Ben Horowitz, founder of leading venture firm Andreessen Horowitz and a successful entrepreneur prior to that published a post over the weekend: The Case for the Fat Start-Up.
In it he argues that lean thinking has been overdone and that startup CEOs should be more aggressive raising capital and investing in building value in their companies. His reasoning is that being number one in a market is the only thing that counts, and that it therefore makes sense to go all out to achieve that goal. Running lean means going slower, increasing the chances that another company takes that coveted number one spot.
I have a ton of respect for Ben. He was produced large volumes of beautifully written guidance for startups that I have enjoyed reading and quote frequently. I’ve also agreed with pretty much all of it.
Even this time I think he is partially right. But his advice needs a major qualification, because whilst it is right for some companies to go all out to secure the number one slot, there are plenty of others for whom raising a ton of cash and investing heavily is the wrong answer. For some it’s because they haven’t reached that point yet, and for others it will never be the right answer.
Let me start by defining the group of companies for whom a ‘Fat start-up’ strategy is the right strategy. I think they have the following characteristics:
- They operate in a very large market
- They know how investing heavily will drive growth – i.e. have some form of product market fit
- They have a path to profitability or confidence they can raise future funds
It is likely all the companies that a large fund like Andreessen Horowitz wants to invest in have all three of these characteristics, making Ben’s advice appropriate for his universe.
However, for earlier stage funds like Forward Partners the picture is a little different.
Some of our portfolio companies have these three characteristics, and most of those are raising as much as they can to maximise their chances of being number one in their market. We love and support that firstly because it’s what the founders want and we are behind them, but also because we are shareholders and know that in nearly all markets the number one company is much more valuable than the number two.
But a lot of our portfolio don’t have all three of those characteristics, and for them it makes sense to run lean, at least for a while. Most of those companies fall into one of these two categories:
- They don’t yet know for sure how big their truly addressable market is. We invest in lots of companies that are playing early in emerging new markets. We believe the markets have a good chance of being large, but at the outset we don’t know for sure. For those companies it is important to make sure they don’t over-fund for their truly addressable market size. If a company’s market ends up being small relative to the amount of capital they have raised then the outcome won’t be good. The exit will likely be similar to or smaller than the amount of capital they raised, meaning investors will be unhappy because they lost money or only just made their investment back, whilst management and founders will only make what they can negotiate out of a side deal.In his post Ben talks about a startup purgatory where under-investment leads to coming second in the market and low returns after years of effort. This is the other type of startup purgatory, where over-investment leads to low returns despite winning the market, again after years of effort. There are few things more annoying than working hard, building a successful business, exiting for a decent, but not huge, amount, and having all the stakeholders be disappointed with the outcome.
Companies in this group should start raising relatively small amounts and then scale up as it becomes clear the opportunity size merits it. Putting that in fat startup vs lean startup terms, these businesses should start lean and only move to fat once they are sure they are in a big market.
- They are in a big market but haven’t found product market fit yet. Most of our investments are pre-product market fit. Many are pre-product entirely – no product, no code, no team, just a great founder and an amazing idea. For these pre-product market fit companies raising a lot of money early is occasionally the right thing to do – mostly when the competition is, or is likely to be, fierce – but for most of them it makes sense to keep things lean until the unit economics are established and it’s clear how more cash will drive growth and enable the next round. Raising a lot of money before this point – which you can consider a working definition of product market fit – is dangerous because of the increased expectations that come with a big round.Getting investors to back you in a big round generally requires showing them a big plan, i.e. one that has rapid revenue growth to make them excited and rapid expense growth to justify the fundraise. Most founders who raise a round like this follow the expense side of the plan, but if they are pre-product market fit they don’t know if the revenues will follow. If those revenues don’t come then the company quickly falls into a precarious position, with a big burn, a big valuation to live up to and little progress to show to potential investors in the next round.
Companies in this group should generally stay lean until they have found product market fit.
I’m as excited about being part of massive companies as everyone else in this industry, but it’s important to recognise that there are lots of great companies that don’t reach $1bn in value, but do make a meaningful contribution to society and deliver great outcomes for their founders and early investors. The overarching point of this post is to note that these sub $1bn companies need to be funded appropriately. Generally speaking, and to simplify, that means staying lean unless or until it’s clear the outcome can be very big, or, in more detail, start lean and become progressively less lean only as the scale of the opportunity becomes clear.
