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EP245 Lecture 1

Contents

What We Now Know

Today's lecture is what have we learned in entrepreneurship for the last 40 years. One of the interesting questions is why are you here? I hope you're here to find out what does it take to go from an idea to a business. For the last 20 years if you wanted to know how to go from an idea to a business,
the answer from educators and investors are simply, "Well, go research and then write a business plan and you'll know everything possible to actually start and run your business." We now know that advice was simply wrong--not kind of wrong but very wrong.
We now today know something we didn't know before. We now know the right way to build startups and so this class is about that right way, but before we get started, let's see how we took the wrong path and then see what we now know work.

History Of The Corporation

The modern corporation as we know it was first formed in 1602
with the government chartered Dutch East India Company. This is kind of the first modern corporation with shareholders and organizations that kind of if you squinted looked like something closed to modern companies today. By the 1850s in the United States with railroads spanning the entire country, corporations needed more sophisticated organizations and the fact the first org chart was drawn in 1856 to just manage corporations and by the beginning of the 20th century, educators started realizing
that there was a need for an educated management class to administer and execute these corporations because at least in the United States we were going from local economies to regional economies to a national economy, yet we did not have a trained management class and so in a brilliant insight, Harvard set up the first masters of business administration course called the MBA and the first graduating class in 1910 was the first of a cadre of business administrators that made the 20th century the modern corporate century.

The MBA curriculum is designed to provide managers and administrators with the tools they needed to run existing and growing companies. Accounting, strategy, operations, leadership, organizational behavior, human resources management and these stack of tools were just incredibly important for the growth of large companies but what's really interesting what that missed is that they were really no tools provided in this curriculum for starting new businesses. One of the things we did not understand for 100 years is that startups are not smaller versions of large companies. Let me say it again--startups are not smaller versions of large companies and what falls out of that is all the traditional tools taught and learned in an MBA curriculum are irrelevant in the first chaotic year or two of an early stage venture.

Eventually, you need that tool set but at first it really gets in the way.

Startups Are Not Smaller Versions Of Large Companies

Let's take a look at what we used to believe, and then contrast it to what we now know. One of the biggest fallacies was believing that startups are just smaller versions of a large company. That everything you do in a large company, you'll do on day one of a startup. What we now know is something very different. The core difference is that startups do something called search while large companies spend their time, at least their core time, executing.
One of the questions we'll answer is search for what and execute what. And so later on in this lecture, you'll see the difference and then in fact will make you a much better enterpreneur. 

Strategy

What we used to believe for strategy
is that you start any company with an operating plan and a financial model. What's an operating plan? Well, it's the business plan. And the belief was all I need to do is spend a lot of time writing this plan, and then all I need to do is execute it and somehow magical thinking said if I thought hard enough and if I was smart enough to do all the great market research in the library and looking up all the data and then put together a forecast the magic 5-year plan in the back of the business plan somehow magically all I needed to do is hire the people to execute that plan. If that doesn't sound silly to you now, don't worry, because it didn't sound silly for 40 years, but we now know that's kind of ridiculous. What we now know is that no business plan survives first contact with customers. The first years on a startup is completely unpredictable.
What you think you're doing on Monday turns out to be completely wrong on Tuesday. On Wednesday, you discover something new, and on Friday, you're almost out of business, but on Monday you gets and next Monday you get sold for a billion dollars. A startup is an incredible roller coaster unpredictable series of advance
that there's no way you could put together in a 5-year plan. Yet somehow investors and educators thought that maybe we could just teach you
how to put this all together in a nice spreadsheet. No one ever noticed that the only other people to do 5-year plans were these guys,
the Soviet Union, and we kind of know how well that turned out as well. Though much like the fallacy about business plans and financial forecast that lasted for about 80 years. The good news is that we now know that business plans and financial forecast
first are just as silly as it was in the Soviet Union. No business plan survives first contact with customers.
This doesn't mean we shouldn't have any planning but it actually means what we need is planning before the plan and what that really mean is you need to figure out how to actually do some planning and then you get to write the business plan. So I'll be clear, I'm not suggesting we never want to do an operating plan
and I'm not suggesting we never want forecast but you need some real facts before you could do that and one of the ways we're going to organize our facts is with Alexander Oscar Walters' Business Model Canvas. We'll talk about this canvas in some excruciating detail in the following lectures but you should know we used to canvas for two things. One is initially we're going to use it organize our thinking
about all the hypothesis about every part of our business. But second is we're going to get out of the building and actually turn those hypothesis into fact as we'll find out how to do later and then as we turn those hypothesis into facts, we'll be updating the canvas on a regular basis and it will become a scorecard-- a way to keep score for our progress of how much we've learned. So what this means is instead of writing the operating plan and financial forecast first, we're going to use the Business Model Canvas to actually capture all our hypothesis first.
For the search for the business model, we're going to start with the model first and then after we find the model, we get to write it up. 

