Having a film crew in your living room for two days is something you want to put on your bucket list.
With a ~$2 billion endowment the Kauffman Foundation is the largest non-profit focused on entrepreneurship in the world. Giving away $80 million to every year (~$25 million to entrepreneurial causes) makes Kauffman the dominant player in the entrepreneurship space.
Kauffman just launched Founders School – a new education series to help entrepreneurs develop their businesses during the startup stage by highlighting how startups are different from big companies. After weeks honing the script and days of filming, I’m honored to present the “Startups” section of Founders School.
Dino Vendetti a VC at Bay Partners, moved up to Bend, Oregon on a mission to engineer Bend into a regional technology cluster. Over the years Dino and I brainstormed about how Lean entrepreneurship would affect regional development.
I visited Bend last year and caught up with his progress.
Today with every city, state, country trying to build out a technology cluster, following Dino’s progress can provide others with a roadmap of what’s worked and didn’t.
As a transplanted Silicon Valley VC and now a regional investor, I often get asked, “How do we go about building up our local tech ecosystem?”
The short answer is, “One step at a time.”
In the beginning in Bend, “necessity was the mother of invention.” Local entrepreneurs just made it up as they went. But today we are intentionally engineering six distinct activities to support this tech cluster: entrepreneurial density, university, transportation, capital, accelerator, and business community.
Let’s look at each of these six elements in more detail and I’ll explain what we have been doing in Bend to accelerate each of these.
1. Entrepreneurial Density: Density – the connection of like-minded firms and their support services – is a critical component of a cluster. The most fertile source of entrepreneurs is the population of existing entrepreneurial companies. But for clusters without sufficient firms you first need to attract companies to your region. However, it’s difficult to create density overnight. Entrepreneurs need to understand and believe the reasons why they should want to cluster in your region given there are other alternatives (nationally Silicon Valley or New York; regionally Seattle and Bellevue, Portland and Bend).
In addition to technical and entrepreneurial talent, a region also needs experienced executive talent with industry appropriate backgrounds and personal networks. The goal of this talent is to help mentor startups as they scale and navigate the myriad of issues they will face in growing their business.
Bend’s economic development agency (EDCO) and city leaders (Visit Bend, City of Bend) get it – and have started communicating that Bend welcomes and is friendly to entrepreneurs and startups. Word is spreading and there are lots of people up and down the West Coast who know of and have been to Bend. But it’s easy to get drowned out by the noise from Silicon Valley and other cities in Washington and Oregon. That means that in regional communities like Bend, everyone needs to turn up the volume to consistently sing praises that will not only put the community on the map but also ensure it doesn’t slip.
2. University Almost every successful tech cluster has a local technical university. This provides a source of technical talent, research, etc. It’s extremely difficult to import enough talent to fuel a rapidly growing tech cluster, so a university is critical to organically generate and retain talent within the region. In particular it’s critical to offer technical degrees that train the talent pool needed to drive the local tech cluster
OSU-Cascades is a new four-year university in Bend that is beginning the build out of its new campus in Bend and offer computer science and user design courses. This effort was over a decade in the making and something that the local community fought hard for.
3. Transportation Direct flights to the San Francisco Bay Area and other major metro areas (depending on location of the region) are vital to reduce the friction of conducting business, encourage talent to test drive your community, and attract investors and other ecosystem partners to the region.
Bend’s economic development agency (EDCO) has worked very hard to establish direct flights to major West Coast cities including San Francisco, Los Angeles, Seattle, Portland, and Denver. At times this required rallying local business leaders to make advance purchases of flights to ensure enough passenger volume for the airlines.
4. Local Early-Stage Risk Capital Early stage venture funds are more important than your mother. If this doesn’t exist your regional cluster is dead-on-arrival. Organize risk-capital in the form of angel funds or venture funds, particularly at the early stage where the largest capital gap exists. This should be a strategic initiative within your state to close the capital gap with in-region capital sources.
Bend is now home to Seven Peaks Ventures and Cascade Angels, both born over the past year in response to the opportunity in the region. The state of Oregon is also making funds available to invest in and support the formation of venture funds within the state.
