Is the Lean Startup Dead?

Posted on September 5, 2018 by steve blank

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.

Filed under: Corporate/Gov't Innovation, Customer Development, Harvard Business Review, Venture Capital | 27 Comments »

The Innovation Stack: How to make innovation programs deliver more than coffee cups

Posted on June 5, 2018 by steve blank

Is your organization full of Hackathons, Shark Tanks, Incubators and other innovation programs, but none have changed the trajectory of your company/agency?

Over the last few years Pete Newell and I have helped build innovation programs inside large companies, across the U.S. federal science agencies and in the Department of Defense and Intelligence Community. But it is only recently that we realized why some programs succeed and others are failing.

After doing deep dives in multiple organizations we now understand why individual innovators are frustrated, and why entrepreneurial success requires heroics. We also can explain why innovation activities have generated innovation theater, but few deliverables. And we can explain why innovation in large organizations looks nothing like startups. Most importantly we now have a better idea of how to build innovation programs that will deliver products and services, not just demos.

It starts by understanding the “Innovation Stack” – the hierarchy of innovation efforts that have emerged in large organizations. The stack consists of: Individual Innovation, Innovation Tools and Activities, Team-based Innovation and Operational Innovation.

Individual Innovation
The pursuit of innovation inside large companies/agencies is not a 21st-century invention. Ever since companies existed, there have been passionate individuals who saw that something new, unplanned and unscheduled was possible. And pushing against the status quo of existing process, procedure and plan, they went about building a demo/prototype, and through heroic efforts succeeded in getting a new innovation over the goal line – by shipping/deploying a new innovation.

We describe their efforts as “heroic” because all the established procedures and processes in a large company are primarily designed to execute and support the current business model. From the point of view of someone managing an engineering, manufacturing or operations organization, new, unplanned and unscheduled innovations are a distraction and a drag on existing resources. (The best description I’ve heard is that, “Unfettered innovation is a denial of service attack on core capabilities.”) That’s because until now, we hadn’t levied any requirements, rigor or evidence on the innovator to understand what it would take to integrate, scale and deploy products/services.

Finally, most corporate/agency innovation processes funnel “innovations” into “demo days” or “shark tanks” where they face an approval/funding committee that decides which innovation ideas are worth pursuing. However, without any measurable milestones to show evidence of the evolution of what the team has learned about validity of the problem, customer needs, pivots, etc., the best presenter and flashiest demo usually win.

In some companies and government agencies, innovators even have informal groups, i.e. an Innovators Alliance, where they can exchange best practices and workarounds to the system. (Think of this as the innovator’s support group.) But these innovation activities are ad hoc, and the innovators lack authority, resources and formal process to make innovation programs an integral part of their departments or agencies.

Innovators vs. Entrepreneurs
There are two types of people who engage in large company/agency innovation: Innovators – those who invent new technology, product, service or processes; and Entrepreneurs – those who’ve figured out how to get innovation adopted and delivered through the existing company/agency procedures and processes. Although some individuals operate as both innovator and entrepreneur, any successful innovation program requires an individual or a team with at least these two skill sets. (More detail can be found here.)

Innovation Tools and Activities
Over the last decade, innovators have realized that they needed tools and activities different from traditional project management tools used for new versions of existing products/customers.They have passionately embraced innovation tools and activities that for the first time help individual innovators figure out what to build, who to build it for and how to create effective prototypes and demos.

Some examples of innovation tools are Customer Development, Design Thinking, User-Centric Design, Business Model Canvas, Storytelling, etc. Companies/agencies have also co-opted innovation activities developed for startups such as Hackathons, Incubators, internal Kickstarters, as well as Open Innovation programs and Maker Spaces that give individual innovators a physical space and dedicated time to build prototypes and demos. In addition, companies and agencies have set up Innovation Outposts (most often located in Silicon Valley) to be closer to relevant technology and then to invest, partner or buy.

These activities make sense in a startup ecosystem (where 100% of the company is focused on innovation,) however they generate disappointing results inside companies/agencies (when 98% of the organization is focused on executing the existing business/mission model.) While these tools and activities educated innovators and generated demos and prototypes, they lacked an end-to-end process that focused on delivery/deployment. So it should be no surprise that very few contributed to the company’s top or bottom line (or an agency’s mission).

One of the ironies of the tools/activities groups is rather than talking about the results of using the tools – i.e. the ability to rapidly deliver new products/services that are wanted and needed – their passion has them evangelizing the features of the tools and activities. This means that senior leadership has pigeonholed most of these groups as extensions of corporate training departments and skeptics view this as the “latest fad.”

Team-based Innovation
Rather than just teaching innovators how to use new tools or having them build demos, we recognized that there was a need for a process that taught all the components of a business/mission model (who are the customers, what product/service solves their problem, how do we get it to them, support it, etc.) The next step in entrepreneurial education was to teach teams a formal innovation process for how to gather evidence that lets them test if their idea is feasible, desirable and viable. Examples of team-based innovation programs are the National Science Foundation Innovation Corps (I-Corps @ NSF), for the Intelligence Community I‑Corps@ NSA, and for the Department of Defense, Hacking for Defense (H4D).

In contrast to single-purpose activities like Incubators, Hackathons, Kickstarters, etc., these curricula teach what it takes to turn an idea into a deliverable product/service by using the scientific method of hypothesis testing and experimentation outside the building. This process emphasizes rapid learning cycles with speed, urgency, accepting failure as learning, and innovation metrics.

Teams talk to 100+ beneficiaries and stakeholders while building minimal viable products to maximize learning and discovery. They leave the program with a deep understanding of all the obstacles and resources needed to deliver/deploy a product.

The good news – I-Corps, Hacking for Defense and other innovation programs that focus on training single teams have raised the innovation bar. These programs have taught thousands of teams of federally funded scientists as well as innovators in corporations, the Department of Defense and intelligence community. However, over time we’ve seen teams that completed these programs run into scaling challenges. Even with great evidence-based minimal viable products (prototypes), teams struggled to get these innovations deployed at scale and in the field. Or a team that achieved product-market fit building a non-standard architecture could find no way to maintain it at scale within the parent organization.

Upon reflection we identified two root causes. The first is a lack of connection between innovation teams and their parent organization. Teams form/and are taught outside of their parent organization because innovation is disconnected from other activities. This meant that when teams went back to their home organization, they found that execution of existing priorities took precedence. They returned speaking a foreign language (What’s a pivot? Minimum viable what?) to their colleagues and bosses who are rewarded on execution-based metrics. Further, as budgets are planned out years in advance, their organization had no slack for “good ideas.” As a result, there was no way to finish and deploy whatever innovative prototypes the innovators had developed – even ones that have been validated.

The second root cause emerged because neither the innovator’s teams nor their organizations had the mandate, budget or people to build an end-to-end innovation pipeline process, one that started with innovation sourcing funnel (both internal and external sources) all the way to integrating their prototypes into mainstream engineering production. (see below and this HBR article on the innovation pipeline.)

Operational Innovation
As organizations have moved from – individual innovators working alone, to adopting innovation tools and activities, to teaching teams about evidence-based innovation – our most important realization has been this: Having skills/tools and activities are critical building blocks but by themselves are insufficient to build a program that delivers results that matter to leadership.  It’s only when senior leaders see how an innovation process can deliver stuff that matters – at speed—that they take action to change the processes and procedures that get in the way.

We believe that the next big step is to get teams and leaders to think about the innovation process from end-to-end – that is to visualize the entire flow of how and from where an idea is generated (the source) all the way to deployment (how it gets into users’ hands). So, we’ve drawn a canonical innovation pipeline. (The HBR article here describes it in detail.) For context, in the figure below, the I-Corps program described earlier is the box labeled “Solution Exploration/Hypotheses Testing.” We’ve surrounded that process with all the parts necessary to build and deliver products and services at speed and at scale.

Second, we’ve realized that while individual initiatives won “awards,” and Incubators and Hackathons got coffee cups and posters, senior leadership sat up and took notice when operating groups transformed how they work in the service of a critical product or mission. When teams in operating groups adopted the innovation pipeline, it made an immediate impact on delivering products/services at speed.

An operating group can be a corporate profit and loss center or anything that affects revenue, profit, users, market share, etc. In a government agency it can be something that allows a group to execute mission more effectively or in a new disruptive way. Operating groups have visibility, credibility and most importantly direct relevance to mission.

Where are these groups? In every large company or agency there are groups solving operational problems that realize “they can’t go on like this” and/or “we need to do a lot more stuff” and/or “something changed, and we rapidly need to find new ways to do business.” These groups are ready to try something new. Most importantly we learned that “the something new” is emphatically not more tools or activities (design thinking, user-centric design, storytelling, hackathons, incubators, etc.) Because these groups want an end-to-end solution, the innovation pipeline resonates with the “do’ers” who lead these groups.

(One example of moving up the Innovation Stack is that the NSA I-Corps team has recently shifted their focus from working with individual teams to helping organizations deploy the methodology at scale.  In true lean startup fashion, they are actively testing a number of approaches with a variety of internal organizations ranging in size from 40 to 1000+ people.)

