How do you know you have the right business model?

The Steve Blank model for developing a business is centered around "pivoting" (i.e. evolving) the company's business model until you hit the right one. When you reach that magic moment, you can focus on scaling the business model. But how do you know when you've hit that moment? How do you know if you've got a good business concept, or whether you need to keep adapting it? These have been some of the questions that have been running through my head.

I stumbled across one possible answer to these questions on Will Price's blog. Lars Leckie, guest posting on Will's blog, gives a formula that Josh James (CEO of Omniture) uses for calculating the "Magic Number". The Magic Number helps you determine the effectiveness of your sales/marketing spend and your likely quarter on quarter growth.

QRev[X] = Quarterly Recurring Revenue for period X
QRev[X-1] = Quarterly Recurring Revenue for the period preceding X
ExpSM[X-1] = Total Sales and Marketing Expense for the period preceding X
Magic Number = (QRev[X] – Qrev[X-1])*4/ExpSM[X-1]

The key, of course, is in interpreting the number:

Fundamentally, the key insight is that if you are below 0.75 then step back and look at your business, if you are above 0.75 then start pouring on the gas for growth because your business is primed to leverage spend into growth. If you are anywhere above 1.5 call me immediately.

PreScouter, the business that I'm working on, is a long way from having quarter-on-quarter financial data. However, as we think about modelling how the scaled up business could work, the Magic Number provides some guidance as to whether we even have the right business model to begin with.