The Four-Way Fit — Chapter 9: The “Heads Up” Motion in Phase II (Part 2)

As you exit Phase I and enter Phase II, the world begins to look different. With a value breakthrough in hand, customers gather at your doorstep. As the customer count rises, investors invest. New resources follow, prompting a division of labor. Once a single-cell organism, your company now divides and subdivides into an ever more complex system. The product itself rises in complexity, as new features address more use case scenarios and segments. Technical infrastructure begins to matter; now you must attend to uptime, latency, scalability, updatability and resilience. With success, competitors emerge. Some gain a foothold. Before, only value creation mattered. Now you must sell, operate, support, report, comply, control, scale and build competitive advantage.

In the face of this rising complexity, how do you keep focused on the customer? How do you construct a high competitive moat, so competitors can’t arbitrage away your profits? As you progress through each Phase II stage, this focus on optimizing customer-defined value and building sustainable competitive advantage becomes pivotal. It all requires a certain discipline — a method. More specifically it requires the Four-Way Fit method, with its “heads up” and “heads down” motions. When you execute the “heads up” and “heads down” motions in the right way, you fire up the pistons of growth that will enable you to progress through Phase II.

This chapter explores the “heads up” motion in Phase II. Phase II is made up of seven stages:

Let’s begin by summarizing the differences between Phase I and Phase II. Then we will explore the final two thinking competencies — systems thinking and strategic thinking — and their significance in Phase II. And finally we’ll review the steps to execute the “heads up” motion at the beginning of each Phase II stage.

Differences Between Phase I and Phase II

The two phases exhibit stark differences. Here are two important ones:

• Prove one minimum viable product (Phase I) vs. optimize, expand and diversify value in both core and extension products (Phase II)
• Mobilize the founding team to find a handful of customers (Phase I) vs. build sustainable competitive advantage and address rising complexity via the coordinated actions of multiple teams operating at enterprise scale (Phase II)

From One Limited Product to Multiple Comprehensive Products

In Phase II, one key mission is to continuously extend and optimize the value of your core product. This is important, because with early success competitors will rise. In the face of competition, your core product’s value will have a half life. You need to continue to innovate to maintain your advantage.

This core product began as a feature-light solution to one problem in one segment; now it evolves into a product capable of solving a whole constellation of problems and needs in multiple segments. But also, as the enterprise continues to scale, opportunities arise that call for more than a core product feature extension — they call for an entirely new product.

In the above image that depicts Phase II, you’ll notice the phase is defined by a horizontal bar called “Value Optimization and Sustainable Advantage”, shown in dark grey. Notice also the three light grey boxes with the word “Discovery” in them, associated with three of the Phase II stages (Minimum Viable Expansion, Minimum Viable IPO Path, and Hot Public Company). These boxes underscore that in the rising enterprise, whenever you initiate a new product concept, the team assigned to work on this concept has to “go back to the beginning”, to go back through the four stages of Phase I within the context of this new opportunity. Too often, new product teams assume too much — they build out a new product based simply on the untested assumptions of some senior executive who “knows” what needs to be built next. Once it’s been built, the team and the senior executive depend on the enterprise sales organization to bundle and sell it.

This approach creates bad products. To build real value, a small new product team must be brought together — 10Xers who possess strong design thinking and lean thinking competencies as well as the necessary functional and domain-knowledge competencies. This team must be awarded significant autonomy from the core. It needs the freedom to begin at the Immerse and Ideate stage, working within the world of visionary customers to observe, learn the jobs to be done, and detect the gaping problems and screaming needs. Only then can it properly conceive and test product ideas.

As these ideas emerge, the team moves into the Minimum Viable Concept stage to figure out the integrated set of claims in the domains of Market, Product, Model and Team that, once concept-tested, will become the foundation for actual product development. This opens the door to an Initial Product Release. Eventually, with enough outside-in feedback and iteration, the team may succeed in proving they have achieved Minimum Viable Product status. At that point, the new product might begin to be integrated with the enterprise’s core product. But first it needs to prove its independent, customer-defined worth.

The point is that while the core product continues down the Phase II growth path, new product concepts must be approached independently, beginning at the beginning — in Phase I. In this sense, Phase I and Phase II co-exist at scale.

Some companies struggle to accommodate Phase I and Phase II teams in the same company. Geoffrey Moore’s book Zone to Win describes strategies for how to do it well. If this is an important challenge in your company, I encourage you to read his book.

Build Competitive Advantage; Deal with Organization Complexity

Few companies become iconic global enterprises, but those that do have mastered the alchemy of two alloys: value and sustainable competitive advantage. The route to breakthrough value at enterprise scale is elusive; it requires continuous dedication so as to understand and act upon customer problems and needs. Furthermore, to construct a defensible competitive moat also takes years of smart, dedicated work.

To address these challenges of leadership in Phase II, the four thinking competencies are all important: design thinking, lean thinking, strategic thinking and systems thinking. However the relative mix of these competencies expresses differently over time, stage by stage, like this:

In Chapter 7, I reviewed design thinking and lean thinking (most vital in Phase I). Here I review strategic thinking and systems thinking (most vital in Phase II).

Strategic Thinking and the “Heads Up” Motion

Hamilton Helmer (in his book Seven Powers) makes the compelling case that the essence of enterprise strategy is to find and follow all available pathways to sustainable competitive advantage. To do so will maximize enterprise value, which is the purpose of strategy. He identifies seven potential pathways:

• Cornered resources
• Counter-positioning
• Switching costs
• Network effects
• Brand
• Systems power (he calls this process power, but the better term is systems power)
• Scale economies

The graphic below shows how competitive advantage can be built over the course of a decade, stage by stage. Yes, pathways to sustainable competitive advantage do take time to build — but when done well, the payoff is dramatic. As with the creation of value, actions to build competitive advantage span all the company-building stages — though most of the work and all of the benefit occur in Phase II:

I briefly described the meaning of each of these seven pathways (“powers”, in Helmer’s language) in Chapter 4. Now it is time to go deeper, and offer examples of companies that have pursued them.

