The Leading Cause of Startup Death – Part 1: The Product Development Diagram

When I started working in Silicon Valley, every company bringing a new product to market used some form of the Product Development Model.  Thirty years later we now realize that its one the causes of early startup failure. This series of posts is a brief explanation of how we’ve evolved from Product Development to Customer Development to the Lean Startup.

The Product Development Diagram
Emerging early in the twentieth century, this product-centric model described a process that evolved in manufacturing industries. It was adopted by the consumer packaged goods industry in the 1950s and spread to the technology business in the last quarter of the twentieth century. It has become an integral part of startup culture.

At first glance, the diagram, which illustrates the process of getting a new product into the hands of waiting customers, appears helpful and benign.  Ironically, the model is a good fit when launching a new product into an existing, well-defined market where the basis of competition is understood, and its customers are known.

The irony is that few startups fit these criteria. (None of mine did.)  We had no clue what our market was when we first started. Yet we used the product development model not only to manage product development, but as a road map for finding customers and to time our marketing launch and sales revenue plan. The model became a catchall tool for all schedules, plans, and budgets. Our investors used the product development diagram in our board meeting to see if we were “on plan” and “on schedule.” Everyone was using a road map that was designed for a very different location, yet they are surprised when they end up lost.

Product Development Diagram

Product Development Diagram

To see what’s wrong with using the product development model as a guide to building a startup, let’s first examine how the model is currently used to launch a new product. We’ll look at the model stage-by-stage.

Concept and Seed Stage
In the Concept and Seed Stage, founders capture their passion and vision for the new company and turn them into a set of key ideas, which quickly becomes a business plan, sometimes on the back of the proverbial napkin. The first thing captured and wrestled to paper is the company’s vision.

Then the product needs to be defined: What is the product or service concept? What are the features and benefits? Is it possible to build? Is further technical research needed to ensure that the product can be built?

Next, who will the customers be and where will they be found? Statistical and market research data plus potential customer interviews determine whether the ideas have merit.

After that there’s a discussion of how the product will reach the customer and the potential distribution channel. The distribution discussion leads to some conclusions about competition: who are they and how they differ. The startup develops its first positioning statement and uses this to explain the company and its benefits to venture capitalists.

The distribution discussion also leads to some assumptions about pricing. Combined with product costs, an engineering budget, and schedules, this results in a spreadsheet that faintly resembles the first financial plan in the company’s business plan. If the startup is to be backed by venture capitalists, the financial model has to be alluring as well as believable. If it’s a new division inside a larger company, forecasts talk about return on investment.  in this concept and seed stage, creative writing, passion, and shoe leather combine  in hopes of convincing an investor to fund the company or the new division.

Product Development
In stage two, product development, everyone stops talking and starts working. The respective departments go to their virtual corners as the company begins to specialize by functions.

Engineering focuses on building the product; it designs the product, specifies the first release and hires a staff to build the product. It takes the simple box labeled “product development” and makes detailed critical path method charts, with key milestones. With that information in hand, Engineering estimates delivery dates and development costs.

Meanwhile, Marketing refines the size of the market defined in the business plan (a market is a set of companies with common attributes), and begins to target the first customers. In a well-organized startup (one with a fondness for process),  the marketing folk might even run a focus group or two on the market they think they are in and prepare a Marketing Requirements Document (MRD) for Engineering. Marketing starts to build a sales demo, writes sales materials (presentations, data sheets), and hires a PR agency. In this stage, or by alpha test, the company traditionally hires a VP of Sales who begins to assemble a sales force.

Alpha/Beta Test
In stage three, alpha/beta test, Engineering works with a small group of outside users to make sure that the product works as specified and tests it for bugs. Marketing develops a complete marketing communications plan, provides Sales with a full complement of support material, and starts the public relations bandwagon rolling. The PR agency polishes the positioning and starts contacting the long lead-time press while Marketing starts the branding activities.

Sales signs up the first beta customers (who volunteer to pay for the privilege of testing a new product), begins to build the selected distribution channel, and staffs and scales the sales organization outside the headquarters. The venture investors start measuring progress by number of orders in place by first customer ship.

Hopefully, somewhere around this point the investors are happy with the company’s product and its progress with customers, and the investors are thinking of bringing in more money. The CEO refines his or her fund-raising pitch and hits the street and the phone searching for additional capital.

Product Launch and First Customer Ship
Product launch and first customer ship is the final step in this model, and the goal the company has been driving for. With the product working (sort of), the company goes into “big bang” spending mode. Sales is heavily building and staffing a national sales organization; the sales channel has quotas and sales goals. Marketing is at its peak. The company has a large press event, and Marketing launches a series of programs to create end-user demand (trade shows, seminars, advertising, email, and so on). The board begins measuring the company’s performance on sales execution against its business plan (which typically was written a year or more earlier, when the entrepreneur was looking for initial investments).

Building the sales channel and supporting the marketing can burn a lot of cash. Assuming no early liquidity (via an IPO or merger) for the company, more fund raising is required. The CEO looks at the product launch activities and the scale-up of the sales and marketing team, and yet again goes out, palm up, to the investor community. (In the dot-com bubble economy, the investors used an IPO at product launch to take the money and run, before there was a track record of success or failure.)

The Leading Cause of Startup Death
If you’ve ever been involved in a startup, the operational model no doubt sounds familiar. It is a product-centric and process-centric model used by countless startups to take their first product to market.  It used to be if you developed a plan on model that looked like this your investors would have thought you were geniuses.

In hindsight both you and your investors were idiots. Following this diagram religiously will more often than not put you out of business. The diagram was developed to be used by existing companies doing product line extensions - not startups creating new markets or resegmenting existing ones. Most experienced entrepreneurs will tell you that the model collapses at first contact with customers.

VC’s who still believe in the product development model in the 21st century offer no value in building a company other than their rolodex and/or checkbook.

Coming next Part 2: What’s Wrong with Product Development as a Model?

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The End of Innocence

I love TechCrunch. If you’re a startup raising money or just want to see your name online, there’s not a better blog on the web.  Reading this TechCrunch post made me remember the first time I saw someone confront a worldview they didn’t expect.

TechCrunch PRDiscovering that your worldview is wrong or mistaken can be a life-changing event. It’s part of growing up but can happen at any age. What you do when it happens shapes who you’ll become.

Dinner in a Strange Land
When I was in my mid 20′s working at ESL, I was sent overseas to a customer site where the customers were our three-letter intelligence agencies. All of us knew who they were, understood how important this site was for our country, and proud of the work we were doing. (Their national technical means of verification made the world a safer place and hastened the end of the Soviet Union and the Cold War.)

As a single guy, I got to live in a motel-like room on the site while the married guys lived in town in houses and tried to blend in with the locals. When asked what they did, they said they worked at “the xxx research facility.”  (Of course the locals translated that to “oh do you work for the yyy or zzz intelligence agency?”)

One warm summer evening I got invited over to the house of a married couple from my company for a BBQ and after-dinner entertainment – drinking mass quantities of the local beer. The quintessential California couple, they stood out in our crowd as the engineer (in his late 20′s, respected by his peers and the customer) had hair down to his shoulders, sharply contrasting with the military crewcuts of the customers and most of the other contractors.

