From Startup to Company, One Step at a Time
TheFamily Papers #015
By Nicolas Colin (Co-Founder & Partner) | TheFamily
What’s a startup? The question has received many answers, and it certainly isn’t our intent to add another one. It should be enough to remind you of the definition crafted by Steve Blank: “a startup is an organization formed to search for a repeatable and scalable business model.”
Many things follow from that seemingly simple definition.
It’s Not About Being a Company
1/ A startup is not necessarily a company. Oftentimes, it is more about two or three people developing an application from their room. (Garages were fashionable when it was about building computers, but rooms tend to be more comfortable when it’s about writing lines of code.) As many startup founders know, it is in their interest to delay the incorporation of a company because it spares the cost of formal, bureaucratic procedures. It also provides time to make sure that the team gets along and it increases the probability that the founders will initially focus on the product, the market, and finding the application’s first users.
It’s Not About Being Young, or Small
2/ A startup is not necessarily a young business. There are old startups. Twitter is a good example: it obviously hasn’t found its business model yet. As investors get wary about oversized companies without business models, those old, enduring startups may become scarcer in the future. But expect them to rise again come the next bubble.
Likewise, don’t confuse startups with small businesses. Strictly speaking, “starting up” is synonymous with founding a business. But those words are now so widely used, notably to describe future tech companies, that at some point it became fashionable to refer to many companies as a ‘startup’. So fashionable, in fact, that many small businesses wrongly assume that they, too, are startups and they claim the title to appear cool and innovative—when in fact, they are simply doing boring, non-scalable businesses such as IT services, web development, consulting, cooking food, cutting hair, or performing strip shows (make sure to watch the Magic Mike trailer above). Having lots of companies who wrongfully call themselves startups is part of the toxicity in an environment such as Paris.
A field where the confusion between startups and small businesses is of particular consequence is public policy. Many government policies are designed to foster a startup ecosystem. But as it is so difficult to define a startup through law, those policies end up pouring money on small businesses in general. You can read this article about the confusion on the part of the US Small Business Administration, and this one about how an “Entrepreneurial Quality Index” could help policymakers measure “how likely a new company is to achieve high growth”—which could help programs that aim to support startups target entities that are indeed startups.
It’s Not About Burning Cash
3/ Burning cash is not enough to claim that a company is a startup—that would be too easy. In fact, you can have a business model, and thus not be a startup anymore (or never have been one, if you exploited a known and mature business model from day one), and yet keep on burning cash to scale up operations. As Frédéric Mazzella, CEO of French ride-sharing giant Blablacar, said last year in an interview (in French),
There are three steps in the life of a company: viability, profitability and expansion. We proved the viability of our business model: if we operated only in France today, we’d be profitable. But given the speed at which things are going today, if we aimed for profitability before international expansion, all the marketplaces would be snatched from us. So we swapped the steps and decided to aim for (expensive) expansion before profitability. We are scaling up right after starting up, which isn’t very common in France, or Europe for that matter.
Indeed, scaling up has become more critical than being profitable if you want to grow fast enough to survive and beat competitors on the global market. But the money that it forces you to burn doesn’t make you a startup: in fact, by then you’re probably well beyond the Steve Blank definition above, because you have found your business model. Only, like BlaBlaCar and many others, you don’t have the luxury of profiting from it… yet.
It’s Not About Innovation
4/ Another common point of confusion is the relationship between startups and innovation. Few people realize it, but innovation in and of itself is NOT a goal for startup Entrepreneurs. It’s only that, in many cases, innovation helps those Entrepreneurs achieve the full potential of their venture. As written by Babak Nivi,
Quality measures how far a product advances the customer. Scale measures how many people use it. For entrepreneurs, there is no tradeoff between quality and scale. The job is to do both — not one or the other. If it can’t be done, you innovate.
Of course there are talented Entrepreneurs in the non-digital economy. But the digital economy attracts the most ambitious Entrepreneurs because it best enables them to reach quality and scale at once. Hence “quality and scale, simultaneously” defines startups more than the occasional innovation that, in some cases, is necessary to achieve that goal.