Bend Venture Conference Winner
5. Local Entrepreneurial Community Entrepreneurial-driven Events The local entrepreneurial community has been active in running Startup Weekends, launching the FoundersPad accelerator, running hackathons and Ruby on Rails conferences (Ruby on Ales), building out shared tech space, offering incentives (The Big Bend Theory) for startups to relocate to Bend from the Valley, and building up the state’s largest tech/venture conference, the Bend Venture Conference which is now going on its 11th year. There are many more efforts underway to build upon what has worked and continue the process of evolving and learning.
6. Business Community Support One of the most difficult things to do is technically the easiest – a dispassionate self-assessment to understand what assets your community has and what you lack.
First, what is your value proposition to a family or business to locate in your region? Recognize that a big part of your job is to remove friction, drive awareness, and amplify the efforts of your local entrepreneurs. Successful entrepreneurs attract other entrepreneurs, so it’s vital to kick start the cycle.
Next, identify your goal. Is it creating a job works program? Stopping brain drain in the region? Attracting and building some key core competency in the region? Ideally your existing talent base and ecosystem naturally support the “core competency magnet” you want to develop.
Finally, put your money where your mouth is – help fund the events and programs in the early years. Once the tech cluster forms, these activities will become self-funding. The ROI won’t be obvious for some early on, but will pay dividends in time.
Regional Cluster Ecosystem
Summary: Bend Is a Global Entrepreneurship Experiment There are about 25,000 economic development agencies in regional markets across the U.S., all trying to expand the number of businesses that create products and services sold outside their region. These regional businesses create primary jobs that lead to the creation of local secondary jobs.
The Bend experiment is a model to consciously engineer an entrepreneurial cluster in a regional market to spur economic development and job creation.
In the past most regional growth strategies have focused on attracting established companies looking to expand or open a new plant. While it may be strategic for the region to recruit some of these established businesses, those deals usually involve huge tax subsidies and typically create a small finite number of jobs. What isn’t part of most regional growth plans is the organic growth of an entrepreneurial tech cluster in the region. If successful, sewing the seeds of entrepreneurship can lead to a more rapid and sustainable job growth for the region.
By engineering a regional tech cluster, we can impact the trajectory of growth in the region and:
Slow and even reverse the historical migration of tech talent and capital out of the region/state
Locally grow successful tech companies to become amazing primary job creators
Recycle the wealth that is created by re-investing in the region versus transferring wealth to Silicon Valley
Help local successful entrepreneurial and technical talent stay local – by creating their next startup in the region versus emigrating to Silicon Valley
Create a more diversified and healthy economic base that includes tech entrepreneurs
The democratization of entrepreneurship has created a huge opportunity for any region with the right characteristics to create its own sustainable tech cluster. But, as with any true democracy, it won’t happen without the combined participation of the community and desire of entrepreneurs to lead the movement. This is happening in Bend, and I look forward to hearing from others about your own experiments.
Regional tech clusters can be engineered if …
the region has key attributes and a focused effort from the entrepreneurial and business community
Opportunity exists for economic development in regions where tech clusters can be formed
potential to dramatically increase the growth of entrepreneurship and job creation in the region.
Entrepreneurs are the path to job creation and growth…
attract them, reduce the friction to growth, and do everything possible to cause the wealth created to recycle locally
Dino Vendetti a VC at Bay Partners, moved up to Bend, Oregon on a mission to engineer Bend into a regional technology cluster. Over the years Dino and I brainstormed about how Lean entrepreneurship would affect regional development.
I visited Bend last year and caught up with his progress.
Today with every city, state and country trying to build out a technology cluster, following Dino’s progress can provide others with a roadmap of what’s worked and what has not.
Tech investing is risky. Success depends on finding startups that have identified acute customer pains in large markets where conditions are ripe for a new entrant. Few entrepreneurs find this scalable and repeatable business model because it’s not easy. However, four critical advances over the past decade (cloud, accelerators, Lean, and Angels) not only changed the math for tech investing but made regional tech clusters possible.
The cloud, open-source development tools and web 2.0 as a distribution channel have vastly reduced the amount of capital a startup needs at the early stage when the risk is greatest. (Startups still need capital to scale once they find good product-market fit and a repeatable-scalable business model.)
