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The Lean Startup

Introduction

Hard work and perseverance don’t lead to success. It’s the boring stuff that matters the most

Startup success can be engineered by following the right process, which means it can be learned, which means it can be taught. We do everything wrong: instead of spending years perfecting our technology, we build a minimum viable product, an early product that is terrible, full of bugs and crash-your-computer-yes-really stability problems. Then we ship it to customers way before it’s ready. And we charge money for it.

I kept having the experience of working incredibly hard on products that ultimately failed in the marketplace. At first, largely because of my background, I viewed these as technical problems that required technical solutions: better architecture, a better engineering process, better discipline, focus, or product vision

The business and marketing functions of a startup should be considered as important as engineering and product development and therefore deserve an equally rigorous methodology to guide them.

Five principles of Lean Startup

  1. Entrepreneurs are everywhere and the Lean Startup approach can work in any size company, even a very large enterprise, in any sector or industry
  2. Entrepreneurship is management. “entrepreneur” should be considered a job title in all modern companies that depend on innovation for their future growth.
  3. Validated learning. Startups exist to learn how to build a sustainable business. This learning can be validated scientifically by running frequent experiments that allow entrepreneurs to test each element of their vision.
  4. Build-Measure-Learn. Turn ideas into products, measure how customers respond, and then learn whether to pivot or persevere
  5. Innovation accounting. We need focus on the boring stuff: how to measure progress, how to set up milestones, and how to prioritize work

Why startups fail?

Planning and forecasting are only accurate when based on a long, stable operating history and a relatively static environment. Startups have neither.

Lean Startup method

Many entrepreneurs take a “just do it” attitude, avoiding all forms of management, process, and discipline. Unfortunately, this approach leads to chaos more often than it does to success.

Progress in manufacturing is measured by the production of high-quality physical goods. As we’ll see in Chapter 3, the Lean Startup uses a different unit of progress, called validated learning.

Consider the recommendation that you build cross-functional teams and hold them accountable to what we call learning milestones instead of organizing your company into strict functional departments (marketing, sales, information technology, human resources, etc.) that hold people accountable for performing well in their specialized areas.

When people are used to evaluating their productivity locally, they feel that a good day is one in which they did their job well all day. When I worked as a programmer, that meant eight straight hours of programming without interruption. That was a good day. In contrast, if I was interrupted with questions, process, or—heaven forbid—meetings, I felt bad

Code and product features were tangible to me. Learning, by contrast, is frustratingly intangible.

The goal of a startup is to figure out the right thing to build—the thing customers want and will pay for—as quickly as possible. Every new version of a product, every new feature, and every new marketing program is an attempt to improve this engine of growth

Lean Startup

Instead of making complex plans that are based on a lot of assumptions, you can make constant adjustments with a steering wheel called the Build-Measure-Learn feedback loop. Startups also have a true north, a destination in mind: creating a thriving and world-changing business. I call that a startup’s vision. Startups employ a strategy, which includes a business model, a product road map, a point of view about partners and competitors, and ideas about who the customer will be. The product is the end result of this strategy. Less frequently, the strategy may have to change (called a pivot). However, the overarching vision rarely changes. Entrepreneurs are committed to seeing the startup through to that destination.

Define

Entrepreneurial prerequisites: proper team structure, good personnel, a strong vision for the future and an appetite for risk taking.

A startup is a human institution designed to create a new product or service under conditions of extreme uncertainty

Take a note that it does not say anything about the size of the company. Anything customers experience from their interaction with a company should be considered part of that company’s product.

Clayton Christensten The Innovator’s Dilemma: Companies very good at incremental improvements to existing products and serving customers (sustaining innovation), but struggle to create breakthrough new products (disruptive innovation) that can create new sustainable sources of growth.

Innovation is a bottoms-up, decentralized, and unpredictable thing. It does not mean it cannot be managed. Cultivating entrepreneurship is the responsibility of senior management. Leadership requires creating conditions that enable employees to do the kinds of experimentation that entrepreneurship requires.

Learn

As an engineer or manager, people are accustomed to measure progress by making sure work proceeded according to the plan, it is high quality and cost fits projections. As an entrepreneur, this might not be the best way of measuring progress. What if we found ourselves building something that nobody wants?

