In 2004, three college sophomores arrived in Silicon Valley with their newly launched college social network. It was live on a handful of college campuses. It was not the market-leading social network or even the first college social network; other companies had launched sooner and with more features. With 150,000 registered users, it made little in revenue, yet that summer the company raised its first $500,000 in venture capital. Less than a year later, they raised an additional $12.7 million.
Of course, by now you’ve guessed that these three college sophomores were Mark Zuckerberg, Dustin Moskovitz, and Chris Hughes of Facebook. Their story is now world-famous. Many things about it are remarkable. But “How Facebook was able to raise so much money with such a small user-base?” Eric Ries focused on this compelling question in his widely read best-seller book “THE LEAN STARTUP”, and also provided adequate strategies that any startup can adopt.
Keep reading to find the answers!
This is part two of my Lean Startup book review. If you haven’t read the first part yet, please go to this link and read the first part. Also, check out my review of Deep Work by Cal Newport and my Article on the Goal Management framework OKRs once you are done reading this.
In “Steer”, the second part of the book, Eric Ries brings up the concept of building the minimum viable product to test the assumptions and an accounting system to evaluate whether entrepreneurs are making progress.
He offers a decision-making method to help entrepreneurs decide if they should pivot or persevere.
Build-Measure-Learn: The Feedback Loop
Per Eric Ries, a startup is a catalyst that transforms ideas into products. As customers interact with those products, they generate feedback and data. He provided the following three-step process with the following diagram:
BUILD: To apply the scientific method to a startup, we need to identify which hypotheses to test. The two most important assumptions are the value hypothesis and the growth hypothesis. Once clear on these leap-of-faith assumptions, the first step is to enter the Build phase as quickly as possible with a minimum viable product (MVP).
The MVP is that version of the product that enables a full turn of the Build-Measure-Learn loop with a minimum amount of effort and the least amount of development time.
A minimum viable product (MVP) helps entrepreneurs start the process of learning as quickly as possible. It is not necessarily the smallest product imaginable, though; it is simply the fastest way to get through the Build-Measure-Learn feedback loop with the minimum amount of effort.
MEASURE: When entering the Measure phase, the biggest challenge will be determining whether the product development efforts are leading to real progress.
A startup’s job is to:
(1) rigorously measure where it is right now, confronting the hard truths that assessment reveals, and then
(2) devise experiments to learn how to move the real numbers closer to the ideal reflected in the business plan.
The minimum viable product lacks many features that may prove essential later on.
The method Eric recommends is called innovation accounting, a quantitative approach that allows seeing whether the engine-tuning efforts are bearing fruit.
Innovation accounting works in three steps:
First, use a minimum viable product to establish real data on where the company is right now. Without a clear-eyed picture of your current status—no matter how far from the goal you may be—you cannot begin to track your progress.
Second, startups must attempt to tune the engine from the baseline toward the ideal. This may take many attempts.
After the startup has made all the micro changes and product optimizations it can to move its baseline toward the ideal, the company reaches a decision point. That is the third step: pivot or persevere.
Upon completing the Build-Measure-Learn loop, we confront the most difficult question any entrepreneur faces: whether to pivot the original strategy or persevere. If we’ve discovered that one of our hypotheses is false, it is time to make a major change to a new strategic hypothesis.
Eric Ries described several types of pivots in detail in the book, which include: Zoom-in Pivot, Zoom-out Pivot, Customer Segment Pivot, Platform Pivot, etc.
I remember reading on Quora that Uber Pivoted its business in the early days of business. When Uber started, it was all about monetizing a huge oversupply of Limos waiting in parking lots, for their next scheduled customer. Getting a black car on demand through an app, for slightly more than a taxi, caught everyone's fancy.
Things were heating up in this space, and Lyft came out with the concept that anyone with a car and a driver's license can become a driver, and give rides to the riders.
Lyft was going to eat Uber's lunch.
Uber pivoted, big time. By copying Lyft's business model, and updating its operations to onboard non-commercial drivers with private vehicles.
When startups start to run low on cash, they can extend the runway in two ways: by cutting costs or by raising additional funds. But when entrepreneurs cut costs indiscriminately, they are as liable to cut the costs that are allowing the company to get through its Build-Measure-Learn feedback loop as they are to cut waste. If the cuts result in a slowdown in this feedback loop, all they have accomplished is to help the startups go out of business more slowly.
The true measure of a runway is how many pivots a startup has left: the number of opportunities it has to make a fundamental change to its business strategy.
Cohort analysis: This is one of the most important tools of startup analytics. Instead of looking at cumulative totals or gross numbers such as total revenue and the total number of customers, one looks at the performance of each group of customers that comes into contact with the product independently. Each group is called a cohort.
In the beginning, I have written that Eric Ries focused on the following question: “How Facebook was able to raise so much money when its actual usage was so small?”
According to Eric, what impressed investors the most were two facts about Facebook’s early growth. The first fact was the raw amount of time Facebook’s active users spent on the site. More than half of the users came back to the site every single day. This is an example of how a company can validate its value hypothesis—that customers find the product valuable.
