My friend, Rouhin, sent me this post by a rather angry fellow, which he and I both had a good chuckle out of, yesterday about how VC is a scam. In one part about startup growth, the author writes that VCs only care about businesses that double its customer base.
The author’s argument isn’t completely unfounded. And it’s something that’s given the industry as a whole a bad rap. True, growth and scalability are vital to us. That’s how funds make back their capital and then some. With the changing landscape making it harder to discern the signal from the noise, VCs are looking for moonshots. The earlier the stage, the more this ROI multiple matters. Ranging from 100x in capital allocation before the seed stage to 10x when growth capital is involved. But in a more nuanced manner, investors care not just about “doubling”, unilaterally, but the last time a business doubles. We care less if a lemonade stand doubles from 2 to 4 customers, than when a lemonade corporation doubles from 200 to 400 million customers, or rather bottles, for a more accurate metric.
After early startup growth
Of course, in a utopia, no businesses ever plateau in its logistical curve – best described as it nears its total TAM. That’s why businesses past Series B, into growth, start looking into adjacent markets to capitalize on. For example, Reid Hoffman‘s, co-founder of LinkedIn, now investor at Greylock, rule of thumb for breaking down your budget (arguably effort as well) once you reach that stage is:
70% core business
20% business expansion – adjacent markets that your team can tackle with your existing resources/product
10% venture bets – product offerings/features that will benefit your core product in the longer run
And, the goal is to convert venture bets into expansionary projects, and expansionary projects to your core business.
Simply put, as VCs, we care about growth rates after a certain threshold. That threshold varies per firm, per individual. If it’s a consumer app, it could be 1,000 users or 10,000 users. And only after that threshold, do we entertain the Rule of 40, or the minimum growth of 30% MoM. Realistically, most scalable businesses won’t be growing astronomically from D1. (Though if you are, we need to talk!) The J-curve, or hockey stick curve, is what we find most of the time.
The Metrics
In a broader scope, at the early stage, before the critical point, I’m less concerned with you doubling your user base or revenue, but the time it takes for your business to double every single time.
From a strictly acquisition perspective, take day 1 (D1) of your launch as the principal number. Run on a logarithmic base 2 regression, how much time does it take for your users (or revenue) to double? Is your growth factor nearing 1.0, meaning your growth is slowing and your adoption curve is potentially going to plateau?
Growth Factor = Δ(# of new users today)/Δ(# of new users yesterday) > 1.0
Why 1.0? It suggests that you could be nearing an inflection point when your exponential graph start flattening out. Or if you’re already at 1.0 or less, you’re not growing as “exponentially” as you would like, unless you change strategies. Similarly, investors are looking for:
ΔGrowth Factor > 0
Feel to replace the base log function with any other base, as the fundamentals still hold. For example, base 10, if you’re calculating how long it takes you to 10x. Under the same assumptions, you can track your early interest pre-traction, via a waitlist signup, similarly.
While in this new pandemic climate (which we can admittedly also evaluate from a growth standpoint), juggernauts are forced to take a step back and reevaluate their options, including their workforce, providing new opportunities and fresh eyes on the gig economy, future of work, delivery services, telehealth, and more. Stay safe, and stay cracking!
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Today, I read a 2017 piece on Nylon about advice from black writers to black writers. And there was one particular quote that caught my eye.
“Don’t edit while writing a draft or else you never finish.” – Terry McMillan
I can’t speak for the writing industry as a whole; I can’t even speak for my friends who are writers. Didn’t ask. But I can speak for myself. For this blog. Admittedly, 70% of all pieces I start writing, I don’t finish. And quite honestly, I almost hate that about myself. Writing for eyes that are more than my own has turned me into a perfectionist. The very thing I once swore to not become.
So, I’m going to try an experiment. More so for myself, in hopes of reducing the friction for me to write more. Every so often, I will post something I will title as “#unfiltered”. It’ll be less of a well-constructed thesis or methodical breakdown, but more of a writing to help me think. In sum, it’ll be a brain barf. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity. Don’t feel obligated to read it. In fact, if you don’t like brain barfs, don’t click on any of them, prefaced by its own #spoileralert. But if you do like unfiltered commentary and my rough thoughts, stay tuned. 😀
Over the past decade, stretching its roots to the dot-com boom, there have been more dialogue and literature around entrepreneurship. In a sense, founding a business is easier than it’s ever been. But like all things in life, there’s a bit more nuance to it. So, what’s the state of startups right now?
Lower Barriers to Entry
A number of factors have promoted such a trend:
There are an increasing number of resources online and offline. Online courses and ed-tech platforms. Fellowships and acceleration/incubation programs. Investor office hours and founder talks. YouTube videos, online newsletters, and podcasts.
The low-code/no-code movement is also helping bridge that knowledge gap for the average person. Moreover, making it easier for non-experts to be experts.
The gig economy have created a fascinating space for solopreneurship to be more accessible to more geographies.
Demand (by consumers and investors) fuels supply of startups, through knowledge and resource sharing. Likewise, the supply of startups, especially in nascent markets, fuels demand in new verticals. So, the ecosystem becomes self-perpetuating on a positive feedback loop. As Jim Barksdale, former Netscape CEO, once said:
“There are only two ways I know of to make money – bundling and unbundling.”
