Is the Lean Startup Dead?

A version of this article first appeared in the Harvard Business Review

Reading the NY Times article “Jeffrey Katzenberg Raises $1 Billion for Short-Form Video Venture,” I realized it was time for a new startup heuristic: the amount of customer discovery and product-market fit you need to find is inversely proportional to the amount and availability of risk capital.

And while the “first mover advantage” was the rallying cry of the last bubble, today’s is: “Massive capital infusion can own the entire market.”


Fire, Ready, Aim
Jeff Katzenberg has a great track record – head of the studio at Paramount, chairman of Disney Studios, co-founder of DreamWorks and now chairman of NewTV. The billion dollars he just raised is on top of the $750 million NewTV’s parent company, WndrCo, has raised for the venture. He just hired Meg Whitman. the ex-CEO of HP and eBay, as CEO of NewTV. Their idea is that consumers will want a subscription service for short form entertainment (10-minute programs) for mobile rather than full length movies. (Think YouTube meets Netflix).

It’s an almost $2-billion-dollar bet based on a set of hypotheses. Will consumers want to watch short-form mobile entertainment? Since NewTV won’t be making the content, they will be licensing from and partnering with traditional entertainment producers. Will these third parties produce something people will watch? NewTV will depend on partners like telcos to distribute the content. (Given Verizon just shut down Go90, its short form content video service, it will be interesting to see if Verizon distributes Katzenberg’s offerings.)

But NewTV doesn’t plan on testing these hypotheses. With fewer than 10 employees but almost $2-billion dollars in the bank, they plan on jumping right in.

It’s the antithesis of the Lean Startup.  And it may work. Why?

Dot Com Boom to Bust
Most entrepreneurs today don’t remember the Dot-Com bubble of 1995 or the Dot-Com crash that followed in 2000. As a reminder, the Dot Com bubble was a five-year period from August 1995 (the Netscape IPO) when there was a massive wave of experiments on the then-new internet, in commerce, entertainment, nascent social media, and search. When Netscape went public, it unleashed a frenzy from the public markets for anything related to the internet and signaled to venture investors that there were massive returns to be made investing in anything internet related. Almost overnight the floodgates opened, and risk capital was available at scale from venture capital investors who rushed their startups toward public offerings. Tech IPO prices exploded and subsequent trading prices rose to dizzying heights as the stock prices became disconnected from the traditional metrics of revenue and profits. Some have labeled this period as irrational exuberance. But as Carlota Perez has so aptly described, all new technology industries go through an eruption and frenzy phase, followed by a crash, then a golden age and maturity. Then the cycle repeats with a new set of technologies.

Given the stock market was buying “the story and vision” of anything internet, inflated expectations were more important than traditional metrics like customers, growth, revenue, or heaven forbid, profits. Startups wrote business plans, generated expansive 5-year forecasts and executed (hired, spent and built) to the plan. The mantra of “first mover advantage,” the idea that winners are the ones who are the first entrants in their market, became the conventional wisdom of investors in Silicon Valley.“ First Movers” didn’t understand customer problems or the product features that solved those problems (what we now call product-market fit). These bubble startups were actually guessing at their business model and did premature and aggressive hype and early company launches and had extremely high burn rates – all predicated on an IPO to raise more cash. To be fair, in the 20th century, there really wasn’t a model for how to build startups other than write plan, raise money, and execute – the bubble was this method, on steroids. And to be honest, VC’s in this bubble really didn’t care. Massive liquidity awaited the first movers to the IPO’s, and that’s how they managed their portfolios.

When VC’s realized how eager the public markets were for anything related to the internet, they pushed startups with little revenue and no profits into IPOs as fast as they could. The unprecedented size and scale of VC returns transformed venture capital from a financial asset backwater into full-fledged player in the financial markets.

Then one day it was over. IPOs dried up. Startups with huge burn rates – building leases, staff, PR and advertising – ran out of money. Most startups born in the bubble died in the bubble.

The Rise of the Lean Startup
After the crash, venture capital was scarce to non-existent. (Most of the funds that started in the late part of the boom would be underwater). Angel investment, which was small to start with, disappeared, and most corporate VCs shut down. VC’s were no longer insisting that startups spend faster, and “swing for the fences”. In fact, they were screaming at them to dramatically reduce their burn rates. It was a nuclear winter for startup capital.