We all know that things get difficult when someone wants something too much. You might have had a needy boyfriend or girlfriend whose constant need for reaffirmation and over-reaction to perceived signs of problems undermined your relationship. Or you might have experience of a co-worker who wanted promotion so much they got obsessed on one thing and lost sight of the big picture.
The same thing happens to founders. A lot.
It’s easy to see why. Starting a company is a big risk and founders invest a lot of themselves into their companies – a lot of time, a lot of emotion and a lot of money (whether by way of direct investment of opportunity cost of a higher salary that could be earned elsewhere). Then they hire people and raise money by promising success.
By this point failure feels unimaginable, an embarrassing waste of time and money, a horrible process of laying people off and a litany of broken promises to people they care about. And then the negative voices can start, I’ve wasted my career, I’m a failure, nobody will ever want me, I won’t be able to keep up the payments on my house etc. etc.
I have had some of these feelings at Forward Partners.
Here are the three most common ways I see needing it too much hurt founders:
- They are less authentic when they pitch. Every startup is an experiment and is best understood as a learning journey, yet when they pitch founders are asked to project into the future with confidence. It’s important that they feel conviction – investors are most definitely looking for that – but it’s also important that they show an understanding that their assumptions might be wrong. Founders who need it too much have a hard time countenancing that idea, making them look brittle and unconvincing.
- They don’t push potential customers and partners to a ‘yes’ or a ‘no’, preferring to let time pass and have more meetings rather than take the chance of getting a ‘no’ that might be too hard to hear. The result is spending a lot of time and effort with companies that don’t come through, time that could have been spent building new pipeline, thus increasing the chances of the business succeeding.
- They are chronically slow to ship product, always wanting to add another feature or add a bit more polish rather than release it to the world who might not like it. As Eric Ries taught us, if some customers don’t love the essence of your product you are doomed anyway and unless you are a most uncommon genius at least some, if not most, of the additional work you do pre launch will turn out to be a waste of time. So much better to release early. There’s a balance of course, and the game has become harder since Ries published The Lean Startup in 2011. Nowadays there’s an existing online alternative for just about every new product, so it’s no longer sufficient to ship a bare bones MVP, if you want people to even think about switching you also have to achieve a minimum level of usability across the whole product. But that doesn’t change the need to ship at the earliest feasible moment.
The first line of defence is self-awareness. If you catch yourself doing anything I’ve described above, or more generally, departing from your normal standards of objectivity then stop and ask yourself if you’re needing it too much. Then, maybe the tougher part is to try and change how you feel. Remember that, as important as it might seem at the time, no one conversation is going to make or break your company. There are always more customers and investors to talk to, so you can afford to relax a little. And if you get good at relaxing you will do better anyway.
The second thing is to take time to think through your Plan B. If you have an acceptable fall-back then it will be that much easier to relax and you should avoid the really negative thought spirals. Our big bet when we started Forward Partners was that we could get better results by investing heavily in an operational team to support our partner companies. Providing a platform that would make it easier for founders to succeed would let us win the best deals and help them reach even higher heights. That’s panning out, but our Plan B was a calculation that if all the extra investment turned out to be a waste of money then the fund would still make OK profits so long as the investments performed as well as companies I had backed in the past.
Finally, find someone to talk to. Best is a coach, if you can afford one. They will help you see when your need for success is getting in the way of clear thinking.
Earlier this week a friend was asking me whether her fundraising chances would be improved if she started generating revenues. She’s a natural salesperson and she’s wondering if having small revenues would make it harder for her to sell a big growth story than if she has no revenues at all. When we unpicked it, the logic behind the question is that if there is a small amount of revenue, maybe with small month on month increases, then projections of much larger month on month increases going forward might look less credible than if there were no revenues at all.
In short, she was wondering if she was in danger of letting numbers get in the way of a good story.
Firstly, note that this is backwards thinking. Letting investor optics determine strategy rarely works out well. I get that fundraising is a nerve-wracking process, that investors can be unpredictable and irrational and how that makes optics important. But delaying monetisation to optimise for fundraising almost always falls into the category of letting the tail wag the dog. I say almost always because the caveat (and this applies to all fundraising advice, and isn’t said enough) is that fundraising success often comes down to just one new person falling in love with your idea, and that generalisations like the one I’m making here might apply to the majority of investors, but they will never apply to all of them.
