost and
getting the value equation wrong.
Hidden Costs are the costs that it would take to run the business without
you, your assets, and your special relationships. They are not paid in cash,
which is why they are so often missed. The largest cost for most Startups is
the Hidden Costs of the salary of the founder. Since the founder rarely
takes a salary, its easy to miss, but you dont want to go without a salary
forever, and if your value equation breaks when you add in the cost of whatyou want to get paid, then youll never get out of the Startup phase.
Thats how some businesses that have been around for decades are still in
the Startup phase they havent calculated the hidden costs, so the founder
is still working at way below market rate for his/her contribution to the
business.
If you imagine having to pay someone else to do your job, how much would
you have to pay to insure that you could get someone who is capable ofdoing a good job? If your business relies on the fact that you own land, or
your brother is doing you a favor, or that cousin Phil is willing to work for
nothing, its very important you count those hidden costs, allocate them if
they are also indirect, and add them into your value equation.
To finalize the COST variable in your value equation, add the direct costs,
then figure out how much Allocated Cost to attribute to each customer,
and then calculate your replacement salary and the rest of your HiddenCosts. Add the three together and you have the true picture of what it costs
to deliver your value to the customer.
In a Web Design business, you might have a direct cost of $1800 to getsomeone to help build your client's website, and allocated costs of $300 foryour equipment and overhead.
Let's calculate hidden cost: It might cost you $90,000 to $150,00 per year
to hire enough staff to run the business completely without you, dependingon where you live and the types of clients that you attract. If you assume
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max utilization is 10 websites per month, then half of that is 5 websites permonth, or 60 websites per year. $90,000 to $150,000 devided by 60websites is $1,500 to $2,500.
That means your hidden costs are between $1,500 and $2,500. Add that to
your direct and allocated costs and you get $3,600 to $4,600 per website
total cost. If you can charge at lest $4,600 or more per website, then you
have found the solution to your value equation.
Direct Cost Per Customer
+ Allocated Cost (Total Divided By 50% of Max Utilization)
+ Hidden Costs (Total Divided By 50% of Max Utilization)
= Total Costs
Sadly, most entrepreneurs dont make this calcluation. It would be an easy
mistake to think It costs me $1,800 to get the website done. If I charge
$3,000 Im making good money on each one. Thats true until you take
into account your hidden costs, and then you realize that in fact you are
losing money on each site, not making good money at all. The money youare losing is the difference between the money you can pay yourself and
the money youd have to pay someone else to take over. Thats why a bad
value equation can trap entrepreneurs in their own businesses.
More than likely, the first time you calculate your costs they are going to
come out higher than your price. Almost every business in the Startup
Phase starts that way. You can temporarily make the business work by
taking less money for yourself, but over time that strategy will take its toll
on you, and youll start to feel imprisoned by the fact that you never solved
your value equation.
That means you have to innovate and iterate over time to drive your costs
down and the value you are providing up. Thats why the most important
focus you can have in a Startup business is understanding the value
equation and getting it right.
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The further you can pry the two apart, driving value up and costs down, the
better business you will create, the more quickly it will grow, and the more
value it will generate for customers and the more cash for you.
The Price Is Right, Isnt It?
Once you know the VALUE and the COST, then you can place your PRICE
point anywhere in between and be safe. But how do you know where in
between to place your price?
Pricing is as much an art as a science, and depending on your industry
there are at least 6 major pricing strategies covered in depth in the MindMoney Meaning System, but to get started, consider profit margin versus
sales velocity.
Profit margin is how much money you make in profit on every sale. Allother things being equal, the more you charge for your product, the moreprofit you make.
But all other things are not equal, and one of them is sales velocity, which is
the speed at which you meet and convert new customers. In the corporateworld, a $250,000 consulting project could take dozens of hours inexploratory meetings over the course of 6 months to turn from an idea intoa sale, whereas a $3,000 strategic software purchase can be approved in a30-minute phone call. How many 30-minute phone calls could you have in6 months? It would only take 14 calls per month selling the $3,000software to be more profitable than the $250,000 consulting project. Thatsbecause of sales velocity.
Lowering your price doesnt always increase sales velocity, but it often
does. Experiment with different pricing models and learn pricingstrategies like the ones taught in the Mind Money Meaning System tobalance getting the most profit you can with the least resistence frompotential customers.
Cash Always Tells The Truth
Your customer may not know what they would buy and what they wouldnt
buy until the time arises to do so. They also may know but not wish to
share. Interviewing potential customers is crucial to getting your value
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equation right, but pay more attention to what customers say with their
time and money than what they say with their mouths.
Your customers spending habits will tell you what they really value and inwhat proportion. Thats why youre not out of the Startup Phase and into
Sustainability until youve not just theorized the solution to your value
equation, but youve demonstrated it.
How? when you have 10-20 customers who have all bought roughly the
same thing from you for roughly the same price, and they are ecstatically
happy with the value theyve received from your products and services.
Cash Always Tells The Truth
Theres a lot of information in this report about what to do in Startup Phase
and how to think about and calculate the solution to your value equation.
If you arent using the Mind Money Meaning System to help you sequence
these steps properly, get a mentor or role model who has been through the
Startup Phase successfully and go over this report with them. Then ask
them to help you focus on what you should do next. Then go step-by-step
in the sequence they recommend until youre safely out of the Startup
Phase.
And perhaps most importantly, ignore the strategies, tactics, ideas, and
approaches that are for businesses that are in the Sustainability phase or
the Scalable phase. Until youve solved your value equation, they will be
distracting at best and detrimental to your success at worst.
If you found this report useful, be sure to share the page where youdownloaded it with entrepreneurs who you believe in and want to see be
successful. Then comment so we can start to become better acquainted
and more fully understand each others businesses, aspirations, desires,
and capabilities.
To your continued success,
Bryan and Jennifer
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