Start-ups most often fail because they don’t understand the market and don’t segment their users

Day 6. January 2015 posted Stanislava Vabšek
In most cases, start-ups fail because they don’t understand the market and the problems of their customers. Their key problems are premature scaling in the phase when the company hasn’t yet reached the product-market fit, and a lack of understanding that users have to be segmented in the problem-solution fit phase – that you should focus only on one customer segment while telling everyone else no. The 6th educational module of the accelerator Start:up Geek House was on the topic of metrics for start-ups and Kristjan Pečanac from Hekovnik has warned about the main problems as well as revealed the tools for defining the optimal user segment. 


4 basic building blocks

Every start-up company has four basic building blocks. These are illustrated by four key questions to which the entrepreneur has to find exact answers by learning about the market scientifically and systematically:
  1. Who is your ideal client and what is their problem?
  2. What’s the solution that solves the client’s problem?
  3. How will the company generate income or what’s the business model like?
  4. What’s the company’s scale-up strategy? 

The key indicator of success is growth

According to Paul Graham, co-founder of one of the most successful accelerators Y Combinator, a start-up company is meant for fast, accelerated growth that should amount to at least 3 percent a week. All else connected to start-ups originates from growth, which is why it’s exactly growth that is the key performance indicator (KPI) for each start-up company. “But we can’t achieve growth if we start building the wrong product right from the very start and it turns out it’s a product that clients don’t want, don’t need and aren’t prepared to pay for,” warns Pečanac.


When do we catch the problem-solution fit?

“By looking for the answer to the first two questions – namely who is the ideal client and what’s the suitable solution to their problem – the team is dealing with the first of altogether three development phases of every start-up company. In the first phase, there is the search for the so-called “problem-solution fit”, during which we find out whether our product addresses a problem worth solving. The proof that we have our problem-solution fit solved is if at least 30 % of our first test clients say that they would strongly miss the product if it were taken away from them,” illustrates Pečanac. The next phase is the so-called “product-market fit”, with which the entrepreneur figures out whether they created something that the customers want. This finding ensures a certain level of success when shifting to the third, growth phase and increasing the scope of the business model.


Start-ups fail because they don’t understand the market

“Once we understand the basic building blocks and the meaning of all three development phases, it’s also easier to understand the fact that start-up companies mostly fail because they don’t understand the market and the problems of their clients,” warns Pečanac. As is usual for his lectures, he listed the most frequent and up-to-date reasons behind the failure of start-up companies. Amongst them, he pointed out four most critical ones that are the reasons behind the failure of as much as 85 % of all start-ups:
  1. Premature scaling in the phase when the company still hasn’t achieved the product-market fit (64 % start-up companies fail for this reason). “Scaling” means that the entrepreneur decides to systematically accelerate growth, self-confident that investing additional resources into staff, sales, infrastructure etc. will also bring the expected results. In more than half of the cases, this doesn’t happen.
  2. The market that you’re entering is too small or even non-existent if you’re solving a problem that doesn’t actually exist or you’re developing a product that no-one needs.
  3. You are trying to take market share from a market leader. It’s better to find a market that isn’t yet over-saturated with big, established players, and then re-segment it in a way of offering customers a significantly better solution than that of the current market leader of the segment.
  4. Lack of clearly defined competitive advantages.  

and because they don’t segment their users

A correctly chosen strategy of entering the market or its first step – choosing the right target group that we “attack” with our product – is thus the most important, but at the same time also the most difficult decision that each start-up company has to make. “Sadly, most start-ups don’t segment their users,” Pečanac found out, “even though a correct market segmentation – first with the selection, later with strong focus on a single customer segment – is a prerequisite for successful implementation of all activities, defining metrics and the KPIs in the problem-solution fit phase.”

Define one key indicator

Disciplined focus on a single user segment – one that’s the most suitable for the start-up company – is thus a guarantee for setting up and measuring relevant metrics and KPIs. Even in this, what applies is the recommendation that a start-up should focus on a single indicator or goal it wishes to achieve, depending on the product type and development phase, and not overburden itself in that period by monitoring a bunch of indicators and data, especially those that bring a false sense of progress.