Then the second thing to say is that projections which involve a step change are always harder to believe than projections which are based on an extrapolation of existing trends. That’s not surprising when you think about it, because in the step change case you have to believe that something new will happen whereas in the extrapolation case you only have to believe that things will continue as they are. That’s why companies that have been stuck in a rut of low or no growth often find it hard to raise cash, even when it’s reasonable to argue that a low level of investment is the reason growth has been lacklustre. I’ve heard many founders in this situation say that it’s very unfair when companies that are similar to their’s, but newer, find it much easier to get investors excited, even though they’ve often got less experience. Hopefully this explains why.
Returning to the case in hand – if there are small revenues and small increases, an extrapolation of existing trends won’t look very exciting. However, the same can be said for if there are no revenues at all. So in both these scenarios, my friend will be asking investors to believe in a step change. Following the logic through it makes sense for her to start monetising as soon as possible because that gives the chance that revenues will grow fast, the step change will have happened, and the fundraising will be easy.
Happily, this brings us away from investor optics determining strategy and back to doing the right thing
In fact, this is so obviously the right thing to do, that the only reason you wouldn’t is if you didn’t really believe in your plan.
And if you don’t believe in your plan, then you have bigger problems, and delaying monetisation in the hope of making fundraising easier is still unlikely to be the right solution.
Let me start by saying that I’m a massive believer in the power of metrics. There’s an old adage that if you don’t measure something it doesn’t happen and I think there’s a tonne of truth in that. As a result we advise our companies to build KPI trees so employees in each department know what to do and there can be confidence that if everyone delivers the company will hit its overall growth and profitability targets.
However, it’s also true that metrics are not a panacea, with difficulties typically arising when a focus on metrics eclipses the big picture. This happens for two related reasons:
- Bad implementation
- Over focus on metrics at the expense of meaning, culture and innovation
Bad implementation is a surprisingly easy trap to fall into. In startups things move fast, and once you get beyond the high level metrics like sales it is often difficult to get good data, particularly at the very early stages. Calculating an accurate CPA by channel is a good example of something that sounds simple, but is notoriously difficult in practice. So entrepreneurs do the best they can, and develop proxy metrics. That works great whilst everyone remembers that they are proxies. The problem is that they forget quickly, particularly when the team grows and the people managing to the proxy weren’t there when the conversation about it being a proxy was had in the first place. If you’re not careful you can end up with a company that is working very precisely to a set of metrics that are slightly off target and everything isn’t working as well as it could.
Or worse, the proxy metrics are only directionally right and when managed to with precision they result in bad outcomes. Arguably that’s what’s happening in the UK and US education systems right now, where schools have been measured on standardised test scores for some time and teachers are now ‘teaching to the test’ at the expense of a more rounded general education. The NHS in contrast has a more comprehensive set of targets comprising waiting lists for operations, wait time in A&E, commitments for cancer patients, maternity patients and many more items. Whilst the NHS is definitely creaking under the pressure of increasing patient numbers and increasing cost-per-patient, it’s my belief that these targets have helped managers to focus on what’s important and improve the quality of the health service provided to us all here in the UK.
The solution to bad implementation, of course, is to improve the implementation rather than ditch the metrics. In education that might mean smaller more regular tests or adding additional measures, maybe of pupil happiness. Some of these might be impossible or prohibitively expensive to measure, but you get the point.
The second thing that can go awry with metrics is much more subtle, and tends to afflict good companies with well defined KPIs. The value of metrics is that they make it simple for people to know what to do. The associated challenge is that people cleve to that simplicity and lose sight of the nuances, particularly if they are comped on the metrics.
Last night, I was talking with one of our portfolio companies which is particularly well run. They make exceptionally good use of metrics and have enjoyed great success as a result. However, growth is now slowing and that’s at least in part because they have been over-focused on what they can measure and neglected brand and some of the more qualitative aspects of customer experience that might have improved retention. Culture and innovation are two other areas that aren’t measurable and can suffer in metrics driven businesses.
