No Business Plan Survives First Contact With A Customer – The 5.2 billion dollar mistake.

At $5.2-billion Iridium was one of the largest, boldest and audacious startup bets ever made. Conceived in 1987 by Motorola and spun out in 1990 as a separate company, Iridium planned to build a mobile telephone system that would work anywhere on earth. It would cover every city, town and square inch of the earth from ships in the middle of the Arctic Ocean to the jungles of Africa to the remote mountain peaks of the Himalayas. And Iridium would do this without building a single cell tower.

How? With an out-of-this-world business plan. First, the company bought a fleet of 15 rockets from Russia, the U.S. and China.  Next, it  built 72 satellites on an assembly line and used the rockets to launch them into orbit 500 miles above the earth. There the satellites acted like 500-mile high cell phone towers capable of providing phone coverage to any spot on the planet. Seven years after it was founded their satellites and ground stations were in place.  It was a technical tour de force.

iridium satellite network

But nine months after the first call was made in 1998, Iridium was in Chapter 11 bankruptcy. It crashed back down to earth as one of the largest startup failures on record. What went wrong?

We Think We Identified a Large Problem
When Iridium was first conceived inside Motorola in 1987, worldwide cell phone coverage was sparse, calls were unreliable and per minute costs were expensive. Cell phone handsets were the size of a lunch box and cost thousands of dollars.

Motorola Dynatac 8000x ~1987

When it was spun out as a a separate company, Iridium’s 1990 business plan had assumptions about potential customers, their problems and the product needed to solve that problem. All were predicated on the state of the mobile phone industry in 1990. They made other assumptions about the type of sales channel, partnerships and revenue model they would need. And they rolled all of this up into a set of financial forecasts with a “size of market” forecast from brand name management consulting firms that said they’d have 42 million customers by 2002. Iridium looked like it would be printing money when it got its satellites into space.

A Business Plan Frozen in Time
But in the 11 years it took Iridium to go from concept to launch, innovation in mobile phones and cell phone networks moved at blinding speed. By the time Iridium launched, there were far fewer places on the planet where cell phone service was unavailable. Traditional cell phone companies now had coverage in the most valuable parts of the world. Prices for local and international cell service declined dramatically. The size of a cell phone handset had shrunk so it could fit in your pocket.

In contrast, when Iridium’s service became available its satellite phone was bigger than a brick and weighed about the same.

iridium-9500 satellite phone ~1999

Worse, Iridium’s cell phone couldn’t make calls from cars, offices or other buildings since phones had to be used outdoors with a line-of-sight connection to the satellites. But the nail in the coffin was price. Instead of the 50 cents per minute for a regular cell phone, Iridium’s calls cost $7 per minute– plus users needed to pay $3,000 for the handset.

In the eleven years since they had been at work, Iridium’s potential market had shrunk nearly every day. But Iridium’s business model assumptions were fixed like it was still 1990. They were dead on arrival as a mass market cell phone service the day they went live.

No Business Plan Survives First Contact With A Customer
The result was a classic startup failure writ large. Iridium followed its original business plan assumptions off a cliff. Their mistakes?  First, in 1990 the company thought it knew the customer problem to solve, and therefore it  knew what solution to build.

Second, since it knew the solution, it went into a 8-year Waterfall engineering development process. Waterfall development is a sequential way to develop a product (requirements, design, implementation, verification – ship.) Waterfall makes lots of sense in a market with the customer problem is known and all customer needs and product features can be specified up front. It is death in a rapidly changing business. Waterfall development shut off Iridium’s ability to listen, learn, test and adapt to changing customer needs and a rapidly changing market place.

Third, its business plan had no notion of learning and discovery. The idea of iteration or pivots was unthinkable. This business plan was a static document.  It was great for fundraising, looked great in business schools and large companies, but completely broke down when confronted by the realities of the changing mobile phone business.  When the company launched, it ran into diminishing customers and markets that didn’t correspond to its business plan and financial projections, but it had no ability to pivot and change their business model.  A Customer Discovery and Validation process that was ongoing with product development could have provided early warning that its market was not developing in Iridium’s favor.  Instead management was more comfortable executing to the plan.

It All Came Crashing Down
All this, plus the corporate hubris of having raised billions of dollars, with no adult on either Iridum’s or Motorola’s board who was asking “does this still make sense?” resulted in a disaster. Instead of the 42 million customers called for in its business plan, Iridium had 30,000 subscribers at its peak. The company burned its way through more than $5.2-billion because it fell in love with technology, succumbed to Waterfall product development and never bothered to get out of the building, get their heads out of their spreadsheets and ask, “What do customers want today?”

In 2000, new investors bought Iridium’s satellites and network for $25-million, or one half of one percent of the invested capital. Today, the successor company serves some 300,000 customers in a series of niche markets including American soldiers calling home from war zones, oil rig managers, and big game hunters.

Customer Development, Business Model Design and Agile Development could have changed the outcome.

