ventures

During the summer, one of the Capital Factory companies developed a plan to sell into the “mid-sized” corporate market. Uh oh.

The startup graveyards are littered with companies who tried to target this seemingly alluring market segment — customers small enough to be intelligent and nimble, young enough to embrace new technology, yet big enough to spend real money to alleviate real pain.

It sounds like it’s best of both worlds. But the reality is it’s the worst of both worlds.

They’re not “small enough to be nimble,” because at fifty employees they’ve already established much of the lumbering process and bureaucracy of companies a hundred times their size. Shackled by budgets and internal politics, technology changes require expensive coordination and retraining, and fear of change trumps potential rewards of improvement.

All this makes for an arduous sales process just like with big companies. But although they have the process and controls of a large company, they don’t have the budgets to match; there’s no large reward for successfully navigating the painful, Herculean sales adventure.

Worst of both worlds.

Why is it like this? Maybe they’re stingy because they’re still being run by a parsimonious small-business founder (like me!) who is still straightening used staples to save pennies. Maybe it’s because with a few dozen people, the segmentation of teams, departments, roles, and behavior is inevitable. Whether because of physical limitations of communication or human tendency towards tribal behavior, we fall into semi-autonomous isolation coupled with formal processes to ensure command-and-control, and a bureaucracy is born, self-generating and largely inescapable.

Whatever the reason, it’s a tar-pit.

Then there’s the numbers game. There are 220,000 businesses in America having 50-500 employees, and only 18,000 businesses with more than 500. That’s often the argument for going after those mid-sized businesses — look how many there are!

But the average employee count of the mid-sized is 119 and of the large is 3,100, so if your goal is to sell a copy of your software to everyone inside a company, you have to sell 30 mid-sized for every large. Or looking at it another way, the total number of employees of mid-sized companies is 26m, whereas large is 60m.

And since the sales effort isn’t much different between 75 seats or 750, this is a lot more work for the revenue.

Even setting aside the internal machinery, “mid-sized companies” isn’t really a market segment anyway.

“Mid-sized companies” have less in common than you’d think; it’s much more important to know what industry they’re in. A 100-person technology startup has a certain makeup of employees — ratios of developers, QA, tech support, sales staff, HR, etc — whereas a 100-person plastics manufacturing company has a very different make-up, for example having no software developers, probably not tech-savvy, and IT is run by a guy who is a Windows “power user,” runs Exchange, hasn’t never heard of Google Apps, and doesn’t know how to open a port in the firewall “my Cisco guy” installed.

So for example if you’re selling server monitoring software, everything about how to sell into these two companies is different: How you find them, what pain you’re solving for them, what that user wants to see in the interface, etc.. The fact that both are monitoring 100 computers is only vaguely “the same;” there’s more differences than similarities.

The most common argument I hear targeting the middle is:

“Small businesses have no money, and the large companies already use Entrenched Competitors X and Y, so it’s in the middle that there’s opportunity.”

But there isn’t necessarily an opportunity. Maybe your competitors have figured out that it’s not cost-effective to sell to the middle.

WP Engine is a perfect example of this. My initial idea was to target the “mid-market” of the WordPress ecosystem — bloggers and websites big enough that cheap hosting was not longer delivering the speed, scale, and support they required, but not big enough that they could afford full-time WordPress experts or the $2500/mo (and up) cost of Automattic’s excellent but expensive “WordPress VIP” program.

There are some drawbacks here to be sure. People with $50/mo blogs have many of the same problems as people with $2000/mo blogs but pay us 40x less, which might imply we should focus on the high-end blogger. But there’s lots of $50/mo bloggers who never call and never have a problem where the profit margin is great (even if the absolute dollar profit is less), whereas a $2000/mo blogger is constantly running into new speed and scalability challenges since even small changes to their configuration is magnified by 10,000,000 hits a month, vaporizing that so-called profit with expensive expert human time.

In other words, exactly the problems of “selling the middle” — with small-blogger budget meets big-blogger problems.

If we just chose one or the other, we could optimize the rest of the business around it — hiring, automation, marketing, sales — and maybe we should. (Actually we have a theory that there’s another way for us to solve this problem, but that will have to remain under wraps for now. I know, I know, I just said hiding your business plan is silly, but although I’ve shared our “secret” plan with dozens of people in person, it’s a little different publishing it in front of 30,000 RSS subscribers… at least, not yet.)

So my immediate reaction to anyone “selling to middle” is the same: Yuck. If you’re going to do it anyway, I hope you have some nice, extenuating circumstances that truly makes you the exception to the rule.

Keep it coming: What’s your experience selling to a middle market? Would you do it again? Tips for doing it better? Let’s continue in the comments.

 

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We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard, because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win…

John F. Kennedy, September 1962

The irony is that as good as some of these nascent startups are in material science, sensors, robotics, medical devices, life sciences, etc., more and more frequently VCs whose firms would have looked at these deals or invested in these sectors, are now only interested in whether it runs on a smart phone or tablet.

And who can blame them.

Facebook and Social MediaFacebook has adroitly capitalized on market forces on a scale never seen in the history of commerce. For the first time, startups can today think about a Total Available Market in the billions of users (smart phones, tablets, PC’s, etc.) and aim for hundreds of millions of customers. Second, social needs previously done face-to-face, (friends, entertainment, communication, dating, gambling, etc.) are now moving to a computing device.  And those customers may be using their devices/apps continuously. This intersection of a customer base of billions of people with applications that are used/needed 24/7 never existed before.The potential revenue and profits from these users (or advertisers who want to reach them) and the speed of scale of the winning companies can be breathtaking.

The Facebook IPO has reinforced the new calculus for investors. In the past, if you were a great VC, you could make $100 million on an investment in 5-7 years. Today, social media startups can return 100’s of millions or even billions in less than 3 years. Software is truly eating the world.

If investors have a choice of investing in a blockbuster cancer drug that will pay them nothing for fifteen years or a social media application that can go big in a few years, which do you think they’re going to pick? If you’re a VC firm, you’re phasing out your life science division.

As investors funding clean tech watch the Chinese dump cheap solar cells in the U.S. and put U.S. startups out of business, do you think they’re going to continue to fund solar?  And as Clean Tech VC’s have painfully learned, trying to scale Clean Tech past demonstration plants to industrial scale takes capital and time past the resources of venture capital.  A new car company? It takes at least a decade and needs at least a billion dollars. Compared to IOS/Android apps, all that other stuff is hard and the returns take forever.

Instead, the investor money is moving to social media. Because of the size of the market and the nature of the applications, the returns are quick – and huge.

New VC’s, focused on both the early and late stage of social media have transformed the VC landscape. (I’m an investor in many of these venture firms.) But what’s great for making tons of money may not be the same as what’s great for innovation or for our country.

Entrepreneurial clusters like Silicon Valley (or NY, Boston, Austin, Beijing, etc.) are not just smart people and smart universities working on interesting things. If that were true we’d all still be in our parents garage or lab.  Centers of innovation require investors funding smart people working on interesting things - and they invest in those they believe will make their funds the most money. And for Silicon Valley the investor flight to social media marks the beginning of the end of the era of venture capital-backed big ideas in science and technology.

Don’t Worry We Always Bounce BackThe common wisdom is that Silicon Valley has always gone through waves of innovation and each time it bounces back by reinventing itself.

[Each of these waves of having a clean beginning and end is a simplification. But it makes the point that each wave was a new investment thesis with a new class of investors as well as startups.]

The reality is that it took venture capital almost a decade to recover from the dot-com bubble. And when it did Super Angels and new late stage investors whose focus was social media had remade the landscape, and the investing thesis of the winners had changed. This time the pot of gold of social media may permanently change that story.

What NextIt’s sobering to realize that the disruptive startups in the last few years not in social media - Tesla Motors, SpaceX, Google driverless cars, Google Glasses - were the efforts of two individuals, Elon Musk, and Sebastian Thrun (with the backing of Google.)  (The smartphone and tablet computer, the other two revolutionary products were created by one visionary in one extraordinary company.)

We can hope that as the Social Media wave runs its course a new wave of innovation will follow. We can hope that some VC’s remain contrarian investors and avoid the herd. And that some of the newly monied social media entrepreneurs invest in their dreams. But if not, the long-term consequences for our national interests will be less than optimum.

For decades the unwritten manifesto for Silicon Valley VC’s has been; We choose to invest in ideas, not because they are easy, but because they are hard, because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win.

Here’s hoping that one day they will do it again.

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If you can’t see the video above click here.

Filed under: Technology, Venture Capital

This weekend finds NYC in between Internet Week (which I largely missed because of my London trip) and Disrupt NYC (which I will be at on and off this coming week). So the development of NYC as a startup hub is very much on my mind. And so I thought I'd post about the development of startup hubs.

This theory, which I like the call The Darwinian Evolution of Startup Hubs, is not new and I certainly didn't come up with it. But I think it is important for everyone to understand and so I'm going to blog about it.

If you study Silicon Valley, what you see is something that looks like a forest where trees grow tall, produce seeds that drop and start new trees, and eventually the older trees mature and stop growing or worse, die of disease and rot, but the new trees grow up even taller and stronger.