However, without a mandate for actually delivering innovation from senior leadership, scaling innovation across the company/agency means finding one group at a time – until you reach a tipping point of recognition. That’s when leadership starts to pay attention. Our experience to date is that 25- to 150-person groups run by internal entrepreneurs with budget and authority to solve critical problems are the right place to start to implement this. Finding these people in large companies/agencies is a repeatable process. It requires patient and persistent customer discovery inside your company/agency to find these groups and deeply understand their pains/gains and jobs to be done.

Lessons Learned

  • Companies/agencies have adapted and adopted startup innovation tools
    • Lean, Design Thinking, User-centric Design, Business Model Canvas, etc.
  • As well as startup activities and team-based innovation 
    • Hackathons, Incubators, Kickstarters, I-Corps, FastWorks, etc.
  • Because they are disconnected from the mainstream business/mission model very few have been able to scale past a demo/prototype
  • Use the Innovation Stack and start working directly with operating groups
    • Find those who realize “they can’t go on like this” and/or “we need to do a lot more stuff” and/or “something changed, and we rapidly need to find new ways to do business”
  • You’ll deliver stuff that matters instead of coffee cups

Filed under: Corporate/Gov't Innovation, Customer Development | 14 Comments »

Why the Future of Tesla May Depend on Knowing What Happened to Billy Durant

Posted on April 23, 2018 by steve blank

A version of this article appeared in the Harvard Business Review

Elon Musk, Alfred Sloan, and entrepreneurship in the automobile industry.

The entrepreneur who founded and grew the largest startup in the world to $10 billion in revenue and got fired is someone you have probably never heard of. The guy who replaced him invented the idea of the modern corporation. If you want to understand the future of Tesla and Elon Musk’s role – something many want to do, given the constant stream of headlines about the company — you should start with a bit of automotive history from the 20th Century.

Alfred P. Sloan and the Modern Corporation
By the middle of the 20th century, Alfred P. Sloan had become 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 U.S. economy.

Today, 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 half a century ago, is still a readable business classic.

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.”

When Sloan arrived at GM in 1920 he realized that the traditional centralized management structures organized by function (sales, manufacturing, distribution, and marketing) were a poor fit for managing GM’s diverse product lines.  That year, as management tried to coordinate all the operating details across all the divisions, the company almost went bankrupt when poor planning led to excess inventory, with unsold cars piling up at dealers and the company running out of cash.

Borrowing from organizational experiments pioneered at DuPont (run by his board chair), Sloan organized the company by division rather than function and transferred responsibility down from corporate into each of the operating divisions (Chevrolet, Pontiac, Oldsmobile, Buick and Cadillac). Each of these GM divisions focused on its own day-to-day operations 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.  Today, we take for granted divisionalization as a form of corporate organization, but in 1920, other than DuPont, almost every large corporation was organized by function.

Sloan put in place GM’s management accounting system (also 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.

Modern Corporation Marketing
When Sloan took over as president of GM in 1923, Ford was the dominant player in the U.S. auto market. Ford’s Model T cost just $260 ($3,700 in today’s dollars) and Ford held 60% of the U.S. car market. General Motors had 20%. Sloan realized that GM couldn’t compete on price, so GM created 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 with new models rolled out every year. (Think of the iPhone and its yearly new models.)

By 1931, with the combination of superior financial management and an astute brand and product line strategy, GM had 43% market share to Ford’s 20% – a lead it never relinquished.

Sloan transformed corporate management into a real profession, and its stellar example was the continuous and relentless execution of the GM business model (until its collapse 50 years later).

What Does GM Have to Do with Tesla And Elon Musk?
Well, thanks for the history lesson but why should I care?

If you’re following Tesla, you might be interested to know that Sloan wasn’t the founder of GM. Sloan was president of a small company that made ball bearings that GM acquired in 1918. When Sloan became President of General Motors in 1923, it was already a $700 million company (about $10.2 billion in sales in today’s dollars).

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

The founder of what became General Motors was William (Billy) Durant. At the turn of the 20th century, Durant was one of the largest makers of horse-drawn carriages, building 150,000 a year. But in 1904, after his first time seeing a car in Flint, Michigan, he was one of the first to see that the future was going to be in a radically new form of transportation powered by internal combustion engines.

Durant took his money from his carriage company and bought a struggling automobile startup called Buick. Durant was a great promoter and visionary, and by 1909 he had turned Buick into the best-selling car in the U.S. Searching for a business model in a new industry, and with the prescient vision that a car company should offer multiple brands, that year he bought three other small car companies — Cadillac, Oldsmobile, and Pontiac — and merged them with Buick, renaming the combined company General Motors. He also believed that to succeed the company needed to be vertically integrated and bought up 29 parts manufacturers and suppliers.

The next year, 1910, trouble hit. While Durant was a great entrepreneur, the integration of the companies and suppliers was difficult, a recession had just hit, and GM was overextended with $20 million in debt ($250 million in 2018 dollars) from all the acquisitions and was about to run out of cash. Durant’s bankers and board fired him from the company he had founded.

For most people the story might have ended there. But not for Durant. The next year Durant co-founded another automobile startup, this one started with Louis Chevrolet. Over the next five years Durant built Chevrolet into a competitor to GM. And in one of the greatest corporate comeback stories, in 1916 Durant used Chevrolet to buy back control of GM with the backing of Pierre duPont. He once again took over General Motors, merged Chevrolet into GM, bought Fisher Body and Frigidaire, created GMAC GM’s financing arm and threw out the bankers who six years earlier had fired him.

Durant had another great four years at the helm of GM. At the time he was not only running GM but was a major Wall Street speculator (even on GM stock) and was big in the New York social scene. But trouble was on the horizon. Durant was at his best when there was money to indulge his indiscriminate expansion. (He bought two car companies – Sheridan and the Scripps-Booth – that competed with his existing products.) But by 1920, a post-World War I recession had hit, and car sales has slowed. Durant kept building for a future assuming the flow of cash and customers would continue.

Meanwhile, inventory was piling up, the stock was cratering, and the company was running out of cash. In the spring of 1920 with company had to go to the banks and he got an $80 million loan (about a billion dollars in 2018) to finance operations. While everyone around him acknowledged he was a visionary and a world-class fund raiser, Durant’s one-man show was damaging the company. He couldn’t prioritize, couldn’t find time to meet with his direct reports, fired them when they complained about the chaos, and the company had no financial controls other than Durant’s ability to manage to raise more money. When the stock collapsed Durant’s personal shares were underwater and were exposed to being called by bankers who would then own a good part of GM. The board decided that the company had enough vision — they bought out Durant’s shares and realized it was now time for someone who could execute at scale.

Once again, his board (this time led by the DuPont family) tossed him out of General Motors (when GM sales were $10 billion in today’s dollars.)

Alfred Sloan became the President of GM and ran it for the next three decades.

William Durant tried to build his third car company, Durant Motors, but he was still speculating on stocks, and got wiped out in the Depression in 1929. The company closed in 1931. 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” who managed and executed existing business models.

But the spirit of Billy Durant would rise again in what would become Silicon Valley. And 100 years later Elon Musk would see that the future of transportation was no longer in internal combustion engines and build the next great automobile company.

Days of Futures Past for Tesla
In all of his companies, Elon Musk has used his compelling vision of a future transformed to capture the imagination of customers and, equally important, of Wall Street, raising the billions of dollars to make his vision a reality.

Yet, as Durant’s story typifies, one of the challenges for visionary founders is that they often have a hard time staying focused on the present when the company needs to transition into relentless execution and scale. Just as Durant had multiple interests, Musk is not only Tesla’s CEO and Product Architect, overseeing all product development, engineering, and design. At SpaceX (his rocket company) he’s CEO and lead designer overseeing the development and manufacturing of advanced rockets and spacecraft. He’s also the founder at The Boring Company (the tunneling company) and co-founder and chairman of OpenAI. And a founder of Neuralink a brain-computer interface startup.

All of these companies are doing groundbreaking innovations but even Musk only has 24 hours in a day and 7 days in a week. Others have noted that diving in and out of your current passion makes you a dilettante, not a CEO.

One of the common traits of a visionary founder is that once you have proven the naysayers wrong, you convince yourself that all your pronouncements have the same prescience.

For example, after the success of the Model S sedan, Tesla’s next car was an SUV, the Model X. By most accounts, Musk’s insistence on adding bells and whistles (like the Falcon Wing doors and other accoutrements) to what should have been simple execution of the next product made manufacturing the car in volume a nightmare. Executives who disagreed (and had a hand in making the Model S a success) ended up leaving the company. The company later admitted that the lesson learned was hubris.

The Tesla Model 3 was designed to be simple to manufacture, but instead of using the existing assembly line Musk said, “the true problem, the true difficulty, and where the greatest potential is – is building the machine that makes the machine. In other words, it’s building the factory. I’m really thinking of the factory like a product.” Fast forward two years and it turns out that the Model 3 assembly line was a great example of over-automation. “Excessive automation at Tesla was a mistake. To be precise, my mistake” Musk recently tweeted,

Sleeping on the factory floor to solve self-inflicted problems is not a formula for success at scale, and while it’s great PR, it’s not management. It is in fact a symptom of a visionary founder imposing chaos just at the time where execution is required. Tesla now has a pipeline of newly announced products, a new Roadster (a sports car), a Semi Truck, and a hinted crossover called the Model Y. All of them will require massive execution at scale, not just vision.