Lessons Learned

  • Business plans are the leading cause of startup death
  • No Business Plan survives first contact with a customer
  • Rapidly changing markets require continuous business model iteration/customer development
  • Your ability to raise money has no correlation with customer adoption

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Checklists for Chaos, The Path to Success

In a startup the search for a business model is chaotic, unpredictable and uncertain. Yet the Customer Development process uses a series of checklists to ensure that you walk through the Customer Discovery and Validation steps. In addition it explicitly calls for synchronization and confirmation of the steps by the entire team.

Surely a checklist and discussion gets in the way of progress in a fast moving startup? Here’s how using it helped E.piphany rather than hindered it.

Tell Them What You’re Hearing
When E.piphany was a small struggling startup in Mountain View, we had a weekly Friday afternoon beer and wine fest, no different than what hundreds of other startups were doing. (Insurance companies in the valley should check the accident rates for Friday traffic.) The company headcount was mostly engineers accomplishing the impossible on a regular basis while a few of us were outside the building trying to do what we would call today Customer Discovery and Validation.

A Checklist for Chaos
While all startups are chaotic, we had been through enough of them (E.piphany was my 8th) to realize that we could understand our potential customer better if we had a standard checklist and process of how to approach complex enterprise sales. These started with the business model hypotheses in Customer Discovery (who’s the customer, channel, pricing model, etc.)

Customer Hypothesis Checklist

I remember that for the first few weeks of the company, my partner Ben and I would give the usual rah-rah platitudes about how great things were going to motivate the engineers.  Then one week Ben turned to me and said, “Why don’t you really tell them what you’re doing and what you’re hearing.”  Uh oh. Thinking about all the ups and downs of sales in a startup and twists and turns in strategy and positioning I wondered if it would be demoralizing. “Do you think they can handle the truth?”  We talked about it and realized our motto for our weekly meeting would be, “Don’t panic when we change the strategy. Only panic if we ask you to rearchitect the product.”  (Today’s version would be “Don’t worry when we pivot the business model, only panic if we ask you to develop the product with a Waterfall methodology.”)

Sharing the Checklist
Soon after, our Friday’s meetings would start with me describing the highs and lows of the week: who we called on, what they said and what happened (essentially walking engineering through the series of checklists as we went through Customer Discovery and Validation. And what I had to report was mostly us getting a “not interested” or “we don’t get it” from a prospective customer.

Almost immediately the most unexpected things started happening at our Friday meetings.

Don’t Treat Them Like Mushrooms
First, I thought that not pumping up engineering every week would demotivate the team. Reality turned out 180 degrees from what I expected. Engineering was much smarter. When it became clear that my partner and I were not going to treat them like mushrooms (keep them in the dark and feed them sx!t) but let them know what was really going on, they engaged on a much different level.

You’re Explaining it Wrong
Second, as I was reporting on my sales calls a few of the engineers realized that I was describing technical professionals in large companies who were just like them. When I detailed how I was explaining the product, our own engineers said, “You’re explaining it wrong. Even I wouldn’t buy it from us if you told me that.” The first time I heard that I was speechless. Who the hell were these engineers telling me how to market and sell our product?  My first instinct was to cycle through all the “my business card says I’m the expert here and you just write code.”

Then I realized – they were right. Our engineers were just like the customer, and if they didn’t think our product description made sense, no one else would.  So in front of the entire company, I threw out our positioning and we started to discuss how to better articulate what we were doing. (I think we invented our meta-data architecture diagram that Friday.) It was great to realize that instead of just me trying to figure out customer feedback, that every Friday I’d have the collective wisdom of engineering engaged.

Confirming the Checklist
Synchronizing our Discovery and Validation had a third benefit. Engineering now felt that they had a stake in making the process better and took a great interest in that mysterious and elusive “customer.”  Soon engineers were spending lots of time talking to customers. More importantly they had a vested interest in getting the process right.

Synchronizing the Discovery and Validation checklists with the entire company made us collectively smarter, faster and gave us a shared understanding of our objective – build great products that customers wanted.

Checklists and synchronization were part of the reason why we grew from $0 to $125 million in three years.

Lessons Learned

  • Customer Discovery and Validation in any type of startup requires a series of checklists (see Appendix B of the Four Steps to the Epiphany)
  • The checklists require the team to share their findings for confirmation and synchronization

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Entrepreneurship as a Science – The Business Model/Customer Development Stack

Over the last 50 years engineers have moved from building computers out of individual transistors to building with prepackaged logic gates. Then they adopted standard microprocessors (e.g. x86, ARM.) At the same time every computer company was writing its own operating system.  Soon standard operating systems (e.g. Windows, Linux) emerged. In the last decade open source software (e.g LAMP) emerged for building web servers.

Each time a standard solution emerged, innovation didn’t stop. It just allowed new innovation to begin at a higher level.

In this post I want offer a solution stack for Entrepreneurship. It’s the combination of Business Model Design and Customer Development.