His wife, about my age, could have been a poster child for the stereotypical California hippie surfer, with politics that matched her style – antiwar, anti government, antiestablishment.

One of the rules in the business was that you didn’t tell your spouse, girlfriend, significant other who you worked for or what you worked on – ever. It was always a welcome change of pace to leave the brown of the unchanging desert and travel into town and have dinner with them and have a non-technical conversation about books, theater, politics, travel, etc. But it was a bit incongruous to hear her get wound up and rail against our government and the very people we were all working for. Her husband would look at me out the corner of his eyes and then we’d segue the conversation to some other topic.

That evening I was there with three other couples cooking over the barbie in their backyard. After night fell we reconvened in their living room as we continued to go through the local beer. The conversation happened to hit on politics and culture and my friend’s’ wife innocently offered up she had lived in a commune in California. Well that created a bit of alcohol-fueled cross-cultural disconnect and heated discussion.

Until one of the other wives changed a few lives forever with a slip of the tongue.

Tell Me it Isn’t True
One of the other wives asked, “Well what would your friends in the commune think of you now that your husband is working for intelligence agencies x and y?”

As soon as the words came out of her mouth, I felt time slow down. The other couples laughed for about half a second expecting my friend’s wife to do so as well. But instead the look on her face went from puzzlement in processing the question, to concentration, as she was thinking and correlating past questions she had about who exactly her husband had been working for. It seemed like forever before she asked with a look of confusion, “What do you mean agencies x and y?”

The laughter in the room stopped way too soon, and the room got deathly quiet. Her face slowly went from a look of puzzlement to betrayal to horror as she realized that that the drunken silence, the dirty looks from other husbands to the wife who made the agency comment, and the wives now staring at their shoes was an answer.

She had married someone who never told her who he was really working for. She was living in a lie with people she hated. In less than a minute her entire worldview had shattered and coming apart in front of us, she started screaming.

This probably took no more than 10 seconds, but watching her face, it felt like hours.

I don’t remember how we all got out of the house or how I got back to the site, but to this day I still remember standing on her lawn staring at strange constellations in the night sky as she was screaming to her husband, “Tell me it isn’t true!”

The next day the site supervisor told me that my friend and his wife had been put on the next plane out of country and sent home (sedated) along with the other couple that made the comment. By the time I came back to the United States, he was gone from the company.

It’s been thirty years, but every once an awhile I still wonder what happened to the rest of their lives.

———-

The End of Innocence
In much smaller ways I’ve watched my children and now my students discover that their worldview is wrong, mistaken or naive. I’ve watched as they realize there’s no Santa Claus and Tooth Fairy; the world has injustice, hypocrisy and inequality; capitalism and politics don’t work like the textbooks and money moves the system; you can’t opt out of dying, and without regulation people will try to “game” whatever system you put in place.

Learning to accept the things you can’t change, finding the courage to change the things you can and acquiring the common sense to know the difference, is part of growing up.

While I love TechCrunch, the post and the quote about the PR agency (“one PR firm has discovered a dynamite strategy, throw ethics out the window”) left me wondering; how do PR agencies interact with TechCrunch and other blog and review sites? Is this behavior an outlier or is it the norm in the PR industry?

Or is it just someones end of innocence?

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Coffee With Startups

I’ve just met four great startups in the last three days.

An Existing Market
All four were trying to resegment an “Existing Market.” An existing market is one where competitors have a profitable business selling to customers who can name the market and can tell you about the features that matter to them. Resegmentation means these startups are trying to lure some of the current or potential customers away from incumbents by either offering a lower cost product, or by offering features that appealed to a specific niche or subset of the existing users.

Some of the conversations went like this:

Startup 1
Entrepreneur -“I’m competing against Company x and have been following the Customer Development process and I’ve talked to lots of customers.”
Me – “Have you used Company x’s product? Do you know have they distribute their product? Do you know how they create demand? Do you know how many units they are selling? Do you know the archetype of their customers?
Entrepreneur -“Well no but my product is much better than their product and I have this great idea….”

Rule 1: In an existing market Customer Development means not only understanding potential customers, but your competitors in detail – their product features, their sales channels, their demand creation strategy, their business model, etc.

Startup 2
Entrepreneur -“I’m competing against Company x and we are going to offer a lower-cost, web-based version. We’re about to ship next week.”
Me –“That’s a great hypothesis, do customers tell you that they’d buy your version if it was cheaper or on the web?
Entrepreneur -“Well no but my product is much cheaper and everyone’s on the web and I have this great idea….”

Rule 2: In an existing market Customer Development means understanding whether your hypothesis of why customers will buy match reality. This is easy to test. Do this before you write code you may end up throwing away.

Startup 3
Entrepreneur -“I’m competing against Large Company x and we solve problems for a set of customers – I’ve talked to many of them and they would buy it.”
Me – “So what’s the problem?”
Entrepreneur – “We just started letting early customers access the product and adoption/sales isn’t taking off the way we thought it would. We only have 20 customers, and Large Company x has millions.”
Me – “How are you positioning your product?”
Entrepreneur – “We tell potential customers about all our features.”

Rule 3: In an existing market directly compare your product against the incumbent and specifically describe the problems you solve and why Company x’s products do not.”

Startup 4
Entrepreneur -“I have something really, really new. No one has anything like it.”
Me – “Isn’t it kind of like Twitter but better?”
Entrepreneur – “You don’t get it.”

Rule 4: You may want to think twice positioning as a New Market. If customers immediately get an analogy for your product, don’t dissuade them. Save the “New Billion Dollar Market” positioning for the investors, not customers.

Lessons Learned

  • Deeply understand the incumbents that make up the Existing Market
  • The “hypotheses tested to lines of code written” ratio ought to be high
  • Position against the incumbents weaknesses – their customers will tell you what they are
  • Existing Markets adoption rates are measured in % market share gained, New Markets have adoption rates which may occur in your company’s lifetime

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Touching the Hot Stove – Experiential versus Theoretical Learning

I’m a slow learner.  It took me 8 startups and 21 years to get it right, (and one can argue success was due to the Internet bubble rather then any brilliance.)

In 1978 when I joined my first company, information about how to start companies simply didn’t exist. No internet, no blogs, no books on startups, no entrepreneurship departments in universities, etc.  It took lots of trial and error, learning by experience and resilience through multiple failures.

The first few months of my startups were centered around building the founding team, prototyping the product and raising money. Since I wasn’t an engineer, my contribution was around the team-building and fund raising.

I was an idiot.

Customer Development/Lean Startups
In hindsight startups and the venture capital community left out the most important first step any startup ought to be doing – hypothesis testing in front of customers- from day one.

I’m convinced that starting a company without talking to customers is like throwing your time and money in the street (unless you’re already a domain expert).

This mantra of talking to customers and iterating the product is the basis of the Lean Startup Methodology that Eric Ries has been evangelizing and I’ve been teaching at U.C. Berkeley and at Stanford. It’s what my textbook on Customer Development describes.