Furthermore, there is innovation in large, traditional, mature companies too. To see this, it’s always useful to recall Clayton Christensen’s theory of the three types of innovation:
- Empowering innovations make costly products available to the masses (the Ford Model T was an empowering innovation, as is Uber’s private chauffeur for everyone); they create jobs (to make, sell, or operate the products or services) but demand lots of capital.
- Sustaining innovations replace old products with new ones: they are important and exciting but are a zero-sum game in terms of jobs and capital.
- Efficiency innovations are about making more with less, almost always result in the net destruction of jobs, and allow for the reallocation of capital elsewhere in the economy.
Large companies tend to favor sustaining and efficiency innovations and shy away from empowering ones. But at the same time not every startup implements empowering innovation—far from it. Furthermore, there could be much more radical innovation in large companies in the future. As Scott Anthony wrote in 2012 in the Harvard Business Review,
Three trends are behind this shift. First, the increasing ease and decreasing cost of innovation mean that start-ups now face the same short-term pressures that have constrained innovation at large companies; as soon as a young company gets a whiff of success, it has to race against dozens of copycats. Second, large companies, taking a page from start-up strategy, are embracing open innovation and less hierarchical management and are integrating entrepreneurial behaviors with their existing capabilities. And third, although innovation has historically been product- and service-oriented, it increasingly involves creating business models that tap big companies’ unique strengths.
In other words, there are still reasons for big companies to aim for innovation. First, they can preserve jobs and avoid pain by intelligently preparing for the inevitable. Second, there are many fields (mining or construction for example) that have not yet attracted many startups, which creates opportunities to be seized by established players. Lastly, some of the world’s problems can be best addressed by global giants who can invest exclusive resources in abundance.
Indeed, “most people continue to believe big companies are where innovation goes to die,” but there certainly is no equivalence between startups and innovation: many startups don’t innovate; some non-startups implement radical innovation. And innovation is certainly not what makes startups so powerful when they aim at taking a position in an industry’s value chain.
It’s Not About Technology
5/ The other issue at stake with startups is their relationship with technology.
The word ‘technology’ has become ubiquitous in today’s economy. It is used as a suffix to refer to the birth of a host of new startups in a given industry, as with ‘FinTech’, ‘EdTech’, ‘LegalTech’, ‘HealthTech’, and even ‘CivicTech’ or ‘SexTech’. Online advertising, which was once thought to be the whole of the digital economy, had to be rebranded as ‘AdTech’, one industry among many in the ever-growing digital economy. It’s as if every company now wants to be called a tech company—as demonstrated by Goldman Sachs’ CTO’s unprecedented prominence.
But ‘technology’ has also become a somewhat misleading word. The word tends to be confused with ‘innovation’ or something along the line of ‘deploying new, scalable business models made possible by information and communication technology’. Here is its full definition in Merriam-Webster:
The practical application of knowledge especially in a particular area or a capability given by the practical application of knowledge; a manner of accomplishing a task especially using technical processes, methods, or knowledge; the specialized aspects of a particular field of endeavor.
Information and communication technology is not startup specific. On the contrary, it is widely used in traditional companies, but mostly to sustain existing business models rather than to create new ones. As Nicholas Carr once wrote, information technology has long since become a commodity:
What makes a resource truly strategic — what gives it the capacity to be the basis for a sustained competitive advantage — is not ubiquity but scarcity. You only gain an edge over rivals by having or doing something that they can’t have or do. By now, the core functions of IT — data storage, data processing, and data transport — have become available and affordable to all. Their very power and presence have begun to transform them from potentially strategic resources into commodity factors of production. They are becoming costs of doing business that must be paid by all but provide distinction to none.
One reason why startups are often confused with technology is that, as they are part of the digital economy, they deploy their business on a common ground enabled by software, which is a general purpose technology—or, as Venkatesh Rao puts it, the third “soft technology” in the world’s history:
Only a handful of general-purpose technologies — electricity, steam power, precision clocks, written language, token currencies, iron metallurgy and agriculture among them — have impacted our world in the sort of deeply transformative way that deserves the description eating. And only two of these, written language and money, were soft technologies: seemingly ephemeral, but capable of being embodied in a variety of specific physical forms. Software has the same relationship to any specific sort of computing hardware as money does to coins or credit cards or writing to clay tablets and paper books.
