Business model

How to apply the Lean Canvas methodology to Santa Claus' operations, as an example

Together with Yurij Riphyak, Managing Partner of online platform Youteam, we continue to examine the use of the Lean Canvas as a tool to clarify startup business model(s). In the previous article we defined the best order to fill the boxes of the Lean Canvas, in this one we consider each block individually. It is important to start with a simplified version of the Santa’s Lean Canvas as if he were in the process of launching his business for the first time.

1. Target market segmentation and problem definition

My view is that the most important block of the Lean Canvas is one for customer segments. The challenge here is that there are often several different kinds of customers for every new market offering and it is often a matter of prioritisation.

It is important to first list all of the different kinds of customer that come to mind, and then sharpen our definition of the problem. The next step is to nominate the initial target audience also known as the early adopters. These are the customers for whom the problem is both acute and urgent and who have already tried to solve it using workaround solutions.

Here is an example of how Santa Claus filled in Lean Canvas for his business model (when he was first starting out). He had several customers segments: good and bad children, children older and younger than 6 years old. His first step should have been to decide which group he should start with.

Santas' Lean Canvas Business Model example:

lean canvas santa claus

He defined the problem as some children not receiving presents for Christmas. This being the problem, he should try to find out which group of children needed to get a present the most, as evidenced by them asking their parents most often.

Bad children are generally undeserving of Christmas presents. Small children often don’t yearn for a present, they are too young to care. Much older children tend to grow out of believing in Santa. So, the group of children of 3 to 6 years old remains and is selected as Santa’s initial Target Audience.

Of course, it is possible to cover the older, younger, and naughty children segments, but Santa intentionally refrained from doing so, because in the early stages of testing a new business model it is better to choose a small and homogeneous group and build a product or service for them.

Why is it important to narrow down the initial target audience?

Because, it is much easier to:

  • Understand the common characteristics of this group and develop a detailed understanding of their needs and desires
  • Recruit a homogeneous sample of early adopters (this would be done in waves of interviews with 5-10 End Users at a time).

It is important to pay particular attention, to whether or not there are alternatives on the market or competitors. It is not a good sign if no-one has tried to solve this problem, because it could mean there could be a problem with the problem space we wish to operating in. It could be that the problem isn’t that important to solve, or there are structural problems in the marketplace we wish to enter.

2. Unique Value Proposition and Solution to the Problem

Next we move to focussing on the Unique Value Proposition (UVP). This box should be filled in with the key statement that ordinarily would be placed in the centre of the landing page of the website.

For example, Youteam’s current UVP is Hire a World-Class Development Team Within 24 Hours. The suggestion is that we are able to solve the problem of sourcing relevant professionals for digital projects  within 24 hours. This is something that nobody else offers, and as such we are offering ‘unique value’ to the market we are serving.

 

Taking Santa Claus' example, it's easy to determine that his unique proposition is to Deliver presents to children all over the world in one night, without waking up children or inconveniencing parents.

For UVP, it's not that important to use sales language. It is much more important to be clearly understood. UVP clearly describes what clients will receive and the unique value your product or service delivers.

The next box to complete is for the Solution. This is essentially the feature list which corresponds to a specific problem a customer wants to solve and consists of must-have features, performance enhances and delighters. Most online services are focus on performance providing excellent User Experience which an excellent example of a desirable performance enhancer.

Santa Claus' solution is to distribute Christmas presents to children who are most in need and have behaved well in a time efficient and convenient way for both parents and children.

3. Defining market channels with customers

By default, the first distribution channel is direct communication which is when the Product Owner organises  to meet with clients to show them the product or a prototype. Beyond direct marketing channels, consideration will need to be given to the range of other marketing channels which may support the promotion/distribution of a product. However, it is important to note that it is hard to anticipate which Marketing Channels will be most effective for a given product and it is therefore important to test and compare the results of each marketing channel.

Distribution channels are paths for the customer to come into contact with a given product or service. In this regard, a website has two primary functions, it is effectively an online shopfront and a tool for increasing online traffic with the hope of converting these visitors into Sales. If it is offline advertising, the distribution channel could involve the placement billboards; in a particular location, taking into consideration the Sales copy and how it is designed.

Santa Clause, as mentioned above, has to consider his delivery options. His sledge and 8 reindeers headed by Rudolf seem to be the most efficient channel in his case.

As a general rule, the first 1-2 channels that work best for software startups are often contextual advertising, SEO or SMM, particular considering the lack of available resources.

4. Budget forecasts: expenses and projected revenues

Capital planning incorporating cost and revenue structures are often overlooked by non-financially minded founders. But it is important to continually re-assess the impact of pivots, however, small on cost and revenue. Pivoting into smaller markets reduces the overall market opportunity and could affect Go/No Go decision making.