In my mental model of Silicon Valley, the first "tree" was Fairchild Semiconductor (founded in 1957) which begat Intel (founded 1968) which begat Apple (1976) and Oracle (1977), which begat Sun (1982), Silicon Graphics (1981), and Cisco (1984) which begat Siebel (1993) and Netscape (1994), which begat Yahoo! (1995) and eBay (1995), which begat Google (1998) and PayPal (1998), which begat YouTube (2005), Facebook (2004), and LinkedIn (2003) which begat Twitter (2006) and Zynga (2007), which begat Square (2010), Dropbox (2008), and many more.

If I left out important foundational companies of this mental model, please forgive me. That was not meant to be a comprehensive history. It was meant to illustrate how this evolutionary scenario plays out over time.

If you drill down a bit deeper, you see that the founders, investors and early employees generate a tremendous amount of wealth from these big successes. The later employees don't make as much wealth but they do learn a ton and make enough money that they don't need to work for someone else and so they strike out on their own and are often funded by the folks who made the big money in the prior startup. That's how the seed drops from the tree and starts a new tree growing. This continues on and on and on.

If you look at that history of silicon valley, you see that in the forty year history (since Intel's formation), there have been close to ten cycles of maturation and new company formation, and those cycles are getting shorter and the number of important foundational companies that are formed each cycle are increasing.

That makes total sense since this darwinian evolutionary model is non linear. One company begets two and those two companies beget four, and so on and so forth. Of course there are exogenous factors that also play out, like technology changes, financial market cycles, and the availability and cost of talent, and they impact how fast the startup hub economy expands.

This darwinian evolutionary model of startup hub development is not limited to silicon valley. We have seen it play out in other places, most notably Boston, and increasingly in NYC. It is also playing out in markets like Boulder Colorado and Austin Texas and many other parts of the US and many parts of the world.

When I look at a startup hub, I like to figure out what the "Fairchild Semiconductor" of that market was and when it got started. That tells me how far along the development cycle that startup hub is. In NYC, that was Doubleclick which was founded in 1996, the same year as my first venture capital firm, Flatiron Partners, which was founded on two premises, that the Internet would be big and that NYC would be an important locus of Internet innovation. We did not invest in Doubleclick (sadly) but we did invest in a lot of interesting Internet companies in NYC in the late 90s.

So NYC's startub ecosystem is 16 years old now. And we are two cycles in. The companies that are getting started and funded right now in NYC are akin to the Apple/Oracle stage of silicon valley. If you want to push, you could suggest that we are three cycles in now and the companies that are getting funded right now are akin to the Sun/Silicon Graphics/Cisco era. That might be right.

But in any case, NYC's tech sector is not anywhere close in terms of fertility to silicon valley. It will be there in another 25 to 30 years. And silicon valley will be even further along. 

Unless, of course, something else happens.

The technological revolution that preceded the digital revolution was autos and airplanes. They were invented in the late 19th and early 20th centuries and the first commercial startups emerged in the first decade of the 20th century.  The auto/airplane revolution played out until the 1960s/1970s. That suggests that a technology revolution last around 75 years.

The transistor was invented in the late 1940s and by 1958 we had commercial startups working on the technology. So if this revolution is anything like the last, the next big thing will be invented any day now and within a decade or two we will be on to the next technology revolution.

And in that case, all bets are off. Silicon Valley could become the next Detroit and who knows what will be the next Silicon Valley.

But of course, all of this is conjecture. History doesn't repeat itself. But it does rhyme. That comes from Samuel Clemens (aka Mark Twain). One of my favorite people ever.

With all the talk of massive amounts of cash sloshing around the web/mobile startup ecosystem (including things I've said recently), you would think that nobody bootstraps anymore. But that is not true at all.

Last week my partner Albert blogged about our most recent investment in Behance. Behance was bootstrapped for its first five years. As Scott Belsky, Behance's founder and CEO, wrote on the Behance blog:

For the past five years, Behance has been a bootstrapped enterprise. We’ve sold Action Pads, books, job postings, conference tickets, and even banner ads (horror!) to generate the income to build Behance. It’s been amazing, and we’ve developed as a team and company in extraordinary ways.

Behance isn't the only recent USV portfolio company to bootstrap its way into our portfolio. Wattpad launched in 2006 and bootstrapped for five years before we invested.

Gabe at DuckDuckGo launched in the fall of 2008, and bootstrapped for three years, working by himself to build DDG, before we invested.

Stack Overflow also launched in the fall of 2008. Joel Spolsky, Jeff Atwood, and the Stack team worked on the project without outside funding for several years before USV invested.

Dwolla launched in the 2010 and operated in bootstrap mode for eighteen months before we invested earlier this year.

Three of the six portfolio companies in our new fund, raised late last year, were bootstrapped for an average of 3 1/2 years before we invested. And at least half of the most recent twenty investments we have made were bootstrapped for well more than a year, and often for a lot longer, before we made our initital investment.

None of this is to suggest that going the accelerator, seed, angel, or some other more fashionable route is a bad idea. They all work just fine. And we are investing in plenty of companies that choose that route. But for some reason our firm is drawn to the bootstrapped model, and increasingly so.

We’re back in gear with the podcast! We’ll be more regular now.  Here’s the deets if you’re unfamiliar with how this works.

Audio attached here, downloadable on iTunes or below, and transcript below.

Listen to this episode with Nick from PinfoB.com to learn how to tell customers no.

Transcript

Announcer:  Welcome to Smart Bear Live with Jason Cohen. In this episode, Jason speaks to Nick from PinfoB.com at the AZ Disruptors Kickoff meeting in December with co-host, Hamid Shojaee.

Nick:  The name of the company is PinfoB.com.

Jason:  Well, it’s certainly a very complicated company because the name is difficult to even spell. Lucky for you, domain names are not case-sensitive or you’d be sunk already, right?

Nick:  Right. Right.

Jason:  PinfoB? Well, I don’t know, fob sounds like freight on board, which is where you’d get things delivered. And so, I guess PinfoB is something that locates where all those things are so that when drivers are going around making their deliveries like UPS, but also other guys, they know where to go, they’ve got it on their mobile devices and it optimizes their routes.

Nick:  Wow. No. However, I think I’m now going to find that company and sell them the name or I’m going to go start it. That was great.

Jason:  All right. What is PinfoB?

Nick:  PinfoB, it actually stands for personal information broker, which is what we do.

Jason:  Okay.

Nick:  And so, we take your personal and consumer information and then we sell it, but then we give you the money.

Jason:  Right. That’s interesting.

Nick:  Yeah. And so, the benefit to the customer is that they get a little bit of money. It won’t be more than like $20 to $25 a month, but then they also, because we know a lot about them, they won’t get junk mail from us, they’ll get actually targeted relevant stuff, offers, deals, etc. And then on the client side, we can super, super target e-mail campaigns and whatever other things.

Jason:  Yeah, we get that part. That’s super. They’ve opted in and you have all their information and it’s probably accurate. They’re not just guessing because my grandma gave me a subscription to, what was it, it was that weird little thin magazine, you know what I’m talking about.

Hamid:  Lighthouse? Highlights?

Jason:  Highlights? Oh that’s a good one, and all of a sudden we got sweepstakes. I was put in a category of: I must be a senior because you can’t possibly read this stuff if you’re not over 67 and so I just got sweepstakes from then on. Hopefully, you can be more targeted than that.

Nick:  Yeah, absolutely.

Jason:  It sounds like people do this to you anyway, and so it sounds like life proceeds as before except you make $20 a month, which I guess is better?.

Nick:  Right.

Jason:  Do you have any control over this beyond that?

Nick:  Well yes, our members have control over everything. So they can control whether or not it’s e-mail, voice messages, whether it’s text messages, however, they want to get contacted, and they choose what they’re giving us and what they’re not giving us, so we can really target it. So really it’s just half of the benefit is the money, the other half is information about stuff you want.

Jason:  Okay. And what’s the question?

Nick:  The question was: How do you know when to tell customers no.

Jason:  Like what?

Nick:  So that’s both sides, so we have really kind of client sides, so we try to do everything we can to make our clients as happy as they can possibly be.

Jason:  Which client?

Nick:  So clients would be the advertisers.

Jason:  Advertisers. Okay.

Nick:  And they say we want to do this, that and the other thing, and some of it just isn’t what we do. And so, we want to tell them no, but we also want to be accommodating.

Jason:  When you say it’s not what you do, do you mean it kind of crosses some boundary of personal this and that, or it literally is features and things that are not your business?

Nick:  It’s both. The personal boundaries, really we kind of cover that because really for us we’re pretty firm about what we can and can’t do with our members’ information, and we don’t bend any rules there. The other side though is features and that’s where because we’re fairly early on, we’re in a Beta and we’re still trying to figure things out.

So we have an idea in our mind of what is good for them, but really we know that they know what’s good for them as well. Somewhere there’s that kind of crisscross where they want these crazy features that are going to be a lot for us and may be specific to them.

Jason:  The first rule is that customers do not know how to tell you what features they need. They will tell you they do not know how to do that. I mean, don’t you agree that just doing things like designing a UI and or what features are good and estimating all that is itself a combination of art and science that very few human beings who are trained in it and have experience can do?

Nick:  Yeah.

