How Investors Make Better Decisions: The Investment Readiness Level

Investors sitting through Incubator or Accelerator demo days have three metrics to judge fledgling startups – 1) great looking product demos, 2) compelling PowerPoint slides, and 3) a world-class team.  Other than “I’ll know it when I see it”, there’s no formal way for an investor to assess project maturity or quantify risks. Other than measuring engineering progress, there’s no standard language to communicate progress.

What’s been missing for everyone is:

  1. a common language for investors to communicate objectives to startups
  2. a language corporate innovation groups can use to communicate to business units and finance
  3. data that investors, accelerators and incubators can use to inform selection

Teams can prove their competence and validate their ideas by showing investors evidence that there’s a repeatable and scalable business model. While it doesn’t eliminate great investor judgment, pattern recognition skills and mentoring, we’ve developed an Investment Readiness Level tool that fills in these missing pieces. Background about the Investment Readiness Level  here and here.

While the posts were theory I was a bit surprised when John Selep, an early-stage investor, approached me and said he was actually using the Investment Readiness Level (IRL) in practice.

Here’s John’s story.

As Selections Committee chair for our Sacramento Angels investor group, I review applications from dozens of startup entrepreneurs looking for investment.  I also mentor at our local university, and guest-lecture at a number of Entrepreneurship courses on how to pitch to investors, so the task of helping students and entrepreneurs visualize the process of investor decision-making has often been a challenge.

When I first read about the Investment Readiness Level (IRL) on Steve’s blog, I was excited by Steve’s attempt to bridge the capital-efficient Lean Startup process for founders with the capital-raising process for funders. But the ‘ah-hah!’ moment for me was the realization that I could apply the IRL framework to dramatically improve the guidance and mentorship I was providing to startup company founders .

Prior to having the Investment Readiness Level framework, this “how to get ready for an investor” discussion had been a “soft” conceptual discussion. The Investment Readiness Level makes the stages of development for the business very tangible. Achieving company milestones associated with the next level on the Investment Readiness Level framework is directly relevant to the capital-raising process.

I use the Investment Readiness Level as part of my sessions to help the students understand that being ready for investment means that besides having a pretty PowerPoint, they need to do real work and show Customer Development progress.

Since I began incorporating the Investment Readiness Level framework I’ve made three observations. The Investment Readiness Level (IRL):

  1. Ties the Lean methodology (and capital efficiency) directly to the capital-raising process – closing the loop and tying these two processes together.
  2. Is Prescriptive – offers founders a “what-you-need-to-do-next” framework to reach a higher level of readiness.
  3. Enables better mentoring. The IRL provides a vocabulary and framework for shifting the conversation between investors and entrepreneurs from simply “No”, to the much-more-helpful “Not yet – but here’s what you can do…”.

Selep IRLTying Fundraising to the Lean Startup
The premise of the Lean Startup is that a startup’s initial vision is really just a series of untested hypotheses, and that the Customer Development process is a systematic approach to ‘getting out of the building’ and testing and validating each of those hypotheses to discover a repeatable, scalable business model. The Investment Readiness Level adds to this methodology by tying each phase of this discovery process or ‘hypothesis-validation’ to milestones representing a startup’s increasing readiness for investor support and capital investment.  For investors this is a big idea.

I remind entrepreneurs that investors are implicitly seeking evidence of progress and milestones (but until the Investment Readiness Level never knew how to ask for it).  Entrepreneurs should always communicate their business’ very latest stage of customer development as part of their investor presentation. Given that a startup is continually learning weekly, the entrepreneur’s investor presentation will evolve on a weekly basis as well, reflecting their latest progress.

In our Angel investor group, our Applicant Selections process ranks applicant companies relative to the other applicants.  In the past, the ranking process relied on our Selection Committee members having an intuitive “feel” for whether a startup was worth considering for investment.

As part of our screening process, I’ve embraced the Investment Readiness Level (IRL) framework as a more-precise way to think through where applicant companies would rank. (BTW, this does not mean that the IRL framework has been embraced by rest of our Selections committee – organizational adoption is a lot more complicated than an individual adopting a framework.) I believe the IRL framework offers a more-precise method to discuss and describe ‘maturity’, and will likely become a more explicit part of our selections discussion in the year ahead.

