Here’s an example in a direct sales channel.

Customer Development Diagnostics over Lunch
A VC asked me to have lunch with the CEO of  a startup building cloud-based enterprise software. (Boy did I feel like Rip Van Winkle.) The board was getting nervous as the company was missing its revenue plan.

These lunches always start with the CEO looking like they had much better things to do. Before lunch even came the CEO ticked off the names of forty or so customers he talked to during the company’s first nine months and gave me a great dissertation on the day-in-the-life of his target customers and what their problems were. He went through his product feature by feature and matched them to the customer problems. He talked about how his business model would make money and how the prospects he talked to seem to agree with his assumptions.

It certainly sounded like he had done a great job of Customer Discovery.

Sales Process
Next, he took me through his sales process. They had five salespeople supported by two in marketing. (They had beta customers, using but not paying for the product.)

Over lunch the CEO told me he had stopped talking to customers since he had been tied up helping get the product out the door and his VP of Sales (a successful sales executive from a large company) had managed the sales process for the last six months. In fact, the few times he had asked to go out in the field the VP of Sales said, “Not yet, I don’t want to waste your time.”

Too Good to Be True
For the first time I started squirming in my seat. He said, “I insist on getting weekly status reports with forecasted deal size and probability of close. We have a great sales pipeline.” When I asked how close any of the deals on the forecast were to getting closed, he assured me the company’s two beta customers—well-known companies that would be marquee accounts if they closed—were imminent orders.

“How do you know this?” I asked. “Have you heard it personally from the customers?”

Now it was his turn to squirm a bit. “No, not exactly,” he replied, “but our VP of Sales assures me we will have a purchase order in the next few weeks or so.”

I put my fork down. Very few large companies write big checks to unknown startups without at least meeting the CEO. When I asked if he could draw the sales road map for these two accounts that were about to close, he admitted he didn’t know any of the details, given it was all in the VP of Sales’ head. Since we were running out of time, I said, “Your sales pipeline sounds great. In fact, it sounds too good to be true. If you really do close any of these accounts, my hat is off to you and your sales team. If, as I suspect they don’t close, do me a favor.”

“What’s that?” He asked, looking irritated.

“You need to pick up the phone and call the top five accounts on your sales pipeline. Ask them this question: if you gave them your product today for free, are they prepared to install and use it across their department and company? If the answer is no, you have absolutely no customers on your forecast who will be prepared to buy from you in the next six months.”

He smiled and stuck me with the tab for lunch. I didn’t expect to hear from him ever again.

What If the Price Were Zero?
Less than two weeks later, I got a call and was surprised to hear the agitated voice of the CEO. “Steve, our brand-name account, the one we have been working on for the last eight months, told us they weren’t going to buy the product this year. They just didn’t see the urgency.” Listening, I got the rest of the story.

“When my VP of Sales told me that,” he said, “I got on the phone and spoke to the account personally. I asked them your question—would they deploy the product in their department or company if the price were zero? I’m still stunned by the answer. They said the product wasn’t mission critical enough for their company to justify the disruption.”

“Wow, that’s not good,” I said, trying to sound sympathetic.

“It only gets worse,” he said. “Since I was hearing this from one of the accounts my VP of Sales thought was going to close, I insisted we jointly call our other ‘imminent’ account. It’s the same story as the first. Then I called the next three down the list and got essentially the same story. They all think our product is ‘interesting,’ but no one is ready to put serious money down now. I’m beginning to suspect our entire forecast is not real. What am I going to tell my board?”

My not-so-difficult advice was that he was going to have to tell his board exactly what was going on. But before he did, he needed to understand the sales situation in its entirety, and then come up with a plan for fixing it. Then he was going to present both the problem and suggested fix to his board. (You never want a board to have to tell you how to run your company. When that happens, it’s time to update your resume.)

The Phantom Sales Forecast
The implications of a phantom sales forecast meant something fundamental was broken. In talking to each of his salespeople, he discovered the sales team had no standardized sales process. Each was calling on different levels of an account and trying whatever seemed to work best. This was just a symptom of something deeper –  while they thought they understood the target customer their initial hypotheses from Customer Discovery were wrong. But no one had told the CEO.

He realized the company was going to have to start from scratch, Pivot back to Customer Discovery and find out how to develop a sales road map. He presented his plan to the board, fired the VP of Sales and kept his best salesperson and the marketing VP. Then he went home, kissed his family goodbye, and went out to the field to discover what would make a customer buy. His board wished him luck and started the clock ticking on his remaining tenure. He had six months to get and close customers.

Customer Validation
The CEO had discovered what happens when you do a good job on Customer Discovery but get too “busy” for to personally get involved in Customer Validation. It wasn’t that he didn’t need a VP of Sales, but he had entirely outsourced the Validation step to him. Until a scalable and repeatable business model is found the CEO needs to be intimately involved in the sales process.

Lessons Learned

• Ownership of Customer Validation belongs to the CEO.
• A VP of Sales can assist but the CEO needs to answer:
• Do I understand the sales process in detail?
• Is the sales process repeatable?
• Can I prove it’s repeatable? (Proof are multiple full-price orders in sufficient quantity.)
• Can we get these orders with the current product and release spec?
• Do we have a workable sales and distribution channel?
• Am I confident we can scale a profitable business?

At best I think business plan competitions are a waste of time. But until now I haven’t been able to articulate a framework of why or had a concrete suggestion of what to replace them with.

Now I do.

Business Plan Versus Business Models
Where did the idea that startups write business plans come from?  A business plan is the execution document that large companies write when planning product-line extensions where customer, market and product features are known. The plan describes the execution strategy for addressing these “knowns.”  In the early days of venture capital, investors and entrepreneurs were familiar with the format of business plans from large company and adopted it for startups. Without much thought it has been used ever since.

It turns out that’s a mistake.  A startup is not executing a series of knowns. Most startups are facing unknown customer needs, an unknown product feature set and is an organization formed to search for a repeatable and scalable business model.  That means that writing a static business plan adds no value to starting a company, as the plan does not represent the iterative nature of the search for the model. A simple way to think about it is that in a startup no business plan survives first contact with customers.

Instead of business plans I have suggested that startups use business models.

Business models are dynamic and reflect the iterative reality that startups face. Business models allow agile and opportunistic founders to keep score of the Pivots in their search for a repeatable business model.

Business Plan Competitions are Great for Schools and Bad For Students
Almost every university, region and car wash now has a business plan competition; the rules, who can participate, how large the prizes and who are the judges vary by school.

Business plan competitions perpetuate everything that is wrong about trying to make plans that were designed to be used in large companies fit startups. (One of my favorites: “Judging will include such factors as: Market opportunity, reward to risk, strategy, implementation plan, financing plan, etc.”) All of which may be true in large companies. But little of it is relevant to the chaos and uncertainty in the life of a startup.

Yet an ever increasing number of schools keep holding Business Plan competitions.  Why?

• They’re a match for the “How to write a business plan” classes that are offered.
• It makes the school appear relevant to their constituencies; students, donors, faculty, VC’s.
• Business plans are easy to grade, score and judge.
• Schools can get Venture Firms to fund prizes for the best business plan.
• Venture Firms use the contests as another source of deal flow and talent.
• There is no alternative.

The irony is that business plan competitions ought to be held for plans from large companies not for startups.

The Alternative – Business Model Competitions
I’ll offer that to be useful for startups Business Plan competitions need to turn into Business Model competitions. A Business Model competition has a radically different goal than writing a business plan.  The Business Model competition measures how well students learn how to Pivot by getting outside the building (not by writing a plan inside one.)

Each team would be judged by their business model presentation on these five steps.

1. What did you initially think your initial business model was? (initial business model hypotheses)
2. What did you build/do? (built first product, talked to users, etc.)
3. What did you learn outside the building? (parts of our feature set/business model were wrong)
4. Then what did you do? (iterated product, changed business model, etc.)
5. Repeat steps 1-4

The business model would be scored and judged based on steps 3 and 4.  And extra credit for multiple times through the loop.

For the first time we’d have a competition that closely resembled the reality that founders face, rather than a creative writing exercise.

There are now examples of business model presentations on the web. They were also at the heart of the Startup Lessons Learned conference.

——–

I’ll be happy to hand out the prizes at the first competition.  Lets call it the “Pivot Award for Excellence.”

Lessons Learned

Business plans are the wrong tool to search for a startup business model

They are best suited for large companies

Yet we have startup business plan contests

Experienced entrepreneurs know that business model iteration and validation occurs outside the building

Some school will be first to hold a contest that rewards what matters

The talk, “Why Accountants Don’t Run Startups” summarized my current thinking about startups, how and why they’re different than large companies and for good measure threw in a few thoughts about entrepreneurial education.

It was a dry run of a talk I’ll be giving at Eric Ries’ Startup Lessons Learned conference April 23 2010 in San Francisco (streaming and simulcast across the world.)  I’m a small part of what’s shaping up to be a spectacular conference and an all-star cast.

The talk is below.

Update: I’ve updated the slides to the latest version of the talk. The original can still be found here.

At a board meeting last week I watched as the young startup CEO delivered bad news. “Our current plan isn’t working. We can’t scale the company. Each sale requires us to handhold the customer and takes way too long to close.  But I think I know how to fix it.” He took a deep breath, looked around the boardroom table and then proceeded to outline a radical reconfiguration of the product line (repackaging the products rather than reengineering them) and a change in sales strategy, focusing on a different customer segment. Some of the junior investors blew a gasket. “We invested in the plan you sold us on.” A few investors suggested he add new product features, others suggested firing the VP of Sales. I noticed that through all of this, the lead VC just sat back and listened.

