I can tell you what your future will look like by knowing which zone you are in.
It all comes down to where you fall on two critical attributes:
Product Market Fit
Management Quality
It’s taken me two decades of start up experience to come up with this framework. I guess I am stubborn and a slow learner. I was exceptional at reality warping and optimism. I mistook effort for progress and I ended up spending too much of my career in the wrong zones. Because I did not recognize where I was i.e. which zone I was in, I had no chance of making the changes to move to better zones. So this framework and the blunt commentary that comes with it is meant to help you, the founder and leader, avoid my mistakes and maximize your chances of success and wealth creation.
Let’s explore the ends of the scale for each attribute.
Product Market Fit
Product Market Fit is more accurately the intersection of products, customers and price.
Strong product market fit is shown by:
- Strong repeat customer purchasing especially recency and frequency. Customers are coming back to purchase again quickly and are making multiple purchases over specific time periods. These metrics will obviously vary by your sector, business model (i.e. subscription or hybrid) and channels.
- Proven ability to raise prices. If you are able to raise prices consistently and not tank the business, you have proven ability.
- Premium pricing. Not all brands want prices that are higher than the competition, but premium pricing is a good indicator.
- Stable CAC’s. Strong demand from the market for your products at your prices will tend to keep CAC’s stable i.e. you don’t have to pay a lot more to acquire the next customer. Whereas steadily or rapidly rising CAC’s could be an indicator that more marketing dollars are required to convert that next customer. As you reach deeper into the TAM, it gets harder and thus more expensive to convert new customers. Your TAM is like picking apples. It’s easy to run around and fill your basket with the apples at the bottom of the tree. But to get the higher apples, you are moving your ladder around, climbing up and down getting scratched. Of course, many other factors could be at play here including a conscious decision to spend more to ramp volume.
- Excellent and consistent reviews.
- Low return and refund rates.
- Low average discounting and high full price sell through rates.
- Strong gross margins for your category.
- Strong sales growth. This is a tricky indicator and I put it last because it has to be strong sales growth as long as the indicators above remain true. For example, cranking up ad spend and discounts to juice revenue while the other indicators fall apart does not count.
Weak product market fit indicators include:
- Poor repeat purchase dynamics or declining repeat purchase dynamics.
- Hyper competitive markets with intense pricing pressure. Think Amazon sellers in a daily knife fight tweaking pricing constantly to maintain top listings.
- Infrequent and tiny price increases. To paraphrase Warren Buffet “you don’t need a prayer session before raising prices.”
- Poor reviews or worsening reviews.
- Return rates, refund rates, discounting that are high and/or getting worse.
- Increasing CAC’s and lengthening payback periods.
Management Quality
Management quality is an assessment of knowing what to do and being able to do what you say you will. As I have discussed in my posts about the value of models (part 1 & part 2), leadership must understand not only the levers in their business but their ability to push those levers. The acid tests of this are how closely does management hit their plans and how quickly and well do they correct when they miss.
Other indicators of high quality management include:
- Strong cash forecasting.
- Solid balance sheet.
- Strong inventory planning and buying process with good Days Inventory/Inventory Turnover.
- Established and followed planning process, variance analysis, adjustment and reforecasting process.
- Discipline on ad budgets, CAC’s, payback periods, MER’s.
- Tight OpEx.
- Good understanding of unit economics with bonus points for applying these insights to product development, inventory buying, retention and customer acquisition.
Signs of weak management:
- Understaffed finance function.
- Inventory accounts on Balance Sheet that don’t change period over period e.g. straight lined WIP or Pre-paid Inventory.
- Lack of a cash forecasting model.
- Upside down Balance Sheet i.e. stacks of MCA, poor Quick and Current Ratios.
- Bloated headcount.
- High OpEx.
- Low unit economics (unless intentional part of strategy which is rare).
- Lack of discipline in marketing, budgets and metrics and daily spends.
