Steve Blank Corporate/Gov’t Innovation

Make No Little Plans – Defining the Scalable Startup

Posted on January 4, 2010 by steve blank

Make no little plans. They have no magic to stir men’s blood…
Daniel Burnham

A lot of entrepreneurs think that their startup is the next big thing when in reality they’re just building a small business. How can you tell if your startup has the potential to be the next Google, Intel or Facebook? A first order filter is whether the founders are aiming for a scalable startup.

Go For Broke
A few years ago I sat on the board of IMVU when the young company faced a choice my mother used to describe as “you should be so lucky to have this problem.” For its first year IMVU had funded itself with money from friends and family. Now with customers and early revenue, it was out raising its first round of venture money. (Not only did their sales curve look like a textbook case of a VC-friendly hockey stick, but their Lessons Learned funding presentation was an eye-opener.)

Staring at us in the board meeting were three term-sheets from brand name VC’s and an unexpected buy-out offer from Google. In fact, Google’s offer for $15 Million was equal to the highest valuation from the venture firms. The question was: what did the founders want to do?

Will Harvey, Eric Ries and the other founders were unequivocal – “Screw the buy-out, we’re here to build a company. Lets take venture capital and grow this thing into a real business.”

The Scalable Startup
Will and Eric implicitly had already made six decisions that defined a scalable startup.

Their vision for IMVU was broad and deep and very big – 3D avatars and virtual goods would eventually be everywhere in the on-line world. They wanted to build an industry not just a product or a company.
Their personal goal wasn’t to have a company that stayed small and paid them well. Nor did they think flipping the company to make a few million dollars would be a win. They believed their vision and work was going to be worth a lot more – or zero.
They envisioned that their tiny startup was to going to be a $100 million/year company by creating an entirely new market – selling virtual goods.
They used Customer and Agile development to search for a scalable and repeatable business model to become a large company. It reduced risk while allowing them to aim high.
They hired a world-class team with co-founders and early employees who shared their vision.
They fervently believed that only they were the ones who could and would make this happen.

These decisions guaranteed that the outcome of the board meeting was preordained. Selling out to Google would mean that someone else would define their vision. They were too driven and focused to let that happen. A few million dollars wasn’t their goal. Taking venture money was just a means to an end. Their goal was to get profitable and big. And risk capital allowed them to do that sooner than later. Venture money also meant that the VC’s goals of obscene returns were aligned with the founders. For the entire team, turning down the Google deal was equivalent to burning the boats on the shore. (One founder quit and joined Google.) After that, there was no doubt to existing employees and new hires what the company was aiming for.

Take No Prisoners
A “scalable startup” takes an innovative idea and searches for a scalable and repeatable business model that will turn it into a high growth, profitable company. Not just big but huge. It does that by entering a large market and taking share away from incumbents or by creating a new market and growing it rapidly.

A scalable startup typically requires external “risk” capital to create market demand and scale. And the founders must have a reality distortion field to convince investors their vision is not a hallucination and to hire employees and acquire early customers. A scalable startup requires incredibly talented people taking unreasonable risks with an unreasonable effort from the founders and employees.

Not All Startups are Scalable
The word entrepreneur covers a lot of ground. It means someone who organizes, manages, and assumes the risks of a business. Entrepreneurship often describes a small business whose owner starts up a company i.e. a plumbing supply store, a restaurant, a consulting firm. In the U.S. 5.7 million companies with fewer than 100 employees make up 99.5% of all businesses. These small businesses are the backbone of American capitalism. But small businesses startups have very different objectives than scalable startups.

First, their goal is not scale on an industry level. They may want to grower larger, but they aren’t focused on replacing an incumbent in an existing market or creating a new market. Typically the size of their opportunity and company doesn’t lend itself to attracting venture capital. They grow their business via profits or traditional bank financing. Their primary goal is a predictable revenue stream for the owner, with reasonable risk and reasonable effort and without the need to bring in world-class engineers and managers.

The Web and Startups
The Internet has created a series of new and innovative business models. Herein lies the confusion; not every business on the web can scale big. While the Internet has enabled scalable Internet startups like Google and Facebook, it has also created a much, much larger class of web-based small businesses that can’t or won’t scale to a large company. Some are in small markets, some are run by founders who don’t want to scale or can’t raise the capital, or acquire the team. (The good news is that there is an emerging class of investors who are more than happy to fund and flip Web small businesses.)

Scalable Startup or Small Business – Which One is Right?
There’s nothing wrong with starting a small business. In fact, it is scalable startups that are the abnormal condition. You have to be crazy to make the bet the IMVU founders did. Unfortunately the popular culture and press have made scalable startups like Google and Facebook the models that every entrepreneur should aspire to and disparages technology small businesses with pejoratives like “lifestyle business.”

That’s just plain wrong. It’s simply a choice.

Just make it a conscious choice.

