The Startup Customer Development Model[i]^,[ii]

We will spend the rest of 2012 and a substantial part of 2013 going through The Startup Owner’s Manual – a recently published book by Steve Blank and Bob Dorf[iii]. Last week we discussed Chapter 1, in which the authors point out the problems that arise when startup founders approach the task ahead of them as if their startup is merely a small version of a big company.Chapter 2introduces the idea of a Customer Development model for startups.

But, before we delve into the Customer Development process: What is a startup? According to Steve Blank and Bob Dorf a startup “is a temporary organization built to search for the answers to what makes a repeatable and scalable business model.” Searching for a business model “is what startups do before they have found a repeatable and scalable business model.” The process of searching uses the Customer Development process. A business model is a description of how the startup will create, deliver and capture value – Steve Blank and Bob Dorf use Alex Osterwalder’s Business Model Canvas, which we have already studied in a fair amount of detail.

The Customer Development model is designed to solve each of the problems that the authors point out in Chapter 1. Customer Development is a 4-step process. In the first two steps the startup engages in a search for a repeatable and scalable business model. In the last two steps the startup executes the business model after having developed it, tested it, and validated and proven it in steps 1 and 2.

Step 1: Customer Discovery – this involves translating the initial vision behind the startup into a set of hypotheses about each component of the business model. This allows experiments to be performed that either validate or invalidate each proposed hypothesis. In my experience the exercise of testing hypotheses about the business model with prospective customers accomplishes at least two things. First the startup entrepreneur gets to hear directly from customers about the elements of the business model’s value proposition that are most critical from the point of view of the startup’s customers or partners. Second it jump-starts the sales process even before the startup has invested much time or money into building a product. The founders of a hardware startup discussed their idea for an innovative new product with a potential partner[iv]. The partner’s input proved crucial in determining the direction they followed with regard to product design – it evolved from a product with one offering to one with three distinct but complementary offerings.

The revenue model also changed based on those discussions. Even better, the partner agreed to work with this startup to bring the product to market when it is ready. Obviously, there’s still a lot to be done – manufacturing for example. But those initial discussions have been critical in conferring the kind of credibility that has made it possible for the startup to seek an audience with other partners. Customer discovery for this startup also involved market research to determine the priority of features from the perspective of individual end-use customers – the men and women who might actually decide to purchase the startup’s offering once it becomes available to consumers.

Step 2: Customer Validation – this step proves that the work done in step 1 is easily repeatable, scalable, and capable of deliveringthe customer volume required to build a profitable company. The startup I described above is now building prototypes based on all the information it gathered during the Customer Discovery process. Soon we will test our ability to deploy the products in the field – a few hundred first, then a few thousand, and barring any major setbacks, tens-of-thousands, then hundreds of thousands. During that process we will test how well the back-end software works with the hardware that we have designed and manufactured once people are actually using the device. At each step I expect we will go back to the drawing board on several aspects of the product and the business model. For example, our pricing model may not reflect reality since our market research confirmed the hypothesis that our potential customers have never encountered a device like the one we are developing. We may discover that customers will gladly pay more for the value proposition we offer than we currently plan to charge. It is important to note that we have gone through a number of product pivots during Customer Discovery. For one, we made an incorrect hypothesis about the amount of space our partners would be willing to devote to this new device, never mind all the assurances they gave us during early conversations.

We also made a number of pivots in terms of the user experience and the interface through which users will interact with the device because we realized that a number of hypotheses we had made about certain design, engineering, and manufacturing issues related to the product were just flat out wrong. The product we will soon show to our partners satisfies the desires individual end-use customers told us they seek in a product like ours[v], in a manner that accounts for the constraints our partners expressed they would eventually have to contend with in deploying the devices when they come to market. Moreover, this exchange of information led us to develop a product with performance characteristics far superior to what we would have achieved within the parameters of our previous vision. We expect to make a few more pivots before all is said and done.

Step 3: Customer Creation – during this step the startup steps on the gas in order to greatly accelerate sales. Accelerating sales involves demand creation as well as driving the product into the sales channel. The kind of specific activities that each startup will undertake in this step vary by product type, and they also vary by market type. Obviously, the costs associated with customer creation will also vary by product and market type. Demand creation might involve developing a market adjacent to the one the startup originally was formed to serve. Facebook went through a transition of that sort – its membership was initially restricted to students at Harvard.

Step 4: Company-Building – the startup ceases to be a startup when its search is complete. The end of the search processes marks the transition from startup to company. The startup was a temporary organization of resources for the purpose of executing the search. The company is different. Barring great misfortune, the company is not expected to be temporary. Also, to function effectively the company will need certain infrastructure that the startup may have been able to do without – human resources, compensation and benefits, marketing, sales, business development, finance, etc. The focus shits from “search, learn and discover” to “execute, execute, and execute.” Sometimes the team that built the company from its startup roots lacks the skills to navigate this new stage. It is not uncommon for a new set of people to eventually takeover the day-to-day management of the enterprise at this point.

Before you run off to engage in your own Customer Development, consider that this concept may not work in the same way for every type of startup[vi]. It may be easy to engage in Customer Discovery if your startup caters to enterprise end-use customers or works with enterprise partners as intermediaries to reach individual end-use customers. Customer Discovery may be more difficult to execute for some startups creating certain consumer products – web-based products for example.

Let’s talk again in two weeks. On deck? More contemplation about The Path to the Epiphany: The Customer Development Model – chapter 2 in The Startup Owner’s Manual. Specifically, we will discuss the 14 rules that comprise the Customer Development Manifesto.