Economic Frameworks (ch. 3)

Building a new product is inherently a creative endeavor. It requires immense vision, imagination, even artistry. We don’t think of startups as being within the artistic domains, typically. Yet, good products are certainly the result of, at a minimum, good design (visual design as well as systems design) and expert craftsmanship in the implementation of that design.

There is a lot more to it, of course. But without a strong creative vision, there isn’t much to work with. Every one of the founders I talked with for this book — and in fact, quite probably all founders I have worked with in my career whom I would consider even a little bit successful — have each had in common a very high degree of creativity.

And yet building a product company is inherently an economic endeavor, firmly rooted in the domain of mathematics and accounting, and more recently, in science. You cannot be successful as a startup without a very strong foundation in general business practices. Even if your true passion is the creative side of product design and development, it is essential to ground your product development activities in a well-defined economic framework.

This is certainly true for Aashi Vel, co-founder of Traveling Spoon, a marketplace that allows travelers to book food-related experiences at the homes of locals across Asia. These experiences can be a home cooked meal, a cooking class, or a guided tour of the local market. I met Aashi and her co-founder Stephanie Lawrence about two years ago when the marketplace was still just an MVP website intended to measure the demand side of their marketplace. By the time we spoke again recently about economic frameworks, Traveling Spoon had already grown significantly, hiring several new team members and striking deals with a few key partner networks.

You don’t have to be a trained CPA or MBA to develop this framework. You just need a basic understanding of the principles of running a business. You’ll account for your costs and revenues, and you’ll attempt to calculate the impact of different actions you might take on your bottom line (which is likely profit, or perhaps revenue in the very beginning). Having an economic framework then enables you to make prioritization decisions based on the overall economic outcomes from those decisions.

About the importance of building an economic model early on in their startup process, Aashi agreed emphatically. Very early on, pretty much at the idea phase, the two founders began quantifying as much of the market information as they could find. The looked at the overall size of the travel market, they estimated the typical annual spend on travel-related experiences for their target demographic, and they carefully examined the competitive landscape for comparable products and services. All this put together gave them a sense of whether their idea had a reasonable chance at becoming a large and successful business.

Once that understanding was in place, the team needed data on the demand for their particular solution idea, both in terms of the volume of demand and the price sensitivity of potential customers, as well as the cost of acquiring potential hosts and matching them with travelers. They used a range of techniques to collect this data, including an MVP website to measure the demand side, and visits to India and Thailand to seek out and interview prospective hosts. But throughout all of this, they continually updated and refined their economic model, adjusting their assumptions accordingly whenever new data required it.

I asked Aashi what mistakes could have been made had they not been so rigorous with their economic model.

“How do you know how much cash you have on hand, at any given time, for starters” she asked in response?

“When you need to make decisions about whether to hire a new team member, or when to raise money, or whether to outsource part of your production system, you have to know the financial effects such decisions will have. At a minimum, you have to have an accurate sense of cash flow just to function on a daily basis.”

It seemed obvious hearing Aashi put it like this. But I can’t tell you how may startup founders I have bluntly asked exactly about cash flow projections only to get blank stares in reply.

“A more complicated example,” she went on, “is if you’re considering a partnership for some part of your business model, such as customer acquisition in our case. We work with tour operators to help us identify and acquire travelers who might be interested in our food experiences. You need to be able to understand very precisely what the benefit of the partnership is going to be in terms of raw numbers of customers acquired through that channel, and exactly what it will cost you to acquire them through this deal. Without a model, you can make very serious errors in these calculations.”

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Originally published at www.startuppatternsbook.com on July 1, 2015.