Finally, when everyone else had their turn, the grey-haired VC turned to the founder and said, “If you do what we tell you to do and fail, we’ll fire you. And if you do what you think is right and you fail, we may also fire you. But at least you’d be executing your plan not ours. Go with your gut and do what you think the market is telling you.  That’s why we invested in you.”  He turned to the other VC’s and added, “That’s why we write the checks and entrepreneurs run the company.”

The Search for the Business Model
A startup is an organization formed to search for a repeatable and scalable business model.

Investors bet on a startup CEO to find the repeatable and scalable business model.

Unlike the stories in the popular press, entrepreneurs who build successful companies don’t get it right the first time. (That only happens after the fact when they tell the story.) The real world is much, much messier.  And a lot more interesting. Here’s what really happens.

Observe, Orient, Decide and Act
Whether they’re using a formal process to search for a business model like Customer Development or just trial and error, startup founders are intuitively goal-seeking to optimize their business model. They may draw their business model formally or they may keep the pieces in their head. In either case founders who succeed observe that something isn’t working in their current business model, orient themselves to the new facts, decide what part of their business model needs to change and then act decisively.

(A U.S. Air Force strategist, Colonel John Boyd, first described this iterative Observe, Orient, Decide and Act (OODA) loop. The Customer Development model that I write and teach about is the entrepreneur’s version of Boyds’ OODA loop.)

Pivoting the Business Model
What happens when the startup’s leader recognizes that the original business model model is not working as planned? In traditional startups this is when the VP of Sales or Marketing gets fired and the finger-pointing starts. In contrast, in a startup following the Customer Development process, this is when the founders realize that something is wrong with the business model (because revenue is not scaling.) They decide what to change and then take action to reconfigure some part(s) of their model.

The Customer Development process assumed that many of the initial assumptions about your business model would probably be wrong, so it built in a iteration loop to fix them. Eric Ries coined this business model iteration loop – the Pivot.

(One of the Pivot’s positive consequences for the startup team is realizing that a lack of scalable revenue is not the fault of Sales or Marketing or Engineering departments – and the solution is not to fire executives – it’s recognizing that there’s a problem with the assumptions in the initial business model.)

Types of Pivots
“Pivoting” is when you change a fundamental part of the business model. It can be as simple as recognizing that your product was priced incorrectly. It can be more complex if you find the your target customer or users need to change or the feature set is wrong or you need to “repackage” a monolithic product into a family of products or you chose the wrong sales channel or your customer acquisition programs were ineffective.

If you draw your business model, figuring out how to Pivot is simpler as you can diagram the options of what to change. There are lots of books to help you figure out how to get to “Plan B,” but great entrepreneurs (and their boards) recognize that this process needs to occur rapidly and continuously.

Operating in Chaos + Speed + Pivots = Success
Unlike a large profitable company, startups are constrained by their available cash. If a startup does not find a profitable and scalable business model, it will go out of business (or worse end up in the “land of the living dead” eking out breakeven revenue.)  This means CEO’s of startups are continually looking to see if they need to make a Pivot to find a better model. If they believe one is necessary, they do not hesitate to make the change. The search for a profitable and scalable business model might require a startup is make multiple pivots – some small adjustments and others major changes.

As a founder, you need to prepare yourself to think creatively and independently because more often than not, conditions on the ground will change so rapidly that your original well-thought-out business model will quickly become irrelevant.

Summary
Startups are inherently chaotic. The rapid shifts in the business model is what differentiates a startup from an established company. Pivots are the essence of entrepreneurship and the key to startup success. If you can’t pivot or pivot quickly, chances are you will fail.

Pivot.

Lessons Learned

A startup is an organization formed to search for a repeatable and scalable business model.

Most startup business models are initially wrong.

The process of iteration in search of the successful business model is called the Pivot.

Pivots need to happen quickly, rapidly and often.

At the seed stage, microcap funds/ superangels understand that companies are still searching for a business model – they get Pivots.

Most of the time when startups go out for Series A or B round, the VC assumption is that a scalable business model has already been found.

Pivots are why startups must be agile and opportunistic and why their cultures are different from large companies.

I was catching up with an ex-graduate student at Café Borrone, my favorite coffee place in Menlo Park. This was the second of three “office hours” I was holding that morning for ex students. He and his co-founder were both PhD’s in applied math who believe they can make some serious inroads on next generation search. Over coffee he said, “I need some cheering up.  I think my startup is going to fail even before I get funded.” Now he had my attention. I thought his technology was was potentially a killer app. I put down my coffee and listened.

He said, “After we graduated we took our great idea, holed up in my apartment and spent months researching and writing a business plan. We even entered it in the business plan competition. When were done we followed your advice and got out of the building and started talking to potential users and customers.” Ok, I said, “What’s the problem?” He replied, “Well the customers are not acting like we predicted in our plan!  There must be something really wrong with our business. We thought we’d take our plan and go raise seed money. We can’t raise money knowing our plan is wrong.”

I said, “Congratulations, you’re not failing, you just took a three and a half month detour.”

Here’s why.

No Plan Survives First Contact With Customers
These guys had spent 4 months writing a 60-page plan with 12 pages of spreadsheets. They collected information that justified their assumptions about the problem, opportunity, market size, their solution and competitors and their team, They rolled up a 5-year sales forecast with assumptions about their revenue model, pricing, sales, marketing, customer acquisition cost, etc. Then they had a five-year P&L statement, balance sheet, cash flow and cap table. It was an exquisitely crafted plan. Finally, they took the plan and boiled it down to 15 of the prettiest slides you ever saw.

The problem was that two weeks after they got out of the building talking to potential customers and users, they realized that at least 1/2 of their key assumptions in their wonderfully well crafted plan were wrong.

Why a business plan is different than a business model
As I listened, I thought about the other startup I had met an hour earlier. They also had been hard at work for the last 3½ months. But they spent their time differently. Instead of writing a full-fledged business plan, they had focused on building and testing a business model.

A business model describes how your company creates, delivers and captures value. It’s best understood as a diagram that shows all the flows between the different parts of your company. This includes how the product gets distributed to your customers and how money flows back into your company. And it shows your company’s cost structures, how each department interacts with the others and where your company can work with other companies or partners to implement your business.

This team had spent their first two weeks laying out their hypotheses about sales, marketing, pricing, solution, competitors, etc. and put in their first-pass financial assumptions. It took just five PowerPoint slides to capture their assumptions and top line financials.

This team didn’t spend a lot of time justifying their assumptions because they knew facts would change their assumptions. Instead of writing a formal business plan they took their business model and got out of the building to gather feedback on their critical hypotheses (revenue model, pricing, sales, marketing, customer acquisition cost, etc.) They even mocked up their application and tested landing pages, keywords, customer acquisition cost and other critical assumptions. After three months they felt they had enough preliminary customer and user data to go back and write a PowerPoint presentation that summarized their findings.

This team had wanted to have coffee to chat about which of the four seed round offers they had received they should accept.

A plan is static, a model is dynamic
Entrepreneurs treat a business plan, once written as a final collection of facts. Once completed you don’t often hear about people rewriting their plan. Instead it is treated as the culmination of everything they know and believe.  It’s static.

In contrast, a business model is designed to be rapidly changed to reflect what you find outside the building in talking to customers.  It’s dynamic.

“So do you mean I should never have written a business plan?” asked the founder who had spent the time crafting the perfect plan. “On the contrary,” I said. “Business plans are quite useful. The writing exercise forces you to think through all parts of your business. Putting together the financial model forces you to think about how to build a profitable business. But you just discovered that as smart as you and your team are, there were no facts inside your apartment. Unless you have tested the assumptions in your business model first, outside the building, your business plan is just creative writing.”

(Next post: Iterating the Business Model – The Pivot.)

Lessons Learned

A startup is an organization formed to search for a repeatable and scalable business model.

There are no facts inside your building, so get outside and get some.

Draw and test the Business Model first, the Business Plan then follows.

Few if any investors read your business plan to see if they’re interested in your business

They’re a lot more interested in what you learned

For undergraduates taking multiple classes finding the time to do it well was tough. But for those with full time jobs this class was a disaster.

Too Much
The first time I taught the Fundamentals of Technology Entrepreneurship class, a quarter of the class were foreign students in a special engineering-entrepreneurship program where they took one entrepreneurship class each quarter at Stanford while working full time in technology startups in Silicon Valley. The Fundamentals of Technology Entrepreneurship was intended to be their introduction to entrepreneurship. However, working full time while simultaneously attempting to participate in a team based project and Customer Discovery outside the classroom just didn’t work. The foreign students felt overwhelmed and the full time Stanford students thought they weren’t carrying their weight (when in fact they were carrying much, much more.)

We quickly realized we needed a different class to introduce entrepreneurship to students who were already knee deep in working in a startup 24/7.

Design a New Class Around Entrepreneurial Guest Speakers
Brainstorming with Tina Seelig we came up with the idea of a survey course – an introduction to entrepreneurship built around Stanford’s Entreprenuerial Thought Leaders speakers series which brings technology speakers to campus every week. In this survey course, the students would listen to the speakers and then attend twice-weekly classes which focused on the basic concepts of a startup (demand creation, sales, partnerships, team building, financing, etc.) We’d use the lectures and guest speakers to help students new to the field understand that a startup is simply a temporary organization to search for a repeatable and profitable business model.  Then we’d have the students interact directly with entrepreneurs and industry leaders in the classroom.

The Spirit of Entrepreneurship – An Interactive Survey Class
We christened the class The Spirit of Entrepreneurship. Open to all students at Stanford it was taught as two, one-hour sessions, one held the day before the guest speaker and one immediately after each guest speaker. To prepare for each speaker, we asked students to analyze the speakers company over the weekend. (For the students who were working full-time this schedule gave them the time they needed to complete their analysis.)