Jason:  And here’s somebody that runs the mail-order section of Walmart and they’re going to be able to design it? They definitely can’t. What they’re doing when they tell you a feature is they are taking a need or a pain or something that they actually want, and then they’re attempting to translate it for you.

What they’re actually doing is obscuring what you want to know, which is that underlying need or pain or value that they’re trying to get out of it. For example, they may think, if I had access to this data, or if I had this report in this other system or whatever, then I could be twice as effective or I could do this in one hour instead of eight, or I could reach more people or I could make my target or make more money, whatever.

So they ask you for some export feature in some bizarre thing you’d never heard of, but that’s not really what they want. They want the data in their mailer or sales force or something. So when they ask for a feature, you can just immediately go back and say “Wow, that sounds really interesting. Why is it that you want that feature? What is it going to do for you? What are you going to do once this feature is there?”

It depends on the feature what your follow-up question is. But you’re trying to dig back into the root thing that is either a problem for them or a perceived value that they have. And sometimes, by the way, it’s perceived value only, so reports are a good example. They say I need a report that shows me this. And you start digging, and there isn’t really any value in that. It really doesn’t tell them anything. It’s really not actionable. It’s just vanity metrics but they want it. Right?

Nick:  Right, that’s exactly it.

Jason:  Right, so what do they think is valuable, whether they’re right or not, and the more right they are, oh boy, because now we’re all on board. But even so, it could be a report that’s vanity and you know that, but you’re not going to train them on lean start up, are you? So just ignore the feature, in a sense; only use it as a foil to get deeper.

Just like you take a resume and you don’t look at it and go, “Wow, you were in software development for five years. That’s fantastic.” No, it’s just a foil to start asking questions. Oh, what did you do about this? You said you have this technology, well then, tell me this deep thing. Oh, I don’t really know that. Well, you listed it on your resume. That’s what the resume’s for, a foil. To get into the truth. So are these feature requests.

Nick:  That’s a great point.

Jason:  And you probably don’t have that many clients right now, anyway

Nick:  No.

Jason:  And so, you have the time and desire and so do they, hopefully, to have these deep conversations. If you have 2,000 of them, maybe you can’t have this kind of conversation, but you still can and so you should.

Nick:  Right, right. Yeah and we definitely should. Our problem is that we only have a few and the ones that we have we really like, and we have them because it’s kind of a two-way communication. Getting new ones that aren’t really willing to do that, I guess, is where we run into more of a problem. But maybe the answer is we don’t need them yet. That’s the wrong kind of client for us right now if they don’t want to get more into it.

Jason:  Not only do you not need them, you don’t want them because they will take some time and they’re not contributing back to you. You need people that will contribute back in the sense of working with you so that you can improve it for real.

Having said there, there definitely is such a thing as a customer that signs up and they don’t complain. They don’t ask for stuff. They’re just happy. That’s okay. You could have that now. It’s not helping you to learn, but it’s certainly better than not having that customer.

So I think you can still say yes to those folks but if they run into trouble and they’re not willing to discuss why, then you also have to be willing to say “Hey guys, I’ll tell you what, maybe we’re just not in the right place yet. You obviously have some interest in this, we’re obviously not quite there yet. You don’t have any time, it seems, to help us through that. We understand that, too; we’re busy, too. Why don’t we just suspend this? We’ll come back in six months when we have something new, and we’ll talk again.” And you can totally do that in a nice way and end it or suspend it, really.

Nick:  Yeah. Suspend. That’s good.

Jason:  But you’re right, if you only have two or three people giving you advice, you are getting idiosyncratic advice and that is a problem. And, of course, the only solution is more people. The other solution is to only look at things that all three of them say. And anything that one person says, it may be right, but you wouldn’t know one way or another with the one person. So you just don’t act yet.

Nick:  I’ll cross my fingers for when they all agree on.

Jason:  Well if they all agree, it’s like Congress, if they all vote for it then OK I guess you should do that. Of course, even then, maybe not. That’s pretty good. What do you think, Hamid?

Hamid:  Well, I think you should get lobbyists if you’re comparing them to Congress. The customers can get lobbyists for their features.

Nick:  We can use lobbyists, actually, to change some things.

Hamid:  No, I think that’s great advice. I don’t have anything to add to that.

Announcer:  Thanks for listening to Smart Bear Live with Jason Cohen. Be sure to visit Jason’s blog at asmartbear.com for more episodes, and if you would like to ask a question of Jason in a future Smart Bear Live, please register at smartbearlive.com.

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Inc. magazine is publishing a 12-part series of excerpts from The Startup Owner’s Manual, the new step-by-step “how to” guide for startups. The excerpts, which appeared first at Inc.com, highlight the Customer Development process, best practices, tips and instructions contained in our book.  Feedback from my readers suggested you’d appreciate seeing the series posted here, as well.

———–

Whether your venture is a new pizza parlor or the hottest new software product, beware: These nine flawed assumptions are toxic.

1. Assuming you know what the customer wants

First and deadliest of all is a founder’s unwavering belief that he or she understands who the customers will be, what they need, and how to sell it to them. Any dispassionate observer would recognize that on Day One, a start-up has no customers, and unless the founder is a true domain expert, he or she can only guess about the customer, problem, and business model. On Day One, a start-up is a faith-based initiative built on guesses. 

To succeed, founders need to turn these guesses into facts as soon as possible by getting out of the building, asking customers if the hypotheses are correct, and quickly changing those that are wrong.

2. The “I know what features to build” flaw

The second flawed assumption is implicitly driven by the first. Founders, presuming they know their customers, assume they know all the features customers need.

These founders specify, design, and build a fully featured product using classic product development methods without ever leaving their building. Yet without direct and continuous customer contact, it’s unknown whether the features will hold any appeal to customers.

3. Focusing on the launch date

Traditionally, engineering, sales, and marketing have all focused on the immovable launch date. Marketing tries to pick an “event” (trade show, conference, blog, etc.) where they can “launch” the product. Executives look at that date and the calendar, working backward to ignite fireworks on the day the product is launched. Neither management nor investors tolerate “wrong turns” that result in delays.

The product launch and first customer ship dates are merely the dates when a product development team thinks the product’s first release is “finished.” It doesn’t mean the company understands its customers or how to market or sell to them, yet in almost every start-up, ready or not, departmental clocks are set irrevocably to “first customer ship.” Even worse, a start-up’s investors are managing their financial expectations by this date as well.

4. Emphasizing execution instead of testing, learning, and iteration

Established companies execute business models where customers, problems, and necessary product features are all knowns; start-ups, on the other hand, need to operate in a “search” mode as they test and prove every one of their initial hypotheses.

They learn from the results of each test, refine the hypothesis, and test again—all in search of a repeatable, scalable, and profitable business model. In practice, start-ups begin with a set of initial guesses, most of which will end up being wrong. Therefore, focusing on execution and delivering a product or service based on those initial, untested hypotheses is a going-out-of-business strategy.

5. Writing a business plan that doesn’t allow for trial and error

Traditional business plans and product development models have one great advantage: They provide boards and founders an unambiguous path with clearly defined milestones the board presumes will be achieved. Financial progress is tracked using metrics like income statement, balance sheet, and cash flow. The problem is, none of these metrics are very useful because they don’t track progress against your start-up’s only goal: to find a repeatable and scalable business model.  

6. Confusing traditional job titles with a startup’s needs

Most startups simply borrow job titles from established companies. But remember, these are jobs in an organization that’s executing a known business model. The term “Sales” at an existing company refers to a team that repeatedly sells a known product to a well-understood group of customers with standard presentations, prices, terms, and conditions. Start-ups by definition have few, if any, of these. In fact, they’re out searching for them!

The demands of customer discovery require people who are comfortable with change, chaos, and learning from failure and are at ease working in risky, unstable situations without a roadmap. 

7. Executing on a sales and marketing plan

Hiring VPs and execs with the right titles but the wrong skills leads to further trouble as high-powered sales and marketing people arrive on the payroll to execute the “plan.” Executives and board members accustomed to measurable signs of progress will focus on these execution activities because this is what they know how to do (and what they believe they were hired to do). Of course, in established companies with known customers and markets, this focus makes sense.

And even in some start-ups in “existing markets,” where customers and markets are known, it might work. But in a majority of startups, measuring progress against a product launch or revenue plan is simply false progress, since it transpires in a vacuum absent real customer feedback and rife with assumptions that might be wrong.

8. Prematurely scaling your company based on a presumption of success

The business plan, its revenue forecast, and the product introduction model assume that every step a start-up takes proceeds flawlessly and smoothly to the next.

The model leaves little room for error, learning, iteration, or customer feedback.

Even the most experienced executives are pressured to hire and staff per the plan regardless of progress. This leads to the next startup disaster: premature scaling. 

9. Management by crisis, which leads to a death spiral

The consequences of most start-up mistakes begin to show by the time of first customer ship, when sales aren’t happening according to “the plan.” Shortly thereafter, the sales VP is probably terminated as part of the “solution.”

A new sales VP is hired and quickly concludes that the company just didn’t understand its customers or how to sell them. Since the new sales VP was hired to “fix” sales, the marketing department must now respond to a sales manager who believes that whatever was created earlier in the company was wrong. (After all, it got the old VP fired, right?)

