How to build companies that matter

Eric Ries, a serial entrepreneur, most recently was co-founder and Chief Technology Officer of IMVU, his third
startup. He’s the author of the blog Lessons Learned, co-author of several books including The Black Art of Java Game Programming (Waite Group Press, 1996), and a Venture Advisor at Kleiner Perkins Caufield & Byers.
He. In 2007, BusinessWeek named Ries one of the Best Young Entrepreneurs of Tech. He’ll be presenting on “The Lean Startup: a Disciplined Approach to Imagining, Designing, and Building New Products” at Web 2.0 Expo.

We’re living in a time of renewed possibility for startups. Major trends – from the pain of the economic crisis to the disruption of web 2.0 – are breaking the old models and paving the way for a new breed of company. I call it the Lean Startup.

The Lean Startup is a disciplined approach to building companies that matter. It’s designed to dramatically reduce the risk associated with bringing a new product to market by building the company from the ground up for rapid iteration and learning. It requires dramatically less capital than older models, and can find profitability sooner. Most importantly, it breaks down the artificial dichotomy between pursuing the company’s vision and creating profitable value. Instead, it harnesses the power of the market in support of the company’s long-term mission.

Tim O’Reilly has recently been advocating that as an industry we focus on building stuff that matters. In response, I want to try and present a way of building startups that can realize that dream. In particular, he as articulated three principles:

(1) Work on something that matters to you more than money,
(2) Create more value than you capture, and
(3) Take the long view.

Given the hype and easy credit that has been the hallmark of technology startups the past few years, it’s been too easy for them to be unclear about whether they are really creating more value or just spending money to create the appearance of success. The lean startup approach tackles this problem from the very beginning of a startup’s life. My experience is that startups need to be built from the ground up for learning about customers and what they will pay for. That means an obsessive focus on finding out “is our company vision really the path to a brave new world, or just a delusion?”

Read the stories of successful startups and, if the founders are willing to be honest, you will see this pattern over and over again. They started out as digital cash for PDAs, but evolved into online payments for eBay. They started building BASIC interpreters, but evolved into the world’s largest operating systems monopoly. They were shocked to discover their online games company was actually a photo-sharing site.

Each of these companies were fortunate to have enough time, resources, and patience to endure the multiple iterations it took to find a successful product and market. The premise of the lean startup is simple: if we can reduce the time between these major iterations, we can increase the odds of success.

And here’s where working on something that matters to you more than money is critical. When you’re committed to something larger than yourself, every minute counts. Hype and transient success won’t keep you going. But the simple process of finding out whether or not your vision is right will. Because people who are dedicated to the truth are more likely to fail fast, learn, and try again.

This is one core tenet of the lean startup approach, called customer development. It has its roots in previous eras of startups (you can read more in the original customer development book, The Four Steps to the Epiphany), but changes in the industry are making it possible to iterate much faster than ever before.

There was a time when many technologies required proprietary licenses, big company permission, or custom deal-making ability to access. Those days are rapidly coming to a close. Most technology startups now have access to a staggering array of high-leverage technologies: free and open source software (and, increasingly, hardware), the data-driven services of web 2.0, user-generated content, and cloud computing, just to name a few. What all of these trends have in common is the increased leverage that development teams enjoy, meaning that for every ounce of effort they expend in building product, they take advantage of the efforts of thousands or even millions of others.

There’s no need to tell Radar readers that these technology trends make it cheaper to make new products. What’s striking to me is that they enable teams to make new products faster. It’s the speed with which companies can move through product iterations that will define this new era. Those that can experiment rapidly will be more likely to uncover what customers truly want; those that take advantage of these high-leverage technologies will be able to experiment the fastest.

Another way smart startups can work faster is to adopt agile product development practices. In traditional waterfall development, which assumes a top-down plan and stable development towards a well-defined outcome, a large number of software projects fail outright (and the lucky ones come in way over budget and way late). The rise of methodologies like Extreme Programming and Scrum has enabled teams to spend more time focused on focused on building products customers actually want and less time engaged in fruitless practices like writing documentation nobody reads or revising specs nobody adheres to.

Still, agile is not always well adapted to the startup experience. That’s not entirely surprising, because most agile methodologies have their roots in big companies. They are specifically designed to build products in situations where the problem is known but the solution is unknown. Thus, they engage in rapid communication between the engineers and an authoritative in-house customer or product owner, who can give them fast resolution on feature decisions as they come up. This is a huge improvement over ever-more-detailed specification documents. But startups routinely face the problem that they don’t even know what problem they are trying to solve.

The Lean Startup takes agile practices and evolves them for use in a startup. The net result is a focus on experimentation and extremely rapid deployment. At IMVU, my most recent startup, we built the systems that allowed us to deploy code to customers fifty times every day. When releases are measured in minutes, not months, you can build a company culture designed to avoid the biggest waste of all: building product nobody wants.

At IMVU, we shipped a product in just a few months. It was terrible. But we decided to charge for it anyway, iterating our way to a freemium business model that brings in more than a million dollars a month. In the early days, though, nobody was buying. It took months of constantly shipping features, measuring the results, and trying again before we realized what was wrong. Although we were able to get a few users to try the product for free, that wasn’t good enough. We wanted to validate the riskiest part of our business plan: that we could get people to pay real money for virtual clothes.

We were always convinced that the next feature we were about to ship would be “the big one” that would fix the product and help us make our paltry monthly revenue targets – only $300 a month in those early days. But these dreams of the instant fix never materialized. No one major release solved the problem, because the problem wasn’t a lack of features.

We eventually realized that our initial product concept, which had seemed so brilliant at the whiteboard, was fundamentally flawed. But because we took a disciplined approach to learning we were able to find out before it was too late. Because we had tried every variation of features, had measured the behavior of the people we were bringing in, and were committed to a revenue plan, we were forced to change direction. It was painful, but if we hadn’t done it, we would never have been able to chart a course that led to our eventual success.

In fact, it wasn’t the risky part of our original vision that had to change. It turns out that people really will pay good money for virtual goods. By discovering the other problems with our concept early, we were able to preserve our larger long-term vision. And, most importantly, we were then able to prove that it could work.

The Lean Startup is a vision for how startups could be built differently. Instead of focusing on hype and mega-growth, we can focus on building companies that serve customers in a fundamental way. That’s what matters.