The Eightfold Path of Entrepreneurship

Your dream of a successful software startup should be preceded with a thorough plan. Cusumano's The Business of Software offers some good tips to lead you in the right direction.

• By Mike Gunderloy
• 12/13/2005

OK, perhaps the comparison is a bit farfetched, but the Buddha's thoughts on the proper way to enlightenment came to mind as I was reading Michael A. Cusumano's The Business of Software (Free Press, 2004). This book, subtitled "What Every Manager, Programmer, and Entrepreneur Must Know to Thrive and Survive in Good Times and Bad," is based on twenty years or so that Cusumano has spent studying (as a professor in MIT's Sloan School of Management) the software industry.

I'm willing to entertain the possibility that somewhere in the world there's a software developer who has not dreamed of launching the next great successful startup firm — I just haven't met that person yet. If they happen to be you, you can stop reading now. For everyone else, I'm going to dig into one particular part of the book: a set of eight points for evaluating software startups. Before you take the plunge into chasing venture capital, it's worth considering how your own plans stack up against this set of metrics.

Start With Yourself
Cusumano's first point is probably also the #1 thing that VC's look for: a strong management team. Yes, that's right: Who you are is more important than what ideas you have if you want to succeed as a software entrepreneur. And note that key word "team": if you can't assemble a strong team, you're unlikely to be able to succeed on any significant scale. That team includes not just the technical side of things (where many developers will be most comfortable), but also sales and marketing. If you can't convince potential customers that you've got something worth buying, it doesn't really matter how great your technical chops are.

What do you do if you've got a great product or service idea, but no management team for it? Find one by doing some networking on your own. If you're not passionate enough about your own ideas to convince some experienced managers of your acquaintance to join you, how do you expect to convince anyone to part with the money to fund you?

But You Do Need Something to Sell
A great management team helps, of course, but you'd better back it up with something to manage. Point #2 of Cusumano's analysis is "An Attractive Market." A market, mind you, doesn't consist of wishful thinking ("Just think how much money we could make if we get only 1 percent of the annual expenditures of U.S. corporations on database products!" Much more likely, you'll get precisely 0 percent). Instead, it consists of identifying the vertical or horizontal segment of the economy where you plan to make your initial sales.

Ideally, the market you've chosen will have high entry barriers to keep out your competition (but you'll have some good reason why they don't keep you out), no good substitutes for the product or service that you plan to sell, a strong demand, and limits to the power of buyers to force you to lower your prices. Whatever the market, you should have a practiced story as to why you think it's large and growing, and why you think you're uniquely poised to make money there, to tell potential investors.

Along with a market, of course, you need something to sell, and that's where point #3 comes in: "A Compelling New Product, Service, or Hybrid Solution." Developers and other technologists tend to start here, but that's a mistake: Just because something is technically slick and sexy doesn't mean that anyone will want to buy it, or that you're the right person to sell it. Assuming you've identified a good market and you have the right team to sell into that market, though, it's time to be concrete about what you're selling.

As a software company, you can be selling a product (your typical shrink-wrapped piece of software, though actually it's been quite a while since I punctured any shrinkwrap), a service (such as Web design or database consulting) or a hybrid solution (such as a product that most clients will want customized to their needs). While developers tend to think in terms of products, Cusumano argues elsewhere in the book that hybrid companies have a better track record than pure product companies for surviving the inevitable downturns in the software industry. That's certainly a factor worth thinking about as you develop the idea that's going to make you rich.

And What About the Customers?
Cusumano's next two points are focused on your potential customers. Apparently he considers it too obvious to state that you'd better have an idea of who those customers are, otherwise your business plan is headed for the drain in no time flat. Anyhow, point #4 is "Strong Evidence of Customer Interest." What most VC firms would like to see, of course, is a fat pile of signed contracts already turning customer money over to you (but if you had that, you probably wouldn't be hunting outside financing at all).

Barring cash in the bank, the next best evidence is a stack of letters of intent to purchase as soon as you get the bugs out. And the best way to generate those is to have a solid working prototype version of your product (assuming you're not a pure service company, anyhow). It's all well and good to say that you can build a stunningly innovative application, but your potential customers aren't likely to sit up and take notice until they can see it actually running.

Point #5 also speaks to customer perception: "A Plan to Overcome the 'Credibility Gap.'" Potential buyers of your product or service know as well as you or I do that the chance is somewhere around 90 percent that your startup will crash and burn, and that you'll be flipping burgers or writing boring UI code for some nameless financial institution a year from now. That's a pretty powerful disincentive to give you any money. Cusumano suggests a few strategies for overcoming this problem. Perhaps you can partner with a larger, more established firm, so there's some hope of your software being maintained even if you go out of business. Alternatively, you can start as a service organization and build customer relationships based on short-term contracts, only later moving into longer-term product commitments.

And on to the Business Plan
Entrepreneurship isn't just about selling software to customers. It's also about making money in the process. The last three points of the eight-point evaluation cover this part of the process. Point #6: "A Business Model Showing Early Growth and Future Profit Potential." You really need to have a grasp of the business fundamentals if you want to win over investors: What your costs will be, how many sales you can expect at what price, what you plan to do to make sure your market keeps growing, and so on. While I have run a consulting company in the past with a four-word business plan ("Have fun, make money"), I wasn't looking for outside investment at the time either.

Point #7 gets to the fact that none of us knows for sure what the future will bring: "Flexibility in Strategy and Product Offerings." Most software companies don't find their golden goose right off the bat. Remember, Microsoft started off by selling BASIC rather than Windows and Office. You may think you know precisely what the market wants, but you also need to have some idea of alternative uses of the technology you're building, and be prepared to listen to your customers. The more ways you can jump, the better your chance of actually landing on a lily pad. (But remember: Don't try to jump in every direction at once. You still need a plan, even if it's a flexible plan.)

Cusumano's point #8 is the one most people start by dreaming of: "The Potential for a Large Payoff to Investors." He suggests that VCs won't even look at you unless you can provide at least a 25 percent return on investment within a few years. Of course you'd like to do even better so you can be fabulously wealthy. One thing you definitely need is a plan for scaling up and an "exit strategy." Both of these things make pure consulting an unlikely bet for successful, funded entrepreneurship, though consulting can be a valuable part of a hybrid strategy.

Evaluating Your Report Card
Give yourself 2 points for each of these areas you can honestly say you're very good in, 1 point where you're neutral, and a big fat zero for any area where you're weak. Then tote up the points. Some case studies and anecdotal evidence suggest that if the total is much below 10 points total, you're not a real good candidate for VC-funded entrepreneurship.

Of course, that's not the end of the world, for two reasons. First, with this checklist at hand, you can think about improving the areas where you're weak. Second, even though we all dream of successful entrepreneurship doesn't mean that we all need to do it. There's still plenty of room to have fun in other aspects of this crazy business.