STEVE BLANK WORKED FOR eight technology companies over the course of twenty-one years before deciding to devote more of his professional life to teaching other people how to build successful startups. Andy Rachleff, a venture capitalist, has said, “Steve Blank wrote an amazing book called The Four Steps to the Epiphany that really started this whole idea of a Customer Development Process.” Steve’s contributions to what has become known as the Lean Startup movement are foundational. He was a natural choice to be the first person discussed in this book (especially since his name starts with “B”). When Steve makes a point about business, he is speaking from personal experience. He founded Epiphany in his living room in 1996; two semiconductor companies, Zilog and MIPS Computers; the workstation company Convergent Technologies; and several other startups. He is also the author of The Startup Owner’s Manual and several other books.
1. “A startup is a temporary organization designed to search for a repeatable and scalable business model.”
A business model describes how your company creates, delivers, and captures value.
There are several different approaches to defining a business model. I like the definition created by the venture capitalist Mike Maples Jr.: A business model is “the way that a business converts innovation into economic value.” A capitalist economy is an evolutionary system. Innovation and best practices are discovered through the experimentation of entrepreneurs who try to establish the evolutionary fitness of their businesses. Products and services that are more fit survive, and the less fit die. Entrepreneurs run experiments when they create or alter a business. Blank and others have created ways to establish a business model by applying a trial-and-error process to a hypothesis to discover the optimal result, rather than trying to create a grand plan at once from whole cloth.
2. “A company is a permanent organization designed to execute a repeatable and scalable business model.”
Large corporations are large because they found a repeatable business model, and they spend most of their energy performing—meaning doing the same thing over and over again. They figured out what the secret is to growing their business.
A business is no longer a startup once it has a repeatable and scalable business model. Blank has said that that once a business is no longer a startup, it may begin to develop “antibodies,” which stifle the development of new products and services, as well as new business models. There is an inherent tension between the creation of new, repeatable, scalable business models and the optimal execution of an existing business model, because superior execution often involves eliminating anything not core to the mission of the existing model.
3. “Business plans are the tool existing companies use for execution. They are the wrong tool to search for a business model.”
Startups are not smaller versions of larger companies. They are something very different. Business plans are operating programs. Startups don’t even know what it is they are supposed to be operating. A business plan is the last thing you want a startup to write.
A business plan is exactly like telling you to go boil water when someone’s having a baby: It’s to keep you busy, but there’s no correlation between success and your activity.
In a startup, no business plan survives first contact with customers.
The world is changing so quickly and there is so much risk and uncertainty that a detailed long-term business plan is essentially a work of fiction, and writing one is a waste of precious time and resources. One of the best business books on what it is like to actually run a business is Shoe Dog, written by Phil Knight, which chronicles the story of Nike. The book describes the long, hard slog that building a business inevitably entails. Knight says, “We had no master plan. It was totally seat of the pants…. There is an immutable conflict at work in life and in business, a constant battle between peace and chaos. Neither can be mastered, but both can be influenced. How you go about that is the key to success.” Nassim Taleb described why business plans rob businesses of their potential value when he said, “A rigid business plan gets one locked into a preset invariant policy, like a highway without exits—hence devoid of optionality.”
4. “A startup is not about executing a series of knowns. Most startups are facing a series of unknowns: unknown customer segments, unknown customer needs, unknown product feature sets, etc.”
A pessimist sees the danger in every opportunity, but an optimist sees opportunity in every danger.
Founders and investors harvest the biggest financial returns when uncertainty is greatest since that is when assets are most likely to be mispriced. In making decisions, founders and investors must assess three factors:
1. Risk: Future states of the world are known, and the probabilities of those future states are known (as in roulette).
2. Uncertainty: Future states of the world are known, but the probabilities of those future states are unknown (as with most things in life).
3. Ignorance: Future states of the world are unknown, and probabilities are therefore not computable (a state of unknown unknowns).