Bundling
Unbundling
Market Maturity
Market Nascency
Horizontalization
Verticalization
Breadth
Depth
Execution Risk Bias
Market/Tech Risk Bias
Right now, we’re at a stage of startup market nascency, unbundling the knowledge gap between the great and the average founder. This might seem counter-intuitive. After all, there’s so much discourse on the subject. There’s a good chance that you know someone who is or have thought about starting a business. But, I don’t believe we’re even close to a global maximum in entrepreneurship. Why?
Valuations are still on the rise. Six years back, $250K was enough runway for our business to last until product-market fit. Now, a typical seed round ranges from $500K-$2M. A decade ago, $500M was enough to IPO with; now it only warrants a late-stage funding round. By capitalistic economic theory, when a market reaches saturation, aka perfect competition, profit margins regress to zero. Not only are there still profits to be made, but more people are jumping into the investing side of the business.
Yes, increasing valuations are also a function of FOMO (fear of missing out), discovery checks (<0.5% of VC fund size), super duper low interest rates (causing massive sums of capital to surge in chase yields), and non-traditional venture investors entering as players in the game (PE, hedge funds, other accredited investors, (equity) crowdfunding platforms). It would be one thing if they came and left as a result of a (near) zero sum game. But they’re here to stay. Here’s a mini case study. Even after the 2018 drop in Bitcoin, venture investors are still bullish on its potential. In fact, there are now more and more specialized funds to invest in cryptocurrency and blockchain technology. Last year, a16z, one of the largest and trendsetting VC players, switched from a VC to an RIA (registered investment advisor), to broaden its scope into crypto/blockchain.
Great founders are scarce
“The only uncrowded market is great. There’s always a fucking market for great.”
– Tim Ferriss, podcaster, author, but also notably, an investor and advisor for companies, like Facebook, Uber, Automattic and more
Even if founders now have the tools to do so, it doesn’t mean they’ll hit their ambitious milestones. For VCs, it only gets harder to discern the signal from the noise. Fundamentally, there’s a significant knowledge delta – a permutation of misinformation and resource misallocation – in the market between founders and investors, and between average founders and great founders.
The Culinary Analogy
Here’s an analogy. 30 years prior, food media was still nascent. Food Network had yet to be founded in 1993. The average cook resorted to grandma’s recipe (and maybe also Cory’s from across the street). There was quite a bit of variability into the quality of most home-cooked dishes. And most professional chefs were characteristically male. Fast forward to now, food media has become more prevalent in society. I can jump on to Food Network or YouTube any time to learn recipes and cooking tips. Recipes are easily searchable online. Pro chefs, like Gordon Ramsay, Thomas Keller, and Alice Waters, teach full courses on Masterclass, covering every range of the culinary arts.
Has it made the average cook more knowledgeable? Yes. I have friends who are talking about how long a meat should sous vide for before searing or the ratio of egg whites to egg yolks in pasta. Not gonna lie; I love it! I’ll probably end up posting a post soon on what I learned from culinary mentors, friends, and myself soon.
Is there still a disparity between the average cook and a world-class chef? Hell ya! Realistically I won’t ever amount to Wolfgang Puck or Grant Achatz, but I do know that I shouldn’t deep fry with extra virgin olive oil (EVOO) ’cause of its low smoke point.
Great businesses are scarcer
The same is true for entrepreneurship. There are definitely more startups out there, but there hasn’t been a significant shift in the number of great startups. And the increase in business tools has arguably increased the difficulty to find business/product defensibility. It’s leveled the playing field and, simultaneously, raised the bar. So yes, it’s easier to start a business; it’s much harder to retain and scale a business.
It’s no longer enough to have an open/closed beta with just an MVP. What startups need now is an MLP (minimum lovable product). Let’s take the consumer app market as an example.
The Consumer App Conundrum
Acquiring consumers has gotten comparatively easier. Paid growth, virality, and SEO tactics are scalable with capital. More and more of the population have been conditioned to notice and try new products and trends, partly as a function of the influencer economy. But retaining them is a different story.
So, consumers have become:
More expensive to acquire than ever before. Not only are customer acquisition costs (CAC) increasing, with smaller lifetime values (LTV), but your biggest competitors are often not directly in your sector. Netflix and YouTube has created a culture of binge-watching that previously never existed. And since every person has a finite 24 hours in a day, your startup growth is directly cutting into another business’s market share on a consumer’s time.
And, harder to retain. It’s great that there’s a wide range of consumer apps out there right now. The App Store and Play Store are more populated than they’ve ever been. But churn has also higher now than I’ve seen before. Although adoption curves have been climbing, reactivation and engagement curves often fall short of expectations, while inactive curves in most startups climb sooner than anticipated. Many early stage ventures I see have decent total account numbers (10-30K, depending on the stage), but a mere 10-15% DAU/MAU (assuming this is a core metric). In fact, many consumers don’t even use the app they downloaded on Day 2.
Luckily, this whole startup battlefield works in favor of consumers. More competition, better features, better prices. 🙂
So… what happens now?
It comes down to two main questions for early-stage founders:
Do you have a predictable/sensible plan to your next milestone? To scalability?
