The Lean Startup Notes

Eric Ries

Prepared By Prepared For

Samuel Mursalin Course: Entrepreneurship
Lecturer, Department of Management Course Title: MGT368
North South University
Table of Contents
Part 1: Vision ....................................................................................................................................................................... 3
Part 2: Steer .......................................................................................................................................................................... 6
Chapter: Test ................................................................................................................................................................... 6
Chapter: Measure............................................................................................................................................................ 7
Chapter: Pivot or Persevere .......................................................................................................................................... 8
Part 3: Accelerate ................................................................................................................................................................ 9
Part 1: Vision
What is Lean Startup?
The Lean Startup provides a scientific approach to creating and managing startups and get a desired
product to customers' hands faster. The Lean Startup method teaches you how to drive a startup-
how to steer, when to turn, and when to persevere-and grow a business with maximum acceleration.
It is a principled approach to new product development.

Too many startups begin with an idea for a product that they think people want. They then spend
months, sometimes years, perfecting that product without ever showing the product, even in a very
rudimentary form, to the prospective customer. When they fail to reach broad uptake from
customers, it is often because they never spoke to prospective customers and determined whether or
not the product was interesting. When customers ultimately communicate, through their
indifference, that they don't care about the idea, the startup fails.

The Lean Startup methodology has as a premise that every startup is a grand experiment that
attempts to answer a question. The question is not "Can this product be built?" Instead, the
questions are "Should this product be built?" and "Can we build a sustainable business around this
set of products and services?" This experiment is more than just theoretical inquiry; it is a first
product. If it is successful, it allows a manager to get started with his or her campaign: enlisting early
adopters, adding employees to each further experiment or iteration, and eventually starting to build a
product. By the time that product is ready to be distributed widely, it will already have established
customers. It will have solved real problems and offer detailed specifications for what needs to be
built.

A core component of Lean Startup methodology is the build-measure-learn feedback loop. The first
step is figuring out the problem that needs to be solved and then developing a minimum viable
product (MVP) to begin the process of learning as quickly as possible. Once the MVP is established,
a startup can work on tuning the engine. This will involve measurement and learning and must
include actionable metrics that can demonstrate cause and effect question.

The startup will also utilize an investigative development method called the "Five Whys"-asking
simple questions to study and solve problems along the way. When this process of measuring and
learning is done correctly, it will be clear that a company is either moving the drivers of the business
model or not. If not, it is a sign that it is time to pivot or make a structural course correction to test a
new fundamental hypothesis about the product, strategy and engine of growth.

Many startups struggle to answer the following questions:

1. Which customer opinions should we listen to, if any?

2. How should we prioritize across the many features we could build?
3. Which features are essential to the product’s success and which are ancillary?
4. What can be changed safely, and what might anger customers?
5. What might please today’s customers at the expense of tomorrow’s?
6. What should we work on next?
These are some of the questions that teams struggle to answer if they have followed the “let’s just
ship a product and see what happens” plan. The team should have a clear vision before starting the
business. Afterwards, they should experiment every action by generating hypotheses. Continuous
experimentation is the way to solve the previously mentioned issues.

Zappos Experimentation
Zappos is the world’s largest online shoe store, with annual gross sales in excess of $1 billion.
Founder, Nick Swinmurn, was frustrated that there was no central online site with a great selection
of shoes. Swinmurn could have waited a long time, insisting on testing his vision with complete
warehouses, distribution partners and the promise of significant sales.

Instead, he started by running an experiment. His hypothesis was that customers were ready and
willing to buy shoes online. To test it, he began asking local shoe stores if he could take pictures of
their inventory. In exchange, he would post the pictures online and come back to buy the shoes at
full price if a customer bought them online.

It was designed to answer one simple question: is there sufficient demand for a superior online
shopping experience for shoes? A well-designed startup experiment like the one Zappos began with
does more than a test a single aspect of a business plan. To sell the shoes, Zappos had to interact
with customers: taking payment, handling returns and dealing with customer support. This is
different from marketing research. If Zappos had relied on existing market research or conducted a
survey, it could have asked what customers thought they wanted. By building a product, the
company learned real customer behavior, interacted with customers and realized unexpected ways
customers behaved.

