Customer discovery turns founders’ initial hypotheses about their market and customers into facts.

The process searches for problem/solution fit: “Have we found a problem lots of people want us to solve (or a need they want us to fill)?” and “Does our solution (a product, a website or an app) solve the problem in a compelling way?” Here’s how:

Develop the Product for the Few, Not the Many

In existing companies, the goal of traditional product management and marketing is to develop a market-requirements document (MRD) for engineering that contains the sum of all possible customer feature requests, prioritized in a collaborative effort among Product Management, Marketing, Sales and Engineering. Marketing or Product Management hosts focus groups, analyzes sales data from the field, and looks at customer feature requests and complaints. This information leads to the adding of requested features to the product specification, and the engineering team builds the features into the next product release.

While this process is rational for an established company entering an existing market, it’s folly for startups. Why? Startups aren’t small versions of large, existing companies where there’s plenty of customer knowledge and input. In established companies, the MRD process ensures that engineering will build a product that appeals to existing customers in a known market, where customers and their needs are known. On a startup’s first day, there’s limited - if any - customer input for creating a formal product specification.

In a startup, the first product is not designed to satisfy a mainstream customer. No startup can afford to build a product with every feature a mainstream customer needs all at once. The product would take years to get to market and be obsolete by the time it arrived. Instead, successful startups solve this conundrum by focusing development and selling efforts on a very small group of early customers who have bought into the startup’s vision. These visionary customers will give the company the feedback necessary to add features to the product over time.

Earlyvangelists: The Most Important Customers of All

Enthusiasts who spread the good news about your product to friends, family or co-workers are often called evangelists. But a new word is needed to describe the early adopters - the visionary customers - who buy unfinished and untested products, because they want to be “first,” whether it’s for the sake of gaining a competitive edge or winning bragging rights.

We call these early adopters earlyvangelists. Unlike “mainstream” business or consumer-product customers who want to buy a finished, completed, tested product, earlyvangelists are willing to make a leap of faith and buy an early product from a startup. Every industry has a small subset of visionaries willing to take a leap of faith on an early product.

One of the mistakes that startup founders make is to give away or heavily discount early alpha/beta products to blue-chip customers. In single-sided markets (where the user is the payer), earlyvangelists will be happy to pay for early access to the product. If they won’t, they aren’t earlyvangelists. Their willingness to pay is a critical part of the customer discovery process. You’ll use it to test the entire buying process.

In Web/mobile apps, where multi-sided markets (separate users and payers) are often found, earlyvangelists can be users or payers. But even as nonpaying users, these earlyvangelists are willing or eager accelerators of your viral growth.

In both physical and Web/mobile channels, earlyvangelists display these common characteristics:

• They have a problem or need.
• They understand they have a problem.
• They’re actively searching for a solution and have a timetable for finding it.
• The problem is so painful that they’ve cobbled together an interim solution.
• They’ve committed, or can quickly acquire, budget dollars to purchase.

Think of earlyvangelists’ characteristics along a scale of customer pain. Earlyvangelist customers will be found only at the top of the scale - those who have already been looking for a solution, built a homegrown solution (whether in a company by building a software solution or at home by taping together a fork, a light bulb and a vacuum cleaner), and have or can acquire a budget.

These people are perfect earlyvangelist candidates. They can be relied on for feedback and initial sales; they’ll tell others about the product and spread the word that the vision is real. Moreover, they can be potential advisory board candidates.

Build a Minimum Viable Product (MVP) First

The idea that a startup builds its product for a small group of initial customers rather than devising a generic mainstream spec is radical. What follows is equally revolutionary.

On the day the company starts, there is very limited customer input. All the startup has is a vision of what the problem, product and solution seem to be. Unfortunately, it’s either a vision or a hallucination. The company doesn’t know who its initial customers are or what features they’ll want.

One option is to start developing an entire full-featured first release of the product, with every feature the founders can think of. We now know this results in wasted engineering effort, time and cash, as customers don’t use, want or need most of the features developed without their input. Another path is to put product development on hold until the customer development team can find customers who can provide adequate feedback. The risk here is lost time and no product for customers to provide feedback against.

A third, more productive approach is to develop the core features of the product (incrementally and iteratively with agile engineering methods), with the feature list driven by the vision and experience of the company’s founders. This is a minimum viable product.

The goal of customer discovery is to test your understanding of the customer’s problem and see if your proposed solution will prompt him to use or buy the product based on its most important features alone. Most users want finished products, but earlyvangelists are the perfect target for the MVP. Tailor the initial product release to satisfy their needs. If no one thinks your MVP solution is interesting or sufficient, iterate or pivot until an adequate number say “yes.”

The shift in thinking to an incremental and iterative MVP as opposed to a fully featured first product release is important. Engineers tend to make a product bigger and more perfect. The MVP helps them focus the most important and indispensable features. Your goal in having an MVP is not to gather feature requests to change the product or to make the feature set larger.

Instead, the goal is to put the MVP in front of customers to find out whether you understood the customer problem well enough to define key elements of the solution. Then you iteratively refine the solution. If, and only if, no customers can be found for the most important features of the MVP, bring customers’ additional feature requests to the product development team. In the Customer Development model, feature requests to an MVP are by exception and iteration rather than by rule. This eliminates the endless list of feature requests that often delay first customer ship and drive product development teams crazy.