Business Model Design
Today every business organization from startup to large company uses the words “business model.”  Some use it with certainty like they know what it means. Others use it with an implied question mark realizing they don’t have a clue to its components.

Alexander Osterwalder and Yves Pigneur defined a business model as how an organization creates, delivers, and captures value. More importantly they showed how any company’s business model could be defined in 9 boxes. It’s an amazing and powerful tool.  It instantly creates a shared visual language while defining a business.  Their book “Business Model Generation,” is the definitive text on the subject.  (And their forthcoming Business Model Toolbox is a killer iPad app for business strategy.)

Business Model Canvas

Yet as powerful as the Business Model Canvas (a template with the nine blocks of a business model) is, at the end of the day it was a tool for brainstorming hypotheses without a formal way of testing them.

Business Model Design Gets Dynamic, Customer Development Gets Strategic
One of the key tenets of Customer Development is that your business model is nothing more than a set of untested hypotheses.  Yet Customer Development has no structured and systematic way of describing a business model.

In the last year I found that the Osterwalder Business Model canvas could be used for something much more than a static planning tool.  I realized that it was the launch-pad for setting up the hypotheses to test, and a scorecard for visually tracking iterations and Pivots during Customer Discovery and Validation.

Meanwhile on the other side of the world Alexander Osterwalder was coming to the same conclusion: tying the two processes together would create a “strategy stack for entrepreneurship.”  We got together this weekend (along with our partners Alan Smith and Bob Dorf and my student Max Marmer) to try to integrate the two.

Business Model Design Meets Customer Development
In its simplest form the way to think about the intersection of the two processes is that you start by designing your business model.  Next, each one of the 9 business model canvas boxes then directly translates into a set of Customer Discovery hypotheses that are described in Customer Development and the Four Steps to the Epiphany.

Business Model Design meets Customer Development

Pivots and Iterations
Many entrepreneurs assume that the assumptions in their original business model (or business plan if they wrote one) will be correct.  Confronting the reality that one of these hypotheses is wrong (finding out you have the wrong sales channel, revenue model, target market or customer) creates a crisis.

Pivots are Business Model Insights

Tying Osterwalder’s Business Model Canvas with the Customer Development process turns these potential crises into learning opportunities called the Pivot. Customer Development forces you to get out of the building and discover and validate each one of the assumptions behind the business model. A Pivot is when reality leads you to change one or more business model hypotheses.  The result is an updated business model not a fired VP of Sales.

The Pivot turns a failed business model hypotheses into insight.

The Business Model/Customer Development Stack
We’ll have more to say about combing these two methodologies in future posts.

Lessons Learned

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Who’s An Entrepreneur-Talk with the Kauffman Foundation

The Kauffman Foundation is the leading private funder of economic research related to growth and innovation in the United States. (Translation: They write checks for $100 Million dollars a year.) The Churchill Club, Silicon Valley’s largest public affairs organization, invited Carl Schramm, president and CEO of the Kauffman Foundation and I to talk about entrepreneurship. (The official title of the talk was Fresh Perspectives on Entrepreneurial Innovation and Economic Growth.) Rich Karlgaard, publisher of Forbes and co-founder of the Churchill Club refereed the event.

Carl has been been shaking up the staid world of academic entrepreneurship research for over 8 years as the head of the foundation. I think the expectation was that putting the two of us together would see the fur fly.

Instead of a brawl it turned out to be collegial, entertaining and informative.

BTW, the definition of entrepreneurship I describe at 2:50 into the video is described in detail in the post “You’re Not a Real Entrepreneur.”

Here’s a 6 minute excerpt from the talk.


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Requiem For A Roommate

And, when he shall die, Take him and cut him out in little stars,
And he will make the face of Heaven so fine
That all the world will be in love with night
And pay no worship to the garish sun.
William Shakespeare

Last week I had my “public servant” hat on in my official capacity as a California Coastal Commissioner.  Walking out after a 13-hour hearing, one of my fellow commissioners asked, “Why on earth do we do this?” As I got back to the hotel, I found myself wondering the same thing.  What ever got me interested in public service and non-profits? As I tried to unwind, I turned on the hotel TV and caught part of an old movie, The Big Chill.

It reminded me that I volunteer my time because of a gift I had received my first year in college.

Unshakable Certainty
I had never been outside of New York so to me Michigan seemed like a foreign country. On the first day of college I wandered down my dorm hall introducing myself and met Michael Krzys, the guy who would one day be the best man at my wedding, making a salad on the floor of his room.  I provided the bowl and as we started talking, I was fascinated that he was from Adrian Michigan, a quintessential small town in the Midwest. He was equally curious about someone who grew up in New York. As we got to know each other, I pretty quickly I realized that I had met my match, someone with even more curiosity, creativity and a wry sense of humor.  As best friends our freshman year, we did all the crazy things that first year college students do (things I still won’t tell my kids.)