Network Effects

Let’s start with network effects, the most powerful of the seven “powers”. A network effect is at work whenever the addition of a new participant to the network increases value for all existing participants. Network effects are so powerful because they tend to create a dramatic advantage — even, in certain circumstances, “winner take all”. A network effect is hard to build — but if you can do it you’ll receive a gift that keeps on giving. Once a network effects business is established, competitors find it very hard to gain purchase.

No one has studied network effects more closely than the VC firm NFX. If your business has the potential to build network effects, I encourage you to go to nfx.com. You will find a rich library of resources on the subject. In this chapter, we will just scratch the surface.

Research conducted by NFX shows that since the Internet emerged in 1994, fully seventy percent of the market value of all public tech companies has come from businesses that feature network effects. These include Facebook, Amazon, Netflix, Google, Salesforce, Microsoft, Twitter, Uber, PayPal, eBay and now, as of this writing, AirBnB (which went public in December of 2020). Network effects have delivered companies such as these a high competitive moat.

Before we can explore how to build network effects, we need first to understand them. In this chapter I’ll focus on three broad types of network effects:

• Direct
• Two-sided
• Data

Let’s go through each.

Direct

The strongest type of network effect is direct. In 1908, AT&T noted in its annual report the following:

“Two exchange systems in the same community cannot be… a permanency. No one has use for two telephone connections if he can reach all with whom he desires connection through one… A telephone without a connection at the other end of the line is not even a toy or a scientific instrument. It is one of the most useless things in the world. Its value depends on its connection with the other telephone — and increases with the number of connections.” ¹

The notion that a network increases in value as the number of nodes increases is one captured by Robert Metcalfe in Metcalfe’s Law. Metcalfe’s Law states that the value of a direct network is N² — i.e. that the value of a network is proportional to the number of connected users squared. Each node is connected to every other node. Since the number of new connections grows exponentially, the network’s density (and therefore its value) grows exponentially. Others argue that the value of a direct network grows even faster. For instance, David Reed posits in Reed’s Law that the rise of subgroups within a direct network leads to a rate of network growth expressed by the exponential formula 2^N. Whether or not networks grow at exactly these rates, it is clear that once network effects take hold the growth rate begins to explode.

There are five types of direct networks. A direct network can be physical — as with telephone systems, cable network providers and infrastructure (roads, railways, electrical grids, sewage systems, water systems, etc.). Or it can be protocol-based — wherein a computational standard is agreed upon. Fax, VHS, bitcoin and ethernet are examples of this type. A third direct network type is the personal utility — such as Facebook Messenger, WhatsApp, Skype or Zoom. In this type, users’ personal identities are directly tied to the network. Here the network becomes the go-to method of personal communication, and as such it is very hard to dislodge. Another direct network type is the personal network, such as Facebook, Instagram or LinkedIn. These networks are expressions of personal identity; offer the means to express oneself and build up one’s reputation.

The fifth type of direct network is the market network. A market network is part personal network and part marketplace. It brings a professional network into an online community within which their personal profiles are presented, and then it facilitates marketplace activity between participants. Such networks target more complex services, such as home building and home services. The marketplace can be multi-sided, and one or more sides of the marketplace may have access to SaaS tools that facilitate their participation. Companies that fit this description include Houzz, AngelList and LiquidSpace.

Two-Sided

A two-sided network incorporates a supply side and a demand side. Each new buyer adds value to sellers, and each new seller adds value to buyers. These markets scale both sides at roughly the same rate. Two types of two-sided networks are worth mentioning: marketplaces and platforms.

The marketplace two-sided network is simple. Think of Uber, Lyft, eBay, Etsy, Craigslist, Bumble, OpenTable and Trulia. Drivers are available on the streets, and passengers take the ride. Sellers post items for sale in the marketplace, and buyers come to buy. Young people make their profiles available on dating sites, and interested partners respond. Media can be thought of as a two-sided market: audiences buy content experiences with their eyeballs, which are sold to advertisers.

The two-sided platform offers an experience to users that is augmented by offerings from developers. Examples of such platforms include iOS, Android, Salesforce Lightning, Xbox, Nintendo Playstation and desktop operating systems (such as Microsoft OS and Mac OS). In such systems, developers create software for the platform. Users gain value from the platform and the additional applications available there.

Data

Data network effects are operative when the value of the product increases with more data, and when that data comes from increasing usage. Most data network effects are asymptotic — the incremental value of additional data begins a rapid decline at some point. For instance, more data will improve lending decisions up to a point, and then the incremental value of additional data begins to decline. So too with insurance underwriting, and other types of predictive modeling.

The only scenarios in which this is not the case are when the data patterns are subject to constant change. Waze is an example of this: traffic patterns are never exactly the same, and so the product’s predictions as to the best route and the drive time are constantly changing while also continuously improving. More users create more density, which improves its dynamic performance. Google also benefits in a similar way. The density of users enriches the performance of the search engine, and every day new items need to be searched. Google’s dynamic performance is continuously improving due to data.

How Network Effects are Built

In direct networks, the secret is to find a “white hot center” of need, and start there. Victor Ho, CEO of FiveStars, began his company by building a simple loyalty program for SMB customers, which launched in 2011. At the time, small businesses did not have the capacity to run the types of loyalty and customer retention programs available to large retailers and restaurant chains. For them, marketing was a time-consuming and suboptimal effort. For such businesses, this gaping problem constituted a white hot center of need.

To make its solution workable, FiveStars needed to integrate its software with a diverse array of SMB point-of-sale systems. Over time, the number of supported integrations became a source of competitive advantage. A device to capture loyalty signups sat on the counter at coffee shops and hair salons. Once signed up, the consumer could receive the FiveStars loyalty card, enabling the consumer to acquire points and rewards. She then could receive the associated offers via email and text, prompting a return to the store. Within a year of launch, the company had signed up 800 SMB customers and had created accounts for a quarter-million consumers.

