If you have a great idea for a new piece of software or a SaaS project or even a new high-tech product, then congratulations, you are taking the first step towards being an entrepreneur. If you are hoping to make many millions of dollars or even become the next Bill Gates, then congratulations again. As a country we sure could do with some more great successes.
If you start your new high-tech business tomorrow, your chances of still being in business in five years time are less than 15%. In fact if your best friend were diagnosed with cancer on the same day that you started, their chance of surviving the next five years are about 500% better than yours.
So the purpose of this article and the ones that follow will be to help young Kiwi entrepreneurs increase their odds of surviving the first five years and then getting the financial rewards many dream about. Why, the focus on five years and then the success. Well experience tells us that building a successful hi-tech business is more like a marathon than a sprint. To win the game you must first live long enough to play the game.
Experience tells us it usually takes 12 to 15 years for a new hi-tech product to become an overnight sensation, that is to reach a point of at least 50% market penetration. That’s been the case for products like mobile phones, fax machines and PCs and also more recently digital music and photography. That’s probably quite a bit longer than most entrepreneurs would guess, and that’s an important point to reflect upon.
Another is to consider the many cases where the company that invented the new product was not the one to successfully commercialise it and in fact make money from it. We can think of examples like the Xerox Parc lab that invented the mouse and graphical user interface at a time when all computers were text based. These superb technical innovations were commercialised not by Xerox but by Apple and Microsoft who did not invent them, but saw how to turn these technical innovations into products that customers would want and would pay for.
Entrepreneurs tend to be optimists by nature and that’s a positive and valuable attribute. But humans also tend to be quite poor at assessing risk. We buy lotto tickets and also drink and drive. So we need to recognise that when optimism and poor risk assessment are combined we have a potential problem to reflect upon right off the bat.
So without further ado lets make a start on building a valuable high-tech business and look firstly at the business rather than the idea. We’ve all seen high-tech companies go from small beginnings to become hugely valuable businesses; we can all think of Microsoft, Oracle, Google, Apple and Facebook among many others.
So what makes a valuable hi-tech company? In a nutshell it’s a reflection of people’s expectation about its future profitability. In a traditional company that usually means profits and a typical company is most often valued as a multiple of its current or previous profit. Thus a company making a profit of say $1 million might be valued at a multiple of five meaning the company has a value of $5 million. The actual multiple is quite variable depending on whether the company is private or public, its stage of development and assumed future potential and, the country it is based in.
This valuation method is sometimes the case with hi-tech companies, particularly the more mature ones. However, that valuation doesn’t really apply well to companies with very high growth rates; (or perhaps just the reasonable expectation of these) nor those companies that enjoy the benefits we often see with high tech companies of network effects. For those unfamiliar with the term, this is the phenomenon we often see with hi-tech products where the value of a business increases exponentially as the number of customers’ increases — think mobile phones.
This is partly because as we see with markets like texting and ring tones the volumes of sales increases rapidly, but also because as market positions are established it becomes harder for new market entrants to take a significant market share away from established market leaders. For example, it would be difficult to displace Vodafone or Telecom in the mobile phone market, Trade Me in the online auction market or Sky in the pay TV market.
It’s difficult but not impossible; Apple’s iPod/iTunes products certainly stole the mobile music market from Sony’s Walkman. But for every success there are probably another 100 failures, and so because we are not great at assessing risk we’ll keep it simple and not make life unduly difficult for ourselves.
The key to building value is to build a profitable business. It doesn’t have to be profitable immediately, investors will often value highly a loss making company if they believe it is building a longer term position, think Vodafone and Sky. However that is in the expectation of strong future profits.
Changing the world or making it a better place are fine ideals, but outside the scope of this series.
For now the key to building value is to build a profitable business, which before we get to looking at a product means we have to first be very sure of the market we will be selling to.
More than any other single factor, how well we choose our market will determine how financially successful our new hi-tech business is or will be. So next time we will look at how to choose a market.
O’Hara is chairman of Clarity Commerce a publicly listed software company based in England, and an independent director of Tait Electronics in Christchurch, and Tekron International in Wellington. He is also a council member for AUT University. Contact him at www.johnohara.co.nz