The idea of the Lean Startup was built on top of the rubble of the 2000 Dot-Com crash.

With risk capital at a premium and the public markets closed, startups and their investors now needed a methodology to preserve capital and survive long enough to generate revenue and profits. And to do that they needed a different method than just “build it and they will come.” They needed to be sure that what they were building was what customers wanted and needed. And if their initial guesses were wrong, they needed a process that would permit them to change early on in the product development process when the cost of changes was small – the famed “pivot”.

Lean started from the observation that you cannot ask a question that you have no words for. At the time we had no language to describe that startups were not smaller versions of large companies; the first insight was that large companies executed known business models, while startups searched for them. Yet while we had plenty of language and tools for execution, we had none for search.  So we (Blank, Ries, Osterwalder) built the tools and created a new language for innovation and modern entrepreneurship. It helped that in the nuclear winter that followed the crash, 2001 – 2004, startups and VCs were extremely risk averse and amenable to new ideas that reduced risk. (This same risk averse, conserve the cash, VC mindset would return after the 2008 meltdown of the housing market.)

As described in the HBR article “Why the Lean Startup Changes Everything,” we developed Lean as the business model / customer development / agile development solution stack where entrepreneurs first map their hypotheses about their business model and then test these hypotheses with customers in the field (customer development) and use an iterative and incremental development methodology (agile development) to build the product. This allowed startups to build Minimal Viable Products (MVPs) – incremental and iterative prototypes – and put them in front of a large number of customers to get immediate feedback. When founders discovered their assumptions were wrong, as they inevitably did, the result wasn’t a crisis; it was a learning event called a pivot— and an opportunity to change the business model.

Every startup is in a race against time. It has to find product-market fit before running out of cash. Lean makes sense when capital is scarce and when you need to keep burn rates low. Lean was designed to inform the founders’ vision while they operated frugally at speed. It was not built as a focus group for consensus for those without deep convictions.

The result? Startups now had tools that sped up the search for customers, ensured that what was being built met customer needs, reduced time to market and slashed the cost of development.

Carpe Diem – Seize the Cash
Today, memories of frugal VC’s and tight capital markets have faded, and the structure of risk capital is radically different. The explosion of seed funding means tens of thousands of companies that previously languished in their basement are getting funding, likely two orders of magnitude more than received Series A funding during the Dot-Com bubble. As mobile devices offer a platform of several billion eyeballs, potential customers which were previously small niche markets now include everyone on the planet. And enterprise customers in a race to reconfigure strategies, channels, and offerings to deal with disruption provide a willing market for startup tools and services.

All this is driven by corporate funds, sovereign funds and even VC funds with capital pools of tens of billions of dollars dwarfing any of the dollars in the first Dot Com bubble – and all looking for the next Tesla, Uber, Airbnb, or Alibaba. What matters to investors now is to drive startup valuations into unicorn territory (valued at $1 billion or more) via rapid growth – usually users, revenue, engagements but almost never profits. As valuations have long passed the peak of the 2000 Internet bubble, VC’s and founders who previously had to wait until they sold their company or took it public to make money no longer have to wait. They can now sell part of their investment when they raise the next round. And if the company does go public, the valuations are at least 10x of the last bubble.

With capital chasing the best deals, and hundreds of millions of dollars pouring into some startups, most funds now scoff at the idea of Lean. Rather than the “first mover advantage” of the last bubble, today’s theory is that “massive capital infusion owns the entire market.” And Lean for startups seems like some quaint notion of a bygone era.

And that explains why investors are willing to bet on someone with a successful track record like Katzenberg who has a vision of disrupting an entire industry.

In short, Lean was an answer to a specific startup problem at a specific time, one that most entrepreneurs still face and which ebbs and flows depending on capital markets. It’s a response to scarce capital, and when that constraint is loosened, it’s worth considering whether other approaches are superior. With enough cash in the bank, Katzenberg can afford to create content, sign distribution deals, and see if consumers watch. If not, he still has the option to pivot. And if he’s right, the payoff will be huge.

One More Thing…
Well-funded startups often have more capital for R&D than the incumbent companies they’re disrupting. Companies struggle to compete while reconfiguring legacy distribution channels, pricing models and supply chains. And government agencies find themselves being disrupted by adversaries unencumbered by legacy systems, policies and history.  Both companies and government agencies struggle with how to deliver innovation at speed. Ironically, for this new audience that makes the next generation of Lean – the Innovation Pipeline – more relevant than ever.

