00:04Stanford University hello in this video
00:10I'm going to continue the series talking
00:13about customer development and lean
00:15startups so in the last video I spoke a
00:20bit about why this is so difficult that
00:23part of it is the psychology of the
00:25entrepreneur and so we spoke about how
00:29entrepreneurship is a balancing act
00:31where you have to balance between being
00:34too optimistic versus too pessimistic
00:36you have to balance between being
00:38flexible and being persistent in today's
00:41video I want to talk about three things
00:43the first is some critiques of the Lean
00:47Startup or customer development model
00:49the second is the debate about lean
00:53versus fat startups and the third is a
00:55little bit about some metrics that you
00:57want to keep track of in a startup
00:59venture so let's start out with some
01:03critiques I've been talking about the
01:05model of customer development and lean
01:07startups what are some possible
01:09criticisms or some alternative views in
01:15some ways the idea that you have to
01:17listen to and respond to feedback from
01:19customers is almost obvious advice but
01:23we also have this famous quote that's
01:25attributed to Henry Ford where he said
01:28if I had asked people what they wanted
01:29they would have said faster horses
01:31so apparently Henry Ford never actually
01:34said this but nonetheless there is this
01:37idea that customers don't necessarily
01:40know or can't necessarily think of these
01:43breakthrough next-generation innovations
01:46and so the other argument that's given
01:48is the argument from Apple and Steve
01:51Jobs that Steve Jobs was this brilliant
01:54visionary who would never assemble a
01:58group of customers for a customer
02:00feedback session or elicit ideas from
02:02them argument is that again radical new
02:06products in the early days it was
02:08forecast that we might need perhaps 10
02:11computers and so when you have something
02:13is radically new as the first desktop
02:16computer can be difficult for people to
02:19imagine how they might use it and and
02:21thus to give these kinds of ideas
02:24customers there's this idea that perhaps
02:27rather than listening too closely to
02:30customers that it might be good to
02:32actually have a vision actually not
02:35necessarily listen to customers but
02:37trust your gut instinct and there might
02:39be some truth to this certainly I would
02:42tell you that if you have an idea that
02:45you believe in strongly and there's some
02:47reason why you've listened to Kuster
02:50potential customer feedback and believe
02:53that the customer is wrong that the idea
02:56has merit then you should consider
02:59pursuing this and still moving forward
03:02but only once you've really considered
03:05why it is that you're not getting the
03:07type of positive feedback from customers
03:09that you think you should and and why
03:11this feedback is wrong not many people
03:14are Steve Jobs and so if you're going to
03:17just trust your gut instinct you have to
03:20be really sure about it so I have
03:25several notions mixed up together one is
03:28this idea of rapid iteration that you
03:31have to respond to feedback from the
03:33market and rapidly iterate another idea
03:36here which I'll talk more about in a
03:38minute is the lean startup idea that you
03:41have to raise the minimal amount of
03:43funding and that you shouldn't spend too
03:45much cash should be very conservative
03:47about what you spend money on how much
03:49money you raise and this has its own
03:52merits but also some downsides I'll talk
03:55the next notion is this idea of
03:58hypothesis testing that and a startup
04:00you're designing experiments and this
04:03can be criticized for the lack of kind
04:07of a bold conviction sometimes in a
04:09start-up rather than spending all this
04:11time going through experiments and
04:13testing your hypotheses you just have to
04:16move forward and you
04:18to quickly design the product and you
04:21can't spend too much time worrying about
04:23do I have the right product market fit
04:25is my revenue model the right one
04:27sometimes you have to act boldly and
04:30similarly on rapid iteration releasing a
04:33product too early releasing a beta
04:35version can potentially harm your
04:37reputation so there's a reason why we
04:40tend to hold back until the product is
04:43more perfected to get feedback so these
04:46are arguments that you'll hear on the
04:48other side and justifiably so if in all
04:52of these arguments and these are things
04:54that need to be balanced carefully with
04:57the customer development or Lean Startup
04:59model next is this notion of the of what
05:05it means to be lean and doing a lean
05:07startup versus a fat startup so there
05:12are advantages and disadvantages to each
05:14some of the advantages of being lean
05:17which basically means raising only the
05:20minimum amount of capital that you need
05:22trying to bootstrap and get by on just
05:26the bare minimum investment obviously
05:28this offers a greater return on
05:31investment if you don't have to raise as
05:33much money if you don't have to invest
05:34enough then you'll wind up getting a
05:36greater return if successful you also
05:39lose less equity to investors each time
05:42you raise money you have to give up a
05:44portion of the company and this also and
05:48perhaps this is the most compelling
05:50reason allows you to retain more control
05:52and more flexibility to change direction