If the fundamental goal of entrepreneurship is to engage in organization building under conditions of extreme uncertainty, its most vital function is learning. We must learn what customers really want, not what they say they want or what we think they should want.

Validated-learning is not after-the-fact rationalization or a good story designed to hide failure. It’s a rigorous method for demonstrating progress. It’s a way of demonstrating empirically that a team has discovered valuable truths about a startup’s present and future business prospects.

The question is not “Can this product be built?” but more like “Should this product be built?” or “Can we build a sustainable business around this set of products and services?”. Everything a startup does is understood to be an experiment designed to achieve validated learning.

Experiment

If the plan is to see what happens, a team is guaranteed to succeed – at seeing what happens – but won’t necessarily gain validated learning. If you cannot fail, you cannot learn. A true experiment follows the scientific method. It begins with clear hypothesis that makes predictions and it then tests predictions empirically. Startup experimentation is guided by startup’s vision. The goal of startups is to discover how to build a sustainable business around that vision.

The two most important assumptions entrepreneurs make are:

  • The value hypothesis tests whether a product or service really delivers value to customers. Experiments provide a more accurate gauge.
  • The growth hypothesis tests how new customers will discover a product or service. The point is not to find the average customer but to find early adopters. Those customers tend to be more forgiving of mistakes and are especially eager to give feedback.

An experiment is a product

Good questions for the team to answer why developing product:

  • Do consumers recognise that they have the problem you are trying to solve?
  • If there was a solution, would they buy it?
  • Would they buy it from us?
  • Can we build a solution for that problem?

Success is not delivering a feature; success is learning how to solve the customer’s problem.

How vision leads to steering

  • Qualitative feedback: What customers like and don’t like.
  • Quantiative feedback: How many customers use the product and find it valuable.

The riskiest elements of a startup’s plan are the leap-of-faith assumptions. The two most important ones are the value hypothesis and the growth hypothesis. 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).

MVP: Is the version of the product that enables a full turn of the Build-Measure-Learn loop with the minimum amount of effort and the least amount of development time. Lacks many features that may prove essential later on. We must be able to measure its impact. We also need to get in front of potential customers to gauge their reactions.

The biggest challenge once we get into the Measure phase is determining if the product development efforts are leading to real progress. We do this by a method called innovation accounting.

Innovation accounting is a quantitative approach that allow us to create learning milestones instead of the traditional business and product milestones.

Upon completing the Build-Measure-Learn loop we confront the most difficult question any entrepreneur faces: whether to pivot the original strategy or persevere.

Planning works in the reverse order: we figure out what we need to learn, use innovation accounting to figure out what we need to measure to know if we are gaining validated learning, and then figure out what product we need to build to run that experiment and get that measurement.

Leap

Strategy is based on assumptions

Every business plan begins with a set of assumptions. A startup early efforts should be to test them as quickly as possible. The first challenge for an entrepreneur is to build an organization that can test these assumptions systematically. The second challenge is to perform that rigorous testing without losing sight of the company’s overall vision.

What differentiates the success stories from the failures is that the successful entrepreneurs had the foresight, the ability, and the tools to discover which part of their plans were working brilliantly and which were misguided, and adapt their strategies accordingly.

Growth

The first step in understanding a new product or service is to figure out if it is fundamentally value-creating or value-destroying.

It’s essential that entrepreneurs understand the reasons behind a startup’s growth. There are many value-destroying kinds of growth that should be avoided (a business that grows through continuos fund-raising from investors and lots of paid advertising but does not develop a value-creating product).

Design and customer archetype

The goal of the early contact with customers is not to gain definitive answers but to clarify at a basic level that we understand our potential customer and what problems they have. The archetype is a brief document that represents a target customer and serves as a guide for product development. An archetype is an hypothesis, not a fact.

Analysis paralysis

There are two ever-present dangers:

  • Just-do-it school of entrepreneurship are impatient to get started and don’t want to spend time analyzing their strategy.
  • Others fall victim to analysis paralysis, talking to customers, reading research reports and whiteboard strategizing are all equally unhelpful.

How do entrepreneurs know when to stop analyzing and start building? The answer is a concept called Minimum Viable Product.