But as I got to know Michael, there was another, completely foreign part of him I didn’t understand. (It would take me another 30 years.) From the day I met him he had a commitment to public service that was deep, heartfelt, profound, unshakable and to me, mysterious and completely unfathomable. Even as a freshman, Michael already knew that his calling was to help others and to do so he was determined to become a public service lawyer. It confused and unnerved me to know someone with so much certainty about the meaning and direction of his life.  It couldn’t have been more different from mine.

After our first year our lives took different paths. When they would touch again, it would be in ways neither of us could have predicted.

Different Paths
With the Vietnam War going full tilt, I left school and joined the Air Force, spending a year and a half in Southeast Asia. Michael and I kept in touch via letters – me telling him about adventures in the military, fighter planes, electronics and foreign countries. His letters explained to me why I was an idiot, war was immoral and that while he appreciated my dedication to national service, it was public servicethat was the higher calling. Each of his letters ended with him reminding me that I was destined for a different career.

When I got back from Thailand the war was winding down and Michael was now in the University of Michigan Law School (having finished his undergrad degree in 3-years.) For my last year in the Air Force, I was stationed on a B-52 bomber base, 183 miles from Ann Arbor. I knew the exact mileage as I would drive it every weekend to see my girlfriend and hang out with Michael. Over dinner we’d argue about politics, talk about how to best save the world, and he’d tell me what he was learning that week in his law school classes.  I remember when he taught me the best way to understand an issue was to learn how to argue both sides of a case.

It didn’t take long before he was loaning me his last quarter’s law books to read during the week at the airbase where I was keeping the world safe for democracy.  (While students in law school were hiding their Playboy magazines inside their law books, I’m probably the only guy who had to hide his law books from fellow airmen under a pile of Playboy magazines.)

Remove the Tag
In his last year in law school, the high point for Michael was arguing his first pro bono case in Detroit for a tenant who he claimed was being illegally evicted. (In Michigan law students could appear and practice in limited court settings under the supervision of an admitted attorney.) When I drove down to Ann Arbor that weekend, I was regaled with Michael’s tale of his passionate defense of his first client as he stood in front of the judge waving his arms for effect in his first-ever sports coat. Michael said he was ecstatic that the judge ruled in his favor, but was a bit confused when the judge motioned him to approach the bench.  In a low voice the judge said, “Son, that was a pretty good argument for a law student. However the next time you’re in court, you may want to remove the price tag from the sleeve of your sports coat.”

When I got out of the military and went back to school, Michael was finishing up law school, and a year later he and his new wife headed to the South to work for Georgia Legal Services in McIntosh County in Georgia. I moved to Silicon Valley, and we kept up a sporadic correspondence, me trying to explain startups and Michael telling me about the world of civil rights and equal justice for the poor. If possible it seemed like his excitement for what he was doing matched mine.  I just didn’t understand why he did it.

It’s a Calling
For entrepreneurs, understanding why people dedicate their lives to working for non-profits is hard to fathom. Why work for low pay, on something that wasn’t going to deliver a product that would change the world?

Today, each time I see the staffs of those non-profits where I’m on the board, I get a glimpse of that same passion, commitment and sense of doing right that I first heard my freshman year decades ago.  For the best of them, it’s not a job, it’s a life-long calling.  The executive directors of the Coastal Commission and POST remind me of what Michael might have become.

A Life Worth Living
One fine California April day in 1981, three years in Silicon Valley now into my second startup, I got a call from someone in Michigan who had been trying to track me down.  Michael and his wife were bringing some kids to camp, and he was killed in a head-on car accident with a drunk driver.  His wife and the kids survived.

It took me a long time, but as I got older I realized that life was more than just about work, technical innovation and business. Michael and others worked to preserve and protect the values that made life worth living.  And while we were making things, they were the ones who were who changing our society into a more just place to live.

There isn’t a day that goes by on the Coastal Commission that I don’t wonder what Michael Kryzs would do. To this day he is my model as a human being who found his own compass.

I always hoped that mine would point in the same direction.

Update: after three decades I finally got to give Michael a memorial even he would have thought was fitting and proper. I established the Michael Krzys Public Interest Fellowship at the University of Michigan Law School. Details here

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Too Young to Know It Can’t be Done

The young do not know enough to be prudent, and therefore they attempt the impossible – and achieve it, generation after generation.
Pearl S. Buck

Ask people what makes entrepreneurs successful and you’ll hear a familiar list of adjectives; agile, tenacious, resilient, opportunistic, etc.

What you don’t hear is that often they didn’t know any better.

It Can’t Be Done
I was just rereading Jessica Livingston’s book Founders at Work, and a common thread through the stories reminded me that there is a type of technology innovation that occurs in startups when a founder/team simply doesn’t know what they’re attempting is impossible.

Steve Wozniak at Apple building the Apple II floppy disk controller without ever seeing one. The original Fairchild Semiconductor team of Moore and Hoerni racing to build the first silicon diffused PNP and NPN transistors and ending up with Planar transistors and integrated circuits. The list of “I just did it without knowing it was impossible” appears time and again as a common thread in stories about technology innovation.