This new class also appealed to a wide variety of non-engineering Stanford students. In addition to the overseas work/study students I found myself teaching history majors, English majors, education majors, et al who were interested in getting their toes wet but weren’t sure they wanted to commit to the hardcore Fundamentals of Technology Entrepreneurship course.

Each week the students had to submit a two-page analysis of the presenting company’s business model, distribution channels, demand creation activities, and engineering. As some of the companies were already large, the students had to find out how the founders discovered their business model, built their team and got funded.

Since I did not select the guest speakers, the course turned into a continual improv session as I tried to match my lectures to the unpredictable variety of industries (biotech, enterprise software, video games, media, web 2.0, etc.) and different life cycle stages of the guest speakers’ companies (startup to 20+billion.)

Guest Speakers
The students saw the guests speak before a live-audience of several hundred of their fellow Stanford students.  (The videos of these speakers are edited, indexed and available as 1600 free videos and podcasts as part of Stanford’s E-Corner, on-line here.)

The heart of the class and its improvisational nature came when every speaker agreed to walk over to our classroom and sit and chat with our class one-on-one for an hour. I would interview them for the first 20 minutes or so and then turn the questioning over to the class. This personal first-hand interaction with entrepreneurs created lots of opportunity for insights. For example, hearing David Heinemeir Hannson of 37Signals talk about why his company will never get “big” and then have Steve Case of AOL/TimeWarner talk the next week about why his did helped students understand that there is no “right answer”. Similarly having the students question Trip Adler from Scribd one week about why posting documents on-line is the future and hearing from Rashmi Sinha and Jonathan Boutelle of Slideshare the next week remind us that it’s all about PowerPoints, vividly demonstrated that entrepreneurs can interpret the same market in very different ways.

Dinners
I spent quite a few dinners with my students in this class. The Stanford students were curious whether startups were for them and we talked about whether entreprenuers are born or can be made (the nature versus nurture debate.) The overseas students were trying to make sense of Silicon Valley, its work ethic and how its entrepreneurial culture would fit back home. In Silicon Valley we take for granted that someone who failed in their previous company is considered an “experienced entrepreneur.”  I was reminded that in other cultures and countries the consequences of failure are much less benign.

Lessons Learned

Entrepreneurship is an art not a science.

Entrepreneurship is driven by people as well as business models.

Entrepreneurship only thrives in a culture that does not penalize risk-taking or failure.

There is no “right path” to success

——————-

In my last post I described my approach to one of the three classes I teach at Stanford in the engineering school: Fundamentals of Technology Entrepreneurship.  The key things I want students to take from the class are:

• Understand that a startup is a temporary organization designed to search for a profitable business model
• Learn how to put together a business model, not a business plan
• Understand that a business model is only a series of hypotheses that need to be validated outside the building

Class Logistics
As described in the previous post, this is a hands-on class. The 55 students formed 11 teams, and each team had to come up with an original idea, size the opportunity, propose a Business Model, get out of the building and test their hypotheses and analyze and explain each of the parts of their model.

The class wouldn’t have been possible without lots of hands other than mine.

Teaching Team
Having a teaching partner makes life a lot easier and the class improves. A partner allows me the flexibility to miss a session or two (my job as a California Coastal Commissioner meets three days every month up and down the coast of California.)  But the best benefit is bringing a second set of eyeballs to the curriculum which always makes it better.

This was the year I finally got the “business model versus business plan” concept nailed down. In previous classes I had experimented with moving away from the traditional focus on writing a business plan to a hands-on approach to building a business model.

But it wasn’t until Ann Miura-Ko joined me as a teaching partner that this “teach the model not the plan” idea jelled. Ann who had been my Teaching Assistant while she had finished her PhD at Stanford felt the same frustration about teaching entrepreneurs to assemble a business plan that we knew in the real world wouldn’t survive first contact with customers. After Stanford, Ann joined Mike Maples’ Venture Capital firm Floodgate as a partner. Over the summer we had both been impressed with Alexander Osterwalder’s Business Model Template work. At first we thought of adopting his template for the class, but found that an even more simplified version of a canonical business model that Ann developed worked better.

Teaching Assistants
Teaching at both Stanford and Berkeley I get to see the difference between the resources in a private university and those of a state university. (For the first 5 years at Berkeley, I taught 60 students by myself with no teaching partner or teaching assistant.) As the Stanford entrepreneurship program for the engineering school sits in the Management Science and Engineering Department, most of our TA’s are students in the MS&E PhD program. For this class Daisy Chung and David Hutton were our Teaching Assistants (TA’s.) TA’s make managing 60 students working on cases and team projects manageable.
They set up and keep the class web site updated.  They provide logistical support for guest speakers. They answer enumerable emails about logistics as well as substantive questions about class content. In addition to Ann and my office hours, Daisy and David held their own office hours to provide student support.

Most importantly, while Ann I reviewed all the grades, the TA’s managed the logistics of grading: grading the homework (in this class the case study summaries) and the business model written summary, keeping track of class participation and rolling up all the grades from the formal presentation. And they gave us feedback after each class session letting us know if we were particularly incoherent and kept us abreast of the usual student and team dynamics/crisis.

Finally our TA’s managed the mentors we had supporting the students.

Mentors
One part of Silicon Valley culture that doesn’t get enough credit is the generosity of entrepreneurs and VC’s who are willing to share their time with students. Ann and I recruited VC’s and entrepreneurs to be mentors for each team. (We’ve never had a problem in getting help for these classes.) Typically we have a mix of new mentors and those who have volunteered their time before.)  I wrote a handbook for the mentors to explain their roles (here.)

Essentially mentors support and coach each team. They typically met once or twice in person with the team, help them network outside the building, answer emails, provide critiques, etc. On average, mentors spent about 6 to 8 hours of time over the quarter with students. Some even came into to class to cheer on their team for their final business model presentations.

Guest Speakers
Two important things I learned early on in teaching are: 1) regardless of how good you are, students get sick of hearing you drone on week after week, and 2) hearing a guest make a point you’ve been trying to get across often makes it stick.  So we tried to break up our lectures with guest speakers.

Ideally we attempt to match the guests with the case or class session subject. For example, when we taught the value of getting out of the building and agile development, we had Eric Ries talk about the Lean Startup. When we covered partnerships with the WebTV case, we had Spencer Tall who negotiated the deal with Sony for WebTV come in and explain to the class what really happened. (Ann also kept me in the 21st century by making sure we had several woman entrepreneurs as guest speakers.)

Results
In the last decade, entrepreneurship has become faddish, particularly in college. It’s now “cool” to be an entrepreneur, and every school wants some type of entrepreneurship course. While that’s gratifying, the fact is that most people are ill suited to survive in the wild as founders or early employees.

I taught this introductory undergraduate class without many compromises. If you want to know what being an entrepreneur is going to be like you didn’t get to sit in a classroom listening to lectures for a quarter and then write a business plan. (I also teach a less intense introduction class for engineers called the Spirit of Entrepreneurship and the Customer Development Class at Berkeley which I’ll describe in a future post.) I actually hoped that some students who were curious about entrepreneurship would discover that it is definitely not for them. Better to find it out in a classroom than as a career choice.

While that did happen to a few (some are still in shock that I “cold-call” in class, others can’t handle the team dynamics or complain that there is no “right” answer, or were disoriented that the mentors, professors and customers all had different answers) the class seems to have had the opposite effect on an interesting segment.

Sometimes you get emails like this at the end of class:

“Just want to say thank you for the “big ideas” you brought to us. Thanks to your class, I have been thinking thoroughly about my future career and have decided that I would become an entrepreneur rather than anything else. Actually I made up my mind just on my plane to my final round of interview with the Boston Consulting Group. I flew there and told the partner that I would become an entrepreneur instead.”

Oh, oh.

——–

Coming Soon
In the fall Ann and I are going to develop a new graduate-level class for Stanford that will take this one to the next level. Students will not only have to assemble a team, come up with the idea and leave the classroom to test the business model – they’ll need to come back with real customer orders.  (And if it’s a web-based product, they’ll have to build it.)

I wonder if we can fill the class.

———–

A few more of the final class presentations are here (click on the thumbnails to enlarge):

One last presentation here:

The class which was authored by Tom Byers, is offered every quarter and taught by four different professors.  But thanks to Tom, we all get to teach it with a slightly emphasis.

I taught the class this semester with Ann Miura-Ko a partner at Maples Investments.

Teaching Goals
Our goal is to teach students the key concepts of the startup process and help them understand that a startup is a search for a profitable business model.  We did this with twice weekly lectures and seven case studies. Most importantly we tied the lectures to a hands-on team project. Students formed 5-person teams, came up with a business idea then got out of the building to validate their business model. (And learn how to pivot their model as reality intrudes.)

Our goal was not to teach the students to write a business plan nor were we trying to teach them how to give a pitch to VC’s.

A Startup is a Search For A Business Model
As I’ve described in previous posts; a startup is an organization formed to search for a repeatable and scalable business model.

A business model describes how your company creates, delivers and captures value. It’s best understood as a diagram that shows all the flows between the different parts of your company.  This includes how the product gets distributed to your customers and how money flows back into your company.  And it shows your company’s cost structures, how each department interacts with the others and where your company can work with other companies or partners to implement your business.

We want to teach our students to think about how their “idea” for a business translated into a business model and then to see if that business model will survive first contact with customers.

In our class Ann and I offered the students a template of a business model diagram.  Their job was to get out of the building and transform the boxes into real data.  (I’ll show you some of their examples at the end of this post.)