Accelerators, which became mechanisms for focused entrepreneurship mentoring and delivery of best practices to startups. This was valuable to startups in the Valley and has been vital to startups in regions where the ecosystem is less developed.
The Lean Movement, led by Steve Blank (and others,) created a set of methodologies that ushered in the era of Evidence Based Entrepreneurship. This has changed the way entrepreneurs think about building their startups and how investors should look at them.
Angels & Crowdfunding: Coincident with the capital efficient movement came the current wave of angel investors, this time armed with the ability to collectively fund startups to the point of meaningful value creation on modest amounts of capital. Sites like AngelList have only amplified the collective reach of individual and grouped angel investors.
These four developments, while important to Silicon Valley, are vital to developing regional tech clusters. While the density of Silicon Valley startups can’t be replicated in regions, the barriers of money and resources have disappeared. These changes make entrepreneurship possible anywhere.
Three types of regional venture funds exist today:
Regionally located funds, such as Foundry Group in Boulder, are located outside of Silicon Valley or NY but their investments are primarily in the Valley or NY… they are not a regional fund per this discussion.
Regional Angel funds that pool investors capital and typically make a one time investment in a startup, sometimes at an early stage but often at a slightly later stage.
Late stage large regionally based funds that invest in late stage or mezzanine deals.
Large regionally based early stage funds have mostly failed. They failed due to:
the dearth of deals in the region that have IPO potential and
most of those funds were also raised and invested prior to the huge capital efficient wave of the past 6-8 years. These regional funds invested in capital-intensive startups that required large initial investments. The result was too much money in too few deals. The inevitable failures then damaged returns.
The Oregon startup scene today looks very different from what it did 10 years ago. Today it’s dominated by capital efficient software, web and mobile startups whereas 10 years ago it was dominated by semiconductor and hardware startups that consumed huge amounts of capital before their first dollar in revenue.
So a regional fund must do three things:
focus on early stage investments
“right sized” for the exit environment;
if it’s too big you won’t be able to intelligently deploy capital;
too small and you won’t be able to follow on and protect your investments or make enough investments to ensure you have enough “at bats.”
find and focus on the entrepreneurs and deals that want to build scalable startups
We believe that regional funds need to walk a delicate balance…but it doesn’t take huge IPOs to return multiples of capital on a small fund.
Why Valley Rules Don’t Work in Regional Economies A typical VC fund in Silicon Valley might raise $200 -$400 million. And over a 10-year life of a fund only one out of five deals will deliver all the returns. A good return to your investors is 20% per year. That means over 10 years investors expect ~6x return on their investment. This means that those winning deals have to make a ~30x return to provide the venture capital fund that 20% compound return (the 6x).
The Valley strategy is to get as much money to work in the high flying deals that are going to pop….It’s an educated/calculated swing-for-the-fences model and it can work and be extremely lucrative if you can consistently get in those deals.
The problem for a regionally based investor is that there will be a limited number of startups in your region that have a realistic chance at an IPO. The percentage of VC backed startups that go public is very small, so counting on those exits in a regional fund would not be prudent (nice if it happens but don’t build the model to rely on it).
The reality is that the super vast majority of liquidity events are M&A and the majority of those are in the under $100M range. As a result, large multi-hundred million-dollar funds focused on early stage investing in the region can be challenging. There just aren’t enough “right” regional startups to invest in.
Regional Moneyball Bend playing Moneyball makes a lot of sense. In fact, it’s the only game that investors in a regional cluster can play. Regional investors need a way of improving their odds of getting base hits and minimize strikeouts.
Playing Moneyball in venture capital means making smaller, smarter bets focused on companies and deals that the big teams, the Silicon Valley heavyweight investors, pass up; because the deals are too far from Silicon Valley, not yet known to them, not in their comfort zone, or not the fad of the month.
Playing Moneyball also means playing with the money you have. The reality for a regional investor is that you have to match the capital you raise to the deal/exit environment you are in.
Specifically this means that a regional fund should be $10-30M. (With a portfolio of at least 20 investments, or you are at risk of the adverse selection problem.) And the fund should be looking at startups that can provide $20M to $100M exits – almost certainly as M&A deals.
The chart below diagrams our regional fund strategy.