HP Experimentation
Caroline Barlerin is a director in the global social innovation division at Hewlett-Packard (HP), a
multinational company with more than three hundred thousand employees and more than $100
billion in annual sales.

Corporate guidelines encourage every employee to spend up to four hours a month of company
time volunteering in his or her community. Because of its talent and values, HP’s combined
workforce has the potential to have a monumental positive impact.

Caroline’s project is just beginning, and most employees do not know that this volunteering policy
exists, and only a tiny fraction take advantage of it. Most of the volunteering has been of the low-
impact variety, involving manual labor, even when the volunteers were highly trained experts.

If Caroline goes down the traditional path, she would undergo a critical evaluation of the feasibility
of her idea with lots of assumptions, for example older employees would be more motivated, top
executives would ask for instant success, and experts would not use their specialized skills for
volunteering purpose and many others.
Rather, if Caroline follows the Lean Startup’s experimentation method she would do the following:

1. Break down the grand vision into two parts: the value hypothesis and the growth
hypothesis.

Value hypothesis tests whether a product or service really delivers value to customers once they are
using it. What’s a good indicator that employees find donating their time valuable? Experiments
provide more accurate answers and save more time. Caroline can organize a small volunteering
project and test how many employees sign up and how many of them show intention of repeating
this intention.

Growth hypothesis tests how new customers will discover about a product or service. Once the
program is up and running, how will the word spread from the early adopters to the mass adoption
throughout the company.

The riskiest element of a startup’s plan is the leap-of-faith assumptions. Every assumption is testable
with the right experiments. Therefore, hypothesize assumptions based on value hypothesis and
growth hypothesis to achieve a well-rounded informed situation and eliminate leap-of-faith.

2. Develop the minimum viable product (MVP)

An MVP is the most basic version of a product or service that allows an entrepreneur to test the
hypotheses on actual customers. It lacks many features that the final product would eventually have.
Using MVP, Caroline can measure how many volunteers actually completed the task and how many
are willing to pass goodwill to a colleague to participate in subsequent activities.

These experiments can be conducted in a matter of weeks of the traditional strategic planning
process. Even when the experiments produce negative results, those failures influence the next
strategies. These experiments are more than just a theoretical inquiry; these are also the first
products. If this or any other experiment is successful, it allows the manager to get started with his
or her campaign: enlisting early adopters, adding improvements to each experiment and eventually
starting to build a product.

By the time that product is ready to be distributed widely, it will already have established customers.

Traditionally, the product manager says, “I just want this.” In response, the engineer says, “I’m
going to build this.” Instead, teams should first answer the following four questions:

1. Do consumers recognize that they have the problem you are trying to solve?
2. If there was a solution, would they buy it?
3. Would they buy it from you?
4. Can you build a solution for that problem?

The common tendency of product development is to skip straight to the fourth question and build a
solution before confirming that customers have the problem.
Part 2: Steer
Chapter: Test
After the assumptions are hypothesized, entrepreneurs must enter the Build phase as quickly as
possible with an MVP. The MVP is that basic version of the product that requires minimum effort
and time to develop.

After building the MVP, the biggest challenge will be determining whether the product development
efforts are leading to real progress which leads to the Measure phase. If you are building something
that nobody wants, it doesn’t matter if you are doing it on time and on budget. Innovative Accounting is
a quantitative approach that allows us to see whether the tuning efforts are bearing fruits.

Finally, and most important, there’s the pivot. Upon completing the Build-Measure-Learn loop, we
confront the most difficult question any entrepreneur faces: whether to pivot the original strategy or
persevere. If we’ve discovered that one of our hypotheses is false, it is time to make a major change
to a new strategic hypothesis.

What differentiates the success stories from the failures is that the successful entrepreneurs had the
ability and the tools to discover which parts of their plans were working brilliantly and which were
not, and adapt their strategies accordingly.