This initial SMB CRM system was expanded in stages. Marketing automation was added in 2012, and promotion capabilities in 2014. Once FiveStars had achieved enough customer density to create a viable network, which it achieved in 2017, it added the “Love Local” Network, enabling FiveStars consumers to receive offers from all non-competing FiveStars SMBs in the surrounding local area. This new customer acquisition capability joined up with loyalty programs, marketing automation programs and promotions in a powerful constellation of CRM capabilities for SMB businesses.

Then in 2018, FiveStars launched its payments product. A new credit card payment device was deployed to participating stores. Loyalty program sign-up was integrated into the payment flow with a simple phone number capture. SMB businesses who adopted the payment product experienced a significant increase in loyalty participation: data shows that 60% of walk-in non-member customers sign up.

Now FiveStars has become a market network. It boasts a powerful network of physical nodes in participating stores, a CRM system that advances both customer acquisition and retention, and a payments system that optimizes the data set. Each SMB customer advances the interests of other SMB customers through the “Love Local” Network, and as density rises the value of this network rises for all participants. You’ll learn more about FiveStars in Chapter 19.

WhatsApp founder Jon Koum found his way to a direct network through the back door. At first he wanted to build an app which would feature statuses next to the names of users. Later, when iOS first allowed push notifications, Koum used the new feature to send updates of status changes between users. But users quickly realized that they could message between each other simply by changing their statuses. WhatsApp morphed quickly into an instant messaging platform. You could log on with just a phone number, work across platforms (iPhone, Android, Blackberry) and send messages via the Internet — as opposed to the then-prevailing SMS protocol. Because it was free, globally available and encrypted, WhatsApp found its “white hot center” within the Russian community as they interacted with friends around the world. Over time, it expanded outward to ex-pat communities worldwide, and then to world travellers. From then on it went viral.

In a two-sided marketplace, the proper starting point is to pursue the hardest side of the market (demand or supply), and within that side, to find its white hot center: the segment with the most gaping problems and screaming needs. Since the marketplace requires two to tango and you don’t yet have the easier side, you must start with some product solution that does not require the other side yet. This can be a SaaS workflow solution, or some other type of product that builds up your customer count. Only once you have a critical mass of participants on the harder side of the market do you pursue the easier side of the market. Uber did this in its early days. It paid taxi drivers to drive around San Francisco without customers, until it had built up enough driver density to assure a short wait for passengers. OpenTable created a SaaS solution for restaurants, and worked for years to build up sufficient restaurant density to be of value to consumers as a restaurant selection portal. In both of these examples, the companies built up the hardest side of the market first.

Two-sided marketplaces can be vulnerable to multi-tenanting, wherein customers shift between competing networks. This limits the degree of competitive advantage they can achieve. Passengers may choose Uber one day and Lyft the next. Online shoppers might choose eBay one day and Etsy the next.

A two-sided platform delivers a direct user experience augmented by third-party offerings built by developers on the platform. In such businesses the first step is to build a compelling direct user experience — often via a SaaS business model. Once the number of customers has reached critical mass, you can then open the platform for third party application development. This is what Apple did with the iPhone. Salesforce built up its CRM customer base before it introduced Salesforce Lightning. In some instances of successful two-sided platform companies, the direct user experience has been augmented by a small number of third-party applications from an inner circle of developer supporters right from the outset, as with the XBox.

The risk of multi-tenanting is lower in the case of two-sided platforms, where the customer has made a significant platform commitment — but even here it can be a factor. For instance, almost half of XBox owners also own a PlayStation. For this reason, enterprises seek to build other stickiness factors into the product.

With a data network effect, the key to success is scale. To achieve scale, the company must find its way through a period of suboptimal performance until the volume of data rises to the point where sharper decision precision is possible. For instance, this dynamic is at play in new lending and insurance businesses. Investors need to fund new companies through this suboptimal phase, recognizing that performance will become ever more optimized as the data volume rises — at least until the incremental benefit of additional data begins to decline.

If your business lends itself to the development of network effects, be sure to pursue them with a relentless focus. They constitute the most powerful pathway to sustainable competitive advantage.

Cornered Resources

If you possess a game-changing resource that enables you to deliver competitively superior value to customers, you possess a cornered resource. It can come in the form of a patent, an exclusive channel partnership, an unassailable data advantage, a market penetration advantage or — in rare circumstances — people. One company for which the cornered resource took the form of its people is Snowflake. Before any business existed, the company’s first investor (Sutter Hill Ventures) began by recruiting the founding team. The business concept came next.

Co-founders Benoit Dageville, Thierry Cruanes and Marcin Zukowski were (and are) world-class data architects and data warehouse experts. These three co-founders set out to devise a business concept that could take advantage of their unique technical competencies. They recognized that legacy enterprises were built on SQL relational databases, but these were managed in proprietary data centers on premises — incapable of taking advantage of cloud-based computing. If they could build a cloud-based relational database environment from the ground up, they could help these enterprises take advantage of the cloud without needing to re-architect their legacy systems. Out of this insight, Snowflake was born. These technical co-founders were the unique cornered resource at the heart of the company’s later success. As of this writing, Snowflake is worth $93B.

Cornered resources can be secured at the beginning of a company, as with Snowflake, or later. In a previous digital generation, I saw the power of a late-arriving cornered resource with my own eyes. Back in 2005 I was on the board of CareerBuilder. CareerBuilder was owned at the time by major newspaper media companies, including Knight Ridder (where I was president of the digital business unit). At the beginning of 2005, CareerBuilder found itself in third place in the job board market, well behind Monster and HotJobs. CareerBuilder did boast one advantage: the number of jobs it listed. This was the result of its relationship with large metro newspapers, at the time still publishing many thousands of job ads per week. CareerBuilder’s newspaper-company owners made sure each newspaper job ad was bundled with a CareerBuilder posting as well. While this boosted its number of job listings, CareerBuilder was far behind its competitors in job seeker traffic and, as a result, in revenue.