Here’s the real problem: No business plan survives first contact with customers. The assumptions in a business plan are simply a series of untested  hypotheses. When real results come in, the smart startups pivot or change their business model based on the results. It’s not a crisis, it’s part of the road to success.

Filed under: Customer Development

TLDR: Brant Cooper and Patrick Vlaskovits, authors of The Entrepreneur's Guide to Customer Development are back with a new book called The Lean Entrepreneur. Illustrations by FAKEGRIMLOCK. You can pre-order it starting today. It's been just about two years since Brant Cooper and Patrick Vlaskovits released their self-published book The Entrepreneur's Guide to Customer Development (you can see my original review here). It took the idea of Customer Development and made it accessible to a whole new audience. Since then, Brant and Patrick have been tireless advocates for the whole Lean Startup movement. From Lean Startup Machine, Lean LA and San Diego Tech Founders, to countless speeches and workshops, I have seen the impact that their leadership has had first hand. There continues to be an incredible demand out there for actionable, practical lessons in how to apply this emerging set of ideas. Today I am excited to be able to share that Brant and Patrick have taken a big step in meeting that need. They are launching their next book, a true field guide for entrepreneurs, called The Lean Entrepreneur: How to Create Products, Innovate with New Ventures, and Disrupt Markets. It will be published by Wiley this fall. And you can pre-order it starting today. Brant and Patrick have set out to write and design a book that not only describes practical steps for implementing Lean Startup principles in your innovative endeavors – but to inspire your creativity as well by sharing diverse examples of what works, and more importantly, what often doesn’t work. Their goal is to share stories of Lean Startup applied in many industries and domains outside of tech startups. While I got my start as a technology entrepreneur, I have always felt that industries such as traditional book publishing or Fortune 500 retailing will reap huge competitive advantages by adopting Lean Startup approaches. Brant and Patrick strongly believe, like I do, that these principles will serve innovators of all types, whatever their industry. Wherever innovators and entrepreneurs face extreme uncertainty --  be it in social entrepreneurship or developing a new musical artist or a machine-vision startup -- a principles-based approach can help. To that end, they've refined their thinking and have incorporated feedback about The Entrepreneur’s Guide to Customer Development into The Lean Entrepreneur. They’ve also augmented their writing with research and interviews, collecting the stories of dozens of entrepreneurs who are now applying Lean Startup thinking to all sorts of ventures, ranging from music and artist development: Legendary music producer Marti Frederiksen (Aerosmith, Def Leppard, Fuel, Mötley Crüe, Ozzy Osbourne), to finance and investment: Dave McClure of 500 Startups to apparel and ecommerce: Chris Lindland, Founder of BetaBrand to automotive manufacturing: Danny Kim, Founder of Litmotors, and of course, technology startups such as Lucas Carlson of AppFog, Hiten Shah of KISSmetrics, Nathan Oostendorp of Ingenuitas and many others. These interviews, nuggets, hacks, insights and case studies have been abstracted into actionable tactics for entrepreneurs of all stripes. The book is still in production, so I haven't seen the whole thing yet. But I've been impressed with what I've seen so far. To whet your appetite, I asked Brant and Patrick for permission to share a few excerpts from the draft manuscript. They are below, followed by one last surprise announcement. In this excerpt from The Lean Entrepreneur, by using fishing as an analogy, Brant and Patrick reveal how market segmentation influences your business model and why “For Whom” is as important as “What” to build.

Market segments drive your business model. The process of segmenting your market is one of the poorest understood concepts in the business startup world, yet is one of the most powerful. The market segment you pursue is inextricably linked to the other aspects of your business model.  Segments determine how future customers will expect to interact with the product, how they will be marketed to, and their method of purchasing. Differences in how people are reached, their expectations of the buying process, how their trust is earned, the price point they’ll accept, what distribution methods are most efficient, the messaging that attracts them -- all these factors (and more) may represent different sub-segments.  A good way to think about market segment is by thinking about fishing.  In the kelp beds off the coast of Southern California, one can find thousands of species of fish, but two of the most sought after by commercial fishermen are the California Halibut and the White Seabass. Both fish are classified as “demersal”, meaning they live near or on the bottom of the ocean floor and catching fish of both species in the 20-30 lb pound range is not uncommon. Halbut are flatfish. They make themselves effectively invisible by nestling into the sandy bottoms between patches of eel grass and when sardines swim by, they explode out of the sand to nab them. They have two eyes on one side of their body, which make them very adept at ambushing predators. Fishermen know that one of best baits for catching halibut is a fellow denizen of sandy bottoms, the lizardfish.  White seabass are long and cylindrical, and have a much more typical “fish” form. They cruise the kelp beds looking for squid or mackerel to eat. White seabass are very difficult to hunt with spear guns as they are very sensitive to noise, and the slightest inorganic noise will set them off.  Any amateur fisherman can throw a line off the end of the local pier baited with frozen squid and pull in a few mackerel, or maybe even a rockfish. But commercial fishermen have to -- day in, day out -- in good weather or in bad -- acquire their target fish and then sell it for more than cost of catching it. To do that repeatedly and scalably, they have to develop a deep understanding of the ethology of the fish. They must learn what sort of bait to use with what tackle, the best time of day and what environment will maximize the potential to catch the particular fish they are looking for. Fish can only be caught when they are accessible -- it doesn’t help you to know that there are fish 1,000 feet below your boat, if your line cannot get down to depth. What are the value propositions, benefits and the messaging (bait), the pricing structure and channels (tackle), and length of sales cycle (how likely a fish will snap your line)? Will you need a big net (full-page ads in the WSJ) to catch lots of small sardines? Or will you need to staff and finance a whaling ship to be out at sea for months at a time to catch two or three whales (enterprise sales model)? Or perhaps you need to chum (freemium) the waters a bit? Maybe you’ll be hunting on a reef with a spear gun for 20lb groupers (B2B sales at a conference)? You can build a mobile app for senior citizens, launch a Facebook campaign targeting Fortune 100 CEOs, or charge $25 for a food cart hamburger if you’d like, but the mismatch between product, tactic, pricing and segment might delay that Hawaiian vacation you’ve been planning. It may seem rather obvious, but as with many aspects of entrepreneurship, the practice of segmenting your market seems commonsensical, but is more complicated than it seems to put into practice. And the problem is that few take the time to really master it. Entrepreneurs carry market segments around in the back of their minds, relying on gut-feel to determine whether customers they are seeing are the “right” customers. The problem is when you’re chasing revenue; any and all customers will seem like the right customer.

In another excerpt from The Lean Entrepreneur, Brant and Patrick describe BetaBrand’s fast, iterative, and MVP-driven approach to manufacturing and selling apparel.

Traditionally, the clothing industry is seasonal. Two to four times a year, large clothing companies release products to the world and eventually the make their way online, but it's an old-fashioned industry that moves at old-fashioned speed compared to the ways people interact with companies on the Internet. But that's not what founder Chris Lindland had in mind for BetaBrand, an online clothing company. Not an online clothing catalog, mind you, but a clothing company. Chris explains: “What I figured is that an online clothing company has to abide by the rules of blogging or Twitter, which people expect when interacting with companies online. The idea with BetaBrand is we're going to try to put up products as rapidly as we can. In order to save on our costs we decided to make those batches very small and as a result of making small batches you can iterate on them if anything is successful. It was a fairly organic thing. It was really done to control our costs to begin with, but it's become a fascinating way to actually improve upon products as we go along." Like Continuous Deployment, whereby IMVU deployed changes to their web application +50 times per day, BetaBrand's aim is to put out a new product every day. They manufacture only a small batch of a particular product, but enough to come to a decision point: “If there's anything that we've learned from our customers, it's that with the first hundred to two hundred pair sold, we can make minor changes on it to improve it and retest, we can turn it into an entire line, or we can kill it.”

Reprinted from The Lean Entrepreneur by Brant Cooper and Patrick Vlaskovits. Copyright © 2012 by John Wiley & Sons, Inc. Reprinted by permission of John Wiley & Sons, Inc. And, these days, no book launch announcement would be complete without a funny book trailer to go with it. Want to know what "Christopher Walken" thinks about The Lean Entrepreneur?

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Lastly and perhaps most importantly, Brant and Patrick tell me that The Lean Entrepreneur will be heavily visual, filled with full-color illustrations of the concepts they're explaining. To that end, they've teamed up with the most unique startup artist there is...my favorite robot dinosaur, FAKEGRIMLOCK. If that doesn't convince you pre-order, you're probably beyond help. But just in case you are right on the fence, and want one more reason to do it, you should know that Brant and Patrick are partnering with LA-based crowdfunding startup Invested.in, to let early adopters of their book become part of co-creating it. If you pre-order The Lean Entrepreneur  from them, they'll list your name as a co-creator in the book and share material with you as they write. The Lean Entrepreneur will be published by Wiley this Fall. You can order it on Amazon. But I suggest you pre-order it at LeanEntrepreneur.co.

I was asked by the excellent folks at Grind, a co-working space near our offices, to give a talk in their monthly #Rethink breakfast talk series. I am drawn to the idea of a #rethink hashtag. It's a good mental exercise. So I said I would do the talk and that I'd like to #rethink the VC industry.

I gave the talk yesterday and William storified it. And there was some blog coverage of the talk yesterday. I started out the talk by stating that I was "thinking outloud in realtime and that my remarks should be taken as such".

