Third Year MBA

So I've realized recently that there is a big difference between the way that most engineers talk and the way that successful entrepreneurs talk. To summarize, most engineers are inherently somewhat conservative and pessimistic, while successful entrepreneurs are unrealistically optimistic. You have all heard something similar to the interaction that I'm about to summarize:

Entrepreneur: We need to finish this software by next Friday so that we can land that big new customer. You're going to deliver it by then, right?
Engineer: That's impossible. No chance. We still haven't started working on two major features.
Entrepreneur: Why? What tasks do we need to finish? I thought we outlined them all, and we only estimated one more week of development.
Engineer: We're running a bit behind schedule on development. We might be able to finish writing the code in two weeks, but we're going to have to cut some corners, and it probably won't be tested enough.
Entrepreneur: Ok. So you have a week to finish. I promised the customer that our software would be ready by then. We can launch those features in our first maintenance release.
Engineer: Grumble Grumble

So the engineer thinks that the entrepreneur is reckless and crazy, and the entrepreneur can't understand why the engineer is always such a sourpuss. Clearly, they are speaking two different languages (we'll later get into why that is). The postscript (in the ideal case) is that the engineering team delivers the software in a week and a half, and it works pretty well (although there are a few bugs that were fixed in the maintenance release, and those features turned out to be unnecessary). The engineer gets his paycheck, and the company makes a million dollars from the deal that they have signed. Essentially, each acted in a rational way given his incentives and understanding of the world, but there was clearly a conflict.

What Makes Them Tick?
So the primary cause of tension here is that the engineer and the entrepreneur are being graded on two very different sets of criteria. The engineer is successful if he delivers a product that works well (from a technical perspective) and is on schedule. Meanwhile, the entrepreneur wants to build a successful business. A successful business usually involves building something that works well, but there is a lot more to it than just that (I know of many products that worked well but that people didn't want, or even that worked well but were unable to successfully reach their target audiences). At the end of the day, the entrepreneur is successful if he builds something of value and eventually generates a good return for his investors, whether through sales, an acquisition, or even an IPO (I'm omitting social entrepreneurs, who also build value, albeit in a slightly different way).

Now, If you want to build something on-time that works well, it makes sense to be pessimistic about your schedule and what you can deliver (obviously there is a reasonable upper bound on this). Most good engineers I have met (who aren't managers) seem to always say "It can't be done. But, if it were possible, this is how long it might take." Then, they somehow manage to deliver the product in 3/4 of the initially estimated time (and maybe they manage to work in a few useless features that they think would be cool). Good engineers succeed by executing well on complicated technical tasks. Unlike entrepreneurs, they tend to get paid mostly in salary (if they are smart). If the company fails, they can pretty easily find another job paying about the same amount of money (or maybe even a little more).

However, when you want to build something of value, the goal is not to launch products that work perfectly or are perfectly on schedule, but to figure out what people want and to deliver that. Sometimes, it is important to cut corners in the short term if that gives you the best chance to reach your eventual goal. Even if an entrepreneur delivers a product that only delivers 10% of the features he set out to build, he can still be wildly successful (if those few features are the ones that people actually want and are willing to pay for). His goal is not to build things, but to build value. I know of successful entrepreneurs who completely failed in their original project, but who still managed to generate a good return by realizing that they had amassed significant talent equity. And how do you build the maximum amount of value?

Well, that requires you to be unreasonably optimistic.

The Reality Distortion Field
Whenever I meet a successful entrepreneur, I inevitably come to the conclusion that he or she resides in a completely different world than the rest of us. He imagines accomplishing not just what he already knows how to do, but he looks just beyond the borders of the realm of possibility, and figures out how to do that. When Steve Jobs first imagined the iPad, no such thing existed. But he knew that technology was approaching the point where it would be possible, and he found engineers who could build it for him (successful entrepreneurs project a reality distortion field that draws in everyone around them). In the end, this eventually led to Apple shipping over 275,000 iOS devices a day. In the longer term, I can see this vision being disruptive to the PC as we currently know it.

There is an old saying among followers of Neuro Linguistic Programming - A belief doesn't have to be true to be helpful. Sometimes, being delusional can actually cause you to ignore things that have held you back, and the ones who accomplish the most are often the ones who imagine they can accomplish the most. An engineer likes to have the entire solution inside his head before he starts. He begins at the present moment, and imagines every detail between the current moment and the time when his hypothetical company IPOs. Then, he inevitably figures out that the numbers won't quite work out, and he decides to go back to work on Monday. This is what makes him good at being an engineer, and it is also what holds him back. Not surprisingly, the engineer doesn't do well with uncertainty. If he does go out and start a company, he will inevitably figure out that things aren't going to work out the way he imagined, and this is often what kills the company (unless his cofounder can get him back on track).

The entrepreneur, on the other hand, sees an opportunity, decides that the market is huge, and he decides to go for it. He may not have any real skills when he starts, but he has enough ability to handle uncertainty that he inevitably either:
1) Learns the skills he needs to succeed
2) Manages to attract the people he needs to succeed
3) Learns a lot, and is successful at his next company (or five companies later).