Unlike Durant, Musk has engineered his extended tenure and this year got his shareholders to give him a new $2.6 billion compensation plan (and it could potentially be worth as much as $55 billion) if he can grow the company’s market cap in $50 billion increments to $650 billion. The board said that it “believes that the Award will continue to incentivize and motivate Elon to lead Tesla over the long-term, particularly in light of his other business interests.”

Elon Musk has done what Steve Jobs and Jeff Bezos did – disrupt a series of stagnant businesses controlled by rent seekers, permanently changing the trajectory of multiple industries – while capturing the imagination of consumers and the financial community. Just a handful of people with these skills emerge every century. However, fewer combine the talent for creating an industry with the very different skills needed for scale. Each of Tesla’s stumbles has begun to squander the very advantage that Musks vision gave the company. And what was once an insurmountable lead by having an economic castle surrounded by a defensible moat (battery technology, superchargers, autonomous driving, over the air updates, etc.) is closing rapidly.

One wonders if $2.6 billion in executive compensation would be better spent finding someone to lead Tesla to becoming a reliable producer of cars in high volume – without the drama in each new model.

Perhaps Tesla now needs its Alfred P. Sloan.

Lesson Learned

  • Founders/visionaries see things other don’t and the extraordinary ones create new industries
  • When technology changes are rapid you want the founder to continue to run the company
  • However, when success depends on exploitation and execution at scale their impatience for continuous innovation and invention often gets in the way of day-to-day execution
  • The best ones know when it’s time to let go

Filed under: Corporate/Gov't Innovation, Harvard Business Review, Tesla | 14 Comments »

Why Entrepreneurs Start Companies Rather Than Join Them

Posted on April 11, 2018 by steve blank

If you asked me why I gravitated to startups rather than work in a large company I would have answered at various times: “I want to be my own boss.” “I love risk.” “I want flexible work hours.” “I want to work on tough problems that matter.” “I have a vision and want to see it through.” “I saw a better opportunity and grabbed it. …”

It never crossed my mind that I gravitated to startups because I thought more of my abilities than the value a large company would put on them. At least not consciously. But that’s the conclusion of a provocative research paper, Asymmetric Information and Entrepreneurship, that explains a new theory of why some people choose to be entrepreneurs. The authors’ conclusion — Entrepreneurs think they are better than their resumes show and realize they can make more money by going it alone.  And in most cases, they are right.

I’ll summarize the paper’s conclusions, then share a few thoughts about what they might mean – for companies, entrepreneurs and entrepreneurial education. (By the way, as you read the conclusions keep in mind the authors are not talking just about high-tech entrepreneurs. They are talking about everyone who chooses to be self-employed – from a corner food vendor without a high school diploma to a high-tech founder with a PhD in Computer Science from Stanford.)

The authors’ research came from following 12,686 people over 30+ years. They found:

  1. Signaling. When you look for a job you “signal” your ability to employers via a resume with a list of your educational qualifications and work history. Signaling is a fancy academic term to describe how one party (in this case someone who wants a job) credibly conveys information to another party (a potential employer).
  2. Capable. People choose to be entrepreneurs when they feel that they are more capable than what employers can tell from their resume or an interview. So, entrepreneurs start ventures because they can’t signal their worth to potential employers.
  3. Better Pay. Overall, when people choose entrepreneurship they earn 7% more than they would have in a corporate job. That’s because in companies pay is usually set by observable signals (your education and experience/work history).
  4. Less Predictable Pay. But the downside of being an entrepreneur is that as a group their pay is more variable – some make less than if they worked at a company, some much more.
  5. Smarter. Entrepreneurs score higher on cognitive ability tests than their educational credentials would predict. And their cognitive ability is higher than those with the same educational and work credentials who choose to work in a company.
  6. Immigrants and Funding. Signaling (or the lack of it) may explain why some groups such as immigrants, with less credible signals to existing companies (unknown schools, no license to practice, unverifiable job history, etc.) tend to gravitate toward entrepreneurship. And why funding from families and friends is a dominant source of financing for early-stage ventures (because friends and family know an entrepreneur’s ability better than any resume can convey).
  7. Entrepreneurs defer getting more formal education because they correctly expect their productivity will be higher than the market can infer from just their educational qualifications. (There are no signals for entrepreneurial skills.)

Lemons Versus Cherries. The most provocative conclusion in the paper is that asymmetric information about ability leads existing companies to employ only “lemons,” relatively unproductive workers. The talented and more productive choose entrepreneurship. (Asymmetric Information is when one party has more or better information than the other.) In this case the entrepreneurs know something potential employers don’t – that nowhere on their resume does it show resiliency, curiosity, agility, resourcefulness, pattern recognition, tenacity and having a passion for products.
This implication, that entrepreneurs are, in fact, “cherries” contrasts with a large body of literature in social science, which says that the entrepreneurs are the “lemons”— those who cannot find, cannot hold, or cannot stand “real jobs.”

So, what to make of all this?
If the authors are right, the way we signal ability (resumes listing education and work history) is not only a poor predictor of success, but has implications for existing companies, startups, education, and public policy that require further thought and research.

Companies: In the 20thcentury when companies competed with peers with the same business model, they wanted employees to help them execute current business models (whether it was working on an assembly line or writing code supporting or extending current products). There was little loss when they missed hiring employees who had entrepreneurial skills. However, in the 21stcentury companies face continuous disruption; now they’re looking for employees to help them act entrepreneurial.  Yet their recruiting and interviewing processes – which define signals they look for – are still focused on execution not entrepreneurial skills.

Surprisingly, the company that best epitomized this was not some old-line manufacturing company but Google. When Marissa Mayer ran products at Google the New York Times  described her hiring process, “More often than not, she relies on charts, graphs and quantitative analysis as a foundation for a decision, particularly when it comes to evaluating people…At a recent personnel meeting, she homes in on grade-point averages and SAT scores to narrow a list of candidates, many having graduated from Ivy League schools, …One candidate got a C in macroeconomics. “That’s troubling to me,” Ms. Mayer says. “Good students are good at all things.”

Really.  What a perfect example of adverse signaling. No wonder the most successful Google products, other than search, have been acquisitions of startups not internal products: YouTube, Android, DoubleClick, Keyhole (Google Maps), Waze were started and run by entrepreneurs. The type of people Google and Marissa Mayer wouldn’t and didn’t hire started the companies they bought.

Entrepreneurship. When I shared the paper withTina Seelig at Stanford she asked, “If schools provided better ways to signal someone’s potential to employers, will this lead to less entrepreneurship?”  Interesting question.

Imagine if in a perfect world corporate recruiters found a way to identify the next Steve Jobs, Elon Musks, or Larry Ellisons. Would the existing corporate processes, procedures and business models crush their innovative talents, or would they steer the large companies into a new renaissance?

The Economic Environment. So, how much of signaling (hiring only by resume qualifications) is influenced by the economic environment? One could assume that in a period of low unemployment, it will be easier to get a traditional job, which would lead to fewer startups and explain why great companies are often founded during a downturn. Those who can’t get a traditional job start their own venture. Yet other public policies come into play. Between the late 1930s and the 1970s the U.S. tax rate for individuals making over $100,000 was 70% and 90% (taxes on capital gains fluctuated between 20% and 25%.) Venture capital flourished when the tax rates plummeted in the late 1970s. Was entrepreneurship stifled by high personal income taxes? And did it flourish only when entrepreneurs saw the opportunity to make a lot more money on their own?

Leaving a Company. Some new ventures are started by people who leave big companies to strike out on their own – meaning they weren’t trying to find employment in a corporation, they were trying to get away from it.  While starting your own company may look attractive from inside a company, the stark reality of risking one’s livelihood, financial stability, family, etc., is a tough bar to cross.  What motivates these people to leave the relative comfort of a steady corporate income and strike out on their own?  Is it the same reason – their company doesn’t value their skills for innovation and is just measuring them on execution? Or something else?

Entrepreneurial Education. Is entrepreneurship for everyone? Should we expect that we can teach entrepreneurship as a mandatory class? Or is it calling? Increasing the number of new ventures will only generate aggregate wealth if those who start firms are truly more productive as entrepreneurs.

Lessons Learned

  • Entrepreneurs start their own companies because existing companies don’t value the skills that don’t fit on a resume
  • The most talented people choose entrepreneurship (Lemons versus Cherries)
  • Read the paper and let me know what you think

 

Filed under: Corporate/Gov't Innovation, Family/Career/Culture | 30 Comments »

The State of Entrepreneurship

Posted on March 13, 2018 by steve blank

Co-founder magazine just interviewed me about the current state of entrepreneurship – in startups and large companies – and how we got here. I thought they did a good job of capturing my thoughts.

Take a read here.

click here to read the rest of the article

Filed under: Corporate/Gov't Innovation, Customer Development, Teaching | 7 Comments »

Innovation at Speed – when you have 2 million employees

Posted on February 13, 2018 by steve blank

Success no longer goes to the country that develops a new fighting technology first, but rather to the one that better integrates it and adapts its way of fighting…Our response will be to prioritize speed of delivery, continuous adaptation, and frequent modular upgrades. We must not accept cumbersome approval chains, wasteful applications of resources in uncompetitive space, or overly risk-averse thinking that impedes change.