Experiential versus Theoretical Learning
After teaching this for a few years, I’ve discovered that subjects like Lean Startups and Customer Development are best learned experientially rather than solely theoretically.

Remember your parents saying, “Don’t touch the hot stove!”  What did you do?  I bet you weren’t confused about what hot meant after that. That’s why I make my students spend a lot of time “touching the hot stove” by talking to customers “outside the building” to test their hypotheses.

However, as hard as I emphasize this point to aspiring entrepreneurs every year I usually get a call or email from a past student asking me to introduce them to my favorite VC’s.  The first questions I ask is “So what did you learn from testing your hypothesis?” and “What did customers think of your prototype?”  These questions I know will be on top of the list that VC’s will ask.

At least 1/3 of the time the response I get is, “Oh that class stuff was real interesting, but we’re too busy building the prototype. I’m going to go do that Customer Development stuff after we raise money.”

Interestingly this response almost always comes from first time entrepreneurs.  Entrepreneurs who have a startup or two under their belt tend to rattle off preliminary customer findings and data that blow me away (not because I think their data is going to be right, but because it means they have built a process for learning and discovery from day one.)

Sigh.  Fundraising isn’t the product.  It’s not a substitute for customer input and understanding.

Sometimes you need a few more lessons touching the hot stove.

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He’s Only in Field Service

The most important early customers for your startup usually turn out to be quite different from who you think they’re going to be.

He’s Only in Field Service
When I was at Zilog, the Z8000 peripheral chips included the new “Serial Communications Controller” (SCC). As the (very junior) product marketing manager I got a call from our local salesman that someone at Apple wanted more technical information than just the spec sheets about our new (not yet shipping) chip. I vividly remember the sales guy saying, “It’s only some kid in field service. I’m too busy so why don’t you drive over there and talk to him.”  (My guess is that our salesman was busy trying to sell into the “official” projects of Apple, the Lisa and the Apple III.)

Zilog was also in Cupertino near Apple, and I remember driving to a small non-descript Apple building at the intersection of Stevens Creek and Sunnyvale/Saratoga. I had a pleasant meeting and was as convincing as a marketing type could be to a very earnest and quirky field service guy, mostly promising the moon for a versatile but then very buggy piece of silicon. We talked about some simple design rules and I remember him thanking me for coming, saying we were the only chip company who cared enough to call on him (little did he know.)

I thought nothing about the meeting until years later. Long gone from Zilog I saw the picture of the original Macintosh design team. The field service guy I had sold the chip to was Burrell Smith who had designed the Mac hardware.

The SCC had been designed into the Mac and became the hardware which drove all the serial communications as well as the AppleTalk network which allowed Macs to share printers and files.

Some sales guy who was too busy to take the meeting was probably retired in Maui on the commissions.

Your Customers are Not Who You Think
For years I thought this “million unit chip sale by accident” was a “one-off” funny story. That is until I saw that in startup after startup customers come from places you don’t plan on.

Unfortunately most startups learn this by going through the “Fire the first Sales VP” drill: You start your company with a list of potential customers reading like a “who’s who” of whatever vertical market you’re in (or the Fortune 1000 list.) Your board nods sagely at your target customer list.  A year goes by, you miss your revenue plan, and you’ve burned through your first VP of Sales.  What happened?

What happened was that you didn’t understand what “type of startup” you were and consequently you never had a chance to tailor your sales strategy to your “Market Type.” Most startups tend to think they are selling into an Existing market – a market exists and your company has a faster and better product. If that’s you, by all means hire a VP of Sales with a great rolodex and call on established mainstream companies – and ignore the rest of this post.

Market Type
But most startups aren’t in existing markets.  Some are resegmenting an existing market–directed at a niche that an incumbent isn’t satisfying (like Dell and Compaq when they were startups) or providing a low cost alternative to an existing supplier (like Southwest Airlines when it first started.) And other startups are in a New Market — creating a market from scratch (like Apple with the iPhone, or iPod/iTunes.)

(“Market Type” radically changes how you sell and market at each step in Customer Development. It’s one of the subtle distinctions that at times gets lost in the process. I cover this in the Four Steps to the Epiphany.)

market-type

Five Signs You Can Sell to a Large Company
If you’re resegmenting an existing market or creating a new market, the odds are low that your target list of market leaders will become your first customers. In fact having any large company buy from you will be difficult unless you know how to recognize the five signs you can get a large company to buy from a startup:

  • They have a problem
  • They know they have a problem
  • They’ve been actively looking for a solution
  • They tried to solve the problem with piece parts or other vendors
  • They have or can acquire a budget to pay for your solution

I advise startups to first go after the companies that aren’t the market leaders in their industries, but are fighting hard to get there. (They usually fit the checklist above.) Then find the early adopter/internal evangelist inside that company who wants to gain a competitive advantage. These companies will look at innovative startups to help them gain market share from the incumbent.

Sell to the Skunk Works
The other place for a startup to go is the nooks and crannies of a market leader.  Look for some “skunk works” project where the product developers are actively seeking alternatives to their own engineering organization.  In Apple’s case Burrell Smith was designing a computer in a skunk works unbeknownst to the rest of Apple’s engineering.  He was looking for a communications chip that could cut parts cost to build an innovative new type of computer – which turned out to be the Mac.

Lessons Learned

  • Early customers are usually not where you first think they are
  • Where they are depends on Market Type
  • Look for aggressive number 2′s or 3′s who are attacking a market leader
  • Look for a “skunk works” inside a market leader

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an early version of this story appeared on folklore.org

Rocket Science 4: The Press is Our Best Product

At Rocket Science while my partner Peter was managing the tools and game development, I was managing everything else. Which at this stage of the company was marketing and financing.

Our “Hollywood meets Silicon Valley” story played great in Silicon Valley, they ate it up in Hollywood, and the business press tripped over themselves to talk to us.  The story had universal appeal, and we spun the tale and keep the buzz going.  It worked. Judging by the ink we had gotten, we were the hottest company in the game business, with stories in Fortune, Forbes, Variety, The Hollywood Reporter, and the cover of Wired magazine. Yet we hadn’t shipped a single product.

While it felt wonderful at the time, this was a very bad idea.

Wired 2.11 Cover

Everyone Else is an Idiot
The theme of our press blitz was all about how we were going to show the old tired game companies the right way to make video games. Our press infuriated the established companies who had spent years building games that sold well, but had zero press recognition.  (They all accurately predicted our demise because of our lack of game expertise.)  Ah, the arrogance of inexperience. Fortunately I’ve never been good at lying, to be effective in communicating a story I truly had to believe in what I was saying.  At the time I was a true believer that Rocket Science was going to change the gaming world. The positive effect of the tidal wave of press was as a door opener for us to raise money from corporate partners.  Companies in the entertainment business around the world knew who we were, and were interested in meeting us, if only to see what the hype was about. Our VP of Business Development had no problems getting meetings and fund raising was easy.