Investment Readiness Level is Prescriptive
At first blush the Investment Readiness Level framework is a diagnostic tool – it can be used to gauge how far a business has progressed in its Customer Development process. A supposition is that startups that have validated hypotheses about key elements of their business have reduced the risks in launching their new business and are more ready for investment.

But the IRL is more than a diagnostic. It enables a much richer investor -> founder dialog about exactly what milestones a startup has actually achieved, and ties that discussion to the stages of the business’ Customer Development and business development progress.  In the same way that Osterwalder’s Business Model Canvas provides a common vocabulary and enables a rich discussion and understanding of exactly what comprises the business’ design and business model, the IRL provides a common set of metrics and enables a rich discussion and understanding of just where the startup is in the maturity of its processes.

This means the IRL is also a Prescriptive tool.  No matter where a startup is in its stage of development, the immediate next stage milestone – where the entrepreneurs should focus their attention next – is immediately clear.  Although every business is unique, and every business model emerges and evolves in its own unique way, the logical sequencing of incremental discovery and validation implicit in the IRL framework is very clear. No ambiguity. Clarity is good.

Investment Readiness Level Enables Better Mentoring
As you might imagine, our Angel group receives applications for funding from a wide, wide variety of businesses, with highly variable quality of the businesses and their applications, and highly variable levels of maturity of those businesses.  Some of our applicants are not scalable, high-growth businesses, and we tell them quickly if they don’t fit our profile. Others have the potential to be scalable, high-growth businesses, but simply aren’t as compelling or as mature as better candidates in our funnel. During every Selections cycle, as we refine our applicant funnel to select the entrepreneurs to present to our membership, I obviously have to say “No” to far more entrepreneurs than those to whom I can say “Yes”.

The Investment Readiness Level adds a new dimension to those conversations, providing a vocabulary and framework for shifting the conversation from simply ‘No’, to the much-more-helpful “Not yet – but here’s what you can do…”.  It has completely changed the nature of the conversations I have with applicants. The prescriptive nature of the IRL means that wherever a business is in its current state of development, the next step on the ladder is nearly always pretty obvious. Of course, there should always be a little latitude for the unique nature of each business, but the IRL framework is a good guidepost. So the “here’s what you can do…” recommendations are clear, logical, and situationally-relevant to the entrepreneur’s business.

I would estimate that perhaps half of the applicants we see have heard of and use some form of Lean Startup or Customer Development methodology. The idea of a “Minimum Viable Product” is something that has entered the general vernacular, but I’m sure that not all of the businesses tossing the term around truly understand the Lean Startup teachings.

So when I’m providing feedback to an entrepreneur applying to our group for funding, I leverage the IRL framework to guide the feedback that I give. I don’t refer to the framework explicitly, but I provide feedback based on where I assess the company to be in their development, and what steps they’d need to pursue to get another rung or two up the ladder.

For example, I might say “The Sacramento Angels have decided that your firm isn’t quite ready for us to consider for potential investment at this point, but if you were able to discuss your prototype with 50-to-100 potential customers and get their feedback, this might help you identify the specific segments that care most-deeply about the advantages you’re offering over the existing alternative. We’d like to stay in touch with you and hear more from you once you’ve identified your initial target segment and how you are going to reach and service them …”

I’ve almost universally found that the entrepreneurs I’m discussing these recommendations with are pleased to have the feedback, even if they’re disappointed that we may not be funding them. For an entrepreneur, receiving guidance of “Not now, but here’s what you can do…” is better than getting a flat, directionless “No”.  For me, the ability to articulate the concept of maturity, and investment readiness as a continuum, is extremely helpful. Being able to articulate that an applicant’s current stage of development, along that continuum, is not aligned with our group’s investment goals but that with further progress on their part, there may be alignment – this is a fundamentally superior message.

The Investment Readiness Level has given me the tools to engage in a consultative, coaching and mentoring conversation that provides much more value to entrepreneurs, resulting in a much more-enjoyable conversation for all involved.

Lessons Learned:

  • Investment Readiness ties capital-raising to the capital-efficient Lean Startup methodology
  • The Investment Readiness Level is Prescriptive
  • The Investment Readiness Level enables better mentoring

When Customers Make You Smarter

We talk a lot about Customer Development, but there’s nothing like seeing it in action to understand its power. Here’s what happened when an extraordinary Digital Health team gained several critical insights about their business model. The first was reducing what they thought was a five-sided market to a simpler two-sided one.

But the big payoff came when their discussions with medical device customers revealed an entirely new way to think about pricing —potentially tripling their revenue.