Class Lectures
We had ten weeks and an hour and fifty minutes twice a week to cover the basics of a startup.

Our lectures were organized as:

• Where do ideas come from?
• How to decide whether an idea is a scalable business opportunity.
• What is a business model?
• Distribution, Demand Creation and Partnerships
• Customer Discovery
• First Team Presentation – What’s the Idea and How Large is the Opportunity
• Regulation and Intellectual Property
• Building Startup Teams
• Metrics That Matter (Business Model Metrics)
• Accounting Basics and Multi-stage Finance
• Liquidity – the End Game
• Final Team Presentation – What’s the Business Model?

Interspersed among the lectures were seven “case studies”: Chegg, IMVU, WebTV. Nanogene, Wily, Solidworks and Barbara Arenson.  Each case study was a real world example of an issue an entrepreneur might encounter as they were building a company.

Final Team Project – What’s the Business Model?
11 student teams of 5 were working outside of class on the Opportunity Assessment Project. Each team had to take an original idea, come up with the positioning and analyze the potential size of the opportunity, propose a Business Model, and analyze and explain each of the parts of their model.

Customer Discovery
Only 5 out of the 55 students had taken an entrepreneurial class before. None of the students were domain experts in their areas, and each team had to figure out how to contact potential customers and channel partners. Yet every team did figure out how to conduct extensive out of building Customer Discovery.  (By design we didn’t give them too much Customer Development theory. The emphasis was on getting out of the building and testing their hypothesis.)

Here are some examples the “out of the building” work the students did.

Presenting the Project
As their final project, each of the 11 teams had 15 minutes to present their conclusions and then later submit a written summary.  (We were equally happy if the students discovered this would not be a profitable business as we were if they found a killer idea.) The presentations were graded on:

• Did they quickly summarize their idea?
• Did they articulate the problem?
• Did they size the opportunity of solving the problem?
• Was their solution clear? (for product companies, this should include manufacturing and cost of goods)
• Did they describe demand creation and assign acquisition costs?
• Did they describe lifetime value of a customer?
• Did they describe distribution channel and assign channel costs?
• Did they get out of the building?
• Did they tell us what they learned from going out of the building?
• Did they adequately diagram the business model?
• Did they describe the risks?

Remember the goal was not a fundable pitch deck or a full business plan with pages of spreadsheets.  Rather we wanted them to start with an idea and see what it would take to build a real business (and tell us in 15 minutes).

This post and the next will have a few of the final presentations (click on the thumbnails to enlarge.)

And here was another presentation in a very different market.

Lessons Taught

• Entrepreneurship is an art not a science.
• It is best learned by a combination of theory and practice.
• No business model survives first contact with customers
• You won’t believe this until you hear customers tell you you’re wrong.
• Agility and resiliency are not tested inside the building.
• They’re essential outside.

Ash Maurya, the CEO of WiredReach, has extended my work by building a model of Customer Development for Web Startups.

I think his process models are pretty good. Go read both of his posts on Discovery and Validation for web startups. His two key slides are at the end of this post but the details on his blog are worth reviewing.

Customer Development In Context
Your startup is an organization built to search for a repeatable and scalable business model.

Your job as a founder is to quickly validate whether the model is correct by seeing if customers behave as your model predicts. Most of the time the darn customers don’t behave as you predicted.

Customer Development is the process startups use to quickly iterate and test each element of their business model. Agile Development is the way startups quickly iterate their product as they learn. A Lean Startup is Eric Ries’s description of the intersection of Customer Development, Agile Development and if available, open platforms and open source.

Diving into the Customer Development diagram inside the diagram above, we see that the first two steps, Customer Discovery and Customer Validation are all about iteration and testing of your business model.

How you actually do Customer Discovery and Validation depends on what type of business you are in. What makes sense for startups selling Enterprise Software may not work for startups on the web. Therefore you need different versions of the actual steps of Customer Development for different types of businesses.

The Customer Discovery step for Enterprise Software Startups
The first step in the Customer Development is Customer Discovery: testing your hypotheses. The flow for Customer Discovery for an enterprise software company was described in the Four Steps to the Epiphany. It looked like this:

.

The Customer Discovery step for Web Startups
Ash Maurya‘s version of the Discovery step of Customer Development for a web startup looks like this:

.

Customer Validation for Enterprise Software Startups
The next step in the Customer Development process is Customer Validation – making sure that there really is a repeatable and scalable revenue and business model before you turn up your cash burn rate.  My version of Customer Validation for an enterprise software company looked liked this:

.

Customer Validation for Web Startups
Ash Maurya‘s version of the Valdiation step of Customer Development for a web startup looks like this:

Lessons Learned

A startup is an organization built to search for a repeatable and scalable business model.

Customer Development is a technique startups use to quickly iterate and test each part of their business model.

You need different versions of the actual steps of Customer Development for different types of businesses.

This post illustrates a version of Customer Development for startups on the web.

Only 57 Questions
Yesterday I got an email from an ex-student lamenting that only 2% of their selected early testers responded to their on-line survey. The survey said in part:

The survey has 57 questions, the last three of which are open ended, and should take about 20 minutes to complete.  Please note that you must complete the entire survey once you begin.  You cannot stop along the way and have your responses to that point saved.

If it wasn’t so sad it would be funny. I called the founder and noted that there are SAT tests that are shorter than the survey. When I asked him if he actually had personally left the building and talked to these potential customers, or even had gotten them on the phone, he sounded confused.  “We’re a web startup, all our customers are on the web.  Why can’t I just get them to give me the answers I need this way?”

Continual Data Flow
Customer Development suggests that founders have continual and timely customer, channel and market information.

Founders need three views of information to truly understand what is going on:

• First-hand knowledge
• A “birds-eye” view
• The view from the eyes of customers and competitors

First-hand knowledge
First-hand knowledge is “getting outside the building” and talking to potential or actual customers. Customer Development proposes that the best way to get customer data is through personal observation and experience—getting out from behind your desk and getting up close and personal with customers, competitors, and the market.

Web startups are at real disadvantage here as founders may confuse web metrics, A/B testing and on-line surveys as the entirety of first-hand knowledge – for most web business models they are not.  In fact, this mistake can be a “going out of business” strategy.  Metrics tell you that something is happening.  A/B testing can tell you that one something is better than another. But neither can tell you why. And getting answers back from customers only with on-line surveys when you can’t watch their pupils dilate or hear the intonation of their voice is not something I’d build a business on.

Of course you need to collect metrics, do A/B testing and run online surveys. It’s just that without having founders “get outside the building”, you are missing a key point of Customer Development – the numeric data you collect may be blinding you to the fact that you’re more than likely working to optimize the wrong business model. Customer needs are non-deterministic.

“Birds-eye view”
The second picture founders need is a synthesized “birds-eye view” of the customer, market and competitive environment. You assemble this view by gathering information from a variety of sources: web sites, social media (Facebook, Twitter, blogs, et al) sales data, win/loss information, market research data (i.e. compete.com, Alexa, etc.,) competitive analyses, and so on. From this big-picture view, founders try to make sense of the shape of the market and the overall patterns in the unfolding competitive and customer situation. At the same time, they can gauge how well industry data and the actual sales match the company’s revenue and market-share expectations.

(Just remember that most market research firms are excellent at predicting the past. If they could predict the future, they’d be entrepreneurs.)

My test for how well you understand this “order of battle” is to hand the founder a marker, have them go up to the whiteboard and diagram the players in the market and where they fit. (Try it.)

See through the eyes of customers and competitors
The third view is of the action as seen through the eyes of customers and competitors. Put yourself in your customers’ and competitors’ shoes in order to deduce possible competitors’ moves and anticipate customer needs. In an existing market this is where you ask yourself, “If I were my own competitor and had its resources, what would my next move be?” In looking through the eyes of a customer, the question might be, “Why should I buy from this company versus the incumbent.” In a new or resegmented market, the questions might be “Why would more than a few early adopters use this app, web site or buy this product? How would I get my 90-year grandmother to understand and buy this product?”

Think of this technique as playing chess. You need to be looking at all the likely moves from both sides of the chessboard. What would we do if we were our competitors? How would we react? What would we be planning? After a while this type of role playing will become an integral part of everyone’s thinking and planning.

Putting it All Together
First-hand knowledge is clearly the most detailed and essential, but offers a narrow field of view. Founders who focus only on this information risk losing sight of the big picture.

The “birds-eye view” provides a view of the market but lacks the critical detail. Founders who focus only on this image risk missing the “ground truth.”

Seeing through the eyes of customers and competitors is a theoretical exercise limited by the fact that you can never be sure what your customers and competitors are up to.

The combination of all three views helps founders form an accurate picture of what is going on in their business and help them hone in on product/market fit.

Even with information from all three views, founders need to remember there will never be enough information to make a perfect decision.

Building an Information Culture
The most important element of data gathering is what to do with the information once you collect it. Customer information dissemination is a cornerstone of Lean and agile companies. This information, whether good or bad, must not be guarded like some precious commodity. Large company cultures reward executives who hoard knowledge or suppress bad news. In any of my companies, that is a firing offense.

All news, but especially bad news, needs to be shared, dissected, understood, and acted upon.

This means that understanding poor click-through rates, retention numbers and sales losses are more important than understanding sales wins; understanding why a competitor’s products are better is more important than rationalizing ways in which yours is still superior. Winning startups build a startup culture that reward not punish messengers of bad news.

Lessons Learned

Three views of information: First-hand knowledge, “birds-eye” view, view from the eyes of customers and competitors

Web startups can fall into the trap of confusing metrics, testing and surveys with Customer Interaction.