I got to see this first hand, when I was lucky enough to be present as an incredibly small team designed and built the Zilog and MIPS microprocessors.  And at Ardent I watched an equally minuscule company tackle building a supercomputer and at again at E.piphany building a data warehouse.

Almost all these innovations were built by people in their 20’s with a few of the old-timers in their 30’s. (One of the common themes was the physical effort to get these projects completed –  entrepreneurs staying up for days to finish a project and/or sleeping at work until it shipped.) I flew more red-eyes than I can remember, and also had days where I just slept in the office with the engineers.

Age Means Wisdom
It’s not that older entrepreneurs can’t start or build innovative companies – of course they can. Older entrepreneurs just work smarter and strategically. (Though my hypothesis is that funding from risk capital sources – angels and VC’s- don’t follow a normal distribution curve for older founders.)

And if they’re really strategic older founders hire engineers in their 20’s and 30’s who don’t know what they’ve been asked to do is impossible (exactly the strategy of my partner Ben at E.piphany.)

Older Means You Know Too Much
However, as I’ve gotten older I’ve observed that it’s not just that stamina that changes for entrepreneurs. One of the traps of age is growing to accept the common wisdom of what’s possible and not. Accumulated experience can at times become an obstacle in thinking creatively. Knowing that “it can’t be done” because you can recount each of the failed attempts in the last 20 years to solve the problem can be a boat anchor on insight and imagination. This not only effects individuals, but happens to companies as they age.

When you’re young anything seems possible.

And at times it is.

Lessons Learned

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Strategy is Not a To Do List

I had breakfast with two of my ex-students from Singapore who were building a really interesting startup. They were deep into Customer Discovery and presented a ton of customer data on the validity of their initial hypothesis – target customers, pricing, stickiness, etc.  I was unprepared for what they said next. “We’re going to do a big launch of our product in three weeks.”  I almost dropped my coffee. “Wait a minute, what about the rest of Customer Development? Aren’t you going to validate your hypotheses by first getting some customers?”

Without any sense of irony they said, “Oh, our investors convinced us to skip that part, because our customer feedback was all over the map and our schedule showed us launching in three weeks and they were worried that we’d run out of cash. They told us to stay on schedule.”  Now I was confused, and I asked, “Well what do you guys believe – Customer Development or launch on a schedule?” Without missing a beat they said, “Oh, we believe both are right.”

I realized I was listening to them treat Customer Development as an item on their
To Do list.

Suddenly, I had a massive case of déjà vu.

Can You Pull This Off
I was VP of marketing at Ardent, a supercomputer company where a year earlier I had a painful and permanent lesson about Customer Discovery. I was smart, aggressive, young and a very tactical marketer who really hadn’t a clue about what strategy actually meant.

One day the CEO called me into his office and asked, “Steve I’ve been thinking about this as our strategy going forward. What do you think?” And he proceeded to lay out a fairly complex and innovative sales and marketing strategy for our next 18 months.  “Yeah, that sounds great,” I said. He nodded and then offered up, “Well what do you think of this other strategy?” I listened intently as he spun an equally complex alternative strategy. “Can you pull both of these off?” he asked looking right at me.  By the angelic look on his face I should have known that I was being set up. I replied naively, “Sure, I’ll get right on it.”

Ambushed
25 years later I still remember what happened next. All of sudden the air temperature in the room dropped by about 40 degrees.  Out of nowhere the CEO started screaming at me, “You stupid x?!x. These strategies are mutually exclusive. Executing both of them would put us out of business.  You don’t have a clue about what the purpose of marketing is because all you are doing is executing a series of tasks like they’re like a big To Do list. Without understanding why you’re doing them, you’re dangerous as the VP of Marketing, in fact you’re just a glorified head of marketing communications.”

I left in daze angry and confused. There was no doubt my boss was a jerk, but unlike the other time I got my butt kicked, I didn’t immediately understand the point. I was a great marketer. I was getting feedback from customers, and I’d pass on every list of what customers wanted to engineering and tell them that’s the features our customers needed. I could implement any marketing plan sales handed to me regardless of how complex. In fact I was implementing three different ones. Oh…hmm… perhaps I was missing something.

I was doing a lot of marketing “things” but why was I doing them?  I had approached my activities as simply as a task-list to get through. With my tail between my legs I was left to ponder; what was the function of marketing in a startup?

Strategy is Not a To Do List, It Drives a To Do List
It took me awhile, but I began to realize that the strategic part of my job was two-fold. First, (in today’s jargon) we were still searching for a scalable and repeatable business model. My job was to test our hypotheses about who were potential customers, what problems they had and what their needs were. Second, when we found these customers, marketing’s job was to put together the tactical marketing programs (ads, pr, tradeshows, white papers, data sheets) to drive end user demand into our direct sales channel and to educate our channel about how to sell our product.

Once I understood the strategy, the To Do list became clear. It allowed me to prioritize what I did, when I did it and instantly understand what would be mutually exclusive.

