What I Learned from the Founders of Floodgate and Benchmark (Part 3): Product Power & Experiment Based Decisions

Prime Movers Wanted

“A business is simply an idea to make other people’s lives better.” — Richard Branson

The value stack doesn’t provide a one-size-fits-all approach to assessing an opportunity and often times Ann and Mike come to different conclusions when evaluating the same deal. Ann mentioned that, “at the very early stage there are a lot of questions, and as an investor, you need to fill in the holes. This is hard and sometimes you get a huge reward and other times you get burned.” The critical function of an early stage investor is to understand the risks associated with a business and make an investment decision based on that understanding.

Product Power Overview
“Product power” is used to describe the phase of a company’s development in which the company finds product-market fit. Ann mentioned that there are three ingredients to finding product-market fit: the product, the market, and the team. There are varying points of view on which elements of this formula matter most, but conventional Silicon Valley wisdom tends to side with Marc Andreessen who believes that the market is “the only thing that matters.” The logic behind this stance is that one could have the best team and the best product in the world, but without a huge market to absorb the offering, the startup is doomed to failure.

In a startup’s early days, it’s common for founders to question whether they have achieved product-market fit. Mike believes that product-market fit is so obvious, that there should be no question in an entrepreneur’s mind when he/she has attained this critical milestone. He mentioned, “If you have to ask if you have achieved product-market fit — you haven’t.” He went on to say that the sensation of finding product-market fit can be described in the following ways:

• “It feels like all hell breaks out.”
• “When you feel it, the experience is palpable.”
• “It feels like you are in one of those game show booths where the money is flying around.”
• “You should feel so much pull that you don’t have control of the market anymore.”
• “There is no more debate on the product that the team needs to build.”

Ann further illustrated that the above descriptions are most aptly used when describing consumer businesses and that product-market fit in enterprise software is “more subtle.” It’s also important to recognize that product-market fit is not limited to occur in an existing market — the most valuable companies are built around products that create new markets.

One of the main challenges in establishing product-market fit is that, in the early days, the market is unclear. An entrepreneur must find a market that has “high potential energy, but low mechanical energy” and take the startup from Zero to One by nailing his/her initial niche. Mike believes that, “When you’re a startup, you don’t have time. You need to hit a beachhead and expand out quickly.” Given the need for speed in a startup’s development, it’s critical to establish product-market fit in a market with a fast current that can pull your company into existence.

Miscellaneous Quotes and Concepts:

• “We tend to back things that are different, not better.” –Ann
• “When you’re investing at the seed stage, the outcome isn’t as clear as it looks in hindsight. In the early days, sometimes the outcome isn’t even obvious to the founder.” –Ann

Aligning Startups with Their Market

“If there is a big enough problem, you can be inarticulate in your description and still succeed.” — Andy Rachleff

Teams with intellectual diversity perform better when building a business in a new market; whereas “getting the band back together” is the best approach for targeting an existing market. The best teams create a diverse decision making process but unite behind the direction once it is established. The CEO’s job isn’t necessarily to make decisions, but rather he/she should create the context for developing the best decisions amongst his/her team. It’s important to recognize that the discovery phase of the venture formation process is ambiguous and no one has the answer, even the CEO.

Value Capture — Not Just Value Creation
It’s not enough for a startup to focus exclusively on value creation if the company can’t figure out how to capture the value it creates. This has become evident in the open source movement whereby enthusiasts build entire ecosystems to share technical developments. Although these open source platforms create tremendous value, their non-excludable, non-zero sum nature makes it difficult for a business to capture value. In these situations products must be built to sit on top of the open source community in order to capture the value created by the community itself. In other words, “your source of value creation may not be your source of value capture.”

Jobs to Be Done
It is critical to distinguish between consumer behavior and what consumers tell you. Understanding the underlying reason why your potential customer behaves a certain way leads to a deeper understanding of the need to be filled. A good exercise to understand behavior is to ask “why?” over and over again until the key insight can be teased out.

The Founder and Chairman of Intuit, Scott Cook, visited our class and spoke about their culture of experiment-based decision making. He believes the role of a leader is to “declare the grand challenge” and “install the culture and systems for fast experiments.” This culture has led Intuit to be one of the world’s most innovative companies for over 25 years.

Scott described the processes Intuit uses to establish product-market fit and conduct experiments. He also mentioned that the best way to gain a deep understanding of the customer is to observe behavior and run experiments. He further offered, “Why bother with surveys? Customers can’t tell you what they want.”

Intuit assesses their ability to solve for product-market fit with the following Venn diagram:

They then utilize the lean experiment loop to test their leap of faith assumptions with experiments and measure the expected result against the actual.

Scott emphasized that the results of these experiments are frequently unexpected and often lead to exciting surprises. Savor the surprises.

Miscellaneous Quotes and Concepts:

• Don’t change the technology, change the way you describe it. (If you change the technology you are in the mist of a restart, not a pivot.)
• In customer discovery: false positives are self correcting, false negatives force a pivot.
• A community-based (business model) approach provides a quicker start, but an integrated (business model) approach usually wins.
• Delighting the customer is the most powerful tool in driving virility, but this delight must be intrinsic — not forced.

Observations / Takeaways:

Identifying and understanding risk is a critical step in any decision making process. The best military planners and investors both earn their stripes by sizing up risk and making critical decisions based on the information available. In the startup ecosystem the largest risk is often lack of market, not technical or execution risk — especially at the seed stage.

Effective leaders are not authoritarian and only utilize executive decisions when time or other constraints make running an experiment impossible. Similarly, the most effective organizations are adaptable and maintain a culture of constructive dissent to pressure-test plans and ideas beyond the discovery phase. It’s important to remember that once a company culture is established it becomes very difficult to modify, therefore an organization is best served by implementing an experiment based model in it’s earliest days.

Check out part 4 here!