MVPs for Web/Mobile Are Different

Web/mobile businesses conduct customer discovery differently from those in the physical channel. They can reach hundreds or thousands more customers by combining online and face-to-face interactions. They place a greater emphasis on customer acquisition, activation and referrals.

Web/mobile minimum viable products can be developed faster and delivered earlier, accelerating the discovery process. When delivered, they can conduct more tests with customers, with more granular customer-response data. This results in a faster iteration of the problem statement, the proposed solution and the MVP itself.

Use the Business Model Canvas as the Customer Discovery Scorecard

Often there’s a lack of a shared and clear understanding of the business model throughout the company. This customer discovery step uses Alexander Osterwalder’s business model canvas to diagrammatically illustrate how a company intends to make money. The canvas represents any company in nine boxes, depicting the details of a company’s product, customers, channels, demand creation, revenue models, partners, resources, activities and cost structure.

In addition to using the business model canvas as a static snapshot of the business at a single moment, frozen in time, Customer Development uses the canvas as a “scorecard” to track progress in searching for a business model.

Editor's note: This is the first in a two-part excerpt from the book The Startup Owner’s Manual, a step-by-step, how-to guide for entrepreneurs. In this excerpt, authors Steve Blank and Bob Dorf explain the Customer Discovery Philosophy.

A startup begins with the vision of its founders: a vision of a new product or service that solves a customer’s problems or needs and of how it will reach its many customers. Customer discovery lowers the odds of spending zillions and getting zeros in return. So the No. 1 goal of customer discovery amounts to this: turning the founders’ initial hypotheses about their market and customers into facts.

Get Out of the Building

Facts exist only outside the building, where customers live, so the most important aspect of customer discovery is getting out of the building, in front of customers. And not for a few days or a week, but repeatedly, over weeks if not months. This critical task can’t be assigned to junior staffers and must be driven by founders. Only after the founders have performed this step will they know whether they have a valid vision or just a hallucination.

Sounds simple, doesn’t it? But for anyone who has worked in established companies, the customer discovery process is disorienting. All the rules about new-product management in large companies are turned upside down. It’s instructive to enumerate all things you are not going to do:

• understand the needs and wants of all customers
• make a list of all the features customers want before they buy your product
• hand Product Development a features list of the sum of all customer requests
• hand Product Development a detailed marketing-requirements document
• run focus groups and test customers’ reactions to your product to see if they will buy

What you are going to do is develop your product for the few, not the many. Moreover, you’re going to start building your product even before you know whether you have any customers for it.

For an experienced marketing or product management executive, these ideas are not only disorienting and counterintuitive but heretical. Why aren’t the needs of all potential customers important? What is it about a first product from a new company that’s different from follow-on products in a large company? What is it about a startup’s first customers that make the rules so different?

Search for the Problem/Solution Fit

The customer discovery process searches for problem/solution fit: “have we found a problem lots of people want us to solve (or a need they want us to fill)” and “does our solution (a product, a website, or an app) solve the problem in a compelling way?” At its core, the essence of customer discovery is to determine whether your startup’s value proposition matches the customer segment it plans to target.

Problem/solution fit is virtually identical to what’s sometimes called “product/ market fit,” as the previous paragraph indicates. Realize, however, that in multi-sided markets, there may be multiple value propositions and multiple customer segments. But problem/solution fit is only achieved when the revenue model, pricing, and customer acquisition efforts all match up with the customers’ needs.

I got a call from Satish, one of my ex-students last week. He got my attention when he said, "following your customer development stuff is making my company fail." The rest of the conversation sounded too confusing for me to figure out over the phone, so I invited him out to the ranch to chat.

But in this case, I suggested we take a hike out to Potato Patch pond.

Potato Patch Pond

We took the trail behind the house down the hill, through the forest, and emerged into the bright sun in the lower valley. (Like many parts of the ranch this valley has its own micro-climate and today was one of those days when it was ten degrees warmer than up at the house.)

As we walked up the valley Satish kept up a running dialog catching me up on six years of family, classmates and how he started his consumer web company. It had recently rained and about every 50 feet we'd see another 3-inch salamander ambling across the trail. When the valley dead-ended in the canyon, we climbed 30-foot up a set of stairs and emerged looking at the water. A "hanging pond" is always a surprise to visitors. All of a sudden Satish's stream of words slowed to a trickle and just stopped. He stood at the end of the small dock for a while taking it all in. I dragged him away and we followed the trail through the woods, around the pond, through the shadows of the trees.

As we circled the pond I tried to both keep my eyes on the dirt trail while glancing sideways for pond turtles and red-legged frogs. When I'm out here alone it's quiet enough to hear the wind through the trees, and after awhile the sound of your own heartbeat. We sat on the bench staring across the water, with the only noise coming from ducks tracing patterns on the flat water. Sitting there Satish described his experience.

We Did Everything Customers Asked For

"We did every thing you said, we got out of the building and talked to potential customers. We surveyed a ton of them online, ran A/B tests, brought a segment of those who used the product in-house for face-to-face meetings. " Yep, sound good.