The leader in job seeker traffic was Monster. This leadership was the result of two key partnerships, with AOL and MSN. Both portals had agreed to let Monster power their jobs pages; the result was an open fire hose of job seekers arriving daily at the Monster home page. CareerBuilder’s COO at the time, Matt Ferguson, understood the significance of these two channel partnerships. He spent a year secretly cultivating relationships with both AOL and MSN. He was determined to win away from Monster the jobs page sponsorship for both portals. Throughout the negotiation process, neither AOL nor MSN knew that the other company’s jobs page sponsorship was in play. One day in the summer of 2005, two press releases came out — one from AOL in the morning, and another from MSN in the afternoon. Both announced that CareerBuilder had won the multi-year jobs page sponsorship away from Monster. The resulting avalanche of job seeker traffic shot CareerBuilder up from worst to first in traffic, with Monster falling to a distant second. Soon, CareerBuilder had taken the lead on all three success dimensions: job seeker traffic, the number of jobs on the site, and revenue. It was a transformational moment, powered by the acquisition of a cornered resource.

Do you have access to a game-changing cornered resource? If so, pursue it with great intensity and sustained focus. That’s what Snowflake did. That’s what CareerBuilder did. As a direct result, both won market leadership.

Counter-Positioning

When a newcomer adopts a new and superior business model that an existing competitor can’t mimic without its business being damaged, the newcomer has executed a counter-positioning move. A counter-positioning strategy can be targeted at a specific competitor, or at the business model of an entire industry.

Netflix targeted Blockbuster when it eliminated late fees — which was a primary source of revenue for its larger competitor at the time. Vanguard did this when it introduced index funds and charged a very low rate — something Fidelity could not copy with its managed funds, which were run by high-priced fund managers.

Lemonade employed a counter-positioning strategy to attack the prevailing business model of an entire industry. The B2C insurance market has always been plagued by a lack of trust. Consumers sense (correctly) that for the insurance company, financial performance is maximized when premiums paid by consumers to the company are higher, and claims paid by the company to consumers are lower. This misalignment of interests is at the heart of the legacy insurance business model.

Lemonade’s founders decided right at the outset that they would reinvent the insurance business model. Instead of leveraging the arbitrage between premiums and claims, they would establish a set fee for their insurance products (25% of premiums). The rest of the money would go into the claims pool. Once a year, after claims for the year are paid out, any surplus money in the claims pool goes to its customers’ charities of choice. This unique business model has been transformative. It has built high trust, especially within its target segment — millennials. It is also a business model that competitors can’t follow. For legacy insurance companies, their entire infrastructure is conformed to the premiums / claims arbitrage model. This leaves Lemonade free to build on this point of differentiation. That’s counter-positioning.

Switching Costs

DispatchTrack is a rising star in the world of last-mile logistics. When the company first built its solution for furniture stores, legacy logistics competitors were focused on helping companies achieve mileage efficiency. These tools focused on the optimization of delivery routes to save money.

DispatchTrack saw a need to transform the experience of the end customer. When a piece of furniture was ready to be delivered, the consumer would be asked to set aside a four-hour time slot and wait. All too often, the furniture would not arrive within that wide window, prompting high customer dissatisfaction. The punching bag on the receiving end of the customer’s dissatisfaction was the driver, who was the one bringing the furniture into the home.

One of DispatchTrack’s first features was an alert system that sent a text message to the consumer, indicating the furniture would arrive within a half hour. This initial product feature was transformative. Now the consumer could go about their day, knowing they would be alerted a half hour before furniture arrival. The impact of this change was most felt by the driver. Whereas once the average day was filled with customer complaints, now the day was filled with customer compliments. Drivers quickly fell in love with DispatchTrack, which led to its rapid adoption throughout the furniture industry. Furthermore, the DispatchTrack platform improves upon the efficiency capabilities of its competitors — which makes management happy.

Today, DispatchTrack is a fast-rising player in the global logistics market. It has moved beyond furniture into many other verticals. Its customer retention rate is at a world-class level, powered by happy managers, happy drivers and happy end customers. Given the high level of customer satisfaction, what business decision maker would want to disrupt the apple cart by switching to an alternative logistics platform? DispatchTrack has built very high switching costs — which have become a key source of competitive advantage.

Brand

A brand delivers sustainable competitive advantage when it prompts customers to choose the company’s product over competitors for reasons other than objective product performance. A competitively advantaged brand is one that has built tribal allegiance to it. The brand experience is characterized by a unique language, imagery and iconography that reinforces its essential identity.

To create such a brand, a company must first create a best-in-class product. In the absence of product leadership, a brand is incapable of becoming a source of competitive advantage. As important as product leadership is, it is not sufficient. The second requirement is a tight brand identity architecture, anchored in potent messaging and breakthrough design. The third requirement is a steady stream of campaigns that target customers and prospects, appealing to key emotional cues, leading to tribal allegiance.

No company has ever done this more successfully than Apple. From its earliest origins, Apple (and, specifically, Steve Jobs) developed both a breakthrough product and a “cool”, cutting-edge cachet. Design thinking was at its heart from the outset, as exhibited in the product. The Macintosh computer was the first computer to provide a graphical user interface, a built-in screen, a mouse and a choice of alternative fonts. It was also offered at a price that consumers could afford.

This outstanding product was launched with one of the most successful brand campaigns ever created. By early 1984, powered by the Apple II and the savvy promotional efforts of its CEO, the Apple brand had already developed a tribe-like niche following. Word got out that a new product would soon be launched. The launch happened during the Super Bowl halftime show, held at Stanford Stadium in the heart of Silicon Valley. The TV commercial 1984, created by Chiat Day, showed a woman warrior running down the center aisle of a room packed with spaced-out automatons fixated on a mind-controlling leader projected on the screen. Everything was in a pale greyish blue, representing IBM, the “big blue”. Swinging a mallet, she lets it fly into the heart of the screen, shattering it. The announcement of the Macintosh comes next: “On January 24, Apple Computer will introduce Macintosh. And you’ll see why 1984 won’t be like ‘1984’”. The wordless Apple logo followed, shown on a black background.