The Digital Dream Team
Way before the Internet phenomenon, we had created “Rocket Science the brand” that was much bigger in size and importance than Rocket Science the company. One magazine called us the “Digital Dream Team”, young, edgy and hip, and by the looks of the company (great building, nice furniture, and well dressed 20-year olds) we were trying to live up to the reputation.  All this activity occurring before we actually shipped a product.  We were larger than life, but as one potential investor told us, “You guys are all hat and no cattle.”

Believing Your Own BS is Toxic
Lots of noise and smoke before a product ships seems to be a toxic byproduct of enthusiastic entrepreneurs. Every generation of new technology seems to find a willing audience in naïve journalists and eager readers.  However, when the smoke clears the surviving companies are more than likely the ones that focussed on execution, not on creating a cacophony of press releases. If Rocket Science wasn’t a clear enough lesson in the danger of premature enthusiasm, the dot-com bubble that followed should have been. The only difference between us and the Internet bubble that would follow was that we did branding on the cheap by creating our image with public relations, whilethe dot-bomb era was to do it by spending enormous sums on advertising (those large venture rounds had to get spent somewhere.)

Hindsight is wonderful.  For years the one solace I was able to take from the Rocket Science debacle was that I had got the branding right. Then I watched the criminally expensive dot-bomb-bust branding activities to see how futile and wasteful it was to brand a company before it has shipped products.

To a Hammer Everything Looks Like a Nail
In hindsight my failure was that I executed to my strength – telling a compelling story – without actually listening to customer feedback.

It wasn’t that I didn’t know how to listen to customers.  It wasn’t that I didn’t have a smart VP of Marketing who was getting early feedback from customers and screaming that the games didn’t match the hype.  It’s that as CEO I was too busy talking to the press and raising money to hear customer comments directly.

I had outsourced customer feedback and ignored the input. In fact, hearing input that contradicted the story I was telling created cognitive dissonance.  So while the words may have passed through my ears I couldn’t “hear” it.  Not being able to hear negative customer input is an extremely bad idea.

Out of the Ashes
A few of the key tenets of Customer Development, came from the ashes.  The Customer Discovery lessons of “get outside the building and test your hypothesis with customers,” and “the founders need to hear the results,” came from this debacle.

The Customer Validation lesson of, “no formal launch until you have early sales validating the product and sales process” was also born here.  Given the lukewarm feedback we were getting from potential customers and channel buyers we should have dramatically dialed back the hype until the follow-on games could match it. Given the talented people we had, there’s no doubt they would have done so.  Instead the huge mismatch between expectations and reality of our first games diminished the brand and demoralized the company – we never recovered.

Lessons Learned

  • PR is not a product- it is a demand creation activity to fill a sales channel
  • The product needs to come close to the hype
  • Fire the CEO who insists on press and PR before they understand customer feedback
  • Branding is a process that should happen after you have customers

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Rocket Science 3: Hollywood Meets Silicon Valley

What do you mean you don’t want to hear about features?
I was now a CEO of Rocket Science, and having a great time building the company (more about that in future posts.) Unfortunately, while I had gone through phases of video game addiction in my life, in no way could I be described as even a “moderate hard-core gamer,” which ruled me out as a domain expert.  So I got out out of the building to meet and understand our customers and distribution partners. I remember after a month or two of talking to 14-22 year old male gamers (our potential target market,) I realized that for the first time in my career I had no emotional connection to my customers or channel partners.

I was about 90 days into the company when I began to realize there was something very different about this business. In previous companies I could talk about technology details and how the product features could solve a customers problem. But people didn’t buy video games on features and they weren’t looking to solve a problem.  I was in a very, very different business.

I was in the entertainment business.

There couldn’t have been a worse choice for CEO in Silicon Valley.

Alarm bell one should have started ringing – for me and my board.

Rocket Science logo

Hollywood Meets Silicon Valley was an Oxymoron
A key premise of our new company was that our video compression and authoring technology would revolutionize how games were made and played. We believed that by putting full motion video (i.e. movies) into video games we could tell stories, build characters, have narratives and bring all the 100 years of craft and cinematic experience of Hollywood to the sterile “shoot and die” twitch games that were currently in vogue.  (This wasn’t just some random Silicon Valley fantasy. My partner had convinced several major Hollywood names that this was the inevitable consequence of the merger of Hollywood and Silicon Valley.  And at the time it was a plausible scenario.)

But in reality our passionate belief that video would transform gaming was just our hypothesis. There was zero proof in the marketplace that was the case. And we weren’t going to be bothered to go out and prove ourselves wrong with facts.  (Why should we – our VC’s had already told us what geniuses we were by fighting to even get into the deal to fund us.  Never mind that no one on our board was in the game business or even played games.)

Alarm bell two should have started ringing – for me and my board.

Swing For the Fences
Since we were so smart we were going to ramp up and build not one game, but an entire game studio based on this hypothesis.  Why shouldn’t we.  Doing one game and seeing customer reaction meant a) acknowledging that some of our assumptions might be wrong, and 2) wasting time.  We were all about scale and swinging for the fences.  That’s what VC funded companies do, don’t they?

Alarm bell three should have started ringing – for my partner and me.

Tools Are the Not the Product
We were going to build an easy to use authoring system that would revolutionize how games were made. (My partner had convinced several of the key members of the Apple Quicktime team to join us.) Our tools group became as important as our content group. Unfortunately, the market was going to remind us that games are about game play.

Customers don’t care about your tools regardless of what business you’re in. Customers of software applications don’t say, “wow, elegant code base.” In movies theater-goers don’t leave talking about your cameras, just whether they were entertained, and in restaurants diners don’t care about your cooking implements, what matters is what the food tasted like.  The tools may provide efficiencies, but what customers care about is your final product. (Later on, way too late, we’d remind ourselves it’s the game stupid.)

Alarm bell four should have started ringing louder for me.

Lessons learned

  • Never, ever, start a company when you’re not passionate about the company, product and customers
  • Always validate your key assumptions on what makes your company tick
  • Swing for the fences is your VC’s strategy.  Make sure it is yours.
  • Don’t confuse your passion for your tools with why your customers will buy your product.

Customer Development Fireside Chat

I did a fireside chat with a few entrepreneurs interested in Customer Development at Draper Fisher Jurvetson, the venture firm behind such Skype, Baidu, Overture, ….

Ravi Belani was nice enough to set it up, blog about the talk and film it.  The relevant part starts about 4:30 into the video (wait for it to download.)

Lessons Learned

  • Most entrepreneurs start a company with hypothesis not facts
  • None of these hypothesis can be tested in the building
  • Therefore – Get out of the building
  • “Market Types” matter
  • Find a market for the product as specified

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Convergent Technologies: War Story 1 – Selling with Sports Scores

When I was a young marketer I learned how to listen to customers by making a fool of myself.

Twenty eight years ago I was the bright, young, eager product marketing manager called out to the field to support sales by explaining the technical details of Convergent Technologies products to potential customers.

The OEM Business
Convergent’s business was selling desktop computers (with our own operating system and office applications) to other computer manufacturers – most of them long gone: Burroughs, Prime, Monroe Data Systems, ADP, Mohawk, Gould, NCR, 4-Phase, AT&T.  These companies would take our computers and put their name on them and resell them to their customers.