- Poor inventory planning and buying based on combination of founder whims and YoY percentage changes.
- Lack of processes i.e. if a person leaves, the whole system crashes because the business is single threaded to that person.
- High turnover.
Companies are NOT evenly distributed across the zones.
You’ve probably already given your company a zone. But here’s a curve. The distribution of brands across the zones is not equal. Golden Zone is rare and Death Zone is common. The distribution of brands looks more like this:
5% in the Golden Zone
10% in the Lucky Zone
25% in the Grinder Zone
60% in the Death Zone
Most founders excel at optimism and their ability to warp reality. Hard-nosed self reflection is not a typical strength and no one wants to hear their baby is ugly. But if you want to improve your future, you must first recognize the truth. So knowing that the dispersion is not equal, try to set aside your ego and give as honest an appraisal of where your company and management stands on the continuums to really understand your zone.
Here’s the hard truth. Your zone determines your future.
The good news is you can change your zone.
Golden Zone
Life is good and will get better. If you are in this zone, your only questions are how aggressive do you want to be and how can you continue winning without taking too much risk.
Lucky Zone
Kudos to you for self assessing this zone. No one wants to admit that they aren’t brilliant leaders with awesome teams especially when the financials are up and to the right and praise is being heaped on you on socials. Your big question is how much effort are you willing to put in to improve the quality of management enough to move into the Golden Zone. If you aren’t willing to make that effort, then you should be thinking of exit opportunities.
Your management quality weakness is almost always in finance and operations. Because you have the margin and brand excitement tailwinds, you have the money to hire top tier talent. You often have an incentive structure problem which is also very fixable when you bring in pro help.
Grinder Zone
Can you get to better product market fit? Maybe. It will take an incredible focus on changing products and your product mix in combination with better market targeting. This usually means selling less things to less people, but making a lot more money from each sale. And this usually means lower sales and lower cash while you get the new product market fit in place. If you have VC’s in the cap table, this path is probably not open to you. If you do attempt this, the good news is that your grinding skills are exactly what is needed to pull this off.
If you don’t want to change your position on the product market fit axis, then you know what you are in for. Frankly for many in this zone, that’s OK. They may bitch, but they like the grind because they excel at the grind. They have the mindset and fortitude to do it indefinitely. And they can be incredibly successful! The qualities that make them great at grinding will also make them great at steady distributions and the slow accumulation of capital and wealth.
Death Zone
Your choice here is simple, but painful. You either decide to change zones or get busy packing it in as best you can.
If you aren’t ready to pack it in, you have an especially hard challenge ahead because you need to decide which axis to improve first and you don’t have the experience in either to know how to do it. Here’s some ways to think this through.
If you have a hero product or sell a small number of products to a small group of customers through one or a couple channels, then moving up the product market fit axis is a function of working through the list of indicators above to figure out if and how you can improve them before cash runs out. In other words, can you improve the product, the positioning, and targeting quickly enough to get the pricing, margin and retention you need?
If you have a ton of products, sold through many channels and a wide set of customers, you have the challenge that Grinders face, but you lack management quality.
You may be able to improve management quality through hiring, but you don’t know what ‘good’ looks like and your brand and financials are tough sells to pros. You will need to give up a lot of equity and you should assemble a hiring team of experienced pros that can help you vet candidates.
Your best and fastest option is to turn to consultants, fractional CFO’s and/or a new investor who has industry experience and is willing to roll up their sleeves for 6 months.
Conclusion
Harsh, but simple. As entrepreneurs we are rewarded for being naive to the challenges, compartmentalizing problems and maintaining relentless optimism. But that becomes our weakness. We mistake exertion for progress. I wanted to create a simple framework, a simple map, that could punch through the daily grind so that leaders could understand where they really are and where they are heading. Knowing that, they can then decide how to change their direction to change their future.
If you are struggling with this or want help thinking it through, please reach out.