Are you optimizing for adoption, as well as retention and engagement?
With so many tools for acquisition hacks, growth is relatively easy to capture. Retention and engagement aren’t. And in engagement, outside of purely measuring for frequency (i.e. DAU/MAU), are you also measuring on time spent with each product interaction?
How are you going to capture network effects? What’s sticky?
Viral loops occur when there’s already a baseline of engagement. So how do you meaningfully optimize for engagement?
From a bottom-up approach (rather than top-down by taking percentages of the larger market), how are you going to convert your customers?
How do you measure product-market fit?
What meaningful metric are you measuring/optimizing?
Why is it important?
What do you know (that makes money) that everyone else is either overlooking or severely underestimating?
What are you optimizing for that others’ (especially your biggest competitors) cannot?
Every business optimizes for certain metrics. That have a set budget used to optimize for those metrics. And because of that, they are unable to prioritize optimizing others. So, can you measure it better in a way that’ll hold off competition until you reach network effects/virality?
Building a scalable business is definitely harder. And to become the 10 startups a year that really matter is even more so. By the numbers, less likely than lightning striking you. In my opinion, that just makes trying to find your secret sauce all the more exciting!
If you think you got it or are close to getting it, I’d love to chat!
Over the weekend, my friend and I were chatting about the next steps in her career. After spending quite some time ironing out a startup idea she wants to pursue, she was at a crossroads. Should she leave her 9-to-5 and pursue this idea full-time, or should she continue to test out her idea and keep her full-time job?
Due to my involvement with the 1517 Fund and since some of my good friends happen to be college dropouts, I spend quite a bit of time with folks who have or are thinking about pursuing their startup business after dropping out. This is no less true with 9-to-5ers. And some who are still the sole breadwinner of their family. Don’t get me wrong. I love the attention, social passion, literature and discourse around entrepreneurship. But I think many people are jumping the gun.
Ten years back, admittedly off of the 2008 crisis, the conversations were entirely different. When I ask my younger cousins or my friends’ younger siblings, “what do you want to be when you grow up?” They say things like “run my own business”, “be a YouTuber”, and most surprisingly, “be a freelancer”. From 12-yr olds, it’s impressive that freelancing is already part of their vocabulary. It’s an astounding heuristic for how far the gig economy has come.
Moreover, media has also built this narrative championing the college dropout. Steve Jobs and Apple. Bill Gates and Microsoft. And, Mark Zuckerberg and Facebook. There’s nothing wrong in leaving your former occupation or education to start something new. But not before you have a solid proof of concept, or at least external validation beyond your friends, family and co-workers. After all, Mark Zuckerberg left Harvard not to start Facebook, but because Facebook was already taking off.
Honing the Idea
The inherent nature of entrepreneurship is risk. As an entrepreneur (and as an investor), the goal should always be to de-risk your venture – to make calculated bets. To cap your downside.
Marc Benioff started his idea of a platform-as-a-service in March 1999. Before Marc Benioff took his idea of SaaS full-time, he spent time at Oracle with his mentor, Larry Ellison, honing this thesis and business idea. When he was finally ready 4 months later, he left on good terms. Those terms were put to the test, when in Salesforce’s early days, VCs were shy to put in their dollar on the cap table. But, his relationship he had built with Larry ended up giving him the runway he needed to build his team and product.
Something that’s, unfortunately, rarely talked about in Silicon Valley and the world of startups is patience. We’ve gotten used to hearing “move fast and break things”. Many founders are taught to give themselves a 10-20% margin of error. What started off as a valuable heuristic grew into an increase in quantity of experiments, but decrease in quality of experiments. Founders were throwing a barrage of punches, where many carried no weight behind them. No time spent contemplating why the punch didn’t hit its mark. And subsequently, founders building on the frontlines of revolution fight to be the first to market, but not first to product-market fit. Founders fight hell or high water to launch their MVP, but not an MLP, as Jiaona Zhang of WeWork puts it.
In the words of the one who pioneered the idea of platform-as-a-service,
The more transformative your idea is, the more patience you’ll need to make it happen.”
– Marc Benioff
As one who sits on the other side of the table, our job is to help founders ask more precise questions – and often, the tough questions. We act more as godmothers and godfathers of you and your babies, but we can’t do the job for you.
The “Tough” Questions
To early founders, aspiring founders, and my friends at the crossroads, here is my playbook:
What partnerships can/will make it easier for you to go-to-market? To product-market fit? To scalability?
What questions can you ask to better test product feasibility?
How can you partner with people to ask (and test) better questions?
What is your calculus that’ll help you systematically test your assumptions?
Do you have enough cash flow to sustain you (and your dependents) for the next 2 years to test these assumptions?
Simultaneously, it’s also to important to consider the flip side:
What partnerships (or lack thereof) make your bets more risky?
How can you limit them? Eliminate them?
And in sum, these questions will help you map out:
At this point in your career, does part-time or full-time help you better optimize yourself for reaching my next milestone?
I have a love-hate relationship with that word. On one hand, I love and seek to learn from creative souls. It’s a trait that I seriously respect in individuals, regardless of industry, profession, or background. On the other hand, it’s rather amorphous. What’s creative to me may not be creative to you. We are bounded by the parameters of our experiences and what we, as individuals, are exposed to.