——

We’re into week 9 of teaching a Lean LaunchPad class for Life Sciences and Health Care (therapeutics, diagnostics, devices and digital health) at UCSF teaching with a team of veteran venture capitalists. The class has talked to ~2,200 customers to date. (Our final – not to be missed – Lessons Learned presentations are coming up December 10th.)

Among the 28 startups in the Digital Health cohort is Tidepool. They began the class believing they were selling an open data and software platform for people with Type 1 Diabetes into a multi-sided market comprised of patients, providers, device makers, app builders and researchers.

tidepool website

The Tidepool team members are:

  • Aaron Neinstein MD  Assistant Professor of Clinical Medicine, Endocrinology and Assistant Director of Informatics at UCSF. He’s an expert in the intersection between technological innovations and system improvement in healthcare. His goal is to make health information easier to access and understand.
  • Howard Look, CEO of Tidepool, was VP of Software and User Experience at TiVo. He was also VP of Software at Pixar, developing Pixar’s film-making system, and at Amazon where he ran a cloud services project. At Linden Lab, delivered the open-sourced Second Life Viewer 2.0 project. His teenage daughter has Type 1 diabetes.
  • Brandon Arbiter was a VP at FreshDirect where he built the company’s data management and analytics practices. He was diagnosed at age 27 with Type 1 Diabetes. He developed a new generation diabetes app, “nutshell,” that gives patients the information they need to make the right decisions about their dosing strategies.
  • Kent Quirk was director of engineering at Playdom and director of engineering at Linden Labs.

A Five-sided Market
In Week 1 the Tidepool team diagramed its customer segment relationships like this:

Tidepool ecosystem

Using the business model canvas they started with their value proposition hypotheses, articulating the products and services they offered for each of the five customer segments. Then they summarized what they thought would be the gain creators and pain relievers for each of these segments.

Tide pool value prop week 1

Next, they then did the same for the Customer Segment portion of the canvas. They listed the Customer Jobs to be done and the Pains and Gains they believed their Value Proposition would solve for each of their five customer segments.

Tide pool cust week 1

It’s Much Simpler
Having a multisided market with five segments is a pretty complicated business model. In some industries such as medical devices its just a fact of life. But after talking to dozens of customers by week 3, Tidepool discovered that in fact they had a much simpler business model – it was a two-sided market.

tidepool simplification

They discovered that the only thing that mattered in the first year or two of their business was building the patient-device maker relationship. Everything else was secondary. This dramatically simplified their value proposition and customer segment canvas.

So they came up with a New Week 3 Value Proposition Canvas:

Tide pool value prop week 3

And that simplified their New Week 3 Customer Segment Canvas

Tide pool cust week 3

Cost-based Pricing versus Value-based Pricing
While simplifying their customer segments was a pretty big payoff for 3 weeks into the class, the best was yet to come.

As part of the revenue streams portion of the business model canvas, each team has to diagram the payment flows.

Tide pool market pricing

The Tidepool team originally believed they were going charge their device partners “market prices” for access to their platform. They estimated their Average Revenue per User (ARPU) would be about $36 per year.

Tide pool market pricing ARPU

But by week 6 they had spoken to over 70 patients and device makers. And what they found raised their average revenue per user from $36 to $90.

When talking to device makers they learned how the device makers get, keep and grow their customers.  And they discovered that:

  • device makers were spending $500-$800 in Customer Acquisition Cost (CAC) to acquire a customer
  • device makers own customers would stay their customers for 10 years (i.e. the Customer Life Time (CLT))
  • and the Life Time Value (LTV) of one customer over those 10 years to a device maker is $10,000

Tide pool market pricing device cac

These customer conversations led the Tidepool team to further refine their understanding of the device makers’ economics.  They found out that the device makers sales and marketing teams were both spending money to acquire customers.  ($500 per sales rep per device + $800 marketing discounts offered to competitors’ customers.)

Tide pool device economics

Once they understood their device customers’ economics, they realized they could help these device companies reduce their marketing spend by moving some of those dollars to Tidepool. And they realized that the use of the Tidepool software could reduce the device companies’ customer churn rate by at least 1%.

This meant that Tidepool could price their product based on the $1,800 they were going to save their medical device customers.  Read the previous sentence again. This is a really big idea.

Tide pool value pricing big idea

The Tidepool team went from cost-based pricing to value-based pricing. Raising their average revenue per user from $36 to $90.