If you read these quotes, you’d think they were from a CEO who just took over a company facing disruption from agile startups and a changing environment. And you’d be right. Although in this case the CEO is the Secretary of Defense. And his company has 2 million employees.

In January, Secretary of Defense Mattis released the 2018 National Defense Strategy. This document tells our military – the Department of Defense – what kind of adversaries they should plan to face and how they should plan to use our armed forces. The National Defense Strategy is the military’s “here’s what we’re going to do,” to implement the executive branch’s National Security Strategy. The full version of the National Defense Strategy is classified; but the 10-page unclassified summary of this strategic guidance document for the U.S. Defense Department is worth a read.

Since 9/11 the U.S. military focused on defeating non-nation states (ISIS, al-Qaeda, et al.) The new National Defense Strategy states that we need to prepare for competition between major powers, calling out China and Russia explicitly as adversaries, (with China appearing to be the first.) Secretary Mattis said, “Our competitive advantage has eroded in every domain of warfare.”

While the Defense Strategy recognizes the importance of new technologies e.g. autonomous systems and artificial intelligence – the search is no longer for the holy grail of a technology offset strategy. Instead the focus is on global and rapid maneuver capabilities of smaller, dispersed units to “increase agility, speed, and resiliency .. and deployment … in order to stand ready to fight and win the next conflict.” The goal is to make our military more “lethal, agile, and resilient.”

The man with a lot of fingerprints on this document is the Deputy Secretary of Defense Patrick Shanahan. Shanahan came from Boeing, and his views on innovation make interesting reading.

“The DoD must become less averse to risk” is something you’ve rarely heard in the government. Yet, Shanahan said, “Innovation is messy, if the (defense) department is really going to succeed at innovation, we’re going to have to get comfortable with people making mistakes.”

All of this means that significant changes will be needed in the Department of Defense’s culture and policies.  But now the change agents and innovation insurgents who have been fighting to innovate from the bottom up at Office of Naval Research, National Geospatial-Intelligence Agency, Joint Improvised-Threat Defeat Organization, Defense Intelligence Agency, National Security Agency, Defense Innovation Unit Experimental, Intelligence Advanced Research Projects Activity, etc., will have the support all the way to the Secretary of Defense.

The innovation language in this document is pretty mind blowing – particularly the summary on page 10. It’s almost as they’ve been reading the posts Pete Newell and I have written on the Red Queen Problem and the Innovation Pipeline.

This document, combined with the split of Acquisition and Logistics, (the office responsible for buying equipment for the military), from Research and Engineering will enable the DoD to better connect with private industry to get technology integrated into the defense department. The last time the country mobilized private industry at scale was the Cold War.

As you read the excerpts below from the 2018 National Defense Strategy imagine the shockwaves this would send through any large company.  This is a pretty unprecedented document for the military.

on page 3
“…Maintaining the Department’s technological advantage will require changes to industry culture, investment sources, and protection across the National Security Innovation Base. “

on page 4
“Defense objectives include: …Continuously deliver performance with affordability and speed as we change Departmental mindset, culture, and management systems;

on page 5
“Foster a competitive mindset. To succeed in the emerging security environment, our Department and Joint Force will have to out-think, out-maneuver, out-partner, and out-innovate revisionist powers, rogue regimes, terrorists, and other threat actors. We will expand the competitive space while … reforming the Department’s business practices for greater performance and affordability. 

on page 7
“Cultivate workforce talent. … Cultivating a lethal, agile force requires more than just new technologies and posture changes; …it depends on the ability of our Department to integrate new capabilities, adapt warfighting approaches, and change business practices to achieve mission success. The creativity and talent of the American warfighter is our greatest enduring strength, and one we do not take for granted.
…A modern, agile, information-advantaged Department requires a motivated, diverse, and highly skilled civilian workforce. We will emphasize new skills and complement our current workforce with information experts, data scientists, computer programmers, and basic science researchers and engineers…The Department will also continue to explore streamlined, non-traditional pathways to bring critical skills into service, expanding access to outside expertise, and devising new public-private partnerships to work with small companies, start-ups, and universities.

on page 10
The current bureaucratic approach, centered on exacting thoroughness and minimizing risk above all else, is proving to be increasingly unresponsive. We must transition to a culture of performance where results and accountability matter.

Deliver performance at the speed of relevance. Success no longer goes to the country that develops a new fighting technology first, but rather to the one that better integrates it and adapts its way of fighting…. Current processes are not responsive to need; the Department is over-optimized for exceptional performance at the expense of providing timely decisions, policies, and capabilities to the warfighter. Our response will be to prioritize speed of delivery, continuous adaptation, and frequent modular upgrades. We must not accept cumbersome approval chains, wasteful applications of resources in uncompetitive space, or overly risk-averse thinking that impedes change. Delivering performance means we will shed outdated management practices and structures while integrating insights from business innovation.

Organize for innovation. The Department’s management structure and processes are not written in stone, they are a means to an end–empowering the warfighter with the knowledge, equipment and support systems to fight and win. Department leaders will adapt their organizational structures to best support the Joint Force. If current structures hinder substantial increases in lethality or performance, it is expected that Service Secretaries and Agency heads will consolidate, eliminate, or restructure as needed.

Up to now innovation within the Department of Defense has been the province of a small group of insurgents, each doing heroic efforts. Now innovation at speed has become a nation’s priority.  Culture change is hardest in the middle of a large organization. It will be interesting to see how each agency in the Department of Defense (and its contractors) adopts the strategy or whether the bureaucratic middle kills it/waits it out. Time will tell whether it provides real change, but this is a great start.

Filed under: Corporate/Gov't Innovation, Hacking For Defense | 3 Comments »

Why GE’s Jeff Immelt Lost His Job – Disruption and Activist Investors

Posted on November 1, 2017 by steve blank

This article first appeared on the Harvard Business Review blog

Jeff Immelt ran GE for 16 years. He radically transformed the company from a classic conglomerate that did everything to one that focused on its core industrial businesses. He sold off slower-growth, low-tech, and nonindustrial businesses — financial services, media, entertainment, plastics, and appliances. He doubled GE’s investment in R&D.

In his Harvard Business Review article summing up his tenure, Immelt recalls that the two things that influenced him most were Marc Andreessen’s 2011 Wall Street Journal article “Why Software Is Eating the World,” and Eric Ries’s book The Lean Startup.

Andreessen’s article helped accelerate the company’s digital transformation. GE made a $4 billion bet on connecting industrial equipment via the Internet of Things (IoT) and analytical software with a suite of products called the “Predix Cloud”.

In response to reading Eric Ries’s The Lean Startup, GE adopted Lean and built their Fastworks program around it. Beth Comstock, GE vice chair responsible for creating new businesses, embraced the lean process. Over a period of years, every GE senior manager would learn the Lean Startup, and GE would be the showcase for how modern companies use entrepreneurial management to transform culture and drive long-term growth.

Innovation at GE was on a roll.

Then it wasn’t.

—

In June 2017, the board “retired” Jeff Immelt and promoted John Flannery to CEO. Since then Flannery has replaced Immelt’s vice chairs responsible for innovation. Beth Comstock is out. So is John Rice, the head of Global Operations along with CFO Jeffrey Bornstein.

Last week’s Wall Street Journal story on GE opened with, “John Flannery, the leader of General Electric for just 2½ months, has already begun dismantling the legacy of his predecessor…” Flannery has pledged to unload $20 billion of GE businesses in the next two years. “We need to make some major changes with urgency and a depth of purpose. Everything is on the table,” Flannery said on a conference call to discuss quarterly earnings. “Things will not stay the same at GE.”

Instead of lean innovation programs, there is a mandate to cut $2 billion in expenses by the end of next year, lift profits and raise the dividend.

So what happened? Are lean innovation and the Startup Way a failure in large companies?

In fact, what happened is activist investors.

During Jeff Immelt’s tenure GE’s stock-market value fell by about half. Its stock is trading where it was 20 years ago. So far in 2017, GE is the worst performing stock on the Dow Jones Industrial average.

In 2015 Trian Partners, an activist investor, bought $2.5 billion of GE stock – about 1.5% of the company. The firm wrote a white paper, “Transformation Underway… But Nobody Cares” which essentially said that GE stock was undervalued because investors didn’t believe that Immelt and GE management would do the things needed to deliver a higher stock price and dividends.

Trian was pretty clear about what they thought the company should do:

  • Take on $20 billion in debt (returning the cash to shareholders by buying back GE stock).
  • Increase operating margins to 18% (by cutting expenses).
  • Buy back more stock than the $50 billion stock purchase plan GE already had in place.

Immelt believed that doing these three things would optimize the stock price and increase the value of Trian’s investment, but the debt and cuts would endanger GE’s long-term investment in innovation.

And now Immelt is now the ex-CEO, and Trian Partners just a got a seat on the GE board.

