After a successful decade making industrial process equipment that treats liquid waste, such as the leachate from landfills, to protect the water table, Bob Salter made a major change. He decided to produce drinking water products for individual users. He was attracted to an opportunity where people choose to buy the product rather than being forced to through environmental regulation. But along with the change came technology risk, new distribution channels, and customers he had yet to serve. How could he justify an uncertain bet with Hydration Technologies Inc. (HTI: when he already had a respectable business going?

It’s not a bet.

Before Bob considered investing toward a product for individual users, he already had a customer. A customer willing to make a financial commitment and that assured him of demand before he ever created a product. That customer was the U.S. Military. Rather than shopping for potential users to explore a possible opportunity, Bob was only willing to “go”ù when a genuine customer seemed committed. Potential customers only lead to potential markets, and this uncertainty represents a big bet for a small company. But committed customers define real markets with tangible revenue.

“Two interesting things happen when you force yourself to get customers on board early. The first is that you might fail to get the commitments you want. But it’s better to know sooner rather than later, and for a lot less money. And second, you might be surprised by the committed customers you actually find, and be led into even more attractive opportunities,”ù says Salter.

And surprised they were. After HTI developed an individual user product, not only have other defense customers joined in but HTI has moved into disaster relief projects and baby formula filtration that prevents disease and saves lives around the world. But there is more to how entrepreneurs make investment decisions.

It’s not their money.

How do you know if a customer is committed? When the customer invests their own time and money, ensuring they have a vested interest in creating a market with you. In HTI’s case, the U.S. Army paid six hundred thousand dollars for initial product development. Naturally they gained influence over what the final product would be, but Bob’s financial bet was dramatically reduced. And the Army’s initial purchase was approximately $7,000,000. Customers, suppliers, and partners that benefit from the value your new business can create are powerful sources of capital. They are more likely to offer favourable payment terms, cash upfront for development, detailed purchase orders to borrow against, and even sell your products and services with theirs. By providing both capital and a market for your idea they can effectively put you in business.

It’s not so risky.

Many people are surprised to learn that entrepreneurs are as risk averse as any average person on the street. What entrepreneurs have figured out are strategies to manage away the risk in a new venture. And one of the most useful strategies is gaining commitments from critical customers and partners as the basis for investing into an opportunity, rather than hoping for a pot of gold at the end of a big bet.

Stuart Read is professor of marketing, IMD, Lausanne, Switzerland. Robert Wiltbank is assistant professor of strategic management, Atkinson School, Willamette University, Oregon.

Publication: British Airways Business Life
Stuart Read
Relevant Principles:
Affordable Loss
Crazy Quilt (Partnerships)