Tide pool value pricing $90 ARPU

There is no possible way that any team, regardless of how smart they are could figure this out from inside their building.

If you want to understand how Customer Discovery works and what it can do in the hands of a smart team, watch the video below. The team ruthlessly dissects their learning and builds value-pricing from what they learned.

This short video is a classic in Customer Discovery.

If you can’t see the video click here.

Lessons Learned

  • Most startups begin by pricing their product based on cost or competition
  • Smart startups price their product based on value to the customer
  • You can’t guess how your product is valued by customers
  • Customer Development allows you to discover the economics needed for value pricing your product

Listen to the podcast here

Download the podcast here

It’s Time to Play Moneyball: The Investment Readiness Level

Investors sitting through Incubator or Accelerator demo days have three metrics to judge fledgling startups – 1) great looking product demos, 2) compelling PowerPoint slides, and 3) a world-class team.

We think we can do better.

We now have the tools, technology and data to take incubators and accelerators to the next level. Teams can prove their competence and validate their ideas by showing investors evidence that there’s a repeatable and scalable business model. And we can offer investors metrics to play Moneyball – with the Investment Readiness Level.

Here’s how.

————–

We’ve spent the last 3 years building a methodology, classes, an accelerator and software tools and we’ve tested them on ~500 startups teams.

  • A Lean Startup methodology offers entrepreneurs a framework to focus on what’s important: Business Model Discovery. Teams use the Lean Startup toolkit: the Business Model Canvas + Customer Development process + Agile Engineering. These three tools allow startups to focus on the parts of an early stage venture that matter the most: the product, product/market fit, customer acquisition, revenue and cost model, channels and partners.

Lean moneyball

  • An Evidence-based Curriculum (currently taught in the Lean LaunchPad classes and NSF Innovation Corps accelerator). In it we emphasize that a) the data needed exists outside the building, b) teams use the scientific method of hypothesis testing c) teams keep a continual weekly cadence of:
    • Hypothesis – Here’s What We Thought
    • Experiments – Here’s What We Did
    • Data – Here’s What We Learned
    • Insights and Action – Here’s What We Are Going to Do Next

Evidence moneyball

  • LaunchPad Central software is used to track the business model canvas and customer discovery progress of each team. We can see each teams hypotheses, look at the experiments they’re running to test the hypotheses, see their customer interviews, analyze the data and watch as they iterate and pivot.

LPC

We focus on evidence and trajectory across the business model. Flashy demo days are great theater, but it’s not clear there’s a correlation between giving a great PowerPoint presentation and a two minute demo and building a successful business model. Rather than a product demo – we believe in a “Learning Demo”. We’ve found that “Lessons Learned” day showing what the teams learned along with the “metrics that matter” is a better fit than a Demo Day.

“Lessons Learned” day allows us to directly assess the ability of the team to learn, pivot and move forward. Based on the “lessons learned” we generate an Investment Readiness Level metric that we can use as part of our “go” or “no-go” decision for funding.

Some background.

NASA and the Technology Readiness Level (TRL)
In the 1970’s/80’s NASA needed a common way to describe the maturity and state of flight readiness of their technology projects.  They invented a 9-step description of how ready a technology project was.  They then mapped those 9-levels to a thermometer.NASA TRL

What’s important to note is that the TRL is imperfect. It’s subjective. It’s incomplete.  But it’s a major leap over what was being used before.  Before there was no common language to compare projects.

The TRL solved a huge problem – it was a simple and visual way to share a common understanding of technology status.  The U.S. Air Force, then the Army and then the entire U.S. Department of Defense along with the European Space Agency (ESA) all have adopted the TRL to manage their complex projects. As simple as it is, the TRL is used to manage funding and go/no decisions for complex programs worldwide.

We propose we can do the same for new ventures – provide a simple and visual way to share a common understanding of startup readiness status. We call this the Investment Readiness Level . 

The Investment Readiness Level (IRL)
The collective wisdom of venture investors (including angel investors, and venture capitalists) over the past decades has been mostly subjective. Investment decisions made on the basis of “awesome presentation”, “the demo blew us away”, or “great team” is used to measure startups. These are 20th century relics of the lack of data available from each team and the lack of comparative data across a cohort and portfolio.

Those days are over.

