Why Facebook is Killing Silicon Valley

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

Innovation
I teach entrepreneurship for ~50 student teams a year from engineering schools at Stanford, Berkeley, and Columbia. For the National Science Foundation Innovation Corps this year I’ll also teach ~150 teams led by professors who want to commercialize their inventions. Our extended teaching team includes venture capitalists with decades of experience.

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 Media
Facebook 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 Back
The 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 Next
It’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.

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

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9 Deadliest Start-up Sins

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.

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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.

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Why Innovation Dies

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

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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:

  • Looking good
  • Doing good for all [or at least citizens of California]
  • Doing well by our enrolled students
  • Fixing our business model to fix our budget crisis
  • Having a good football team – or at least filling the stadium
  • Attracting donations
  • Attracting faculty
  • Oh and yes – building an efficient, high quality education machine
But the minute the memo started talking about a Policy Team developing detailed implementation plans, it was all over.

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 Rooms
The “lets put together a committee” strategy fails for four 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.
My bet is that there will be more people involved in this schools Strategy Committee then in the startups that find the solution.

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

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