Process

What did we use to believe on how you physically build a startup? What was the process we used?
We used to build startups by managing processes. We said, "Well hey, we understand how to build products." We built them exactly like we built them in large companies. We hire product managers, and we do something called waterfall engineering, which I'll explain in a second which basically are step by step by step.
In fact, what we used to do is we used to draw this diagram on napkins. We used to say, "Well you come up on a concept then you raise some seed funding and then you go into product development, and then you have alpha test, beta test, and first customership. What could be wrong with that? In fact for 30-40 years this was the canonical model for how to build startups and we'd say marketing, well, we understand.
While engineering is developing the product, marketing is creating all the marketing
communications material, hiring a PR agency, and creating early buzz and then from marketing
the world's most fun job was have the party. You get to create demand by having a launch event and you think about branding
and your job really was to create end-user demand and derive it into the potential sales channel.
For sales, what that meant is unless the VP of Sales was the founder you tended to hire them
around the time engineering were saying, "We're in alpha and beta test." And they were going out and starting to hire their first sales staff, and they were looking at your 5-year revenue plan
and since it obviously came from a burning bush and it was the word of God,
they were just going to execute that plan. Why? Because it's said so, and you said so, and if you had investors, they said so. There might not be any facts behind it but there it was. It was the spreadsheet. And so they were building the sales organization so again and at first customership, if marketing was going to drive demand they were jut going to have a sales curve that took off because the revenue plan said so. The next piece was the Bus Dev. In business development used to mean the group that put together
all the deals to create the whole product. The whole product meant startups just because of their size are incapable of creating all the features and services, etc., that a mainstream customer might need. So why don't we hire business development people to do partnerships.
So at first customership we could look like a large company for mainstream customers. The only fallacy in this is that you assume that your first customers are going to be in the mainstream.
It turns up for most startups your first customers are actually crazy people like you
and so therefore creating this entire cloud of deals are actually useful a year after first customership
but in fact just get in your way on day one. The other piece is engineering, and engineering--how simple could that be? It was understood.
We did exactly what we did in the large corporations. You wrote a market requirements document then engineering shut their doors, rolled up their sleeves, and went into waterfall engineering, which we'll describe a little later. You hired a QA department then at the end finally when it was all done you hired a tech pubs department and all the products were ready to go in version 1.0. All the features at one time at first customership. And this for 30 or 40 years was the way we thought about startups. There can be no other way. This is how we manage the process.
We now know these are just simply wrong and I'll explain to you what we're going to do instead.

Waterfall Development

If you remember I said engineering was doing waterfall development.
Waterfall development is just a step by step process that says marketing rights are requirements of what the product should do. Engineering takes that and translates that into features. Engineering then designs the product.
Either codes it or builds the hardware.
They test it and they maintain it and this is kind of a waterfall life cycle step by step. But if you really look at this, there's an implicit fallacy that no one ever noticed for 40 years.
To write the requirements and do the design, assumes on day one you know the problem or need the customer has. Let me say it again, waterfall development assumes
you understand the customer problem and need on day one. Now in a large company with existing customers, existing products, existing sales channel,
you know what, this might actually be true but in most startups all you have is the founder's vision and what you tend to do in a startup is confuse a faith-based vision
with customers facts about problems and needs and what happens? The consequence of assuming you know the customer problem
means you assume you know every possible feature to ship on day one. So therefore you shut the door and you start implementing
and instead of just implementing a piece at a time,
you actually implement every possible feature you could think about for version 1.0. The irony is that we now know somewhere between 85 and 90 percent of most software product features are unwanted and unneeded by customers.
That's an enormous amount of waste of time and money that ends up on the floor.
We now know that waterfall and product management execution on two knowns is just kind of the wrong way to approach it in a startup. It makes all the sense in the world in a large company.

Customer vs Product Development

What we now know is most startups fail from a lack of customers
than from a failure of product development and that's really interesting even in Silicon Valley where we would probably take more technical risk
per square inch or square foot than anywhere else in the world. We go out of business typically not because we didn't deliver a product. We go out of business, because we didn't find enough customers to pay us enough money.
That's a big idea, because if you think about it, we have all these processes
to manage the engineering process, why?
Because that is the biggest risk in a large company, but we had no processes to manage the customer risk. In fact, the best we could do, in the old days, is hire a VP of sales who told you "Oh, I have a great Rolodex, great set of contacts." But we really have no formal process for searching for what customers needs are, and in fact, we've just come up with one and that's going to be a key part of this course.
This search for the business model. This search for the truth is called customer development, and customer development really has two pieces, the search and its execution, And in this class, we're going to be talking about the first two steps, customer discovery, customer validation, the pivots that connect them, and then a few that are lucky. We actually get to execute your business model in customer creation and company building. The other piece that goes with the process in a startup
is now in a customer development process but in agile engineering process. One example is extreme programing or XP, which basically
is built around this idea of iteration and incremental delivery of the product.
This is a big idea; it says instead of building every possible feature on day one,
we're actually going to incrementally and iteratively interact with customers, test each portion of the product, and see if what we're building actually has a home outside the building. So what this really means is that for process instead of just going to execution first, hiring product managers, doing waterfall development, or maybe even agile nowadays, we're actually going to start with a customer development process
coupled with some kind of agile engineering process. Which one you pick? How to use XP as an example? But it could be whatever your favorite process is, and by the way,
don't only think that agile engineering and agile development is about software.
Toyota and the Toyota production system actually have it for a hardware of decade before anybody in software who ever thought about it.
So you could be building products anything from microprocessors to medical equipment
to hardware, software, etc. using an iterative and incremental engineering process. And again, once you're done with that, of course, you want to manage this in a formal process,
but not before you do the plan.