"Next, we built a minimum viable product." OK, still sounds good.

"And then we built everything our prospective customers asked for." That took me aback.

"Well everyone uses the product for awhile, but no one is upgrading to our paid product. We spent all this time building what customers asked for. And now most of the early users have stopped coming back."

I looked at hard at Satish trying to remember where he had sat in my class. Then I asked, "Satish, what's your business model?

What's Your Business Model?

"Business model? I guess I was just trying to get as many people to my site as I could and make them happy. Then I thought I could charge them for something later and sell advertising based on the users I had."

I pushed a bit harder.

"Your strategy counted on a freemium-to-paid upgrade path. What experiments did you run that convinced you that this was the right pricing tactic? Your attrition numbers mean users weren't engaged with the product. What did you do about it?

"Did you think you were trying to get large networks of engaged users that can disrupt big markets? 'Large' is usually measured in millions of users. What experiments did you run that convinced you could get to that scale?"

The wind was picking up over the pond so I suggested we start walking.

We stopped at the overlook a top of the waterfall, after the recent rain I had to shout over the noise of the rushing water. I offered that it sounded like he had done a great job listening to customers. And better, he had translated what he had heard into experiments and tests to acquire more users and get a higher percentage of those to activate.

But he was missing the bigger picture. The idea of the tests he ran wasn't just to get data - it was to get insight. All of those activities - talking to customers, A/B testing, etc. needed to fit into his business model - how his company will find a repeatable and scalable business model and ultimately make money. And this is the step he had missed.

Customer Development = The Pursuit of Customer Understanding

Part of customer development is understanding which customers make sense for your business. The goal of listening to customers is not please every one of them. It's to figure out which customer segment served his needs - both short and long term. And giving your product away, as he was discovering, is often a going out of business strategy.

The work he had done acquiring and activating customers were just one part of the entire business model.

As we started the long climb up the driveway, I suggested his fix might be simpler than he thought. He needed to start thinking about what a repeatable and scalable business model looked like.

He really needed to think through his revenue model (the strategy his company uses to generate cash from each customer segment). And how was he going to use pricing, (the tactics of what he charged in each customer segment) to achieve that revenue model. Freemium was just one of many tactics. Single or multi-sided market? And which customers did he want to help him get there?

My guess was that he was going to end up firing a bunch of his customers - and that was OK.

As we sat back in the living room, I gave him a copy of The Startup Owner's Manual and we watched a bobcat catch a gopher.

Lessons Learned

• Getting out of the building is a great first step
• Listening to potential customers is even better
• Getting users to visit your site and try your product feels great
• Your job is not to make every possible customer happy
• Pick the customer segments and pricing tactics that drive your business model

From sources that the studios at one time claimed would put them out of business: Pay-per view TV, cable and satellite channels, video rentals, DVD sales, online subscriptions and digital downloads.

The Movie Industry and Technology Progress

• 1920's: The record business complained about radio. The argument was because radio is free, you can't compete with free. No one was ever going to buy music again.
• 1940's: Movie studios had to divest their distribution channel - they owned over 50% of the movie theaters in the U.S. "It's all over," complained the studios. In fact, the number of screens went from 17,000 in 1948 to 38,000 today.
• 1950's: Broadcast television was free; the threat was cable television. Studios argued that their free TV content couldn't compete with paid.
• 1970's: Video Cassette Recorders (VCR's) were going to be the end of the movie business. The movie businesses and its lobbying arm MPAA fought it with "end of the world" hyperbola. The reality? After the VCR was introduced, studio revenues took off like a rocket. With a new channel of distribution, home movie rentals surpassed movie theater tickets.
• 1998: The MPAA got congress to pass the Digital Millennium Copyright Act ( DCMA), making it illegal for you to make a digital copy of a DVD that you actually purchased.
• 2000: Digital Video Recorders (DVR) like TiVo allowing consumer to skip commercials was going to be the end of the TV business. DVR's reignite interest in TV.
• 2006: Broadcasters sued Cablevision (and lost) to prevent the launch of a cloud-based DVR to its customers.

Today it's the Internet that's going to put the studios out of business. Sound familiar?

Why was the movie industry consistently wrong? And why do they continue to fight new technology?

Technology Innovation

The movie industry was born with a single technical standard - 35mm film, and for decades had a single way to distribute its content - movie theaters (which until 1948 the studios owned.) It was 75 years until studios had to deal with technology changing their platform and distribution channel. And when it happened (cable, VCR's, DVD's, DVR's, the Internet,) it was a relentless onslaught. The studios responded by trying to shut down the new technology and/or distribution channels through legislation and the courts.

Regulation/Legislation

But why does the movie business think their solution is in Washington and legislation? History and success.

In the 1920's individual states were beginning to censor movies and the federal government was threatening to do so as well. The studios set up their own self-censorship and rating system keeping most sex and politics off the screen for 40 years. Never again wanting to be at the losing side of a political battle they created the movie industry's lobbying arm, MPAA.

By the 1960's, the MPPA achieved regulatory capture (where an industry co-opts the very people who are regulating it) when they hired Jack Valenti, who ran the studios' lobbying efforts for the next 38 years. Ironically, it was Valenti's skill in hobbling competitive innovation that negated any need for studios to develop agility, vision and technology leadership.

