The label ‘startup’ is an integral part of today’s business landscape and vocabulary. Whilst self-evident what it is, the definition from Eric Ries, author of The Lean Startup, who defines a startup as a human institution dedicated to creating something new under conditions of extreme uncertainty captures the essence of a new venture.
The emphasis on conditions of extreme uncertainty is important as experience has shown that an approach to startup development based on a set of simple assumptions is often fundamentally flawed.
In The Lean Startup, Ries states: Too many startup business plans look more like they are setting out to launch a rocket ship. They prescribe the steps to take and the results to expect in excruciating detail, and as in planning to launch a rocket, they are set up in such a way that even tiny errors in assumptions can lead to catastrophic outcomes.
This is where the Lean Startup provides a scientific methodology for running startups and launching new products. For me, there are three key elements:
- A new way for startups to measure their progress from testing hypotheses
- Using the ‘build-measure-learn’ feedback loop for ‘validated learning’
- Pivoting, when you have clear product-market fit
The Lean Startup model is designed to drive a startup in a process. Instead of making complex plans that are based on assumptions, you can make constant adjustment via the build-measure-learn feedback loop.
The key principle is that entrepreneurship is management, and a startup needs to be managed. It’s underlying premise is that startups exist not just to make a product and make money, but to learn how to create a sustainable business model. This is done using frequent experiments and testing to reach a vision, and proving hypotheses from validated learning, measuring how customers respond and then learn whether to pivot or persevere.
The starting point is to see a startup as an experiment, set some hypothesis based on hunches or insights, and test the thinking to see what works. A true experiment follows the scientific method. It begins with a clear hypothesis that makes predictions about what is supposed to happen.
It then tests those predictions empirically on two dimensions – the value hypothesis tests whether a product really delivers value to customers once they are using it, and the growth hypothesis tests how new customers will discover the product.
This strategy is constantly optimised by ‘pivot or persevere’ – move on, or go back and rethink. Under conditions of extreme uncertainty, the most vital function is learning. We must learn the truth about which elements of our strategy are working to realise our vision and which are just crazy. Validated learning is the process of demonstrating empirically that a team has discovered valuable truths about a startup’s present and future business prospects.
You need to set up real tests, not just surveying people – the phrase ‘get out of the building’ captures the essence of real world testing with real potential customers. This means iterating your product or service and testing key metrics to determine if your hypothesis is true or false.
For startups, that information is much more important than money because it can influence and reshape the next set of ideas. The learning about how to build a sustainable business is the outcome of those experiments.
Each iteration of a startup is an attempt to rev this engine to see if it will turn. Once it is running, the process repeats, shifting into higher and higher gears. Once clear on these leap-of-faith assumptions, the first step is to enter the build phase as quickly as possible with a minimum viable product (‘MVP’). The MVP is that version of the product that enables a full turn of the Build-Measure-Learn loop with a minimum amount of effort and the least amount of development time.
The MVP lacks many features that may prove essential later on but helps entrepreneurs start the process of learning as quickly as possible. It is not necessarily the smallest product imaginable though, it is simply the fastest way to get through the Build-Measure-Learn feedback loop with the minimum amount of effort and get something out to the market.
The MVP helps to rigorously measure where the new product is right now, confronting the hard truths that assessment reveals, and then devise experiments to answer the questions of how to increase customer adoption. To answer these kinds of questions, startups have a strong need for a new kind of accounting geared specifically to disruptive innovation, and that’s what Reis calls ‘innovation accounting ‘. Here’s how innovation accounting works:
- Establish the baseline. Understand where are you now, and how are you currently performing.
- Tune the engine. Initiate your experiment to test your value or growth hypothesis. e.g. a company might spend time improving the design of its product to make it easier for new customers to use. This presupposes that the activation rate of new customers is a driver of growth and that its baseline is lower than the company would like.
- Pivot or persevere. Based on the data, you can persevere with the product/features/process you now know to be correct, or pivot and test your next assumption.
Instead of looking at cumulative totals or gross numbers such as total revenue and total number of customers, innovation accounting looks at the performance of each group of customers that comes into contact with the product independently (cohort analysis). e.g. new customer signups by month.
This where traditional accounting measures add no value, a startup needs to measure different metrics. They need to be:
- Actionable: they display cause and affect.
- Accessible: can be understood by everyone.
- Auditable: we must ensure that the data is credible.
Everything discussed so far is a prelude to a seemingly simple question: are we making sufficient progress to believe that our original hypothesis is correct, or do we need to make a major change? That change is called a pivot – a structured course correction designed to test a new fundamental hypothesis about the product, strategy, and engine of growth.
A startup’s runway is the number of pivots it can still make. The true measure of runway is how many pivots a startup has left, i.e. the number of opportunities it has to make a fundamental change to its business strategy. Measuring runway through the lens of pivots rather than that of time suggests another way to extend that runway, that is get to each pivot faster.
A pivot is not just an exhortation to change, it is a special kind of structured change designed to test a new fundamental hypothesis about the product, business model, and engine of growth.
Sustainable growth is characterised by one simple rule: new customers come from the actions of past customers. There are four primary ways past customers drive sustainable growth – word of mouth, as a side effect of product use, through funded marketing and sales, and through repeat purchase or use.
These sources of sustainable growth provide feedback loops that Reis termed ‘engines of growth’ – the faster the loops turn, the faster the company will grow – and there are three core engines:
- The sticky engine of growth. Companies using the sticky engine of growth track their attrition rate or churn rate. The churn rate is defined as the fraction of customers in any period who fail to remain engaged with the company’s product. The rules that govern the sticky engine of growth are pretty simple: if the rate of new customer acquisition exceeds the churn rate, the product will grow.
- The viral engine of growth. Awareness of the product spreads rapidly from person to person similarly to the way a virus becomes an epidemic. Like the other engines of growth, the viral engine is powered by a feedback loop that can be quantified. It is called the viral loop, and its speed is determined by a single mathematical term called the viral coefficient. For a product with a viral coefficient of 0.1, one in every ten customers will recruit one of his or her friends. This is not a sustainable loop.
- The paid engine of growth. As the name suggests, this engine of growth is dependent on paying to acquire customers, and it can do so in one of two ways: increase the revenue from each customer or drive down the cost of acquiring a new customer.
In a nutshell, The Lean Startup is about taking the scientific process to this question: How can we build a sustainable organisation around a new set of products or services? Since our productive capacity exceeds our ability to know what to build, the question to ask is never can it be built? but instead should it be built?
This is because the stated goal of innovation is to learn that which is currently unknown. It is not to efficiently and quickly build something to see what happens, simply because we can.
In order to learn, failure must be an option, and failure while learning must be accepted. If you cannot fail, then you cannot succeed. You can only do, and there is no bigger waste of startup time than doing without it leading anywhere. Do work that leads you to learn about what works and what doesn’t work.
You have to repurpose what has been built as a means to find a more positive direction. One foot firmly planted where you’ve been and what you’ve learned, one foot moving where you want to go. A startup is an experiment, testing hypotheses until you have enough facts to pivot to the next stage.