Hypotheses testing and data collection
We’ve instrumented our startups in our Lean LaunchPad classes and the NSF I-Corps incubator using LaunchPad Central to collect a continuous stream of data across all the teams.  Over 10 weeks each team gets out and talks to 100 customers. And they are testing hypotheses across all 9 boxes in the business model canvas.

We collect this data into a Leaderboard (shown in the figure below) giving the incubator/accelerator manager a single dashboard to see the collective progress of the cohort. Metrics visible at a glance are number of customer interviews in the current week as well as aggregate interviews, hypotheses to test, invalidated hypotheses, mentor and instructor engagements. This data gives a feel for the evidence and trajectory of the cohort as a whole and a top-level of view of each teams progress.

leaderboard moneyball

Next, we have each team update their Business Model Canvas weekly based on the 10+ customer interviews they’ve completed.

canvas updates moneyball

The canvas updates are driven by the 10+ customer interviews a week each team is doing. Teams document each and every customer interaction in a Discovery Narrative. These interactions provide feedback and validate or invalidate each hypothesis.

disovery 10 moneyball

Underlying the canvas is an Activity Map which shows the hypotheses tested and which have been validated or invalidated.

activty updates moneyball

All this data is rolled into a Scorecard, essentially a Kanban board which allows the teams to visualize the work to do, the work in progress and the work done for all nine business model canvas components.

scorecard update moneyball

Finally the software rolls all the data into an Investment Readiness Level score.

IRL

MoneyBall
At first glance this process seems ludicrous. Startup success is all about the team. Or the founder, or the product, or the market – no metrics can measure those intangibles.

Baseball used to believe that as well. Until 2002 – when the Oakland A’s’ baseball team took advantage of analytical metrics of player performance to field a team that competed successfully against much richer competitors.

Statistical analysis demonstrated that on-base percentage and slugging percentage were better indicators of offensive success, and the A’s became convinced that these qualities were cheaper to obtain on the open market than more historically valued qualities such as speed and contact. These observations often flew in the face of conventional baseball wisdom and the beliefs of many baseball scouts and executives.

By re-evaluating the strategies that produce wins on the field, the 2002 Oakland A’s spent $41 million in salary, and were competitive with the New York Yankees, who spent $125 million.

Our contention is that the Lean Startup + Evidence based Entrepreneurship + LaunchPad Central Software now allows incubators and accelerators to have a robust and consistent data set across teams. While it doesn’t eliminate great investor judgement, pattern recognitions skills and mentoring – it does provide them the option to play Moneyball.

if you can’t see the video above click here

Last September Andy Sack, Jerry Engel and I taught our first stealth class for incubator/accelerator managers who wanted to learn how to play Moneyball.

We’re offering one again this January here.

Lessons Learned

  • It’s not clear there’s a correlation between a great PowerPoint presentation and two minute demo and building a successful business
  • We now have the tools and technology to take incubators and accelerators to the next step
  • We focus on evidence and trajectory across the business model
  • The data gathered can generate an Investment Readiness Level score for each team
  • the Lean Startup + Evidence based Entrepreneurship + LaunchPad Central Software now allows incubators and accelerators to play Moneyball

Listen to the podcast here

Download the podcast here

Free Reprints of “Why the Lean Startup Changes Everything”

The Harvard Business Review is offering free reprints of  the May 2013 cover article, “Why the Lean Startup Changes Everything

Available here

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When Hell Froze Over – in the Harvard Business Review

Page 1 HBR with text

“I refuse to join any club that would have me as a member.”

Groucho Marx

In my 21 years as an entrepreneur, I would come up for air once a month to religiously read the Harvard Business Review. It was not only my secret weapon in thinking about new startup strategies, it also gave me a view of the management issues my customers were dealing with. Through HBR I discovered the work of Peter Drucker and first read about management by objective. I learned about Michael Porters’s five forces. But the eye opener for me was reading Clayton Christensen HBR article on disruption in the mid 1990’s and then reading the Innovators Dilemma. Each of these authors (along with others too numerous to mention) profoundly changed my view of management and strategy. All of this in one magazine, with no hype, just a continual stream of great ideas.

HBR Differences

For decades this revered business magazine described management techniques that were developed in and were for large corporations –  offering more efficient and creative ways to execute existing business models. As much as I loved the magazine, there was little in it for startups (or new divisions in established companies) searching for a business model. (The articles about innovation and entrepreneurship, while insightful felt like they were variants of the existing processes and techniques developed for running existing businesses.) There was nothing suggesting that startups and new ventures needed their own tools and techniques, different from those written about in HBR or taught in business schools.