Jobs did it again when he returned to Apple after his exile, with the “Think Different” campaign. Ever since, Apple’s brand has built a dedicated following. Brand and design are at the heart of the Apple ethos, and the company has continuously invested in them. The result is a brand powerhouse. In certain circles, walking into a meeting with a laptop other than a Mac is considered certain proof you “don’t get it”. Founders giving funding pitches to Silicon Valley VCs have lost out simply because they failed to open a Mac to initiate the pitch.

Another company that exhibits rising brand power is Canva. Melanie Perkins, a professor of design at the University of Western Australia, became frustrated with the cost and difficulty of existing design tools. She built a company that lives its vision to empower the entire world to design. The Canva product unifies the many silos of activity once involved in the design process, and then enables the resulting designs to be built in all formats — from images to video — and rendered in all contexts — from print ads to coffee mugs to websites to Instagram. Perkins then democratized access to this simplified user experience via a robust freemium model. Canva was a hit almost right from the start. Now designers could create great designs even with the free product.

Canva expanded virally at its outset, and continues to do so to this day. This viral expansion fuels the brand in a virtuous cycle. The company is a “sales ready “ product pursuing a PLG strategy; it places great focus on the first mile of the customer experience. The goal is to ensure that a newly arriving designer can experience value from the product as quickly as possible. This focus on the new user experience elevates the Canva brand and increases customer advocacy. Such efforts are augmented by sustained growth marketing investments.

In 2014, just two years after Canva’s founding, Perkins succeeded in recruiting Guy Kawasaki to become the company’s chief evangelist. Thirty years previously, Kawasaki had joined Apple right out of Stanford as its chief evangelist. His first responsibility was the Macintosh launch. By 2014 he had become a world-renowned author and speaker, and a respected technology marketing and messaging expert. Since joining Canva, Kawasaki has played a decisive role in building the brand. Today, Canva is seen by designers of all stripes as their tool of choice. Canva has built a tribe-like following. As to Kawasaki, he has said he considers it a privilege to have started his career at Apple, and to be ending it at Canva.

To create a powerful brand, some companies define and popularize a new category. Tien Tzuo, the founder and CEO of Zuora, did this when he coined the phase “the subscription economy”. He wrote a book with that title, and mobilized a sustained, multi-year global campaign to popularize the idea. Zuora is a company that provides financial back-office solutions to subscription-based companies. By building awareness of the rise in subscription-based business models, he created a new category: subscription-based services management. It’s a powerful brand-building technique. Zuora is the unquestioned leader in this category.

Systems Power

I will write more about this topic in the next section of this chapter, on systems thinking. For now, suffice it to say that if a company has been organized to perform as an integrated system, and if its technical systems have been built via reactive microservices architecture, with modern data infrastructure and mobile-friendly applications, then its pace of innovation will be orders of magnitude faster than any legacy competitor. This is the impact of systems power.

Deputy is an example of a company that has done just this. Ashik Ahmed, Deputy’s CEO, has built an elegant workforce management solution for shift worker businesses. The mobile-centric platform is built via microservices. Because its systems are built modularly, Deputy’s technical domain teams are free to optimize their assigned domains of the product at all technical layers — data, application, integration and infrastructure. The result is a powerful combination of speed, quality and agility. Meanwhile, its primary legacy competitor, Kronos, is stuck with monolithic technology and custom hardware; its capacity to innovate at the speed of opportunity is nil.

Scale Economies

The bigger the market footprint you command, the more you may benefit from economies of scale. With market leadership, you gain power over suppliers. With scale, your company systems rise in maturity. Workflows have been streamlined via continuous improvement, and technical systems have been better aligned with workflows. Scale opens the door to scale economies, but company leaders must walk through that door. Company systems don’t just automatically become more mature — they become that way because leaders invest the necessary time and effort. So too with vendor relationships and input costs.

It’s hard to conceive of a company that has taken greater advantage of scale economies than Amazon. For every vertical and segment within its vast global marketplace, its end-to-end supply chain and its warehousing and distribution facilities exhibit the power of scale economies. These provide Amazon an unassailable competitive advantage, even against huge and cost-efficient competitors such as WalMart.

Systems Thinking and the “Heads Up” Motion

To properly execute the “heads up” motion, you will need understand and address the consequences of enterprise success. In Phase II it’s time to seize the advantage your value breakthrough created. Product development teams begin to build new value. Your business model now opens new pathways to competitive advantage. As your success grows, so does your company. Rising scale creates rising complexity: more people, teams, segments, products, features, packages… more of everything.

To address this rising complexity, the leadership thinking competency called systems thinking now takes center stage. Leaders need to understand the system dynamics at play inside (and beyond) the enterprise. Take a moment to consider the enterprise from a systems point of view.

I first introduced this idea in Chapter 6. An enterprise is made up of operating systems that drive results, and meta systems that advance operating system health. Once again, here is a reference architecture which depicts the enterprise as a system:

Operating systems include the product management system, the revenue engine system, the HR system, the accounting system and so forth. These are the performance engines of the enterprise. Three of these operating systems are uniquely important in finding the Four-Way Fit. These are the customer-centric operating systems: the product discovery system, the product management system and the revenue engine system. The first (product discovery system) is focused on the proper launch and development of new products. The second (product management system) is focused on the optimization of existing products. And the third (revenue engine system) is focused on business model concerns: the optimization of pricing, unit economics, cash flow, customer acquisition; and the building of a competitive moat.

I use the words “operating systems” in the socio-technical sense. Operating systems feature interactions between people, workflows, technology and money flows. Most operating systems in the enterprise are cross-functional. For instance, the product management system includes product managers, engineers, designers and data analysts. The revenue engine system includes marketers, salespeople, customer success people, finance folks and product managers (such as for the first-mile product experience).

Resting atop these operating systems are five meta systems. Taken together, the job of these meta systems is to advance the health of the operating systems, from which all results emerge.

The five meta systems are the engineering system (to ensure tight, modular, scalable technology), the DataOps system (to ensure teams throughout the enterprise receive the data they need to continuously improve), the culture system (to ensure the full potential of human talent is unleashed), the strategy, planning and architecture system (to achieve top-to-bottom alignment and direct change), and the governance system (to advise and align investors and management).

