What Is Market Validation? Market Validation In A Nutshell

In simple terms, market validation is the process of showing a concept to a prospective buyer and collecting feedback to determine whether it is worth persisting with. To that end, market validation requires the business to conduct multiple customer interviews before it has made a significant investment of time or money. A transitional business model is an example of market validation that helps the company secure the needed capital while having a market reality check. It helps shape the long-term vision and a scalable business model.

Understanding market validation

Market validation, therefore, is used to determine whether there is a need for a product or service in a business’s target market.

Market validation can be used in several different contexts. Some entrepreneurs use it when they are founding a new startup based around an innovative product idea. More established businesses may also use market validation when considering whether to launch a new product or add new features to an existing product.

Market validation is important for two main reasons:

  • Failure avoidance – the sunk costs associated with a product that fails when presented to the market are significant. Market validation is a way to validate an idea for viability before committing substantial resources.
  • Funding procurement – when an idea is deemed to be viable, this validation is used to convince key stakeholders to commit to funding the rest of the project. This is particularly crucial for early-stage startups where time is of the essence and funding tends to be more difficult to obtain.

How to perform market validation

There is no set market validation framework, with many of the framework components dependent on the nature of the industry, project, and the way project managers like to work.

Nevertheless, we have provided a basic outline of the process below.

Start with an assumption 

To validate an assumption about the market, the business must first define a list of assumptions that it wants to test. These may be related to market demand, the ability of a product to solve consumer problems, or whether the product price will be suitable.

Define the test 

The most prevalent market validation methods are those we mentioned earlier: customer interviews and surveys. However, some businesses will build an MVP while others will conduct prototype, usability, or SEO-based tests.

It is important to construct the tests with questions that provide clarification on the assumptions made in step one. Consider, for example, the following survey questions:

  • Does this feature help solve your problem? 
  • How would you explain what this product does? 
  • How often do you estimate you’d use the new feature? 
  • What tools or products, if any, were you using to solve the problem previously?

Recruit participants

While an obvious point to make, the business must recruit participants that represent the actual end-user or buyer. People tend to be averse to studies as a general rule, so it may be wise to provide various incentives to ensure the data set collected is sufficiently large. 

For instance, the business may opt to cover travel costs of each participant or provide them with a voucher to use in-store.

Conduct the experiment and review 

Once everything is in place, run the experiment and evaluate the results. Remember that proving an assumption wrong is not the same as failing; it is simply a matter of repeating the process until the assumptions are correct. 

If nothing else, this keeps the product team humble and serves as a reminder to never assume they know exactly what the consumer wants before asking them.

Transitional Business Models

A transitional business model is used by companies to enter a market (usually a niche) to gain initial traction and prove the idea is sound. The transitional business model helps the company secure the needed capital while having a reality check. It helps shape the long-term vision and a scalable business model.

Connected Business Concepts

Financial Structure

In corporate finance, the financial structure is how corporations finance their assets (usually either through debt or equity). For the sake of reverse engineering businesses, we want to look at three critical elements to determine the model used to sustain its assets: cost structure, profitability, and cash flow generation.

CAPM Model

In finance, the capital asset pricing model (or CAPM) is a model or framework that helps theoretically assess the rate of return required for an asset to build a diversified portfolio able to give satisfactory returns.

Capital Structure

The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).

Financial Modeling

Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.

Behavioral Finance

Behavioral finance or economics focuses on understanding how individuals make decisions and how those decisions are affected by psychological factors, such as biases, and how those can affect the collective. Behavioral finance is an expansion of classic finance and economics that assumed that people always rational choices based on optimizing their outcome, void of context.

Value Investing

Value investing is an investment philosophy that looks at companies’ fundamentals, to discover those companies whose intrinsic value is higher than what the market is currently pricing, in short value investing tries to evaluate a business by starting by its fundamentals.

Balanced Scorecard

First proposed by accounting academic Robert Kaplan, the balanced scorecard is a management system that allows an organization to focus on big-picture strategic goals. The four perspectives of the balanced scorecard include financial, customer, business process, and organizational capacity. From there, according to the balanced scorecard, it’s possible to have a holistic view of the business.

Buffet Indicator

The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.

Double Entry Accounting

Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double entry is that a single transaction, to be recorded, will hit two accounts.

Income Statement

The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).

Financial Statements

Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.

Revenue Modeling

Revenue modeling is a process of incorporating a sustainable financial model for revenue generation within a business model design. Revenue modeling can help to understand what options make more sense in creating a digital business from scratch; alternatively, it can help in analyzing existing digital businesses and reverse engineer them.

Financial Accounting

Financial accounting is a subdiscipline within accounting that helps organizations provide reporting related to three critical areas of a business: its assets and liabilities (balance sheet), its revenues and expenses (income statement), and its cash flows (cash flow statement). Together those areas can be used for internal and external purposes.

Read Next: Income StatementBalance SheetCash Flow Statement, Financial StructureWACCCAPM.

Key takeaways:

  • Market validation is used to determine whether there is a need for a product or service in a business’s target market.
  • Market validation is important for two main reasons: failure avoidance and funding procurement. Each reason is related to the other and enables product development teams to move forward with viable ideas that do not prove to be fruitless.
  • Market validation can be performed in four basic steps: start with the assumption, define the test, recruit participants, and conduct the experiment and review.

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