The entrepreneur never sees anything as a failure. He just learns from all of his steps (whether correct or missteps), and tries again. James Lindenbaum is one of those prototypical entrepreneurs. Heroku was like his fifth company; he failed a lot, but inevitably kept going until he was wildly successful (and I predict that this won't be his last or greatest success). By contrast, a lot of engineers see everything as a failure. No matter how much they accomplish, they always see something that could have been done better.

Why Entrepreneurs and Engineers Work Together
The irony is that, even though they hate to admit it, most engineers actually love working with entrepreneurs because they are always so optimistic. Even though they tell everyone else that the entrepreneurs "have no clue what they are doing," they secretly wish they were able to totally buy into a vision, and to project that reality distortion zone. Likewise, most smart entrepreneurs surround themselves with engineers who keep them at least loosely grounded in reality. It's an interesting synergy, and one that is necessary to build successful technology company. Rarely, there is that paradoxical person who can simultaneously fill both roles, but these are about as rare as unicorns...

Strangely, it isn't impossible for an engineer to become a successful entrepreneur, but it does require a pretty radical shift in thinking. He needs to stop always seeing things for what they are, and learn to occasionally look at things for what they could be. Sadly, a lot of people just aren't able to make this leap, and end up as wannabe entrepreneurs who didn't make it for some reason or another. In thinking about and writing this essay, I've realized that a lot of my tendencies fall on the "engineer" side, and that I could benefit a lot from seeing things "the other way."

I recently received an email from a friend that contained the following (somewhat paraphrased):

I'm looking for a job at a startup. I would like to work for an early-stage startup with ten or fewer people where I can learn a lot and feel like I'm an important part of the company. I want to do something entrepreneurial, but at this point, I would rather join an existing startup than create my own.

I thought about this a bit, and realized that there are a bunch of conflicting values here. Clearly, this guy is looking for something more exciting than a job at a large and faceless corporation. But he also isn't looking to take the full risk of starting his own company. This is fine - a lot of founders work for a startup before they go out on their own. Paul Graham says that working for a startup makes you 1/2^n of a founder, where n is the number of existing employees. However, not all startup opportunities are equal, and not all are right for each person. If you want to find the right fit, it's important to know what you are looking for, and to make sure that you find the right opportunity for your situation.

Quantifying Your Level of Risk Tolerance
Probably the most important thing is knowing how much risk you are willing to tolerate, and which opportunities cater to that risk level. My friend Jason Freedman has said that there are three essential things that people can bring to a startup, and probably the most important one is the ability to handle risk. With few exceptions, the most successful startup founders are the ones who ate Ramen and packed three people into a one-bedroom apartment. If you're looking for a job, you most likely aren't willing to do that (and it really isn't at all glamorous), but you should probably understand exactly what you are willing to live with.

For example, are you looking to reduce the financial risk (ie. Are you looking for something that will pay a livable salary from day 1)? Or are you looking to reduce the risk of building a team (by starting with well rounded team that may already have experience working together)? Or, perhaps you want to work for a small company that already has a stable revenue stream and is on the road to profitability? (Ask yourself whether you could you possibly handle working for a company that might go out of business at any point?)

Understanding What the Rewards Will Be
Once you have quantified your risk tolerance, you should understand what the probable rewards will be. A lot of people have the dream of joining a startup that pays a salary and gives them 10% equity. Most likely this isn't going to happen (unless you are already some sort of celebrity), but you should know what to expect. And remember that the company you are working for will most likely fail, and your equity will be worth somewhere between zero and your strike price (this may happen even if the company has an exit).

If you're employee number one, you could potentially expect 2-3%, and maybe 5% in some extraordinary situations (if you fill a gap that no one on the founding team can fill, or if having you on the team will drastically increase the probability of the company getting funding). If you come in after employee 5 or so (or after the company takes a significant funding round), I wouldn't expect to get more than 1%, and potentially a lot less (if they are particularly promising/have funding from a well-known investor).

If you consider that most exits that aren't entirely talent acquisitions seem to be in the $10-$30M range (and even those are relatively rare), a 1% share would give you $100-$300K, and this would require working for the acquiring company, which is probably a large corporation, for 2-3 years after the exit. Imagine going back to your corporate job but making 50-100% more salary, and then ask yourself whether you could live with that being one of the better possible outcomes. Everyone thinks about the Google or Facebook-sized exits, but those happen about once every five years or so. Even getting acquired by Google or Facebook (for a sizable sum) is a lot rarer than anyone expects. There are further things that reduce your chance of getting rich by working for a startup, but those are probably too complicated to discuss here.

On a more positive note, most companies that can't give you a huge chunk of equity will probably pay you something approaching market rates. So you get to work for a startup, and make almost as much as you would have at a large company.

My Recommendations
After having made some mistakes on this side, I don't see much benefit to being an employee of a pre-funding (or pre-profitability) startup. They are never as stable as they seem, and you will be taking a lot less equity than the founders for only marginally reduced risk. You will get either no salary or a barely-livable wage, and the company could go out of business at any point (making your few percent equity essentially worthless). If you can get 5% of a company that has taken a couple hundred thousand in a seed round, you might want to go for it, but in all likelihood, that probably won't happen. If you are comfortable working without livable pay for an indefinite period of time, found your own startup. Otherwise, my advice follows:

If you're primarily looking to learn a lot and to prepare for your own startup, I would target a startup with 15-30 employees who has taken a decent-sized round. They will pay you a salary that is close to what you could have gotten elsewhere, and you will still have the opportunity to feel like you are part of a small team that can have a big impact. Plus, money won't be super-tight, so they won't need a quick exit, and will be likely to be around for a while. The reward won't be as great as if you were the founder, but the expected value will be greater (since the company already has had some success), and you might actually learn more. They will already have some senior engineers on board, and there will be less focus on getting things done NOW, and more on getting them done correctly.

