Good Business: The Four Steps to the Epiphany



The Path to Disaster:
The Product Development Model ...
For the gate is wide and the road broad that leads to destruction, and those who enter through it are many. — Matthew 7:13

EVERY TRAVELER STARTING A JOURNEY MUST
cecide what road to take. The road well traveled seems like the obvious choice.
The same is true in the search for startup success: Following a path of common wisdom—one taken by scores of startups before—seems like the right way. Yet for most startups, the wide road often leads straight to disaster. This chapter looks at how and why this is so. Let me begin with a cautionary tale. In the heyday of the dot-com bubble, Webvan stood out as one of the most electrifying new startups, with an idea that would potentially touch every household. Raising one of the largest financial war chests ever seen (over $800 million in private and public capital), the company aimed to revolutionize the $450 billion retail grocery business with online ordering and same-day delivery of household groceries. Webvan believed this was a “killer application” for the Internet. No longer would people have to leave their homes to shop.

They could just point, click, and order.
Webvan’s CEO told Forbes magazine Webvan would “set the rules for the largest consumer sector in the economy.”
Besides amassing megabucks, the Webvan entrepreneurs seemed to do
everything right.
The company raced to build vast automated warehouses and purchased fleets of delivery trucks, while building an easy-to-use website. Webvan hired a seasoned CEO from the consulting industry, backed by experienced venture capital investors. What’s more, most of their initial customers actually liked their service. Barely 24 months after the initial public offering, however Webvan was bankrupt and out of business. What happened? It wasn’t a failure of execution. Webvan did everything its board and investors asked. In particular, the company religiously followed the traditional Product Development model commonly used by startups, including “get big fast,” the mantra of the time. Its failure to ask, “Where Are the Customers?”

however, illuminates how a tried-and-true model can lead even the best-funded,
best-managed startup to disaster. The Product Development Model Every company bringing a new product to market uses some form of Product Development Model (Figure 1.1).

Emerging early in the 20th century, this product-centric model described a process that evolved in manufacturing industries. It was adopted by the consumer packaged goods industry in the 1950s and spread to the technology business in the last quarter of the 20th century. It has become an integral part of startup culture. At first glance, the diagram appears helpful and benign, illustrating the process of getting a new product into the hands of waiting customers. Ironically, the model is a good fit when launching a new product into an established, well-defined market where the basis of competition is understood, and its customers are known.

The irony is that few startups fit these criteria. Few even know what their market is. Yet they persist in using the Product Development model not only to manage Product Development, but as a roadmap for finding customers and to time their sales launch and revenue plan. The model has become a catchall tool for every startup executive’s schedule, plan, and budget. Investors use the Product Development model to set and plan funding. Everyone involved uses a roadmap designed for a very different location, yet they are surprised when they end up lost. The Product Development Model (Figure 1.1) To see what’s wrong with using the Product Development model as a guide to building a startup, let’s first look at how the model is currently used to launch a new product. We’ll view the actions at each step in two ways: in general practice and in the specific example of Webvan, which managed to burn through $800 million in three years. Then we will dissect the model’s toxic consequences for startups. What’s wrong with the old model in general, and how did Webvan compound those wrongs in their billion-dollar implosion? Let’s look at the model stage-by-stage. Concept and Seed Stage In the Concept and Seed Stage, founders capture their passion and vision for the company and turn them into a set of key ideas, which quickly becomes a business plan, sometimes on the back of the proverbial napkin. The first thing captured and wrestled to paper is the company’s vision. Next, issues surrounding the product need to be defined: What is the product or service concept? Is it possible to build? Is further technical research needed to ensure the product can be built? What are the product features and benefits?

Third, who will the customers be and where will they be found?
Statistical and market research data plus potential customer interviews determine whether the ideas have merit.
Step four probes how the product will ultimately reach the customer and the potential distribution channel. At this stage companies start thinking about who their competitors are and how they differ.
They draw their first positioning chart and use it to explain the company and its benefits to venture capitalists. The distribution discussion leads to some basic assumptions about pricing.

Combined with product costs, an engineering budget, and schedules, this results in a spreadsheet that faintly resembles the first financial plan in the company’s business plan. If the startup is to be backed by venture capitalists, the financial model has to be alluring as well as believable. If it’s a new division inside a larger company, forecasts talk about return on investment.

