Sure, there may be 7 billion people in the world with close to 14B legs, but how many of those individuals will stop what they’re doing and switch to this company’s brilliant new brand of pants?
Customers, or a lack thereof. It’s why businesses thrive or eventually fold. Every business plan projects ever-increasing sales (often exhibiting a hockey stick growth line), but can the company truly acquire and retain real, paying customers at that rate?
When you are considering investing in a company, we encourage you to conduct your due diligence and ask about the company’s customers in terms of the BIG picture (macro), as well as more focused (micro), issues.
- Among numerous factors to weigh, investors should feel comfortable that there is a large market for the product or service.
- What is a reasonable estimate of the aggregate market size for the company’s product or service, and is that market likely to grow?
- What factors will contribute to the industry’s expansion, and what could derail that growth, e.g., will international trade tariffs affect its profitability?
- Is this a highly regulated industry, and is the projected market growth susceptible to shifts in the regulatory environment?
Stepping back to the pants illustration, clearly there is enormous market potential, but it, like so many other companies, is subject to global supply disruptions, rising material costs, international trade barriers, and other macro risks. A large market is one key macro consideration for an investor.
- Do you think that this company can sell its product or service to a large enough segment of the target audience(s) —profitably— to survive?
- Among multiple micro considerations is this central question: What motivates customers within the target market to “pull the trigger” and make a purchase decision? As noted by Carofin in other articles and white papers – customers for a new product or service typically are very difficult to generate. Making sales is often the highest hurdle for young companies.
- If the company doesn’t keenly understand its customers’ motivations for purchasing a product or service and allocate marketing resources appropriately, these potential customers may remain on the sidelines indefinitely…
- Does the company have satisfied customers who “embrace” the product?
- Have they generated “raving fans,” as Kenneth Blanchard noted in his book of the same name, who are loyal to the brand? And is the business attracting a growing audience? Are there repeat customers?
- Can you determine what these potential customers think about the company to gauge how hot these leads are?
- Has the company conducted any marketing studies to determine its customers’ depth of conviction? Or, if the company sells on the web, how have the buyers rated the products or services?
- What does the company’s target list of near-term customers look like, and how aggressively is the Issuer managing this list? In other words, is it likely that prospective customers will engage with the company, how many sales is that company likely to make, and in what timeframe?
- If a company has an extended sales cycle – slowly converting prospects to paying customers—will those revenues arrive in time to keep the company afloat?
- Is this a one-time purchase, or do customers come back repeatedly for the same product or service, e.g., a razor/razor blade model? Alternatively, imagine a solar panel installation company, to pick one example. If that’s all the company does, then the customer will represent a single opportunity to generate revenues. Unless there is an ongoing stream of revenues from maintenance contracts, system upgrades, and more, the company will need to find more customers every year just to survive – a tough business model.
- On the other hand, if the business model is based on repeat customers, then the company’s focus should be directed to retaining and cross-selling to its customer base. Borrowing from Khalid Saleh in invespcro.com, it costs “five times as much to attract a new customer than to keep an existing one.” Building loyalty is critical to a product’s (and company’s) success, and, yet, most companies allocate a preponderance of their marketing dollars to customer acquisition, rather than measuring and extending the “Customer Lifetime Value.”1 Does this company focus on customer retention?
- What are the sales or marketing channels for reaching potential or existing customers, and how quickly should a company expand? Are there distributors, or is this a direct-to-consumer business? At one time we worked with a company that had 14 separate sales channels – and couldn’t determine whether any was profitable. The company should have a well-defined and narrowly focused channel strategy until each either has proven profitable or has been jettisoned. Once achieved, then it’s time to consider expanding the scope of the business.
- If businesses are the company’s customers (B2B), what processes do buyers typically follow when deciding to adopt to the selling company’s products or services? Is there usually a single decision maker or a committee? Is the capital derived internally, or are there other actors, e.g., significant minority owners, who will play a part and may delay the purchase decision? If selling to a governmental entity, plan to add a slew of additional factors to the process. Is seasonality a factor?
Returning to the central micro issue, a realistic investor will recognize that, usually, a very small fraction of a targeted market that will ultimately adopt a new product or service. Reaching, motivating, converting, and retaining enough of that market profitably is one critical factor Carofin addresses for investors in our white paper, “Seven Key Questions for Evaluating a Private Company.”