05:55once you've raised money from venture
05:57capital investors particularly if it's a
06:00large amount of money it can become more
06:02difficult to change direction if you
06:04need to and so you lose some of the
06:07flexibility that startups might need
06:09when they're still in the process of
06:11finding their business model on the
06:14other hand we shouldn't discount the
06:16advantages of being fat of raising
06:19sufficient capital some types of
06:22opportunities may require more money it
06:25may require spending more money to get
06:28top engineers and top talent you
06:30certainly don't want to
06:31save money by going with second-rate
06:33talent in your startup it also provides
06:37you some cushion if there's a downturn
06:38if you've been raising the minimum
06:41possible amount of money and there's a
06:43recession then it can become much more
06:46difficult to raise additional funding
06:48and so if you allow yourself to raise
06:51more money than you actually need this
06:53gives you some cushion in case there's a
06:55recession in case there's a large
06:57competitor who moves into your space who
07:00you suddenly have to start competing
07:01with and expending more cash and so I
07:05want to show you one short video clip
07:07that's talking about this debate so this
07:10is Mark Shuster and he's talking a
07:14little bit about this debate but about
07:16lean versus fat startups mark Shuster
07:25says that a lean startup shouldn't raise
07:29that much money and then eventually if
07:32it hits product market fit should become
07:34fat I said that it's true Eric Ries one
07:42of the most beloved young speakers
07:45lectures in Silicon Valley someone who's
07:47reading I write I read and enjoy wrote a
07:51response which I found curious he said
07:53mark misunderstood the meaning of the
07:57term lean startup luckily there's an
08:01internet so I pulled up the definition
08:03of lean without much flesh or fat not
08:07plump of edible meat containing little
08:09or no fat lacking in riches full spare
08:12economical and yet he says the Lean
08:15Startup is about moving fast the fast
08:19startup is about moving fast the rapid
08:22startup is about moving fast the quick
08:24startup not the lean startup and okay
08:29it's not my movement I'll let you have
08:31your movement but I believe in lean
08:34startup and then something changes you
08:39raised a little bit of money you work on
08:41your product you don't do what I did
08:43which is spend too much
08:45money hire a bunch of developers before
08:47you figured it all out what I often tell
08:50people is you should be flipping
08:51hamburgers if you're gonna run a
08:53hamburger chain and that means that
08:56you're doing customer support you're
08:58answering phone calls you're going on
09:00sales calls you're involved in product
09:02management you do user testing raising
09:05too much capital too quickly before
09:07there's a product market fit makes this
09:09very hard to do so I sort of agree with
09:13what ben horowitz said which is the fat
09:17startup and it's okay later in life
09:19obviously I would think this to get a
09:23bit fat and what I mean is if you become
09:27Foursquare you got two choices you can
09:32sell and that one hundred million dollar
09:34outcome for most people that Yahoo
09:36reportedly had offered would have been
09:38quite nice but the founders had already
09:40had one exit and I think they really
09:42wanted to change the world and I think
09:44but if you're gonna change the world and
09:46you wake up the sleeping lions of
09:49Silicon Valley to this opportunity
09:51you better get fat pretty quickly
09:53because you've got Yelp in town here and
09:56those guys are smart and move fast and
09:58you obviously have Facebook in town
10:00there and those guys are very smart and
10:02move very fast so if you're going to
10:04compete with people in what people call
10:07winner take most markets you need to be
10:10fat so we see Groupon and LivingSocial
10:13who have raised money and are big and
10:16I don't think number five six seven
10:18eight are going to be that relevant in
10:20the long run so there are times where
10:23fat is okay so you heard mark Schuster a
10:29venture capitalist here in Silicon
10:31Valley talking about how you should stay
10:33lean until you've reached what he called
10:35product market fit and then you should
10:38become fat and raise more capital to
10:40start scaling up we want to start
10:42talking about so how would you know when
10:45you've reached a product market fit the
10:46point at which you've developed a
10:47product that fits the market and you're
10:50ready to start scaling up the venture
10:52you need to start paying attention to
10:54certain startup metrics so what are
10:58tricks for startups in a large company
11:02the relevant metrics that you might look
11:04at are things like the cash flow
11:06statement income profit and loss
11:08statement but as you can imagine for a
11:11startup most of these things are going
11:13to be zero you have very little revenue
11:15you're making losses how do you tell if
11:18you're actually making progress if the
11:20time has come to raise additional
11:22capital and begin building out the
11:24organization this is a different set of
11:28metrics for a start-up and you'll have
11:30to think through your own venture in the
11:32industry that you're in to know exactly
11:34which set is right for you but these
11:37things might be things that are