To fill this gap I wrote The Four Steps to the Epiphany, a book about the Customer Development process and how it changes the way startups are built. The Four Steps drew the distinction that “startups are not smaller versions of large companies.” It defined a startup as a “temporary organization designed to search for a repeatable and scalable business model.” Today its concepts of  “minimum viable product,” “iterate and pivot”, “get out of the building,” and “no business plan survives first contact with customers,” have become part of the entrepreneurial lexicon. My new book, The Startup Owners Manual, outlined the steps of building a startup or new division inside a company in far greater detail.

HBR Cust DevIn the last decade it’s become clear that companies are facing continuous disruption from globalization, technology shifts, rapidly changing consumer tastes, etc. Business-as-usual management techniques focused on efficiency and execution are no longer a credible response. The techniques invented in what has become the Lean Startup movement are now more than ever applicable to reinventing the modern corporation. Large companies like GE, Intuit, Merck, Panasonic, and Qualcomm are leading the charge to adopt the lean approach to drive corporate innovation. And  the National Science Foundation and ARPA-E adopted it to accelerate commercialization of new science.

Today, we’ve come full circle as Lean goes mainstream. 250,0000 copies of the May issue of Harvard Business Review go in the mail to corporate and startup executives and investors worldwide. In this month’s issue, I was honored to write the cover story article, “Why the Lean Startup Changes Everything.”  The article describes Lean as the search for a repeatable and scalable business model – and business model design, customer development and agile engineering – as the way you implement it.

I’m  proud to be called the “father” of the Lean Startup Movement. But I hope at least two—if not fifty—other catalysts of the movement are every bit as proud today. Eric Ries, who took my first Customer Development class at Berkeley, had the insight that Customer Development should be paired with Agile Development. He called the combination “The Lean Startup” and wrote a great book with that name.

HBR CanvasAlexander Osterwalder‘s inspired approach to defining the business model in his book Business Model Generation provide a framework for the Customer Development and the search for facts behind the hypotheses that make up a new venture. Osterwalder’s business model canvas is the starting point for Customer Development, and the “scorecard” that monitors startups’ progress as they turn their hypotheses about what customers want into actionable facts—all before a startup or new division has spent all or most of its capital.

The Harvard Business Review is providing free access to the cover story article, “Why the Lean Startup Changes Everything.  Go read it.

Then go do it.

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Listen to the post here or download the podcast here

Nail the Customer Development Manifesto to the Wall

When Bob Dorf and I wrote the Startup Owners Manual we listed a series of Customer Development principles. I thought they might be worth enumerating here:

A Startup Is a Temporary Organization Designed to Search
for A
 Repeatable and Scalable Business Model

  1. There Are No Facts Inside Your Building, So Get Outside
  2. Pair Customer Development with Agile Development
  3. Failure is an Integral Part of the Search for the Business Model
  4. If You’re Afraid to Fail You’re Destined to Do So
  5. Iterations and Pivots are Driven by Insight
  6. Validate Your Hypotheses with Experiments
  7. Success Begins with Buy-In from Investors and Co-Founders
  8. No Business Plan Survives First Contact with Customers
  9. Not All Startups Are Alike
  10. Startup Metrics are Different from Existing Companies
  11. Agree on Market Type – It Changes Everything
  12. Fast, Fearless Decision-Making, Cycle Time, Speed and Tempo
  13. If it’s not About Passion, You’re Dead the Day You Opened your Doors
  14. Startup Titles and Functions Are Very Different from a Company’s
  15. Preserve Cash While Searching. After It’s Found, Spend
  16. Communicate and Share Learning
  17. Startups Demand Comfort with Chaos and Uncertainty
Quite a few people have asked for a way to remember these without having to dig through the book.  So by popular demand, here’s a poster of the Customer Development Manifesto.  You can order a copy here.
Nail it to your wall.

Nail the Manifesto to your Wall
Get your own Poster here: http://sblank.com/HpwmuN

Listen to the post here: Download the Podcast here

When It’s Darkest Men See the Stars

When It’s Darkest Men See the Stars
Ralph Waldo Emerson

This Thanksgiving it might seem that there’s a lot less to be thankful for. One out of ten of Americans is out of work. The common wisdom says that the chickens have all come home to roost from a disastrous series of economic decisions including outsourcing the manufacture of America’s physical goods. The United States is now a debtor nation to China and that the bill is about to come due. The pundits say the American dream is dead and this next decade will see the further decline and fall of the West and in particular of the United States.