The good news for regional investors is that these factors allow you to play Moneyball if (and that’s a big IF) you are investing in entrepreneurs who are living and breathing evidence-based entrepreneurship and who are building scalable startups. This is true whether the company is concept stage or ramping revenue. I’ve found a lot of companies in the region that have found a way to get to some level of revenue traction but haven’t broken out. When you dig in, the reasons are usually easily discoverable and observable.
The Bend Experience One of the fundamental benefits of being so active in building the FoundersPad accelerator (a 12-week, Lean Startup program focused on customer development) is working with the cohort participants on refining their business models. This experience has provided me a whole new set of pattern matching filters as an investor.
The business model canvas and the customer development process provide investors an incredible opportunity to evaluate how deeply an entrepreneur has engaged with their target customers and, more importantly, what they have learned about the problem-solution space they are going after. This learning and the measurements and metrics that surround it is what evidence based entrepreneurship is all about and what makes it a powerful tool for entrepreneurs, investors and accelerators.
If you are a regional accelerator or investor and would like to talk and compare notes please feel free to email me.
Regions are missing early-stage capital.
Valley-sized VC funds don’t work.
Build $10-30M funds.
Look for $20-100M exits.
Focus on capital efficient, scalable startups and founders
When Customer Development and the Lean Startup were just a sketch on the napkin, Dino Vendetti, a VC at Bay Partners, was one of the first venture capitalists I shared my ideas with.
Dino and I kept in touch as he moved up to Bend, Oregon on a mission to engineer Bend into a regional technology cluster. Over the years we brainstormed about how Lean entrepreneurship would affect regional development.
I visited Bend last year and caught up with his progress.
This post and the two that follow highlight what Dino has learned about the characteristics of the startup and investing landscape in a regional market, and what it takes to intentionally engineer a thriving regional tech cluster.
Today, with every city, state and country trying to build out a technology cluster, following Dino’s progress can provide others with a roadmap of what’s worked and what has not. Bend, Oregon is an ideal case study because of its size, location and entrepreneurial characteristics.
Here’s Part 1 of Dino’s story…
Let’s get right to the point… I fell in love with Bend, Oregon, once a sleepy logging town, now population 79,000. If you like skiing, hiking, biking, rafting, golfing, camping, fishing, picnicking, rock climbing, and startups – you’d like Bend.
Before moving to Bend last year, my career took me from engineering development roles at defense contractors in the 80’s to product management and executive marketing roles in companies like Qualcomm in the 90’s, to the world of venture capital at several firms including Bay Partners, Formative Ventures and Vulcan Ventures.
After several visits skiing here, I had become smitten with the “mojo” of Bend – its superb quality of life, recreational opportunities and proximity to the San Francisco Bay Area. The vibe of Bend is appealing, unique and unpretentious given the number of successful business, tech and professional athlete transplants who call it home. It’s home to a small but growing tech community that has been developing over the past decade, and that’s what piqued my interest.
What’s Different The differences between the Bend, Oregon region and Silicon Valley are obvious. The sheer density of talent, companies, capital and universities that exist in the Valley are second to none. It truly is the epicenter of the startup world and it’s the regional cluster for innovation and entrepreneurship. Working in the Valley, I took for granted the constant and real time networking opportunities, the volume of deals, and the ability to access nearly every corner of the tech industry – no surprise to anyone who has spent any time in the Valley.
However, what I found in Bend was a deeply entrepreneurial community that is leaps and bounds beyond just a destination resort town. Bend fights way above its weight class and is professional scale for its size. Its ability to do so is tied to the deep entrepreneurial DNA that permeates the region (a very similar characteristic to Silicon Valley), originally out of necessity and now out of strategy.
Startups in Bend So what types of entrepreneurs and startups exist in Bend? There’s a concentration around several sectors: software, hardware, medical-technology, aviation, and a specialty of Oregon – craft beer brewing. The chart below shows the clustering of startups around these sectors.
Bend Startup Ecosystem
In addition to the four major data centers that include Facebook and Apple, Bend currently boasts 95 startups across multiple technologynsectors: 47 software, 26 hardware/semi and 22 med tech related startups. Nearby Portland Oregon (just 160 miles away) is home to over 300 startups; between the two markets, nearly 80 new startups are forming each year.
