It’s just made of canvas
The last few posts point to ways of thinking about and using the business model canvas. Follow those instructions, and what are you still missing? Here are five answsers:
You don’t get the transition. If you’ve built a working caterpillar (that is, designed experiments that have gotten good results in each box); how do you turn that thing into a butterfly? It’s not exactly implementation risk – because a lot of the testing in finding partners, building in-house resources, and running in-house activities, has addressed implementation risk. But the path from MVP to thing that works in the real world isn’t likely to be smooth. Likewise, the path from knowing you can attract partners or customers or employees to actually creating those relationships, twists and turns.
You might not have the skills. Entrepreneurs need to sell. They need to negotiate. They need to understand their investor’s motivations. They need to empower and motivate people on the team. They need to create a productive business culture. None of this is addressed specifically in the canvas.
You’re at the mercy of the environment. Your validated plan to sell to the Greek market could go up in flames. Your ability to provide taxi service in Washington DC could fall victim to regulations. A nationwide recession or a bad swing in oil futures could lead your most promising angel investors to think twice. A key platform provider could come out with a new version that cuts you out. The MLB, MPAA, ATT, Ap Store, GOP, Sierra Club, or who knows who else could fix their eye on you like Sauron in Lord of the Rings and take you right out of the game. What looked like clear skies to everyone could turn stormy in a week.
Your competition could act. The real companies with a lot to lose, could take aim, or just come out with a new product and beat you on features. If you saw a hole in the market, it’s not inconceivable that people actually in the market saw it too.
The canvas is an incredible tool. Use it right, and you will KNOW you’ve got a viable company. But viable companies go out of business all the time. It’s just a first step.
First Time Founders
Andreas Klinger has a great post with a long list of things first time founders do. Here are some standouts (with our comments in parentheses):
They do mental incest by bouncing ideas off the same people every time.
(And even more often, mental masturbation, where you bounce ideas off of yourself)
They do “aspects of customer development, but…”
(Steve Blank is well enough known by now that in order to appear professional, you have to at least dismiss him. But getting what Steve is up to is pretty tough, and walking the walk is much tougher.)
They do “lean, but…”
(Ditto Eric Ries)
They confuse customer assumptions with facts.
(In a startup context, where your customers are mostly prospective, asking potential customer’s what they want, and then building it is an express lane to failure. People can’t articulate what they really want, are unconscious of the reasons they don’t already have it, and are hopelessly biased by the questions you’re asking. If your solution is conventional, someone is already doing it better than a startup. If it’s unconventional, aka innovative, there’s no direct path the customer’s buying decision.)
They have a society vision not a product vision.
(Not quite sure what Klinger has in mind here, but a “society vision” is a state of society that includes ubiquitous use of your product. In the society we’re unfortunately living in, no one has ever heard of your product. What’s relevant is the next steps of the path you take, not a science fiction tableau of what the future looks like. It won’t look like that.)
They cannot name failures in their product iterations.
(The essential difference between a startup and a company is that a startup is there to provide information about a business model for the entrepreneurs, while a company is there to provide value to customers. Failures that lead to product iterations are little heaps of information, they are the coin of the realm. So a startup that can’t name it’s failures is like a company that can’t accept money.)
They believe the Techcrunch posts about large investment rounds apply to them.
(This is the equivalent to worrying about terrorists or plane crashes. If it’s in the news, then it’s a newsworthy – read “extremely rare” event.)
They don’t get that a low burnrate and being prelaunch doesn’t mean you have more time to waste.
(When you and your investors commit, you have a bucket of resources. That bucket is leaking, and momentarily it’ll be empty.)
They spend more time on fundraising than on their product and value investment over traction.
(This one’s hard not to do, because fundraising takes way more time and effort than you think. But traction is the most bankable asset a startup can have; with enough of it, it’ll be the investors spending that time and effort; with too little, you can fundraise till eternity to no avail.)
They validate their customer hypothesis with investors.
(Different animal.)
They improve their product based on investor feedback.
(As above.)
They launch ‘in one month’.
(It’ll certainly take two or three months. But much worse than that, during those three months, little or no value will be added every day.)
Asking the Right Questions – Canvas Part 3
As discussed in previous posts, the business model canvas works differently for existing businesses than it does for startups. For an existing business, the contents of each box need to be a clear description of how business is actually conducted. It doesn’t follow, though, that for a startup, it’s sufficient to describe how the founders anticipate that they will conduct business.