A founder or investor who can remain rational despite risk, uncertainty, and ignorance will be better able to capitalize on a mispriced opportunity. It is when other investors act emotionally rather than rationally that assets and opportunities may be mispriced. For example, it was precisely when the economy was at its lowest point after the financial crisis of 2008 that the greatest opportunities existed for an investor or founder. The best time to found a business is often in a downturn since employees are easier to recruit, resources are less expensive, and competition is less intense. It takes courage to found a business, especially in a recession, but that courage can pay big dividends. Optimists and people who have been through previous business cycles are much more likely to realize that the business environment will inevitably get better despite a downward phase; they understand that business cycles inevitably swing from boom to bust and back again.
5. “Products developed with senior management out in front of customers early and often win. Products handed off to a sales and marketing organization that has only been tangentially involved in the new product development process lose. It’s that simple.”
The reality for most companies today is that existing product introduction methodologies are focused on activities that go on inside a company’s building. While customer input may be a checkpoint or “gate” in the process, it doesn’t drive it.
There are no facts inside the building, so get the hell outside.
Blank has developed what he calls a Customer-Development Process, based on the idea that startups should apply the scientific method just as scientists do: Start with a hypothesis, test it, and prove it—or move on to further iterations of the hypothesis if it proves incorrect. Startups should therefore start with the product and then try to find its market, as opposed to starting with the market and then trying to find the product. Nothing drives the Customer-Development Process forward more efficiently than time spent with actual customers. The best founders, CEOs, managers, and engineers spend massive amounts of time with their customers. They do so because they love their products and want to share this love with others.
6. “This whole ‘lean’ stuff works best if you’ve failed once. If you’ve failed once, you appreciate the value of not just following your passion, but maybe devoting 10 percent to testing your passion before you commit three to four years of your life to it.”
Good judgment tends to come from experience, which tends to come from bad judgment. So failure, while painful, can often have positive benefits. Certainly, it is less painful to learn from the mistakes of others, but personal failure is the most memorable. Few things in starting up a business are more precious than time and energy spent early in the process figuring out whether “the dogs will eat the dog food.” Following your passion right off a cliff makes no sense if a relatively small effort devoted to the early testing of an idea can keep you from that fate.
7. “ ‘Build it and they will come’ is not a strategy; it’s a prayer. Why are so many founders so reluctant to invest even five hundred or one thousand hours upfront to be sure that, when they’re done, the business they’re building will face genuine, substantial demand or enthusiasm? Without passionate customers, even the most passionate entrepreneur will flounder at best.”
Psychological denial can be very powerful. People who want something badly often just pretend they have created something consumers will want to buy when there is no evidence that this is the case since the reality is too terrible to contemplate. For example, a team running out of seed funds and under pressure from investors may convince itself that it has created a product desired by consumers even though a child of ten knows the product isn’t valuable enough for customers to pay for it. If a business has not discovered core product value (a solution to a valuable customer problem), no amount of growth is going to save that business.
8. “The company that consistently makes and implements decisions rapidly gains a tremendous, often decisive, competitive advantage.”
What matters is having forward momentum and a tight, fact-based data–metrics feedback loop to help you quickly recognize and reverse any incorrect decisions. That’s why startups are agile. By the time a big company gets the committee to organize the subcommittee to pick a meeting date, your startup could have made twenty decisions, reversed five of them, and implemented the fifteen that worked.
The businesses that survive in a rapidly evolving environment are those that are most agile. The lean startup movement and agile development both use a process of continuous experimentation and feedback from the results of experiments to stay on top of changes. Nassim Taleb describes a foundational principle for this type of approach in his book Antifragile: “Any trial and error can be seen as the expression of an option, so long as one is capable of identifying a favorable result and exploiting it.”
9. “Founders see a vision, but then they manage to attract a set of world-class employees to help them create that vision.”
A founder must be able to sell many things to build a successful startup. A founder’s ability to recruit a team is tested early. Convincing world-class people to join something with as much uncertainty attached to it as a startup is a genuinely valuable skill and optimally the work of a person with missionary zeal. The best venture capitalists know that the first hires are critical so they will often help founders with recruiting, especially at very early stages or with first hires.
10. “You don’t have to be the smartest person, but showing up is 80 percent of the game. My career has been all about just showing up and people saying, ‘Who’s here? Blank is here. Let’s pick him.’ Volunteering and showing up has been a great thing for me. But all along the way, I’ve always been very good at pattern recognition and picking signal out of the noise. Not smarter than everyone else, but more competent perhaps at seeing patterns.”