Goal is to build an information culture to help you get to product/market fit.

The Times Square Strategy discussion I had with Eric Ries, was still top of mind, so instead of my standard Customer Development lecture, I offered my thoughts on: the origin of Customer Development, where we are today, and where does Customer Development go, and how you can help get it there.

The video below was my presentation to the group.

The slides below go with the video. Just click through them as you watch the video. Extra credit if you know the back-story of slide 1 and why it’s appropriate for founders and their team.

.
……………
Thursday is Thanksgiving Day in the U.S.  I’ll have a non-entpreneuership post about family and reflection.

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.

Luckily Eric Ries was spending a few days in New York, so we sat down in the middle of Times Square and hashed this out.

What we concluded is that the Customer Development model needs an additional overlay.

Four Questions
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.

Use the Lean Startup - When There's Market Risk

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.

Business Model Affects Metrics and Exit Criteria

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.

But Cafepress’s most memorable moment was when the founders used a “Lessons Learned” VC pitch to raise their second round of funding and got an 8-digit term sheet that same afternoon.

Here’s how they did it.

Fail Fast and Cheap
Fred and Maheesh had started 9 previous companies in 6 years.  Their motto was: “Fail fast and cheap. And learn from it.” Cafepress literally started in their garage and was another set of experiments only this time it caught fire.  They couldn’t keep up with the orders.

Tell the Story of the Journey
The company got to a point where additional capital was needed to expand just to keep up with the business (a warehouse/shipping center collocated with UPS, etc.) Rather than a traditional VC pitch I suggested that they do something unconventional and tell the story of their journey in Customer Discovery and Validation.  The heart of the Cafepress presentation is the “Lessons Learned from our Customers” section. Their presentation looked like this:

• Market/Opportunity
• Lessons Learned Slide 1
• Lessons Learned Slide 2
• Lessons Learned Slide 3
• Why We’re Here

Telling the Cafepress Customer Discovery and Customer Validation story allowed Fred and Maheesh to take the VC’s on their journey year by year.

After these slides, these VC’s recognized that this company had dramatically reduced risk and built a startup that was agile, resilient and customer-centric.

The presentation didn’t have a single word about Lean Startups or Customer Development. There was no proselytizing about any particular methodology, yet the results are compelling.

The VC firm delivered a term sheet for an 8-digit second round that afternoon.

Your results may vary.

This post describes how companies using the Customer Development model can increase their credibility, valuation and probability of getting a first round of funding by presenting their results in a “Lesson Learned” venture pitch.

It should go without saying that this post is not advice, nor is it recommendation of what you should do, it’s simply my observation of how companies using Customer Development positioned themselves to successfully raise money from venture investors.

Product Development – Getting Funded as The Goal
In a traditional product development model, entrepreneurs come up with an idea or concept, write a business plan and try to get funding to bring that idea to fruition. The goal of their startup in this stage becomes “getting funded.” Entrepreneurs put together their funding presentation by extracting the key ideas from their business plan, putting them on PowerPoint/Keynote and pitching the company – until they get funded or exhausted.

What are Early Stage VC’s Really Asking?
When you are presenting to a VC there are two conversations going on – the one you are presenting and the one that investors are thinking as they are listening to your presentation. (If they’re not busy looking at their Blackberry’s/iPhone’s.)

A VC listening to your presentation is thinking, “Are you going to blow my initial investment, or are you going to make me a ton of money? Are there customers for what you are building? How many are there?  Now?  Later?” Is there a profitable business model? Can it scale?”  And finally, “Is this a team that can build this company?”

The Traditional VC Pitch
Entrepreneurs who pursue the traditional product development model don’t have customer data to answer these questions. Knowing this venture firms have come up with a canonical checklist of what they would like to see.  A typical pitch to a venture firm might cover:

• Technology/Product
• Team
• Opportunity/Market
• Customer Problem
• Business Model
• Go to Market Strategy
• Financials

Given that the traditional pitch has no hard customer metrics, (and VC’s don’t demand them,) you get funded on the basis of intangibles that vary from firm to firm: Do you fit the theme or thesis of the venture firm? Did the VC’s like your team? Do they believe you have a big enough vision and market. Did the partner have a good or bad day, etc.  Tons of advice is available on how to pitch, present and market your company.

I believe all this advice is wrong. It’s akin to putting lipstick on a pig.  The problem isn’t your pitch, it’s your fundamental assumption that you can/should get funded without having real customer and product feedback. No amount of learning how to get a VC meeting or improving your VC demo skills will fix the lack of concrete customer data. You might as well bring your lucky rabbits foot to the VC meeting.

Customer Development – Getting Funded After You Find a Repeatable Model
In contrast, if you are following a Customer Development process you have a greater chance of getting listened to, believed and funded.

Just as a refresher.  The first step in Customer Development was Customer Discovery; extracting hypotheses from the business plan and getting the founders out of the building to test the hypotheses in front of customers. Your goal was to preserve your cash while you turned these guesses into facts and searched for a repeatable and scalable sales model. Your proof that you have a business rather than a hobby comes from customer orders or users for your buggy, unfinished product with a minimum feature set.

If you’re following Customer Development you are now raising money because even with this first rev of the product you think you’ve found product/market fit and you want to scale.

What VC’s Really Want But Don’t Know How to Ask For or Get
Mike Maples at Maples Investments observes that the quality of pitches from entrepreneurs get better as you climb the “Hierarchy of Proof.”

1. On the bottom, and least convincing are statements about your “idea.”
2. Next are hypothesis – “I think customers will care about x or y “
3. Better are facts from customers – “We interviewed 30 customers with 20 questions”
4. Even better is “Customer Validation”– “We just got $50K from a customer” or “we got 100,000 users spending x minutes on our site”
5. Finally if you’re ever so lucky – “Everyone’s buying in droves and we’re here because we need money to scale and execute”

If you’ve actually been doing Customer Development at a minimum you’re at step 3 or 4.  If not, you don’t have enough data for a VC presentation.  Get out of the building, get some more customer feedback, spin your product and go back and read the book.

“Lessons Learned” – A New Type of VC Pitch
A Customer Development fundraising presentation tells the story of your journey in Customer Discovery and Validation.  While your presentation will cover some of the same ground as the traditional VC pitch, the heart of the presentation is the “Lessons Learned from our Customers” section. The overall presentation looks something like this:

• Market/Opportunity
• Team
• Lessons Learned Slide 1
• Lessons Learned Slide 2
• Lessons Learned Slide 3
• Why We’re Here

IMVU's Original VC Presentation - Will Harvey & Eric Ries

Here’s What We Thought, What We Did, What We Learned
Notice that each of the “Lessons Learned” slide has three major subheads and a graph:

• “Here’s What We Thought.”
• “Here’s What We Did.”
• “Here’s What Happened.”
• A Progress Graph

Here’s What We Thought is you describing your initial set of hypotheses. Here’s What We Did allows you to talk about building the first-pass of the products minimum feature set. Here’s What Happened is the not so surprising story of why customers didn’t react the way you thought they would. A Progress Graph on the right visually shows how far you’ve come (in whatever units of goodness you’re tracking – revenue, units, users, etc.)

Telling the Customer Discovery and Customer Validation story this way allows you to take VC’s on your journey through all the learning and discovery you’ve done. After three of these slides, smart VC’s will recognize that by iterating on your assumptions you have dramatically reduced risk– on your nickel, not theirs.  They will realize that you have built a startup that’s agile, resilient and customer-centric.

Your presentation doesn’t have a single word about Lean Startups or Customer Development. There is no proselytizing about any particular methodology, yet the results are compelling.

This is a radical departure from a traditional VC pitch. It will blow the minds of 70-80% of investors.  The others will throw you out of their office.

Guaranteed Funding – Not
Will this type of presentation guarantee you funding? Of course not. Even if you have the worlds best Lessons Learned slides you might find out that your particular market (i.e. consumer Internet) might have a really, really high bar of achievement for funding.

In fact, just trying to put three Lessons Learned slides together showing tangible progress will make most startups realize how hard really doing Customer Development is.

Try it.

For those of you who have been following the discussion, a Lean Startup is Eric Ries’s description of the intersection of Customer Development, Agile Development and if available, open platforms and open source.

Lean Startups aren’t Cheap Startups
A Lean Startup is not about the total amount of money you may spend over the life of your startup. It is about when in the life of your company you do the spending.

Over its lifetime a Lean Startup may spend less money than a traditional startup. It may end up spending the same amount of money as a traditional startup. And I can even imagine cases where it might burn more cash than a traditional startup.

Lets see why.

The Price of Mistakes are Inversely Proportional to Available Capital
In times of abundant venture capital if you miss your revenue plan, additional funding from your investors is usually available to cover your mistakes – i.e. you get “do-overs” or iterations without onerous penalties (assuming your investors still believe in the technology and vision.) In times when venture capital is hard to get, investors extract high costs for failure (down-rounds, cram downs, new management teams, shut down the company.)

The key contributors to an out-of-control burn rate is 1) hiring a sales force too early, 2) turning on the demand creation activities too early, 3) developing something other than the minimum feature set for first customer ship. Sales people cost money, and when they’re not bringing in revenue, their wandering in the woods is time consuming, cash-draining and demoralizing. Marketing demand creation programs (Search Engine Marketing, Public Relations, Advertising, Lead Generation, Trade Shows, etc.) are all expensive and potentially fatal distractions if done before you have found product/market fit and a repeatable sales model. And most startup code and features end up on the floor as customers never really wanted them.