To be maximally useful, the propositions (hypotheses, guesses) in each box need to meet at least three tests: coherence, binary testability, and framing.
Here are Joe and Amy working on the canvas. Joe’s an entrepreneur who believes in the benefits of organic food, wants to share those benefits with his dog, but can’t afford premium organic dog foods. He meets an organic farmer, Amy, at the farmers’ market, who tells him that frequently she can’t sell all of her produce, and she’d love to be able to get rid of aging goods, even at a discount price. An idea is born: discount organic dog food made from farmers’ excess inventory.
Joe and Amy start OrganicDogFood.com and construct the following business model canvas:
CoherenceThis canvas is a reasonable-seeming description of a business model, but is it a useful tool? A useful canvas is one with testable propositions which, as you validate them, take you through a process of developing and discovering a repeatable, value adding business model.
A proposition must be coherent in the sense that it works in the context of the business model as a whole. Amy is an expert, so her opinion that organic farmers will partner with OrganicDogFood.com to manage excess inventory carries some weight. But that opinion is only a starting point. What validation would be sufficient? Further evidence along the same lines (ten more organic farmers corroborating Amy’s experience) wouldn’t solve the problem, because a valid partnership with organic farmers has to work in the context of the entire business model. For example:
- The key activity of “developing recipes” implies that different ingredients may be needed. What are they? Are the organic farmers willing to sell at a discount in a position to provide those specific ingredients?
- Are ALL the necessary ingredients available from organic sources? (If not, the value proposition is in question.)
- Are ingredients available in all seasons or with a short enough lead time to meet the needs of potential channel partners? How about manufacturing partners?
- What volumes will be required to keep manufacturing and distribution costs low enough to maintain the cost model? Will organic farmer partners guarantee enough produce to meet these requirements?
The final formulation of the proposition, might be something like “organic farmers and ranchers producing all the ingredients needed for several different dog food products, will have sufficient excess inventories at the right times and for the right prices, to satisfy the requirements of the value proposition, key activities, and cost structure, related partnerships, and other aspects of the business model.”
Some of these questions may occur to Joe and Amy beforehand; others emerge during research and can’t be anticipated. Most attempts to validate a proposition lead to a set of new propositions. These sets aren’t infinite, but they’re not immediately knowable either. Coherence-testing the questions leads to finer grained questions.
Testing
Peter Thiel’s advice for venture capitalists “force yourself into a binary mode” applies here too. Propositions are not meaningful if they cannot be invalidated. Daniel Kahneman talks about the “illusion of validity.” People jump to conclusions based on available evidence, however partial that evidence happens to be, and all without recognizing the size of the jump. Worse, our intuitive sense of whether something is true or not responds much more sensitively to a good story than it does to a lack of evidence. If it’s a bad story, it smells wrong and we can tell. If it’s a good story based on bad evidence, it smells fine and we can’t.
With their extremely limited resources, startups need to ruthlessly invalidate. This means figuring out what constitutes evidence, and designing metrics around that evidence, BEFORE you start gathering it. It also means making sure the questions and tests are designed to elicit binary judgments.
In the “customer relationship” box, Joe and Amy have listed generic marketing vehicles. Spending money on any one of these channels will have some result. Some people will make a purchase based on an email link; but that doesn’t make email with links in the right channel. A valid proposition about a marketing channel is one that’s designed in the form of a metric that is tied to a performance level required by other aspects of the model.
Coherence pushes the business model canvas in the direction of greater resolution – behind every question several new questions are hidden. Test-ability is designed to invalidate propositions, and therefore push the canvas in a new direction – toward a somewhat different picture. The two processes work together — invalidated propositions make way for new iterations to be tested, and new propositions call for new rounds of coherence testing. For example, less efficient channels might raise the cost to acquire customers, which might impact manufacturing or packaging contracts, which might raise prices, which might impact the value proposition. The ultimate goal is a high resolution picture of a valid business.
Framing
Broad framing is an important heuristic to support both coherence and testability. When asking yourself about a product of feature, or asking customers or partners, you get better information if you avoid narrow framing “What do you think of X?” and look for broader-framed equivalents. “What do you think of X or Y or Z?” There are two reasons for this – the first is that it’s too easy for you or your team or your potential customers or partners to make a decision and then through rationalize it, rather than to make thoughtful judgments. The second is that multiple options expose nuances, while fewer options hide them.