After a few years, hopefully this startup will be successful, the founders will retire, and you can move on to your own startup (possibly with some angel funding from people you meet along the way). Or, maybe they won't be successful, and you can avoid their mistakes when you go out on your own.

I'm not going to get into culture fit issues here, although that probably justifies a separate post.

For the past several months, I have been working for a startup that sells software-as-a-service to consumers and businesses. This experience, when combined with reading several interesting blog posts, has led me to think a lot about how to properly price your products. Pricing can be extremely difficult - in fact, most startups get pricing wrong the first time. And it isn't easy to change pricing after fact. If you read popular tech blogs, you have probably seen several examples of startups who pissed off their users by changing pricing (even if what they were doing was actually the most logical move).

So I can't say that I have developed a formula for optimal pricing, but I have come up with two general (and slightly hazy) guidelines for maximizing your profits. They are as follows:

• Get as many engaged users as possible
• Maximize the profitability of your paying users

Engage Your Users

So this one may seem logical, but there are actually some unforeseen consequences. There are actually two ways to increase the number of paying customers. The first is to get more users. This one is actually the easier of the two, since it is directly actionable (or at least more actionable than the second). Spend more money on marketing, or on business development with your channel partners. By increasing the number of users, you will get more paying customers. This definitely works, although it isn't a trivial process. The problems of this are two-fold: user acquisition costs tend to get exponentially higher after a point, and increasing users will often increase incremental costs. There are a lot of startups that are actually unprofitable based on marginal costs - their TCO for a user is higher than the lifetime value. A lot of these companies believe that they can attain profitability by acquiring more customers - unfortunately, the math does not bear this out.

So, what can they do to escape this trap? Well, the easiest way is to engage a higher percentage of their users. For every hundred users that sign up for a service, a relatively small number will continue to use it past the first few days or weeks. Although the overall free-to-paid conversion rate is pretty small, the free-to-paid conversion rate of active users is significantly higher (possibly by an order of magnitude). This makes the assumption that your free product is sufficiently limited such that users will actually want to upgrade - if you give away too much for free, people will not upgrade out of the goodness of their hearts. So, the best way to increase the number of paid users is to increase the number of actively engaged users. If you increase your engaged users by 1%, your paid users will likely increase by a similar amount. For simplicity's sake, let's assume that you have 100 users. Of those, 20 are engaged, and four pay for your product. If you can get another 10 engaged, you will have six paying customers. If you had attempted to do the same thing with user growth, you would have needed to gain an additional 50 customers. At the same time, you would have had to support those 50 customers, only two of whom would actually pay you anything. So, if possible, it makes sense to go for user engagement over sheer user acquisition.

Maximize the Profitability of Your Paying Users

The second point also seems obvious, but has some hidden subtleties. Notice that I didn't say "maximize the number of paying users." Instead, you need to maximize the overall profitability. Sometimes this involves charging more. Most startups charge too little for their products. A lot of them could probably be profitable if only they charged more. "But we offer a number of different pricing options," you may say. The problem is that most users won't upgrade out of the goodness of their own hearts. They will choose the least expensive plan that meets their needs.

One of the things that you learn about in business school is price elasticity. As you increase the cost, fewer people will buy. My theory is that once people actually pull out their credit card to pay, they are somewhat price insensitive. You assume that if you increase your price by $1, you will lose a fixed percentage of your customers. The truth is that people think in terms of thresholds (which is why most prices end in $9s). So, for example, most people may perceive all prices from $3 - $10 as being roughly the same, and then all prices from $10 - $50 may be roughly the same, and then $50 - $200, and so on and so forth (these numbers are all invented). You will experience some drop-off as you increase the price within a range (since all customers are not equal), but the change in demand will be relatively small within a range (sort of like a step function).

If you increase pricing from $3 to $9, and you see a drop-off of 50%, you have still increased your revenues by 50%. And it's possible that you have even increased your profits more because you have to support half as many paying users. You can make those paying users super-happy, which should hopefully decrease churn. Even if you see a drop-off of 66%, the move may still make sense since you have reduced the user support load. Plus, the users are probably higher quality, since they are paying more.

One interesting strategy I have seen is converting low-paying users to ambassadors. Many companies do this with referral bonuses. So let's assume that you get X capacity for free, and the low-cost plan costs $3 a month and includes 5X the capacity. The high-cost plan costs $9 a month, and includes 20X the capacity. Let's say that you have 9 customers paying for the low-cost plan (since the low-cost plan actually provides plenty of capacity). You are making $27 a month. So now let us assume that you increase the cost to $9 by eliminating the low-cost plan. For simplicity's sake, let's assume that 2/3 of the customers don't sign up for the more expensive plan. Your revenue is identical. But let's also assume that you allow users to increase their capacity to 5X by referring 20 friends. Not everyone will want to refer friends. Some will continue to pay, and others will use the free option or go to a competitor. But let's assume for this contrived example that the 6 customers refer an average of 10 friends, or 60 customers in total (the non-paying users will refer friends, but we will lump those into this pot). From those 60 customers, you can expect at least 12 engaged users, and 2 paying customers. So your revenue has actually increased to $45. Overall, this can provide a significant win.