Activist Investors
The “corporate raiders” of the 20th century have rebranded themselves as “activist investors” of the 21st. With refrains of “unlock hidden value” and “increase shareholder value,” and powered by over $120 billion in assets, activist investors like Trian look for companies like GE (or Procter and Gamble) that have a share price which is underperforming relative to its peers (or those with large amounts of cash on their balance sheets). They then buy stock in these public companies and attempt to convince management to increase the price of the shares.

One key difference in 21st century activists is that they don’t need to buy much of the company’s stock to gain control. (Trian only owns ~1.5% of the GE and P&G shares.) They do it by influencing the votes of the majority of the shareholders. And in the 21st century, the majority of public company shareholders are institutional investors (banks, insurance companies, pensions, hedge funds, REITs, investment advisors, endowments, and mutual funds), not individuals. (In 2015, the 10 largest shareholders in a typical S&P 500 company held almost half of the company’s stock.)  What gives institutions even more say is that while individual shareholders vote their shares 30% of the time, institutions vote their shares 90%. (In the case of P&G, 40% of its stock was owned by small investors, helping the company fight off a 2017 proxy battle with Trian.)

After the dot.com crash in 2001 and the financial crisis of 2008, traditional investors who previously held their shares for the long-term — public pension funds, institutional investors and money managers — are now more interested in short-term gains. This means that company boards who used to side with management no longer automatically protect them, and as Jeff Immelt discovered, may even side with an activist.

Activist investors have a simple goal: increase the value of their investment. But first they need to get management of a company to change their existing strategy. To do that, they start with an implicit (GE) or explicit (P&G) threat of a proxy fight for a seat on the company board.  Next, they make a public presentation to management — like Trian’s “Transformation Underway… But Nobody Cares” — explaining what actions they think the company should take to increase the price of the stock.  Next, they use the financial press and blogs to spread their message to the institutional investors. If that still doesn’t work, they can start a proxy fight and try to gain control of shareholder votes so they can replace the board — and ultimately the company management.

If their campaign is successful, like Trian’s was at GE, they’ll have a seat on the board and a new CEO and management. They’ll have GE execute a playbook to increase the value of their investment: share repurchase programs, increased dividends, and, to reduce expenses, layoffs, factory closings, spin-offs of profitable parts of the company, sell-offs of the least profitable divisions, and asset stripping. And as Trian’s presentation suggests, they’ll get GE to take on more debt to buy back stock. And often they calculate that selling the sum of parts is greater than keeping the company together as a whole. Or they may even put the entire company up for sale.

There is an upside to an activist investor taking a run at a company. It’s often a cattle prod to a stagnant company, or one ignoring disruption by new startups. GE’s gross margin was 21% last year, compared with 28% at United Technologies and 30% at Siemens. At a minimum, as is happening to GE now, it forces a company to go through a review of its strategy. (At GE the biggest problem in 2017 was major revenue misses in their Power business.) The new GE CEO is focusing on a back-to-basics approach to the business: dramatically reducing expenses, with the visible symbols of getting rid of company planes, company cars, and delaying a fancy new headquarters, etc.

The bad news is once they take control of a company, long-term investment is not the goal of an activist investor. They often kill any long-term strategic initiatives. Often the short-term cuts directly affect employee salaries, jobs, and long-term investment in R&D. The first things to go are R&D centers and innovation initiatives.

So What is a CEO to Do?
A CEO of a public company needs to know what explicit and implicit guidance they are getting from their board and institutional investors.

Large public companies like Amazon, Tesla, Netflix, etc. capture the imagination of investors and can focus on revenue and user growth instead of on the bottom line. Almost 20 years after Amazon was launched, it has massive revenue growth and barely has a meaningful profit. Investors in these companies believe that the company’s investments in user growth will result in long-term profits. (Newly public tech companies are now going public with dual-class stock, which allows the founders to have more voting rights than the general public. This protects them from activist investors and allows them to put long-term interests ahead of quarterly results.)

But GE’s core businesses don’t have the scale of those online businesses. No innovation program, lean or otherwise, would have helped the dismal performance of their Power segment.

Companies and government organizations are discovering that innovation activities without a defined innovation pipeline results in innovation theater.  And an innovation pipeline needs to be driven with speed and urgency and results measured by the impact on the top and bottom line.

In hindsight, GE Fastworks wasn’t the problem at GE, and while the Predix Cloud has had a painful birth, GE’s investment in the industrial Internet of Things (IoT) and lean will pay off in the future. But the impact of future innovations couldn’t compensate for poor execution in its traditional businesses. GE’s board was not happy with their margins, stock price, and how Wall Street viewed the future of the company. The immediate threat of a proxy fight with an activist investor forced a decision on the future direction of the company.

Filed under: Corporate/Gov't Innovation, Harvard Business Review | 30 Comments »

Why Uber is The Revenge of the Founders

Posted on October 24, 2017 by steve blank

A version of this article is in the Harvard Business Review

Uber, Zenefits, Tanium, Lending Club CEOs of companies with billion dollar market caps have been in the news – and not in a good way.  This seems to be occurring more and more.  Why do these founders get to stay around?

Because the balance of power has dramatically shifted from investors to founders.

Here’s why it generates bad CEO behavior.

—

Unremarked and unheralded, the balance of power between startup CEOs and their investors has radically changed:

  • IPOs/M&A without a profit (or at times revenue) have become the norm
  • The startup process has become demystified – information is everywhere
  • Technology cycles have become a treadmill, and for startups to survive they need to be on a continuous innovation cycle
  • VCs competing for unicorn investments have given founders control of the board

20th Century Tech Liquidity = Initial Public Offering
In the 20th century tech companies and their investors made money through an Initial Public Offering (IPO). To turn your company’s stock into cash, you engaged a top-notch investment bank (Morgan Stanley, Goldman Sachs) and/or their Silicon Valley compatriots (Hambrecht & Quist, Montgomery Securities, Robertson Stephens).

Typically, this caliber of bankers wouldn’t talk to you unless your company had five profitable quarters of increasing revenue. And you had to convince the bankers that you had a credible chance of having four more profitable quarters after your IPO.  None of this was law, and nothing in writing required this; this was just how these firms did business to protect their large institutional customers who would buy the stock.

Twenty-five years ago, to go public you had to sell stuff – not just acquire users or have freemium products. People had to actually pay you for your product. This required a repeatable and scalable sales process, which required a professional sales staff and a product stable enough that customers wouldn’t return it.

Hire a CEO to Go Public
More often than not, a founding CEO lacked the experience to do these things. The very skills that got the company started were now handicaps to its growth. A founder’s lack of credibility/experience in growing and managing a large company hindered a company that wanted to go public. In the 20th century, founding CEOs were most often removed early and replaced by “suits” — experienced executives from large companies parachuted in by the investors after product/market fit to scale sales and take the company public.

The VCs would hire a CEO with a track record who looked and acted like the type of CEO Wall Street bankers expected to see in large companies.

A CEO brought in from a large company came with all the big company accoutrements – org charts, HR departments with formal processes and procedure handbooks, formal waterfall engineering methodology, sales compensation plans, etc. — all great things when you are executing and scaling a known business model. But the CEO’s arrival meant the days of the company as a startup and its culture of rapid innovation were over.

Board Control
For three decades (1978-2008), investors controlled the board. This era was a “buyer’s market” – there were more good companies looking to get funded than there were VCs. Therefore, investors could set the terms. A pre-IPO board usually had two founders, two VCs and one “independent” member. (The role of the independent member was typically to tell the founding CEO that the VCs were hiring a new CEO.)

Replacing the founder when the company needed to scale was almost standard operating procedure. However, there was no way for founders to share this information with other founders (this was life before the Internet, incubators and accelerators). While to VCs this was just a necessary step in the process of taking a company public, time and again first-time founders were shocked, surprised and angry when it happened. If the founder was lucky, he got to stay as chairman or CTO. If he wasn’t, he told stories of how “VCs stole my company.”

To be fair there wasn’t much of an alternative. Most founders were woefully unequipped to run companies that scaled.  It’s hard to imagine, but in the 20th century there were no startup blogs or books on startups to read, and business schools (the only places teaching entrepreneurship) believed the best thing they could teach startups was how to write a business plan. In the 20th century the only way for founders to get trained was to apprentice at another startup. And there they would watch the canonical model in action as an experienced executive replaced the founder.

Technology Cycles Measured in Years
Today, we take for granted new apps and IoT devices appearing seemingly overnight and reaching tens of millions of users – and just as quickly falling out of favor. But in the 20th century, dominated by hardware and software, technology swings inside an existing market happened slowly — taking years, not months. And while new markets were created (i.e. the desktop PC market), they were relatively infrequent.

This meant that disposing of the founder, and the startup culture responsible for the initial innovation, didn’t hurt a company’s short-term or even mid-term prospects.  A company could go public on its initial wave of innovation, then coast on its current technology for years. In this business environment, hiring a new CEO who had experience growing a company around a single technical innovation was a rational decision for venture investors.

However, almost like clockwork, the inevitable next cycle of technology innovation would catch these now-public startups and their boards by surprise. Because the new CEO had built a team capable of and comfortable with executing an existing business model, the company would fail or get acquired. Since the initial venture investors had cashed out by selling their stock over the first few years, they had no long-term interest in this outcome.