What makes a difference in the startup world is not the fact that Entrepreneurs use technology, but the way they use it. The spreading of software technology has a measurable impact on productivity statistics thanks in no small part to the considerable efforts of those who went beyond simply sustaining pre-existing business models with technology. But contrary to what is widely assumed, technology is not so much of an issue for a startup — at least not in its early stages. Several factors have even turned technology into a commodity for any company operating at a small scale: you can read all about them in this previous issue.
Finally, the most crucial problem with the word ‘technology’ is how misleading it is depending on context and language. France, for instance, is a country with a passion for technology. We train exceptional engineers (and we breed the best mathematicians in the world). And so the idea of startups here is engineers / researchers / inventors / scientists developing breakthrough technologies protected by patents. The problem is that French engineers, while usually good in their field, are also painfully bad at hacking new business models: hence the tendency of our ‘startups’ to fail miserably. The widespread view that startups are all about technology is a deep and lasting misunderstanding—a key part of what makes France such a toxic environment for startups.
It’s All About Growth
6/ A startup is all about growth. This is a point that has been made clear by Paul Graham, and we frequently use it as a complement for Steve Blank’s definition. It is, in fact, a corollary:
A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of “exit.” The only essential thing is growth. Everything else we associate with startups follows from growth.
The equivalence between startups and growth is extremely important to understand founders’ culture in the startup world. Startup Entrepreneurs are obsessed with growth; conversely, they don’t really care about innovation or technology, which they mostly (and rightfully) see as a means to sustain higher growth.
Growth is present at every stage in a tech company’s life: at the seed stage, when the founders have to do those things that don’t scale and find their first users; at the growth stage, when all that matters is, well, growth; and even at domination stage, when the growth starts to plateau on the startup’s original market and it needs to diversify and look for other growth drivers.
When a startup finally becomes a tech company, the persistence of its founders’ growth obsession explains why most tech companies CEOs are, following Marc Andreessen’s words, “imperial, will-to-power people who want to crush their competition.” This is why companies that used to be startups always beat those who grew up with a different, less growth-driven culture. (And being financed by venture capitalists only amplifies that culture.)
Can You Keep on Being a Startup?
7/ Large tech companies are almost all former startups. This is not to say that all tech companies were once founded. That would be self-evident: companies are not gods, and like humans they had to be born at some point. This is to say that most tech companies (except maybe for older ones like Apple and Microsoft) were founded with the explicit purpose of searching for a repeatable and scalable business model.
In fact, the best large tech companies are successful because even though they’ve finally found their business model, they desperately try to remain startups and like to put themselves in a state of permanent danger. Tech companies can keep their small startup DNA if they remain in a state of perpetual search for a future repeatable and scalable business model.
Amazon is a case in point, as pointed out by Philip Evans and Patrick Forth. Apple is another one. Google-turned-Alphabet is a third. Facebook, having chosen the Hacker Way, continues to see itself as a startup. Those companies desperately want to remain startups because they know how superior startups are in terms of culture and performance—as opposed to rent-seeking, predatory companies such as those described by Steve Blank:
Some companies have so lost the DNA for innovation they become “rent seekers.” Rent seekers fight to keep the status quo. Instead of offering better products or superior service, rent seekers hire lawyers and lobbyists to influence politicians to pass laws that block competition.
From Startup to Tech Company
8/ To overcome the many erroneous visions about startups, we have designed the following framework, loosely based on Steve Blank’s work. It has two separate goals: to show that technology matters only quite late in the life of a tech company; and to explain to our portfolio Entrepreneurs what they should focus on during their earliest steps.
The first step here is activation. In today’s competitive and saturated environment, a startup Entrepreneur must be creative and analytical, adopting and adapting strategic methods to improve activation—which, by the way, is exactly what the phrase “growth hacking” means. (In Dave McClure’s AARRR framework, activation is actually the second step, following acquisition—but never mind.)