In some cases it won’t be possible to accurately fill out the Cost and Revenue boxes unless you have previous experience in Startup and/or certain domain expertise. It is important to understand the cost structure of most of the elements required to take a particular product to market. It is important to brainstorm what expenses might be involved, however, at the end of the day, it is difficult to arrive accurate figures until you have arrived at a viable business model to operate in the chosen market.

To determine whether the chosen business model is indeed profitable, it is necessary to list out all the expenses and compare them to the predicted revenue streams. For the purpose of the break-even calculation, investment in product development and non-recurring costs like startup fees can be excluded Below is an example of Santa Claus’ recurring expenses and revenues:

santa revenue vs expenses

It is particularly important to verify the revenue side of the business model, otherwise it could be that the profitability of the business is compromised or non-existent.

5. Key metrics in Lean Canvas: two approaches to setting meaningful KPIs

There are effectively 2 approaches to setting meaningful KPIs. The first is to consider KPI as a natural indicator, for example, for the Youteam site, one of our KPIs is the number of development hours we sell.

Why are these not monetary? Because a monetary indicator can be adjusted artificially by increasing prices or cutting expenses. KPIs should measure the successful execution of the intended business model(s) of an organisation.

The second approach is so-called pirate metrics promoted by Dave McClure. This is the AARRR concept:

  • Acquisition — attraction; the cost of attracting customers is calculated, this figure should be minimal in order to remain competitive
  • Activation — the level of motivation required to return to the page; time spent on the site, number of clicks, and reviewed pages are considered;
  • Retention — ability to retain interested customers using email marketing, push notifications or even internal triggers based on certain emotional states;
  • Referral — motivation of regular customers to promote a certain product or service (reposts, referral links);
  • Revenue — a financial metric; it is easy to test efficiency: the more customers become regular and the higher the price we can demand, the higher the revenue.

AARRR metric funnel diagram

Santa Claus’ Key Performance Indicators

The Natural Indicator: number of children who received presents.

AARRR Metrics:

santa claus' AARRR Metrics

6. How to identify a true unfair advantage

It is important for startups to have a sustainable unfair advantage, such that they can remain competitive in the medium to long term. If a startup doesn’t have a sustainable competitive advantage then once it proves the basic hypotheses of its business model and begins to grow, other players of the market may see and could easily copy the idea.

The most obvious sustainable unfair advantage is a patent on a primarily mechanical or electrical invention or technology.

Other possibilities include:

  • Brand (as is the case for Santa Claus)
  • Generated network (network of vendors/customers)
  • Attributes of founders (if they have sufficient clout in the industry or charisma)

Santa Claus' unfair advantage is receiving letters from children in which he learns their wishes and preferences. Every time a child for a Christmas present, they get exactly what they want.

Three ways of identifying risk in Lean Business Model Canvas

Once the Lean Canvas Model has been filled in, you will have a complete picture of the business model. To move further, it is important to define the risks associated with every different element.

The business model of any startup is built on a number of hypotheses. When the canvas is ready, these risks become visible. It is important to analyse all of the risk associated with the core hypotheses and try to quantify the level of risk associated with each hypothesis to ascertain if there are any deal breakers.

Three ways of identifying risk in Lean Business Model Canvas

Here are three areas where founders typically make poor judgements with respect to risk:

  • Customer risk: wrong choice of the target audience or early adopters segment, incorrect selection of the channel for engaging with the target market;
  • Product risk: a mistake in designing the product, overestimation of the problem, offering a poor solution, wrong positioning or wrong assessment of success;
  • Market risk: under- or overestimate external market forces, competitors are stronger than anticipated, incorrect estimation of market opportunity, incorrect pricing point for a product or it is too expensive to enter a given market.

MVPs are built in order to assess risk levels in these three areas. Interesting however for customer risk, it often isn’t necessary to develop a fully functional product. It is enough to develop a visual prototype and start interacting with customers, such that customer related risk, market segmentation/customer personals, and marketing channels will be tested.

For product risk, it is more critical to develop a functional MVP. Customers interviews won't demonstrate whether or not it is technically possible to develop a given product and it is therefore important to have at least a partially functional product. It will then become possible to ascertain whether or not our solution will be technically superior than the alternatives on the market.

Market risk is the most difficult to account for because sometimes it appears only after the product is launched into the market and the startup is trying to monetise their innovation. In this case, it's crucial not only to develop prototypes and start showing them, but also launch a functional Minimum Viable Product to see if it succeeds or fails, that is if we are able to generate revenue.

Header photo: mast3r / Depositphotos.com

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