Funding a Company with a Strong Value Proposition, a Guide for VCs

by andy on May 20, 2010

Buyer and SellerIn my last post I took the position that venture capitalists need to give more weight to a company’s customer value proposition than the strength of the management team.  Admittedly it can be difficult and time consuming to determine a strong value proposition that real customers will spend real money on.  A value proposition must answer the customer question “what’s in it for me?”  (WIIFM)

The first thing to remember is that a customer will base buying decisions on emotion rather than logic.  Most advertisers will attest to that fact, and a very interesting new research project released last month by Raj Raghunathan and Szu-Chi Huang at the University of Texas supports this.  People subconsciously have an emotional reason for making all decisions, including purchasing decisions, and then use logical reasons to support their decision.

This is extremely important to understand when determining a strong value proposition, because if your product or service doesn’t fulfill an emotional need, it absolutely won’t be purchased.

Emotional Value Proposition

Emotional needs are quite varied and include ego gratification, professional advancement, better health, avoiding embarrassment, pride of accomplishment, and many more.   The emotional value proposition isn’t necessarily obvious and often goes unstated, both by the customer and the company.  Emotions are feelings, and feelings, whether good or bad, tend to make people feel vulnerable when exposing them.  Therefore the customer may not want to talk about the emotional need.

For example, when selling software or hardware to IT professionals, sometimes a good emotional need to fill is the need to play with a cool new technology.   Or you could also be selling a product that relieves a lot of pain.  When I worked at TippingPoint, one of the top emotional needs the Intrusion Prevention System (IPS) served was giving IT staffs their after-hours and weekends back when recovering from malware outbreaks like spyware.  If you have ever accidently gotten spyware on your computer and had the extensive and laborious chore to remove the spyware, you know what I mean.  It is truly an emotional toll that it takes on you.  By blocking the bad stuff from ever getting on an organization’s servers and desktops, it literally was a huge emotional relief to these customers.

Once you establish that the product can really tap into a usually unstated emotional need, you must have solid logical reasons for a customer to want to buy your product.

Logical Value Proposition

Dr SpockThere are three key logical reasons that can be used by a customer to support a purchase decision of a product.  The product needs to do at least one of these things really well, and ideally it should do at least two of these things.

1)      Save time. A product or service should save the customer a minimum of 50% of the time it normally takes to complete a task.  Best if it can save over 90%.  That’s a winner.

2)      Save money.  The product or service should provide significant savings.  The actual savings can vary a lot based on the industry.  Sometimes a 1% savings is considered huge.  Other times you need to have 50% savings or more.

3)      Make money. Particularly if you aren’t saving money, you need to make money with a quick ROI.  A couple examples of a money making product are a third-party component of another product, or a private label product or service offering.

Alternatives to your Product

What alternatives does the customer have to your product?  The number one alternative is usually doing nothing.  For many products, this can be a tough alternative to overcome.

To fully assess alternatives you have to look closely at competitors, including indirect competitors.

With all this in mind, let’s look at an example, the Apple iPad.

Real World Example – Apple iPad

Nothing has set the tech world on fire as of late as much as the introduction of the Apple iPad.  The iPad definitely gets the checkbox for satisfying emotional needs.   I’m not an iPad customer yet, but I want to be.  That tells me something.   People with iPads get longing stares at coffee shops and lunch hangouts.   Wannabes come up and want to see it and talk to them about it.  Granted that will change soon but it definitely says something about the desire factor.

And of course, the iPad satisfies a logical need because it is a computing device like a laptop or an iPhone.  Could you get by with your laptop or your iPhone if you have one?  Sure you can.  But do you still want an iPad?  Sure you do.  Because if you buy one you are declaring yourself one of the cool kids.

Summary

When I look at a company’s potential value proposition for customers, I start by looking at what the emotional and logical reasons a customer would want to buy the product.  I really try to get in the customer’s head.  Then I look at the competitors, indirect competitors, and the overall market to get a sense for where I think this company is positioned.   It’s good to have competitors because that means there is a market for your product.  If you are inventing both a product and a market, that’s an uphill battle and turns every sale into an evangelical sale.  You don’t want that.

As an investor, you want to have a solid market analysis for a product during your due diligence to determine whether the value proposition is real and tangible.   In the end, you need extensive data to support your decision.  As you can probably now guess, yes, your ultimate decision to invest is going to be based on emotion rather than logic.

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