Our second step is retention, when a maximum number of users come back after a great first experience. For a retail application, it means making people become repeat buyers. For a SaaS company, it means lowering churn. For a startup providing content, it means getting people to read, listen or watch this content regularly. Retention is a critical part because it enables a startup to collect data on a regular basis and to ultimately understand its users. Read what Andrew Chen has to say here.
The third step is knowledge, which is now available thanks to the accumulated data about those who repeatedly use a startup’s product. The intimate knowledge of their likes and dislikes is what makes it possible to constantly improve that product. Early users help Entrepreneurs better solve the problem they’re tackling—or, as explained by Paul Graham, “the initial user serves as the form for your mold; keep tweaking till you fit their needs perfectly, and you’ll usually find you’ve made something other users want too.”
Entrepreneurs start up a business with the initial intent of solving a given problem. Because of this intent, they acquire a first group of users who have that problem. As these users behave like clients, they provide feedback and demand improvement, thus forcing the Entrepreneur to redefine the problem and the way to address it. Intimate knowledge of early users allows for complete personalization, with the startup settling for the product that best fits the needs of those demanding early users. The Entrepreneur ends up developing a product that addresses the problem as defined by the pickiest ‘clients’.
At that stage, the startup is about to pass a very important inflection point: product-market fit. From serving clients, it will soon learn to serve customers. Seth Godin best defined the key difference between clients and customers:
Customers hear you say, “here, I made this,” and they buy or they don’t buy. Clients say to you, “I need this,” and if you want to get paid, you make it. The customer, ironically, doesn’t get something custom. The key distinction is who goes first, who gets to decide when it’s done.
Past product-market fit, the version of the product that satisfies all the early users is standardized, packaged into an exceptional user experience, and offered to everyone else. If the most demanding can be retained with a standardized value proposal, then everyone else can, too—those are even “wowed” by a product initially developed for the pickiest, which they didn’t imagine they could afford. This is why, at that point, the product merges into an exceptional experience. Within that experience, there remains some room for marginal personalization, but standardization at the highest level of quality is absolutely critical on the path from startup to company: Uber, Google, Amazon all offer a (mostly) standardized experience, because it’s a condition for scaling up the operations.
Scaling up is when technology takes the center stage. Technology enables efficiency, like when Amazon replaces warehouse workers with Kiva robots. And technology enables machine learning, with data being harnessed to constantly improve the user experience. Advanced technology, including that resulting from the company’s own research & development, helps it scale its exceptional experience up to hundreds of millions of users.
And that’s finally when increasing returns kick in, with the powerful, technology-driven combination of economy of scale, network effects, data, and virality. Increasing returns help the company increase its activation rate exponentially, with a rapidly diminishing marginal cost. The former startup has finally become a digital giant, ready to take all or most of their market.
One Step at a Time
9/As a conclusion, let me stress how the stakes evolve all along the various steps of that long and treacherous process.
The first two steps (activation and retention) are all about marketing: this is the stage when a startup’s most important skill is that of the growth hacker. The three following steps (knowledge, personalization, exceptional experience) mark the reign of design: only designers can exploit the intimate knowledge of early users to devise what the startup’s standardized value proposal should be. It takes primarily good designers to achieve product-market fit. Finally, scaling up and sustaining a company’s increasing returns are about technology. Those last steps ultimately confront the startup with raw technological challenges. Only then does it finally become a tech company—whereas as a startup it could rely on cheap, commoditized technology.
If you’re an Entrepreneur, focus on the right steps at the right time: first, marketing; then, design; and finally, technology. This is the know-how that TheFamily brings about to its portfolio companies, among many other resources. (And of course your feedback is welcome on what is obviously still a work in progress.)
(This is an issue of TheFamily Papers series, which is published in English on a regular basis. It covers various areas such as entrepreneurship, strategy, finance, and policy, and is authored by TheFamily’s partners as well as occasional guest writers. Thanks to Kyle Hall and Laetitia Vitaud for reviewing drafts.)