In Joe and Amy’s canvas, customers are listed as “pet owners.” Will pet owners buy their organic pet food? This is a tough question to validate, and worse, conclusions about its validity are tough to turn into a business activity. Better to test propositions about lots of customers:
- Pet owners in the Northwest
- Pet owners in big cities
- Boarding kennels
- Holistic vets
- New pet owners
- Owners of geriatric animals
- People who shop at Whole Foods and have pets
- People who shop at Costco and have pets
Having a lot of options will guard Joe and Amy against investing too much in validating a single customer segment, and subconsciously putting their thumbs on the scale. Plus, thinking through different types of customers is a great way to narrow and concretize your hypotheses. Validating the proposition that the customers are “pet owners” wouldn’t tell them much about the rest of the canvas. But good evidence that “pet owners in the Northwest who shop at Whole Foods” are interested, reverberates through the rest of the canvas, with implications for manufacturing, pricing, communicating, distributing, and partnering.
Startup Discontinuity – Canvas Part 2
The business model canvas has become ubiquitous in startup environments, but has yet to develop much traction as an analytical tool in larger organizations.[1] That’s ironic, because using the canvas at a large organization is much more straightforward. To use it productively in a startup environment, it’s first necessary to overcome a confusing discontinuity:
A startup is not just a smaller version of a large company
It’s more like a precursor entity
Piper Cubs are pretty different from 787s, but only in superficial ways. Both carry people through the air to their destinations, using engines that generate forward motion, wing structures that generate lift, and flaps that allow directional changes. In contrast, caterpillars don’t eat or move or defend themselves or reproduce in the same way as butterflies. They’re designed not to be but to become butterflies.
In exactly the same way, startups are designed not to be but to become companies. So in a startup context, a filled-out canvas is not a description of reality but a set of guesses or hypotheses. A startup can use the canvas to keep track of current hypotheses, or to keep track of what they’re actually doing week to week, but using it for both purposes invites confusion.
Business Anatomy – Canvas Part 1
Business Model Generation by Osterwalder and Pigneur, with its nine-bucket “business model canvas,” sits on the work tables at virtually every startup working at Flashpoint, and at desks and worktables and night tables around the globe, wherever people are dreaming up or implementing startups. The canvas is easily misconstrued as a template – something like a form you need to fill out if you’re writing a business plan in business school. Using it that way is a waste. It’s really more like an anatomy chart. You can think of human systems in terms of what we need to survive as living beings – systems for locomotion, for energy, for defense, reproduction, sensing, etcetera. These systems are what define us. Companies are constituted out of the systems labeled in the business model canvas in exactly the same way: they need customers, relationships, activities, a value proposition, and the five other systems in order to BE companies. Steve Blank provides a nice overview of the state of the art of using the canvas for startups here.
Anatomy Chart[1]
Business Model Canvas
|
Key Partners |
Key Activities |
Value Proposition |
Cust. Relationship |
Cust. Segment |
|
|
Key Resources |
Channels |
||||
|
Cost Structure |
Revenue Structure |
||||
When you encounter a person, millennia of evolution leap to your aid in figuring out what’s going on. You know what people are, you’ve got norms in mind for physical, mental, emotional, cultural, and lots of other realms: this one’s a big friendly cop who doesn’t seem very bright, that’s a quick-witted, shady competitor, he’s a potential date, she’s an executive deciding whether to hire you – we don’t need a canvas to help clarify essential human attributes and size people up.
But we usually encounter companies a little bit like the proverbial blind men touching different parts of an elephant. Apple makes products you like, Starbucks seems to be everywhere, Google’s stock keeps going up, Budweiser reminds you of having fun, Enron is (was) smart and unethical, etcetera.
Without the canvas, we assess companies, and startup ideas, based on partial information. Worse, we habitually labor under the mistaken impression that what we know is all we need to know to make a wise judgment. What I know about Apple (the products are cool and the stores busy) is all I need to know to make a decision about buying Apple stock. What I know about my startup idea (everyone I talk to agrees that it sounds like a great idea) is sufficient to moving forward. The canvas helps out by ushering us out of idle imagination into creativity.