Good Luck and Thanks For the Fish
My students were going through the motions of Customer Development rather than understanding the purpose behind it. It was trendy, they had read my book and to them it was just another step on the list of things they had to do. They had no deep understanding of why they were doing it.  So they were at a crossroads. Since their investors had asked them to launch now, what happened if their initial assumptions were wrong?

As they left I hoped they would be really lucky.

Lessons Learned

  • Entrepreneurs get lots of great advice.
  • Most of it is mutually exclusive.
  • Don’t do it if you can’t explain why you’re doing it.
  • Or else it all becomes a To Do list.

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Why Pioneers Have Arrows In Their Backs

First-Mover Advantage is an idea that just won’t die. I hear it from every class of students, and each time I try to put a stake through its heart.

Here’s one more attempt in trying to explain why confusing testosterone with strategy is a bad idea.

First mover advantage – great bad idea
The phrase “first mover advantage” was first popularized in a 1988 paper by a Stanford Business School professor, David Montgomery, and his co-author, Marvin Lieberman.[1]

This one phrase became the theoretical underpinning of the out-of-control spending of startups during the dot-com bubble. Over time the idea that winners in new markets are the ones who have been the first (not just early) entrants into their categories became unchallenged conventional wisdom in Silicon Valley. The only problem is that it’s simply not true.

The irony is that in a retrospective paper ten years later (1998), [2] the authors backed off from their claims. By then it was too late. Using this idea to differentiate themselves as the hot new Silicon Valley VCs, some of his former business school students made this phrase their rallying cry. Soon every other VC was using the phrase to justify the reckless “get big fast” strategies of dot-com startups during the Internet Bubble.

Fast Followers – a better idea
In fact, a 1993 paper by Peter N. Golder and Gerard J. Tellis had a much more accurate description of what happens to startup companies entering new markets.[3] In their analysis Golder and Tellis found almost half of the market pioneers (First Movers) in their sample of 500 brands in 50 product categories failed. Even worse, the survivors’ mean market share was lower than found in other studies. Further, their study shows early market leaders (Fast Followers) have much greater long-term success; those in their sample entered the market an average of thirteen years later than the pioneers. What’s directly relevant from their work is a hierarchy showing what being first actually means for startups entering new or resegmented markets:


Innovator First to develop or patent an idea
Product Pioneer First to have a working model
First Mover First to sell the product 47% failure rate
Fast Follower Entered early but not first 8% failure rate

The Race to Fail First
What this means is that first mover advantage (in the sense of literally trying to be the first one on a shelf or with a press release) is not real, and the race to be the first company into a new market can be destructive. Therefore, startups whose mantra is “we have to be first to market” usually lose. What startups lose sight of is there are very few cases where a second, third, or even tenth entrant cannot become a profitable or even dominant player. (The rules are different in the life-sciences arena.)

Ford vs. GM, Overture vs. Google
For example, Ford was the first successfully mass produced car in the United States. In 1921, Ford sold 900,000 Model Ts for 60 percent market share compared to General Motors 61,000 Chevys, a 6 percent market share. Over the next ten years, while Ford focused on cost reductions, General Motors built a diverse and differentiated product line. By 1931 GM had 31% of the market to Ford’s 28%, a lead it has never relinquished.  Just to make the point that markets are never static, Toyota, a company that sold its first car designed for the US market in 1964, is poised to surpass GM as the leader in the US market. The issue is not being first to market, but understanding the type of market your company is going to enter.

If the car business is too removed from high tech as an example, how about the story of Overture. In 1998 Goto.com, a small startup (later Overture, now part of Yahoo!), created the pay per click search engine and advertising system and demo’d it at the TED conference.

It was not until October 2000 that Google offered its version of a pay per click advertising system  -AdWords -allowing advertisers to create text ads for placement on the Google search engine.

Google is a $25 billion dollar company with most of its revenue from AdWords.

Overture was acquired by Yahoo for $1.6 billion.

Implicit Customer Discovery and Validation in Fast Followers
Why do fast followers win more often?  It’s pretty simple. First Movers tend to launch without really fully understanding customer problems or the product features that solve those problems. They guess at their business model and then do premature, loud and aggressive Public Relations hype and early company launches and quickly burn through their cash.. This is a great strategy if there’s a bubble occuring in your market or you are going to bet it all on flipping your company for a sale. Otherwise the jury is in. There’s no advantage. [4]

Astute fast-followers recognize that part of Customer Discovery is learning from the first-mover by looking at the arrows in their backs. Then avoiding them.

Lessons Learned

  • Believing in First Mover Advantage implies you understand your business model, customers problems and the features needed to solve those problems.
  • That’s unlikely.
  • Therefore you’re either going to burn through your cash or pray that the hype can help you can flip your company.
  • None of the market leaders in technology were the first movers

[1] Montgomery, M. Lieberman.1988  “First Mover Advantage.” Strategic Management Journal, Volume 9, Issue S1, pages 41–58, Summer 1988.