Business customers were starting to ask for “office automation solutions” – word processing, spreadsheets, graphing software on a desktop.  This was just before the IBM PC hit the desktop so there were no “standard” operating systems or applications for desktop platforms. Computer hardware companies were faced with their customers asking for low-cost (relatively) desktop computers they had no experience in building. Their engineering teams didn’t have the expertise using off-the-shelf microprocessors (back then “real” computer companies designed their own instruction sets and operating systems.) They couldn’t keep up with the fast product development times that were enabled by using standard microprocessors. So their management teams were insisting that they OEM (buy from someone else) these products.  Convergent Technologies was one of those OEM suppliers.

Their engineers hated us.

I was traveling with the regional sales manager who had called on these companies, gotten them interested and now needed someone from the factory to provide technical details and answer questions about how the product could be configured and customized.

See How Smart I Am
As the eager young marketer on my first sales call, as soon as we shook hands I was in front of the room pitching our product and technical features. I knew everything about our operating system, hardware and applications – and I was going to prove it.  I talked all about how great the new products were and went into excruciating detail on our hardware and operating system and explained why no one other than our company could build something so brilliantly designed. (This being presented to another company’s proud engineering team who was being forced to buy product from us because they couldn’t build their own in time.)  After I sat down I was convinced the only logical conclusion was for the customer to tell us how many they wanted to buy.

The result wasn’t what I expected. The customers didn’t act particularly excited about the product and how brilliantly I presented it. I do believe some actually rolled their eyes.  They looked at their watches, gave our sales guy a quizzical look and left.

After the meeting our sale rep took me aside and asked if “perhaps I wouldn’t mind watching him on the next call.“

Sports Scores
The next day, as I drove to our next meeting the sales guy was intently reading the sports section of the newspaper and as I glanced over he seemed to be writing down the scores.  I wondered if he had a bookie.  When we got to the meeting he reminded me to be quiet and follow his lead.

We shook hands with the customers, but instead of launching into a product pitch (or better, letting me launch into the pitch) he started asking how their families were.  He even remembered the names of their wives and kids and some details about schools or events. (I couldn’t believe it, here we were wasting precious time and the dumb sales guy is talking about other stuff.)

Just as I thought we were going to talk about the product, he then mentioned the previous nights football game. (Damn, another five minutes down the tube as the whole room chimed in with an opinion as we talked about something else unimportant.)

The Customer is a Genius
Then instead of talking about our products he segued the conversation into their products. He complemented their elegantly designed minicomputers and made some astute comment about their architecture (now I’m rolling my eyes, their computers were dinosaurs) and asked who were the brilliant designers.  I was surprised to see that they were in the room.  And soon the conversation were about architectural tradeoffs and then how customers didn’t appreciate the elegant designs and how the world was going to hell in a handbasket because of these commodity microprocessors.  And our sales guy was agreeing and commiserating.  (And I’m thinking why is he doing all this, just tell these idiots that the world has passed them by and they need to buy our stuff and lets get an order.)

The engineers spoke about all the pressure they were getting from management to build desktop personal computers rather than their traditional minicomputers. And that their management wanted these new systems on a schedule that was impossible to meet. Then our sales guy says something that makes me stop breathing for a while.  “I bet if your management team would give you guys the resources you guys could build desktop computers better than anyone, even better than us.”  There’s a unanimous agreement around the table about how great they were and how bad management was.

The Consultative Sale
Our sales guy then quietly asked if there was any way we could help them.  (Help them?!! We’re here to sell them our stuff, why can’t we just present what we got and they’ll buy it.)  The VP of Engineering says, “well we don’t have the resources or time, and as long as you know we could build better computers then you guys, why don’t you tell us the details about your computers.”

I had just watched a master of the consultative sale.

Engineers as Salesmen
I thought (and still do) that this sales guy walked on water. He had spent 12 years at DEC, first as a hardware engineer designing part of the PDP-16, then as the marketing manager for the LSI-11 and then into sales.

Making sales calls with him taught me what a world class salesperson was like.  It also made me understand what kind of support sales people needed from marketing and what marketing programs were wasted motion.

It also made me realize that there are times you don’t want any sales people in your company.

Startups and Sales
If you read this post you can come away with the impression that every startup with a direct salesforce needs a consultative sales team.  Not true.

The answer depends on your answer to two questions:

  1. which step in the Customer Development process are you on?
  2. what Market Type is your startup?

Customer Development and Selling Strategy
If you’ve just started your company you are in customer discovery.  If you’ve tried to slog your way through my book on Customer Development you know that I’m insistent that the founders need to be the ones getting outside the building (physically or virtually) to validate all the initial hypotheses of the business model and product.  If you hire a VP of Sales with the idea that they can do customer discovery you violated the first principle of Customer Development – this isn’t a step the can be outsourced to a non-founder.

Customer Development DiagramHiring a VP of Sales in customer discovery typically sets a startup back. It’s only after you’re done with customer discovery and are in the final steps of customer validation (building a repeatable and scalable sales process) that you start hiring a sales executive.

The next thing you need to do is match your sales team with your market type.

Market Type and Sales Teams
If you remember from a previous post, startups fall into four Types of Markets. You need to hire the right type of sales people for the type of market.

market-typeIf you are in a New Market, (delivering what Clayton Christensen calls disruptive innovation) the market doesn’t even have a name and customers have no clue on how your product works or how it could help them.  This market cries out for a sales force that can help educate and guide the market to making the right choices.  Your sales team is an extension of your marketing department.  The same is true if you are in an existing marketing and trying to sell to a niche or a segment of the market based on your knowledge of their particular needs.  Both New Markets and Resegmented Niche Markets required a skilled consultative sales force.

This is very different from the sales team you would hire to sell in an existing market or a cheaper product.

If you’re in an existing market and you have a superior product, by all means tout your features and specifications.  However, your product itself will be doing a lot of the selling.  If it is demonstrably better as you claim your marketing department needs to communicate that competitive advantage and your sales curve should look linear as you take share from the existing incumbents.

If you are resegmenting an existing market a product with a cheaper alternative, by all means tout your price.  Your marketing department should be all over this.  In both cases you really don’t need a skilled/consultative sales force.  A sales team with a great rolodex will do.

Sales by Market Type

Sales by Market Type

Lessons Learned

  • Get out of the building (physically or virtually)
  • Sales calls aren’t your IQ test or PhD defense
  • Stop talking and listen to the customers problem
  • Hire a sales team at the Customer Validation step
  • Match the sales team to market type

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Epitaph for an Entrepreneur

Raising our kids and being an entrepreneur wasn’t easy. Being in a startup and having a successful relationship and family was very hard work.  But entrepreneurs can be great spouses and parents.

This post is not advice, nor is it recommendation of what you should do, it’s simply what my wife and I did to raise our kids in the middle of starting multiple companies. Our circumstances were unique and your mileage will vary.  Read the previous post first for context.

Biological Clocks
After Convergent and now single again, I was a co-founder of my next two startups; MIPS and Ardent.  I threw myself into work and worked even more hours a day.  And while I had great adventures (stories to come in future posts,) by the time I was in my mid-30’s I knew I wanted a family. (My friends noticed that I was picking up other people’s babies a lot.) I didn’t know if I was ready, but I finally could see myself as a father.