Management of Innovation

The introduction of new technology is always disruptive to existing markets, particularly to content/copyright owners whose sell through well-established distribution channels. The incumbents tend to have short-sighted goals and often fail to recognize that more money can be made on new platforms and distribution channels.

In an industry facing constant technology shifts the exec staff and boards of the studios have lawyers, MBAs and financial managers, but no management skill in dealing with disruption. So they rely on lobbying ($110 million a year), lawsuits, campaign contributions (wonder why the President won't be vetoing SOPA?) and Public Relations.

Ironically, the six major movie studios have a great technology lab in Silicon Valley with projects in streaming rights, Video On Demand, Ultraviolet, etc. But lacking the support from the studio CEOs or boards, the lab languishes in the backwaters of the studios' strategy. Instead of leading with new technology, the studios lead with litigation, legislation and lobbying. (Imagine if the $110 million/year spent on lobbying went to disruptive innovation.)

Piracy

One of the claims that studios make is that they need legislation to stop piracy. The fact is piracy is rampant in all forms of commerce. Video games and software have been targets since their inception. Grocery and retail stores euphemistically call it shrinkage. Credit card companies call it fraud. But none use regulation as often as the movie studios to solve a business problem. And none are so willing to do collateral damage to other innovative industries (VCRs, DVRs, cloud storage and now the Internet itself.)

The studios don't even pretend that this legislation benefits consumers. It's all about protecting short-term profit.

SOPA

When lawyers, MBAs and financial managers run your industry and your lobbyists are ex-Senators, understanding technology and innovation is not one of your core capabilities. The SOPA bill (and DNS blocking) is what happens when someone with the title of anti-piracy or copyright lawyer has greater clout than your head of new technology. SOPA gives corporations unprecedented power to censor almost any site on the Internet.

History has shown that time and market forces provide equilibrium in balancing interests, whether the new technology is a video recorder, a personal computer, an MP3 player or now the Net. It's prudent for courts and congress to exercise caution before restructuring liability theories for the purpose of addressing specific market abuses, despite their apparent present magnitude.

What the music and movie industry should be doing in Washington is promoting legislation to adapt copyright law to new technology- and then leading the transition to the new platforms.
The U.S. State Department has been championing the Internet Freedom initiative across the world. Secretary of State Clinton said, "...when ideas are blocked, information deleted, conversations stifled, and people constrained in their choices, the Internet is diminished for all of us."

It's too bad the head of the MPAA - an ex Senator - made a mockery of her words when he wondered "why our online censorship can't be like China?" We wonder, "Why can't the film industry innovate like Silicon Valley?"

Lessons Learned

• Studios are run by financial managers who have no corporate DNA to exploit disruptive innovation
• Studio anti-piracy/copyright lawyers trump their technologists
• Studios have no concern about collateral damage as long as it optimizes their revenue
• Studios110M/year lobbying and political donations trump consumer objections
• Politicians votes will follow the money unless it will cost them an election

Movie camera by Jeremy Burgin

I was invited to Finland as part of Stanford's Engineering Technology Venture Program partnership with Aalto University. (Thanks to Kristo Ovaska and team for the fabulous logistics!) I presented to thousands of entrepreneurs, talked to 17 startups, gave 12 lectures, had nine interviews, chatted with eight VC's, sat on four panels, talked policy with two government ministers, two members of parliament, one head of a public pension fund and was in one TV documentary.

A Computer in every Home

• A whole lot of smart, passionate entrepreneurs who want to build a startup hub in Helsinki
• A government that's trying to help, but gets in the way
• A number of exciting startups, but most with a narrow, too-local view of the world
• The sense that, before too long, they may well get it right!

While a week is not enough time to understand a country, this post - the first of two - looks at the Finnish entrepreneurial ecosystem and its strengths and weaknesses.

The Helsinki Spring

Entrepreneurship and innovation are bubbling around Helsinki and Aalto University. There are thousands of excited students, and Aalto University is working hard to become an outward-facing institution. Having a critical mass of people who think startups are cool in the same location is a key indicator of whether a cluster can catch fire. Finnish startup successes on a global stage include MySQL, F-Secure, Rovio, Habbo, Playfish, The Switch, Tectia, Trulia and Linux. While it's not clear yet whether the numbers of startups in Helsinki are sufficient to ignite, it feels like it's getting there (and given the risk-averse and paternal nature of Finland, that by itself is a miracle).

The good news is that for a 5 million-person country, there's an emerging entrepreneurial ecosystem that looks like something this:

• Aalto University: Aalto Center for Entrepreneurship, Aalto Entrepreneurship Society
• Startup Accelerators: Startup Sauna Vigo which includes Lifeline Ventures, KoppiCatch, and Veturi
• Startup Blog: Arctic Startup
• Business Angels: FiBAn, Sitra
• Venture Capital: FVCA, NextIt Ventures, Primus Ventures, Open Ocean Capital, Connor VC, and Inventure
• Government Funding: Tekes, Sitra, Finnvera, Finnish Investment Industry

9-to-5 Venture Capital
Ironically one of the things that's holding back the Finnish cluster is Tekes, the government organization for financing research, development and innovation in Finland. It's hard enough to pick which existing companies with known business models to aid. Yet Tekes does that and is trying to act like a government-run Venture Capital firm. At Tekes, government employees (and their hired consultants) - with no equity, no risk or reward, no startup or venture capital experience - try to pick startup winners and losers.