Basic but critical actions like being on time and developing sound judgment are the blocking and tackling of the startup and business worlds. In a letter, Woody Allen once wrote about a famous saying attributed to him:
My observation was that once a person actually completed a play or a novel, he was well on his way to getting it produced or published, as opposed to a vast majority of people who tell me their ambition is to write, but who strike out on the very first level and indeed never write the play or book. In the midst of the conversation, as I’m now trying to recall, I did say that 80 percent of success is showing up.
To create a startup or new line of business, you must first start. As an example, the way I wrote my first book was to just start writing. I didn’t know anything about book proposals, agents, or the ins and outs of the publishing world. I just wrote a book and sent it to a publisher, who accepted it. I would not recommend that process now, knowing more about the industry, but by writing that first book, I “showed up.”
11. “Upper management needs to understand that a new division pursuing disruptive innovation is not the same as a division adding a new version of an established product. Rather, it is an organization searching for a business model (inside a company that’s executing an existing one). When you’re doing disruptive innovation in a multibillion-dollar company, a $10 million/year new product line doesn’t even move the needle. So to get new divisions launched, large optimistic forecasts are the norm. Ironically, one of the greatest risks in large companies is high-pressure expectations to make these first-pass forecasts that subvert an honest Customer-Development Process. The temptation is to transform the vision of a large market into a reliable corporate revenue forecast—before Customer Development even begins.”
Established businesses spend a lot of time coming up with optimistic market forecasts. It can also happen at many startups. These market forecasts are often created using methods pioneered by “Professor Rosy Scenario.” Market-research firms make a great living supplying these supportive forecasts, some of which may leverage confirmation bias to make the firms popular with clients. Unfortunately, many of these market-research forecasts are often little more than imaginative storytelling. I like stories. Stories can be useful in motivating people and can be fun to tell. But it is important to remember that they are just stories and may not apply to reality in a significant way.
12. “I said, ‘There are five hundred people in this room. The good news is, in ten years, there’s two of you who are going to make $100 million. The rest of you, you might as well have been working at Walmart for how much you’re going to make.’ And everybody laughs. And I said, ‘No, no, that’s not the joke. The joke is all of you are looking at the other guys feeling sorry for those poor sons of bitches.’ ”
Financial success in creating and funding startups follows a power-law distribution. This phenomenon occurs because, in venture capital and entrepreneurship, feedback introduced by correlated and nonindependent decisions can produce network effects and information cascades. In contrast, so-called normal distributions arise from many independent random decisions averaging out. You will hear the term “power law” mentioned and discussed throughout this book since it is central to the venture capital business and to startups generally.
Founders, employees, consumers, and distributors take cues from previous successes in making decisions. In this way, past success feeds back on itself. The best venture capital firms and startups tend to get the best results, and the distribution of financial returns tends to reflect a power-law distribution. The researcher Duncan Watts writes about this phenomenon more generally:
People almost never make decisions independently—in part because the world abounds with so many choices that we have little hope of ever finding what we want on our own…. When people tend to like what other people like, differences in popularity are subject to what is called “cumulative advantage,” or the “rich get richer” effect. This means that if one object happens to be slightly more popular than another at just the right point, it will tend to become more popular still.
Overconfidence bias makes most people believe that they will be included among the winners. The inevitable failures that occur in attempts to create a new startup business are hard for the individuals involved but are the right thing for society. Nassim Taleb writes, “Most of you will fail, disrespected, impoverished, but we are grateful for the risks you are taking and the sacrifices you are making for the sake of the economic growth of the planet and pulling others out of poverty. You are the source of our antifragility. Our nation thanks you.” Being a founder or early employee of a startup is not a rational act, given the odds of success. Of course, as George Bernard Shaw wrote in Man and Superman, “All progress depends on the unreasonable human being.” The reason books like The Hard Thing About Hard Things by Ben Horowitz and Shoe Dog by Phil Knight resonate so strongly with people who have been involved in startups is that they accurately describe the terror, inevitable setbacks, and daily struggle of life in a startup business, not just the seemingly glamorous parts of the experience. Scott Belsky calls this stage of building a business “the messy middle.”