At some point yesterday I see the words "death of the VC business" in my twitter stream with my name attached to it.

 

Fred Wilson and the death of venture capital. A good read. > forbes.com/sites/jjcolao/…

— Martin Bryant (@MartinSFP) May 8, 2012

 

I can assure you I never said anything about the "death of the venture capital business" in my talk. The venture capital business is not dying.

My talk was a rumination on the forces at work on the venture capital business today and the changes that may be required to remain relevant and profitable in this new world. The talk was provocative and "out there" but it was not a eulogy.

I expect that Grind will post the talk at some point and everyone can come to their own conclusions.

This post is a plea to bloggers and journalists not to use the word "death" casually. It is a big word, a strong word, it means something real and devastating. And it is a word I would not use lightly.

This is part of an ongoing startup advice series where I answer (anonymized!) questions from readers, like a written version of Smart Bear Live. To get your question answered, email me at asmartbear -at- shortmail -dot- com.

Embarras de Choix writes:

I have a startup with thirty paying customers. We’ve been bootstrapping up to this point.

I think there’s a big opportunity to raise money, but also I could continue as I have been. I don’t know way to go.

I already know the pros and cons of the decision, so don’t lecture me about that. I just don’t know how to pick!

This is one of those few dilemmas where there’s no wrong answer. So, whichever you choose, never let anyone else make you feel guilty about not choosing the other.

But “there’s no wrong answer” doesn’t answer the question.

Asking for more advice from other people probably won’t resolve it. While I was bootstrapping WP Engine I constantly heard that we’re hamstrung by not taking an investment; after raising a Series A a different set of people expressed their disappointment that I had “sold out.”

Who’s right? Both. Neither. This is why you cannot look externally for the answer.

Every day you delay the decision is costing you. Dithering doesn’t move you closer to either goal — it’s draining time and energy from whatever is actually valuable, and it’s blocking other decisions about spending money, hiring, your lifestyle, stories for the press, features, everything.

So you need a fast decision, and other people cannot give you the answer. That leaves you, alone.

What kind of company sounds like the most fun to build?

Do you like working alone or with a very small team? Does hiring ten people in the next 12 months sound exhilarating or depressing? Do you like having a hand in everything or would you rather be evangelizing and leading? Do you enjoy carefully, slowly growing a backyard garden or would you have more fun strapping on an afterburner and seeing just how much of an impact you can have on the Earth? Do you like being good at what you’re good at now or do you want to learn how to run a completely different kind of business?

Are you proud of bootstrapping? Do you enjoy the balance in the conversation when you tell that to someone funded, tacitly saying “I’m in control, I don’t need help, I have a product so good people actually pay for it?” Or does it make you feel small, knowing you’re not growing as fast as you could, not making as much reach as you could, not making as much money as you could?

What sounds like fun? Yes, fun. Enjoyable. Fulfilling. This is your yardstick.

I think fulfillment and joy barely enter into the calculus for most founders, and that’s a mistake. Why build a company — or anything else for that matter — if it’s not fulfilling?

You’re in an enviable and rare condition in that both of your options are valid and rational in every way, and that means you get to pick based something we all really ought be valuing, but lack either the means or courage to do so.

But you can.

And remember, five years from now when you look back on this with hindsight, you still won’t know which one would have been “right.” Even if the path you picked “failed” in some objective sense, you still won’t know that the other necessarily would have been “better” — more money, more fulfilling, happier, whatever.

P.S. Other people can help, in that they can help ask you more questions. But only you can decide the answer.

 

Add your advice to the discussion section!

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Yesterday, my partners and I invited Paul Romer over to USV for lunch. For those that don't know, Paul is a leading thinker in the world of economics and currently a Professor at NYU. It was a fascinating conversation. My favorite part of it was Paul's "lecture" on William Penn, early Pennsylvania, and the reaction to the growth of Pennsylvania from neighboring states.

William Penn was a Quaker and when King Charles II gave him a large piece of his land holdings in America, Penn created the colony of Pennsylvania and grounded it in the notions of tolerance and religious freedom. Instead of limiting Pennsylvania to Quakers, they welcomed all comers. And the result was that Philadelphia became the fastest growing city in America with a vibrant economy and lifestyle.

The neighboring colonies, which were initially centered around a single religion, reacted to Pennsylvania's and Philadelphia's economic success by opening up their cultural norms and becoming more tolerant as well.

Paul told us this story as a lesson in why cultural norms, even more than laws, are a determinant of prosperity and economic development. And tolerance is one of the more important cultural norms in this regard.

As Paul was giving us this lecture, I thought of my friend Bob Young's blog post about North Carolina's Amendment One, which seeks to ban same sex marriages. North Carolina is the only southern state that does not have such a law on its books. North Carolinans will be voting on Amendment One next tuesday, May 8th.

Bob's argument is as much an economic one as a social one. Bob says:

This proposed amendment to our state constitution is specifically telling them we don’t want their friends and fellow Americans to come here.   We need these talented, intelligent young Americans to come to North Carolina to help our technology industries succeed, but they have choices.   They can go to states with mottos like “Live Free or Die” instead of states that attempt to tell them how to live their lives, such as this Amendment One does.  And trust me, these bright young Americans can and will chose to join my competitors in Seattle, or San Jose, or New York. 

North Carolina has enjoyed a vibrant tech/startup economy and Bob's Red Hat and Lulu.com are two of its best known successes. Bob asserts that changing the cultural norms (and laws) of his home state are not going to be good for the local startup scene. Bob is right and his concerns are consistent with the lesson that Paul Romer gave us yesterday.

Tolerance and Prosperity go hand in hand. History tells us this. I hope the good citizens of North Carolina listen to Bob because I agree with him strongly on this one.

The results of a serendipitous live experiment were recently published as guest posts on this blog. Sacha demonstrated the benefits of selling many copies of an eBook at a low price, while Jarrod pointed out the advantages of higher prices, bringing in more revenue with 1/6th the number of units sold.

The ensuing discussion swirled around the merits of selling more units (i.e. maximizing reach) versus selling more expensive units (i.e. maximizing per-unit profitability). This is a choice that every startup founder must make, so I’d like to dig in deeper.

To clarify the discussion, let’s use a simpler model:

Companies A and B both sell products with recurring monthly revenue, and both brought in $10,000 in revenue last month.

Company A has 1,000 customers each paying $10/mo.

Company B has 10 customers each paying $1,000/mo.

Which is better?

Oops, bad question. How about: Which company would you rather own? Or: What primary problem should each company be working to solve? Or: Under what conditions are each of these companies interesting? Or: Which company could raise money more easily?

Let’s focus on just one question: For which company would be easier to raise money?

Wait! That’s shitty! Why the obsession with raising money, what if you don’t want a huge company, what if you want to bootstrap, don’t you know raising money isn’t a measure of correctness or success, …

I agree! But “raise money or not” is also a decision everyone must make, and it turns out that exploring that question will end up answering all the other ones. So let’s play!

Market size

Suppose the total addressable market is small. In that case, A can’t keep growing forever, so its revenue is limited, which is a bad spot. B can extract more money from the limited pool of customers, so that’s better. Except, of course, investors don’t like small markets!

In a large market, B isn’t necessarily bad, but A shows far more potential. Over time companies at small price points are able to increase prices and otherwise extract more money from various customer segments, which means A has a bigger revenue potential.

Perhaps most importantly, A demonstrates that there is a large market at all.  If you’ve already found 1,000 customers, there’s 10,000, and likely 100,000. If you’ve only found 10, there might be 10,000 out there, but if so, you don’t have supporting evidence. Riskier.

Speaking of risk…

Market risk

Many companies die because they can’t find enough people to pay. Many more die that way than die because the product sucks or doesn’t have enough features or because they don’t have a staff designer.

There’s a million variables — can you locate potential customers, can you bring them to your website, can you get them to read and click, can you get them to sign up, can you get them to agree to your price. A million variables means it’s hard to get it right.

Therefore, an investor is always impressed with a company like A who has made irrefutable progress on this particular front. Having 1,000 people paying you any amount of money whatsoever goes a long way. It’s a lot harder to get 1,000 paying customers than to add three features, because the latter is a matter of time and money whereas the former is largely out of your control.

Getting 10 people to pay you — even a large amount — is actually not that hard. If a co-founder has a rolodex in the industry — extremely common — then it would be surprising not to find 10 people. That doesn’t prove you have a repeatable, scalable method for finding customers, nor that there are a lot more potential customers out there.

Market risk is most startups’ biggest risk. One interesting way of reducing that risk is to build a company like B where you just don’t need to sell very much to achieve your goals. That’s awesome because the risk is low when the bar is low. That’s not intended as an “insult” — in fact I believe far more companies should have this attitude.

Time heals many wounds (but not all)

Over the time scale of “years,” you can count on certain treads.

For example, the average cost of customer acquisition diminishes. Why? Because you get organized around marketing metrics, because your campaigns get optimized, because your landing pages and drip campaigns become stronger, because word of mouth produces sales “for free,” and so forth.

Another is that average revenue per customer increases. Why? Because new pricing tiers better segment customers, prices go up as reputation grows, you create add-on products and services, you create new revenue through business development, and so forth.