Lessons Learned:

  • When capital for startups is readily available at scale, it makes more sense to go big, fast and make mistakes than it does to search for product/market fit.
  • The amount of customer discovery and product-market fit you need to do is inversely proportional to the amount and availability of risk capital.
  • Still, unless your startup has access to large pools of capital or have a brand name like Katzenberg, Lean still makes sense.
  • Lean is now essential for companies and government agencies to deliver innovation at speed
  • The Lean Startup isn’t dead. For companies and government the next generation of Lean – the Innovation Pipeline – is more relevant than ever.

22 Responses

  1. Seems like there will be a huge amount of wasted funds, executing and scaling (or at least trying to) even before a repeatable, scalable and viable business model is found.

    Is it really sensible and possible for the Ubers and Katzenbergs to own the whole market if there is no viable business model there? Won’t they come crashing down eventually?

    PS Typo Reis.

    Like

    • It’s a bit strange to use Uber and Katzenberg (by which I assume NewTV) in the same sentence. Uber is definitely providing a service people want and other people are willing to provide. There’s a paper showing that Uber generates a huge consumer surplus — despite being operationally profitable. This is literally the opposite of a company that has a pretty bad idea, no execution, no market research, and a bunch of (presumably not very smart) money.

      Assuming NewTV is right, how does it beat Youtube?

      Liked by 2 people

      • Thanks @podperson I hadn’t thought of Uber as operationally profitable as the venture spends billions to “own the entire market.” The billions, in my opinion, seem to obfuscate / hide the fact that their position is not that defensible, their business model not that different than taxis, and the future is not clear with regards to how things will work with self driving cars (e.g. who will own them). I don’t see it as a sure win, apart from the strong brand awareness.

        I don’t know enough about NewTV or what young people see in YouTube to suggest how it could beat YouTube. I know one of our sons consumes more YouTube than TV. In fact, more YouTube than pretty much anything except SnapChat. I’m not sure they are looking for high production value or higher quality content. I’m not even sure what high quality content would be like in that format (i.e. short form videos). I guess we will see soon enough.

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        • >I’m not sure they are looking for high production value or higher quality content. I’m not even sure what high quality content would be like in that format (i.e. short form videos).

          On the contrary, I think a big part of the appeal of YouTube in the first place is the lower production value of the videos on the platform. I think anyone who’s attempting to compete with YouTube by offering higher production value with their videos is completely missing the mark, imo.

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  2. Hi Steve, you are referring to the less than 1% of enterprises (unicorns) in the above article and I still believe that for the 99% Lean Start-up is more relevant than ever. It has been very interesting to see how Lean has been implemented in various sectors and enterprise stages and types over the years. There is a rich base of knowledge emerging from its diverse application which is still very meaningful and helpful. I must, however, continue to ask why focus on the 1% when it is the 99% that fuel our economies and in increasing numbers are providing real solutions to systemic problems that we face?

    Liked by 3 people

    • I think the title is clickbait and deceiving. As you said, the article is focused on the 1% unicorns but characterized in a way that makes it sound like it applies to all organizations, which it doesn’t.

      Liked by 1 person

      • The title poses a question which the article answers. The article is about the capital markets and shifts in perceptions and sensibilities of VCs and some entrepreneurs. Like most Steve’s articles it either provides easy to miss insights or points to the changes in trends to those of us who are too busy running businesses to pay attention to the news or connect the dots (that would be me).

        Liked by 1 person

      • I see it differently. If the title were “Is Lean Dead for Unicorns?” I’d skip the article because that’s lofty for the 99%ers.
        But, if unicorns can finance their way around the lean process to expose new markets, history suggests those new markets create huge opportunities for that 99% (a la Amazon, Etsy, AirBnB, Uber, YouTube, etc.).
        Too, the unicorn also has to educate consumers about that new market which traditionally takes years, but Blank is suggesting may be speeded up with funding. So the 99%ers would need to understand this paradigm if they want to be early adopters and secure a niche in the new market.

        Liked by 1 person

  3. Maybe the real difference here is that when the potential market is huge you can worry less about “fit”. Maybe lean has been going about things in reverse and the first step to find a realistic measure of market size for the product before iterating around a “fit”. Maybe the knob to adjust is market size rather than the knob being the entirety of the product. And maybe a variable in all of this is how much effort a potential customer would need to put into altering their behavior to use our product.