I met my wife on a blind-date and we discovered that not only did we share the same interests but we were both ready for kids. My wife knew a bit about startups.  Out of Stanford Business School she went to work for Apple as an evangelist and then joined Ansa Software, the developer of Paradox, a Mac-database.

Product Launch
Our first daughter was born about four months after I started at SuperMac. We ended up sleeping in the hospital lounge for 5 days as she ended up in intensive care.  Our second daughter followed 14½ months later.


Family Rules
My wife and I agreed to a few rules upfront and made up the rest as went along. We agreed I was still going to do startups, and probably more than most spouses she knew what that meant.  To her credit she also understood that meant that child raising wasn’t going to be a 50/50 split; I simply wasn’t going to be home at 5 pm every night.

In hindsight this list looks pretty organized but in reality we made it up as we went along, accompanied with all the husband and wife struggles of being married and trying to raise a family in Silicon Valley.  Here are the some of the rules that evolved that seemed to work for our family.

  • We would have a family dinner at home most nights of the week.  Regardless of what I was doing I had to be home by 7pm.  (My kids still remember mom secretly feeding them when they were hungry at 5pm, but eating again with dad at 7pm.)  But we would use dinner time to talk about what they did at school, have family meetings etc.
  • Put the kids to bed.Since I was already home for dinner it was fun to help give them their baths, read them stories and put them to bed.  I never understood how important the continuity of time between dinner through bedtime was until my kids mentioned it as teenagers.
  • Act and be engaged.My kids and wife had better antenna than I thought.  If I was home but my head was elsewhere and not mentally engaged they would call me on it.  So I figured out how to spit the flow of the day in half.  I would work 10 hours a day in the office, come home and then…
  • Back to work after the kids were in bed. What my kids never saw is that as soon as they were in bed I was back on the computer and back at work for another 4 or 5 hours until the wee hours of the morning.
  • Weekends were with and for my kids. There was always some adventure on the weekends. I think we must have went to the zoo, beach, museum, picnic, amusement park, etc. a 100 times.
  • Half a day work on Saturday.  While weekends were for my kids I did go to work on Saturday morning.  But my kids would come with me.  This had two unexpected consequences; my kids still remember that work was very cool.  They liked going in with me and they said it helped them understand what dad did at “work.”  Second, it set a cultural norm at my startups, first at Supermac as the VP of Marketing, then at Rocket Science as the CEO and at E.piphany as President. (Most Silicon Valley startups have great policies for having your dog at work but not your kids.)
  • Long vacations.We would take at least a 3-week vacation every summer.  Since my wife and I liked to hike we’d explore national parks around the U.S. (Alaska, Wyoming, Colorado, Washington, Oregon, Maine.) When the kids got older our adventures took us to Mexico, Ecuador, India, Africa and Europe. The trips gave them a sense that the rest of the country and the world was not Silicon Valley and that their lives were not the norm.
  • Never miss an event.As my kids got older there were class plays, soccer games, piano and dance performances, birthdays, etc.  I never missed one if I was in town, sometimes even if it was in the middle of the day. (And I made sure I was in town for the major events.)
  • Engage your spouse. I asked my wife to read and critique every major presentation and document I wrote. Everything she touched was much better for it.  What my investors never knew is that they were getting two of us for the price of one.  (And one of us actually went to business school.)  It helped her understand what I was working on and what I was trying to accomplish.
  • Have a Date-Night. We tried hard to set aside one evening a week when just the two of us went out to dinner and/or a movie.
  • Get your spouse help.Early on in our marriage we didn’t have much money but we invested in childcare to help my wife.  While it didn’t make up for my absences it offloaded a lot.
  • Traditions matter.Holidays, both religious and secular, weekly and yearly, were important to us.  The kids looked forward to them and we made them special.
  • Travel only if it needed me. As an executive it was easy to think I had to get on a plane for every deal. But after I had kids I definitely thought long and hard before I would jump on a plane.  When I ran Rocket Science our corporate partners were in Japan (Sega), Germany (Bertelsmann) and Italy (Mondadori) and some travel was unavoidable.  But I probably traveled 20% of what I did when I was single.
  • Document every step. Like most dads I took thousands of photos.  But I also filmed the girls once a week on the same couch, sitting in the same spot, for a few minutes – for 16 years.  When my oldest graduated high school I gave her a timelapse movie of her life.

“Live to Work” or “Work to Live”?
When I was in my 20’s the two concepts that mattered were, “me” and “right now.” As I got older I began to understand the concept of “others” and “the future.” I began to realize that working 24/7 wasn’t my only goal in life.

As a single entrepreneur I had a philosophy of, “I live to work” – nothing was more exciting or important than my job.  Now with kids it had become, “I work to live.”  I still loved what I did as an entrepreneur but I wasn’t working only for the sheer joy of it, I was also working to provide for my family and a longer term goal of retirement and then doing something different. (The irony is when I was working insane hours it was to make someone else wealthy.  When I moderated my behavior it was when they were my startups.)

Work Smarter Not Harder
As I got older I began to realize that how effective you are is not necessarily correlated with how many hours you work.  My ideas about Customer Development started evolving around these concepts.  Eric Ries’s astute observations about engineering and Lean Startups make the same point.  I began to think how to be effective and strategic rather than just present and tactical.

Advice From Others
As my kids were growing up I got a piece of advice that stuck with me all these years.

The first was when our oldest daughter was 6 months old, and a friend was holding her.  She looked at the baby then looked at me and asked, “Steve do you know what your most important job with this baby is?”  I guessed, “Take care of her?” No. “Love her?” No. “OK, I give up, what is my most important job.” She answered,  “Steve, your job is teaching her how to leave.”  This was one of the most unexpected things I ever heard.  This baby could barely sit up and I have to teach her how to leave?

My friend explained, “your kids are only passing through.  It will seem like forever but it will be gone in a blink of an eye. Love them and care for them but remember they will be leaving.  What will they remember that you taught them?”

For the next 18 years that thought was never far from my mind.

What Will Your Epitaph Say?
At some point I had heard two aphorisms which sounded very trite when I was single but took on a lot more meaning with a family.

  • This life isn’t practice for the next one. I started to realize that some of the older guys who I had admired as role models at work had feet of clay at home.  They had chose their company over family and had kids who felt abandoned by their dads for work – and some of these kids have turned out less than optimally. I met lots of other dads going through the “could-have, would-have, should-have” regrets and reflections of the tradeoffs they had made between fatherhood and company building.  Their regrets were lessons for me.
  • What will your epitaph say? When our kids were babies I was still struggling to try to put the work/life balance in perspective.  Someone gave me a thought that I tried to live my live my life around.  He asked me, when you’re gone would you rather have your gravestone say, “He never missed a meeting.” Or one that said, “He was a great father.”  Holding my two kids on my lap, it was a pretty easy decision.

I hope I did it right.

Know When to Hold Them, Know When to Fold Them,Know When to Walk Away
When my last startup, E.piphany went public in the dot.com boom, I was faced with a choice; start company number nine, or retire.