Tekes has ended up competing with and stifling the nascent VC industry, indiscriminately handing out checks to entrepreneurs like an entitlement. (To be fair this is an extension of the government's role in almost all parts of Finnish life.)

In addition to Tekes, Vigo, the government's attempt at funding private business accelerators, started with good intentions and got hijacked by government bureaucrats. The accelerators I met with (the ones the government pointed to as their success stories) said they were leaving the program.

Tekes lacks a long-term plan of what the Finnish government's role should be in funding startups. I suggested that they might want to consider putting themselves out of the public funding business by using public capital to kick-start private venture capital firms, incubators and accelerators. And they should give themselves a 5-10 year plan to do so. Instead they seem to be stuck in the twilight zone of not having a long-term vision of their role. (There have been tons of reports on what to do, all seemingly ignored by an entrenched bureaucracy.)

Lack of Business Experience
Direct government funding of startups has also delayed the maturation of business experience of local angels and VC's. Finnish private investors don't yet have enough time-in-grade to have developed good pattern recognition skills, and most lack operating backgrounds. I have no doubt they'll get there by themselves, but in wouldn't take much imagination to attempt to recruit some seasoned overseas investors to add to the mix.

Even a more serious challenge is the lack of global business competence. The number of serial entrepreneurs is very low and until recently most of the talented sales and marketing professionals choose to work for Nokia.

Helsinki photo by Timo Newton-Syms

We're All in This Together - The Chips are Down

A Computer in every Home

In 1975 a local set of hobbyists with the then crazy idea of a computer in every home formed the Homebrew Computer Club and met in Menlo Park at the Peninsula School, then later at the Stanford AI Lab. The goal of the club was: "Give to help others." Each meeting would begin with people sharing information, getting advice and discussing the latest innovation (one of which was the first computer from Apple.) The club became the center of the emerging personal computer industry.

Helping Our Own

Mentoring The Next Generation

They were the beginning of the Pay-It-Forward culture, the unspoken Valley culture that believes "I was helped when I started out and now it's my turn to help others."

By the early 1970's, even the CEOs of the largest valley companies would take phone calls and meetings with interesting and passionate entrepreneurs. In 1975, a young unknown, wannabe entrepreneur called the Founder/CEO of Intel, Bob Noyce and asked for advice. Noyce liked the kid, and for the next few years, Noyce met with him and coached him as he founded his first company and went through the highs and lows of a startup that caught fire.

The entrepreneur was Steve Jobs. "Bob Noyce took me under his wing, I was young, in my twenties. He was in his early fifties. He tried to give me the lay of the land, give me a perspective that I could only partially understand," Jobs said, "You can't really understand what is going on now unless you understand what came before."

What Are You Waiting For?

We'll see if they do.

Over the last half a century in Silicon Valley, the short life cycle of startups reinforced the idea that the long term relationships that lasted was with a network of people - much larger than those in your current company. Today, in spite of the fact that the valley is crawling with IP lawyers, the tradition of helping and sharing continues. The restaurants and locations may have changed, moving from Rickey's Garden Cafe, Chez Yvonne, Lion and Compass and Hsi-Nan to Bucks, Coupa Café and Café Borrone, but notion of competitors getting together and helping each other and experienced business execs offering contacts and advice has continued for the last 50 years.

It's the "Pay-It-Forward" culture.

Lessons Learned

• Entrepreneurs in successful clusters build support networks outside of existing companies
• These networks can be around any area of interest (technology, ethnic groups, etc.)
• These were mutually beneficial -- you learned and contributed to help others.
• Over time, experienced executives "pay-back" the help they got by mentoring others.
• The Pay-It-Forward culture makes the ecosystem smarter.

What makes startups succeed or fail? More than 90% of startups fail, due primarily to self-destruction rather than competition. For the less than 10% of startups that do succeed, most encounter several near-death experiences along the way. Simply put, while we now have some good theory, we just are not very good at creating startups yet. After 50 years of technology entrepreneurship it's still an art.

Three months ago I wrote about my ex-student Max Marmer and the Startup Genome Project. They've been attempting to quantify the art. They believe that they can crack the code of innovation and turn entrepreneurship into a science if they had hard data rather than speculation of why startups succeed or fail. Max and his partners had interviewed and analyzed over 650 early-stage Internet startups. In May they released the first Startup Genome Report-- an in-depth analysis on what makes early-stage Internet startups successful.

Now 90 days later Max and his team have gathered data on 3200 startups and they believe they've discovered the most common reason startups fail.

Today you're invited to benchmark your own internet startup and see how you compare to the winners.

Benchmarking Your Startup

I hadn't heard from Max for awhile so I thought he took the summer off. I should have known better, it turned out he was hard at work.

Max and his team built a website called the Startup Genome Compass (their benchmarking web site) that allows an Internet startup to evaluate their business performance. The Startup Genome Compass uses a hybrid "Stage and Type" model that describes how startups progress through their business development lifecycle.

