The Lean Startup: How Today’s Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses
Entrepreneurship is a kind of management. No, you didn’t read that wrong. We have wildly divergent associations with these two words, entrepreneurship and management. Lately, it seems that one is cool, innovative, and exciting and the other is dull, serious, and bland. It is time to look past these preconceptions.
THE LEAN STARTUP METHOD This is a book for entrepreneurs and the people who hold them accountable. The five principles of the Lean Startup, which inform all three parts of this book, are as follows: 1. Entrepreneurs are everywhere. You don’t have to work in a garage to be in a startup. The concept of entrepreneurship includes anyone who works within my definition of a startup: a human institution designed to create new products and services under conditions of extreme uncertainty. That means entrepreneurs are everywhere and the Lean Startup approach can work in any size company, even a very large enterprise, in any sector or industry. 2. Entrepreneurship is management. A startup is an institution, not just a product, and so it requires a new kind of management specifically geared to its context of extreme uncertainty. In fact, as I will argue later, I believe “entrepreneur” should be considered a job title in all modern companies that depend on innovation for their future growth. 3. Validated learning. Startups exist not just to make stuff, make money, or even serve customers. They exist to learn how to build a sustainable business. This learning can be validated scientifically by running frequent experiments that allow entrepreneurs to test each element of their vision. 4. Build-Measure-Learn. The fundamental activity of a startup is to turn ideas into products, measure how customers respond, and then learn whether to pivot or persevere. All successful startup processes should be geared to accelerate that feedback loop. 5. Innovation accounting. To improve entrepreneurial outcomes and hold innovators accountable, we need to focus on the boring stuff: how to measure progress, how to set up milestones, and how to prioritize work. This requires a new kind of accounting designed for startups—and the people who hold them accountable.
As a society, we have a proven set of techniques for managing big companies and we know the best practices for building physical products. But when it comes to startups and innovation, we are still shooting in the dark.
A comprehensive theory of entrepreneurship should address all the functions of an early-stage venture: vision and concept, product development, marketing and sales, scaling up, partnerships and distribution, and structure and organizational design. It has to provide a method for measuring progress in the context of extreme uncertainty. It can give entrepreneurs clear guidance on how to make the many trade-off decisions they face: whether and when to invest in process; formulating, planning, and creating infrastructure; when to go it alone and when to partner; when to respond to feedback and when to stick with vision; and how and when to invest in scaling the business. Most of all, it must allow entrepreneurs to make testable predictions.
The goal of a startup is to figure out the right thing to build—the thing customers want and will pay for—as quickly as possible. In other words, the Lean Startup is a new way of looking at the development of innovative new products that emphasizes fast iteration and customer insight, a huge vision, and great ambition, all at the same time.
Once a team is set up, what should it do? What process should it use? How should it be held accountable to performance milestones? These are questions the Lean Startup methodology is designed to answer.
A startup is a human institution designed to create a new product or service under conditions of extreme uncertainty.
Validated learning is the process of demonstrating empirically that a team has discovered valuable truths about a startup’s present and future business prospects.
Our failure to move the numbers prodded us to accelerate our efforts to bring customers into our office for in-person interviews and usability tests. The quantitative targets created the motivation to engage in qualitative inquiry and guided us in the questions we asked; this is a pattern we’ll see throughout this book.
Lean thinking defines value as providing benefit to the customer; anything else is waste.
I’ve come to believe that learning is the essential unit of progress for startups. The effort that is not absolutely necessary for learning what customers want can be eliminated. I call this validated learning because it is always demonstrated by positive improvements in the startup’s core metrics. As we’ve seen, it’s easy to kid yourself about what you think customers want. It’s also easy to learn things that are completely irrelevant. Thus, validated learning is backed up by empirical data collected from real customers.
We adopted the view that our job was to find a synthesis between our vision and what customers would accept; it wasn’t to capitulate to what customers thought they wanted or to tell customers what they ought to want.
“Traditionally, the product manager says, ‘I just want this.’ In response, the engineer says, ‘I’m going to build it.’ Instead, I try to push my team to first answer four questions: 1. Do consumers recognize that they have the problem you are trying to solve? 2. If there was a solution, would they buy it? 3. Would they buy it from us? 4. Can we build a solution for that problem?” The common tendency of product development is to skip straight to the fourth question and build a solution before confirming that customers have the problem.
At its heart, a startup is a catalyst that transforms ideas into products. As customers interact with those products, they generate feedback and data. The feedback is both qualitative (such as what they like and don’t like) and quantitative (such as how many people use it and find it valuable).
If we do not know who the customer is, we do not know what quality is.
Customers don’t care how much time something takes to build. They care only if it serves their needs.
As you consider building your own minimum viable product, let this simple rule suffice: remove any feature, process, or effort that does not contribute directly to the learning you seek.
