The first mistake we make when we pitch our "great idea" to stakeholders is that we lead with our solution. We spend a disproportionate amount of time talking about the uniqueness of our product’s features or its underlying technology breakthroughs. We can’t help it -- we have the innovator’s bias for the solution.
The solution is what we most clearly see and what gets us most excited. But our stakeholders don’t necessarily see what we see. More important, their goals are different. They don’t care about our solution but rather about a business model story that promises them a return on their investment within a set time frame.
This is what they really want to know:
How big is the market opportunity? They don’t care who your customers are, but how many -- your market size.
How will you make money? They want to understand the intersection of your cost structure and revenue streams -- your margins.
And finally, they want to know how you will defend against copycats and competition that will inevitably enter the market if you are successful -- your unfair advantage.
Let’s look at an example. Say you have invented a method for reliably capturing an eye-tracking signature. So what? Instead of leading your pitch with a description of your invention, lead with your business model. If this eye-tracking signature can be used as an early diagnostic system for autism in children (big market) at a fraction of the cost of existing alternatives (potential margins), and you have a patent pending on the method (unfair advantage) -- that is a big deal.
But what gets an investor’s attention above everything else is traction. If you walk into an investor’s office with the beginnings of a hockey-stick curve, they’ll sit you down and try to understand your business model. The hockey-stick curve starts out flat, but has a sharp inflection point when it starts quickly trending up and to the right -- indicating that good things are happening.
This inflection point, or evidence of traction, signals that people other than yourself, your team, and possibly your mom care about your idea. The problem is that traction means different things to different people. And it too can be gamed.
It’s not enough to simply pick any convenient metric for the y-axis of your hockey-stick curve, one that conveniently happens to be going up and to the right, and pass it off as traction. For instance, plotting the cumulative number of users over time has nowhere to go but up and to the right.
A more sophisticated investor will see right through this facade of vanity metrics. You have to instead pick a metric that serves as a reliable indicator for business model growth. In this chapter, I’m going to share such a metric with you.
What Is traction?
Because traction is a measure of the output of a working business model, let’s first turn our attention to the definition of a business model. You create value for your customers through your Unique Value Proposition, which is the intersection of your customers’ problems and your solution. The cost of delivering this value is described by your Cost Structure. Some of this value is then captured back through your Revenue Streams.
The first insight is that value in the business model is always defined with respect to customers. It follows that the right traction metric must also track a customer action or behavior. Neither the amount of stuff you build, the size of your team nor your funding qualifies as traction.
Next, in order to establish a business model that works, the following two conditions must be met:
1. Created value > captured value.
This is the value equation that drives your business model’s unique value proposition (UVP). You need to create more value for your customers than you capture back. If your customers don’t get back more value (even perceived) than they pay for your product or service, they will not have enough incentive to use your product and your business model will be a nonstarter.
It is equally important that you run tests early in the business model validation process to ensure that you can also capture back some of this value as monetizable value that can be converted into revenue. I’m a big proponent of testing this as early in the business model validation process as possible. Otherwise, you delay testing one of the riskiest assumptions in your business model, which can be a costly assumption to get wrong.
Even “free” users in services like Facebook and Twitter aren’t truly using these services for free. They pay for their usage through a derivative currency that I’ll describe shortly.
2. Captured value >/= cost (delivering delivery).
This is the monetization equation that drives sustainability and profits in your business model: you need to capture back at least as much value as it costs you to deliver this value or your business model also falls apart.
A for-profit business model aims to maximize the difference between value captured and the cost of delivering value, while a not-for-profit business model aims to keep this difference as close to zero as possible.
There is no business in your business model without revenue.
3. Created value > >/= cost (value delivery).
While every business needs to eventually satisfy both of these equations, it doesn’t need to do so from the outset. In the “lean” approach, we tackle them one at a time from left to right. After all, creating value for users is a prerequisite to being able to capture value from them, and capturing value from users is a prerequisite to optimizing your cost structure.
In other words, the value created for customers is an investment in your business model system that is returned when some of that value is converted into revenue.
Capturing value is the common factor in both the value equation and the monetization equation and key to the definition of traction:
Traction is the rate at which a business model captures monetizable value from its users.
Traction vs. revenue.
While booked revenue can be manufactured in many different ways, traction is revenue that needs to be attributable to key user actions in the past. These past user actions serve as leading indicators for extrapolating future business model growth.
Using customer behavior trends and sales data, Starbucks realized that time spent in their coffee shops correlated with more money being spent in their stores. In other words, time spent in a coffee shop was a leading indicator of traction. This was a key insight in Starbucks’ differentiated positioning of “creating a third space between work and home.” While other coffee shops drove you out once you made a purchase, Starbucks welcomed you in, and it paid off very well for them.