One of the benefits of teaching is that it forces me to get smarter. I was in New York last week with my class at Columbia University and several events made me realize that the Customer Development model needs to better describe its fit with web-based businesses.
Dancing Around the Question
Union Square Ventures was kind enough to sponsor a meetup the night before my class. In it, I got asked a question I often hear: “What if we have a web-based business that doesn’t have revenue or paying customers? What metrics do we use to see if we learned enough in Customer Discovery? And without revenue how do we know if we achieved product/market fit to exit Customer Validation?”
I gave my boilerplate answer, “I’m a product guy and I tend to invest and look at deals that have measurable revenue metrics. However the Customer Development Model and the Lean Startup work equally well for startups on the web. Dave McClure has some great metrics…” It was an honest but vaguely unsatisfying answer.
Union Square Ventures
The next morning I got to spend time with Brad Burnham, partner at Union Square Ventures talking about their investment strategy and insights about web-based businesses. Bill and his partner Fred Wilson have invested in ~30 or so companies with 27 still active.
They’re putting money into web services/business – most without early revenue. It’s an impressive portfolio. By the time the meeting was over I left wondering whether the Customer Development model would help or hinder their companies.
Eric Ries in Times Square
For any model to be useful it has to predict what happens in the real world – including the web. I realized the Customer Development model needs to be clearer in what exactly a startup is supposed to do, regardless of the business model.
What we concluded is that the Customer Development model needs an additional overlay.
Just as a reminder, the Customer Development has four simple steps: Discovery, Validation, Creation and Company Building. But it also requires you to ask a few questions about your startup before you use it.
The first question to ask is: “Does your startup have market risk or is it dominated by technical risk?” Lean Startup/Customer Development is used to find answers to the unknowns about customers and markets. Yet some startups such as Biotech don’t have market risk, instead they are dominated by technical risk. This class of startup needs to spend a decade or so proving that the product works, first in a test tube and then in FDA trials. Customer Development is unhelpful here.
The second question is: “What’s the “Market Type” of your startup? Are you entering an existing market, resegmenting an existing market, or creating an entirely new market?” Market Type affects your spending and sales ramp after you reach product/market fit. Startups who burn through their cash, usually fail by not understanding Market Type.
The third question (and the one Eric and I came up with watching the people stream by in Times Square): “What is the “Business Model” of your startup?” Your choice of Business Model affects the metrics you use in discovery and validation and the exit criteria for each step.
Web-based Business Model Exit Criteria
In a web-business model you’re looking for traffic, users, conversion, virality, etc – not revenue. Dave McClure’s AARRR metrics and Andrew Chen‘s specifics on freemium models, viral marketing, user acquisition and engagement both offer examples of exit criteria for Customer Discovery and Validation for startups on the web.
Eric and I will be working on others.