I looked at my kids and never went back.

Thanks to my wife for being a great partner.  It takes two.

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Lies Entrepreneurs Tell Themselves

Watching my oldest daughter graduate high school this week made me think about what it was like raising a family and being an entrepreneur.

Convergent Technologies
When I was in my 20’s I worked at Convergent Technologies, a company that was proud to be known as the “Marine Corps of Silicon Valley.”  It was a brawling “take no prisoners,” work hard, party hard, type of company. The founders coming out of the DEC (Digital Equipment Corporation) and Intel culture of the 1960’s and ‘70’s. As an early employee I worked all hours of the day, never hesitated to jump on a “red-eye” plane to see a customer at the drop of a hat, and did what was necessary to make the company a winner.  I learned a lot at Convergent, going from product marketing manager in a small startup to VP of Marketing of the Unix Division as it became a public company.  Two of my role models for my career were in this company.  (And one would become my mentor and partner in later companies.) But this story is not about Convergent.  It’s about entrepreneurship and family.

Like most 20-somethings I modeled my behavior on the CEO in the company.  His marketing and sales instincts and skills seemed magical and he built the company into a $400 million OEM supplier, ultimately selling the company to Unisys.  But his work ethic was legendary. Convergent was a 6-day a week 12-hour day company. Not only didn’t I mind, but I couldn’t wait to go to work in the morning and would stay until I dropped at night.  If I did go to social events, all I would talk about was my new company. My company became the most important thing in my life.

But the problem was that I was married.

Uh oh.

What’s More Important – Me or Your Job?
If you’re are a startup founder or an early employee, there may come a time in your relationship that your significant other/spouse will ask you the “what’s more important?” question. It will come after you come home at 2 am in the morning after missing a dinner/movie date you promised to make. Or you’ll hear it after announcing one morning that weekend trip isn’t going to happen because you have a deadline at work. Or if you have kids, it will get asked when you’ve missed another one of their plays, soccer games or school events because you were too busy finishing that project or on yet another business trip.  At some point your significant other/spouse’s question will be, “What’s more important, me and your family or your job?

I remember getting the question after missing yet another event my wife had counted on me attending. When she asked it, I had to stand there and actually think about it.  And when I answered, it was “my job.”  We both then realized our marriage was over.  Luckily we had no kids, minimal assets and actually held hands when we used the same lawyer for the divorce, but it was sad.  If I had been older, wiser, or more honest with myself, I would have understood that my wife and family should have been the most important thing in my life.

Lies Entrepreneurs Tell Themselves
Part of my problem was that my reality distortion field encompassed my relationships. In hindsight I had convinced myself that throwing myself into work was the right thing to do because I succumbed to the four big lies entrepreneurs tell themselves about work and family:

  • I’m only doing it for my family
  • My spouse “understands”
  • All I need is one startup to “hit” and then I can slow down or retire
  • I’ll make it up by spending “quality time” with my wife/kids

None of these were true.  I had thrown myself into a startup because work was an exciting technical challenge with a fixed set of end points and rewards.  In contrast, relationships were messy, non deterministic (i.e. emotional rather than technical) and a lot harder to manage than a startup.

The Reality
If it was up to my wife she wouldn’t have had me working the hours I was working and would rather have me home.  She didn’t sign up for my startup, she had signed up for me.

While she stuck it out for seven years, she had no connection to the passion and excitement that was driving me; all she saw was a tired and stressed entrepreneur when I got home.

At this point in my career I had hit a couple of successful startups as a low level exec, making enough to remodel our kitchen, but not the big “hit” that made us so much money I could slow down or retire.  And even if it did, startups are like a gambling addiction – if I had been honest, I would have had to admit I would probably be doing many of them.

“Quality time” with the wife or kids is a phrase made up by guilty spouses.  My relationship wasn’t going to be saved by one great three-day weekend after 51 weekends at work.  A great vacation with my wife wasn’t going to make up for being AWOL from home the rest of the year.

Summary
For the next few years I licked my wounds and threw myself into two more startups.  Over time I began to recognize and regret the tradeoffs I had made between work and relationships.  I realized that if I ever wanted to get married again and raise a family that my life/work balance needed to radically change.

The next post describes what I have learned and observed in the following years about balancing my entrepreneurial drive with building a healthy relationship with my wife and kids.

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Am I a Founder? The Adventure of a Lifetime.

When my students ask me about whether they should be a founder or cofounder of a startup I ask them to take a walk around the block and ask themselves:

Are you comfortable with:

  • Chaos – startups are disorganized
  • Uncertainty – startups never go per plan

Are you:

  • Resilient – at times you will fail – badly.  How quickly will you recover?
  • Agile – you may find the real opportunities for your company was somewhere else.  Can you recognize and capitalize on them?
  • Creative / Pattern Recognition – can you think “out of the box?”  Or if not, can you recognize patterns others miss?
  • Passionate – is the company/product/customers the most important thing in your life? 24/7?
  • Tenacious – can you keep going when everyone else gives up? Can you keep giving 200% despite all the naysayers who don’t believe in your idea?
  • Articulate – can you create a reality distortion field and have others see and share your vision and passion?

And I remind them that they should be bringing some type of domain expertise (technical or business) to the table.

This is the minimum feature set for founders.

Other Roles in a Startup
Generic advice given to entrepreneurs assumes that everyone is going to be the founder/co-founder. Yet for every founder there are 10-20 other employees who take the near-equivalent risks in joining an early-stage company.  If you’re not a founder (by choice, timing or temperament,) you may be an early employee or a later stage startup employee.

(And my advice to students who believe they want to do a startup but are unsure if they want to start one, is to join one that’s already raised their first round of funding. Founders know they want to start something.  If you’re unsure, you’ve just decided.)

I believe that founder, early and later stage employees require different risk/personality profile.

The Early Employee
If you’re a founder/co-founder all the attributes I mentioned above are needed in spades.  However, if you want to join a startup as an early employee (say in the first 25 employees,) you can modify the list above.

You still need to be comfortable with chaos and uncertainty, but by this time the major risk of where the first round of funding is coming from is gone.  However, you will be dealing with almost daily change, (new customer feedback/insights from a Customer Development process and technical roadblocks,) as the company searches for a repeatable and scalable business model. This means you still need to have a resilient personality, and be agile.

Early stage employees are “self-starters” and show initiative rather than waiting for other people to tell them what to do or how to do it. (You may be wearing multiple hats in one-day.) You have to be passionate about your work, the company and its mission to be working 24/7. But more than likely you don’t need to be as articulate or creative as the founders (they’re doing the talking, while you’re doing the work.)  And while you do need to be tenacious, you won’t need to be the last man standing if the ship goes down.

The Later Employee
If you want to join a startup as a later employee (say employee number 25-125, before the company is profitable) you can continue to modify the list above.

You still need to be comfortable with chaos and uncertainty.  And you will be dealing with change, but it won’t be the constant daily change the early employees dealt with. By now the company may have found and settled on a repeatable business model. And at this stage of the company rather than everyone doing everything, actual departments may begin to form. However, job responsibilities  and organizations will change regularly and you need to feel comfortable in embracing those changes and taking responsibility and ownership.