With the canvas you can start imagining what’s possible. Animals generally need a form of locomotion. Lots of forms are possible – legs, wings, tentacles, flippers, but each form has implications for the rest of the animal – where they live, how they avoid danger, find food, how big they’ll be. Likewise, companies generally need a form of communicating with customers — what should mine have? Emailing, knocking on doors, sending catalogs, social media, locating in malls – each option comes with a set of implications for all the other company systems. It’s the implications together with the reminder to touch every important base, that makes the the canvas helpful in imagining a potentially real company.
[1] By Naked human male body front anterior.png: Mikael Häggström Frau-2.jpg: Rainer Zenz derivative work: Lamilli [CC-BY-SA-3.0 (www.creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons
Lemon Tree Very Pretty
One of the catchphrases from the last post, “make sure the lemons ripen early” is usually meant to warn investors against putting more money into failing companies. Entrepreneurs do better too, when they keep it in mind.
Both entrepreneurs and their investors are usually optimists. Daniel Kahneman takes a dim view of entrepreneurial optimists, accusing them of the following judgment errors:
- Focusing on their own goal and on plans, neglecting relevant experience and statistics from similar efforts
- Focusing on their own actions, neglecting the plans and skills of others
- Believing they are superior to most others with respect to most desirable traits
- In understanding the past and predicting the future, focusing on the causal role of skill and neglecting the role of luck, thereby gaining an illusion of control
- Focusing on what they know and neglecting what they do not know, making them overly confident in their beliefs.[1]
In other words, entrepreneurial optimists believe they can buck the odds and do better than others, based on an illusion that they can control things and buoyed by an unwarranted level of confidence. Without optimists, we wouldn’t have startups; but the same traits and mindsets that lead to starting a new business also lead to new business failure. It’s an environment where a little pessimism goes a long way.
When VCs talk about lemons, they’re talking about lemon companies in their portfolio. Entrepreneurs can think of lemons as lemon hypotheses in their business model. Every idea about how your company is going to operate starts out as a guess, and every guess can be wrong. Steve Blank and Eric Reis urge you to validate those guesses. If entrepreneurs were rational, that would be sufficient advice. But entrepreneurs aren’t rational, they’re optimists. So telling them to “validate” is an invitation to over-reach and stamp “validated” on things they merely wish to believe are true. Instead, try to invalidate. Pretend your idea about the customer segment or a good value proposition or the way you’ll reach the market is someone else’s idea – someone you don’t like. What would your obnoxious neighbor have to do to prove to you that he was right about something and you were wrong? Approach your hypotheses like that, and you’ll ripen the lemons early – leaving you enough time and money to discover the real winners.
[1][1] Daniel Kahneman, Thinking Fast and Slow, pages 258-259.
Startup Catchphrases and Rules of Thumb
In his fabulous Thinking, Fast and Slow, Daniel Kahneman clarifies a distinction about the learnability of environments. Where can you be an expert, and where is it impossible? Kahneman de-mythologizes the idea of intuition by linking it to memory and learnability. He argues that learnable environments are those where situations can be recognized and remembered, moves can be made in those situations, and those moves result in feedback that you can assess. He gives the example of learning to drive around a curve as a very learnable environment. As a driver, you see lots of different curves, but not an infinite number. You can act, by braking, accelerating, or steering, and you get immediate feedback on your decision. Drive enough and you will become an expert on negotiating curves. Playing tic tac toe is another highly learnable environment. There are about a quarter of a million possible games, but only 1145 that people are likely to play.[1] Chess is more challenging but still learnable. There are an estimated 10 to the 111th reasonable chess games, but you don’t have to memorize all of them – instead, you learn to recognize prototypical situations, variations on them, and potential outcomes of various changes. Kahneman calls all of these “high validity environments.”
There are also low-validity and zero-validity environments. Zero-validity environments are like predicting the future of the Middle East, or the career path of young child, where the potential number of situations and moves are infinite, and the feedback is sparse. In these situations, experts are usually over-confident about their intuitions. Low-validity environments are somewhere in between, and decision-making in a startup is one of them.
Kahneman shows that in low validity environments, you almost always make better decisions by following a simple algorithm than by using your intuition. If you want healthy babies or productive employees, then simple algorithms like the Apgar Score for newborns or a checklist for new hires work consistently better than a doctor’s intuition or a managers feel for a candidate.