Silicon Valley Transplants In addition to local entrepreneurs building startups, I found something else I wasn’t expecting in Bend: a deep pool of talented Valley transplants who’ve made their way to Bend – either during their careers or after. There are retired Fortune 500 CEOs, senior execs from Valley startups and public companies as well as successful entrepreneurs who exited their companies. These smart, successful transplants have gotten involved with the local business community as mentors, advisors, entrepreneurs, or investors.
But the real surprise was learning that for some Bend is a Silicon Valley bedroom community. A daily direct flight on United can have you in your Bay Area office by 8 a.m. Monday. Every week I meet someone new who just moved to Bend and commutes to work for Google, Facebook, Salesforce, Oracle, Marketo, Workday, and on and on….These people are important and useful in the engineering of a tech cluster; as startup coaches, angel investors and advocates for the community. They communicate and pass on the DNA of how Silicon Valley operates and what level of performance is needed to compete on a global scale.
Entrepreneurs in Bend Within the Bend tech startup community I found three kinds of startups/entrepreneurs:
Scalable entrepreneurs similar to those you would find in Silicon Valley (although a smaller concentration exists in Bend). These entrepreneurs want to build a big company. They’re typically Silicon Valley transplants who had enough success and experience to know what they were getting themselves into, what it means to raise capital from investors, what it means to scale a company, and how to engineer an exit.
Viable entrepreneurs who think they are building scalable startups but lack either a key element of their business model and/or lack the right team DNA to “go for it..” In this region, these are the majority of new startups I see. They have two limitations, which I help coach to see if they have the capability and desire to become scalable.
They go after a market opportunity that’s too limited to result in a truly scalable business (still might be an M&A candidate, but at the lower end of the range).
Most teams have a reluctance and willingness to “go for it” when they finally do have a scalable business and have validated the key aspects of their business model. This “small business” mindset is a holdover of how capital starved early stage startups are/were in Oregon. Entrepreneurs (and angel investors) prioritize profitability over growth (this is OK for lifestyle startups, but not for scalable startups where capturing market share and thought leadership is vital).
Lifestyle entrepreneurs who are just building a business to make a profit and support their awesome lifestyle (Bend has a lot of these). There is nothing wrong with lifestyle entrepreneurs as they are providing valuable products and services to the local/regional economy, but these do not make for good venture or angel investments under the traditional equity based venture model.
Regional entrepreneurs are at an inherent disadvantage in getting the attention of customers and late stage VCs. Therefore they need to focus on building the most efficiently scalable business model possible. Without focus, it’s difficult to create enough signal to noise ratio to become relevant in their market segment. The good news is that whether you are an investor or accelerator, if your startup is located in an advantageous regional market (defined below) and if you apply lean methodologies, you can improve your on-base and slugging percentage.
The opportunity and challenge in regional markets is to:
Educate the ecosystem about the differences between the three kinds of startups/entrepreneurs
Find, nurture and invest in the truly scalable startups and entrepreneurs, as they will be the ones that have the potential to deliver outsized returns
Fixing the Missing Pieces of Infrastructure The evolution of very capital efficient business models and Lean Startup methodologies has led to easier paths to funding, launching and growing businesses. With a tech cluster developing in Bend, it was clear that there were four missing pieces in its infrastructure.
I decided to fix each of them.
Bend needed a startup accelerator. While entrepreneurship in Bend was talked about, and everyone read the same blogs, there was no central place founders could get focused and intense coaching and mentorship. So I co-founded the FoundersPad accelerator, a 12-week, Lean Startup program focused on customer development that helps founders develop, refine and grow their business.
Bend needed its own venture firm. While Silicon Valley and New York are magnets for great startups, our bet is that awesome startups exist in (or can be attracted to) Oregon and Northern California. So I launched Seven Peaks Ventures with a team of investors that includes some of the region’s most active angel investors. We help Oregon-based startups build and scale their businesses by providing highly relevant mentoring and leveraging our deep network in Silicon Valley and beyond.
Bend needs to attract more entrepreneurs. So I launched The Big Bend Theory with Bruce Cleveland. We’ll fly founders and their spouses/significant others along with a team member to Bend to meet local startup executives and community leaders and experience the lifestyle. If they choose to relocate in Bend we’ll offer free temporary office space and help get them funded.
