While working on one of my Excel models, a question popped up in my mind: what cash metric could translate the Lean Startup Methodology‘s principles in the most accurate way?
We certainly count on great cash metrics, such as the burn rate and the runway.
But, I wasn’t satisfied with them as answers to my question.
If we think about the burn rate as a startup’s monthly cash outflows, it’s natural we want it as low as possible. Right? The less the burn rate, the longer the runway.
However, by following the Lean Startup Methodology mantra of “failing fast”, something odd happens with these two metrics.
By reducing the time it takes to perform your tests, you’ll end up performing more tests in a specific period. And if we’re not able to reduce the costs of the tests at the same rate, we’ll increase our burn rate. On the other hand, if we take more time to run the tests, we’ll reduce the monthly spending pace (i.e., lower burn rate).
So, is there another metric that better translates the benefits of running your startup lean?
Yes, I believe there is. But, first, let’s review one of the key pillars of the Lean Startup Methodology.
The “Build-Measure-Learn” Cycle
The Lean Startup Methodology tells us that your startup idea is a hypothesis, based on several different assumptions. In other words, it’s just an idea. So, the focus of your early-stage startup is to validate the assumptions and, consequently, conclude whether the hypothesis is valid or not.
Accordingly to the methodology, the best way of doing that is through “Build-Measure-Learn” cycles.
A “Build-Measure-Learn” cycle is a process composed of the 3 following steps:
- BUILD something that represents the value of your idea (or part of it). It may be a simple wireframe, mockup, landing page, MVP, etc.
- MEASURE what happens when you put what you’ve built in step 1 into contact with real people. How many people loved it? Ignored it? How many of them wanted to buy it?
- LEARN about the results. What do these metrics mean? Should you go on with your original idea? Iterate it? Pivot it?
So, you run the first cycle. Based on what you’ve learned from it, you adjust things and run the second one. Depending on the insights you’ve gained from the second one, you run the third cycle. And so on…
Basically, you do it, until you have something promising that you can scale.
The Cycle’s Average Burn
Now, let’s go back to our key metric—which I call the Cycle’s Average Burn.
This metric represents how much money you’re burning per cycle.
Why do I love it? Because it’s derived from three other metrics strongly related to The Lean Startup Methodology principles: The cycle’s average cost, the cycle’s average time, and the monthly average operating expenses.
The cycle’s average cost is simply how much you spend on average to run a cycle. How much do you pay to build something, test it with real people and gain insights from it? Of course, the lower you spend the better. Spending $5,000, instead of $10,000 to validate the same assumptions is obviously preferred.
The cycle’s average time means how long it takes for you to run your cycles. How long does it take for you to build, test, and learn from your potential customers? In this case, the less time you spend, the better. Spending 3 weeks, instead of 2 months to validate the same assumptions is definitely an improvement.
Finally, the monthly average operating expenses represent how much you spend per month to simply run the business. Every dollar not directly related to the validation process falls into this category. Expenses such as rent, utilities, secretary, and other G&A should be considered here. So, as you may have presumed, the lower the average monthly operating expenses, the better.
The Cycle’s Average Burn Formula
Now, to calculate the cycle’s average burn we must combine the three elements I presented above. And it goes like this:
A: Average Monthly Operating Expenses (non-validation)
B: Average Cycle’s Costs (to build, test, and learn)
C: Average Cycle’s Time (to build, test, and learn)
Cycle’s Average Burn = (A * C) + B
For example, if your operating expenses (A) are $2,000 per month, your cycle’s average cost (B) is $1,000, and your cycle’s average time (C) is 1 month, your Cycle’s Average Burn will be… $3,000 (per cycle).
When we multiply the Average Monthly Operating Expenses for the Average Cycle’s Time (A * C), we find how much those expenses represent for each cycle we run.
That means, if you spend $1,000 per month in operating expenses (A) and you’re taking 2 months to run a build-test-learn cycle (C), it means each cycle carries $2,000 of operating expenses.
But, let’s consider you found a way of reducing the Average Cycle’s Time by 1 month. Now, each cycle carries $1,000 of operating expenses (half of the previous $2K).
That’s how reducing the cycle’s average time (failing faster) is beneficial for your cycle’s average burn.
So, despite faster cycles may increase your burn rate, they reduce your cycle’s average burn, which will, in its turn, increase the number of cycles you may run in a certain period.
It’s All About Having More Cycles To Run
So, as an early-stage startup founder, you must work hard to reduce your cycle’s average burn.
A lower cycle’s average burn will give you a positive surprise: more cycles to run.
For example, let’s suppose you have $20,000 to invest in your early-stage startup, and you burn $2,000 per cycle on average. That means you’ll have a “credit” of 10 cycles to validate your hypothesis ($20,000 / $2,000).
But, what happens if you reduce your cycle’s average burn by half? Yep, you’ll double the number of cycles you’re able to run ($20,000 / $1,000 = 20 cycles).
So, keep in mind that your first mission as a startup founder is to find ways of bringing your cycle’s average burn down. Find ways of reducing your operating expenses (do you really need to pay for that fancy office?). Be creative about your validation process—lower costs, less time (do you really need to start with an app? Or a website would be enough?)
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