Your job is to scale the operating and meta systems from their nascent states into an integrated, high-performing enterprise. This requires you to act within these systems. An enterprise can only grow in maturity and scale if the operating and meta systems do.

In Phase II, three key dependencies are particularly significant in addressing rising complexity and building an iconic enterprise. They are:

• Domain-driven organization design
• Technology built via reactive microservices architecture
• Data infrastructure

Domain Driven Organization Design

An organization architected based just on functions will encounter rising difficulty as it scales. This is because functional teams struggle to deal with cross-functional problems, and at scale many problems are cross-functional. The superior way to design an organization is by following the principles of domain-driven design. Each operating system (such as the revenue engine) is composed of natural workflow clusters, called domains.

For instance, the conversion of incoming leads into sales involves tightly knit workflows — as raw leads are designated Marketing Qualified Leads (MQLs) by marketing people; which are sent to sales development reps who in turn qualify them further into Sales Accepted Leads (SALs); which become appointments for Account Executives, who are responsible for turning these into Opportunities and then moving the prospect along to Closed / Won. This lead-to-sale activity can be called a domain. It involves multiple functions: marketing, sales development and sales.

Similarly, in product development a technical domain team responsible for the “first mile” of the prospect experience will be composed of multiple functions: product managers, designers, front-end engineers, back-end engineers and data analysts. All need to work together in a coordinated fashion to build software.

When an organization is composed of small domain teams built to address natural clusters of workflows, the organization becomes more responsive, resilient and scalable. Domain-based teams may be cross-functional or uni-functional, but they each are built to manage one building block of the enterprise. Inside this building block, people, workflows, technology and money flows work together towards a common purpose. Across the enterprise, each domain team’s purpose links to the purposes of other domain teams, and rises up to operating system purpose and, finally, the enterprise purpose. Tied to each domain’s purpose is a set of time-bound business outcome objectives. Tied to these objectives are KPIs. These hierarchies —the purpose hierarchy, the business outcome objectives hierarchy, and KPI metrics hierarchy— are key elements in domain-driven organization design.

In the context of the Four-Way Fit, domain-driven organization design in Phase II is focused on value optimization and building competitive advantage. For this purpose three customer-focused operating systems matter most: the product discovery system (to build new products), the product management system (to optimize the core product) and the revenue engine system (to optimize business model performance).

Technology Built via Reactive Microservices Architecture

A systems thinker brings a sophisticated perspective to technology development. Since all modern enterprises feature technology at the core, it’s imperative for the top team to clearly understand the impact of technology design. Without systems thinkers at the top, the tech stack is sure to evolve into a monolith. That’s because it takes extra work in the beginning to build technology the right way. But if you don’t, and you end up with a monolith, your enterprise will stagnate. Your pace of innovation will slow to a crawl, because every change to one part of the monolith will risk taking down the entire monolith.

For this reason, technical systems architecture fundamentally impacts your capacity to innovate. It impacts your engineering organization design. It impacts your engineering culture. If tech is built via microservices architecture, you can organize into cross-functional technical domain teams. Each team can be assigned a purpose, business outcome objectives and supporting KPI metrics. The team can continuously improve the technical environment within their assigned domain, at all four layers — data, application, integration and infrastructure — without any excessive external dependencies. This gives the team the autonomy to chase the domain’s business purpose and business outcome objectives as they see fit, continuously improving via disciplined agile delivery methods. Then if a software update within a microservice goes wrong, it will only impact that one microservice — which can be quickly replaced or fixed by the team.

But if the technical architecture is monolithic, none of that can happen. Since changes to the monolith put the entire system at risk, a team of senior engineers will need to preplan every change with great care. This bureaucratic “waterfall” approach is unavoidable. It places the engineering function in a policing, gating, minimum-change-required posture. A company in such a situation is not just slowed to a crawl. Worse, it can’t attract top engineering talent; no 10Xer engineers want to work on a monolith.

Microservices architecture enables domain-based teams, significant team autonomy balanced by purpose-driven alignment, disciplined agile delivery methods, and rapid and continuous product improvement. It yields enterprise technology that is modular, responsive, resilient, elastic, easily updatable and massively scalable. It takes a systems thinker to lead the enterprise towards the right technical architecture, the right organization design, the right development methods and the right engineering culture.

Data Infrastructure

Another key aspect of systems thinking is an appreciation for the significance of feedback loops. People need access to the right data at the right time in order to make effective decisions. You need to build a data infrastructure that can deliver rich feedback loops to domain teams throughout the enterprise, enabling robust continuous testing and optimization of everything. When your plans address these three, you attack complexity head-on. You create the conditions to better optimize value and build sustainable competitive advantage.

As said earlier, domain-based teams are more capable of responding directly to customer needs than those trapped inside functional silos. Product enhancements can be executed faster, better and cheaper if built atop microservices-based systems. Rich data feedback loops ensure that throughout the enterprise these domain teams can know the current state of things, track progress on key performance metrics and observe the results of tests.

Just a few more words on data infrastructure. At enterprise scale, if you’re doing it right your data infrastructure will look something like this:

SOURCE: Ash Damle, in a working session with the author, 2019

Sophisticated data infrastructure doesn’t just happen. It requires sustained leadership over multiple years. You need to make significant year-by-year financial investments. You need to recruit a diverse set of people with requisite technical and statistical competencies. In establishing enterprise-wide data protocols such as shared data schemas and data state definitions, you need to ensure cross-functional coordination between the “operations” functions — MarketingOps, SalesOps, FinanceOps, DevOps and so forth. Moreover, you need to build a culture that values data over opinion in decision making. You must empower teams to use data to make good decisions consistent with team purpose.

Developing a data infrastructure plan is an important part of the “heads up” motion in Phase II. It will only happen under leaders that are systems thinkers. Despite all the time and money it takes, it’s worth it. With sustained commitment, a data-driven culture and sophisticated data infrastructure becomes a key source of competitive advantage — one of the seven, the one known as “systems power”. My book The Fit Systems Enterprise was devoted to the subject of systems thinking and design. To learn more on this subject, I encourage you to read it.