The benchmark takes 20 or so minutes to go through as series of questions, and in the end it spits out an analysis of how you are doing.

The benchmark is not perfect, it may even be flawed, but it is head and shoulders above what we have now - which is nothing - for giving Internet startups founders specific advice on best practices. If you have a few world-class VC's on your board you're probably getting this advice in person. If you're like thousands of other startups struggling to get started, it's worth a look.

It's Not How Big It Is - It's How Well It Performs

If you're interested (and you should be) in how you compare to other early stage ventures, they summarized their results in a report, "Startup Genome Report Extra: Premature Scaling."

One of the biggest surprises is that success isn't about size - of team or funding. It turns out Premature Scaling is the leading cause of hemorrhaging cash in a startup - and death. In fact:

• The team size of startups that scale prematurely is 3 times bigger than the consistent startups at the same stage
• 74% of high growth Internet startups fail due to premature scaling
• Startups that scale properly grow about 20 times faster than startups that scale prematurely
• 93% of startups that scale prematurely never break the $100k revenue per month threshold

The last time I wrote about Max I said, "I can't wait to see what Max does by the time he's 21." Turns out his birthday is in a week, September 7th.

Happy birthday Max.

Compass photo by Calsidyrose

The combination of venture capital and technology entrepreneurship is one of the great business inventions of the last 50 years. It provides private funds for untested and unproven technology and entrepreneurs. While most of these investments fail, the returns for the ones that win are so great they make up for the failures. Yet this system isn't perfect. From the point of view of scientists and engineers in a university lab, too often entrepreneurship in all its VC-driven glory - income statements, balance sheets, business plans, revenue models - seems like another planet. There didn't seem to be much in common between the scientific method and starting a company and this has been a barrier to commercializing the best of our science research.

Until today.

To commercialize these university innovations, NSF will be putting the Innovation Corps (I-Corps) teams through a class that teaches scientists and engineers to treat starting a company as another research project that can be solved by an iterative process of hypotheses testing and experimentation. The class will be a version of the Lean LaunchPad class we developed in the Stanford Technology Ventures Program, (the entrepreneurship center at Stanford's School of Engineering).

This is a big deal. Not just for scientists and engineers, not just for every science university in the U.S., but in the way we think about bringing discoveries ripe for innovation out of the university lab. If this program works it will change how we connect basic research to the business world. And it will lead to more startups and job creation.

Introducing the Innovation-Corps?

The NSF Innovation-Corps program (I-Corps) is designed to help bridge the gap between the many scientists and engineers with innovative research and technologies, but little knowledge of the first steps to take in starting a company. I-Corps will help scientists take the first steps from the research lab to commercialization.

At the end of the program each team will understand what it will takes to turn their research into a commercial success. They may decide to license their intellectual property based on their research. Or they may decide to try to get funded as a startup (with strategic partners, investors, or NSF programs for small businesses). At the end of the class there will be a Demo Day when investors get to see the best this country's researchers have to offer.

What Took You So Long??

A first reaction to the NSF I-Corps program might be "You mean we haven't already been doing this?" But on reflection it's clear why. The common wisdom was that for scientists and engineers to succeed in the entrepreneurial world you'd have to teach them all about business. But it's only now that we realize that's wrong. The insight the NSF had is that we just need to teach scientists and engineers to treat business models as another research project that can be solved with learning, discovery and experimentation. And Stanford's Lean LaunchPad class could do just that.

Join the I-Corps?

The National Science Foundation is publishing the application for admission (what they call the "solicitation for proposals") to the program. See the NSF I-Corps web page for details.

The syllabus for NSF I-Corps version of the Lean LaunchPad class can be seen here. Along with a great teaching team at Stanford, world-class VC's who get it and foundation partners, I'm proud to be a part of it. This is a potential game changer for science and innovation in the United States.

Finally they admitted, "Steve, we're a new fund. Everybody will think we are idiots if we do that." I said, "All right. Can you do some other number close to my number?" So I stepped out of the room as they caucused, and they called me back in 10 minutes later and said, "So, listen. We can do $9.99 million." I'm trying to play poker with the deal, and one of the partners at the time was a great photographer - the firm had big prints of his on the walls. I was really in love with the one in the boardroom. So, without thinking, when they made me that offer, trying to keep a straight face, I reached behind me, grabbed the photo off the wall and slammed it on the desk, and said, "If you throw this photo in, you got the deal!"

The $10 Million Photo

Invest in the Team

Before we closed our Series A with Infinity, I had called on Mohr, Davidow Ventures, the firm which had funded my last company, Rocket Science. The senior partner at the time was Bill Davidow, a marketing legend and a hero of mine who had also funded other Enterprise software companies. I went in and pitched Bill the idea about how to automate the marketing domain. He gave me 15 minutes, then as politely as he could do it, walked me out the door and said, "Stupidest idea I ever heard, Steve. Enterprise software means across the Enterprise. Marketing is just one very small department."

(Kleiner Perkins would do the Series B round for E.piphany. After our IPO, Infinity's and Kleiner Perkins' investment in Epiphany would be worth $1 billion dollars to each of them.)

I still have the photo.