So, where do innovators draw inspiration?
Over the years, I’ve seen inspiration stem from three main frameworks:
The flow from art;
Margins;
And, what people dislike.
The Flow from Art
I seem to find that the data largely (with a few outliers) points towards the following:
Art precedes science. Science precedes tech. Tech precedes business. Business precedes law.
Art is bounded only by one’s imagination. Science, which draws inspiration from art, is limited by our physical universe and the fundamental laws. And, tech rides on the coattails of science, restricted by the patterns recognized in our universe by scientists before them. Similarly, business can only optimize existing technology. Following suit, regulations and legal practice can only debate and prevent ramifications that have turned from hypothesis to reality.
On one end of the spectrum, fiction has driven innovation on the fundamental, scientific front. Scientists have tried to make the impossible – fiction, superstition, assumptions, and imagination – possible. On the other end, the legal and regulatory space has empirically lagged behind business innovation. From autonomous driving to the shared economy to video games, a regulatory emphasis came only after incidents occurred. I’m a huge proponent of founders becoming self-regulatory. But that is a discussion for another day.
Margins
As Jeff Bezos famously said:
“Your margin is my opportunity.”
In the lens of a businessperson, profits exist on the margins. In a fully saturated market, as we learned in economics class, perfect competition will squeeze out profits. That margin can be delta between human perfection and imperfection. It can be the difference between a naive and sophisticated individual. It can also be the blind spots between a self-awareness and ignorance.
The good news (and bad news?) is that humans aren’t rational. As much as we try to be, we’re not. We repeat the same mistakes. After all, that’s where our favorite stories come from – the fact that we’re imperfect. If we were rational, our friendly neighborhood kid from Queens wouldn’t have to struggle with identity. Or, Skinner, the head chef at Auguste Gusteau’s restaurant, wouldn’t be out to exterminate my favorite rat chef.
From a nonfictional front, if we were rational, gambling, the lottery, therapy, and more wouldn’t exist. In fact, there’s a whole industry that capitalizes on human imperfection – insurance. We choose to reach for that last cookie when we know a healthier diet with less sugar is better for us (I’m guilty as well). We set New Year’s resolutions to work out more, but regress to our couch norm after the first month. Walter Mischel famously conducted The Marshmallow Experiment. When given the option to wait 15 minutes to double their treats, many children opted for immediate gratification.
There would be way fewer founders if they were rational. I mean, come on, the numbers work against them. 90% of startups fail. So, from a VC’s perspective, we have to ask ourselves:
What’s is the underlying notion that makes this product work?
What is that innate theme in human or societal development that won’t disappear anytime soon? What factors produce such a trend? And what margin is it taking advantage of? Uber was made possible with the evolution of smartphone and faster data. As more data were archived online, Google became a reality because of the internet and browser. Two current examples of underlying notions include:
Audio, including, but not limited to, podcasts and audiobooks, is the new form of content consumption. Not only does it free up consumers’ hands and eyes up, audio content is often easier to digest. The spoken word has been around millennia, whereas print is fairly new invention. Emotions and sarcasm is often easier to relay via audio than via print. So, what else is possible?
With growing consumer sentiment against traditional social media, like Facebook, Twitter, and Instagram, there is a shift to social experiences surrounding active participation. Sarah Tavel writes a great piece on this. Examples include Discord, Medium, TikTok, and user-generated content (UGC) in video games, like mods and in-game skins. Many of the traditional social media platforms leave users with a more negative passive experience, where they feel a sense of FOMO (fear of missing out). Through active participation, users can be a part of the conversation, rather than watch from the sidelines.
What do you dislike?
Speaking of negative experiences, aversion is a strong motivating emotion humans have. Like prospect theory illustrates, loss invokes a stronger response than gains. It also happens to be one of the reasons why I probe how obsessed a founder is about a certain problem.
In a recent interview with Andrew “Kappy” Kaplan, host of the podcast, Beyond the Plate, Grant Achatz, legendary chef, talks briefly about how he drew inspiration from his daughter’s dislike of cheese, yet she still ate pizza and grilled cheese sandwiches. Similarly, when his guests at Alinea didn’t like sea urchin, he thought about the ‘why’ and if he could circumvent their aversion by playing with various variables, including iodine concentration.
So, what do you dislike (with a passion)? What about the people around you? And can you figure out a way to change or eliminate that frustration? Take some time through the idea maze.
In closing
Ideas come in all shapes and sizes. Some may be more obvious than others. Some may snowball into a best-selling one. Although I’ve shared the three most common frameworks that I’ve personally generated and seen others find inspiration, it is, of course, not the only ways to exercise your creative muscle. In fact, the first step into being more “creative” is being cognizant about everything around you.
Two years ago, one of my former professors recommended I start ‘idea-journaling’ every day. Since I’ve started, I began noticing more and more stimuli from my surroundings, conversations and frustrations.
It may be a start, but it’s by no means an end. Stay curious.
Founders take on many different types of risk when creating a business. Subsequently, investors constantly put founders and their businesses under scrutiny using risk as a benchmark. In broad terms, in my experience, they largely fall under two categories: execution risk and market risk.