Therefore when money is hard to come by, entrepreneurs (and their investors) look for ways to reduce cash burn rate and increase the chance of finding product/market fit before waste you bunch of money. The Customer Development process (and the Lean Startup) is one way to do that.

Repeatable and Scalable Sales Model
In Customer Development your goal is not to avoid spending money but to preserve your cash as you search for a repeatable and scalable sales model and then spend like there is no tomorrow when you find one.

This is the most important sentence in this post and worth deconstructing.

• Preserve your cash: When you have unlimited cash (internet bubbles, frothy venture climate,) you can iterate on your mistakes by burning more dollars. When money is tight, when there aren’t dollars to redo mistakes, you look for processes that allow you to minimize waste. The Customer Development process says preserve your cash by not hiring anyone in sales and marketing until the founders turn hypotheses into facts and you have found product/market fit.

• As you search: Customer Development observes that when you start your company, all you and your business plan have are hypotheses, not facts –and that the founders are the ones who need to get out of the building to turn these hypotheses into customer data. This “get out of the building” activity is the Customer Discovery step of the Customer Development Model.

Customer Development Model

• Repeatable: Startups may get orders that come from board members’ customer relationships or heroic, single-shot efforts of the CEO. These are great, but they are not repeatable by a sales organization. What you are searching for is not the one-off revenue hits but rather a repeatable pattern that can be replicated by a sales organization selling off a pricelist or by customers coming to your web site.

• Scalable: The goal is not to get one customer but many – and to get those customers so each additional customer adds incremental revenue and profit. The test is: If you add one more sales person or spend more marketing dollars, does your sales revenue go up by more than your expenses?

• Sales model A sales model answers the basic questions involved in selling your product: “Is this a revenue play or a freemium model going for users? Something else? Who’s the customer? Who influences a sale? Who recommends a sale? Who is the decision maker? Who is the economic buyer? Where is the budget for purchasing the type of product you’re selling? What’s the customer acquisition cost? What’s the lead and/or traffic generation strategy? How long does an average sale take from beginning to end? Etc.”
  Finding out whether you have a repeatable, scalable sales model is the Customer Validation step of Customer Development. This is the most important phase in customer development. Have you learned how to sell your product to a target customer? Can you do this without running out of money?

• Scale like there is no tomorrow The goal of an investor-backed startup is not to build a lifestyle business. The goal is to reach venture-scale (~10x return on investment.) When you and your board agree you’ve found a repeatable and scalable sales model (i.e. have product/market fit,) then you invest the dollars to create end user demand and drive those customers into your sales channel.

If you confuse Lean with Cheap when you do find a repeatable and scalable sales model, you will starve your company for resources needed to scale. Customer Development (and Lean) is about continuous customer contact/iteration to find the right time for execution.

The Customer Development Venture Pitch
At this point I often hear entrepreneurs say, “We don’t have the money to scale. We’ve been running on small investments from friends and family or angels. How do we raise the big bucks?”

How to raise real money with a Customer Development presentation in the next post.

Most startups lack a process for discovering their markets, locating their first customers, validating their assumptions, and growing their business. A few successful ones do all these things. The difference is that the ones that succeed invent a Customer Development model. This post describes such a model.

The Customer Development Model
Customer Development is designed to solve the problems of the Product Development model I described in the four previous posts.  Its strength is its rigor and flexibility. The Customer Development model delineates all the customer-related activities in the early stage of a company into their own processes and groups them into four easy-to-understand steps: Customer Discovery, Customer Validation, Customer Creation, and Company Building. These steps mesh seamlessly and support a startup’s ongoing product development activities. Each step results in specific deliverables.

The Customer Development model is not a replacement for the Product Development model, but rather a companion to it.  As its name should communicate, the Customer Development model focuses on developing customers for the product or service your startup is building.

The Customer Development Model

Four Steps
While startups are inherently chaotic (and will never be run from a spreadsheet or checklist inside your building,) the Four Steps of Customer Development are designed to help entrepreneurs leverage the chaos and turn it into actionable data;

• Customer Discovery focuses on testing hypotheses and understanding customer problems and needs – in front of customers – by the founders
• Customer Validation is where you develop a sales model that can be replicated and scaled
• Customer Creation is creating and driving end user demand to scale sales
• Company Building transitions the organization from one designed for learning and discovery to a well-oiled machine engineered for execution.

Market Type
Integral to the Customer Development model is the notion that Market Type choices affect the way the company will deploy its sales, marketing and financial resources. Market Type changes how you evaluate customer needs, customer adoption rate, how the customer understands his needs and how you should position the product to the customer, etc. As a result different market types modify what you do in in each step of Customer Development.

Customer Development is Iterative
Learning and discovery versus linear execution is a major difference between this model and the traditional product development model. While the product development model is linear in one direction, the customer development model is a circular track with recursive arrows.The circles and arrows highlight the fact that each step in Customer Development is iterative. That’s a polite way of saying, “Unlike product development, finding the right customers and market is unpredictable, and we will screw it up several times before we get it right.” (Only in business school case studies does progress with customers happen in a nice linear fashion.) The nature of finding a market and customers guarantees that you will get it wrong several times.

The Customer Development model assumes that it will take several iterations of each of the four steps until you get it right. It’s worth pondering this point for a moment because this philosophy of “It’s OK to screw it up if you plan to learn from it”  is the heart of the methodology.

The Facts Reside Outside Your Building
Customer Development starts by testing your hypotheses outside the building. Not in planning meetings, not in writing multiple pages of nicely formatted Marketing Requirements Documents, but by getting laughed at, ignored, thrown out and educated by potential customers as you listen to their needs and test the fundamental hypotheses of your business.

Failure Is an Option
Notice that the circle labeled Customer Validation in the diagram has an additional iterative loop going back to Customer Discovery. As you’ll see later, Customer Validation is a key checkpoint in understanding whether you have a product that customers want to buy and a road map of how to sell it. If you can’t find enough paying customers in the Customer Validation step, the model returns you to Customer Discovery to rediscover what you failed to hear or understand the first time through the loop.

Customer Development is Low Burn by Design
The Customer Development process keeps a startup at a low cash burn rate until the company has validated its business model by finding paying customers. In the first two steps of Customer Development, even an infinite amount of cash is useless because it can only obscure whether you have found a market. (Having raised lots of money tempts you to give products away, steeply discount to buy early business, etc., all while saying “we’ll make it up later.”  It rarely happens that way.) Since the Customer Development model assumes that most startups cycle through these first two steps at least twice, it allows a well-managed company to carefully estimate and frugally husband its cash. The company doesn’t build its non-product development teams (sales, marketing, business development) until it has proof in hand (a tested sales road map and valid purchase orders) that it has a business worth building. Once that proof is obtained, the company can go through the last two steps of Customer Creation and Company Building to capitalize on the opportunity it has found and validated.

Customer Development is For Winners and Warriors
The interesting thing about the Customer Development model is that the process represents the best practices of winning startups. Describe this model to entrepreneurs who have taken their companies all the way to a large profitable business, and you’ll get heads nodding in recognition. It’s just that until now, no one has ever explicitly mapped their journey to success.

Even more surprising, while the Customer Development model may sound like a new idea for entrepreneurs, it shares many features with a U.S. war fighting strategy known as the “OODA Loop” articulated by John Boyd and adopted by the U.S. armed forces in both Gulf Wars – and by others.

The next post provides more details about each of the four steps in the Customer Development model.

13. Not All Startups Are Alike
There’s an urban legend that Eskimos-Aleuts have more words to describe snow than other cultures. While that’s not true, it is a fact that entrepreneurs only have one word for “startup.”  This post points out that the lack of adequate words to describe very different “types” of startups can lead not only to confusion in execution but also at times to disaster.

The product development model treats all startups like they are in an Existing Market – an established market with known customers. With that implicit assumption, startups hire a VP of Sales with a great rolodex and call on established mainstream companies while marketing creates a brand and buzz to create demand and drive it into the sales channel (web, direct salesforce, etc.)

Most startups following the Product Development Model never achieve their revenue plan and burn through a ton of cash not knowing what hit them.

They never understood Market Type.

Why does Market Type matter?
Depending on the type of market it enters, a startup can have very different rates of customer adoption and acceptance and their sales and marketing strategies would be dramatically different. Even more serious, startups can have radically different cash needs.  A startup in a New Market (enabling customers to do something they never could before,) might be unprofitable for 5 or more years, (hopefully with the traditional hockey stick revenue curve,) while one in an Existing Market might be generating cash in 12-18 months.

Handspring in a Existing Market
As an example, imagine it’s October 1999 and you are Donna Dubinsky the CEO of a feisty new startup, Handspring, entering the billion dollar Personal Digital Assistant (PDA) market.  Other companies in the 1999 PDA market were Palm, the original innovator, as well Microsoft and Hewlett Packard.  In October 1999 Donna told her VP of Sales, “In the next 12 months I want Handspring to win 10% of the Personal Digital Assistant market.”  The VP of Sales swallowed hard and turned to the VP of Marketing and said, “I need you to take end user demand away from our competitors and drive it into our sales channel.”  The VP of Marketing looked at all the other PDAs on the market and differentiated Handspring’s product by emphasizing its superior expandability and performance.  End result?  After twelve months Handspring’s revenue was $170 million.  This was possible because in 2000, Donna and Handspring were in an Existing Market.  Handspring’s customers understood what a Personal Digital Assistant was. Handspring did not have to educate them about the market. They just need to persuade customers why their new product was better than the competition – and they did it brilliantly.

