Preface:
Charlie Munger uses a “lattice of mental models” approach to acquiring what he calls “worldly wisdom.” Here’s Munger:
“What are the models? Well, the first rule is that you’ve got to have multiple models—because if you just have one or two that you’re using, the nature of human psychology is such that you’ll torture reality so that it fits your models…”
Eric Ries has created a very important model in the startup world that has risen to the level of a movement. I find his ideas and the model to be very useful. Whether you agree or disagree with aspects of The Lean Startup, it is beyond question that Ries’ ideas and model have been influential to many successful founders.
That some people might have issues with his ideas which should not be a surprise to anyone. As an example, Tom Tungz has a post describing Peter Thiel’s critical views on Lean Startup. Pinterest co-founder and CEO Ben Silbermann has also expressed issues with the methodology. Silbermann said he was glad he didn’t read The Lean Startup “because it might have convinced him to give up…” Silbermann’s advice: “Don’t take too much advice… Most people generalize whatever they did, and say that was the strategy that made it work… In reality, there’s very little way of knowing how various factors contributed to success or failure.” (Mark Suster has argued that it is best to triangulate when it comes to advice, and that takes this preface full circle to a multiple models approach, as I think this is essentially what Suster advocates.)
I don’t think Eric Ries has created the only useful model for startups, but it should be part of anyone’s lattice of mental models. Actively listening to alternative or different views (like Sam Altman presented this week) helps create that lattice of mental models effect.
Here’s my take on Eric’s ideas and the Lean Startup model in my usual format.
1. “If learning is the essential unit of progress for start-ups, any effort that is not absolutely necessary for learning what customers want should be eliminated. So how do we do that? By building what I call a minimum viable product—or MVP.” The process of creating a minimum viable product is based more on discovery than prediction. The business creates a less than fully developed but still “viable” product or service and offers it to a small number of early adopter customers to obtain feedback. The business efficiently and quickly learns what customers want through the MVP process. Society as whole benefits from the innovation produced when new approaches are tried, even if they mostly fail.
MVP is not the only way to build a business and is not the right approach in all cases. For example, an Elon Musk style business (e.g., launching rockets; building an automobile) is not a good candidate for Lean Startup methodology. But Lean Startup is a process which enables the business to reduce failures based on faulty predictions in a very cost effective manner. Learning what you did wrong after all the resources are gone or the market opportunity has passed is part of what a MVP process is intended to avoid. If you aren’t a very experienced entrepreneur with a big financial backer, Lean Startup is a particularly attractive process. The principles can also be beneficial to organizations which are not startups. Large businesses, governments and nonprofits can also benefit from building a MVP, in the right circumstances.
2. “The question is not ‘Can this product be built?’ Instead, the questions are ‘Should this product be built?’ and ‘Can we build a sustainable business around this set of products and services?’” “Products a start-up builds are really experiments…Learning about how to build a sustainable business is the outcome of those experiments [which follow] a three-step process: Build, measure, learn.” “[A startup is] … an organization dedicated to creating something new under conditions of extreme uncertainty.” The only certainty in the world is uncertainty. Various forms of ignorance are also common. This uncertainty and ignorance is a very good thing for investors since it enables them to benefit from mispriced opportunity. By using a process based around experimentation, uncertainty can be incrementally “retired” and value created.
It is important to be crisp about what uncertainty actually is: future states of the world known, probability unknown. Ignorance is: future states of the world unknown. What you want to avoid is risk when the house has the advantage: future states of the world known, probability known. The Lean Startup process is designed to give a business quick feedback so it can adapt to a changing world. As Sam Altman said in his talk this week (linked above): “The best businesses have the tightest feedback loops.”
3. “The nice thing about relying on human judgment and using the scientific method is (we develop) a system for training judgment to get better over time.” Eric Ries’s point is that learning to be a better entrepreneur is a trained response. People who are paying attention while engaging in the startup creation process can learn by doing. Yes, some people actually do create a startup and learn little. Ries is also saying judgment about company formation gets better when it is systematized based on the scientific method. Of course, the primary cause of good judgment is bad judgment so it is best to (1) jump into the fray and learn via making some mistakes and having some successes and (2) engage with a community of others doing the same thing so you can learn vicariously from the successes and mistakes of others. Learning from the experiences of many people has a multiplier effect on the acquisition of good judgment.