Where I first introduced the dichotomy of market and execution risk in the frame of idea-market fit.
Some Background
Contrary to popular belief, VCs are some of the most risk-averse people that I know. As an investor, the two goals are to:
Take calculated bets, via an investment thesis and diligence;
And de-risk each investment as much as possible.
From private equity to growth equity to venture capital, more and more investors are writing ‘discovery checks.’ Typically, funds write checks that are 2-4% of their fund size. For example, $100M fund usually write $2-4M initial checks. Yet, more and more investors are writing increasingly smaller check sizes (0.1-0.5% fund size). In the $100M fund example, that’s $100-500K checks. This result is a function of FOMO (fear of missing out), as well as a proving grounds for founders before the fund’s partners put in their core dollar. Admittedly, this upstream effect does lead to:
Less diligence before checks are written (closing within 48-72 hours on the extreme end, and inevitably, more buyer’s remorse);
Less bandwidth allotted per portfolio startup (even less for startups given discovery checks);
The risks for a startup investor are fairly obvious, and so are the rewards. Effectively, an early-stage investor is betting millions of dollars on a stranger’s claim. But not all risks are the same.
In the eyes of a VC, an execution risk is categorically less risky than a market risk. Furthermore, even within the category of execution, a product risk is usually less risky than a team risk.
Execution Risk
Why are more and more early-stage investors defaulting to enterprise over consumer startups?
Two reasons.
Enterprise startups often run on a SaaS (software-as-service) subscription business model. There will always be recurring revenue, assuming the product makes sense. For an investor, that’s foreseeable ROI.
It’s an execution risk, not a market risk. Often times, an enterprise tech startup is the culmination of existing frustrations prevalent in the respective industry already. And therefore, have reasonably stable distribution channels and go-to-market strategies.
Using discovery checks, and playing pre-core business, VCs can evaluate team risk. Between the discovery check and their usual ‘core checks’, VCs can also test their initial hypotheses on their founders.
As a startup grows, especially after realizing product-market fit, market risk becomes more of a product risk. Best illustrated by market share, product risk is when a product fails to meet the expectations of their (target) customers. It can be evaluated via a permutation of key metrics, like unit economics, NPS, retention and churn rate. There is an element of technological risk early on in the startup lifecycle for deep tech ventures, but admittedly, it’s not a vertical I have my finger on the pulse for and can share insight into.
Given that VCs are either ex-operators or have seen a breadth of startup life-cycles, VCs can best use their experience to mitigate a startup’s execution risk.
Market Risk
Market risk requires a prediction of human/market behavior. And unfortunately, the vast majority of investors can predict about the constant evolution of human behavior as well as a founder can. What does that mean? Founders and VCs are walking hand-in-hand to gain market experience. It, quite excitingly, is an innovator’s Rubrik’s cube to solve.
Market risk is frequently attributed to consumer tech products. In an increasing proliferation of consumer startups, consumers have become more expensive to acquire and harder to retain. Distribution channels change frequently and are determined by political, economic, technological, and social trends.
In Closing
Every VC specializes in tackling a certain kind of risk. But founders must quickly adapt, prioritize, and tackle all the above risks at some point in the founding journey. As Reid Hoffman, co-founder of LinkedIn, famously said:
“An entrepreneur is someone who will jump off a cliff and assemble an airplane on the way down.”
While on my way to see a friend the other day, instead of cancelling, our Uber Pool driver decided to wait for the third rider. After a few exchanges of texts and calls, to the vocally evident dismay of the rider before me, we ended up waiting eight minutes. Therefore, delaying the rest of our arrival times by that same margin. In the ensuing silence that followed, I spent a little time thinking about the fascinating dichotomy between being nice and running a great business.
At the risk of receiving two low-star ratings, our driver opted to be nice and wait for the potential one five-star rating. To his credit, the third rider was incredibly grateful for his patience. In an alternate universe, he would have chosen to cancel the last rider’s request after waiting about two minutes.
The Examples
Social stereotypes might suggest that being nice and running a great business are two polar opposites. The portrayals of Mark Zuckerberg, in The Social Network, and Steve Jobs, in every biographical movie of him, only further perpetuate this motif. But, the truth is they’re not mutually exclusive. Many of the best businesses out there, like TOMS and Salesforce, are purpose-driven and spread positive impact. In the past few years, it should and has been, for many, a priority for building a brand.
Driving positive social impact is beginning to gain traction among a class of notoriously financially-driven individuals: venture investors. Although impact investing is one way, prominent VCs, like Felicis Ventures and Brad Feld, have also committed to founder’s mental health.
The marriage of being nice and running a great business comes in two parts:
Transparent and honest communication with your customers,
And, follow-through on promises and feedback implementation.
After all, it’s a collaborative effort.
One of my favorite examples is Digital Extremes – the developer for one of the most popular games on Steam, Warframe. Like many other businesses, they donate regularly to charities – from leukemia awareness to children’s health to most recently, the Australian wildfire. But, unlike many others, they engage their users every week through their stellar community management team. In fact, their community director, Rebecca Ford, was recognized in the 30 Under 30 Forbes list this year. Through a weekly permutation of developer streams, forum posts/polls, and social media content, they listen and engage with feedback. And through weekly hotfixes and content updates, which already speaks volumes in the game industry, they incorporate that feedback.