All of the numbers in this post are contrived, but you can see that there can be significant increases in paying customers without actually increasing total users. It seems like the number of users has become the most important statistic (eg. Facebook has 500 million users), but engaged users seems to be far more correlated with profitability. And it is even possible that correctly pricing (and incentivizing) your product can help to maximize engagement.

Before I started business school, my program assigned a pre-reading list. On this list was one of the best books I have ever read - "The Innovator's Dilemma" by Clayton Christensen. If you haven't read this book, you should order it right now (here), but I'll summarize it in a few sentences. Every technology will eventually be disrupted by newer technologies.

At first, these new technologies may be radically worse, and will look like toys, but they will eventually get to the point where they are good enough. Even though these new technologies may never approach the originals for sheer power, they will provide other attributes that give them a significant advantage (for example, low cost or light weight). One of the products that Christensen uses to illustrate the point is hard drives. Every few years, a new drive came along with a smaller form factor than the previous drives. At first, capacities were smaller, and performance was laughable. However, both capacities and performance eventually improved to the point where no one really wanted the old technology because the new technology was good enough.

This pattern continues to today. In fact, I believe that we have just hit that point for 2.5" drives. With the advent of (this) drive, 2,5" drives are now faster than pretty much all 3.5" drives. Sure, it is a bit more expensive (you can buy a 2TB drive for the price of this), but 500GB is plenty of capacity for almost anyone, and it is smaller, lighter, and more power efficient, which makes it good for laptops and small form factor desktops (which are sufficient for 90% of the people out there). Of course SSDs will probably be the end point of this revolution, but we are still a few years off from that.

So, the funny thing is that disruptive technologies appear to be a step backwards from the things that proceeded them. A bit over a year ago, I decided that netbooks were going to be disruptive to modern PCs. I told this to some of my b-school classmates, and they pretty much laughed at me. "But the Atom Processor is equivalent to the PCs of four years ago," said one of my classmates. And, at that point, he was correct. Netbooks were a cheap toy. The displays and keyboards were too small, and the interfaces were clumsy. The only thing that they had going for them was their size and cost. A year later, netbooks aren't too much better - they are still powered by the same underpowered CPUs, and the keyboards are still too small to be useful. Some of them have dedicated video decoders, which allow them to do the only thing they are decent at, media consumption. There is actually one interesting and potentially compelling use case, which was announced just today, and involves some of the coolest out-of-the box thinking I've seen in a long time (here).

But the real competition actually came from below, and not from above. I'll give you a hint: fruit. That's right, Apple Computer. Apple had refused to introduce a netbook, but they essentially pioneered the second generation of netbooks. The keyboard wasn't useful, so they just got rid of it. And even a stripped down PC processor consumed too much power, so they substituted one from a cell phone. And why use a hard disk when you can substitute a few GB of flash? It didn't even have a built-in camera (although I bet the second generation will). Instead, they focused on the one thing that mattered - the screen and the accompanying touch interface. After all, the only thing it's good for (well pretty much) is consuming media.

No one really knew what to make of the iPad. It was too expensive to be a smartphone (and didn't make calls), but it lacked features available in even the lowest-end netbook. Apple got around that by calling it "magical" - I suspect that Steve Jobs completely understands the strategy, but figured that most people wouldn't really understand if he explained it (plus, Steve never really explains himself). Apple still sold around 2 million to early adopters, many of whom just wanted the newest and coolest thing from Apple.

So, here's my prediction. I suspect that, in the long term, a lot of these early adopters will find that the iPad does like 75% of what they use their PC for, and some of them may even forego their next notebook purchase. In about two generations, the iPad (and whatever Google comes out with) will be capable of replacing about 90% of the function of the PC. When coupled with cloud computing/storage, a lot of us won't even own PCs any more. Just an xPad and maybe a bluetooth keyboard (for writing blog posts). And possibly some sort of media box that attaches to your PC (although maybe the xPad will handle that with a wireless video link). When it comes down to it, we're a nation of consumers more than anything else...

So I have another story of disruptive technology, but that is best left for another post.

A few months ago, I was speaking to a now ex-cofounder. We had hit a
rough patch where we invalidated our original hypothesis, and were
thinking about new directions for our business. I was trying to figure
out the least expensive strategy that would allow us to get back on
track, while he kept proposing things that would require several
months of engineering effort.

At the time, I was thinking about leaving his team, mostly because he
seemed to be dead-set on following a single path, come hell or
highwater. He had spent several years working on this product without
really launching anything, and had brought me in much later as an
engineering cofounder. His excuse for his failure thus far was "I
didn't have a competent engineer."

Then, it sort of hit me. Based on your personal talents and the
talents of your founding team, certain courses of action are MUCH more
expensive than others. If you are an enterprise salesperson (as this
guy was before he left to start a company), sales is fairly cheap.
Engineering, however, was pretty expensive for him. It took him years
to find a good engineering team, and it would have cost him 30-50% of
the company if we had stayed. In hindsight, those years could have
been spent making an enterprise play. Once he did the sales, he could
hire the engineers to build the product.