[2] Montgomery, M. Lieberman “First-mover (dis)advantages: retrospective and link with the resource-based view.” Strategic Management Journal Volume 19, Issue 12, pages 1111–1125, December 1998

[3] P. N. Golder and G. J. Tellis. 1993. “Pioneer Advantage: Marketing Logic or Marketing Legend?” Journal of Marketing Research, 30(2):158–170.

[4] Did First-Mover Advantage Survive the Dot-Com Crash? . M. Lieberman 2007

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Less is More, More or Less

In Customer Development the goal of a minimum feature set is to pare the features of the first product release to the minimum necessary for early customers.

But finding what those “minimum” features are can be an adventure.

All the Data and Not a Drop to Think
We started Epiphany to solve the “too much data but not enough insight” problem. During the 1990’s large corporations had bought different software applications to automate each part of their enterprise – finance, customer support, manufacturing, sales, etc. Yet the data these applications collected were accessed via reporting tools from the IT organization. More importantly, the data existed in “virtual silos” with each functional system walled off from the other. The finance system didn’t talk to the sales system which didn’t know the manufacturing system even existed. (Queries like – compare the sales data of green dresses versus the blue ones, with how many of each does manufacturing have in inventory, and what does finance say the gross margin by region of these product are – would be hard to answer because it required combining data from three incompatible applications.) It might take days or even weeks to get a report. And if that question led to another one, add more days or weeks to get the next answers back. And once you got the data you asked for, it still took weeks or months for a marketer to tease out any customer insight and trends from the data. And if you actually want to respond to shifting customer behavior by running a new marketing campaign (ads, email, etc.,) it would again take weeks or months.

An Epiphany
Initially our engineering team designed three products to solve these problems: an On-Line Analytical Processing (OLAP) tool – think of it as a multi-dimensional Excel to search through reams of customer data, data mining tools to search for patterns in customer data, and a campaign manager to combine all the data and generate customer specific ads/emails. And underneath these products was our own data warehouse (a place to store all this different data) and our own tools to Extract, Transformation and Load (ETL) customer information from existing enterprise applications like SAP, PeopleSoft, Oracle Financials, etc. And back then the radical notion was that you could view this information anytime and anywhere through this new technology called a web browser.

You’re An Idiot
As a founder my first job was Customer Discovery – getting out of the building to listen to customers and see whether our understanding of what problems customers had was correct, and if so whether our product as spec’d would solve that problem.  Over time one of our hypothesis was that our product should be a great fit for companies who had lots of customers, tons of data on them and wanted to quickly come up with new marketing campaigns.

We had put together an advisory board, and one of our advisors was the VP of Database Marketing at Schwab. She was incredibly generous with her time and said that our system might work in their application. She introduced me to five other Database Marketing executives who essentially said, “If you get a system working at Schwab, we’ll have to buy one as well.” You couldn’t get much better than that. I thought we had found our first Earlyvangelist and first market.

But each time we met and she looked at the technical details of our system, and politely told me I was an idiot and my engineering department was even dumber. It took two meetings before I finally got what she was trying to tell me – we understood her problem all right, but our architecture was missing the most important feature to solve it. Our database schema didn’t include “householding” and without this feature was she could never buy our system. (Householding means recognizing that two or more people at the same physical address live together. This feature was crucial to direct marketers who did not want to send multiple ads to the same address.) Our data warehouse didn’t have the concept of householding in its schema. And no amount of sales and marketing hand waving was going to fix the problem.

Founder Too
My engineering co-founder and I had a great relationship. If I thought I discovered a customer with a feature we were missing he was coming out to hear it himself.  Just don’t waste his time on the first “getting to know you” meetings. We had agreed that Schwab and the database marketing application sounded like the right fit for the technology so he was as eager as I was to figure out what we were missing. So now, a week later, he’s in San Francisco with me listening to the Schwab VP of Database Marketing and her engineering team go into a deep technical dive about what our software needed to do. My partner asked five or ten questions, everybody nods and the meeting was over.

What Do You Mean Page 6?
We got back into my car for the drive back from San Francisco to our office in Silicon Valley. 5 miles goes by and we’re talking about the weather. 10 miles goes by and he’s talking about his kids, and 20 miles goes by and we’re talking about my kids.  Finally, unable to stand it any longer, I ask, “Ben, what are we going to do about the Householding feature that Schwab asked for?”  In an innocent and deadpan voice, he replied, “Well just take a look at page 6 of our spec.” I had to think for another couple of seconds until I said, “What do you mean page 6? Our spec only has 5 pages!”

He looked at me and smiled as he said, “Not any more.”

Our first order from Schwab came the next week.

We had just iterated the product and refined the minimum feature set.

A week later we sat down to figure out what other feature we would toss out to make room for this one.

Lessons Learned

  • Founders’ start with a hypothesis of what the minimum feature set is.
  • Your customers teach you which features actually matter by whether they will buy.
  • You swap (not add) features as you learn what will optimize market share of earlyvangelists.