So how to choose the right user segment?

One of the tools that helps start-ups define the optimal user segment is the so-called Problem Barrier Pyramid, with which we define the intensity of the customer’s problem on a scale of 1 to 5 as well as the barriers that prevent us from reaching clients with these problems. These values are inserted into the Market map matrix, for which start-ups first define individual customer segments, then problems that these clients have and then the level of problem intensity for each quadrant and the barriers preventing them from entering the chosen segment.

Source: Start-up school Hekovnik. Note: the right and left sides of the pyramid aren’t connected; see only the value of the individual level on the scale.

Draw a map of the market. If it doesn’t work, pivot.

Bootcamp participants were doing the above-mentioned exercise with help of Pečanac, namely by “drawing the first map of the market you wish to enter. It helps you understand the dynamics of the market and its moves while at the same time enables you to focus more easily and choose the user segment you will focus on,” the mentor explained to the teams. “If it turns out that the chosen segment isn’t the best representative of your target group, repeat the exercise! Before the product-market fit phase, start-ups are focused on learning and pivoting either way, whereby the data of the Startup Genome research show that the most successful start-ups pivot two to three times.”

The intensity of the client’s “distress”

Since for a start-up, time is more important than money, the team has to understand how difficult it is to get to individual customer segments compared to how strong of a distress they are in. It’s best to focus on clients with the intensity of the problem of 4 or 5. The entire scale that describes the intensity of a customer’s problem or the level of their “distress” is the following:
  • The client has already obtained resources or budget for buying the solution that would solve their problem (value 5)
  • The client has found or drawn up a partial solution (value 4)
  • The client is actively searching for a solution (value 3)
  • The client realizes that they have a problem (value 2)
  • The client has a problem, but doesn’t realize it (value 1) 

How difficult is it to get to the client?

Once the entrepreneur defines the intensity of the client’s problem, an analysis of the barriers follows, including how hard it is to enter an individual market segment, whereby the following scale is taken into account:
  • Entrance isn’t possible (value 5)
  • It’s hard to enter the segment (value 4)
  • Normal entrance but with long sales cycles (value 3)
  • Normal entrance (value 2)
  • It’s easy to enter the segment (value 1) 

The formula and the right time to enter

Together with the analysis of competitive solutions that are present in individual customer segments and the type of their problem, we come to all the elements of the formula that helps us calculate which user segment is the best to focus on:
Identification of the user segment = level of the problem’s intensity – intensity of the entrance barrier– evaluation of the competition’s strength
When choosing and focusing on a single user segment we also have to understand the time, or period, during which we should try to conquer a specific market. In line with the innovation diffusion theory, there are several types of users – innovators, early adopters, the early majority, the late majority and laggards. The final expected result of the market entrance also depends on their characteristics. Innovators, for example, are much more tolerant towards imperfections of the first version of the product and like to give feedback, which is very valuable to start-ups for future product development. By entering the market of early adopters, where the tolerance towards imperfection eases off, the company can anticipate quick and steep growth.

Speed, learning and focus

But it’s also important to know the costs of obtaining an individual customer, whereby certain theories claims that the number of months in which this cost is reimbursed should be at the most 12 (one calendar year). In this, the ratio between the life value and the cost of customer acquisition should be taken into account and should be at least 3 against 1. In the problem-solution fit phase, three key elements are needed for optimal implementation of all tests when getting to know clients, namely speed, learning and focus.


When you know which clients to say NO to

Since the goal of a start-up is to find a plan that works before the resources run out, the speed is very important. When learning, we are focused on meeting customers and finding the right customer segment, focusing on it to come to a product that truly works: “And when do you know that you’re truly focused? When you know which clients to say no to, simply because they aren’t your ideal clients,” was how the experienced start-up mentor Kristjan Pečanac concluded this workshop.

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Izvedba: Mojdenar IT d.o.o.