For me, an engineer by trade, building is cheap, but selling is
expensive. I spent all summer trying unsuccessfully to sell my product
to enterprises, and I had no idea where to find people who actually
knew how to sell. This showed me that I need to primarily focus on
building products, because that best leverages my talents. Unless I
have a salesperson or a marketer on my cofounding team, it doesn't
make sense to do something that requires heavy sales.

So, what can we learn from this? First of all, when you evaluate
business ideas, choose ones that play to your strengths. Take an
honest look at the skills of your founding team, and ask yourselves,
"do we have what it requires to execute here?" Sure, an engineer can
sell a little bit, but most engineers will get demotivated pretty
quickly if they spend most of their time selling. Likewise, if your
core competency is sales, you should be thinking up things that you
can sell BEFORE they are built (and that don't require two years of
engineering work before sales can start working).

Furthermore, you may want to make tweaks to your founding team to
account for the business idea. If you have two engineers on your team,
you might not want to bring on a third engineering cofounder. Maybe
that third guy should know sales, or maybe he should be an Internet
marketer. It all depends on what you need to make your company
successful. If you pick the wrong person, it could be worse than doing
nothing.

So, here's an exercise: think of the first (or next) few milestones
that you need to hit to build your company. Now, think about what
skills are required to hit those milestones, and then ask yourself
whether these skills are present in the founding team. If not, then
you should consider changing either the idea or the team. Pick a
product strategy that's reasonably cheap for your team to execute,
because starting a company is already pretty hard, and you don't need
to make your lives any more difficult.

After working with a lot of potential co-founders who didn't quite fit
the bill, I've distilled the ideal co-founder down to three core
characteristics:

1) Smart
2) Trustworthy
3) Hardworking

This may sound obvious, but the core problem is that a lot of
seemingly great people only fulfill two of the three. Which means that
they won't work out as your cofounder. I think that the definition of
each characteristic is pretty self-explanatory, so I'll describe the
trait combinations that don't quite work.

QUICK NOTE: These are caricatures. Everyone will probably have one or
more of these to some extent. The thing that really matters is the
magnitude of that extent, and how the flaw interacts with your
personality.

Smart and Hardworking (But Inconsistent)
You meet this guy (or girl), and you can see the spark in his eyes. He
has lots of interesting ideas, and is always in a rush to implement
them. The quality of his work is high, and he seems like he is going
places. But there is something about him that you just don't quite
trust. Maybe it's something concrete (like constantly being late, or
blowing you off inexplicably), or maybe it's just a feeling of unease
in the pit of your stomach. Whatever the case, this isn't going to
work. One day, this guy is going to sell you out when something better
comes along. Or he's going to exploit your work and then use a
loophole to con you out of your equity. Soak up everything you can get
from this guy, but keep your eyes on the knife drawer

Hardworking and Trustworthy (But a Bit Inept)
Honestly, this combination is the hardest to ditch. This guy is sweet
- he's obviously super-loyal, and he works tirelessly. But... his work
isn't quite what you could have produced. When you give him a task
that you could have finished in a day, he finishes it in three or four
days. And he needs a lot of direction - the only way to guarantee that
his work is top-quality is to hold his hand through all of it.

This guy could be a great employee at a larger company, but he just
won't cut it as a cofounder. The startup needs to move fast, and
everyone needs to contribute on a reasonably equal basis. Some
cofounders will be unable to do the work that you do because they have
a completely different set of talents, and that's fine. But, when
there is a lot of overlap, you should feel like your cofounder is
roughly equal to you, if not better in many respects.

Smart and Trustworthy (But A Bit Lazy)
You geninely enjoy being around this guy, and he has so many great
ideas. He can think through literally anything - you're sure that you
and he are toe-to-toe in the brains department. But he doesn't get
that much done, unless you push him. I'm sorry to say it, but this guy
is lazy. At a large company, he could be at home in the strategy
department. But, at a startup, there are no strategy roles. Everyone
needs to be building or selling the product at all times. There is no
place for the non-self motivated. It's a tough world out there.

Conclusions?
So, something I've realized is that there is no perfect cofounder.
Everyone has one or more of these flaws. They are either inconsistent,
inept, lazy, or a combination of the above. As an aside, when I say
inept and lazy, I'm talking about a lot of people who would be
considered brilliant and hardworking in comparison to 95% of the
people out there. It's important to be honest about everyone's flaws
(including your own), and to find people whose talents complement your
flaws. Maybe you are lazy, and can find a cofounder who is happy to do
do your work. Or maybe you are inconsistent, and can find someone who
is trustworthy and won't double-cross you (until you find someone
better).

This is one major reason why the smart money in the startup world
suggests that you date your cofounder before you take the plunge.
After dating, joining, and even splitting from a bunch of cofounders,
I can say that you need to tread carefully...

So you get a great idea, and you decide to turn it into a company. You
get together with a few friends, and start hacking. But at some time,
you may encounter what I call a critical devalidation. Essentially,
this is the point where you realize that it just isn't going to work.
Maybe you don't have the right team, or people just don't want the
product, or it costs you too much to sell relative the revenue it will
bring in. For some reason, you cannot keep holding the current course
any longer. You need to abandon your current efforts and go back to
the drawing table.