It may be that all the doomsayers are right.

But I don’t think so.

Let me offer my prediction. There’s a chance that the common wisdom is very, very wrong. That the second decade of the 21st century may turn out to be the West’s and in particular the United States’ finest hour.

I believe that we will look back at this decade as the beginning of an economic revolution as important as the scientific revolution in the 16th century and the industrial revolution in the 18th century. We’re standing at the beginning of the entrepreneurial revolution. This doesn’t mean just more technology stuff, though we’ll get that. This is a revolution that will permanently reshape business as we know it and more importantly, change the quality of life across the entire planet for all who come after us.

There’s Something Happening Here, What It Is Ain’t Exactly Clear
The story to date is a familiar one. Over the last half a century, Silicon Valley has grown into the leading technology and innovation cluster for the United States and the world. Silicon Valley has amused us, connected (and separated us) as never before, made businesses more efficient and led to the wholesale transformation of entire industries (bookstores, video rentals, newspapers, etc.)

Wave after wave of hardware, software, biotech and cleantech products have emerged from what has become “ground zero” of entrepreneurial and startup culture. Silicon Valley emerged by the serendipitous intersection of:

  • Cold war research in microwaves and electronics at Stanford University,
  • a Stanford Dean of Engineering who encouraged startup culture over pure academic research,
  • Cold war military and intelligence funding driving microwave and military products for the defense industry in the 1950’s,
  • a single Bell Labs researcher deciding to start his semiconductor company next to Stanford in the 1950’s which led to
  • the wave of semiconductor startups in the 1960’s/70’s,
  • the emergence of venture capital as a professional industry,
  • the personal computer revolution in 1980’s,
  • the rise of the Internet in the 1990’s and finally
  • the wave of internet commerce applications in the first decade of the 21st century.

The pattern for the valley seemed to be clear. Each new wave of innovation was like punctuated equilibrium – just when you thought the wave had run its course into stasis, a sudden shift and radical change into a new family of technology emerged.

The Barriers to Entrepreneurship
While startups continued to innovate in each new wave of technology, the rate of innovation was constrained by limitations we only now can understand. Only in the last few years do we appreciate that startups in the past were constrained by:

  1. long technology development cycles (how long it takes from idea to product),
  2. the high cost of getting to first customers (how many dollars to build the product),
  3. the structure of the venture capital industry (a limited number of VC firms each needing to invest millions per startups),
  4. the expertise about how to build startups  (clustered in specific regions like Silicon Valley, Boston, New York, etc.),
  5. the failure rate of new ventures (startups had no formal rules and were a hit or miss proposition),
  6. the slow adoption rate of new technologies by the government and large companies.

The Democratization of Entrepreneurship
What’s happening is something more profound than a change in technology. What’s happening is that all the things that have been limits to startups and innovation are being removed.  At once.  Starting now.

Compressing the Product Development Cycle
In the past, the time to build a first product release was measured in months or even years as startups executed the founder’s vision of what customers wanted. This meant building every possible feature the founding team envisioned into a monolithic “release” of the product. Yet time after time, after the product shipped, startups would find that customers didn’t use or want most of the features.  The founders were simply wrong about their assumptions about customer needs. The effort that went into making all those unused features was wasted.

Today startups have begun to build products differently.  Instead of building the maximum number of features, they look to deliver a minimum feature set in the shortest period of time.  This lets them deliver a first version of the product to customers in a fraction on the time.

For products that are simply “bits” delivered over the web, a first product can be shipped in weeks rather than years.

Startups Built For Thousands Rather than Millions of Dollars
Startups traditionally required millions of dollars of funding just to get their first product to customers. A company developing software would have to buy computers and license software from other companies and hire the staff to run and maintain it. A hardware startup had to spend money building prototypes and equipping a factory to manufacture the product.

Today open source software has slashed the cost of software development from millions of dollars to thousands. For consumer hardware, no startup has to build their own factory as the costs are absorbed by offshore manufacturers.

The cost of getting the first product out the door for an Internet commerce startup has dropped by a factor of a ten or more in the last decade.

