When I started working in Silicon Valley, every company bringing a new product to market used some form of the Product Development Model. Thirty years later we now realize that its one the causes of early startup failure. This series of posts is a brief explanation of how we’ve evolved from Product Development to Customer Development to the Lean Startup.
The Product Development Diagram
Emerging early in the twentieth century, this product-centric model described a process that evolved in manufacturing industries. It was adopted by the consumer packaged goods industry in the 1950s and spread to the technology business in the last quarter of the twentieth century. It has become an integral part of startup culture.
At first glance, the diagram, which illustrates the process of getting a new product into the hands of waiting customers, appears helpful and benign. Ironically, the model is a good fit when launching a new product into an existing, well-defined market where the basis of competition is understood, and its customers are known.
The irony is that few startups fit these criteria. (None of mine did.) We had no clue what our market was when we first started. Yet we used the product development model not only to manage product development, but as a road map for finding customers and to time our marketing launch and sales revenue plan. The model became a catchall tool for all schedules, plans, and budgets. Our investors used the product development diagram in our board meeting to see if we were “on plan” and “on schedule.” Everyone was using a road map that was designed for a very different location, yet they are surprised when they end up lost.
To see what’s wrong with using the product development model as a guide to building a startup, let’s first examine how the model is currently used to launch a new product. We’ll look at the model stage-by-stage.
Concept and Seed Stage
In the Concept and Seed Stage, founders capture their passion and vision for the new company and turn them into a set of key ideas, which quickly becomes a business plan, sometimes on the back of the proverbial napkin. The first thing captured and wrestled to paper is the company’s vision.
Then the product needs to be defined: What is the product or service concept? What are the features and benefits? Is it possible to build? Is further technical research needed to ensure that the product can be built?
Next, who will the customers be and where will they be found? Statistical and market research data plus potential customer interviews determine whether the ideas have merit.
After that there’s a discussion of how the product will reach the customer and the potential distribution channel. The distribution discussion leads to some conclusions about competition: who are they and how they differ. The startup develops its first positioning statement and uses this to explain the company and its benefits to venture capitalists.
The distribution discussion also leads to some assumptions about pricing. Combined with product costs, an engineering budget, and schedules, this results in a spreadsheet that faintly resembles the first financial plan in the company’s business plan. If the startup is to be backed by venture capitalists, the financial model has to be alluring as well as believable. If it’s a new division inside a larger company, forecasts talk about return on investment. in this concept and seed stage, creative writing, passion, and shoe leather combine in hopes of convincing an investor to fund the company or the new division.
In stage two, product development, everyone stops talking and starts working. The respective departments go to their virtual corners as the company begins to specialize by functions.
Engineering focuses on building the product; it designs the product, specifies the first release and hires a staff to build the product. It takes the simple box labeled “product development” and makes detailed critical path method charts, with key milestones. With that information in hand, Engineering estimates delivery dates and development costs.
Meanwhile, Marketing refines the size of the market defined in the business plan (a market is a set of companies with common attributes), and begins to target the first customers. In a well-organized startup (one with a fondness for process), the marketing folk might even run a focus group or two on the market they think they are in and prepare a Marketing Requirements Document (MRD) for Engineering. Marketing starts to build a sales demo, writes sales materials (presentations, data sheets), and hires a PR agency. In this stage, or by alpha test, the company traditionally hires a VP of Sales who begins to assemble a sales force.
In stage three, alpha/beta test, Engineering works with a small group of outside users to make sure that the product works as specified and tests it for bugs. Marketing develops a complete marketing communications plan, provides Sales with a full complement of support material, and starts the public relations bandwagon rolling. The PR agency polishes the positioning and starts contacting the long lead-time press while Marketing starts the branding activities.
Sales signs up the first beta customers (who volunteer to pay for the privilege of testing a new product), begins to build the selected distribution channel, and staffs and scales the sales organization outside the headquarters. The venture investors start measuring progress by number of orders in place by first customer ship.
Hopefully, somewhere around this point the investors are happy with the company’s product and its progress with customers, and the investors are thinking of bringing in more money. The CEO refines his or her fund-raising pitch and hits the street and the phone searching for additional capital.
Product Launch and First Customer Ship
Product launch and first customer ship is the final step in this model, and the goal the company has been driving for. With the product working (sort of), the company goes into “big bang” spending mode. Sales is heavily building and staffing a national sales organization; the sales channel has quotas and sales goals. Marketing is at its peak. The company has a large press event, and Marketing launches a series of programs to create end-user demand (trade shows, seminars, advertising, email, and so on). The board begins measuring the company’s performance on sales execution against its business plan (which typically was written a year or more earlier, when the entrepreneur was looking for initial investments).
Building the sales channel and supporting the marketing can burn a lot of cash. Assuming no early liquidity (via an IPO or merger) for the company, more fund raising is required. The CEO looks at the product launch activities and the scale-up of the sales and marketing team, and yet again goes out, palm up, to the investor community. (In the dot-com bubble economy, the investors used an IPO at product launch to take the money and run, before there was a track record of success or failure.)
The Leading Cause of Startup Death
If you’ve ever been involved in a startup, the operational model no doubt sounds familiar. It is a product-centric and process-centric model used by countless startups to take their first product to market. It used to be if you developed a plan on model that looked like this your investors would have thought you were geniuses.
In hindsight both you and your investors were idiots. Following this diagram religiously will more often than not put you out of business. The diagram was developed to be used by existing companies doing product line extensions - not startups creating new markets or resegmenting existing ones. Most experienced entrepreneurs will tell you that the model collapses at first contact with customers.
VC’s who still believe in the product development model in the 21st century offer no value in building a company other than their rolodex and/or checkbook.
Coming next Part 2: What’s Wrong with Product Development as a Model?