The equivalent of this in the startup world includes the rules of thumb, proverbs, and catchphrases used in the venture community. Even simple catchphrases like “dry powder” or “burn rate” effectively work as rules of thumb because they draw attention to something important that VCs attend to. Rules of thumb are not always true, but on average, you are more likely to go wrong by ignoring them than by following them.
The trick is to know when you really know enough about some aspect of your business to do better than by using a rule of thumb. There’s an epidemic of illusions of expertise in low-validity environments. If you have some experience, assume you’ve caught this disease. Be mindful about recovering from it by acquiring and validating data and by focusing on learnable domains. In the meantime, pay attention to rules of thumb.
Herewith some of the best, culled from several places on the web, especially Quora:
A fish doesn’t know it’s swimming in water: some market conditions which are second nature to people who have been immersed in them for a long time, can be interesting or valuable to customers who are new to the situation.
Adult supervision: bringing in a CEO with substantial market and/or company building experience on top of founding entrepreneurs
Bet the jockey, not the horse: Invest in great entrepreneurs, rather than in a particular business plan
Bootstrapping: Funding a company only by reinvesting your initial profits; from ‘pulling yourself up by your own bootstraps.
Cram Down: When a new funding round is done at a lower valuation than the previous one, meaning the original investors (or Founders) end up with a much smaller percentage ownership.
Burn Rate: The monthly negative cash flow from a pre-profitable startup.
Dance partner: If you’re entering an established market, find a partner with established credibility.
Don’t be without a chair when the music stops: Don’t be the last company that is not acquired after all the market leaders have acquired competitors in your segment.
Drip Feed: When investors fund a startup a little bit at a time instead of in a lump sum. This is very painful for both entrepreneurs and investors.
Drive-by Deal: an investment by a VC looking for a quick exit through a short term sale; different from the current ‘Early Exit’ approach by angel groups, which is a strategic focus
Dry Powder: Money held in reserve by a VC or angel in order to be able make additional investments in a company
Hire A players: A players hire A players. B players hire C players
If you’re not at the table, you’re on the menu
Is that a ‘top 3′ pain? Most IT departments have 3 priority initiatives that they are working to fix at any one time and your solution should address one of those commonly held initiatives across the market
Magical thinking. When investors or company executives create irrational theories to justify their causal role in things that succeed by happenstance or sheer luck
Make sure the lemons ripen early: Recognize failure early and stop wasting resources on it.
More companies die of indigestion than starvation: This one is attributed to David Packard
Most startups die of self-inflicted wounds: In other words, internal conflicts are far more likely to kill your startup than external competition
Nine women can’t make a baby in one month: When companies try to go faster by growing the technical and product teams but then discover the larger team doesn’t go any faster than the smaller (and therefore less cash consuming) team
No conflict, no interest
On mergers & acquisitions: Tying two stones together doesn’t make them float.
Put some wood behind this arrow: putting substantial resources behind a well-conceived tactic
Retail investors: angels and other outsiders who invest at full price, without any perks, quid pro quo, or other advantages.
Skate to where the puck is going: position a company in front of emerging secular trends as opposed to today’s market reality
Soft landing: selling an underperforming company or its assets quietly at a bargain, to avert a crash-and-burn.
Smart money: investors with inside knowledge, connections, or other personal attributes of use to the target company.
Special sauce, black box, mojo, magic, etc. Intellectual property of unspecified nature that may or may not exist, used to justify why a company’s product is unique, valuable, and hard to copy.
Spray and Pray: investing in lots of companies in the hopes that one of them will hit it big
The Golden Rule: The investor with the gold makes the rules. Forget whatever any previous contracts say; if you need money and only one source is willing to supply it, you’ll take the money on their terms, period.
Tip of the Spear: the starting sales proposition/use-case for a broad-based technology that will help with market and account penetration
Runway: How long a startup can survive before it goes broke; that is, the amount of cash in the bank divided by the Burn Rate.
Valley of Death: The period between the initial funding and the end of the Runway.
Walking Dead: a company that isn’t bankrupt, but will never succeed, and thus can’t be sold or otherwise exited
Waterfall: the order in which investors (and everyone else) get their money out on an exit. Almost always this is ‘last in, first out
Wave a dead chicken over it: in due diligence, a perfunctory analysis of factors unrelated to company value, designed to legitimize a faith-based investment. Comes from a coder reference to voodoo programming.
What you get when you hire B players, who then hire C players: “The bozo explosion”