Don’t just take my word for it. Their subreddit serves as an example of one of the most positive and honest communities I’ve ever seen.
In Closing
Of course, no business is perfect. And the business may not always agree with the consumer’s thoughts. But, through transparent communication, radically candor (thank you to the brilliant Kim Scott), and following through, you can be nice and run a great business.
Instead of staying silent, if our Uber driver had asked us if we were in a hurry and agreed on a time limit to how long we’d wait (maybe even offered us a snack during the wait, but that might be stretching it), he might have gotten three five-star reviews.
I just started my second read of Ben Horowitz‘s new book, What You Do is Who You Are: How to Create your Business Culture. It’s a brilliant deep dive on what culture and virtues mean for a growing company or team. From the most successful slave revolution in history to prison culture to the samurai bushido, Ben draws parallels between those and startup culture, where you can get a snapshot here.
On page 31, Ben wrote “Create Shocking Rules.” Why “shocking”? So people will ask why. So people will pause, think, and remember them. What is “shocking”? In a time when raping and pillaging was the norm, Toussaint Louverture, the man who led the Haitian Revolution, forbade officers from having concubines. And he kept to that promise. When “shocking” isn’t the only game changer, you need uncompromising commitment to those rules. Weak follow-through is another fallacy in creating the culture you want. What you let slide will define the new culture, with or without your approval.
Sun Tzu and the Concubines
Rereading about Toussaint Louverture reminded me of a story my dad used to tell me by my bedside. About another brilliant general, who lived 2000 years prior to Toussaint during the Spring and Autumn Period, and best known for authoring The Art of War, Sun Tzu.
Through his thirteen chapters, dubbed The Art of War, he eventually earned an audience with the king of the State of Wu. Hoping to test Sun Tzu’s strategies to its extremes, possibly expecting to see Sun fail, the king asked Sun to test it on his harem of concubines.
After accepting the task at hand and separating the concubines into two companies, Sun had them all take a spear in hand and said, “I presume you know the difference between front and back, right hand and left hand?”
The women answered, “Yes.”
After explicitly explaining what “Eyes front”, “Left turn”, “Right turn”, and “About turn” meant, he issued his first order at the sound of the drums, “Right turn.” But, the concubines responded with fits of laughter. Sun Tzu proclaimed, “If words of command are not clear and distinct, if orders are not thoroughly understood, then the general is to blame.”
In another attempt, he called out, “Left turn.” His words met the same fate as the ones he uttered just prior – with laughter. This time, he said, “If words of command are not clear and distinct, if orders are not thoroughly understood, the general is to blame. But if his orders are clear, and the soldiers still disobey, then it is the fault of their officers.”
Subsequently, he ordered the heads of the two companies beheaded, whom happened to be king’s favorite two concubines. Seeing what had unfolded from his pavilion, the king sent a messenger to plead with Sun to keep his two favorite alive. But Sun did not relent.
After their execution, he immediately installed two new officers, and from then on, the concubines followed every order that Sun issued to the T.
Using the principles he shared and taught in The Art of War, Sun Tzu won many battles for the State of Wu, most notably, when Sun Tzu led an army of 30,000 to defeat an enemy numbering ten times more than the troops from Wu. As Jon Stewart, former The Daily Show host, once said:
“If you don’t stick to your values when they’re being tested, they’re not values: they’re hobbies.”
In Closing
In his book, Ben shares quite a bit how some of the best leaders in the world shaped their organizational culture. It wasn’t from catered lunches or having dogs in the office every Friday. Culture comes down to setting “shocking” rules, paired with a set of priorities, and more importantly, keeping them. Culture is what your team members remember about your organization and how it made and makes them feel 20 years down the road.
Though not perfect, my former swim coach instilled the same virtues in us. He was never a fan of tardiness. To him, it demonstrated a lack of character and commitment. And to enforce that, if we were late, by even a minute, to get into the water (not arrive at the pool), the offenders had to swim the entire warm-up in butterfly – the whole 2000 yards. And not one person escaped that law, not even him – not that I ever saw him late.
In the first startup I joined, we messed up our initial business model by not providing a reason for small- and medium-sized business (SMB) owners to stay. We created a marketplace between SMBs to transact with each other. But, after the first one to three transactions, they had no need for our platform. The scary thing about marketplaces isn’t that you’re connecting suppliers to their demand network, but not providing any bonuses after onboarding – a reason to stay.
Some of the stickiest companies are marketplaces because they provide that reason to stay. More often than not, providing a lovable product so convenient, it’s much easier to use the marketplace platform than to do the transaction themselves, and an easy, passive way to be discovered by future clients/customers that would be much more difficult on their own.
Why Multiplayer Video Games Work
In his book The Messy Middle, Scott Belsky, Chief Product Officer at Adobe and founder of Behance (acq. by Adobe), a discovery platform where creatives can showcase their portfolios and engage with others’, shares that when crafting the ‘first mile’ experience, you need to optimize for three questions:
Why are your customers here?
What can they accomplish?
What can they do next?