Test

An MVP is simply the fastest way to get through the Build-Measure-Learn feedback loop with the minimum amount of effort. The goal of an MVP is to begin the process of learning, not end it. Unlike a prototype or concept test, an MVP is designed not just to answer a product design or technical questions but to test fundamental business hypothesis.

First products aren’t mean to be perfect

Before new products can be sold successfully to the mass market, they have to be sold to early adopters.

The concierge minimum viable product

This is a personal in-home visits and manual works (no software) just to learn as fast as possible. In a concierge MVP, the personalized service is not the product but the learning activity designed to test the leap-of-faith assumptions in the company’s growth model.

Wizard of Oz test: Customers believe they are interacting with the actual product but behind the scenes human beings are doing the work.

The role of quality and design in an MVP

It challenges the traditional notions of quality.

If we do not know who the customer is, we do not know what quality is.

MVPs require the courage to put one’s assumptions to the test.

The Lean Startup method is not opposed to building high-quality products, but only in service of the goal of winning over customers. This does not mean operating in a sloppy or undisciplined way. There is a category of quality problems that have a net effect of slowing down the Build-Measure-Learn feedback loop. Defects make it more difficult to evolve the product. They actually interfere with our ability to learn and so are dangerous to tolerate in any production process. Instead of reducing the quality, reduce the scope: remove any feature process, or effort that does not contribute directly to the learning seek.

Measure

A startup job is to:

  1. Rigorously measure where it is right now.
  2. Devise experiments to learn how to move the real numbers closer to the ideal reflected in the business plan.

Accountability framework

It begins by turning the leap-of-faith assumptions into quantitative financial model.

The rate of growth depends primarily on three things: the profitability of each customer, the cost of acquiring new customers, and the repeat purchase rate of existing customers.

Three learning milestones

First, use an MVP to establish real data on where the company is right now.

Second, startups must attempt to tune the engine from the baseline towards the ideal. Then the company reaches a decision point.

Third: Pivot or persevere. If the company is making good progress toward the ideal, that means it’s learning appropriately and using that learning effectively.

Establish the baseline

Smoke tests (ability to preorder a product that is yet to be built) with its marketing materials. It will measure if customers are interested in trying a product.

These MVPs provide the first example of learning milestone.

When one is choosing among the many assumptions in the business plan, it makes sense to test the riskiest assumptions first.

Tuning the engine

Every product development, marketing, or other initiative that a startup undertakes should be targeted at improving one of the drivers of its growth model.

Remember that a good design is one that changes customer behavior for the better.

Pivot or persevere

If we are not moving the drivers of our business model, we are not making progress. That becomes a sure sign that it’s time to pivot.

Improving a product on five dollars a day

We tracked the “funnel metrics” behaviours that were critical to our engine of growth. Five dollars bought us a hundred clicks every day. From a marketing point of view this was not very significant, but for learning it was priceless. Every single day we were able to measure our product’s performance with a brand new set of customers. Each day was a new experiment.

Cohort analysis

Instead of looking at cumulative totals or gross numbers such as total revenue and total number of customers, one looks at the performance of customers that comes into contact with the product independently.

Out of frustration of not knowing what to do I was finally ready to turn to the last resort: talking to customers. I was ready to ask the right questions.

Optimization versus learning

Engineers, designers and marketers are all skilled at optimization. A startup has to measure progress against a high bar: evidence that a sustainable business can be built around its products or services. This can only be assessed only if a startup has made clear, tangible predictions ahead of time.

Actionable metrics versus vanity metrics

How do we know which features to prioritize? How can we get more customers to sign up and pay? How can we get out the word about our product?

Cohorts and split-tests

Instead of looking at gross metrics, Grockit switched to cohort-based metrics, and instead of looking for cause-and-effect relationships after the fact, Grockit would launch each new feature as a true split-test experiment.

Many features that make the product better in the eyes of engineers and designers have no impact on customer behaviour.

The value of the three a’s

Three A’s of metrics:

  • Actionable: It must demonstrate clear cause and effect.
  • Accessible: Reports as simple as possible so everyone understands them. Use tangible, concrete units. Cohort-based reports are the gold standard of metrics: they turn complex actions into people reports. Reports deal with people and their actions. Accessibility also refers to widespread access to the reports.
  • Auditable: The data is credible to employees. The loser of the argument would challenge the veracity of the data. We need to test the data by hand by talking to customers. This is the only way to be able to check if the reports contain true facts. This also has the benefit to giving insight into why customers are behaving the way the data indicate.