The second impressive thing about Facebook’s early traction was the rate at which it had taken over its first few college campuses. The rate of growth was staggering: Facebook launched on February 4, 2004, and by the end of that month almost three-quarters of Harvard’s undergraduates were using it, without a dollar of marketing or advertising having been spent. In other words, Facebook also validated its growth hypothesis. These two hypotheses represent two of the most important leap-of-faith questions any new startup faces.
There are many famous entrepreneurs who made millions because they seemed to be in the right place at the right time. However, for every successful entrepreneur who was in the right place at the right time, there are many more who were there, too, in that right place at the right time but still managed to fail.
Henry Ford was joined by nearly five hundred other entrepreneurs in the early twentieth century. Imagine being an automobile entrepreneur, trained in state-of-the-art engineering, on the ground of one of the biggest market opportunities in history. Yet the vast majority managed to make no money at all. We saw the same phenomenon with Facebook, which faced early competition from other college-based social networks whose head start proved irrelevant.
What differentiates the success stories from the failures is that the successful entrepreneurs had the foresight, the ability, and the tools to discover which parts of their plans were working brilliantly and which were misguided, and adapt their strategies accordingly.
A startup’s earliest strategic plans are likely to be hunch- or intuition-guided, and that is a good thing. To translate those instincts into data, entrepreneurs must, in Steve Blank’s famous phrase, “get out of the building” and start Learning.
Small Batches in Entrepreneurship
Toyota discovered that small batches made their factories more efficient. In contrast, in the Lean Startup, the goal is not to produce more startups: efficiently. It is to—as quickly as possible—learn how to build a sustainable business. Working in small batches ensures that a startup can minimize the expenditure of time, money, and effort that ultimately turns out to have been wasted.
Per Eric, the engine of growth is the mechanism that startups use to achieve sustainable growth.
Sustainable growth is characterized by one simple rule: New customers come from the actions of past customers. There are four primary ways past customers drive sustainable growth:
1. Word of mouth. Embedded in most products is a natural level of growth that is caused by satisfied customers’ enthusiasm for the product.
2. As a side effect of product usage. Fashion or status, such as luxury goods products, drive awareness of themselves whenever they are used. When you see someone dressed in the latest clothes or driving a certain car, you may be influenced to buy that product. This is also true of so-called viral products such as Facebook and PayPal. When a customer sends money to a friend using PayPal, the friend is exposed automatically to the PayPal product.
3. Through funded advertising. Most businesses employ advertising to entice new customers to use their products. For this to be a source of sustainable growth, the advertising must be paid for out of revenue, not one-time sources such as investment capital. As long as the cost of acquiring a new customer (the so-called marginal cost) is less than the revenue that the customer generates (the marginal revenue), the excess (the marginal profit) can be used to acquire more customers. The more marginal profit, the faster the growth.
4. Through repeat purchase or use. Some products are designed to be purchased repeatedly either through a subscription plan (a cable company) or through voluntary repurchases (groceries or lightbulbs). By contrast, many products and services are intentionally designed as one-time events, such as wedding planning.
The book provides several kinds of growth engines of growth, each providing frameworks with specific metrics on which to focus:
Sticky Engines of growth rely on lots of repeat business. Startups must pay close attention to the churn rate, or the percent of customers who don’t stay engaged with the product. If they can acquire new customers faster than they lose them, then they are growing.
With Viral Engines of growth, people are exposed to the product as a result of customer use. Customers aren’t necessarily trying to spread your product around, but that’s what happens. The Viral Engine is powered by a feedback loop — the viral loop — and its productivity is measured with the viral coefficient.
The Paid Engine of Growth features traditional methods such as advertising. It’s important that the cost of acquiring a new customer is less than the potential profit to be harvested from them. There are many other ways to pay for growth beyond spending money on advertising, including hiring a sales team or even relying on foot traffic. The important thing is that these methods increase revenue from customers and/or reduce the cost of acquiring new customers.
Established companies can have more than one engine of growth working at any given time. Startups, on the other hand, should probably just stick to one at a time. It will be easier to test things and make decisions.
Apart from the growth strategies Eric mentioned in the book, I also intend to write extensively on my favorite topic Growth Hacking in the coming days!
The ‘Lean Startup’ book provides the largest impact on the thinking of methodology to build a successful startup. Since, in a startup situation, things constantly go wrong. trying to adopt a lean startup as a defined set of steps or tactics will not be effective.
Thus, I suggest using the lean startup as a framework, not a blueprint of steps to follow. It is designed to be adapted to the conditions of each specific company. Rather than replicating exactly what others have done, practice the techniques mentioned in the book to build something that is perfectly suited for your company.
Using the same language as Eric’s - as a movement, the Lean Startup must avoid doctrines and rigid ideology. We must avoid the caricature that science means formula or a lack of humanity in work. In fact, science is one of humanity’s most creative pursuits. Applying it to entrepreneurship will unlock a vast storehouse of human potential.
We would dedicate ourselves to the creation of new institutions with a long-term mission to build sustainable value and change the world for the better.
Most of all, we would stop wasting people’s time!
This review was originally published on 16 November 2019. Updated on 24 July 2023.