Arguably, I believe that founders should always have these three questions hovering above their product strategies, beyond the ‘first mile’, only embedded more implicitly. Video games do an amazing job in this regard, especially massively multiplayer online role-playing games, or MMORPGs for short.
Why play the game? Find escape and sanctuary to be someone players want to be but can’t in the confines of reality.
What can they accomplish? Achieve that endgame that players see in the trailers and in the tutorial (the onboarding for an MMORPG user). The endgame is self-defined as well. Of course, the game optimizes for the power creep meta endgame. Yet, players can always opt for a ‘destiny’, a story, they find compelling, like becoming a fashionista, a wealthy merchant, a mentor, a content creator, and with faster computing systems and more robust infrastructure, a contributor to the game itself, through user-generated content (UGC). The Steam Workshop is an excellent example of UGC.
What can they do next? Level up their character and gear. Tackle the next quest – main or side – towards something larger than themselves. There’s always a defined goal, as well as actionable steps and additional incentives laid out for the players. This creates high retention value – a reason to stay.
The same is true for many other types of genres of multiplayer games – multiplayer online battle arenas (MOBA), battle royale (BR), first-person shooters (FPS), and more. It’s just the narrative of the endgame may change a little towards leaderboard domination. E-sports, content creation, and live streaming then offers a new tier of recognition and endgame for many veteran players.
Back to Marketplaces
I’ve always argued that as a founder, you want to focus on unscalable wins before thinking of scale pre-product-market fit. Focus on the individual experiences. As Li Jin, partner at the reputable a16z, wrote in a post about the passion economy, “[great founders] view individuality as a feature, not a bug.” The best marketplaces, like Uber, Airbnb, and Medium, started off focusing on the unscalable wins for a small individual subset of their potential users. These products offered their early users a reason to stay:
(Additional) Incentives and tools, to make their stay worthwhile;
Discovery platform to help them grow their brand and customer base, actively and passively;
And, subsequent community and network effects.
Early adopters jump on a new product, as fast as they jump off one. They’re finicky. They’re window shoppers, but at the same time, the most willing and likely to try out your product. Luckily and unluckily, the San Francisco Bay Area has no shortage of these folks, and being a tech startup, with its initial user base here, often inflates your early metrics. In short, the goal of your product is to make these technological butterflies fall madly in love with you and your product. That’s the tough part, but it’ll also mean you’ve found product-market fit (PMF).
Where do we find ‘love’?
Instead of a minimum viable product, or MVP, Jiaona Zhang, Senior Director of Product at WeWork, in her First Round Review piece, chases the “pixie dust”, or what I like to call the secret sauce – a truly unique, money-making insight. This magic is found through diligent iteration on consumer feedback, especially in the beta stages of a product. During the beta, users have the serendipity to discover “that magical moment in the user journey where the user realizes that this product is different from anything else they’ve ever experienced”. Her framework, designed from the perspective of the consumer:
Wouldn’t it be cool if users could [a process/action that would 10X their lives]?
What We Learned
The same was true for us at Localwise. Of course, we were motivated by poor retention metrics. But, we learned what businesses truly needed by asking each of them in person, as well as flyering (and getting rejected, or worse, ignored) to college students and to shops. So, still deeply in love with the community we built, we found that need when connecting local talent to SMBs. For businesses with high churn rate with temporary employees and a need to build a brand, that was their reason to stay.
I was recently inspired by a fascinating conversation between Mike Maples Jr., co-founder and partner at Floodgate, and Andy Rachleff, co-founder of Benchmark Capital and Wealthfront, but more interestingly, the founder of the term, product-market fit, or PMF – a term that signifies when a product is recognized by a strong demand in the market. Over the years, there have been various ways entrepreneurs, go-to-market strategists, and investors have defined when an idea reaches product-market fit. But before I dive into the PMF, let’s take a look at market definitions first, which admittedly is a step off the beaten path.
The Markets
How I Like to Think about Market Sizes. *Not drawn to scale
Traditionally, the total addressable market (TAM), serviceable addressable market (SAM), and the serviceable obtainable market (SOM) are defined according to the geographic location of your market. It makes sense – your market is as big as where you can offer the service. But now, in an increasingly connected world, technologies are less and less inhibited by the geographical boundaries that plagued the decades before. That said, there are still cultural, social and economic differences when accessing new demographics, which is why I like to characterize the TAM, SAM, and SOM by psychological resistances to new ideas. The TAM is still defined by the total upside potential of a product, where it still excludes laggards, or folks who would most likely never (seek to) use your product. The SAM is construed of people who would use the product after three to five friends in their network recommend and are using the product themselves. And finally, the SOM consists of customers who are desperate, as Andy Rachleff called it, for your product. They have spent sweat, blood, and tears finding or building their own solution. They have already traversed the idea maze themselves and put the dollar (or the euro, peso, krone, pound, yen, RMB, BTC, ETH… you get my point) here their mouth is at. And here, in the SOM, is where you find your product-market fit.
Product-Market Fit
PMF is most noticeable on the hockey stick curve. Before PMF, traction is slow and looks very much like the blade of a hockey stick. And after PMF, traction skyrockets and exemplifies exponential growth.