Lessons Learned

Not all startups are scalable startups

6 initial conditions differentiate a scalable startup from a small business;

Breadth of an entrepreneurs’ vision

Founders’ personal goals

Size of the target market

Customer and Agile development to find the business model

World-class founding team and initial employees

Passionate belief and a reality distortion field

Understand your personal risk profile/ don’t try to be someone you’re not

Which one is “right” is up to you, not the crowd

Filed under: Corporate/Gov't Innovation, Customer Development, Technology, Venture Capital | 21 Comments »

Durant Versus Sloan – Part 1

Posted on October 1, 2009 by steve blank

The entrepreneur who built the largest startup in the United States is someone you probably never heard of. The guy who replaced him invented the idea of the modern corporation. Understanding the future of entrepreneurship may depend on understanding the contribution each of them made in the past.

This is the first of several posts on Durant versus Sloan.

Alfred P. Sloan
In the middle of the 20th Century Alfred P. Sloan was one of the most famous businessman in the world. Known as the “Inventor of the Modern Corporation,” Sloan was president of General Motors from 1923 to 1956 when the U.S. automotive industry grew to become one of the drivers of the global economy.

If you look around the United States it’s hard to avoid Sloan. There’s the Alfred P. Sloan Foundation, the Sloan School of Management at MIT, the Sloan program at Stanford, and the Sloan/Kettering Memorial Cancer Center in New York. Sloan’s book My Years with General Motors written 40 years ago is still a business classic.

The Modern Corporation
Sloan is rightly credited with formalizing the idea of the modern U.S. corporation, and by extension Sloan laid the foundation for America’s economic leadership in the 20th century. One guy really did all of this.

Peter Drucker wrote that Sloan was “the first to work out how to systematically organize a big company. When Sloan became president of GM in 1923 he put in place planning and strategy, measurements, and most importantly, the principles of decentralization.”

Sloan realized that the traditional centralized management structures (like General Motors had in 1920) were poor fits for the management of GM’s already diverse product lines. Top management was trying to coordinate all of the operating details (sales, manufacturing, distribution and marketing,) across all the divisions and the company almost went bankrupt that year when poor planning led to excess inventory (with unsold cars piling up at dealers and the company running out of cash.)

Sloan transferred responsibility down from corporate into each of the operating divisions (Chevrolet, Pontiac, Oldsmobile, Buick and Cadillac). Each of these GM divisions each focused on its own day-to-day operations and with each division general manager responsible for the division’s profit and loss. Sloan kept the corporate staff small and focused on policymaking, corporate finance and planning. Sloan had each of the divisions start systematic strategic planning.

Sloan put in place GM’s management accounting system (borrowed from DuPont) that for the first time allowed the company to: 1) produce an annual operating forecast that compared each division’s forecast (revenue, costs, capital requirements and return on investment) with the company’s financial goals. 2) Provide corporate management with near real-time divisional sales reports and budgets that indicated when they deviated from plan. 3) Allowed management to allocate resources and compensation among divisions based on a standard set of corporate-wide performance criteria.

Finally, Sloan transformed corporate management into a real profession, establishing the standard that the professional manager is duty-bound to put the interests of the enterprise ahead of his own.

Modern Corporation Marketing
At the same time General Motors also revolutionized automotive marketing by creating multiple brands of cars, each with its own identity targeted at a specific economic bracket of American customers. The company set the prices for each of these brands from lowest to highest (Chevrolet, Pontiac, Oldsmobile, Buick and Cadillac.) Within each brand there were several models at different price points.

The idea was to keep customers coming back to General Motors over time to upgrade to a better brand as they became wealthier. Finally, GM created the notion of perpetual demand within brands by continually obsoleting their own products yearly with new models rolled out every year. (Think of the iPod family and its yearly new models.)

When Sloan took over as president of GM in 1923, Ford and its Model T was the dominant player in the U.S. auto market with 60% of the U.S. car market. General Motors had 20%. By 1931, with the combination of superior financial management and a astute brand and product line strategy, GM had 43% market share to Ford’s 20% – a lead it never relinquished.

Thanks for the History Lesson – So What?
Well thanks for the history lesson but why should you care?

If you’re an entrepreneur you might be interested to know that when Sloan took over General Motors in 1923, it was already a $700 million dollar company (about $8.5 billion in sales in today’s dollars.)

Yet you never hear who built that company. Who founded what would become General Motors 16 years earlier in 1904? Where are the charitable foundations, business schools and hospitals named after him? What happened to him? Who was he?

The founder of what became General Motors was William (Billy) Durant. His board (led by the DuPont family) tossed him out of General Motors (for the second time) in 1920 when GM sales were $567 million (about $6 billion in today’s dollars.)

William Durant died managing a bowling alley in Flint Michigan in 1947.

From the day Durant was fired in 1920, and for the next half a century, American commerce would be led by an army of “Sloan-style managers.”

But the spirit of Billy Durant would rise again.

This time in what would become Silicon Valley.

Billy Durant – Founder General Motors

Touching the Hot Stove – Experiential versus Theoretical Learning

Posted on August 13, 2009 by steve blank

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

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

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

I was an idiot.

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

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

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

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

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

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

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

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

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

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