What’s not true is that you always unlock big growth drivers. Indeed, many companies get stuck at a certain growth rate which, while positive, eats too much money during its slow crawl to cash-flow-positiveness, and by the same math doesn’t generate interesting profits after that. Once profitable, at least that sort of company is creating jobs and still could unlock something someday, but of course an investor in general isn’t interested in that outcome.

So back to our two companies. Company A has demonstrated that some growth is possible, and where there’s 1,000 customers from a shoestring budget there’s likely several other growth drivers out there; anyway, one is unlocked. Which is more than you can say for B. So, along one of the dimensions which doesn’t automatically improve with time, A wins.

That’s why, even if A isn’t doing well in other areas, that’s not as important. Suppose you argue that $10/mo isn’t enough money to be interesting — perhaps, but average revenue increases, so that’s not a long-term problem. Suppose you discover that it costs $60 to acquire a new $10/mo customer which is too much to be sustainable — perhaps, but that cost diminishes over time, so it’s not a long-term problem.

Investors are of course more interested in where you could be in two years than where you are right now. They’re more worried about the problems which don’t naturally get corrected over time.

Pivotability

Nowadays everyone agrees that it’s both likely and healthy for an early-stage startup to be on the lookout for an intelligent pivot.

Actually, more than “on the lookout,” you should be actively probing the market, which means interviewing customers and non-customers alike, attending industry events to have real conversations (not quipping to each other on Twitter), exploring the metrics of your website, your marketing, and product features, and so on.

One of the most common answers to “what made you successful” is “we decided to stop X and do Y.” Therefore, actively collecting the data on what’s actually happening, what customers actually will pay for, where the valuable hole in the market actually is — this is one of the most valuable things you can do, and the company which does it best is increasing its chance of success.

Given no other information about the companies, company A clearly has access to far more market data. They have 100x the quantity and range of customers to interview and analyze. They probably have a correspondingly large amount of website traffic to mine. They can subdivide their user population and try four ideas at once, iterating quicker to better information.

Lean Startup tells us that the speed at which theories can be tested is directly proportional to learning; the company who can do that faster and more accurately has a significant advantage.

I posit that this is true regardless of whether you’re taking investment.

A flurry of arguments in favor of B

So it’s clear that in general an investor will prefer A to B. But B is preferable in many cases, so let’s even the score.

If the cost of support is high, A will kill profitability and B wins.

If the cost of customer acquisition is 10x the monthly revenue or monthly revenue is 1/100th of where it should be to sustain the operations of the company, then the argument of “it gets better over time” doesn’t work, because although it gets incrementally better, it’s hard to justify orders of magnitude of improvement.

If the human cost of scaling A is higher than B, then at scale B might be much more profitable.

If you’re keeping the company small, it’s almost always cheaper and more fun to run it like B. You spend less on marketing/advertising/acquisition. Less time training customers. You have more time to make customers love you forever and therefore less churn and a happier general existence. In product development you have the delightful job of serving handful people with homogeneous needs rather than appeasing the disparate needs of thousands people who can’t agree on anything. Pretty much everything about it is nicer!

If the market is small, it’s hard to get more than a few customers, so you need a business model like B that extracts the most amount of money from the limited available pool.

But “freemium” is not Company A

I often see founders and investors alike using many of the above arguments to argue why a company with 100,000 free users is more valuable than a company with 1,000 paying customers.  I disagree.

While it’s true that the potential for the company with vast numbers of freebie customers is indeed there, there’s just too many examples of startups with great products, great marketing, huge growth, large customer bases, where they just could not convert enough of the freebies to paid, and even after conversion, not paying enough.

Of course if there is a conversion rate, you can start applying the above logic again.  Conversions rates increase over time, etc., so as long as the absolute number of paying numbers is interesting and the growth rate is large, you’re back to good.  Better than good, in fact, because you have more levers to play with in terms of increasing conversions, offering different products, pivoting, etc..

Which is right for you?

Hopefully the detail above should be sufficient for you to decide which is appropriate for you.

If I had to boil it down to a sentence it would be:

If you want happiness and fulfillment from a small company, strive for B; if you want to maximize growth, influence, and financial value, strive for A.

Now leave a comment about your choice! Did you have other considerations as well?

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Faced with disruptive innovation, you can be sure any possibility for innovation dies when a company forms a committee for an “overarching strategy.”

—–

I was reminded how innovation dies when the email below arrived in my inbox. It was well written, thoughtful and had a clearly articulated sense of purpose. You may have seen one like it in your school or company.

Skim it and take a guess why I first thought it was a parody. It’s a classic mistake large organizations make in dealing with disruption.

The Strategy Committee

Faculty and Staff:

We believe online education will become increasingly important at all levels of the educational experience. If our school is to retain its current standards in terms of access and excellence we think it is of paramount importance that we develop an overarching campus strategy that enables and supports online innovation.

We believe our Departments play an essential leadership role in the design and implementation of online offerings. However, we also want to provide guidance and support and ensure that campus goals are met, specifically ensuring that our online education efforts align with our mission, values and operational requirements.

To this end, we are convening a Strategy Committee that is charged with overseeing our efforts and accelerating implementation. The responsibilities of the group will be to provide overall direction to campus, make decisions concerning strategic priorities and allocate additional resources to help realize these priorities. Because we anticipate that most of the innovation in this area will occur at the school/unit level we underscore that the purpose of the Strategy Committee is to provide campus-level guidance and coordination, and to enable innovation. The Strategy Committee will also be responsible for reaching out to and receiving input from the Presidents Staff and the Faculty Senate.

The Strategy Committee will be comprised of Mark Time, Nick Danger, Ralph Spoilsport, Ray Hamberger, Audrey Farber, Rocky Rococo, George Papoon, Fred Flamm, Susan Farber, and Clark Cable.

A Policy Team, which is charged with coordinating with the schools/unit to develop detailed implementation plans for specific projects, will report to the Strategy Committee. The role of the Policy Team will be to develop a detailed strategic framework for the campus, oversee the development of shared resources, disseminate best practices, create an administrative infrastructure that provides consistent financial and legal expertise, and consult with relevant campus groups: and the the Budget Office. The Policy Team will be led by two senior campus leaders, one from the academic side and one from the administration side.

We are extremely pleased that Dean TIrebiter has accepted the administrative lead role of the Policy Team. Dean Tirebiter brings to this position a deep knowledge of the online environment.  He will be helping to identify a member of our Faculty to serve as the academic lead of the Policy Team.

The Strategy Committee will be meeting for a half-day retreat at Morse Science Hall in the coming weeks to begin work. We will be sending out an update to faculty and following this retreat, so stay tuned for further updates.

Sincerely,

President Peter Bergman

We Can Figure it Out in A Meeting The memo sounds thoughtful and helpful. It’s an attempt to get all the “right” stakeholders in the room and think through the problem.

One useful purpose a university committee could have had was figuring out what the goal of going online was.  It could have said “the world expects us to lead so lets get together and figure out how we deal with online education.”  Our goal(s) could be:

The problem is that the path to implementing online education is not known. In fact, it’s not a solvable problem by committee, regardless of how many smart people in the room. It is a “NP complete” problem – it is so complex that figuring out the one possible path to a correct solution is computationally incalculable. (See the diagram below.)

If you can’t see the diagram above click here.

Innovation Dies in Conference RoomsThe “lets put together a committee” strategy fails for three reasons:

1. Online education is not an existing market. There just isn’t enough data to pick what is the correct “overarching strategy”.
2. Making a single bet on a single strategy, plan or company in a new market is a sure way to fail. After 50-years even the smartest VC firms haven’t figured out how to pick one company as the winner.  That’s why they invest in a portfolio.
3. Committees protect the status quo. Everyone who has a reason to say “No” is represented.
4. Dealing with disruption is not solved by committee. New market problems call for visionary founders, not consensus committee members.

In a perfect world, the right solution would be a one page memo encouraging maximum experimentation with the bare minimum of rules (protecting the schools brand and the applicable laws.)

 Lessons Learned

• Innovation in New Markets do not come from “overarching strategies”
• It comes out of opportunity, chaos and rapid experimentation
• Solutions are found by betting on a portfolio of low-cost experiments
  • With a minimum number of constraints
• The road for innovation does not go through committee

Filed under: Big Companies versus Startups: Durant versus Sloan, Customer Development, Teaching

When a blockbuster deal happens, a lot of people get excited. The press is all over it, money comes pouring into startups in search of the next one, people quit jobs and school to get in the game. It's a gold rush.

But there's another reaction that I have heard a lot in the past few weeks that is quite different. It is "why not me?" The title of this post is from an email between me and an entrepreneur I know who will go nameless.

It sums up the emotion so well for me.

Startups are hard. They require great sacrifice from everyone. They are stressful and fail more often than they succeed.

And when you've been toiling away month after month, year after year, with no pot of gold in sight, it can be hard to watch that billion dollar deal go down. It's a punch to the gut. It hurts.

I'd love to say to all of you who are feeling that pain that your time will come. But most likely it will not. That's the way this game is played.

Over the history of the institutional VC business (the past 40 years) the number of companies started every year that turn out to be worth billions sustainably is in the tens not the hundreds. If you are looking for a billion dollar check in the startup game, you are playing for lottery odds.