The Hockey Stick Curve
While there are many heuristics to assess PMF across different verticals, I’m the most fluent in consumer tech where I’ve spent most of my time in. And in consumer tech, I’d like to underscore the notion of ‘exponential organic growth’, and subsequently, a short analysis on each word of that phrase.
Exponential is probably the most straight-forward, where at the early stages of a business, we’re looking for rapidly compounding growth.
Organic growth, as opposed to paid growth, is a measurement for word-of-mouth. Investors tend to measure the effectiveness of a product by its virality from its initial customers to its nth customer – growth that is achieved without directly spending (ad) dollars on acquiring the new customers.
Growth is something I break down into – retention and adoption. Increasing adoption is great as measured by the growth of total users on consumer platform or for a consumer product, but focusing only on adoption leads to a leaky funnel, or in my case, trying to hold too many groceries in my hand without a shopping cart. Every time I grab another item on the shopping list, I drop some other item I was already trying to balance and hold. Of course, focusing only on retention means there’s no growth, which for keeping your best friend circle is fine (unless you want a thousand BFFs), but not for growing a startup.
Below are some growth signs to pay attention to signify that your product is near/at PMF:
Retention
Adoption
> 25% DAU/MAU
100s of organic signups/day
40% are active day after signup
> 30% MoM growth
Usage 3 days out of every week
“Idea-Market Fit”
As a founder with an ambitious idea, reaching product-market fit is a great goal to have, but the truth is PMF is a mystical beast – a chimera – in and of itself. Market demands change; what satisfied the definition of PMF a decade ago may not satisfy it now and will most likely not satisfy it ten years from now. Many studies have shown that most startups don’t fail from technological risk, but rather the inability to reach PMF, which ends up leading to lack of investor interest, demotivation, and the founding team falling apart. And quite obviously, before you reach PMF, the hardest part about starting a business is reaching PMF, or what Peter Thiel and many call the Zero to One. I’ll dive into the lessons I learned about the journey to “1” in future posts, but for the purpose of this post, I’m going to focus on the “0” – or what I like to call, “idea-market fit“, or IMF.
What differentiates a good idea from a great money-making idea? I’m going to borrow Andy’s thought calculus exercise. In a 2×2 matrix with right/wrong on one axis and consensus and non-consensus on the other, “you want to be right on the non-consensus.”
Andy Rachleff’s 2×2 Startup Idea Matrix
Why? Discounting the situations where you’re wrong (because you don’t make much, if any money), if you’re right on consensus, it means the market’s already mature, and perfect competition in a capitalistic market squeezes you out of your profit margins. If you do pursue this option as a founder, you’re more or less tackling an execution risk. On the other hand, if you’re right on the non-consensus, the market is still nascent, and you have the potential for monopolistic control of the market. In other words, you’re taking a market risk.
It definitely isn’t intuitive. At the very least, it wasn’t to me when I was on the operating side of the table. I wanted validation. When I was at Localwise helping build a community of local talent, I wanted people to say “I totally agree” or “You’re onto something.” But often times, I just received friction and resistance, with the toughest to receive from some of my friends.
“No one would ever buy that.”
“You’re wasting your time.”
“When are you going to get a real job?”
And at some points in time, I did think, “Maybe they’re right.” Until I started meeting a few people who thought a hiring destination for local mom-and-pop shops wasn’t a bad idea, and especially when small business owners started opening up about their frustrations. Hiring platforms, at that time, focused on the sexier brands and companies to get more demand side traction – the Googles, the Big Four’s, or the Bains, but had seemingly completely underrepresented the population of local businesses. Even if these SMBs were on these other platforms, they were overshadowed by the presence of bigger brands.
When validating startup ideas, you don’t want consensus. If your idea is truly revolutionary, people have yet to be conditioned to accept the idea. Take Uber or Airbnb, for example. If you asked the average person if they would use such a product, most would have thought that you’d be crazy to have a stranger sharing a car ride or home with them. These days, take e-sports or streaming. If someone told me in my pre-teen days that I could make a living off of playing video games, I’d most likely think I was dreaming. After all, I grew up playing Snake on my dad’s Motorola Razr, which admittedly seems to have made a return to the markets.
IMF is about challenging convention and the status quo. That’s what makes an idea revolutionary, or as people in Silicon Valley like to call it, disruptive. A crazy good idea challenges the explicit and implicit biases we have about society and ourselves. In other words, we have to detect the deception we bestow onto ourselves to find the gems in the rough, which Josh Wolfe of Lux Capital explains in his 2019 Lux Annual Dinner Talk – one of the best VC thesis-driven thought pieces I’ve ever seen.
In closing
As a geeky quote collector, I’d like to close this piece not in my own words, but in the words of three brilliant investors who have a few more patches of scar tissue on their back than I do now.
“Most of the big breakthrough technologies/companies seem crazy at first: PCs, the internet, Bitcoin, Airbnb, Uber, 140 characters…you are investing in things that look like they are just nuts… it has to be something where, when people look at it, at first they say, ‘I don’t get it, I don’t understand it. I think it’s too weird, I think it’s too unusual. “
“Breakthrough ideas have the traditionally been difficult to manage for two reasons: 1) innovative ideas fail far more than they succeed, and 2) innovative ideas are always controversial before they succeed. If everyone could instantly understand them, they wouldn’t be innovative.”