Potential Drawbacks of MVPs

The most common drawbacks that entrepreneurs feel that an MVP can pose are as legal issues, fears
about competitors, branding risks and the impact on morale.

For startups that rely on patent protection, there are special challenges with releasing an early
product. In some jurisdictions, the window of filing a patent begins when the product is released to
general public, and depending on the way the MVP is structured, releasing it may start this clock.
However, the patent risk of an MVP are minor compared with the learning benefits. However, in
industries in which a new scientific breakthrough is at the heart of a company’s competitive
advantage, these risks need to be balanced more carefully. In all cases, entrepreneurs should seek
legal counsel to ensure that they understand the risks carefully.

The second potential drawback is the fear of competitors – especially large established companies –
stealing a startup’s idea. The truth is that most managers in most companies are already
overwhelmed with good ideas. Their challenge lies in prioritization and execution, and it is those
challenges that give a startup hope of surviving. If a competitor can outperform a startup once the
idea becomes widespread, the startup is doomed anyway. A startup has much bigger problems and
secrecy is not one of the major concerns. Sooner or later, a successful startup will face competition
from fast followers. A head start is rarely significant enough to matter. The only way to win is to
learn faster than anyone else.

Thirdly, many startups plan to invest in building a great brand, and an MVP can seem like a
dangerous branding risk. Similarly, entrepreneurs in established organizations are often constrained
by the fear of damaging the parent company’s established brand. In either case, there is an easy
solution: launch the MVP under a different brand name. Long-term reputation is only at risk when
companies engage in vocal launch activities such as PR and building hype. When a product fails to
live up to those expectations, real long-term damage can happen to a corporate brand. Startups have
the advantage being obscure, having a small number of customers, and not having much exposure.

Finally, if an MVP fails, teams are liable to give up hope and abandon the project altogether. Failures
of MVPs seriously hamper the morale of the startup team overall. However, such problems are
solvable and should act as learning opportunities for the entrepreneurs.

Chapter: Measure
Innovation Accounting enables startups to prove objectively that they are learning how to grow
sustainable business. Innovation accounting begins by turning an assumption into a quantitative
model. It measures appropriate results for every tuning.

Innovation accounting works in three steps: first, use an MVP to establish a baseline of real data
on where the company is right now. Without a clear picture of your current status – no matter how
far from the goal you may be – you cannot begin to track your progress.

Before building the MVP, the company might perform a smoke test with its marketing materials.
For example, there is an old direct marketing technique in which customers are given the
opportunity to preorder a product that has not yet been in the market. By itself, this is insufficient to
validate an entire growth hypothesis. Nonetheless, it can be very useful to get feedback on this
assumption before committing more resources into the product.

Second, startups must attempt to tune the engine from the baseline toward the ideal. This may take
many attempts.

Third, after the company gets toward the ideal point, they have to make a decision: whether to pivot
or persevere.

A/B Testing/Split Testing

A/B Testing or Split Testing is a technique that allows testing of effectiveness of two versions of
offerings at the same time to understand which offering serves the determined objective. For
example, an entrepreneur has two different designs of websites. When people enter the website, two
versions are randomly given to two different random sets of people. Based on the results (e.g.
activation rate, retention rate and many others) that each design generates, the entrepreneur can
conclude which layout to use.
Chapter: Pivot or Persevere
The word pivot sometimes is used incorrectly as a synonym for change. A pivot is a special kind of
change designed to test a new fundamental hypothesis about the product, business model and
engine of growth.

Types of Pivot
1. Zoom-in Pivot: What was previously considered a single feature in a product becomes the whole
product. E.g. a 360-degree computer service company that provides services such as both software
and hardware services realizes that its hardware service is not doing well. Therefore, the entire
company decides to become a computer software service company and eliminates hardware services.

2. Zoom-out Pivot: In a reverse situation, what was previously considered a single feature is
insufficient to support a whole product. Therefore, what was considered a product becomes a single
feature of a much larger offering.