Startups now understand what they should be doing in their early formative days is search for a business model. The process they use to guide that search is "Customer Development"; and to track their progress startups now have a scorecard to document their week-by-week changes – the business model canvas.

Yet even with all these tools, early stage startups still need to physically meet with advisors and investors. That's great if you can get it. But what if you can't?

What's missing is a way to communicate all this complex information and get feedback and guidance for startups who cannot get advice in a formal board meeting.

We propose that early stage startups communicate in a way that didn't exist in the 20th century: online, collaboratively, through blogs.

We suggest that the founders/CEO invest one hour a week providing advisors and investors with "Continuous Information Access" by blogging and discussing the progress of their startup's search for a business model online. They would:

• Blog their Customer Development progress as a narrative
• Keep score of strategy changes with the Business Model Canvas
• Comment/dialog with advisors and investors on a near-realtime basis

What Does This Change?

Structure: Founders operate in a chaotic regime. So it's useful to have a structure that helps "search" for a business model. The "boardroom as bits" uses The “boardroom as bits” uses Customer Development as the process for the search and the business model canvas as the scorecard to keep track of the progress, while providing a common language for the discussion.

This approach offers VCs and angels a semi-formal framework for measuring progress and offering their guidance in the "search"? for a business model. It turns ad hoc startups into strategy-driven startups.

Asynchronous Updates: Interaction with advisors and board members can now be decoupled from the – once every six weeks, “big event” – board meeting. Now, as soon as the founders post an update, everyone is notified. Comments, help, suggestions and conversation can happen 24/7. For startups with formal boards, it makes it easy to implement, track and follow-up board meeting outcomes.

Monitoring and guiding a small angel investment no longer requires the calculus to decide whether the investment is worth a board commitment. It potentially encourages investors who would invest only if they had more visibility but where the small number of dollars doesn't justify the time commitment.

A board as bits ends the repetition of multiple investor coffees. It's highly time-efficient for investor and founder alike.

Coaching: This approach allows real-time monitoring of a startup's progress and zero-lag for coaching and course-correction. It's not just a way to see how they're doing. It also provides visibility for a deep look at their data over time and facilitates delivery of feedback and advice.

Geography: When the boardroom is bits, angel-funded startups can get experienced advice - independent of geography. An angel investor or VC can multiply their reach and/or depth. In the process it reduces some of the constraints of distance as a barrier to investment.

Imagine if a VC took $4 million (an average Series A investment) and instead spread it across 40 deals at $100K each in a city with a great outward-facing technology university outside of Silicon Valley. In the past they had no way to monitor and manage these investments. Now they can. The result – an instant technology cluster – with equity at a fraction of Silicon Valley prices. It might be possible to create Virtual Valley Ventures.

We Ran the Experiment

At Stanford our Lean Launchpad class ran an experiment that showed when "the boardroom is bits" can make a radical difference in the outcome of an early stage startup.

Our students used Customer Development as the process to search for a business model. The used a blog to record their customer learning and their progress and issues. The blog became a narrative of the search by posting customer interviews, surveys, videos and prototypes. They used the Business Model Canvas as a scorekeeping device to chart their progress. The result invited comment from their “board” of the teaching team.

Here are some examples of how rich the interaction can become when a management team embraces the approach.

We were able to give them near real-time feedback as they posted their results. If we had been a board rather than a teaching team we would have added physical reality checks with Skype and/or face-to-face meetings.

Show Me the Money

While this worked in the classroom, would it work in the real world? I thought this idea was crazy enough to bounce off a five experienced Silicon Valley VC's. I was surprised at the reaction – all of them want to experiment with it. Jon Feiber at MDV is going to try investing in startups emerging from universities with great engineering schools outside of Silicon Valley that have entrepreneurship programs, but minimal venture capital infrastructure. (The University of Michigan is a possible first test.) Kathryn Gould of Foundation Capital and Ann Miura-Ko of Floodgate also want to try it.

Shawn Carolan of Menlo Ventures not only thought the idea had merit but seed-funded the LeanLaunchLab, a startup building software to automate and structure this process. (More than 700 startups signed up for the LeanLaunchLab software the day it was first demo'd.) Other entrepreneurs think this is an idea whose time has come and are also building software to manage this process including Alexander Osterwalder, Groupiter and Angelsoft. Citrix thought this was such a good idea that their Startup Accelerator has offered to provide GoToMeeting and GoToMeeting HD Faces free to participating VC's and startups. Contact them here.

Summary

For startups with traditional boards, I am not suggesting replacing the board meeting - just augmenting it with a more formal, interactive and responsive structure to help guide the search for the business model. There's immense value in face-to-face interaction. You can't replace body language.

But for Angel-funded companies I am proposing that a "board meeting in bits" can dramatically change the odds of success. Not only does this approach provide a way for founders to "show your work" to potential and current investors and advisors, but also it helps expand opportunities to attract investors from outside the local area.

Lessons Learned

• Startups are a search for a business model
• Startups can share their progress/get feedback in the search
• Weekly blog of the customer development narrative
• Weekly summary of the business model canvas
• Interactive comments and questions
• Skype and face-to-face when needed
• This may be a way to augment traditional board meetings
• This might be a way to rethink our notion of geography as a barrier to investments

Read the first post – What's Wrong With Today's Board Meetings?