Oregon State University’s new Bend campus didn’t have a Computer Science or User Experience design program. So I helped develop the Computer Science program at Oregon State. (We’re looking for Computer Science professors, so email me if you want to live and teach in Bend!)
Bend is a bet on a regional tech cluster
To build a successful regional cluster, look for an eco-system with:
experienced professionals willing to mentor
entrepreneurs with the energy and drive to build businesses
viable startups under development
We are engineering the infrastructure that lacks: accelerator, venture firm, outreach, university and training.
It is critical to understand the types of startups and entrepreneurs in your region and for venture funding
Seek out the truly scalable startups.
Listen to the blog post here
Download the podcast here
The article summarized 10 key learnings from the Unicorn club. Surprisingly one of the “learnings” said that, “…the “big pivot” after starting with a different initial product is an outlier. Nearly 90 percent of companies are working on their original product vision. The four “pivots” after a different initial product were all in consumer companies (Groupon, Instagram, Pinterest and Fab).”
One of my students sent me the article and asked, “What does this mean?” Good question.
Since the Pivot is one of the core concepts of the Lean Startup I was puzzled. Could I be wrong? Is it possible Pivots really don’t matter if you want to be a Unicorn?
Short answer – almost all the Unicorns pivoted. The authors of the article didn’t understand what a Pivot was.
What’s a pivot? A pivot is a fundamental insight of the Lean Startup. It says on day one, all you have in your new venture is a series of untested hypothesis. Therefore you need to get outside of your building and rapidly test all your assumptions. The odds are that one or more of your hypotheses will be wrong. When you you discovery your error, rather than firing executives and/or creating a crisis, you simply change the hypotheses.
What was lacking in the article was a clear definition of a Pivot. A Pivot is not just changing the product. A pivot can change any of nine different things in your business model. A pivot may mean you changed your customer segment, your channel, revenue model/pricing, resources, activities, costs, partners, customer acquisition – lots of other things than just the product.
Definition: “A pivot is a substantive change to one or more of the 9 business model canvascomponents.”
Think of a business model as a drawing that shows all the flows between the different parts of your company’s strategy. Unlike an organization chart, which is a diagram of how job positions and functions of a company are related, a business model diagrams how a company makes money – without having to go into the complex details of all its strategy, processes, units, rules, hierarchies, workflows, and systems.
Alexander Osterwalder’s Business Model canvas puts all the complicated strategies of your business in one simple diagram. Each of the 9 boxes in the canvas specifies details of your company’s strategy. (The Business Model Canvas is one of the three components of the Lean Startup. See the HBR article here.)
So to answer to my students question, I pointed out that the author of the article had too narrow a definition of what a pivot meant. If you went back and analyzed how many Unicorns pivoted on any of the 9 business model components you’d likely find that the majority did so.
Take a look at the Unicorn club and think about the changes in customer segments, revenue, pricing, channels, all those companies have made since they began: Facebook, LinkedIn – new customer segments, Meraki – new revenue models, new customer segments, Yelp – product pivot, etc. – then you’ll understand the power of the Pivot.
A Pivot is not just when you changethe product
A pivot is a substantive change to one or more of the 9 business model canvascomponents
Almost all startups pivot on some part of their business model after founding
Startups focused on just product Pivots will limited their strategic choices – it’s like bringing a knife to a gunfight
Listen to the blog post here [audio http://traffic.libsyn.com/albedrio/steveblank_hplewis_140114_FULL.mp3]
For the last 75 years products (both durable goods and software) were built via Waterfall development. This process forced companies to release and launch products by model years, and market new and “improved” versions.
In the last few years Agile and “Continuous Deployment” has replaced Waterfall and transformed how companies big and small build products. Agile is a tremendous advance in reducing time, money and wasted product development effort – and in having products better match customer needs.
But businesses are finding that Continuous Deployment not only changes engineering but has ripple effects on the rest of its business model. And these changes may have unintended consequences leading to customer dissatisfaction and confusion.
Smart companies will figure out how to educate their customers and communicate these changes.
The Old Days – Waterfall Product Development (skip this part of you’re conversant in Waterfall and Lean.)
In the past both hardware and software were engineered using Waterfall development, a process that moves through new product development one-step-at-a-time.