11:39characteristics of your user base things
11:42like the number of registrations or the
11:45number of activations what percentage of
11:47people who land on your website are
11:49actually signing up or downloading the
11:52software how many of these customers do
11:55you retain for at least 30 days or for
11:57at least 90 days how many of them switch
12:00over to become paying customers or you
12:04might look at other types of financials
12:06revenue certainly is a relevant one the
12:09margins that you're making which is your
12:13profit margin the amount of revenue
12:15minus the costs for each sale York at
12:18the level of cash that you have is
12:20certainly key in a start-up you can't
12:22survive and if you're running out of
12:24cash your burn rate how much cash are
12:27you burning per month or they might be
12:31customer acquisition metrics things like
12:34what does it cost you to acquire a new
12:37what are your advertising expenses
12:39what's your viral acquisition ratio so
12:43for each customer that you get how many
12:45other customers do they refer to the
12:47site who wind up coming and signing up
12:50you can also do things like web metrics
12:52the total number of unique visitors or
12:54pageviews what's the present value or
12:58the net present value of acquiring a
13:00customer what's the lifetime value of
13:03having that customer and retaining them
13:05these are the types of metrics that are
13:07more important for a start-up venture
13:09and that will talk more about as we go
13:12the course finally I want to play one
13:15more video clip for you which comes from
13:17the debate between two VCS
13:20about lean versus fat startup model
13:28if it helps you being lane to achieve
13:31then that's great but if not if it's
13:34better to deploy a lot of capital to
13:36achieve that goal then by all means
13:39embrace your fatness getting into the
13:42specifics let me restate Fred's
13:45definition of Lean Startup which is
13:47basically don't raise a boatload of cash
13:50until you've both achieved product
13:53market fit and you're getting real
13:56traction in the market and by real
13:57traction what Fred meant was people are
14:00buying or using your product and droves
14:02and as I said this is a good tactic but
14:06unfortunately it's been elevated by many
14:09people in the venture capital community
14:10and the entrepreneurial community from a
14:13tactic to a complete and comprehensive
14:15operational theory and as an operational
14:19theory it has quite a few holes let me
14:21point out three first it presumes that
14:24you actually know when you've achieved
14:25product market fit and this is often
14:28quite done obvious for example apples
14:32iPod did not sell a million units until
14:34after three years until two years after
14:37it was launched compare this with iPhone
14:39which sold a million units in its first
14:41three days so at what point did the iPad
14:44did the iPod have product market fit and
14:47at what point should have Apple invested
14:49in the Mini in the Nano bylanes start-up
14:51theory maybe not for a while but that
14:53would have been incorrect
14:54now Lean Startup theory does explain
14:57what to do with the iPhone once they
14:58sold a million units in three days but
15:00that's also not very interesting the
15:03second problem with it is the length
15:06start of theory presumes that once you
15:09have product market fit you can't lose
15:10it and this is also not the case for
15:14example at one of the previous startups
15:16that I was at Netscape we had product
15:18market fit on the browser but lost it
15:20when Microsoft eliminated the market for
15:22browsers and we were 250 million dollars
15:25in revenue per year at that time they
15:27eliminated the market by basically
15:28saying it was part of the OS and
15:30removing all the money from the market
15:31so at that point we had to regain
15:34product market fit and we didn't have
15:36the luxury of taking the time to do it
15:39in the lean startup way and in fact we
15:42the silver the server product line from
15:43zero to six hundred million dollars in
15:45two years by applying what might be
15:48referred to as a fad methodology and
15:50then the third problem is the Lean
15:52Startup theory implies that there are
15:56presumes there's no competition and so
15:58what happens if prior to achieving
16:00product market fit prior to building the
16:02product that everybody wants and are
16:04buying it in droves even though you
16:07believe you have a theory that's going
16:08to work you believe the market is very
16:10large a very scary competitor emerges
16:13VMware had this issue and their answer
16:17was to double headcount every single
16:19year to make sure that they took the
16:21market ahead of open-source competitors
16:23like Xen and big scary competitors like
16:26Microsoft and that worked well so
16:30basically as an operational theory the
16:32Lean Startup method doesn't work very
16:34well so why do I even care about this at
16:36all and why did I write the post well
16:38for two reasons one entrepreneurs are
16:41confused and a lot of them are harming
16:43their companies by avoiding things that
16:46cost money when they should spend money
16:47on them like building a Salesforce for
16:50example but more importantly we see
16:53entrepreneur is avoiding big ideas and
16:55every day somebody comes into our office
16:58every week and somebody from Harvard or
17:00MIT or Stanford a brilliant computer
17:03scientist and pitches us on a very small
