In our article “Small Business Owners: Why Cash Flow Is So Important” we talked about how improper management of cash flow is one of the top reasons why new businesses fail. The more complete picture shows us that cash flow problems are often the byproduct of two earlier mistakes: Weak fit between product & market, and Unsustainable business models. These three observations are actually linked, and often exhibit a causal relationship.
Between team, product, and market (the 3 pillars to any new business), the consensus is that market always trumps team and product. You can have a great team with a great product, but a bad or non-existent market, and you will find failure despite your best efforts. As well, a mediocre team with a mediocre product, coupled to a great market, can achieve success. Various permutations of these three pillars can be analyzed, and time and time again, market trumps team and product. The main point is that even if you have a great team, and have developed an amazing product, if the market is bad or basically non-existent, you won’t get much traction and will likely fail. Understanding the market that fits your product is considered by many leading VCs to be the single most important factor in determining the odds of success for a new business.
Once a strong product and market fit has been identified, a sustainable business model has to be built and scaled to capture the opportunity presented by what should be a strong market for your product or service. Customer Acquisition Cost and Customer Lifetime Value, are the two major variables that must be properly balanced in order to support a successful monetization strategy that fits your business.
How much does it cost to get your customer, and how much is that customer worth to you over the life of their relationship with your business?
While many businesses succeed at nailing the product/market fit challenge, they often fail at assessing and optimizing the CAC/CLV relationship. Underestimating/not knowing how much your company is actually spending to land a customer (and to retain them), while overestimating or not knowing what their actual value is to your business over the course of their life as your customer, is perhaps the second leading issue that causes new businesses to fail. One can easily imagine a scenario where their business is spending way more money to get customers, than those customers are actually worth. When this occurs repeatedly, we have an unsustainable business model.
As mentioned earlier, cash flow mismanagement is often a direct cause of business failure, but even more fundamentally, a weak fit between product and market (often due to a lack of appreciation of the importance of a good market) and an imbalance between CAC and CLV are what actually lead to the cash flow problems.