Venture Hacks

This post is by Steve Blank, a serial entrepreneur with eight startups under his belt, including two large craters (Rocket Science and Ardent), one dot.com bubble home run (E.piphany), and several base hits. Steve is also the creator of customer development and this is one of his best posts on the topic. If you like it, check out his blog and tweets @sgblank. – Nivi

At an entrepreneur’s panel last week, questions from the audience made me realize that the phrase “Lean Startup” was being confused with “Cheap Startup.”

For those of you who have been following the discussion, a Lean Startup is Eric Ries’s description of the intersection of Customer Development, Agile Development and if available, open platforms and open source.

Lean Startups aren’t Cheap Startups

A Lean Startup is not about the total amount of money you may spend over the life of your startup. It is about when in the life of your company you do the spending.

Over its lifetime, a Lean Startup may spend less money than a traditional startup. It may end up spending the same amount of money as a traditional startup. And I can even imagine cases where it might burn more cash than a traditional startup.

Lets see why.

The Price of Mistakes are Inversely Proportional to Available Capital

In times of abundant venture capital if you miss your revenue plan, additional funding from your investors is usually available to cover your mistakes — i.e. you get “do-overs” or iterations without onerous penalties (assuming your investors still believe in the technology and vision.) In times when venture capital is hard to get, investors extract high costs for failure (down-rounds, cram downs, new management teams, shut down the company).

The key contributors to an out-of-control burn rate are 1) hiring a sales force too early, 2) turning on the demand creation activities too early, 3) developing something other than the minimum feature set for first customer ship. Sales people cost money, and when they’re not bringing in revenue, their wandering in the woods is time consuming, cash-draining and demoralizing. Marketing demand creation programs (Search Engine Marketing, Public Relations, Advertising, Lead Generation, Trade Shows, etc.) are all expensive and potentially fatal distractions if done before you have found product/market fit and a repeatable sales model. And most startup code and features end up on the floor as customers never really wanted them.

Therefore, when money is hard to come by, entrepreneurs (and their investors) look for ways to reduce cash burn rate and increase the chance of finding product/market fit before they waste a bunch of money. The Customer Development process (and the Lean Startup) is one way to do that.

Repeatable and Scalable Sales Model

In Customer Development your goal is not to avoid spending money but to preserve your cash as you search for a repeatable and scalable sales model and then spend like there is no tomorrow when you find one.

This is the most important sentence in this post and worth deconstructing.

• Preserve your cash: When you have unlimited cash (internet bubbles, frothy venture climate) you can iterate on your mistakes by burning more dollars. When money is tight, when there aren’t dollars to redo mistakes, you look for processes that allow you to minimize waste. The Customer Development process says preserve your cash by not hiring anyone in sales and marketing until the founders turn hypotheses into facts and you have found product/market fit.

• As you search: Customer Development observes that when you start your company, all you and your business plan have are hypotheses, not facts — and that the founders are the ones who need to get out of the building to turn these hypotheses into customer data. This “get out of the building” activity is the Customer Discovery step of the Customer Development Model:

• Repeatable: Startups may get orders that come from board members’ customer relationships or heroic, single-shot efforts of the CEO. These are great, but they are not repeatable by a sales organization. What you are searching for is not the one-off revenue hits but rather a repeatable pattern that can be replicated by a sales organization selling off a pricelist or by customers coming to your web site.

• Scalable: The goal is not to get one customer but many – and to get those customers so each additional customer adds incremental revenue and profit. The test is: If you add one more sales person or spend more marketing dollars, does your sales revenue go up by more than your expenses?

• Sales model: A sales model answers the basic questions involved in selling your product: “Is this a revenue play or a freemium model going for users? Something else? Who’s the customer? Who influences a sale? Who recommends a sale? Who is the decision maker? Who is the economic buyer? Where is the budget for purchasing the type of product you’re selling? What’s the customer acquisition cost? What’s the lead and/or traffic generation strategy? How long does an average sale take from beginning to end? Etc.” Finding out whether you have a repeatable, scalable sales model is the Customer Validation step of Customer Development. This is the most important phase in customer development. Have you learned how to sell your product to a target customer? Can you do this without running out of money?

• Scale like there is no tomorrow: The goal of an investor-backed startup is not to build a lifestyle business. The goal is to reach venture-scale (~10x return on investment.) When you and your board agree you’ve found a repeatable and scalable sales model (i.e. have product/market fit) then you invest the dollars to create end user demand and drive those customers into your sales channel.

If you confuse Lean with Cheap when you do find a repeatable and scalable sales model, you will starve your company for resources needed to scale. Customer Development (and Lean) is about continuous customer contact/iteration to find the right time for execution. (Ed: In other words, eliminate generic startup risks in the right order.)

The Customer Development Venture Pitch

At this point I often hear entrepreneurs say, “We don’t have the money to scale. We’ve been running on small investments from friends and family or angels. How do we raise the big bucks?”

How to raise real money with a Customer Development presentation in the next post on steveblank.com.