Palm in a New Market
What makes this example really interesting is this: rewind the story 4 years earlier to 1996. Before Handspring, Donna and her team had founded Palm Computing, the pioneer in Personal Digital Assistants. Before Palm arrived on the scene, the Personal Digital Assistant market did not exist. (A few failed science experiments like Apple’s Newton had come and gone.) But imagine if Donna had turned to her VP of Sales at Palm in 1996 and said, “I want to get 10% of the Personal Digital Assistant market by the end of our first year.”  Her VP of Sales might had turned to the VP of Marketing and said, “I want you to drive end user demand from our competitors into our sales channel.” The VP of Marketing might have said, “Let’s tell everyone about how fast the Palm Personal Digital Assistant is and how much memory it has.”  If they had done this, there would have been zero dollars in sales.  In 1996 no potential customer had even heard of a Personal Digital Assistant.  Since no one knew what a PDA could do, there was no latent demand from end users, and emphasizing its technical features would have been irrelevant. What Palm needed to do first was to educate potential customers about what a PDA could do for them. In 1996 Palm was selling a product that allowed users to do something they couldn’t do before. In essence, Palm created a New Market. In contrast, in 2000 Handspring entered an Existing Market. (“Disruptive” and “sustaining” innovations, eloquently described by Clayton Christensen, are another way to describe new and existing Market Types.)

The lesson is that even with essentially identical products and team, Handspring would have failed if it had used the same sales and marketing strategy that Palm had used so successfully. And the converse is true; Palm would have failed, burning through all their cash, using Handspring’s strategy.  Market Type changes everything.

Market Type Changes Everything
Here’s the point. Market Type changes how you evaluate customer needs, customer adoption rate, how the customer understands his needs and how you should position the product to the customer. Market Type also affects the market size as well as how you launch the product into the market. As a result different market types require dramatically different sales and marketing strategies.

As a result, the standard product development model is not only useless, it is dangerous. It tells the finance, marketing and sales teams nothing about how to uniquely market and sell in each type of startup, nor how to predict the resources needed for success.

—–

Next: Part 5 of the Customer Development Manifesto – why your goals and those of your venture investors may not be the same –  the last post on what’s broken in the Product Development Model.

This post describes how following the traditional product development can lead to a “startup death spiral.”  In the next posts that follow, I’ll describe how this model’s failures led to the Customer Development Model – offering a new way to approach startup sales and marketing activities. Finally, I’ll write about how Eric Ries and the Lean Startup concept provided the equivalent model for product development activities inside the building and neatly integrates customer and agile development.

12. The Startup Death Spiral: The Cost of Getting Product Launch Wrong
By the time of first customer ship, if a startup does not understand its market and customers, failure unfolds in a stylized ritual, almost like a Japanese Noh play.

Three to six months after first customer ship, if Sales starts missing its numbers, the board gets concerned. The VP of Sales comes to a board meeting, still optimistic, and provides a set of reasonable explanations – “our pipeline looks great, but orders will close next quarter” or “we’ve got lots of traffic to our site, we just need to work on conversion.” The board raises a collective eyebrow. The VP of Sales goes back and exhorts the troops to work harder.

To support sales, Marketing tries to “make up a better story,” and the web site and/or product presentation slides start changing (sometimes weekly or even daily). Morale in Sales and Marketing starts to plummet.

Meanwhile, if you have a direct sales force smart salespeople realize that the sales strategy and marketing materials the company headquarters provided don’t work. Each starts inventing and testing their own alternatives about how to sell and position the product. They try different customers, different customer contacts, different versions of the presentations, etc. Instead of a Sales team and organized to sell with a consistent and successful sales roadmap generating revenue, it is a disorganized and unhappy organization burning lots of cash.

You’re Just Not Selling it Right
By the next board meeting, the VP of Sales looks down at his shoes and shuffles his feet as he reports that the revenue numbers still aren’t meeting plan. Now the board collectively raises both eyebrows and looks quizzically at the CEO. The VP of Sales, forehead bathed in sweat, leaves the board meeting and has a few heated motivational sessions with the sales team.

Fire the First VP of Sales
By the next board meeting, if the sales numbers are still poor, the stench of death is in the air.  No one wants to sit next to the VP of Sales. Other company execs are moving their chairs to the other side of the room. Having failed to deliver the numbers, he’s history. Whether it takes three board meetings or a year is irrelevant; the VP of Sales in a startup who does not make the numbers is called an ex-VP of Sales.

Now the company is in crisis mode. Not only hasn’t the sales team delivered the sales numbers, but now the CEO is sweating because the company is continuing to burn cash at what now seems like an alarming rate. Why is it only alarming now? Because the company based its headcount and expenses on the expectation that the Sales organization will bring in revenue according to plan. The rest of the organization (product development, marketing, support) has been burning cash, all according to plan, expecting Sales to make its numbers. Without the revenue to match its expenses, the company is in now danger of running out of money.

Blame it On Marketing
In the next 3-6 months, a new VP of Sales is hired. She quickly comes to the conclusion that the company’s positioning and marketing strategy were incorrect. There isn’t a sales problem, the problem is that marketing just did not understand its customers and how to create demand or position the product.

Now the VP of Marketing starts sweating. Since the new VP of Sales was brought on board to “fix” sales, the marketing department has to react and interact with someone who believes that whatever was created earlier in the company was wrong. The new VP of Sales reviews the sales strategy and tactics that did not work and comes up with a new sales plan. She gets a brief honeymoon of a few months from the CEO and the board.

In the meantime, the original VP of Marketing tries to come up with a new positioning strategy to support the new Sales VP. Typically this results in conflict, if not outright internecine warfare. If the sales aren’t fixed in a short time, the next executive to be looking for a job will not be the new VP of Sales (she hasn’t been around long enough to get fired), it’s the VP of Marketing—the rationale being “We changed the VP of Sales, so that can’t be the problem. It must be Marketing’s fault.”

Time for an Experienced CEO
Sometimes all it takes is one or two iterations to find the right sales roadmap and marketing positioning that connects a startup with exuberant customers ready to buy. Unfortunately, more often than not, this is just the beginning of an executive death spiral. If changing the sales and marketing execs doesn’t put the company on the right sales trajectory, the investors start talking the “we need the right CEO for this phase” talk. This means the CEO is walking around with an unspoken corporate death sentence. Moreover, since the first CEO was likely to have been one of the founders, the trauma of CEO removal begins. Typically, founding CEOs hold on to the doorframe of their offices as the investors try to pry their fingers off the company. It’s painful to watch and occurs in a majority of startups with first-time CEOs after First Customer Ship.

In flush economic times the company may get two or three iterations to fix a failed launch and bad sales numbers. In tougher times investors are tighter with their wallets and make the “tossing good money after bad” calculations with a more frugal eye. A startup might simply not get a next round of funding and have to shut down.

Any of this sound familiar? Part 4 of the Customer Development Manifesto to follow.

This post describes how the traditional product development model distorts startup sales, marketing and business development.  In the next few posts that follow, I’ll describe how thinking of a solution to this model’s failures led to the Customer Development Model – that offers a new way to approach startup sales and marketing activities. Finally, I’ll write about how Eric Ries and the Lean Startup concept provided the equivalent model for product development activities inside the building and neatly integrates customer and agile development.

8. The Lack of Meaningful Milestones for Sales, Marketing and Business Development
The one great thing about the product development methodology is that it provides an unambiguous structure with clearly defined milestones. The meaning of alpha test, beta test, and first customer ship are pretty obvious to most engineers. In contrast, sales and marketing activities before first customer ship are adhoc, fuzzy, and don’t have measurable, concrete objectives. They lack any way to stop and fix what’s broken (or even to know if it is broken.)

What kind of objectives would a startup want or need for sales and marketing? Most sales executives and marketers tend to focus on execution activities because at least these are measurable. For example, some startup sales execs believe hiring the core sales team is a key objective. Others focus on acquiring early “lighthouse” customers (prominent customers who will attract others.) Once the product begins to ship, startup sales execs use orders and revenue as its marker of progress in understanding customers. (Freemium models have their own scorekeeping.) Marketers believe creating a killer web presence, corporate presentation, are objectives. Some think that hiring a PR agency, starting the buzz and getting coverage in hot blogs or on  the cover of magazines at launch are objectives.

While these objectives provide an illusion of progress, in reality they do little to validate the business plan hypotheses about customers and what they will buy. They don’t help a startup move toward a deep understanding of customers and their problems, discovering a repeatable road map of how they buy, and building a financial model that results in profitability.

9. The Use of a Product Development Model to Measure Sales
Using the product development diagram for startup sales activities is like using a clock to tell the temperature. They both measure something, but not the thing you wanted.

Here’s what the product development diagram looks like from a sales perspective.

A VP of Sales looks at the diagram and says, “Hmm, if beta test is on this date, I’d better get a small sales team in place before that date to acquire my first ‘early customers.’ And if first customer ship is on this date over here, then I need to hire and staff a sales organization by then.” Why? “Well, because the revenue plan we promised the investors shows us generating customer revenue from the day of first customer ship.”

I hope this thinking already sounds inane to you. The plan calls for selling in volume the day Engineering is finished building the product. What plan says that? Why, the business plan, crafted with a set of hypotheses now using the product development model as a timeline for execution. This approach is not predicated on discovering the right market or learning whether any customers will actually shell out cash for your product. Instead you use product development to time your readiness to sell. This “ready or not, here we come” attitude means that you won’t know if the sales strategy and plan actually work until after first customer ship. What’s the consequence if your stab at a sales strategy is wrong? You’ve built a sales organization and company that’s burning cash before you know if you have demand for your product or a repeatable and scalable sales model. No wonder the half-life of a startup VP of Sales is about nine months post first customer ship.

“Build and they will come” is not a strategy, it’s a prayer.

