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