Why Do Startups Fail

Why do the most startups fail? Is it because co-founders fight and company breaks up? Is it because they can't build their initial spec or vision, or is it that no one will fund the idea, or is it that too few people buy or use the product?

Why Do Startups Fail Solution

Why do startups fail? Well, the answer is really all of the above. Co-founders do fight. Somewhere between a quarter and third of startups never even get to the beginning of the company because the founders just couldn't agree. Two is that sometimes your vision is just too far in advance to actually be built. The three is it's such an interesting vision or such a bad vision, but it can't attract sufficient capital to get started and it's maybe too expensive to fund on your own through your own resources. And the one we'll be actually talking about in some detail during the series of lectures is that you never actually found product market fit and there's too few people who will buy or will use the product.

Organization

Now the last interesting thing that's a holdover from thinking about startups as smaller versions of large companies is kind of the hardest to get your height around. And that's large companies, they got VP of sales, what we need of VP of sales on day 1. Large companies, they have had some marketing. I need to have a market. In large companies, they have bus dev and all those external organizations. We need those too. Without ever thinking about what's the point? Why is it that we want to duplicate these same organizations? Cause if you're a founder like I was, boy, you really want someday to see you on top and look at all these nice silos working for me. Isn't this great and look, they're all doing their jobs, etc. I have to tell you if this is your vision on day 1, you're already out of business. Cause we now know that functional organizations actually are the wrong way to set up sales marketing and bus dev on day 1. What we now know is that the founders need to run what's called the customer development team. And a customer development team says, "Listen, we're not going to have sales marketing and bus dev on day 1. We're not going to hire a VP of sales on day 1. We're actually going to have the founder get out of the building." And later in this lecture, we'll explain why. It's a really big idea to understand for organization, you need the founders spending at least and figuring out how that matches with the features at your building before you start organizing in functional organizations and silos. Well, the thing I mention which I'll expand on later in this course is that one of the mistakes that we've also made for decades is confusing the titles, sales marketing and bus dev with the job specifications. It turns out that the title "VP of Sales" has a very different job spec in a large company that it does on a startup of VP and marketing does very different things in a large company than they do on a startup and for years, we could never explain why is it that incredibly competent executives who have been executing business models in large corporations collapse in startups when they're company is smaller than their administrative staff in their large corporation. It turns out that job specification, what we do day to day has nothing similar.

Entrepreneurial Education

Let's just take a look at the last piece which is why you're here. How do we teach entrepreneurship? Well, in the past, entrepreneurial education was about execution. We're going to teach you how to write a business plan. We're going to teach you how to put together the power point for the VC presentation. If we're doing it really well, we'll have you lots of research. But it really assumed it was all about execution. What we now know that's just simply not the case. Entrepreneurial education, the reason why you're taking this class is about the search for the business model and we're going to teach you how to search. And so what that means about entrepreneurial education is that eventually we do need you to know everything an MBA knows. Eventually if your success in growing your startup into a large company, you're going to need to know about accounting and HR and organizational behavior and global leadership and etc. But at first, you need a different set of skills that just never existed before, and so welcome to the first class of its type that's going to put search first and that's a radical change. It's not just one more methodology. This class is going to teach you all the skills about strategy and process and organization and eventually if you build a successful company, we'll then allow you to write the plans and operating documents and financial spreadsheets to actually execute the company. Hold on to your seats, we're about to get started and let's jump in to business models and customer development.

Startup Outcomes

What can happen to a startup? Take a look at the list below and check all that apply.

Startup Outcomes

What can happen to a startup? Well, the best thing that could happen to a startup is that it can grow into a company and hopefully a large company after you found a repeatable and scalable business model. Or 2 is well you can still pivoting and iterating as you continue to search for a business model. Or 3 is you could have found a business model but may be one that isn't an explosive growth, but you could be growing slowly and barely breaking even. Or 4 is maybe you never found the business model but you can make money and you run out of money in time and you shut your company down. The answer is all of the above.