So if you are doing the startup game for money, and lots of it, you are in for a plate full of frustration. It must be for more than that. It must be for the love of the game, a passion for what you are bringing to market, and for the chance that you will hit paydirt. But it is a lot more likely that you will watch someone else hit the big payday than hitting it yourself. And that sucks.

We’ve taught our Lean LaunchPad entrepreneurship class at Stanford, Berkeley, Columbia and the National Science Foundation in 8 week, 10 week and 12 week versions.  We decided to find out what was the Minimum Viable Product for our Lean LaunchPad class.

Could students get value out of a 5-day version of the class?

The SetupAt the invitation of Murray Low at the Entrepreneurship Center in the Columbia Business School, we went to New York to find out.  We were going to teach the Lean LaunchPad class in 5-days.   I was joined by my Startup Owners Manual co-author Bob Dorf, Alexander Osterwalder (author of Business Model Generation) and Fred Wilson of Union Square Ventures.

As we’ve done in previous classes, the students form teams and come up with an idea before the class.

Potential students watched an on-line video of Osterwalder explaining the Business Model Canvas and then applied for admission to the class with a fully completed business model canvas. Here are two examples:

If you can’t see the presentation above, click here.

If you can’t see the presentation above, click here.

The ClassWe had 69 students in 13 teams. Instead of going around the room introducing themselves, each group hit the ground running by presenting their canvas.

The class organization was pretty simple:

• textbooks were The Startup Owners Manual and Business Model Generation
• team presentations 9-12:30 (with continual instructor critiques)
• working lunch 12:30-1:30 (with office hours)
• lecture 1:30-3:00
• get out of the building 3:00-on
• repeat for 5-days

ResourcesThe 5-day syllabus is here.

All 13 teams Day 1 presentations are here.Day 2 presentations here.Day 3 presentations here. Day 4 presentations here. Day 5 presentations here.

The OutcomeAfter 5 days the teams collectively had ~1,200 face-to-face customer interviews, with another 1,000+ potential customers surveyed on-line.

Take a look at the same two teams presentations (compare it to their slides above):

If you can’t see the presentation above, click here.

If you can’t see the presentation above, click here.

Lessons Learned:

• A five day Lean Launchpad Class is definitely worth doing.
• The Business Model Canvas + Customer Development works even in this short amount of time
  • However we were in NYC where customer density was high.
• As we’ve already found, this class needs to be taught as a joint engineering/mba class
• Next time we teach we will complete the transition to a flipped classroom:
  • Have no lectures during class. We’ll offer video lectures, and use the time for class labs built around detailed analysis of 2 or 3 canvas pivots
  • Make teams use Salesforce, or some similar package, to track all contacts/customer calls

Filed under: Business Model versus Business Plan, Customer Development, Lean LaunchPad, Teaching

One of the most noticeable changes to the VC business over the past decade is the movement of investment allocation from capital and time intensive sectors like biotech and clean tech to capital efficient and fast moving sectors like internet and mobile.

This makes total sense if you think about it. VCs are professional money managers. We are provided capital to invest as long as we can return it to our investors with a strong return in a reasonable amount of time. A strong return is 3x cash on cash. A reasonable amount of time is ten years max.

Internet and mobile product development cycles are measured in months not years. And the capital required to get a product built and into the market is less than $1mm. And the returns, when things work out, can be enormous.

Contrast that with biotech. A new drug takes $100mm in capital investment to get to market. And that process can take a decade or more.

If you were a professional money manager, where would you invest? Where has USV invested our investors' capital for the past eight years? It's not even a contest. Internet and mobile wins hands down.

But internet and mobile will not and can not solve all of society's problems. We need new medical approaches to preventing and/or curing disease. We need new scientific approaches to generating, storing, and being more efficient with energy. Maybe we need more space exploration. Maybe we need more undersea exploration.

Enter the crowd.

When the Gotham Gal and I allocate our personal capital, we do it broadly. We give it away to good causes. We invest in things we want to see in the world regardless of whether there is a good return on it. We are driven by the outcome as much as the return.

I suspect that many people approach the allocation of their personal capital similarly. And that is very different than a professional money manager behaves.

So the advent of crowdfunding, for equity, for philanthropy, and for patronage, seems like a great fit with these capital and time intensive projects that the VC business has largely abandoned.

If we saw a promising technology that could prevent or cure cancer, we would be inclined to help fund that, regardless of the timing and magnitude of the financial returns it could produce. If we saw a promising technology that could store and move energy more efficiently, we would be inclined to fund that as well.

I can feel the crowdfunding movement coming. It's in the air. And I think it will be impactful and helpful in many way. And I hope that its impact will be most felt in the sectors that have been starved for capital, not the sectors that are awash in capital.

I read a post by my friend Brad Feld this morning that struck me as great advice. Brad says:

I’ve been noticing an increasing amount of what I consider to be noise in the system – lots of drama that has nothing to do with innovation, creating great companies, or doing things that matter. I expect this noise will increase for a while as it always does whenever enthusiasm for startups and entrepreneurship increases. When that happens, I’ve learned that I need to go even deeper into the things I care about.

I've been noticing the same nonsense and I've been trying to put up blinders myself. Brad's advice is to make a list of the thing that interest you and then dig deeper on them. His is at the end of his post.

I am interested in extending the internet/web/mobile disruption we've seen in media to big industries like finance, education, healthcare, energy, etc in order to address the challenging economic and social issues of our time. I'm going to take Brad's advice and dig deeper on these areas. And I want to write more about this stuff and discuss it with all of you here.

The following is an excerpt from HBS Professor Noam Wasserman’s new book, The Founder's Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup. Noam is one of a rare breed of business academics: he studies entrepreneurship using a rigorous empirical approach. The book taps Noam’s analyses of data on 10,000 founders, plus the personal stories of Evan Williams of Twitter, Tim Westergren of Pandora, and two dozen other founders. As an example of the kind of insight that this data makes possible, take a look at this diagram, which is one of my favorites in the whole book: Noam calls this the Rich vs King tradeoff, and it's a remarkable finding. On average, the founders who keep the most control over their company make the least amount of money. As with any data-based result, this raises more questions than it answers. For example, most entrepreneurs know that the most successful entrepreneurs - from Bill Gates to Jeff Bezos - kept tight control over their companies. We therefore seek to emulate their approach, to our own detriment, because we're often emulating the wrong things. Having the real facts helps us ask better questions. We should be asking not "how much control did Bill Gates seek?" but rather "what else is exceptional about his decisions that allowed him to escape the more common fate?" If you're interested in answering questions like this, read on. I was lucky enough to get to read a version of the book when it was still in draft form. Now that the final version has come out, I'm excited to share a bit of it with you. At the time, I was asked to give an official endorsement of the book. Here's what I said:  "If you're starting a new company, you probably already know that a crazy variety of landmines await you. What if you had a map that showed exactly where they are and how to avoid them? Having seen these dilemmas derail countless startups, I wish every entrepreneur and prospective founder would read this book." - Eric The following is an exclusive excerpt which sets up a common pitfall regarding equity splits. In Noam’s dataset, 73% of founding teams split equity within a month of founding, a striking number given the big uncertainties early in the life of any startup. The majority of those teams set the equity in stone by failing to allow for future adjustments to equity stakes if there are major changes within the team or the startup. After this excerpt, the book outlines specific solutions that help founders avoid this pitfall. Setting the early equity split in stone is one of the biggest mistakes founders can make. With their confidence in their startup and themselves, their passion for their work and their mission, and their desire not to harm the fragile dynamic within the nascent founding team, cofounders tend to plan for the best that can happen. They assume that their early, high levels of commitment will last long into the future, rather than waning as the challenges of founding begin to sap their passion for the idea and for each other. They assume that no adverse events will change the composition of the team.They also tend to take a very short-term view of the factors that should affect equity splits. They assume that the tasks that they are performing during the early stage of startup development are the same tasks that will be performed during the next and very different stages. They assume that their skills will remain as valuable to the startup as they are right now. They overestimate the amount of value that they will build in the first months compared to the value they hope to build over the subsequent years, and thus overweight their past contributions compared to the future contributions that will be required of them. Each founder places more value on his or her own contributions than on the contributions of the other cofounders,knowing the cost and extent of his or own efforts in a way that he or she cannot know the cost and extent of others’ efforts. But such a best-case approach is hazardous. Uncertainties abound. At the company level, founders learn about the flaws in their initial plans and adjust the startup’s strategy, business plan,and business model. Professor Scott Shane reports that “almost half(49.6 percent) of new firm founders indicated that their business ideas [had] changed between the time they first identified them and the time when they were surveyed about them.” Such adjustments can cause major changes in the obstacles that the startup faces, the skills needed to address those obstacles, and thus the roles that each founder (or perhaps a new founder or a nonfounder) will have to play in building the startup. At the individual level, as the strategy and business model shift,the skills of some founders become more important than the skills of others and roles often shift. As each founder learns about the demands of building a startup, reflects on his or her motivations,and sees how well his or her abilities address the startup’s needs, his or her commitment to the startup may change. The founders also come to understand each other’s abilities and commitment at a far deeper level than was possible at the beginning. Yet founders tend to overestimate how much value they will build during those early days, which can cause even bigger problems when a cofounder’scontributions wane later on. A founder’s personal life may also affect his or her commitment and contributions. At Ockham Technologies, all of the founders were aware of the imminent arrival of idea-person Ken’s first child. However, even Ken was unsure how this would affect his willingness to quit his full-time job and focus on building Ockham.Extreme and unexpected health problems can catch all parties by surprise. For instance, while Microsoft was still a private company, cofounder Paul Allen was diagnosed with Hodgkin’s lymphoma,which caused him to quit the company, leaving Bill Gates as the sole active founder during the crucial three years before it became a public company. In such ways, even the most comfortable equity split can be thrown into disarray. For instance, when Robin Chase and her partner, Antje, founded the car-sharing startup Zipcar, they agreed with a quick handshake to split the equity 50–50. The team believed it had avoided destructive tension over the equity split and could now focus on building the startup. “We shook across the table,50–50,” Robin recalls, “and I thought ‘great.’” Robin had heard about other teams that had faltered because of tough equity-split negotiations, and she breathed a sigh of relief that she and Antjehad avoided such problems. Robin poured her heart and soul into the startup, making major contributions to its growth, and was fully expecting Antje to do the same. Antje, however, remained at her full-time job and, by the summer, was expecting her second child. Robin wondered when her partner would be able to become more involved, but, in the end, Antje never joined full-time. Knowing that Antje still owned the same percentage as she did ate away at Robin, who later reflected, “That was a really stupid handshake, because who knows what skill sets and what milestones and what achievements are going to be valuable as you move ahead. That first handshake caused a huge amount of angst over the next year and a half.” Eventually Antje left the company altogether while continuing as a shareholder. The cost to fix such problems can be very high, ranging from Robin Chase’s “angst” to more tangible financial costs. At govWorks.com, founders Kaleil and Tom had a cofounder, Chieh,who put up $19,000, worked “after hours” for five months (he had kept his day job instead of joining govWorks full-time), and then dropped out. When the remaining cofounders were about to close their first round of financing, their potential funder, Mayfield, was not willing to close until Kaleil and Tom bought Chieh out and reclaimed his equity. The VCs were willing to do a $410,000 “sweetheart deal” to facilitate the buyout. However, Chieh wanted $800,000. Amid the pressure to close the round, Kaleiland Tom ended up settling with Chieh for $700,000, making up the $290,000 out of their own pockets. Kaleil felt he was “beingextorted.” Although the risks of this kind of outcome are real,teams often fail to address them proactively. In my dataset, half of the teams had neglected to include any dynamic elements (vesting, buyout terms, and the like) in their equity agreements, sentencing themselves to the same risks faced by the Zipcar and govWorks.com teams.      How should founders deal with such developments? In short, by assuming when they do the initial split that things will change, even if the specific changes cannot be foreseen, and therefore structuring a dynamic equity split rather than the static splits used at Zipcar, govWorks, and many other startups. As important as it is to get the initial equity split right—by matching it as closely as possible thefounders’ past contributions, opportunity costs, future contributions, and motivations—it is equally important to keep it right; that is, to be able to adjust the split as circumstances change. Copyright © 2012 by Princeton University Press. Reprinted by permission.