3. Customer Segment Pivot: In this pivot, the company realizes that the product it is building
solves a real problem for real customers but they are not the type of customers it originally planned
to serve.

4. Business Architecture Pivot: Companies generally follow one of two major business
architectures: high margin, low volume architecture or low margin, high volume architecture. In a
business architecture pivot, a company switches from one architecture to the other.

5. Engine of Growth Pivot: In this type of pivot, a company changes its growth strategy to seek
faster and more profitable growth.

6. Channel Pivot: A channel pivot is a recognition that many channels can be integrated or
disintegrated to give value to customers.
Part 3: Accelerate
Chapter: Growth

How Existing Customers Drive Sustainable Growth for Companies

There are four primary ways past customers drive sustainable growth:

1. Word of mouth: Embedded in most products is a natural level of growth that is cause by satisfied
customers’ enthusiasm for the product.

2. As a side effect of product usage: Fashion or status, such as luxury goods products, drive
awareness of themselves whenever they are used. When you see someone dress in the latest clothes
or driving a certain car, you may be influenced to buy that product.

3. Through funded advertising: Most businesses employ advertising to entice new customers to
use their products. For this to be a sustainable growth, the advertising must be paid for out of
revenue, not one-time sources such as investment capital.

4. Through repeat purchase or use: Some products are designed to be purchased repeatedly either
through a subscription plan or through voluntary repurchases. By contrast, many products and
services are intentionally designed as one-time events.

The Three Engines of Growth

Engines of growth are designed to give startups a relatively small set of metrics on which to focus
their energies.

1. The Sticky Engine of Growth: Companies use the sticky engine of growth to track their
attrition (retention) rate or churn rate very carefully. The churn rate is defined as the fraction of
customers in any period who fail to remain engaged with the company’s product. The rule that
govern the sticky engine of growth is pretty simple: if the rate of new customer acquisition exceeds
the churn rate, the product will grow.

2. The Viral Engine of Growth: Viral engine of growth determines how quickly the word of your
offering spreads from one customer to another potential customer. The viral engine is powered by a
quantifiable measure, called the viral coefficient. The higher this coefficient is, the faster the product
will spread. The viral coefficient measures how many new customers will use a product as a
consequence of each new customer who signs up.

For a product with a viral coefficient of 0.1, one in every ten customers will recruit one of his or her
friends. This is not a sustainable loop. Imagine that one hundred customers sign up. They will cause
ten friends to sign up. These ten friends will cause one additional person to sign up, but there the
loop will fizzle out. By contrast, a viral loop with a coefficient that is greater than 1.0 will grow
exponentially. A coefficient of 1.0 means 1 customer will make 1 friends to sign up. A coefficient of
10.0 means 1 customer will make 10 friends to sign up.

A consequence of this is that many viral products do not charge customers directly but rely on
indirect sources of revenue such as advertising. Viral products cannot afford to have any friction
impede the process of signing customers up and recruiting their friends. When customers spend
time and attention in these offerings, the networks become valuable to advertisers, which become an
earning source.

3. The Paid Engine of Growth: Paid engine of growth refers to investments to acquire customers.
Each customer pays a certain amount of money for the product over his or her lifetime as a
customer. This is referred to as a customer’s Lifetime Value (LTV). Suppose an advertisement costs
$100 and causes 50 customers to sign up. This means that cost per acquisition (CPA) is $2.

The margin between LTV and CPA determines how fast the paid engine of growth will turn. If LTV
is greater than $2, the engine of growth turns towards marginal profit. If the LTV is less than $2, the
company’s growth will slow down. Companies can make up for the losses by using invested capital
or one time publicity stunts, but those tactics are not sustainable.

Generally, acquisition cost of affluent customers and B2B customers is higher than the acquisition
cost of mass customers. In the long run, affluent customers and B2B customers have higher lifetime
value per customer.

Recommendation: Technically, more than one engine of growth can operate in a business at a
time. However, for startups, it is ideal to focus on one of the engines at a time. Only after pursuing
one engine thoroughly should a startup consider a pivot to one of the others.