17:05idea they want to do ad targeting
17:06optimization and this is tragic sorry
17:11that was supposed to be funny but it is
17:16tragic some of you are probably building
17:17ad targeting optimization companies
17:19right now but if you look at if the
17:23inventors of yesteryear took Bing Lane
17:25as seriously as entrepreneurs do today
17:27instead of airplanes and telephones and
17:30automobiles we would have pantyhose that
17:33fit exactly right and we're targeted at
17:38so in conclusion building a company is
17:40really hard so you might as well build
17:41something important and when you're
17:45going to build something important keep
17:47focused on that goal and if being lean
17:49is the right way to reach the goal great
17:51but if it requires being fat remember
17:53the big is beautiful okay
17:56Fred so I want to address this question
17:59from both the entrepreneurs perspective
18:02and also the investors perspective I
18:04think from the entrepreneurs perspective
18:06what you want it the equation you want
18:07to solve for is the expected value of
18:11exit for you personally is the
18:12entrepreneur and I think that equation
18:14looks like something like the
18:18probability of a meaningful exit times
18:20the amount of ownership you'll have at
18:23exit times the value of the expected
18:26exit so let's just leave the value the
18:28expected exit the same for this argument
18:32and focus on the two variables that
18:34really matter here which is the
18:36probability of a successful exit and the
18:39ownership that you will have at exit and
18:43I don't think that you can double the
18:47probability of an expected exit by
18:51doubling the amount of cash that you
18:53raise and the reason is that the
18:55probability of a successful exit is
18:58going to be a function of many things
18:59the most common are the quality the idea
19:02the quality of the product quality the
19:05team the amount of capital resources you
19:07have the market and how it develops and
19:10and while cash is one of those variables
19:14it's not the only variable and so if you
19:16double the amount of cash you have you
19:18don't necessarily double the probability
19:21of success on the other hand if you
19:24double the amount of cash that you raise
19:25at any point along the way at asset
19:28valuation you double the amount of
19:29dilution so if you just look at that
19:31formula you optimize for probability to
19:35success and and in doing so increase the
19:38amount of dilution you take you probably
19:40are going to reduce the expected value
19:44of your personal exit you may increase
19:46the success of the company and you make
19:50may increase the overall value to
19:52society which Ben points to and I think
19:55those are very good points but for you
19:56as an entrepreneur this I think is a bad
19:59idea now let's talk about it from the
20:01investor's perspective investors are
20:03really solving for two things they're
20:06solving for the highest return on
20:09dollars out / dollars in and they're
20:12solving for mitigating as much of the
20:14risk in the investment as they possibly
20:16can and the way that you do that as an
20:19investor is you put very small amount of
20:21capital in when the risk is very high
20:23and as the opportunity develops over
20:27time you increase the amount of capital
20:30that you have at risk as the risk gets
20:32mitigated in the opportunities that are
20:34scaling into their markets the way you
20:37want that's the classic early-stage
20:39venture capital model you start with a
20:42quarter or a half a million dollar seed
20:43then you follow with a million to first
20:47quote-unquote venture round then maybe
20:49three to five million and then as the
20:51opportunity scales 5 10 15 20 million
20:54dollars and that allows you to have a
20:57lot of capital in and a lot of capital
20:59out but also minimizing the amount of
21:03risk along the way so for both the
21:05entrepreneurs perspective and the
21:07investors perspective staying lean in
21:10the beginning and keeping the amount of
21:11dollars at risk and the amount of
21:13dilution as small as possible along the
21:16way until the valuation reaches a point
21:18where you can raise a lot of money and
21:21minimize your dilution is the absolute
21:24best way to maximize the expected value
21:27the exit for the entrepreneur and is
21:29also the way to maximize the return on
21:32investment and risk mitigation for the
21:34investor and that's why the venture
21:36capital model has been worked so well
21:38over the past 30 or 40 years is because
21:41the alignment when done correctly
21:43between the entrepreneur and the
21:45investor is very very high and that
21:48allows the entrepreneur and the
21:50investors the early stage investors to
21:52act as true partners in building that
21:54business so so while I agree with Ben
21:56that there are times when you need to
21:58get fat I think early on it's a very bad
22:01idea and the lean model works very well
22:04in the first two three maybe even four
22:06years of a company's existence and you
22:10want to stay lean for as long as you
22:11possibly can they saw there some of the
22:15debate but between the lean versus fat
22:17startup models and we'll talk more about
22:20financing and fundraising
22:23future videos but I wanted to at least
22:25introduce some of these ideas and some
22:27of the debate around them thank you very
22:30much for more please visit us at
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