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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7 Responses

  1. Getting feedback from customers is an obvious thing todo; but I know that it doesn’t happen very often. Is there any particular reason for this? I wonder if it is the psychology of not asking for directions while driving; 🙂 if that’s the case, I wonder if women are better at customer development.

    • Naveen,
      My personal experience says it may be because entrepreneurs are driven to bring their ideas to fruition – at all costs -regardless of the odds, risks, nay sayers, lack of capital, etc.

      Ignoring the impossible to make a startup happen sometimes means ignoring all the facts staring you in the face as well.

      Being able to sort out which common wisdom you want to listen to versus which you want to ignore, makes starting a company an art, not a science.


  2. I would be interested in how a 2 sided market fits into your approach.

    Is it just as simple as applying your methods to both constituents?

    • If by two-sided market you mean something like Ebay where there are buyers and sellers, or the medical device market where there are the patients, the doctors and the insurance companies? If so, yes Customer Development allows you to explore all sides of those markets – and at times uncovering who the real customer is. For example, in medical devices the patient surprisingly doesn’t make the list.

      Multi-sided markets just take longer to Discover and Validate.

      And keep in mind that in these markets who’s important may shift over time.


  3. A two-sided market would imply a need for technical evanglism in one of the markets.

    Moore used client engagements as the mechanism for risk reduction before entering the vertical market. This approach works for software. I can see where it would be much more difficult to use this approach in biotech. Still, the Mayo clinic seemed to be a platform for product introductions.

    I would warn those that try to sell a raw technology that it is far easier to embed the technology in a product defined by a client. Technology adoption occurs because the products are bought. The underlying technology layer can remain a black box until you move into the horizontal market.

    Moore’s bowling alley is another risk reduction mechanims as you build from a collection of verticals towards the horizontal market. The applications in the bowling alley would not necessarily be similar. They would all reply on the same technology laryer.

  4. Hi Steve,

    “The Customer Development model says that when you start your company customer needs are unknown.”

    Have you heard about Outcome Driven Innovation?

    best regards,

  5. […] Additionally, the point about the 10xers taking less big risks reminds me of Steve Blank’s point that startups focus on reducing risk wherever possible, whether that be invention or market risk. […]

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