Not every startup ended up this way. Bill Hewlett and David Packard got to learn on the job. So did Bob Noyce and Gordon Moore at Intel. But the majority of technology companies that went public circa 1979-2009, with professional VCs as their investors, faced this challenge.

Founders in the Driver’s Seat
So how did we go from VCs discarding founders to founders now running large companies? Seven major changes occurred:

  1. It became OK to go public or get acquired without profit (or even revenue)

In 1995 Netscape changed the rules about going public. A little more than a year old, the company and its 24-year-old founder hired an experienced CEO, but then did something no other tech company had ever done – it went public with no profit. Laugh all you want, but at the time this was unheard of for a tech company. Netscape’s blow-out IPO launched the dot-com boom. Suddenly tech companies were valued on what they might someday deliver. (Today’s version is Tesla – now more valuable than Ford.)

This means that liquidity for today’s investors often doesn’t require the long, patient scaling of a profitable company. While 20th century metrics were revenue and profit, today it’s common for companies to get acquired for their user base. (Facebook’s ~$20 billion acquisition of WhatsApp, a 5-year-old startup that had $10 million in revenue, made no sense until you realized that Facebook was paying to acquire 300 million new users.)

2.     Information is everywhere
In the 20th century learning the best practices of a startup CEO was limited by your coffee bandwidth. That is, you learned best practices from your board and by having coffee with other, more experienced CEOs. Today, every founder can read all there is to know about running a startup online. Incubators and accelerators like Y-Combinator have institutionalized experiential training in best practices (product/market fit, pivots, agile development, etc.); provide experienced and hands-on mentorship; and offer a growing network of founding CEOs. The result is that today’s CEOs have exponentially more information than their predecessors. This is ironically part of the problem. Reading about, hearing about and learning about how to build a successful company is not the same as having done it. As we’ll see, information does not mean experience, maturity or wisdom.

3.     Technology cycles have compressed
The pace of technology change in the second decade of the 21st century is relentless. It’s hard to think of a hardware/software or life science technology that dominates its space for years. That means new companies are at risk of continuous disruption before their investors can cash out.

To stay in business in the 21st century, startups  do four things their 20th century counterparts didn’t:

  • A company is no longer built on a single innovation. It needs to be continuously innovating – and who best to do that? The founders.
  • To continually innovate, companies need to operate at startup speed and cycle time much longer their 20th century counterparts did. This requires retaining a startup culture for years – and who best to do that? The founders.
  • Continuous innovation requires the imagination and courage to challenge the initial hypotheses of your current business model (channel, cost, customers, products, supply chain, etc.) This might mean competing with and if necessary killing your own products. (Think of the relentless cycle of iPod then iPhone innovation.) Professional CEOs who excel at growing existing businesses find this extremely hard.  So who best to do it? The founders.
  • Finally, 20th century startups fired the innovators/founders when they scaled. Today, they need these visionaries to stay with the company to keep up with the innovation cycle. And given that acquisition is a potential for many startups, corporate acquirers often look for startups that can help them continually innovate by creating new products and markets.

4.     Founder-friendly VCs
A 20th century VC was likely to have an MBA or finance background. A few, like John Doerr at Kleiner Perkins and Don Valentine at Sequoia, had operating experience in a large tech company, but none had actually started a company. Out of the dot-com rubble at the turn of the 21st century, new VCs entered the game – this time with startup experience. The watershed moment was in 2009 when the co-founder of Netscape, Marc Andreessen, formed a venture firm and started to invest in founders with the goal of teaching them how to be CEOs for the long term. Andreessen realized that the game had changed. Continuous innovation was here to stay and only founders – not hired execs – could play and win.  Founder-friendly became a competitive advantage for his firm Andreessen Horowitz. In a seller’s market, other VCs adopted this “invest in the founder” strategy.

5.     Unicorns Created A Seller’s Market
Private companies with market capitalization over a billion dollars – called Unicorns – were unheard of in the first decade of the 21st century. Today there are close to 200. VCs with large funds (~>$200M) need investments in Unicorns to make their own business model work.

While the number of traditional VC firms have shrunk since the peak of the dot com bubble, the number of funds chasing deals have grown. Angel and Seed Funds have usurped the role of what used to be Series A investments. And in later stage rounds an explosion of corporate VCs and hedge funds now want in to the next unicorns.

A rough calculation says that a VC firm needs to return four times its fund size to be thought of as a great firm. Therefore, a VC with a $250M fund (5x the size of an average VC fund 40 years ago) would need to return $1 billion. But VCs own only ~15% of a startup when it gets sold/goes public (the numbers vary widely). Just doing the math, $1 billion/15% means that the VC fund needs $6.6 billion of exits to make that 4x return. The cold hard math of “large funds need large exits” is why VCs have been trapped into literally begging to get into unicorn deals.

6.    Founders Take Money Off the Table
In the 20th century the only way the founder made any money (other than their salary) was when the company went public or got sold. The founders along with all the other employees would vest their stock over 4 years (earning 1/48 a month). They had to hang around at least a year to get the first quarter of their stock (this was called the “cliff”).  Today, these are no longer hard and fast rules. Some founders have three-year vesting. Some have no cliff. And some have specific deals about what happens if they’re fired, demoted or the company is sold.

In the last decade, as the time startups have spent staying private has grown longer, secondary markets – where people can buy and sell pre-IPO stock — have emerged. This often is a way for founders and early employees to turn some of their stock into cash before an IPO or sale of company.

One last but very important change that guarantees founders can cash out early is “founder friendly stock.”  This allows founder(s) to sell part of their stock (~10 to 33%) in a future round of financing. This means the company doesn’t get money from new investors, but instead it goes to the founder.  The rationale is that since companies are taking longer to achieve liquidity, giving the founders some returns early makes them more willing to stick around and better able to make bets for the long-term health of the company.

7.   Founders take Control of the Board
With more VCs chasing a small pool of great deals, and all VCs professing to be the founder’s best friend, there’s an arms race to be the friendliest. Almost overnight the position of venture capitalist dictating the terms of the deal has disappeared (at least for “hot” deals).

Traditionally, in exchange for giving the company money, investors would receive preferred stock, and founders and employees owned common stock. Preferred stock had specific provisions that gave investors control over when to sell the company or take it public, hiring and firing the founder etc.  VCs are giving up these rights to get to invest in unicorns.

Founders are taking control of the board by making the common stock the founders own more powerful. Some startups create two classes of common stock with each share of the founders’ class of common stock having 10 – 20 votes. Founders can now outvote the preferred stock holders (the investors). Another method for founder control has the board seats held by the common shareholders (the founders) count 2-5 times more than the investors’ preferred shares. Finally, investors are giving up protective voting control provisions such as when and if to raise more money, the right to invest in subsequent rounds, who to raise it from and how/when to sell the company or take it public. This means liquidity for the investors is now beholden to the whims of the founders. And because they control votes on the board, the founders can’t be removed. This is a remarkable turnabout.

In some cases, 21st century VCs have been relegated to passive investors/board observers.

And this advent of founders’ control of their company’s board is a key reason why many of these large technology companies look like they’re out of control.  They are.

The Gift/Curse of Visionary CEOs
Startups run by visionaries break rules, flout the law and upend the status quo (Apple, Uber, AirBnB, Tesla, Theranos, etc.). Doing something that other people consider insanity/impossible requires equal parts narcissism and a messianic view of technological transformation.

Bad CEO behavior and successful startups have always overlapped. Steve Jobs, Larry Ellison, Tom Seibel, etc. all had the gift/curse of a visionary CEO – they could see the future as clearly as others could see the present. Because they saw it with such clarity, the reality of having to depend on other people to build something revolutionary was frustrating. And woe to the employee who got in their way of delivering the future.

Visionary CEOs have always been the face of their company, but today with social media, it happens faster with a much larger audience; boards now must consider what would happen to the valuation of the company without the founder.

With founders now in control of unicorn boards, with money in their pockets and the press heralding them as geniuses transforming the world, founder hubris and bad behavior should be no surprise.  Before social media connected billions of people, bad behavior stayed behind closed doors. In today’s connected social world, instant messages and shared videos have broken down the doors.

The Revenge of the Founders – Founding CEOs Acting Badly
So why do boards of unicorns like Uber, Zenefits, Tanium, Lending Club let their CEOs stay?

Before the rapid rise of Unicorns, when boards were still in control, they “encouraged” the hiring of “adult supervision” of the founders. Three years after Google started they hired Eric Schmidt as CEO. Schmidt had been the CEO of Novell and previously CTO of Sun Microsystems. Four years after Facebook started they hired Sheryl Sandberg as the COO. Sandberg had been the vice president of global online sales and operations. Today unicorn boards have a lot less leverage.

  1. VCs sit on 5 to 10 or more boards. That means most VCs have very little insight into the day-to-day operation of a startup. Bad behavior often goes unnoticed until it does damage.
  2. The traditional checks and balances provided by a startup board have been abrogated in exchange for access to a hot deal.
  3. As VC incentives are aligned to own as much of a successful company as possible, getting into a conflict with a founder who can now prevent VC’s from investing in the next round is not in the VCs interest.
  4. Financial and legal control of startups has given way to polite moral suasion as founders now control unicorns.
  5. As long as the CEO’s behavior affects their employees not their customers or valuation, VCs often turn a blind eye.
  6. Not only is there no financial incentive for the board to control unicorn CEO behavior, often there is a downside in trying to do so

The surprise should not be how many unicorn CEOs act badly, but how many still behave well.