And you’ll still need to have a resilient and agile personality, as new customer and product opportunities will appear and change your work.  But it won’t be happening daily.  And while you still need to love what you do your passion doesn’t have to extend to tattooing the company’s logo on your arm.

The Adventure of a Lifetime
Take the time and think through who you are and what level of challenge you are looking for.

You’re not joining a big company.  Startups are the adventure of a lifetime.  But make sure it fits who you are.

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Faith-Based versus Fact-Based Decision Making

I’ve screwed up a lot of startups on faith.

One of the key tenets of entrepreneurship is that you start your company with insufficient resources and knowledge.

Faith-based Entrepreneurship
At first, entrepreneurship is a Faith-based initiative.  There is no certainty about a startup on day-one.  You make several first order approximations about your business model, distribution channels, demand creation, and customer acceptance. You leave the comfort of your existing job, convince a few partners to join you and you jump off the bridge together.

At each startup I couldn’t wait to do this.  No building, no money, no customers, no market?  Great, sign me up.  We’ll build something from scratch.

You start a company on a vision; on a series of Faith-based hypotheses.

Fact-based Execution
However, successfully executing a startup requires the company to become Fact-based as soon as it can.

Think about all the assumptions you’ve made to get your business off the ground.  Who are the customers?  What problems do they have?  What are their most important problems?  How much would they pay to solve them?  What’s the best way to tell them about our product?…

Ad infinitum. These customer and market risks need to be translated into facts as soon as possible.

You can blindly continue to execute on faith that your hypothesis are correct.  You’ll ship your product and you’ll find out if you were wrong when you run out of money

Or you can quickly get out of the building and test whether your hypothesis were correct and turn them into facts.

In hindsight, when I was young, this where I went wrong.  It’s a lot more comfortable to hang on to your own beliefs than to get (or face) the facts.  Because at times facts may create cognitive dissonance with the beliefs that got you started and funded.

Customer Development
This strategy of starting on faith, and quickly turning them into facts is the core of the Customer Development process.


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Vertical Markets 3: Reducing Risk in Startups

This post makes sense when you read the previous two vertical markets posts first.

Reducing Risk – Simulation versus Customer Development
If you remember the first part of this discussion, startups face two types of risk; invention risk and/or customer/market risk.  In either type of startup you want to put in place processes in place to reduce risk.

Simulation to Reduce Invention Risk
If you’re in a vertical where “invention risk” is dominant, then you want to do everything you can to manage and reduce those risks. Simulation allows you to build test, fail, and iterate without actually building the physical device. (You can use static methods like Monte Carlo simulation, or dynamic methods using continuous or discrete simulation.) But however you do it, in companies with invention risk you want to simulate as much of process as possible, as early as possible. For some markets you can design a model of your product on a computer and conduct experiments with the computer model to understand whether it will work, long before you actually build it. For example, in the semiconductor business engineers spend enormous time, money and effort on simulation, the process of actually building the chip in software and running tests to see how well it will perform – well before they ever get to first silicon. And the holy grail of the biotech business is another simulation process called computer aided drug discovery, which someday might be used to streamline the drug discovery and development process. 

Customer Development to Reduce Risk
Conversely, if you’re in a startup where the greatest set of risks are about failing to find the right customers/markets you would look for processes to reduce those risks.  The Customer Development Process I teach and write about is designed to do just that.

Customer Development Diagram

The Customer Development Model

The Customer Development model says that when you start your company customer needs are unknown.  You may have a set of hypothesis about them but you really don’t know.  The Customer Development process puts you in continuous contact with customers to test your concept, fail, and iterate way before you actually ship the product. It allows you to systematically replace each business-critical hypothesis with facts.

(When I wrote the Four Steps to the Epiphany, the Customer Development text, I hadn’t yet thought about what vertical markets it might be appropriate for.)

Since my class was using the Customer Development text, I updated this diagram on to reflect in which markets the process was appropriate.  For example, I told my students doing life sciences projects it would be 5-10 years before they needed to worry about customers. However, for the Web 2.0 companies they needed to start the Customer Development process now.

Customer Development by Vertical - Click to Enlarge

Customer Development by Vertical - Click to Enlarge

(As a reminder, if you’ve slogged you way through the Customer Development textbook, you know the Customer Development process says your business plan is just a series of untested hypothesis (unless you’re a domain expert.)  So starting with the vision of your product, get out of the building, and see if you can find customers and a market for the product as specified. In contract to the linear execution via business plan, the Customer Development process is built on low-cost and continuous learning and iterating.)

Two Sides of the Same Coin
Simulation and Customer Development are simply two sides of the same coin.  They both have offer startups a path of getting it wrong often and early without go out of business.

The next Vertical Markets post will put all the pieces together.

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Vertical Markets 2: Customer/Market Risk versus Invention Risk

This post makes sense when you read the previous vertical markets post first.

Customer/Market Risk Versus Invention Risk
One day I was having lunch with a VC sharing what I learned from my students. “Steve,” he said, “you’re missing the most interesting part of vertical markets.  Our firm has a portfolio of companies across a broad range of markets and the way we look at it is pretty simple – the deals fall into two types: those with customer/market risk and those with invention risk.”

Markets with Invention Risk are those where it’s questionable whether the technology can ever be made to work – but if it does customers will beat a path to the company’s door. 

Markets with Customer/Market Risk are those where the unknown is whether customers will adopt the product.

Based on this insight, I updated my earlier diagram to look like this.  (The line is just a first approximation, nothing hard and fast about it.)

Invention Risk

Market Risk vs. Invention Risk - Click to Enlarge

For companies building web-based products, product development may be difficult, but with enough time and iteration engineering will eventually converge on a solution and ship a functional product - it’s engineering, not invention. The real risk in markets like Web 2.0 is whether there is a customer and market for the product as spec’d.  In these markets it’s all about customer/market risk.

There’s a whole other set of markets where the risk is truly invention. These are markets where it may take 5 or even 10 years to get a product out of the lab and into production. (Whether it will eventually work no one knows, but the payoff could be so large, investors will take the risk.)  If the product does work, and say we’ve developed a drug that cures a type of cancer, your only problem is how big is the licensing deal going to be – not about whether there will be customers. In these markets it’s all about invention risk.

A third type of market has both invention and market risk.  For example, complex new semiconductor architectures, (i.e. a new type of graphics architecture, or a new communications chip architecture) mean you may not know if the chip performs as well as you thought until you get first silicon.  But then, because there might be entrenched competitors and your concept is radically new, you still need to invest in the customer development process to learn how to get design wins from companies who may be happy with their existing vendors.

The implications for entrepreneurs is that each of these (market risk versus invention risk,) require radically different financing models, a different type of venture investor, different timing for hiring sales and marketing, etc.

I now advise entrepreneurs to add these questions to their checklist when they start a company:

  • Am I in a “customer/market risk” company?
  • Am I in a company with “invention risk?
  • Or does my company have both types of risk?
  • How would that change my company strategy?

We’ll talk about how to reduce risk in each type of market in the next post.

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