Marketing delivers a “requirements” document to engineering.
Then engineering develops a functional specification and designs the product.
Next comes the work of actually building the product – implementation.
Then validation ensures the product was built to spec.
After the product ships, it’s maintained by fixing flaws/bugs.
Customers would get their hands on a product only after it had gone through a lengthy cycle that could take years – enterprise software 1-2 years, new microprocessors 2-4 years, automobiles 3-5 years, aircraft a decade.
Waterfall – The Customer View When customers purchased a product they understood that they were buying this year’s model. When next year’s model arrived, they did not expect that the Ford station wagon or Maytag washer they purchased last year would be updated to match all the features in the new model. (Software at times had an upgrade path, often it required a new purchase.)
Waterfall allowed marketers to sell incremental upgrades to products as new models. First starting in the fashion business, then adopted by General Motors in the 1920’s annual model year changeovers turned into national events. (The same strategy would be embraced 75 years later by Microsoft for Windows and then Apple for the iPhone.)
As the press speculated about new features, companies added to the mystique by guarding the new designs with military secrecy. Consumers counted the days until the new models were “unveiled”.
With its punctuated and delineated release cycles, waterfall development led consumers to understand the limited rights they had to future product upgrades and enhancements (typically none.) In other words, consumer expectations were bounded.
At the same time, manufacturers used new model changeovers to generate excitement over new features/versions convincing consumers to obsolete perfectly functional products and buy new ones.
Agile Development: Continuous Delivery and Deployment In contrast to Waterfall development, Agile Development delivers incremental and iterative changes on an ongoing basis.
Agile development has upended the familiar consumer expectations and company revenue models designed around the release cycles of Waterfall engineering. In a startup this enables deployment of Minimum Viable products at a rapid pace. For companies already in production, Continuous Deployment can eliminate months or years in between major releases or models. Companies can deliver product improvements via the cloud so that all customers get a better product over time.
While continuous delivery is truly a better development process for engineering, it has profound impacts on a company’s business model and customer expectations.
Continuous Delivery/Deployment – The Marketers View Cloud based products has offered companies an opportunity to rethink how new business models would work. Adobe and Tesla offer two examples.
Tesla While most of the literature talks about continuous Delivery/Deploymentas a software innovation for web/mobile/cloud apps, Tesla is using it for durable goods – $100,000 cars – in both hardware and software.
First, Tesla’s Model S sedan downloads firmware updates on a regular basis. These software changes go much further than simply changing user interface elements on the dashboard. Instead, they may modify major elements of the car from its suspension to its acceleration and handling characteristics.
Secondly, in a break from traditional automobile practices, rather than waiting a year to roll out annual improvements to its Model S, Tesla has been continuously improving its product each quarteron the assembly line. There are no model years to differentiate a Tesla Model S built in 2012 from one built this year. (The last time this happened in auto manufacturing was the Ford Model T.)
Adobe Adobe, which for decades sold newer versions of its products – Photoshop, Illustrator, etc. – has now moved all those products to the cloud and labeled them the Adobe Creative Cloud. Instead of paying for new products, customers now buy an annual subscription.
The move to the cloud allowed Adobe to implement continuous delivery and deployment. But more importantly the change from a product sale into a subscription turned their revenue model into a predictable annuity. From an accounting/Wall Street perspective it was a seemingly smart move.
Continuous Delivery/Deployment – The Customer View But this shift had some surprises for consumers, not all of them good.
As many companies are discovering, incremental improvement doesn’t have the same cachet to a consumer as new and better. While it may seem irrational, inefficient and illogical, the reality is that people like shiny new toys. They want newer things. Often. And they want to be the ones who own them, control them and decide when they want to change them.
Adobe While creating a predictable revenue stream from high-end users, Adobe has created two problems. First, not all Adobe customers believe that Adobe’s new subscription business model is an improvement for them. If customers stop paying their monthly subscription they don’t just lose access to the Adobe Creative Suite software (Photoshop, Illustrator, etc.) used to create their work, they may lose access to the work they created.
The consequence of discarding low margin customers and optimizing revenue and margin in the short-term, Adobe risks enabling future competitors. In fact, this revenue model feels awfully close to the strategy of the U.S. integrated steel business when they abandoned their low margin business to the mini-mills.