Lesson Learned

  • VC/Founder relationship have radically changed
  • VC “Founder Friendly” strategies have helped create 200+ unicorns
  • Some VC’s are reaping the downside of the unintended consequences of “Founder Friendly”
  • Until the consequences exceed the rewards they will continue to be Founder Friendly

Filed under: Corporate/Gov't Innovation, Family/Career/Culture, Harvard Business Review, Venture Capital | 4 Comments »

The Red Queen Problem – Innovation in the DoD and Intelligence Community

Posted on October 17, 2017 by steve blank

“…it takes all the running you can do to keep in the same place. ”
The Red Queen Alice in Wonderland

Innovation, disruption, accelerators, have all become urgent buzzwords in the Department of Defense and Intelligence community. They are a reaction to the “red queen problem” but aren’t actually solving the problem. Here’s why.

In the 20th century our nation faced a single adversary – the Soviet Union. During the Cold War the threat from the Soviets was quantifiable and often predictable. We could specify requirements, budget and acquire weapons based on a known foe. We could design warfighting tactics based on knowing the tactics of our opponent. Our defense department and intelligence community owned proprietary advanced tools and technology. We and our contractors had the best technology domain experts. We could design and manufacture the best systems. We used these tools to keep pace with the Soviet threats and eventually used silicon, semiconductors and stealth to create an offset strategy to leapfrog their military.

That approach doesn’t work anymore. In the 21st century you need a scorecard to keep track of the threats: Russia, China, North Korea, Iran, ISIS in Yemen/Libya/Philippines, Taliban, Al-Qaeda, hackers for hire, etc. Some are strategic peers, some are near peers in specific areas, some are threats as non-state disrupters operating with no rules.

In addition to the proliferation of threats, most of the tools and technologies that were uniquely held by the DoD/IC or only within the reach of large nation states are now commercially available (Cyber, GPS, semiconductors, analytics, centrifuges, drones, genetic engineering, agile and lean methodologies, ubiquitous Internet, crypto and smartphones, etc.). In most industries, manufacturing is no longer a core competence of the U.S.

U.S. agencies that historically owned technology superiority and fielded cutting-edge technologies now find that off-the-shelf solutions may be more advanced than the solutions they are working on, or that adversaries can rapidly create asymmetric responses using these readily available technologies.

The result is that our systems, organizations, headcount and budget – designed for 20th century weapons procurements and warfighting tactics on a predictable basis – can’t scale to meet all these simultaneous and unpredictable challenges. Today, our DoD and national security agencies are running as hard as they can just to stay in place, but our adversaries are continually innovating faster than our traditional systems can respond. They have gotten inside our OODA loop (Observe, Orient, Decide and Act).

We believe that continuous disruption can only be met with a commitment to continuous innovation.

Pete Newell and I have spent a lot of time bringing continuous innovation to government organizations. Newell ran the U.S. Army’s Rapid Equipping Force on the battlefields of Iraq and Afghanistan finding and deploying technology solutions against agile insurgents. He’s spent the last four years in Silicon Valley out of uniform continuing that work. I’ve spent the last six years teaching our country’s scientists how to rapidly turn scientific breakthroughs into deliverable products by creating the curriculum for the National Science Foundation Innovation Corps – now taught in 53 universities. Together Pete, Joe Felter and I created Hacking for Defense, a nationwide program to teach university students how use Lean methodologies to solve defense and national security problems.

The solution to continuous disruption requires new ways to think about, organize, and build and deploy national security people, organizations and solutions.

Here are our thoughts about how to confront the Red Queen trap and adapt a government agency to infuse continuous innovation in its culture and practices.
—

Problem 1: Regardless of a high-level understanding that business as usual can’t go on, all agencies are given “guidance and metrics (what they are supposed to do (their “mission”) and how they are supposed to measure success). To no one’s surprise the guidance is “business as usual but more of it.” And to fulfill that guidance agencies create structure (divisions, directorates, etc.) designed to execute repeatable processes and procedures to deliver solutions that meet the requirements of the overall guidance.

Inevitably, while all of our defense and national security agencies will tell you that innovation is one of their pillars, innovation actually is an ill-defined and amorphous aspirational goal, while the people, budget and organization continue to flow to execution of mission (as per guidance.)

There is no guidance or acknowledgement that in our national security agencies, even as we execute our current mission, our capabilities decline every year due to security breaches, technology timing out, tradecraft obsolescence, etc. And there is no explicit requirement for creation of new capabilities that give us the advantage.

Solution 1: Extend agency guidance to include the requirements to create a continuous innovation process that a) resupplies the continual attrition of capabilities and b) creates new capabilities that gives us a mission advantage. The result will be agency leadership creating new organizational structures that make innovation a continual process rather than an ad hoc series of heroic efforts.

Problem 2: The word “Innovation” actually describes three very different types of activities.

Solution 2: Use the McKinsey Three Horizons Model to differentiate among the three types. Horizon 1 ideas provide continuous innovation to a company’s existing mission model and core capabilities. Horizon 2 ideas extend a company’s existing mission model and core capabilities to new stakeholders, customers, or targets. Horizon 3 is the creation of new capabilities to take advantage of or respond to disruptive technologies/opportunities or to counter disruption.

We’d add a new category, Horizon 0, which kills ideas that are not viable or feasible (something that Silicon Valley is tremendously efficient at doing).

These Horizons also apply to government agencies and other large organizations. Agencies and commands need to support all three horizons.

Problem 3: Risk equals failure and failure is to be avoided as it indicates a lack of competence.

Solution 3: The three-horizon model allows everyone to understand that failure in a Horizon 1/existing mission activity is different than failure in a Horizon 3 “never been done before” activity. We want to take risks in Horizon 3. If we aren’t failing with some efforts, we aren’t trying hard enough. An innovation process embraces and understands the different types of failure and risk.

Problem 4: Innovators tend to create activities rather than deployable solutions that can be used on the battlefield or by the mission. Accelerators, hubs, cafes, open-sourcing, crowd-souring, maker spaces, Chief Innovation Officers, etc. are all great but they tend to create innovation theater – lots of motion but no action. Great demos are shown and there are lots of coffee cups and posters, but if you look at the deliverables for the mission over a period of years the result is disappointing. Most of the executors and operators have seen little or no value from any of these activities. While the activities individually may produce things of value, they aren’t valued within the communities they serve because they aren’t connected to a complete pipeline that harnesses that value and turns it into a deliverable on the battlefield where it matters.

Solution 4: What we have been missing is an innovation pipeline focused on deployment not demos.

The Lean Innovation process is a self-regulating, evidence-based innovation pipeline. It is a process that operates with speed and urgency, where innovators and stakeholders curate and prioritize their own problems/Challenges/ideas/technology. It is evidence based, data driven, accountable, disciplined, rapid and mission- and deployment-focused.

The process recognizes that Innovation isn’t a single activity (an incubator, a class, etc.) it is a process from start to deployment.
The canonical innovation pipeline:

As you see in the diagram, there are 6 steps to the innovation pipeline: sourcing, challenge/curation, prioritization, solution exploration and hypothesis testing, incubation and integration.

Innovation sourcing: a list of problems/challenges, ideas, and technologies that might be worth investing in. These can come from hackathons, research groups, needs from operators in the field, etc.

Challenge/Curation: innovators get out of their own offices and talk to colleagues and customers with the goal of finding other places in the DoD where a problem or challenge might exist in a slightly different form, to identify related internal projects already in existence, and to find commercially available solutions to problems. It also seeks to identify legal issues, security issues, and support issues.

This process also helps identify who the customers for possible solutions would be, who the internal stakeholders would be, and even what initial minimum viable products might look like.

This phase also includes building initial minimal viable products (MVPs.) Some ideas drop out when the team recognizes that they may be technically, financially, or legally unfeasible or they may discover that other groups have already built a similar product.

Prioritization: Once a list of innovation ideas has been refined by curation, it needs to be prioritized using the McKinsey Three Horizons Model.

Once projects have been classified, the team prioritizes them, starting by asking: is this project worth pursing for another few months full time? This prioritization is not done by a committee of executives but by the innovation teams themselves.

Solution exploration and hypotheses testing: The ideas that pass through the prioritization filter enter an incubation process like Hacking for Defense/I-Corps, the system adopted by all U.S. government federal research agencies to turn ideas into products.

This six- to ten-week process delivers evidence for defensible, data-based decisions. For each idea, the innovation team fills out a mission model canvas. Everything on that canvas is a hypothesis. This not only includes the obvious – is there solution/mission fit? — but the other “gotchas” that innovators always seem to forget. The framework has the team talking not just to potential customers but also with people responsible for legal, support, contracting, policy, and finance. It also requires that they think through compatibility, scalability and deployment long before this gets presented to engineering. There is now another major milestone for the team: to show compelling evidence that this project deserves to be a new mainstream capability. Alternatively, the team might decide that it should be spun into its own organization or that it should be killed.