Executing “Heads Up” Motion Steps in Phase II

As you enter each new stage on your Phase II journey, you must begin with the “heads up” motion. You begin by defining the set of claims that, if proved true, will lead you to the next value inflection point. This occurs inside the framework spreadsheet — a more detailed, multi-tab version of the framework canvas.

As was true in Phase I, some framework claims will be designated settled assumptions, and some testable claims. Settled assumptions form the foundation for plans. Testable claims yield test designs. This is vital “heads up” work. But in Phase II this is just the beginning of the “heads up” work to be done. In Phase II, a key “heads up” goal is to keep customer-centric considerations at the forefront as other priorities crowd in. It’s not easy. You need an accounting system upgrade. Compensation decisions are too ad hoc; they need to be formalized. Leadership training is a disaster; an overhaul is needed. A pressing legal issue now sucks up CEO time. An accounting audit starts next month, so the CFO is MIA for anything other than audit prep. Your governance mechanisms need to be upgraded. Investor meetings encroach on senior leader calendars.

All of these demands are legitimate, but they steal away top team time from customer concerns. In the face of rising internal demands, far too many companies turn attention inward. The voice of the customer dims as a jungle choir of other voices rises. When you commit to the Four-Way Fit method and its “heads up” motion, you place the customer at the center of planning. Customer-focused plans and tests are completed and resourced first — all else waits in line. To pursue this “heads up” motion in Phase II, you must:

• Complete the framework spreadsheet
• Turn settled assumptions into action plans
• Turn testable hypotheses into test plans
• Derive customer-centric strategic imperatives
• Integrate other company-wide strategic imperatives and plans
• Maintain top-team alignment and accountability
• Replan when a claim proves flawed

Complete the Framework Spreadsheet

In Phase II, planning becomes more formalized. The CEOs of most rising enterprises mobilize a comprehensive strategic planning cycle twice a year. The first step in this cycle is to complete the Four-Way Fit framework, expressed in its spreadsheet form. The spreadsheet form gives you the space to build out a more comprehensive set of testable claims and settled assumptions than would be possible within the canvas. As with Phase I’s canvas, however, the objective here in Phase II is the same: to help you organize your thinking in the four domains (Market, Product, Model and Team).

You need a spreadsheet to do this work because as you scale, there is more to think through. The engine called your enterprise is now made up of many more components; they all need to work together — in a comprehensive, integrated and internally consistent way. Whereas once you were focused on just one top-priority segment in the US, now you are focused on three segments, each operative in three global regions. Whereas once you offered just one product, now you have two or more — with multiple packaging options. Your business model now features a multidimensional pricing scheme. Direct sales are no longer handled by three people; now direct teams in the three global regions are augmented by four channel partners. You get the idea. It’s complex. The spreadsheet, explained in detail in Part 1 of this book, helps you to wrestle this complexity to the ground.

Turn Settled Assumptions into Action Plans

At least seventy percent of the claims in your framework spreadsheet should be settled assumptions. Each needs a plan. Why seventy percent? To tilt that ratio too much the other way would be to overwhelm your testing capacity — a bridge too far. That’s why it’s so important to scale in manageable stepping stones, stage by stage, always returning to the “heads up” motion at the beginning of each new stage.

A sound plan identifies all the stepping stones to be traversed so as to progress from current reality to an intended future state. It takes into account people, workflows, technology and money flows. It lays out project dependencies. It assigns roles and tasks to the people who will make the change happen. However, it’s important to remember that a plan is not a rigid contract — it is a dynamic tool for decision making.

A sound plan:

• Identifies a purpose
• Identifies a scope
• Names a competent plan owner and team
• Describes current state
• Envisions the future state
• Shows how the interactions between people, workflows, technology and money flows will change in the future state
• Defines the “from / to” path

Make sure your plans do these things well.

Turn Testable Claims into Test Plans

You can act on settled assumptions, but unsubstantiated claims must be put to the test. As you did in the first company-building phase, to prioritize tests you will consider the significance and certitude of claims. How significant is this claim, if true? Does it make a major or minor contribution towards reaching the next value inflection point? And what is your level of certitude that it is true? These two factors will guide the prioritization and sequencing of these tests.

Different claims require different tests. It’s helpful to think of claims as falling into two broad categories: “already true” claims, and “if / then” claims. An “already true” claim is one that posits an existing truth. Examples include, “The total addressable market for our product is $2B;” or “The meta job in our top priority segment is to deliver a quality dining experience at a 30%+ profit margin;” or “The best external vendor to power our product’s location awareness feature is Google Maps.” An “if / then” claim, on the other hand, is a claim that posits “if” we change an independent variable, “then” there will be a change to a dependent variable. For instance, “if we reduce our subscription price from $100,000 per year to $80,000 per year, then we will increase bottom-funnel conversion by 40%,” or “if we hire Ashish Kapoor as our VP Marketing, then we will increase our measured brand awareness by 20% and lead volume by 30%.”

“Already true” claims require research; they are tested and validated via evidence. In law, the rules of evidence establish that you need a sufficient quantum and quality of evidence. So it is in business. The quantum is the necessary amount of evidence; the quality is the authority of that evidence. In “already true” claims, it is important to specify both the quantum and quality of evidence required to satisfy that the claim has been validated. As to the claims that conform to the “if / then” type, these can be tested via either research or experimentation.

Derive Customer-Centric Strategic Imperatives

In the face of complexity, leaders need to name the strategic imperatives most central to progressing to the next value inflection point. In Phase II, this is done as part of the strategic planning cycle. To derive a strategic imperative, smart leaders will work both bottom-up and top-down, moving between the abstracted “mountain top” view and the detailed “valley” view. They will expose their own mental models to new data, and to challenge from others. They will encourage inputs from the front lines, proposals from mid-management and debates with top executives.