Second, Telsa’s elimination of model years and its aggressive marketing of the benefits of continuous development of hardware and software have set its current customers expectations unreasonably high. Some feel entitled to every new hardware feature rolled into manufacturing, even if the feature (i.e. faster charging, new parking sensors,) was not available when they bought their cars – and even if their car isn’t backwards compatible.
Model years gave consumers an explicit bound of what to expect. This lack of boundaries results in some customer disappointment.
Continuous Delivery/Deployment is a major engineering advance
It enables new business models
Customers don’t care about your business model, just it’s effect on them
While irrational, inefficient and illogical, people like shiny new toys
Subscription revenue models versus new purchases require consumer education
If your subscription revenue model “fires” a portion of your customers, it may enable new competitors
Companies need to clearly communicate customer entitlements to future features
Listen to the blog post here
Download the podcast here
This post is part of our series on the National Science Foundation I-Corps Lean LaunchPad class in Life Science and Health Care at UCSF. Doctors, researchers and Principal Investigators in this class got out of the lab and hospital talked to 2,355 customers, tested 947 hypotheses and invalidated 423 of them. The class had 1,145 engagements with instructors and mentors. (We kept track of all this data by instrumenting the teams with LaunchPad Central software.)
Jason Crane – PhD UCSF Manager Scientific Software Development
Raphaelle Loren – Managing Director – Health Practice at the Innovation Management Institute
Todd Morrill was the diagnostics cohort instructor. Matt Cooper CEO of Carmenta BioSciences was the Mira Medicineteam mentor.
Multiple Sclerosis – MS Multiple Sclerosis – MS – is an immune system disease that attacks the myelin, the fatty sheath that surrounds and protects nerve fibers of the central nervous system (brain, spinal cord, and optic nerve). T-cells, (a type of white blood cell in the immune system,) become sensitized to myelin and cross the blood-brain barrier into the central nervous system (CNS). Once in the CNS, these T-cells injure myelin, and secrete chemicals that damage nerve fibers (axons) and recruit more damaging immune cells to the site of inflammation.
There are currently ten FDA approved MS medications for use in relapsing forms of MS. None of these drugs is a cure, and no drug is approved to treat the type of MS that shows steady progression at onset. MS disease management decisions are complex and requires a patients neurologist to figure out what drugs to use.
Mira Medicine and Multiple Sclerosis The team came to class with the thought of commercializing the UCSF Multiple Sclerosis BioScreen Project a Precision Medicine application that integrates a patients medical records with the latest population-based data from hundreds of other Multiple Sclerosis patients, (including their 3D MRI scans,) and using predictive algorithms makes it possible to chart a unique course of treatment for each patient. (Mira Medicine team member Pierre-Antoine Gourraud was the project co-leader.)
Mira wanted to commercialize the UCSF Multiple Sclerosis Bioscreen project and to add additional neurological diseases which require multiple types of data (including biomarkers, clinical, and imaging). They wanted to help medical centers and large providers assess disease progression to guide therapeutic decision-making. Over the course of the class Mira Medicine team spoke to over 80 customers, partners and payers.
Then reality hit. First, the team found that their Multiple Sclerosis Bioscreen application (which they used as their MVP) was just a “nice-to-have”, not a “must-have”. In fact, the “must have features” were their future predictive algorithms. Next, they found that if their tool can enable a diagnosis, (even without claiming it could) then it was likely that the FDA would require a 510(k) medical device clearance. Then they found to get reimbursed they need a CPT code (and they had to decide whether to code stack – using multiple codes for “one” diagnosis, and thereby getting multiple reimbursements for one test. (The rules have changed so that code stacking is hard or impossible), Or get a new CPT code, or use miscellaneous code.) To get a new CPT and a 510(k) they would have to perform a some sort of clinical study. At a minimum a 1-year prospective study (a study to see if the neurologists using the application had patients with a better outcome then those who didn’t have access to the app). Getting approval to use an existing (aka old) CPT code means showing equivalence to an existing dx process or test, and the requirements are code-specific. Finally, to get access to data sources of other MS patients they would need to have HIPPA Business Associate Agreement.
Watch their Lessons Learned video below and find out how they pivoted and what happened.