The first thing I can say is that you want to encounter these points
as quickly as possible. It is much easier to cope with abandoning
something you have worked on for a few weeks than something you have
been doing for a few years. If you are talking to your customers and
validating your ideas, you should pretty quickly get an indicator that
something isn't right. However, regardless of when it happens, this is
always a crushing moment. You can literally see the spark in someone's
eyes fade as they have that realization.

So how do you deal with this? I'm going to confess that I haven't been
terribly good at dealing with it in the past, but I will give you a
bunch of options that don't work, and then I will recommend a few
options that seem reasonable.

What Doesn't Work
Here are some things I have tried in the past. None have worked well
for me, so I will tell you about the possible pitfalls of each.

Giving Up
If you give up, there is no way you will possibly succeed. Sure this
is hard, but that's why the potential rewards are high. Sure you could
go back to Corporate America and make a nice steady paycheck working
for some big corporation, but that isn't what you want to do. You want
to make this work. You have this stuff in your blood.

Doing Nothing
The first thing that doesn't work is doing nothing. You can sit around
moping, thinking about what could have happened if your idea made it
big. Sure, it's fine to take a little while to mourn. In fact, it is
better to mourn for a little while than it is to jump immediately into
something new. But don't take too long. Realize that the sooner you
get back to work, the sooner you will find the idea that makes you
successful.

Keep the Same Course
A second option is to ignore the critical devalidation, and to keep on
going. This actually could be a reasonable option in some cases. Maybe
you made some bad assumptions, which led you to unfairly conclude that
your product is the wrong one. Possibly there is a different market
for the same product, or you can figure out how to reach the actual
people who want your product. Remember that startups are outliers - I
would never immediately dismiss an idea because there isn't a $1
billion addressable market (I have seen people do this). Many of the
best companies start out small, and hit it big later on.

However, it is important to be realistic. If people don't want your
product, they don't want it. Don't keep beating a dead horse. If you
can figure out how to make them want it, do that, but it isn't going
to magically happen. Sure, Hail Mary shots hit the basket once in a
blue moon, but each Hail Mary shot will prevent you from getting back
to two-point attempts. Build something people want. You can build the
best product, but if no one wants it, then you won't make any money
(or make the world a better place).

Quickly Jump to Another Product in the Same Vertical
So you have spent a while understanding a vertical. You don't want to
abandon that and start again. So you tell your team, "why don't we
build Y instead of X?" The problem with this is that you may not be
passionate about product Y. My original startup killed our first idea
because of lack of addressable market. We quickly jumped to another
product that catered to the same industry. Honestly, we weren't as
passionate about the second product as we were about the first. So it
never quite felt the same. Plus, we pretty much failed for the same
reasons the second time around.

Leap Without Looking
It is easy to jump to the next reasonable sounding idea. After all, it
is better to be working on something than to sit around twiddling your
thumbs. However, if you jump too quickly, you may end up making the
same mistakes all over again. It took a lot of effort to get to the
point where you abandoned your last idea, so don't waste that. Look
around, and some time really thinking before you start working on
something new.

What to Try
Here are some things that I have tried. None of them have worked yet
because I haven't hit it big, but they all seem like reasonable
approaches. I'm probably going to focus more on them in the future.

Reevaluate Your Team
Do you have the right team? If you failed because of lack of sales
talent, find sales people. If you couldn't reach enough users, find
marketing people. If you don't have an engineer on your core team, get
one. This is not to say that you should spend your time pointing
fingers, but definitely think about what it takes to get the job done,
and figure out whether you have that. If not, this is a good time to
switch.

Find Something That Caters to Your Strengths
Everyone has certain talents. There are products that cater to those
talents, and products that don't. Maybe one of you is an experienced
Enterprise Salesperson. Well, if you are creating Consumer Internet
products, their talents probably aren't going to best use. Maybe you
love bikes but are spending your time trying to create a product that
sells bowling balls. It's easier to do something you know how to do
than something completely new. Starting a company is hard enough
without having to do things that you have no particular talent for or
interest in.

Build Something Exciting
This is easy. What are you passionate about? Build that. Build a
product that solves one of your major problems. In business school, I
learned a lot about Kaizen. Hold a Kaizen for your life. Keep a pen
and paper with you at all times. Every time something annoys you,
write it down. Every time you feel like it would be nice to have "X",
write it down. After a while, look at your list, and there are
probably a whole slew of new product ideas.

Start Testing Early
So you probably waited too long to test your last idea. After all, it
was your baby, and it wasn't ready to face the big bad world. But it
still got trampled by elephants as soon as you let it out there. So
accept that some ideas will fail, and write that off as the casualty
rate. Think up several ideas, and test all of them as quickly as
possible. Think up the tests before you build the product, so that you
can build a minimum implementation with the fewest possible features.
Then you can build, test, pick the best idea, and focus on making that
one successful. Or maybe none of them pass your tests. Then you have
saved yourself a lot of time and trouble.