The rate of growth depends primarily on three things: the profitability of each customer, the cost of acquiring new customers, and the repeat purchase rate of existing customers. The higher these values are, the faster the company will grow and the more profitable it will be. These are the drivers of the company’s growth model.
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.
To read the graph, you need to understand something called cohort analysis. This is one of the most important tools of startup analytics. Although it sounds complex, it is based on a simple premise. Instead of looking at cumulative totals or gross numbers such as total revenue and 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.
the three A’s of metrics: actionable, accessible, and auditable.
Actionable metrics are the antidote to this problem. When cause and effect is clearly understood, people are better able to learn from their actions. Human beings are innately talented learners when given a clear and objective assessment.
This is why cohort-based reports are the gold standard of learning metrics: they turn complex actions into people-based reports. Each cohort analysis says: among the people who used our product in this period, here’s how many of them exhibited each of the behaviors we care about.
First, remember that “Metrics are people, too.” We need to be able to test the data by hand, in the messy real world, by talking to customers. This is the only way to be able to check if the reports contain true facts. Managers need the ability to spot check the data with real customers. It also has a second benefit: systems that provide this level of auditability give managers and entrepreneurs the opportunity to gain insights into why customers are behaving the way the data indicate.
Unfortunately, the real work that determines the success of startups happens during the photo montage. It doesn’t make the cut in terms of the big story because it is too boring. Only 5 percent of entrepreneurship is the big idea, the business model, the whiteboard strategizing, and the splitting up of the spoils. The other 95 percent is the gritty work that is measured by innovation accounting: product prioritization decisions, deciding which customers to target or listen to, and having the courage to subject a grand vision to constant testing and feedback.
The more money, time, and creative energy that has been sunk into an idea, the harder it is to pivot.
Business Architecture Pivot This pivot borrows a concept from Geoffrey Moore, who observed that companies generally follow one of two major business architectures: high margin, low volume (complex systems model) or low margin, high volume (volume operations model).
Sustainable growth follows one of three engines of growth: paid, viral, or sticky. By identifying which engine of growth a startup is using, it can then direct energy where it will be most effective in growing the business. Each engine requires a focus on unique metrics to evaluate the success of new products and prioritize new experiments. When used with the innovation accounting method described in Part Two, these metrics allow startups to figure out when their growth is at risk of running out and pivot accordingly.
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. For example, when I bought my first TiVo DVR, I couldn’t stop telling my friends and family about it. Pretty soon, my entire family was using one. 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 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. These sources of sustainable growth power feedback loops that I have termed engines of growth. Each is like a combustion engine, turning over and over. The faster the loop turns, the faster the company will grow. Each engine has an intrinsic set of metrics that determine how fast a company can grow when using it.
The churn rate is defined as the fraction of customers in any period who fail to remain engaged with the company’s product.
The way to find growth is to focus on existing customers for the product even more engaging to them. For example, the company could focus on getting more and better listings. This would create an incentive for customers to check back often. Alternatively, the company could do something more direct such as messaging them about limited-time sales or special offers. Either way, its focus needs to be on improving customer retention. This goes against the standard intuition in that if a company lacks growth, it should invest more in sales and marketing. This counterintuitive result is hard to infer from standard vanity metrics.
Most sources of customer acquisition are subject to competition. For example, prime retail storefronts have more foot traffic and are therefore more valuable. Similarly, advertising that is targeted to more affluent customers generally costs more than advertising that reaches the general public. What determines these prices is the average value earned in aggregate by the companies that are in competition for any given customer’s attention. Wealthy consumers cost more to reach because they tend to become more profitable customers.
the ability to grow in the long term by using the paid engine requires a differentiated ability to monetize a certain set of customers.
At IMVU, we developed techniques for collecting online payments from customers who did not have a credit card, such as allowing them to bill to their mobile phones or send us cash in the mail. Therefore, we could afford to pay more to acquire those customers than our competitors could.
Marc Andreessen, the legendary entrepreneur and investor and one of the fathers of the World Wide Web, coined the term product/market fit to describe the moment when a startup finally finds a widespread set of customers that resonate with its product:
the metrics for each engine of growth work in tandem with the innovation accounting model discussed in Chapter 7 to give direction to a startup’s product development efforts. For example, if a startup is attempting to use the viral engine of growth, it can focus its development efforts on things that might affect customer behavior—on the viral loop—and safely ignore those that do not. Such a startup does not need to specialize in marketing, advertising, or sales functions. Conversely, a company using the paid engine needs to develop those marketing and sales functions urgently.
I call this building an adaptive organization, one that automatically adjusts its process and performance to current conditions.
investigated. This is one of the most important discoveries of the lean manufacturing movement: you cannot trade quality for time.