Pivot (or persevere)

Pivot: A structured course correction designed to test a new fundamental hypothesis.

The heart of the scientific method is the realization that although human judgment may be faulty, we can improve our judgment by subjecting to theories to repeated testing.

Startup productivity is not about cranking out more widgets or features. It is about aligning our efforts with a business and product that are working to create value and drive growth.

The problem with the notion of shipping a product is that you are guaranteed to succeed at seeing what happens.

Direct contact with customers proved essential.

A startup’s runway is the number of pivots it can still make.

Pivots require courage

Entrepreneurs need to face their fears and be willing to fail, often in a public way. Run away from vanity metrics as they form false conclusions and create an alternate private reality.

The pivot or persevere meeting

The decreasing effectiveness of product experiments and the general feeling that product development should be more productive. Whenever you see those symptoms, consider a pivot.

Catalog of pivots

  • Zoom-in pivot: What previously was considered a single feature in a product becomes the whole product.
  • Zoom-out pivot: Sometimes a single feature is insufficient to support the whole product.
  • Consumer segment pivot: The company realizes that the product it is building solves a real problem for real customers but that they are not the type of customers it originally planned to serve.
  • Customer need pivot: It sometimes becomes clear that the problem we’re trying to solve for them is not very important, we discover other related and more important problems.
  • Platform pivot: From an application to a platform or vice versa.
  • Business architecture pivot: Two major business architectures: High margin, low volume (complex systems) or low margin, high volume (volume operations model).
  • Value capture pivot: Capture the value of a company creates. Monetization or revenue models. Capturing value is an intrinsic part of the product hypothesis.
  • Engine of growth pivot: Three primary engines of growth that power startups: the viral, sticky and paid growth models.
  • Channel pivot: The mechanism by which a company delivers its product to customers is called the sales channel or distribution channel. A channel pivot is a recognition that the same basic solution could be delivered through a different channel with greater effectiveness. It is precisely because of its destructive effect on sales channels that the Internet has had such a disruptive influence in industries that previously required complex sales and distribution channels.
  • Technology pivot: A company discovers a way to achieve the same solution by using a completely different technology. The only question is whether the new technology can provide superior price and/or performance compared with existing technology.

A pivot is a strategic hypothesis

A pivot is better understood as a new strategic hypothesis that will require a new minimum viable product to test. Even after a company achieves initial success, it must continue to pivot. It’s a special kind of structured change designed to test a new fundamental hypothesis about the product, business model, and engine of growth.

Accelerate

How much time and energy should companies invest in infrastructure and planning early on in anticipation of success? Spend too much and you waste precious time that could have been spent learning. Spend too little and you may fail to take advantage of early success and cede market leadership to a fast follower.

Traditional departments create incentive structures that keep people focused on excellence in their specialities: marketing, sales, product development.

The critical first question for any lean transformation is: which activities create value and which are a form of waste?

What products do customers really want? How will our business grow? Who is our customer? Which customers should we listen to and which should we ignore? These are the questions that need answering as quickly as possible to maximize a startup’s chances of success.

Today’s companies must learn to master a management portfolio of sustainable and disruptive innovation.

Batch

Daddy, first you should fold all of the newsletters. Then you should attach the seal. Then you should put the stamps.

Their father wanted to do it the counterintuitive way: complete each envelope one at a time. They - like most of us - thought that was backward “That wouldn’t be efficient!”

Doing it one at a time is faster. Intuition does not take into account the extra time to sort, stack and move around the large piles of half-complete envelopes when it’s done the other way.

In process-oriented work like this, individual performance is not nearly as important as the overall performance of the system.

The small-batch approach produces a finished product every few seconds, whereas the large-batch approach must deliver all the product at once, at the end. What if it turns out that the customers have decided they don’t want the product? Which process would allow a company to find this out sooner?

Lean manufacturers discovered the benefits of small batches ago. Innovators as Taiichi Ohno, Shigeo Shingo and others found a way to succeed by using small batches. Instead of buying large specialized machines that could produce thousands of parts at a time, Toyota used smaller general-purpose machines that could produce a wide variety of parts in small batches.