Keep Going
Regardless of what you do, keep going. You will miss 100% of the shots
you don't take. A lot of people give up too early; it is easy to give
up. After all, you put your neck out there, worked your butt off for a
while building something, and got rejected hard. But the most
successful entrepreneurs keep going until they succeed. If your
product fails, build another one. If your team falls apart, build
another one. If you are out of money, figure out how you can get by
for a little longer (maybe some consulting work or a part-time gig).
If you are dejected, tap into your support network. Make sure that
they are people who will provide encouragement to the end - some
well-meaning people will prematurely tell you to quit.

This isn't easy, but you can succeed if you keep trying (and learning
from your mistakes).

So you have a great product idea, but how do you prove that the world
wants it? Well, one way to do this is to spend 3-6 months building
that product (for your sake, we assume that's all it will take). You
hack away, building the features that you want. When it is finished,
you attempt to get some people to come to your site and try it out. If
all goes well, you get a bunch of people to try it, and they give you
feedback on whether they like it. Hopefully they do, and if not, well,
it's back to the drawing table. Maybe they even tell you what they
want to build next time. However, you have just burnt 3-6 months of
runway (which could be coming out of your pocket). It's also pretty
dejecting to build a product that no one wants.

There has to be an easier way to do this. Well, there is. Until
recently, it was pretty expensive and difficult to validate your ideas
(pay someone to run a focus group), but recently this has become easy,
thanks to two inventions: Google Adwords and rapid development
frameworks (Ruby on Rails and Django are two that come to mind).

So there are two things that every web startup needs to do: user
behavior studies and experiments. These can save you a lot of time and
money, and can help put your product on the right track in minimal
time. If you haven't already started. you should be doing them now. So
what are these things, and why are they important?

User Behavior Studies
I'll start with these first, because they are simple. This could more
simply be called "talking to users," but they are actually better than
talking to users, because you get to see how a user truly feels about
your application (and this is pretty obvious when you do a user
behavior study). To your face, a lot of users will tell you that your
product idea sounds great, but that doesn't mean that they truly mean
it (or that they will use it).

If you were a big company like Google, you would have a fancy
usability lab. You would have people who were hired just to do
usability testing. They would run users through a set of actions, and
the product managers and engineers would watch behind one-way glass
(the product managers would furiously scribble notes about every move
that the user made). There would even be fancy computerized systems
tracking where the user is looking at all time. In the end, you would
be able to see real users use the product. It would be a big
production. No one would get any work done for days, and then you
would have a big meeting to discuss the "learnings."

How do startups hack this process to their advantage? Well, you can
put together a quick demo of your product, and load it on your laptop.
Build the simplest possible demo that exposes the functionality you
want to test. Then head out to the nearest busy coffee shop. Talk to
some random people, and ask them if they will take part in a quick
test (most people are pretty nice about this). I know it's scary to
talk to random people, but much less scary than spending 6 months on a
product that flops. Start by asking general questions about how they
already accomplish what your product wants to help them do. If, for
example, your product helps them to shop, show them a blank browser,
and ask them to shop for a product that they want to buy. Observe what
they do. Encourage them to speak their thought process aloud. Observe
what pains they encounter.

Next, whip out your demo. Ask users to attempt to "use" it. Give them
as little instruction as possible. Mostly, just watch. Encourage them
to narrate. If they get stuck, observe that before you tell them what
to do.

Watching a few users can give you invaluable feedback. My current team
had some conflicting hypotheses about how users would use our product,
so we resolved this by showing the product to five random people at a
coffee shop. In two and a half hours, and pretty much for free (I got
a parking ticket for being over time in a two hour zone), we learned
key facts about how people shop for products on the Internet. And we
probably saved ourselves one to two months of wasted effort.

If you haven't done this yet, do it tomorrow.

Experiments
So while user behavior studies are descriptive, these give you hard
data. To do this, you hack together several possibilities, and you put
it out to the users to vote. But you don't tell them what you are
doing - you can randomize the behavior of your site. First of all,
build the minimum possible experience required to expose a feature.
Then build a few alternatives, and make your application randomly
serve one of the possibilities (be sure to keep track of which
possibility you are testing). Then, use analytics software such as
Mixpanel to record what the user does in each situation.

Finally, drive some Google or Facebook Ads to your page. Don't pay a
lot of money - you often don't need all that many impressions to
figure out what is going on (I think it cost us $6 to run one test
that gave us valuable information). You may need to do some work
figuring out which creatives lead to the highest click-through rates.
Click-through rates don't matter terribly much, although Google will
stop serving your ads if your CTR is too low. Plus, you will probably
need to learn how to do this for when your product launches.

In the end, you can analyze the results, and draw conclusions based on
what happens. It can be surprisingly quick - each time we have run an
experiment, we have had fairly convincing results within a few hours.
Of course, it is important to control the variables. If you change too
many things between conditions, it may be hard to figure out what the
true differences are.

In our case, we looked to see what would lead users to give us their
email address (a big portion of our functionality involves emailing
updates to users). We tried three conditions:

1) We immediately prompt the user for their email address.
2) We wait until the user does something on our site, and then we
prompt them for their email address.
3) We display some site functionality related to the query term that
the user clicked through on, and then we ask for the email.

Interestingly, the third condition had a massively higher conversion
rate (actually pretty respectable), followed by the second condition,
and no users gave us their email in the firstcondition (big shocker).