4. “…every action you take in product development, in marketing, every conversation you have, everything you do – is an experiment. If you can conceptualize your work not as building features, not as launching campaigns, but as running experiments, you can get radically more done with less effort.” Here Ries is expanding the Lean concept beyond the product offering. Many aspects of a business can be turned into lean experiments. Marketing, for example, can be systemized in ways that reduce inefficiency. One caveat is that the Lean process shouldn’t be used as an excuse to rely on viral adoption that you hope will suddenly appear. If your product or services does “go viral,” great. But don’t count on that happening. Learn how to SELL.
5. “The two most important assumptions entrepreneurs make are what I call the value hypothesis and the growth hypothesis. … The value hypothesis tests whether a product or service really delivers value to customers once they are using it. … The growth hypothesis tests how new customers will discover a product or service.” A business provides value when it solves a genuine customer problem. Growth means the offering is able to generate significant revenues as product or service sales grow. Without value you don’t have a business and without growth you don’t have a startup (as Paul Graham has defined it). Some new businesses are not startups. There is nothing wrong with that. In fact, a business like plumbing or dentistry can be very attractive for some people since it is antifragile.
Andy Rachleff had a fantastic post this past week that provides definitions of these hypotheses and the right sequencing:
“Eric (and I) believes in order to increase the likelihood of succeeding, a startup should start with a minimally viable product to test what he calls a value hypothesis. The value hypothesis should state the founder’s best guess as to what value will drive customers to adopt her product and indicate which customers the product is most relevant to, as well as what business model should be used to deliver the product. It’s highly unlikely that a founder’s initial hypothesis will prove correct, which is why an entrepreneur has to iterate on her hypothesis through a series of experiments before product/market fit is achieved. As a consumer company, you know you have proved your value hypothesis if your business grows organically at a rapid pace with no marketing spend. Only once the value hypothesis has been proven should an entrepreneur test her growth hypothesis. The growth hypothesis covers the best way to cost-effectively acquire customers. Unfortunately many founders mistakenly pursue their growth hypothesis before their value hypothesis.”
6. “All of our process diagrams [in major corporations] are linear, boxed diagrams that go one way. But entrepreneurship is fundamentally iterative. So our diagrams need to be in circles. We have to be willing to be wrong and to fail.” The “build, measure, learn process” is one loop in a process. An example of a model for developing a customer is set out below.
A decision to pivot shouldn’t be taken lightly. Some founders pivot their way right into bankruptcy. Failing is not a good thing. Instead, having the ability to fail and then possibly still recover is a good thing,
7. “Innovation accounting works in three steps: (1) Use a minimum viable product to establish real data on where the company is right now. (2) Startups must attempt to tune the engine from the baseline toward the ideal. This may take many attempts. After the startup has made all the micro changes and product optimizations it can to move its baseline toward the ideal, the company reaches a decision point. That is the third step: (3) Pivot or persevere.” If “the dogs aren’t eating the dog food”, that is the outcome of the trial and error process. The business can then either pivot (try a new approach) or move on. In one sense the tuning process is many small pivots that are improving the offering, leading to a big decision that may lead to a big pivot. Pivoting is not something that should be desired. The better outcome is to stay the course and persevere. If you are doing a big pivot, you have made a mistake. Mistakes are costly. That one might be able to sustain a big pivot and still win is a feature of The Lean Startup process, but it is not a goal.
8. “The mistake isn’t releasing something bad. The mistake is to launch it and get PR people involved. You don’t want people to start amping up expectations for an early version of your product. The best entrepreneurship happens in low-stakes environments where no one is paying attention, like Mark Zuckerberg’s dorm room at Harvard.” Some people argue that early adopters can actually be skeptical of an offering from a startup that is too polished. That’s an interesting thesis but unproven I think. I look at it this way: A business which over promises and under delivers can quickly die. My friend Craig McCaw has said to me several times: “You can spend the rest of your life recovering from a bad first impression in business.”