The New Structure of the Venture Capital industry
The plummeting cost of getting a first product to market (particularly for Internet startups) has shaken up the venture capital industry. Venture capital used to be a tight club clustered around formal firms located in Silicon Valley, Boston, and New York. While those firms are still there (and getting larger), the pool of money that invests risk capital in startups has expanded, and a new class of investors has emerged. New groups of VC’s, super angels, smaller than the traditional multi-hundred million dollar VC fund, can make small investments necessary to get a consumer internet startup launched. These angels make lots of early bets and double-down when early results appear. (And the results do appear years earlier then in a traditional startup.)

In addition to super angels, incubators like Y Combinator, TechStars and the 100+ plus others worldwide like them have begun to formalize seed-investing. They pay expenses in a formal 3-month program while a startup builds something impressive enough to raise money on a larger scale.

Finally, venture capital and angel investing is no longer a U.S. or Euro-centric phenomenon. Risk capital has emerged in China, India and other countries where risk taking, innovation and liquidity is encouraged, on a scale previously only seen in the U.S.

The emergence of incubators and super angels have dramatically expanded the sources of seed capital. The globalization of entrepreneurship means the worldwide pool of potential startups has increased at least ten fold since the turn of this century.

Entrepreneurship as Its Own Management Science
Over the last ten years, entrepreneurs began to understand that startups were not simply smaller versions of large companies. While companies execute business models, startups search for a business model. (Or more accurately, startups are a temporary organization designed to search for a scalable and repeatable businessmodel.)

Instead of adopting the management techniques of large companies, which too often stifle innovation in a young start up, entrepreneurs began to develop their own management tools. Using the business model / customer development / agile development solution stack, entrepreneurs first map their assumptions (their business model) and then test these hypotheses with customers outside in the field (customer development) and use an iterative and incremental development methodology (agile development) to build the product. When founders discover their assumptions are wrong, as they inevitably will, the result isn’t a crisis, it’s a learning event called a pivot — and an opportunity to change the business model.

The result, startups now have tools that speed up the search for customers, reduce time to market and slash the cost of development.

Consumer Internet Driving Innovation
In the 1950’s and ‘60’s U.S. Defense and Intelligence organizations drove the pace of innovation in Silicon Valley by providing research and development dollars to universities, and purchased weapons systems that used the valley’s first microwave and semiconductor components. In the 1970’s, 80’s and 90’s, momentum shifted to the enterprise as large businesses supported innovation in PC’s, communications hardware and enterprise software. Government and the enterprise are now followers rather than leaders. Today, it’s the consumer – specifically consumer Internet companies – that are the drivers of innovation. When the product and channel are bits, adoption by 10’s and 100’s of millions users can happen in years versus decades.

The Entrepreneurial Singularity
The barriers to entrepreneurship are not just being removed. In each case they’re being replaced by innovations that are speeding up each step, some by a factor of ten. For example, Internet commerce startups the time needed to get the first product to market has been cut by a factor of ten, the dollars needed to get the first product to market cut by a factor of ten, the number of sources of initial capital for entrepreneurs has increased by a factor of ten, etc.

And while innovation is moving at Internet speed, this won’t be limited to just internet commerce startups. It will spread to the enterprise and ultimately every other business segment.

When It’s Darkest Men See the Stars
The economic downturn in the United States has had an unexpected consequence for startups – it has created more of them. Young and old, innovators who are unemployed or underemployed now face less risk in starting a company.  They have a lot less to lose and a lot more to gain.

If we are at the cusp of a revolution as important as the scientific and industrial revolutions what does it mean? Revolutions are not obvious when they happen. When James Watt started the industrial revolution with the steam engine in 1775 no one said, “This is the day everything changes.”  When Karl Benz drove around Mannheim in 1885, no one said, “There will be 500 million of these driving around in a century.” And certainly in 1958 when Noyce and Kilby invented the integrated circuit, the idea of a quintillion (10 to the 18th) transistors being produced each year seemed ludicrous.

Yet it’s possible that we’ll look back to this decade as the beginning of our own revolution. We may remember this as the time when scientific discoveries and technological breakthroughs were integrated into the fabric of society faster than they had ever been before. When the speed of how businesses operated changed forever. As the time when we reinvented the American economy and our Gross Domestic Product began to take off and the U.S. and the world reached a level of wealth never seen before.  It may be the dawn of a new era for a new American economy built on entrepreneurship and innovation.

One that our children will look back on and marvel that when it was the darkest, we saw the stars.

Happy Thanksgiving.
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