Ego Check
If you love your product idea more than your first-born child, you
probably don't want to do this. There is nothing more crushing than
having your product idea completely devalidated by an experiment or
user behavior study. But it is even more crushing to spend six months
to a year working on something that you end up killing because no one
wants it. I've done both, and I would drastically prefer the former to
the latter.

So get out there and start already.

I just came across this post by Paul Buchheit. In it, he talks about
how you should focus on doing three things extremely well. If you can
succeed at that, people will use your product, and you can build the
rest later.

I've been working on a new startup with a new team (more on that
later), and we're trying to nail down the product. When I came in, we
started talking about getting out the minimum viable product. One of
my cofounders has been working on the product for quite some time, and
he already had a demo up, but for various reasons, we essentially
started from scratch. So we mapped out the "minimum viable product,"
and started building.

Sounds good so far, but there were some issues. The first was a lack
of customer development (I need to talk about that more later), but
more importantly, the minimum viable product was defined in functional
terms. So, for example, if the product were a task list (it isn't),
the MVP would be:

1) add task
2) check off task
3) edit task

The problem with this is that we didn't define the MVP in terms of any
sort of core value proposition. When I thought about it (after about a
month of hacking), I realized that what we were building differed
significantly from the original stated vision. We were building
something that didn't really accomplish any of our key goals (as I
understood them). Sure, it was usable, but it seemed like a
compromise. To be completely honest, I was unconvinced that people
would want to use what we were building (this became more obvious once
we started talking to real customers).

So we started talking about our core value proposition, and how we
were going to deliver on it. I came across Paul's blog post later, but
it actually simplifies a lot of what we have been talking about. You
have to focus on defining and delivering a few key features. These
features should differentiate you from everything else that is out
there. If you trying to be all things to all people, you don't make
anyone happy. I have heard nerds gush about all of the features that
Archos puts into their media players. The problem is that I don't know
anyone who actually owns an Archos (whereas most people seem to own an
iPod or iPhone). I don't want an Archos. It fails to create a
compelling core value proposition.

So three actually seems like a good number of core features. It is
enough to give your product some definition, but not so much that you
try to do everything. It is actually an interesting exercise to limit
yourself to three features, especially if you are an engineer "but it
would only take ten minutes to add one more thing".

So what would be a compelling core value feature set for our
hypothetical task list product? (I'm actually building this as a side
project).

1) Makes it super easy to enter your tasks from anywhere
2) Uncluttered and simple interface that is accessible from any device
3) Bugs you relentlessly to complete the things that you put on your list

Now that I think about it, I accomplished goals 1) and 2) relatively
quickly, but didn't focus on 3). The interface became cluttered with
features, but not the one that mattered. Recently, I have slid into
not using my own product. I'm going to refocus on my core value
proposition, and hopefully I will get back to creating something that
is useful for me.

I would actually argue that, of your three features, one has to be a
draw, one has to become immediately obvious once people start using
it, and one functions to keep users coming back. With the iPod, people
bought it either because it was easy to use (simple interface, easy
syncing with the mac) or because it had a large capacity. Once they
started using it, the other features became obvious ("wow. I can store
all my music on this" or "wow. this is easy to use"). I would argue
that the stickiness was that it was small. You could effortlessly
carry it with you (especially the iPod mini and Nano). Unlike a
portable CD player (and the hard drive-based mp3 players of the time
looked like a CD player), it fit in your pocket.

What are your product's three features?

Someone recently asked me which companies I would work for if I were
looking for a job. I'm not looking for a job, but I figured that it
would be a fun exercise to think about. I spent a while coming up with
a list, so I figured that I would post it here.

So here goes (in no particular order):

Zynga - They are doing ridiculously well, and focusing on a big market
that is just shaping up. Seems like a company where you could have a
lot of impact. The CEO is a really interesting guy and has a lot of
interesting ideas (and is supposedly very approachable). If I were
looking for a job at a company, this might actually be my top pick.

Facebook - Probably the most engineering-centric of the larger
internet companies. Not really a startup any more, but still has lots
of potential (once they better monetize their application platform).

LinkedIn - Social Networking is hot. Plus I hear that they are a good
company to work for (lots of opportunities). I don't think that they
will be as big as Facebook, but they cater to a crowd that's actually
willing to pay them money to use the service.

Playdom - Another Facebook applications company. Probably second to Zynga

Twitter - I have no idea how big they are going to be in the
long-term, but they define hot right now. They are doing lots of
interesting and innovative things.

Foursquare - People use it like crack. I don't know if they are
hiring, but I'm sure that they will soon. Also Gowalla, although they
aren't in the bay area.

Yelp - I think that they will get acquired soon (rumor has it by
Google). The business model is a bit shady, but they've created a
great service and built a rabid following.

Square - Credit card processing from any mobile phone. Started by the
guy who created Twitter. Could potentially be a game changer. And they
are hiring.

Eventbrite - Well-done product and they actually have a pretty
straightforward business strategy (unlike a lot of the companies I
have mentioned). They are hiring aggressively.

Bump - They are great guys and have a lot of potential. Just took a
bunch of money from Sequoia, and I believe that they are staffing up a
bit. If they can figure out how to turn all of those bumps into money,
they will be golden.