The New (Old) Approach to Startups

(I originally wrote this article back in 2000 when I was Entrepreneur in Residence at the Carleton University Tech Venture program)

Every few years there seems to be a new management fad or business trend that catches everyone’s attention and garners headlines. This seems especially true if you look at the way in which technology companies are launched. Yet I am happy to see that today’s successful start-ups are based on customers and revenues, just the same as those that were launched when I entered the workforce 15 years ago. This approach has not always been in vogue.

When I began working in the mid eighties for a company delivering technology-based professional services, it along with many other companies were participating in the PC revolution that created many wealthy people. In turn, these and the successful entrepreneurs before them became investors and created an investment infrastructure that accelerated the development of future start-up companies. By the early 90’s the PC revolution was in full force and along came the Internet. When I was a co-founder of an Internet company, GlobalX, in 1994 – although the investment infrastructure was maturing- it was not yet to a point where it was broadly accessible.

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At GlobalX, my co-founders and I had to work hard to make ends meet. If we wanted to pay our rent or even salaries, we had no choice but to find customers who would pay for what we had to offer. For us customers equaled cash flow. This meant many adjustments to our business plan as we tinkered to create an offering that would pay the bills, and before long our business model had evolved so radically from the one we embarked on at the outset, that an outsider would have thought we were a different company. Luckily our hard work paid off and before too long we had a strong base of happy, paying customers.

And while the PC revolution paved the way for the Internet boom, the latter was more explosive and quickly created many millionaires. This in turn completed the development of the venture capital funding infrastructure and throughout the nineties huge financings, lavish expenditures, splashy marketing campaigns and lucrative employment offers became the norm. Capital was in such supply that a “get big fast” mentality prevailed. The feverish gold rush meant that often companies were started without much research or validation of the basic concept. It seemed as if a concept sounded good on paper, it was worth doing. Once a company was launched, there was little emphasis on the bottom line. In fact, turning a blind eye to the bottom line was most often the case; the more profile a company could create through high power marketing, the more likely a lucrative acquisition offer would present itself. The bottom line was the subject of little consideration and many companies not only ran without profits, but, if you can imagine, without revenues or customers. And why not? The stock markets were surging upwards, and finding investment capital was easy, so a company only had to last until its next infusion of cash from investors or until it received the right purchase offer. During this time, I was a co-founder in another start-up, Ventrada, and, as evidence of the predominating atmosphere, we were able to secure investment to start the company based on a series of brief assumptions.

Shortly thereafter, things came to an abrupt halt. In early 2000, the stock markets lost steam. Company valuations were slashed, liquidity vanished, investment dried up and many companies were suddenly left with no way to finance operations. This led to a significant amount of consolidation, through a wave of mergers and acquisitions, but eventually even the strong companies stopped making moves and the weak companies were simply forced to close shop. Ventrada was one of the victims.

What does all this mean? From the mid 80’s to the present, I have witnessed a shift in the way companies were started and as I observe start-up philosophy today, I see things shifting again. Start-ups are now following a strategy based upon fundamentals of understanding real problems, solving problems for real customers and building revenues. More simply put, the newest approach is an old one.

What are the elements of the latest approach?

Today’s successful technology start-ups are built around a problem or set of problems that cause great frustration for people or enterprises. Good entrepreneurs do a lot of research to make sure that they understand the true nature of a problem, which organizations have it, why and how it is currently being addressed. Quality research is the key and there are many sources of information for learning about problems ranging from the Internet, other technology vendors, competitors, trade press and analysts. The most important part of this research, is speaking directly with potential customers to test assumptions and determine the severity of the problem. Ideally, the problem causes so much frustration, that potential customers are prepared to pay to make it go away.

Strong start-ups also recognize the relationships between problems and budgets. Buyers set priorities for expenditures against budgets and in good economic times spending can seem frivolous, however in poorer times spending often is only directed at mission critical requirements – those that must be in place for the company be successful. I have learned this the hard way: products that are “nice to have” do not pay the rent.

In stark contrast to many start-ups in the boom years, today’s start-ups also engage customers early on, and often before there is even a product to offer. Entrepreneurs approach the same people that participated in researching the business opportunity and ask for business. By pursuing customers at the outset, a start-up learns whether its assumptions are valid based on whether a potential customer will buy the offering. If not, adjustments are required. On the other hand, if a start-up can convince a customer to issue a contract to develop a solution, other great benefits ensue especially if the start-up is able to retain the ownership of the intellectual property that is created. In so doing, the start-up will learn more about the problem, accumulate valuable experience about how to develop solutions, earn revenue, while developing a solution, and acquire a reference customer of critical value for capturing new business. Such a venture will now be “post-customer,” “post-revenue,” and, assuming that the development effort led to enough of a product, “post-product.”

However, one project does not make a viable company. Strong start-ups look at the “repeatability” of one project and the opportunity to satisfying the needs of other customers. One reference is used to secure the next project with another customer, thus giving the start-up an opportunity to further expand its expertise and, its product. The important consideration is to maintain a product focus, and employ a services approach to becoming a product company.

Another big change seen in today’s start-ups is the emphasis on sales before marketing. In my experience, marketing means creating profile, forming partnerships and generating sales leads by performing activities such as advertising, trade shows, and obtaining press. Sales means converting the sales leads into revenue generating contracts and ultimately, revenues. More simply put, marketing is about broadcasting a message to people that will listen, while sales is about making a call to a specific person and asking for business.

In the past, when companies grew based upon profile alone, promoting the start-up consumed a large proportion of resources, in many cases before products or customers even existed. Now, with no capital to fund such activities, companies must focus on sales to grow. This is not to say that marketing is not important. On the contrary, great companies are market oriented, identifying attractive niches to pursue and differentiating themselves with value (as perceived by the customer) versus competitors. However, it is often aggressive and targeted sales activities, not advertising, that leads to a critical mass of early customers upon which a strong start-up is based. Once the lead customer references have been secured, then marketing is a very important strategy to attract new customers to the start-up.

Finally, the role of financing in a start-up has changed. When sales were not expected at the outset of a startup, it was customary to secure investment to start a company and fund product development and marketing activities. This still happens and in certain businesses with very long product development cycles, it is necessary, but increasingly, today’s start-ups are viewing financing as a way to fund growth, once the fundamental assumptions have been proven, lead customers won, and the first version of the product developed. Then financing can contribute to accelerated product development and expanded marketing and sales. Further, a company that waits until the right time to raise investment will avoid the complacency and false sense of security that can sometimes accompany external money, thus ensuring that the start-up stays intensely focused on solving real customer needs.

So there you have it. The old is new again. If all of this sounds tough, it is. The odds are stacked against the entrepreneur and it’s tough to successfully launch a company. If the boom years sound easier and you wish you had launched a company then, count yourself lucky that you didn’t. You won’t have developed any of the bad habits many of us may have developed in the easy years. They say “even turkey’s fly in a tornado”; the problem is that when the tornado stops, a rough landing awaits the bird that doesn’t know how to fly. By focusing on real problems, on engaging customers early, on recognizing when to sell and when to market, and on raising investment to grow your business, you will be following a proven path to successfully launch a tech company, in the best and worst of times. Good luck!

Note: This article is the first in a series for the Student Technology Venture Challenge which will address the challenges facing start-ups and first-time entrepreneurs. If you have questions or issues you would like to see addressed in this series, please write me at: burdett@uptangent.com.

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