9. “Startups employ a strategy, which includes a business model…” “The Lean Start up process is a method that can be used to create or refine a business model, a business strategy and/or a business design.” This quotation requires some agreement on definitions. A business model is a concept people often misunderstand. Mike Maples Jr. puts it this way: “A business model is a way a business turns innovation into economic value.” The business objective is simple, says Bill Gates: “Take sales, take costs, and try to get this big positive number at the bottom.” I believe that the best business models are built around mechanisms which generate barriers to entry (a moat).
A business model is very different than a business plan, which is a written document setting out what a company will do in the future. A business plan is only as good as the assumptions that underlie it. Steve Blank points out: “Unless you have tested the assumptions in your business model first, outside the building, your business plan is just creative writing.” Business strategy is yet another concept and refers to the manner in which the business strives to be unique. Business design is the totality of everything a business must do to be a success.
10. “You need the ability to ignore inconvenient facts and see the world as it should be and not as it is. This inspires people to take huge leaps of faith. But this blindness to facts can be a liability, too. The characteristics that help entrepreneurs succeed can also lead to their failure.” Optionality is most often found in places where others are not looking or not seeing what is actually happening. This is why venture capitalists are looking for businesses that seem half crazy. Most things that are crazy are actually nuts, but once in a while there is a huge opportunity no one has discovered yet. As I’ve said many times before, there is no optionality in following the crowd. The entrepreneur’s blind faith is both how new products and services are discovered and why many businesses fail. Failures vastly outnumber successes but the impact of the successes outweighs all the failures. It is magnitude of success and not frequency of success that makes the process worthwhile for society (the Babe Ruth Effect).
11. “New customers come from the actions of past customers.” “The speed of growth is determined by what I call the rate of compounding, which is simply the natural growth rate minus the churn rate.” “Each customer pays a certain amount of money for the product over his or her “lifetime” as a customer. Once variable costs are deducted, this usually is called the customer lifetime value (LTV).” My favorite post on the lifetime value model is by Benchmark Capital’s Bill Gurley. I like to say that ARPU, COGS, CPGA, churn, and WAAC are the Five Horsemen of the Business Apocalypse. Each Horseman is deadly and can kill you on their own. Understanding each Horseman is worthy of a book or two, or at least an article. Tom Tunguz has a nice essay on churn here.
12. “Anybody can rent the means of production, which means entrepreneurship is becoming truly democratized, which means nobody is safe.” This is a fundamental opportunity and challenge in business today. Profit is generated by a barrier to entry (otherwise price drops to opportunity costs) and barriers to entry (moats) now have shorter lives than ever before. Warren Buffett writes: “All economic moats are either widening or narrowing, even though you can’t see it.” Occasionally you will see someone say that moats don’t matter anymore. This sort of thinking is rubbish. The idea that supply of products and services from competitors does not matter to a business result is the business equivalent of insanity. When this principle is forgotten, as it was by Jonathan Schwartz while at Sun Microsystems, the result is a disaster. Moats are more important than ever, but they need to be renewed more than ever as well.
P.S., Nassim Taleb has described why a Lean Start Up approach works well: “it is in complex systems, ones in which we have little visibility of the chains of cause-consequences, that tinkering, bricolage, or similar variations of trial and error have been shown to vastly outperform the teleological—it is nature’s modus operandi. But tinkering needs to be convex; it is imperative…. Critically [what is desired is to] have the option, not the obligation to keep the result, which allows us to retain the upper bound and be unaffected by adverse outcomes.” This is what is known as positive optionality. As an example for a venture capitalist, all they can lose is 100% of what they invest and what they can gain is potentially many multiples of that investment – which gives them positive optionality. Success is found via negativa.
Notes:
Principles of Lean Startup Methodology
FastCompany – Eric Ries is a Lean Startup Machine
McKinsey – Interview with Eric Ries
Inc – Eric Ries on Usability, Testing, and Product Development
Reuters – Bringing Order to the Unruly World of Early Stage Entrepreneurship