The remedy is for the CEO to stay brave and maintain a clear vision for where she or he wants the company to go in the areas which aren’t measurable as well as the areas that are. That requires clarity of thought, constant communication, and allowing for objectives that aren’t fully SMART. Perhaps more challenging, it requires creating an environment where people work effectively toward soft targets as well as delivering KPIs. By soft targets I mostly mean areas where there is no firm definition of quality so gut feel rules – branding is an obvious example, as are mission and vision statements, innovation more generally, and managing to company values.
In our experience, structured customer development work is right up there amongst the most valuable things a founder can do in the early days of their startup. Once you have an idea that feels strong, it’s imperative to speak with customers about it. But good customer development is tough to do. It takes a long time, think 10-20 hours of interviews plus preparation and digest time, and conducting structured interviews with strangers is outside the comfort zone of many founders. So lots of entrepreneurs skimp on this vital piece of work. That’s a bad decision. It leaves you flying blind when with a little hard work you can be seeing clearly.
Let me use the Jobs To Be Done (JTBD) framework for product development to explain why.
Reams have been written about the JTBD framework. I will give you a high-level summary here, but if you are building products then I recommend spending some time with Google to find out a bit more.
The core idea of the JTBD framework is that customers use products or services to do a job for them (in the US many people say they “hire” the product or service to do the job, but that doesn’t translate too well into UK English so I prefer “use”).
For example, I used my bike to do the job of getting from home to work this morning. I could have used a bus or a tube, but I used a bike.
That job breaks down into component parts. I have to access the mode of transport, pay for it, travel, dispose of the mode of transport at the other end and maybe get from the disposal point to my final destination. With my bike that breaks down to getting it out of the bikeshed in my front garden, no payment, cycle for 15 mins, put it in the bike rack in our office garden, and then walk five metres to my desk. If I was getting the bus the breakdown would be walking to the bus stop, paying with my iPhone, sitting on the bus for 30 mins, getting off the bus, and walking 200 metres to my desk.
Each of those component parts has associated outcomes that I’m looking for. Some of those are functional and others are emotional. Taking the travel component of the job, the functional outcomes I’m looking for include speed, comfort, exercise and predictability whilst the emotional ones include safety, anxiety, and consistency with my identity as an active person.
Those component jobs could be broken down further and then there would be outcomes associated with each job at the next level of detail down the stack. Part of the art of using the JBTD framework well is picking the right level of detail to work at.
The work I’ve described so far is a desk exercise. That’s valuable, but the real insight comes from talking with customers to discover what’s important to them, how satisfied they are with their existing provider, what needs to change and how much they would be willing to pay. The focus should be on the outcomes they want and their answers will tell you what features you need to build and where the opportunities for differentiation lie.
Before you start you will probably have a gut feel for the answers customers will give you to these questions. I originally titled this post “Two compelling reasons to do structured customer dev” because unless you do it you won’t know whether you are right or wrong until you’ve invested the time and money it takes to design your MVP, build it, release it and find some customers. Now that we all follow lean development methodologies mistakes are much cheaper than they used to be, but they are still a hell of a lot more expensive than 10-20 hours of customer dev.
Common mistakes which lead to wasted effort include building a feature to drive an outcome that isn’t important to customers and not realising that an outcome provided by competitors is important for customers. This second one is particularly dangerous as it will result in low conversion and might lead you to the erroneous conclusion that your point of differentiation isn’t resonating (a false negative).
The second reason to do structured customer dev is that the interviews can yield insights which drive marketing. An example from Photobox. They sell personalised photo gifts, photo books, mugs, calendars etc. Using the JTBD framework they established that one of the jobs they do for their customers is help them remember when a birthday or anniversary is coming up and they need to give a gift. Through the customer interviews they discovered that remembering and not forgetting had very different emotions associated with them. Remembering something is nice, but not remarkable, whereas not forgetting means avoiding all the anxiety associated with forgetting something important and letting someone down. They used this insight to change the subject line in some of their reminder emails. The message moved from “remember XYZ” to “don’t forget XYZ” and the response rate was much improved.
I could go on for ever about the importance of customer dev work. It really does make a huge difference. The reason many founders skimp on it is that the benefits often seem a bit nebulous. I hope they seem less nebulous now.
A quick shout out to Dave Wascha from Photobox who was kind enough to spend time with the Forward Partners team on Monday educating us about the JTBD framework. His talk was the inspiration for this post.