As customer and agile development reinvent the startup, it's time to ask why startup board governance has not kept up with the pace of innovation. Board meetings that guide startups haven't changed since the early 1900's. It's time.

Reinventing the board meeting may offer venture-backed startups a more efficient, productive way to direct and measure their search for a profitable business model. Reinventing the board meeting may offer angel-funded startups - which because of geography or size of investment typically don't have formal boards or directors - to attract experienced advice and investment outside of technology clusters (i.e. Silicon Valley, New York).

Here's how.

Because We've Always Done It This Way

The combination of Venture Capital and technology startups is only about 50 years old. Rather than invent a new form of corporate governance, venture investors adopted the traditional board meeting structure from large corporations. Yet boards of large companies exist to monitor efficient strategy and execution of a known business model.

While startups eventually get into execution mode, their initial stages are devoted to a non-linear, chaotic search for a business model: finding product/market fit to identify a product or service people will buy in droves at a sustainable, profitable pace.

In the last few years, our understanding that startups are not smaller versions of large companies, made us recognize that startups need their own tools, different from those used in existing companies: Customer Development - the process to search for a Business Model, the Business Model Canvas - the scorecard to measure progress in the search, and Agile Engineering - the tools to physically construct the product.

Yet while we've reinvented how startups build their companies, startup investors are still having board meetings like it's the 19th century.

Why Have a Board Meeting?

From a VCs point of view there are two reasons for board meetings.

1. It's their fiduciary responsibility. Once a startup gets going, it has asymmetric information. Investors get board seats to assure themselves and their limited partners that they are duly informed about their investment.
2. Investors believe that their experience and guidance can maximize their return. Here it's the board that has asymmetric knowledge. A veteran board can bring 50-100 times more experience into a board meeting than a first-time founder. (VCs sit on six to 12 boards at a time. Assume an average tenure of four years per board. Assume two veteran VCs per board equals 50-100 times more experience.)

From a founder's point of view there are three reasons for board meetings.

1. It's an obligation that came with the check.
2. Founders who have a great board do recognize the uncanny pattern recognition skills that good VCs bring.
3. An experienced board brings an extensive network of customers, partners, help in recruiting, follow-on financing, etc.

What's Wrong With a Board Meeting?

The Wrong Metrics: Traditional startup board meetings spend an insane amount of wasted time using Fortune 100 company metrics like income statements, cash flow, balance sheet, waterfall charts. The only numbers in those documents that are important in the first year of a startup's life are burn rate and cash balance. Most board meetings never get past big company metrics to focus on the crucial startup numbers. That's simply a failure of a startup board’s fiduciary responsibility.

The Wrong Discussions: The most important advice/guidance that should come from investors in a board meeting is about a startup’s search for a business model: What are the business model hypotheses? What are the most important hypotheses to test now? How are we progressing validating each hypothesis? What do those numbers/metrics look like? What are the iterations and Pivots - and why?

Not Real-time: Startup board meetings occur every 4-6 weeks. While that's great when you showed up in your horse and buggy, the strategy-to-tactic-to implementation lag is painful at Internet speeds. And unless there's rigor in the process, because there is no formal structure for follow up, tracking what happened as a result of meeting recommendations and action items gets lost in the daily demands of everyone's work. (Of course great VC’s mix in coffees, phone calls, coaching and other non-board meeting interactions but it’s ad hoc and not always done.)

Wastes Founders Time: For the founders, "the get ready for the board meeting" drill is often a performance rather than a snapshot. Powerpoints, spreadsheets and rehearsals consume time for materials that are used once and discarded. There are no standards for what each side (board versus management) does. What is the entrepreneur supposed to be doing? What are the board members supposed to be contributing?

The Wrong Structure: If you read advice on how to run a board meeting you'll get advice that would have felt comfortable to Andrew Carnegie or John D. Rockefeller.

In the age of the Internet why do we need to get together in one room on a fixed schedule? Why do we need to wait a month to six weeks to see progress? Why don't we have standards for what metrics VCs want to see from their early stage startup teams?

Angels In America

For angel-funded startups, life is even tougher. Data from the Startup Genome project shows that startups that have helpful mentors, listen to customers, and learn from startup thought leaders raise 7x more money and have 3.5x better user growth. If you're in a technology cluster like Silicon Valley you may be able to attract ad hoc advice from experienced investors. But very little of it is formal, and almost none of it approaches the 50-100x experience level of professional investors.

As there's no formal board, most of these angel/investors meetings are over coffees. And lacking a board meeting there's no formal mechanism to get investor advice. Angel investments in mobile and web apps today are approaching the "throw it against the wall and see if it sticks" strategy.

And for startups outside of technology clusters, there's almost no chance of attracting Silicon Valley VCs or angels. Geography is a barrier to investment.

So given all this, the million dollar question is: Why in the age of the Internet haven't we adopted the tools we build/sell to solve these problems?

Lessons Learned

• Early stage board meetings are often clones of large company board meetings
• That's very, very wrong
• Angel-funded startups have no formal mechanism for experienced advice
• There's a better way

In the next post – Reinventing the Startup Board Meeting.