Incubation: Once hypothesis testing is complete, many projects will still need a period of incubation as the teams championing the projects gather additional data about the application, further build the minimum viable product (MVP), and get used to working together. Incubation requires dedicated leadership oversight from the horizon 1 organization to insure the fledgling project does not die of malnutrition (a lack of access to resources) or become an orphan (continue to work with no parent to guide them).

Integration and refactoring: At this point, if the innovation is Horizon 1 or 2, its time to integrate it into the existing organization. (Horizon 3 innovations are more likely set up as their own entities or at least divisions.) Trying to integrate new, unbudgeted, and unscheduled innovation projects into an engineering organization that has line item budgets for people and resources results in chaos and frustration. In addition, innovation projects carry both technical and organizational debt. This creates an impedance mismatch between the organizations that can be easily be resolved with a small dedicated refactoring team. Innovation then becomes a continuous cycle rather than a bottleneck.

Problem 5: The question being asked across the Department of Defense and national security community is, “Can we innovate like startups in Silicon Valley” and insert speed, urgency and agility into our work?

Solution 5: The reality is that the DoD/IC is not Silicon Valley. In fact, it’s much more like a large company with existing customers, existing products and the organizations built to support and service them. And much like large companies they are being disrupted by forces outside their control.

But what’s unique is, that unlike a large company that doesn’t know how to move rapidly, on the battlefields of Iraq and Afghanistan our combatant commands and national security community were more agile, creative and Lean than any startup. They wrote the book on how to collaborate (read Team of Teams) or adopt new technologies (see the Rapid Equipping Force.) The problem isn’t that these agencies and commands don’t know how to be innovative. The problem is they don’t know how to be innovative in peacetime when innovation succumbs to the daily demands of execution. Part of the reason is that large agencies are run by leaders who tend to be excellent Horizon 1 managers of existing people, process and resources but have no experience in building and leading Horizon 3 organizations.

The solution is to understand that an innovation pipeline requires different people, processes, procedures, and metrics, then execution.

Problem 6: How to get started? How to get leadership behind continuous innovation?

Solution 6: To leadership, incubators, cafes, accelerators and hackathons appear to be just background noise unrelated to their guidance and mission. Part of the problem lies with the innovators themselves. Lots of innovation activities celebrate the creation of demos, funding, new makerspaces, etc. but there is little accountability for the actual rapid deployment of useful tools. Once we can convince and demonstrate to leadership that continuous innovation can solve the Red Queen problem, we’ll have their attention and support.

We know how to do this. Our country requires it.
Let’s get started.

Lessons Learned

  • Organizations must constantly adapt and evolve, to survive when pitted against ever-evolving opposition in an ever-changing environment
  • Government agencies need to both innovate and execute
  • In peacetime innovation succumbs to the demands of execution
  • We need explicit guidance for innovation to agencies and their leadership requiring an innovation organization and process, that operates in parallel with the execution of current mission
  • We need an innovation pipeline that delivers rapid results, not separate, disconnected innovation activities

Filed under: Corporate/Gov't Innovation, Hacking For Defense, Science and Industrial Policy | 17 Comments »

Office of Naval Research (ONR) Goes Lean

Posted on October 10, 2017 by steve blank

The Office of Naval Research (ONR) has been one of the largest supporters of innovation in the U.S. Now they are starting to use the Lean Innovation process (see here and here) to turn ideas into solutions. The result will be defense innovation with speed and urgency.

—-

Here’s how the Office of Naval Research (ONR) was started. In World War II the U.S. set up the Office of Scientific Research and Development (OSRD) to use thousands of civilian scientists in universities to build advanced technology weapons (radar, rockets, sonar, electronic warfare, nuclear weapons.) After the war, the U.S. Navy adopted the OSRD model and set up the Office of Naval Research – ONR. Since 1946 ONR has funded basic and applied science, as well as advanced technology development, in universities across the U.S. (Stanford’s first grants for their microwave and electronic lab came from ONR in 1946.)

Rich Carlin heads up ONR’s Sea Warfare and Weapons Department. He’s responsible for science and programs for surface ships, submarines, and undersea weapons with an annual budget of over $300 million per year.

Rich realized that while the Department of Defense DoD spends a lot of money and has lots of requirements and acquisition processes, they don’t work well with a rapid innovation ecosystem. He wanted to build an innovation pipeline that would allow the Navy to:

  • Create “dual-use” products (build solutions that could be used for the military but also sold commercially, and attract venture capital investments.) “Dual-use” products reduce the cost for defense adoption of products.
  • Test if the Lean Innovation process actually accelerates technology adoption and an innovation ecosystem.
  • Use best practices in contracting that accelerate awards and provide flexibility and speed in technology maturation and adoption.

Today ONR has taken the Lean Innovation process, adapted it for their agency, and is running pilots for defense innovation teams.

Lean Innovation is a Process
The Lean Innovation process is a self-regulating, evidence-based innovation pipeline. It is a process that operates with speed and urgency. Innovators and stakeholders curate and prioritize their own problems/Challenges/ideas/technology.

The process recognizes that Innovation isn’t a single activity (an incubator, a class, etc.). It is a process from start to deployment.

The ONR pipeline has all the steps of the canonical innovation pipeline:

Innovation sourcing: a list of problems/challenges, ideas, and technologies that might be worth investing in.

Problem/Challenge Curation: innovators get out of their own offices and talk to colleagues and customers with the goal of finding other places in the DoD where a problem or challenge might exist in a slightly different form, identifying related internal projects already in existence, and finding commercially available solutions to problems. They also seek to identify legal issues, security issues, and support issues.

This process also helps identify who the customers for possible solutions would be, who the internal stakeholders would be, and even what initial minimum viable products (MVPs) might look like.

This phase also includes building initial MVPs. Some ideas drop out when the team recognizes that they may be technically, financially, or legally unfeasible or they may discover that other groups have already built a similar product.

Prioritization: Once a list of innovation ideas has been refined by curation, it needs to be prioritized using the McKinsey Three Horizons Model. Horizon 1 ideas provide continuous innovation to a company’s existing business model and core capabilities. Horizon 2 ideas extend a company’s existing business model and core capabilities to new customers, markets or targets. Horizon 3 is the creation of new capabilities to take advantage of or respond to disruptive opportunities or disruption. We added a new category, Horizon 0, which refers to graveyard ideas that are not viable or feasible.

Once projects have been classified, the team prioritizes them, starting by asking: is this project worth pursing for another few months full time? This prioritization is not done by a committee of executives but by the innovation teams themselves.

Solution exploration and hypotheses testing: The ideas that pass through the prioritization filter enter an incubation process like Hacking for Defense/I-Corps, the system adopted by all U.S. government federal research agencies to turn ideas into products.

This six- to ten-week process delivers evidence for defensible, data-based decisions. For each idea, the innovation team fills out a mission model canvas. Everything on that canvas is a hypothesis. This not only includes the obvious -is there solution/mission fit? — but the other “gotchas” that innovators always seem to forget. The framework has the team talking not just to potential customers but also with regulators, and people responsible for legal, contracting, policy, and finance support.  It also requires that they think through compatibility, scalability and deployment long before this gets presented to engineering. There is now another major milestone for the team: to show compelling evidence that this project deserves to be a new mainstream capability. Alternatively, the team might decide that it should be spun into its own organization or that it should be killed.

Incubation: Once hypothesis testing is complete, many projects will still need a period of incubation as the teams championing the projects gather additional data about the application, further build the MVP, and get used to working together. Incubation requires dedicated leadership oversight from the horizon 1 organization to insure the fledgling project does not die of malnutrition (a lack of access to resources) or become an orphan (no parent to guide them).

Lean Innovation Inside the Office of Naval Research (ONR)
To come up with their version of the innovation pipeline ONR mapped four unique elements.

First, ONR is using Hacking for Defense classes to curate “Problem Statements” (ONR calls them Challenge/Opportunity Statements) to find solution/mission fit and commercial success.

Second, they’re using existing defense funding to prove out these solutions depending on the level of technical maturity. (There are three existing sources for funding defense innovation: COTS/GOTS validation (testing whether off-the-shelf  products can be used); Concept Validation and Technology Advancement; and SBIR/STTR funds – there’s over >$1B per year in the DoD SBIR program alone.)

Third, they are going to use Pete Newell’s company, BMNT and other business accelerators to apply Lean Launchpad Methodologies to build the business case for resulting prototypes and products and to attract private investments.

Fourth, they are going to use grants, purchase orders and Other Transaction Agreements (OTAs) to attract startups and nontraditional defense contractors, speed the award process, and provide startups the flexibility to pivot their business model and prototype/product solution when necessary.

BMNT and Hacking for Defense serve as the essential crosslink for tying together the assets already available in DoD to implement the Lean Innovation process for defense innovation.

Lessons Learned

  • The Office of Naval Research has been funding innovation in universities for 70+ years
  • They are piloting the Lean Innovation Process to move defense innovation forward with speed and urgency

Filed under: Corporate/Gov't Innovation, Hacking For Defense | 5 Comments »

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