October 18-20 | Tucson, AZ

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Startups: market validation attracts early investors

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October 18-20, 2023 / Tucson, AZ
The annual summit for research institution gap fund and accelerator programs, including proof of concept programs, startup accelerators, and university venture funds

The Story

Many early-stage startups have a common problem: it’s hard to attract investors without proof that customers will pay for their product. Yet without investment to fund product development, it’s difficult to obtain market validation.

The key to overcoming this challenge is to find creative and inexpensive ways to conduct market validation — a step in the product development process that lies between having a product concept and investing in final product creation.

Benefits of conducting market validation before product development include:

  • The opportunity to avoid product failure – Developing full-scale products is expensive and time-consuming. Thus, failure to attract customers after launch can spell disaster for a startup. Market validation helps avoid this problem by building a product that people want.
  • A chance to help secure investors – Market validation helps attract early investors to fund product development because it provides real data about the viability of the business venture.

Steps in the market validation process

The market validation process has six key steps. Here’s an example startup scenario to demonstrate each step: A startup has sources around the world that buy thousands of functional, secondhand cellphones. The startup seeks an inexpensive way to test and acquire a large volume of used phones on an ongoing basis.

1) Identify customer need. Through secondary research and customer interviews, the startup defines the needs of the target customer and market size of that need.

  • How it gets done: Through secondary research and interviews with cellphone owners, the startup establishes the quantity of cellphones that are upgraded each year and what happens to old cellphones. They determine that most cellphone users don’t have a quick, easy way to sell their old phones and get enough money for them.

2) Determine value proposition. Define the value the offering brings to the customer. Solve their problem better than other solutions available to them today.

  • How it gets done: The startup defines that cellphone owners want to get an estimate for their used phones and receive a compelling cash payout with minimal effort in just a few minutes. The value to the reseller — target end customer — is that they can source phones from a single partner who guarantees the phones to be in working order.

3) Establish business model. Define the business model, pricing strategy and how the target customer will acquire the product.

  • How it gets done: The business model is to acquire cellphones for 60% of the resale market value. The end customer — the reseller — would pay a premium if there is confidence that the phones are working properly.

4) List key assumptions. In making progress through the above steps, a startup should make assumptions that have not been tested. List these assumptions, in order of importance or risk to your business success. Examples:

  • Most cellphone owners want an easy way to sell their used cellphone. Roughly 80% of cellphone owners would accept 60% of the resale value if the process was fast and convenient.
  • As well, 80% of these cellphone owners would use an automated kiosk to sell their phone.

5) Test assumptions. Design and perform empirical tests to validate or refute these assumptions in the fastest and most cost-effective way possible. This is where the quantitative results and qualitative market research converge to define a first-pass product that can be sold to customers. Example empirical tests:

  • The startup sets up tables outside of grocery stores offering to pay cash for used cellphones and takes data to validate or refute assumptions.
  • The startup creates a box that looks like an automated kiosk. They put a person in the box, obscured from the user, to fake the “automation” and gather data to validate or refute the assumption.

6) Full systems test. Integrate learnings into a full systems test, consisting of the minimum viable business product (MVBP), a concept defined by entrepreneur and professor Bill Aulet in his book Disciplined Entrepreneurship. MVBP is the minimum product for which the customer will pay that enables a startup to demonstrate real validation of the customer need, opportunity and a sustainable business model. Future investors need to see this validation before investing in full product development.

  • How it gets doneThe startup builds a prototype of an automated kiosk. Some functionality is automated, but elements that are too expensive to implement are faked on the back end with manual intervention. This prototype is used to validate and improve cellphone evaluation, pricing and payment processes, as well as to gather sales statistics. The team then sells the cellphones to a reseller to validate the full life cycle use case. All of this demonstrates market demand and the business model, which leads to a significant seed investment round.

For some startups, building an MVBP is still too expensive and time consuming — for example, if it uses complex or expensive hardware products. In those cases, try being creative with simple empirical tests combined with using methods like quantitative Kano analysis and other quantitative methods, which are the best alternative to customer adoption and sales.

In the end, the more confidence and data that a startup can give to investors to prove market validation and opportunity, the more likely they are to invest — allowing the venture to continue on to full product development.

Source: Buffalo Inno – Startups: market validation attracts early investors

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