10. The Use of a Product Development Model to Measure Marketing
The head of Marketing looks at the same product development diagram and sees something quite different.

For Marketing, first customer ship means feeding the sales pipeline with a constant stream of customer prospects. To create this demand at first customer ship, marketing activities start early in the product development process. While the product is being engineered, Marketing begins to create web sites, corporate presentations and sales materials. Implicit in these materials is the corporate and product “positioning.” Looking ahead to the product launch, the marketing group hires a public relations agency to refine the positioning and to begin generating early “buzz” about the company. The PR agency helps the company understand and influence key bloggers, social networks, industry analysts, luminaries, and references. All this leads up to a flurry of press events and interviews, all geared to the product/web site launch date. (During the Internet bubble, one more function of the marketing department was to “buy” customer loyalty with enormous advertising and promotion spending to create a brand.)

At first glance this process may look quite reasonable, until you realize all this marketing activity occurs before customers start buying—that is, before the company has had a chance to actually test the positioning, marketing strategy, or demand-creation activities in front of real customers. In fact, all the marketing plans are made in a virtual vacuum of real customer feedback and information. Of course, smart marketers have some early interaction with customers before the product ships, but if they do, it’s on their own initiative, not as part of a well-defined process. Most first-time marketers spend more of their time behind their desks inside the building then outside talking to potential customers.

This is somewhat amazing since in a startup no facts exist inside the building – only opinions.

Yet even if we get the marketing people out from behind their desks into the field, the deck is still stacked against their success. Look at the product development diagram. When does Marketing find out whether the positioning, buzz, and demand creation activities actually work? After first customer ship. The inexorable march to this date has no iterative loop that says, “If our assumptions are wrong, maybe we need to try something different.”

11. Premature Scaling
The Product Development model leads Sales and Marketing to believe that by first customer ship, come hell or high water, they need fully staffed organizations leads to another disaster: premature scaling.

Startup executives have three documents to guide their hiring and staffing; a business plan, a product development model and a revenue forecast.  All of these are execution documents – they direct the timing and hiring of spending as if all assumptions in the business plan are 100% correct. As mentioned earlier there are no milestones that alert a startup to stop or slow down hiring until you have proven until you understand you customers. Even the most experienced executives succumb to the inexorable pressure to hire and staff to “plan” regardless of the limited customer feedback they’ve collected to this point in Alpha and Beta test.

Premature scaling is the immediate cause of the startup Death Spiral.  More on this in the next post.

——————-

Part 3 of the Customer Development Manifesto to follow.

After 20 years of working in startups, I decided to take a step back and look at the product development model I had been following and see why it usually failed to provide useful guidance in activities outside the building – sales, marketing and business development.

Every startup has some methodology for product development, launch and life-cycle management. At their best, these processes provide detailed plans, checkpoints and milestones for every step in getting a product out the door: sizing markets, estimating sales, developing marketing requirements documents, prioritizing product features.  Yet at the end of the day even with all these processes 9 out of 10 of new products are failures.

So what’s wrong the product development model? The first hint lies in its name; this is a product development model, not a marketing model, not a sales hiring model, not a customer acquisition model, not even a financing model (and we’ll also find that in most cases it’s even a poor model to use to develop a product.) Yet startup companies have traditionally used this model to manage and pace not only engineering but also non-engineering activities.

In this post I’m going to describe the flaws of the product development model.  In the next few posts that follow, I’ll describe more specifically how this model distorts startup sales, marketing and business development. And how thinking of a solution to this commonly used model’s failures led to a new model – the Customer Development Model – that offers a new way to approach startup activities outside the building. Finally, I’ll write about how Eric Ries and the Lean Startup concept provided the equivalent model for product development activities inside the building and neatly integrates customer and agile development.

Product Development Diagram

1. Where Are the Customers?
To begin with, the product development model completely ignores a fundamental truth about startups and new products. The greatest risk in startups —and hence the greatest cause of failure—is not the technology risk of developing a product but in the  risk of developing customers and markets. Startups don’t fail because they lack a product; they fail because they lack customers and a profitable business model. This alone should be a pretty good clue about what’s wrong with using the product development diagram as the sole guide to what a startup needs to be doing. Look at the Product Development model and you might wonder, “Where are the customers?”

The reality for most startups today is that the product development model focuses all their attention on activities that go on inside a company’s own building. While customer input may be a checkpoint or “gate” in the process, it doesn’t drive it.

2. The Focus on a First Customer Ship Date
Using the Product Development model also forces sales and marketing to focus on the end point of the process – the first customer ship date. Most sales and marketing executives hired into a startup look at the “first customer ship date,” look at the calendar on the wall, and then work backwards figuring out how to do their job in time so that the fireworks start the day the product is launched.

The flaw in this thinking is that “first customer ship” is simply the date when engineering thinks they “finished” the 1.0 release of the product. The first customer ship date does not mean that the company understands its customers, how to market or sell to them or how to build a profitable business. (Read the preceding sentence again. It’s a big idea.)

Even worse, a startup’s investors are managing their financial milestones by the first customer ship date as well.

The product development model is so focused on building and shipping the product that it ignores the entire process of testing your basic hypothesis about your business model (customers, channel, pricing, etc.) before you ship. Not testing these hypotheses upfront is a fundamental and, in many cases, fatal error most startups make.

Why? Because it isn’t until after first customer ship that a startup discovers that their initial hypotheses were simply wrong (i.e. customers aren’t buying it, the cost of distribution is too high, etc.) As a result the young company is now saddled with an expensive, scaled-up sales organization frustrated trying to execute a losing sales strategy and a marketing organization desperately trying to create demand without a true understanding of customers’ needs.

As Marketing and Sales flail around in search of a sustainable market, the company is burning through its most precious asset—cash.

3. The Focus on Execution Versus Learning and Discovery
The product development model assumes that customers needs are known, the product features are known, and your business model is known. Given this certainty, it’s logical that a startup will hire a sales and marketing team to simply execute your business plan. You interview sales and marketing execs for prior relevant experience and their rolodexes, and hope they execute the playbook that worked for them in prior companies.

All of this is usually a bad idea.  No one asks, “Why are we executing like we know what we are doing? Where exactly did the assumptions in our startup business plan come from?”  Was the sales revenue model based on actually testing the hypotheses outside the building? Or were they a set of spreadsheets put together over late night beers to convince an investor that this is going to be a great deal?

No newly hired sales and marketing exec is going to tell a founder, “Hey my prior experience and assumptions may not actually be relevant to this new startup.” Great sales and marketing people are great at execution – that’s what you hired for. But past experience may not be relevant for your new company. A new company needs to test a series of hypothesis before it can successfully find a repeatable and scalable sales model. For startups in a new or resgemented market, these are not merely execution activities, they are learning and discovery activities that are critical to the company’s success or failure.

4. The Focus on Execution Versus Agility
The product development diagram has a linear flow from left to right. Each step happens in a logical progression that can be PERT charted with milestones and resources assigned to completing each step.

Anyone who has ever taken a new product out to a set of potential customers can tell you that the real world works nothing like that. A good day in front of customers is two steps forward and one step back. In fact, the best way to represent what happens outside the building is more like a series of recursive circles—recursive to represent the iterative nature of what actually happens in a learning and discovery environment. Information and data are gathered about customers and markets incrementally, one step at a time. Yet sometimes those steps take you in the wrong direction or down a blind alley. You find yourself calling on the wrong customers, not understanding why people will buy, not understanding what product features are important. Other times potential customers will suggest a new use for the product, new positioning or even a much better idea.

The ability to learn from those missteps, to recognize new opportunities, and to rapidly change direction is what distinguishes a successful startup from those whose names are forgotten among the vanished.

5. The Outsourcing of Founders Responsibility
The Product Development model separates founders from deeply understanding their customers and market. The responsibility for validating the founders original hypotheses is delegated to employees – the sales and marketing team.

This means the founders are isolated from directly hearing customer input – good, bad and ugly. Worse, founders really won’t understand whether customers will buy and what features are saleable until after first customer ship.

When an adroit and agile founder gets outside the building and hears for the nth time that the product is unsellable they will recognize, regroup and change direction. A process to give the founders continuous customer interaction – from day one – is essential.

6. The Focus on a Finished Product Rather than a Minimum Feature Set
The passion of an entrepreneur coupled with the product development diagram drives you to believe that all you need to do is build the product (in all its full-featured glory) and customers will come. A Waterfall development process reinforces that inanity. The reality is quite different.  Unless you are in an Existing Market, (making a better version of what customers are already buying) you’ll find that your hypothesis about what features customers want had no relationship to what they really wanted.

Most startup code ends up on the floor.

7. Investor Focus on a Broken Model
Ask VC’s why they use the Product Development model to manage a startup and you get answers like, “It’s the way my firm has always done it. Why change something that has worked so well over the last three decades?” Or, “Look at our returns, its always worked for us.” Or at times an even more honest answer, “My senior partners say this is the only way to do it.”

Some firms correctly point out that, “It’s fine if 8 out of 10 of our companies fail if the remaining two return 20x our money. That’s a better return than having 10 out of 10 companies succeed and each return 2x our money.  Therefore we don’t want startups doing anything but swinging for the fences.”

The fallacy is that the product development model is the most efficient model for new ventures swinging for the fences– this year, last year, last decade, or since the first startup met their first investor.

Venture portfolio companies don’t succeed because they used the Product Development model they succeeded in spite of using it. The fact is most successful startups abandon the product development model as soon as they encounter customers.

Today, startups using the product development model iterate and learn and discover by burning investor cash. When cash is tight, they go out of business – or they adopt a more efficient model.

—–

Part 2 of the Customer Development Manifesto to follow.