Creative writing, passion, and shoe leather combine in hopes of convincing an investor to fund the company or the new division.
Webvan did all of this extremely well. Founded in December 1996, with a compelling story, and a founder with a track record, Webvan raised $10 million from leading Silicon Valley venture capitalists in 1997. In the next two years, additional private rounds totaling an unbelievable $393 million would follow before the company’s IPO (initial public offering).

Product Development In stage two, Product Development, everyone stops talking and starts working. The respective departments go to their virtual corners as the company begins to specialize by functions. Engineering designs the product, specifies the first release and hires a staff to build the product. It takes the simple box labeled “Product Development” and using a Waterfall development process makes detailed critical path method charts, with key milestones.

With that information in hand, Engineering estimates delivery dates and development costs. Meanwhile, Marketing refines the size of the market defined in the business plan (a market is a set of companies with common attributes), and begins to target the first customers. In a well-organized startup (one with a fondness for process) the marketing folk might even run a focus group or two on the market they think they are in and prepare a Marketing Requirements Document (MRD) for Engineering. Marketing starts to build a sales demo, writes sales materials (presentations, data sheets), and hires a PR agency. In this stage, or by alpha test, the company traditionally hires a VP of Sales.

In Webvan’s case, Engineering moved along two fronts: building the automated warehouses and designing the website. The automated warehouses were a technological marvel, far beyond anything existing grocery chains had. Automated conveyors and carousels transported food items off warehouse shelves to workers who packed them for delivery.

Webvan also designed its own inventory management, warehouse management, route management, and materials handling systems and software to manage the customer ordering and delivery flow processes.

This software communicated with the Webvan website and issued instructions to the various mechanized areas of the distribution center to fulfill orders. Once a delivery was scheduled, a route-planning feature of the system determined the most efficient route to deliver goods to the customer’s home.
At the same time, planning began for a marketing and promotion program designed to strengthen the Webvan brand name, get customers to try the service in the first target market, build customer loyalty, and maximize repeat usage and purchases.

The plan was to build Webvan’s brand name and customer loyalty through public relations programs, advertising campaigns, and promotional activities. Alpha/Beta Test In stage three, alpha/beta test, Engineering works with a small group of outside users to make sure the product works as specified and tests it for bugs.

Marketing develops a complete marketing communications plan, provides Sales with a full complement of support material, and starts the public relations bandwagon rolling. The PR agency polishes the positioning and starts contacting the long lead-time press while Marketing starts the branding activities. Sales signs up the first beta customers (who volunteer to pay for the privilege of testing a new product), begins to build the selected distribution channel, and staffs and scales the sales organization outside the headquarters.

The venture investors start measuring progress by number of orders in place by first customer ship. Hopefully, somewhere around this point the investors are happy with the company’s product and its progress with customers, and the investors are thinking of bringing in more money.

The CEO refines his or her fund-raising pitch, and hits the street and the phone searching for additional capital. Webvan began to beta-test its grocery delivery service in May 1999 to approximately 1,100 people. At the same time, the marketing buzz started with a PR blitz as hundreds of articles appeared touting the newest entrant in the online grocery business. Private investors poured hundreds of millions of dollars into the company.

Product Launch and First
Customer Ship Product launch and first customer ship mark the final step in this model, and what the company has been driving for.
With the product working (sort of), the company goes into “big bang” spending mode. Sales is heavily building and staffing a national sales organization; the sales channel has quotas and sales goals.
Marketing is at its peak.
The company has a large press event, and Marketing launches a series of programs to create end-user demand (trade shows, seminars, advertising, email, and so on).

The board begins measuring the company’s performance on sales execution against its business plan (which typically was written a year or more earlier, when the entrepreneur was looking for initial investments). Building the sales channel and supporting the marketing can burn a lot of cash.
Assuming no early liquidity (via an IPO or merger) for the company, more fund raising is required.

The CEO looks at the product launch activities and the scale-up of the sales and marketing team, and yet again goes out, palm up, to the investor community.
(In the dot-com bubble economy, investors used an IPO at product launch to take the money and run, before there was a track record of success or failure.)
If you’ve ever been involved in a startup, the operational model no doubt sounds familiar.
It is a product- and process-centric model used by countless startups to take their first product to market. Webvan launched its first regional Webstore in June 1999
(just one month after starting beta test) and filed for its public offering 60 days later.

The company raised $400 million and had a market capitalization of $8.5 billion the day of its IPO—larger than the top three grocery chains combined. What’s Wrong With This Picture? Given that the Product Development model is used by almost every organization launching a new product, asking what’s wrong with it might seem as heretical as asking “What’s wrong with breathing?