As these are thrown into the pot, leaders will then need to render them down into the four to six strategic imperatives most essential to ensuring achievement of the next value inflection point. The most important strategic imperatives are those tied to optimizing customer-defined value and building sustainable competitive advantage. These are the customer-centric strategic imperatives.

Not all strategic imperatives need to be customer-centric. For instance, completing a funding event or replacing the accounting system might be named a strategic imperative. It’s fine for key initiatives such as these to rise to the level of an imperative — as long as the customer-centric strategic imperatives claim primary attention.

How do you determine these customer-centric strategic imperatives? They will naturally emerge from the framework spreadsheet. Your work in the spreadsheet will help you discern the limiting factors impeding growth. The strategic imperative, of course, is to remove these limiting factors.

Integrate these into Company-wide Strategic Imperatives and Plans

Strategic imperatives call for plans. These plans must clarify how the imperative will be achieved. Plans are often interdependent. For instance, two plans might fight for the time and attention of one executive. Multiple plans might require changes to one common technical infrastructure. For this reason, each plan must be brought into alignment with all other plans. In Phase II, this aligning work is an important part of the “heads up” motion.

Once all top-level plans have been integrated and responsibilities assigned, these can be rolled into the company financial and operational plans and companywide objectives and success metrics — so as to create alignment. One common way to express objectives and metrics is “ OKRs” (Objectives and Key Results). Another framework (initially developed by Marc Benioff at Salesforce) is called “V2MOM”, which stands for Vision, Values, Methods, Obstacles and Metrics. Benioff argues V2MOM is more focused on long term vision and creates more flexibility than OKRs. Nonetheless, to keep things simple I’ll refer to such alignment frameworks as OKRs from this point forward.

Every plan involves expenses; many plans will include revenue projections. These must end up in the financial and operational plans. Once the financial and operational plans settle, the financial plan becomes the pinnacle of the KPI metrics hierarchy. Domain-level KPI metrics roll up to it. In its monthly comparisons of plan to actual, the financial plan serves as a de facto accountability tool. Similarly, companywide OKRs drive senior executive OKRs, which cascade down to mid-manager OKRs and domain team OKRs. The financial plan, operational plans and OKR pyramid keep individuals and teams focused on the right priorities.

To appreciate the power of a good financial plan, do yourself a favor and google David Skok’s seminal blog, “SaaS Metrics 2.0”. Even if yours is not a SaaS business, it’s worth a look. A sound financial plan goes far beyond GAAP; it synthesizes the most essential company-wide metrics into a powerful performance tracking and planning tool:

In the “heads up” motion, all of these tools (the framework spreadsheet, the financial and operational plans, KPI dashboards and the OKR pyramid) need to come into alignment. Only then can every domain team in the company be freed to act in service of its assigned purpose and be accountable for its results.

Alignment requires a set of sequential steps:

A) Define the next value inflection point, and state the strategic imperatives that must be addressed to get there

B) Within each enterprise operating system, define the action plans and testing plans that are needed to advance the customer-centric strategic imperatives

C) Define all other plans — those related to any other strategic imperatives (arising from such systems as accounting, HR, cash management, control, etc.)

D) Determine the architectural implications of all these plans

E) Update the financial plan, OKRs and KPIs accordingly

F) Define functional plans as necessary

G) Iterate the content of these plans until top team alignment is achieved

It’s represented graphically as follows:

Maintain Top-Team Alignment and Accountability

The “heads up” motion is fully expressed in the twice-a-year planning cycle, but it is revisited whenever a significant claim proves flawed. When this happens, it is important that the top team brings itself back into alignment and remains accountable. Do all agree on the impact of the flawed claim? Are all debates materially resolved as to the update to this claim? How will this updated claim be tested? Has every executive accepted his part in next steps? More broadly, do all plans have a leader, a team and a clear set of measurable outcome objectives? Does each executive accept the OKRs assigned to him and his teams, as tracked by KPIs? That’s how you achieve enterprise-wide alignment and accountability.

Replan When a Claim Proves Flawed

Whenever a claim or a settled assumption is disproven, you must fix it. It’s best fixed at the lowest possible level of the enterprise. Some claims live within the scope of a single domain team. In such situations you can leave it to that team to respond. For instance, the technical domain team responsible for the prospect-to-customer journey will know what to do if one free trial offer in an A/B test performs decisively better than another.

But the highest-impact claims are the responsibility of your top team. For instance, you might claim that you can pass on a 10% price increase to all existing customers without suffering more than 2% customer churn. Or you might claim it makes sense to disband the direct sales team in the EMEA region, in favor of a new distribution partner. How you test such claims, and the level of validation required to turn them into settled assumptions, are consequential decisions. They are, unavoidably, top team decisions.

Whenever a key claim is disproved, you must update the framework spreadsheet, the financial plan and, if necessary, the OKR pyramid. The amount of replanning that is required when a claim is disproven depends on its significance. If it imperils key growth assumptions, then you may need to conduct a significant reset.

The speed and effectiveness of this replanning effort is a critical success factor. If you can incorporate change into your top team alignment process, planning tools and accountability disciplines efficiently, the entire enterprise gains agility. That itself becomes a source of competitive advantage.

Summary

Your fast-rising enterprise is complex; that complexity must be mastered. It takes systems thinking and a formal planning discipline to do so. With success, competitors rise. It becomes more important to build a high competitive moat. All of this requires smart plans, well executed.

Because alignment is hard, it’s tempting to make plans rigid. That way they don’t need to change. But the reality is that change is constant. Plans must be built with flexibility in mind. Flexibility becomes harder at scale, but it remains as important as it ever was. Your “heads up” motion is perfected when it can accommodate changes and achieve top team realignment with efficiency and effect.

The healthy enterprise is self-aware; it seeks and finds faulty assumptions. It knows when a test has failed. Its leaders welcome that fact, knowing that the faster a flaw is found the faster it can be fixed. Its leaders are not afraid to redesign and realign plans. Its “heads down” motion informs its “heads up” motion, which informs the “heads down” motion and so on — pistons in the engine of growth.

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