Because of its smaller batch size, Toyota was able to produce a much greater diversity of products.

The biggest benefit of working in small batches is that quality problems can be identified much sooner. This is the origin of Toyota’s famous andon cord, which allows any worker to ask for help as soon as they notice any problem, such a defect in physical part, stopping the entire production line if it cannot be corrected immediately. It can interrupt the flow as the line is halted repeatedly. The benefits of finding and fixing problems faster outweigh this cost. This process of continuously driving out defects has been a win-win for Toyota and its customers.

Small batches in entrepreneurship

In the Lean Startup the goal is not to produce more stuff efficiently but to learn how to build a sustainable business. as quickly as possible.

Working in small batches ensures that a startup can minimize the expenditure of time, money, and effort that ultimately turns out to have been wasted.

Nowadays large batches are still the rule. The work that goes into the development of a new product proceeds on a virtual assembly line. Product managers figure out what features are likely to please customers; product designers then figure out how those features should look and feel. These designs are passed to engineering, which builds something new or modifies an existing product and, once this is done, hands it off to somebody responsible for verifying that the new product works the way the product managers and designers intended

Instead of working in separate departments, engineers and designers would work together side by side on one feature at a time. Whenever that feature was ready to be tested with customers, they immediately would release a new version of the product, which would go live on our website for a relatively small number of people.

Continuous deployment beyond software

  • Hardware becoming software. What can be built out of software can be modified much faster than a physical or mechanical device can.
  • Fast production changes. When the design changes, there is no excess inventory of the old version to slow things down. Since machines are designed for rapid changeovers, as soon as the new design is ready, new version can be produced quickly.
  • 3D printing and rapid prototyping tools. By reducing the batch size, we can get through the Build-Measure-Learn feedback loop more quickly than our competitors can.

Growth

Where does growth come from?

Sustainable growth is characterized by one simple rule: New customers come from the actions of past customers.

  • Word of mouth. Natural level of growth that is caused by satisfied customers’ enthusiasm for the product.
  • As a side effect of product usage. When you see someone dressed int he latest clothes or driving a certain car, you may be influenced to by that product.
  • Through funded advertising. As long as the cost of acquiring a new customer (the so-called marginal cost) is less than the revenue of that customer generates (the marginal revenue), the excess (the marginal profit) can be used to acquire more customers. The more marginal profit, the faster growth.
  • Through repeat purchase or use. Some products are designed to be purchased repeatedly either through a subscription plan or through voluntary repurchases.

The three engines of growth

There are always a zillion new ideas about how to make the product better floating around, but the hard truth is that most of those ideas make a difference only at the margins. They are mere optimizations. Startups have the focus on the big experiments that lead to validated learning.

The sticky engine of growth

Products are designed to attract and retain customers for the long term. There is an expectation that once you start using their product, you’ll continue to do so. Companies using the sticky engine of growth track their attrition rate or churn rate very carefully. 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 speed of growth is determined by what I call the rate of compounding, which is simple the natural growth rate minus the churn rate. Example: 61% retention rate, 31% growth rate, compounding growth rate of just 0.02%, almost zero.

The viral engine 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. The higher this coefficient is, the faster the product will spread. How many friends will each customer bring with him or her? A viral loop with a coefficient that is greater than 1.0 will grow exponentially. Many viral products do not charge customers directly but rely on indirect sources of revenue such as advertising. This is the case because viral products cannot afford to have any friction impede the process of signing customers up and recruiting their friends.

The paid engine of growth

If either company wants to increase its rate of growth, 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.

The paid engine of growth is powered by a feedback loop. Each customer pays a certain amount of money for the product over his or her “lifetime” as a customer. Once variable costs are deducted, this usually is called customer lifetime value (LTV). This revenue can be invested in growth by buying advertising.

Example: If the CPA remains at $2 but the LTV falls bellow $2, the company’s growth will slow down. It may make up the difference with one-time tactics such as using invested capital or publicity stunts, but those tactics are not sustainable.

Technical caveat

More than one engine of growth can operate in a business at a time. It’s strongly recommended to focus one engine at a time. What really matters is not the raw numbers or the vanity metrics but the direction and degree of progress.