    Liked by 1 person

  4. Steve,

    The Lean Startup is no more, or less “dead” than any other moment in time, which point you make very clear. The real question is how soon traditional banking and national currency systems will be “dead” by comparison. When all measure of capitalization is secured beyond institutional and national power systems—a trend well underway in what is essentially now all-out war between timeless civil- and faith-based power structures—the traditional currencies by which we “bankroll” what we deem as a good payoff or investment will be just another “virtual” alternative. The real wealth opportunity is in backing truly free capital flow among individual human beings—which of course is exactly what is being done in both NewTV capitalization via Katzenberg/Whitman reputation and Lean Startup entrepreneurship everywhere else in the world.

    Best, Steve

    312-375-0123

    > WordPress.com

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  5. It is a valuable clarification that being lean with respect to money my not be the smartest investment of your energies if money is available in abundance.

    However, I find that lean methodologies are most useful when they are applied to the resource of time. Dominant market positions are acquired in ever shorter periods of time and hence being very efficient with that resource is becoming ever more important imho.

    It doesn’t matter how much money you have the bank, if you waste valuable time executing against an unproven hypothesis, you may still loose against less well funded competitors who are more frugal with respect to time and get to product-market fit faster.

    Liked by 1 person

    • Hey Steve,

      if big cash is a faster lane to success than slow and rigorous customer development, why should the bottom 99% of cash starved founders not focus on raising more cash rather than on understanding customer problems?

      there is a time cost for funding as there is a time cost for customer development. Obviously whether at seeking funding or customer understanding, there are fast lanes: credibility vis à vis investors and customers

      so would you advise cash starved entrepreneurs to work more on credibility than on customer development?

      Bilel

      Like

  6. There is a typo in the fourth paragragp in the The Rise of the Lean Startup section. It’s Ries, Eric Ries, not Reis.

    Liked by 2 people

  7. Hi, Steve.
    I think every author should do this kind of post once in a while. “When my methodology might not be the best alternative…”
    It’s rare, because the more we put our efforts on developing something, the least susceptible we are to admit our idea might not fit in every case (similar attitude of incumbents to disrupting business models…)
    Of course, your analysis reinforces the importance of Lean Startup for the great majority of startups. But, being able to reflect and share an opposite argument regarding the work you’ve being doing for so many years is still admirable. Thanks.

    Liked by 1 person

  8. And for Latin America, Africa, and other places where capital is scarse, Lean and bootstrapping is sometimes the only alternative.

    Liked by 2 people

  9. I wonder if we are in a period of irrational exuberance at the moment. We have too many unicorns that aren’t even at a TRL level of 9.

    Like

  10. We are back in the cash-slush cycle. The investors have turned the faucet back on in 2018. However, all this easy capital floating around won’t kill the lean startups. One bust and people will be talking about them again.

    Liked by 1 person

  11. Thanks for connecting the dots and summarizing shifts in the trends Steve. As I am not looking for capital and too busy getting stuff done your articles always provide me with a viewpoint one can only form by reading, analyzing, discussing and distilling, a lot. Thank you.

    Look forward to each and every one of your articles.

    p.s. Twitted the quotes and link and noticed the promo image isn’t optimal, would be nice to fix that, see https://twitter.com/webbie

    Liked by 1 person

  12. This is an interesting perspective indeed.

    Good theories tend to strengthen with time. If the lean methodology is already coming to an end then it leads me to believe that it was never a strong theory to begin with. This leads to point two..

    Good theories should also be able to predict the future. Does this mean that the lean methodology was a post rationalisation? I.e. a narrative we created to explain how successful startups were created?

    My initial instinct is that if a business like the one described in this post will succeed, that it would be a new category of business. Not really a “startup” but something else, as in my experience the lean methodology simply works.

    The question still remains though whether this category would ever work. There is massive risk in raising so much capital and generally speaking the first mover advantage in the “long run” (a few years) is over rated when a new entrant refines the initial idea and finds a better business model (such as Google Vs Yahoo).

    Liked by 1 person

  13. Dear Steve,
    with utmost respect, I have a different interpretation. Full detail can be found in my recent post “Narrative Backed Thinking”
    View story at Medium.com

    Like

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