” Nevertheless, for Webvan and thousands of other startups, it has failed miserably. The first hint lies in its name. The Product Development model is not a marketing, sales hiring, customer acquisition, or even a financing model. Yet startup companies have traditionally used a Product Development model to manage and pace all these non-engineering activities. In fact, there are 10 major flaws to using the Product Development model in a startup.

1. Where Are the Customers? To begin with, the Product Development model ignores the fundamental truth about startups and all new products.
The greatest risk—and hence the greatest cause of failure—in startups is not in the development of the new product but in the development of customers and markets. Startups don’t fail because they lack a product; they fail because they lack customers and a proven financial model. This alone should be a pretty good clue about what’s wrong with using the Product Development model as the sole guide to what a startup needs to be doing. Look at the Product Development model and ask,
“Where are the customers?”

2. The Focus on First Customer Ship Date Using the Product Development model forces sales and marketing to focus on the first customer ship date. Most competent sales and marketing executives look at the first customer ship date, look at the calendar, and then work backwards figuring out how to do their job in time so the fireworks start the day the product is launched.

The flaw in this thinking is that “first customer ship” is only the date when Product Development thinks they are “finished” building the product. The first customer ship date does not mean the company understands its customers or how to market or sell to them. (Read the preceding sentence again. It’s a big idea.) Yet in almost every startup, ready or not, the sales, marketing, and business development people are busy setting their departmental watches to the first customer ship date.

Even worse, a startup’s investors are managing their financial expectations by this date as well. Investors say: “Why of course that’s what you do.
Getting the product to market is what sales and marketing people do in startups. That’s how a startup makes money.” This is deadly advice. Ignore it. Focusing only on first customer ship results in a “Fire, Ready, Aim” strategy.
Obviously, your new division or company wants to get a product to market and sell it, but that cannot be done until you understand who you are selling your product to and why they will buy it.

The Product Development model is so focused on building and shipping the product that makes the fundamental and fatal error of ignoring the process I call Customer Discovery. Think about every startup you’ve been in or known about. Haven’t the energy, drive, and focus been on finishing the product and getting it to market?

Think about what happens after the first customer ship party is over, the champagne is flat, and the balloons are deflated. Sales now must find the quantity of customers the company claimed it could find when it first wrote its business plan. Sure, Sales may have found a couple of “beta” customers, but were they representative of a scalable mainstream market?
(A mainstream market is where the majority of people in any market segment reside. They tend to be risk-averse, pragmatic purchasers.)


Time after time, only after first customer ship, do startups discover their early customers don’t scale into a mainstream market, the product doesn’t solve a high-value problem, or the cost of distribution is too high. While that’s bad enough, these startups are now burdened with an expensive, scaled-up sales organization getting increasingly frustrated trying to execute a losing sales strategy, and a marketing organization desperately trying to create demand without a true understanding of customers’ needs. And as Marketing and Sales flail around in search of a sustainable market, the company is burning through its most precious asset—cash.

At Webvan, the dot-com mania may have intensified their inexorable drive to first customer ship, but its single-minded focus was typical of most startups.
At first customer ship, Webvan had close to 400 employees. It hired over 500 more during the next six months.

By May 1999 the company opened its first $40 million distribution center, built and scaled for a customer base it could only guess at, and had committed to 15 more distribution centers of the same size. Why? Because the Webvan business plan said that was the goal—regardless of whether the customer results agreed.

3. An Emphasis on Execution Instead of Learning and Discovery In startups the emphasis is on “get it done, and get it done fast.
” So it’s natural that heads of Sales and Marketing believe they are hired for what they know, not what they can learn. They assume their prior experience is relevant in this new venture.

They assume they understand the customer problem and therefore the product that needs to be built and sold. Therefore they need to put that knowledge to work and execute the product development, sales and marketing processes and programs that have worked for them before.
This is usually a faulty assumption.

Before we can build and sell a product, we have to answer some very basic questions: What are the problems our product solves?
Do customers perceive these problems as important or “must-have”?
If we’re selling to businesses, who in a company has a problem our product could solve?
If we are selling to consumers how do we reach them?
How big is this problem?

Who do we make the first sales call on?
Who else has to approve the purchase?
How many customers do we need to be profitable?
What’s the average order size? Most entrepreneurs will tell you,
“I know all the answers already.
Why do I have to do it again?