This is part of an ongoing startup advice series where I answer (anonymized!) questions from readers, like a written version of Smart Bear Live. To get your question answered, email me at asmartbear -at- shortmail -dot- com.

Employee-Investor writes:

I’ve been invited to join as startup as employee #1. They’re giving me a salary and an OK stock grant, but I want more stock.

I have $95,000 saved from a previous exit. I don’t need the money in savings because I’ve been making $150/hour as a consultant so my “plan B” is fine.

Should I invest my $95k at a $1m valuation to bring my total stock allocation into the double-digits?  Or should I keep that money as an investment in my next venture?

Since make $150/hour, you probably think that’s what you’re time is worth. And the question is: Will you get enough of a return on that $95k to be worth it?

First I need to negate your assumption. Your time is actually worth $1000/hour. Go read that linked article so you truly believe this in your gut.

Once you understand this, the decision becomes quite clear, because the $95k is actually not your primary investment. The time you invest in this company is worth far more than the $95k.

Let’s do the math.

The $1000/hour thing is based on 100% risk with no salary, which is not your situation. So let’s re-do it:

Say you’ll make $75k/year salary but you were making $150k/year as a consultant, so your nominal opportunity cost of being with this company for four years is $300k. Assuming a 15% chance of success (like in the other article), you need a potential payout of at least $300k ÷ 0.15 = $2m on a successful exit.

Assuming you’re granted something like 2% in stock, the company would need a $100m exit in four years to cover that. That sounds unlikely. Bad bet.

But now let’s consider the $95k investment which brings you up to 10% in stock. Now your total investment is $395k. (See how the $95k is only 1/4 of your true investment?) Now you need a potential payout of at least $395k ÷ 0.15 = $2.6m, but with 10% of the company that’s an exit of $26m in four years, which sounds quite reasonable.

In short, your $95k investment buys you far more equity than your time does, whereas your time is much more valuable to you than your money.

So here’s the answer to your question:

If you believe this company has a good shot, you must invest your $95k, because it’s the only logical way to make the finances work!

If you don’t think the company has a good shot, you should not “work there but save the $95k” because you’re wasting your most valuable asset — your time. You’re better off spending time with your family and making a good living, or doing just enough consulting to fund a startup where you can own a big chunk of the company.

You might argue that you’re already putting yourself at risk by working at the company, so you should save your $95k as a cushion for your family. But actually you’re still doing your family a disservice, because it’s almost impossible for you to earn back the reward on your time. You’d serve them better by making $150k/year consulting at 20 hours/week and spend all that extra time with your family. Besides, if it all fails, you can make so much as a consultant — especially if you work the same hours of a startup founder — that you can put your savings back easily.

Of course the value of working at a startup isn’t just financial. It’s more fulfilling, more exciting, more fun, and nowhere else will you learn as much about as many things. That absolutely counts, perhaps even more than the potential for making money!

Add your advice to the discussion section!

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I was up at Columbia University on thursday speaking to Steve Blank's students. Steve did a weeklong version his Lean LaunchPad class at Columbia last week. During the Q&A, a student asked me how I engaged with the startups we invest in. I answered that I planned to play paintball with two of our portfolio companies on the coming weekend. That got a chuckle from the class but it wasn't a joke. I don't think VCs should be meddling with the companies they invest in but I do think they should be engaged. And playing paintball is a good way to do that.

I like to stop by the offices of the companies we invest in and have lunch with the team. Over one of those lunches at Canv.as a few months ago, I told the team that I had been in ROTC in college and that I still had decent skills. I described a paintball game I had played with my son and his friends a few years ago. The next thing I know, Chris Poole, the founder of Canv.as emails me and tells me that he wants me on his team for a paintball throwdown with Codecademy, another USV portfolio company. How could I say no to that after bragging about my skills to the Canvas team at lunch?

So we trucked out to Staten Island yesterday morning to Cousins Paintball and spent three hours running around the woods shooting each other with paintballs. It was a blast. There are a couple photos of the event here.

I got to know everyone on both teams a lot better and got shot by most of them at least once. Chris and Zach trash talked and beefed a fair bit at the start but by the end it was all hugs.

Great day, great bonding. That's what I call engaging wtih the companies we invest in.

I was having lunch with a veteran of the entertainment and the video game business this past week. It was an interesting and wide ranging chat. One of the things we discussed that stuck in my mind was the thought that web and mobile apps might behave more like TV shows than traditional software applications.

I've watched my kids go from myspace to facebook to instagram over the past seven years. And who knows what social app will be their "go to app" in five years. This has always been the case in videogames. Farmville to Cityville to something else. Words With Friends to Draw Something to something else.

This round trip from nothing to everything to nothing again is also true at some level with many tech companies. Digtal Equipment Corporation was founded in 1957 and shuttered in 1998. RIM was founded in 1984 and in all liklihood will be gone before the end of this decade. Same with Sun Microsystems, Silicon Graphics, and many more iconic tech companies.

This concern or observation depending on where you sit has wide ranging implications for valuations, returns, and many other aspects of the startup economy. Companies are worth the net present value of their future cash flows. Said another way, if you knew that a company was going to earn $1mm a year for the next ten years and then be shut down, there is no way you'd pay more than $10mm for that company and certainly you'd pay something a bit less than that.

There are web and mobile applications that seem more immune to the "here today gone tomorrow" concern. Utilities like search, email, calendar, document store, etc feel less likely to be subject to this issue. YouTube also feels fairly secure. But purely social apps, the ones that depend on having your friends on them, seem quite vulnerable to a mass exodus. RIM's demise among my kids' generation had more to do wtih everyone leaving BBM than anything else. For as long as all of their friends were on BBM, they all wanted to be on it too.

Network effects are powerful in both directions. They can help you grow exponentially. But when they are going against you, they work just as fast. Myspace's decline was mind blowingly quick. RIM's has been as well. Who is next?

I am not writing this post to pour cold water on the internet sector. There are so many amazing things happenning right now. We are investing actively and agressively and are not the least bit bearish.

But it is important to understand the entire life cycle of what you are investing in. If you are playing a game of musical chairs, you have to know that's what you are playing. Or you will be the one left standing with nowhere to sit. And that sucks.