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Panic at the Pivot – Aligning Incentives By Burning the Boats

It’s a paradox, but early sales success in a startup can kill its chances of becoming a large successful company. The cause is often sales and marketing execs who’ve become too comfortable with an initial sales model and panic at the first sign of a Pivot. As a result they block new iterations of the business model that might take the company to the next level.

Fairchild
As I was reading a history of the startup years of Fairchild Semiconductor, I realized that a problem I thought was new – sales as an obstacle to Pivots – had occurred 50 years ago at the dawn of what would become Silicon Valley.

Fairchild, the first successful semiconductor company in the valley, was founded on two technical innovations: manufacturing transistors out of Silicon instead of the then conventional Germanium, and using a diffusion manufacturing process which enabled the production of silicon mesa transistors in batches on assembly line. (While this might sound like Greek to you, it was a revolution.)

Early on, the young company made a dramatic technical pivot when it discovered a way to build silicon planar transistors that dramatically improved reliability. (This was an even bigger revolution.) This increased reliability qualified Fairchild’s transistors for military weapons systems (airborne electronics, missile guidance systems, etc.) With orders from military subcontractors arming the cold war, Fairchild’s sales skyrocketed from $500K in 1958  to $7M in 1959 to $21M in 1960.

By the end of 1960, Fairchild was at the top of its game. In less than three years from the day it started, the company had pivoted its technology process, sales had done a masterful job of Customer Discovery and had found a sweet spot in the market and its fabrication plants were busy turning out as many transistors and diodes as they could make.

What could go wrong?

It was when engineering Pivoted again. And this time sales revolted.

The Revolution Will Not Be Televised
When Fairchild engineers realized that its planar process of manufacturing individual transistors could now be connected together on a single piece of silicon, the Integrated Circuit was born. Engineering thought this could dramatically change the way electronic systems were built, but the head of sales tried to kill the Integrated Circuit program, loudly and vociferously. Engineering was confused, why didn’t the Fairchild salesforce want a revolutionary new product line?

Over My Dead Body
From the point of view of the sales organization this new family of integrated circuits were a major distraction. The Fairchild sales team was on a roll executing a known business model – selling planar diodes and transistors into an existing market. In the transistor market, the problem was known, the customer was known and the basis of competition was known (technical features, price and delivery schedule.)

Integrated circuits were different. Unlike transistors, no one in 1960 was clamoring for the new technology. Integrated circuits were a new market. It wasn’t clear exactly what problem the product would solve, or who the customer was. In fact, the most likely customers, computer designers were openly hostile as they saw integrated circuits doing what they were supposed to be doing – designing circuits.  So selling integrated circuits meant a search for a business model.

This meant that a high testosterone sales team that was busy “executing” as order takers and deal makers had to put on a different hat and become educators and consultative engineers.  No way.

You Get What You Incent
What the engineers also didn’t know is that the head of Sales of Fairchild had cut a great deal on his compensation package. He was paid 1% of gross sales. While this made sense in the first few years when Fairchild was a startup, now it had unintended consequences. His salesmen were also compensated on a commission basis. Why would they want a product they had to force customers to take when they had existing products that were making them rich?

The VP of sales’ incentives led him to stifle any innovation that got in the way of selling as much of the current technology as he could – even if it meant killing the future of the company. Luckily for Fairchild and the future of the semiconductor and computer business, he quit when his compensation plan was changed.

The Land of the Living Dead
I see this same pattern in early stage startups. Early sales look fine, but often plateau. Engineering comes into a staff meeting with several innovative ideas and the head of sales and/or marketing shoot them down with the cry of “It will kill our current sales.”

The irony is that “killing our current sales” is often what you need to do. Most startups don’t fail outright, they end up in “the land of living dead” where sales are consistently just OK but never breakout into a profitable and scalable company. This is usually due to a failure of the CEO and board in forcing the entire organization to Pivot. The goal of a scalable startup isn’t optimizing the comp plan for the sales team but optimizing the long-term outcome of the company. At times they will conflict. And startup CEO’s need a way to move everyone out of their comfort zone to the bigger prize.

Burn The Boats
In 1519 Hernando Cortes landed in the Yucatan peninsula to conquer the Aztec Empire and bring their treasure back to Spain. His small army arrived in 11 boats. As they landed Cortes solved the problem of getting his team focused on what was ahead of them – he ordered them to burn the boats they came in. Now the only way home was to succeed in their new venture or die.

Pivots that involve radical changes to the business model may at times require burning the boats at the shore.

——

Every chip company in Silicon Valley is descended from Fairchild.

Lessons Learned

  • Sales organizations may get too comfortable to early.
  • Sales execs execute to their compensation plans.
  • Pivots are not subject to a vote in the exec staff meeting.
  • CEO’s and their boards make the Pivot decisions.
  • To force a Pivot burn the boats at the shore.

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