” It’s human nature that what you think you know is not always what you know.
A little humility goes far. Your past experience may not be relevant for your new company. If you already know the answers to the customer questions,
the Customer Development process will go quickly and reaffirm your understanding.
A company needs to answer these questions before it can successfully ramp up
sales. For startups in a new market, these are not merely execution activities; they are learning and discovery activities critical to the company’s success or failure.

Why is this distinction important ?
Take another look at the Product Development model. Notice it has a nice linear flow from left to right. Product Development, whether it is intended for large companies or consumers, is a step-by-step, execution-oriented process. Each step happens in a logical progression that can be PERT charted
(a project management technique for determining how much time a project takes to complete), with milestones and resources assigned to completing each step.

Yet anyone who has ever taken a new product out to a set of potential customers can tell you a good day in front of customers is two steps forward and one step back.
In fact, the best way to represent what happens outside the building is with a series of recursive circles—recursive to represent the iterative nature of what actually happens in a learning and discovery environment. Information and data are gathered about customers and markets incrementally, one step at a time. Yet sometimes those steps take you in the wrong direction or down a blind alley.

You find yourself calling on the wrong customers, not understanding why people will buy, not understanding what product features are important. The ability to learn from those missteps is what distinguishes a successful startup from those whose names are forgotten among the vanished. Like all startups focused on executing to plan, Webvan hired a vice president of merchandising, a vice president of marketing and a vice president of product management—to head three groups oriented around executing a sales strategy, not learning and discovering customer needs. Sixty days after first customer ship these three groups employed over 50 people.

4. The Lack of Meaningful Sales, Marketing and Business Development Milestones The one great thing you can say about Product Development using a Waterfall methodology is that it provides an unambiguous structure with clearly defined milestones.

The meaning of requirements documents, functional specifications, implementation, alpha test, beta test, and first customer ship are obvious to most engineers. If the product fails to work, you stop and fix it. In stark contrast, sales and marketing activities before first customer ship are ad hoc, fuzzy, and absent measurable, concrete objectives.

They lack any way to stop and fix what’s broken (or even to know if it is broken,
or how to stop at all). What kind of objectives would a startup want or need?
That’s the key question. Most sales executives and marketers tend to focus on execution activities because these are measurable.
For example, in sales, revenue matters most. Sales uses revenue as its marker of progress in understanding customers. Some startup sales execs also believe hiring the core sales team is a key objective.

Others focus on acquiring early “lighthouse” customers (prominent customers who will attract others). Marketers believe creating corporate presentations, data sheets, and collateral are objectives. Some think hiring a PR agency, starting the buzz and getting on the covers of magazines at launch are objectives.

In reality none of these is the true objective. Simply put, a startup should focus on reaching a deep understanding of customers and their problems, their pains, and the jobs they need done discovering a repeatable roadmap of how they buy, and building a financial model that results in profitability. The appropriate milestones measuring a startup’s progress answer these questions: How well do we understand what problems customers have? How much will they pay to solve those problems? Do our product features solve these problems? Do we understand our customers’ business? Do we understand the hierarchy of customer needs?

Have we found visionary customers, ones who will buy our product early?
Is our product a must-have for these customers?
Do we understand the sales roadmap well enough to consistently sell the product?
Do we understand what we need to be profitable?
Are the sales and business plans realistic, scalable, and achievable?
What do we do if our model turns out to be wrong?
Webvan had no milestones saying “stop and evaluate the results” (2,000 orders per day versus 8,000 forecasted) of its product launch.

Before any meaningful customer feedback was in hand, and only a month after the product started shipping, Webvan signed a $1 billion deal (yes, $1,000,000,000) with Bechtel. The company committed to the construction of up to 26 additional distribution centers over the next three years. Webvan leapt right over learning and discovery in its rush to execution.

There is a big difference between a process that emphasizes getting answers to the fundamental questions I’ve listed above and a process using the Product Development model to keep early sales and marketing activities in sync with first customer ship. To see what I mean, consider the Product Development model from the perspective of people in sales and marketing (Figure 1.2).

5. The Use of a Product Development Methodology to Measure Sales Using the Product Development Waterfall diagram for Customer Development activities is like using a clock to tell the temperature. They both measure something, but not the thing you wanted. Figure 1.2 shows what the Product Development model looks like from a sales perspective.

A VP of Sales looks at the diagram and says, “Hmm, if beta test is on this date,
I’d better get a small sales team in place before that date to acquire my first ‘early customers.’ And if first customer ship is on this date over here, then I need to hire and staff a sales organization by then.” Why?
“Well, because the revenue plan we promised the investors shows us generating customer revenue from the day of first customer ship.”

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