Develop the Product for the Few, Not the Many

In a traditional product management and marketing process the goal is to develop a Marketing Requirements Document (MRD) for engineering. The MRD contains the sum of all the possible customer feature requests, prioritized in a collaborative effort among Marketing, Sales and Engineering. Marketing holds focus groups, analyzes sales data from the field, and looks at customer feature requests and complaints. This information leads to requested features that are added to the product specification, and the engineering team builds these features into the next release.

While this process is rational for an established company entering an existing market, it is folly for startups. Why? In established companies, the MRD process ensures engineering will build a product that appeals to an existing market. In this case the customers and their needs are known. In a startup, the first product is not designed to satisfy a mainstream customer. No startup can afford the engineering effort or the time to build a product with every feature a mainstream customer needs in its first release. The product would take years to get to market and be obsolete by the time it arrived. A successful startup solves this conundrum by focusing its development on building the product incrementally and iteratively and targets its early selling efforts on a very small group of early customers who have bought into the startup's vision. This small group of visionary customers will give the company the feedback necessary to add features into follow-on releases. Enthusiasts for products who spread the good news are often called evangelists. But we need a new word to describe visionary customers—those who will not only spread the good news about unfinished and untested products, but also buy them. I call them earlyvangelists. ¹

Earlyvangelists: The Most Important Customers You'll Ever Know

Earlyvangelists are a special breed of customer willing to take a risk on your startup's product or service because they can envision its potential to solve a critical and immediate problem—and they have the budget to purchase it. Unfortunately, most customers don't fit this profile. Here's an example from the corporate world:

Imagine a bank with a line around the block on Fridays as customers wait an hour or more to get in and cash their paychecks. Now imagine you are one of the founders of a software company whose product could help the bank reduce customers’ waiting time to 10 minutes. You go into the bank and tell the president, “I have a product that can solve your problem.” If his response is “What problem?” you have a customer who does not recognize he has a pressing need you can help him with. There is no time in a startup's first two years of life that he will be a customer, and any feedback from him about product needs would be useless. Customers like these are traditional “late adopters” because they have a “latent need.”

Another response from the bank president could be, “Yes, we have a terrible problem. I feel very bad about it, and I hand out cups of water to our customers waiting in line on the hottest days of the year.” In this case, the bank president is the type of customer who recognizes he has a problem but hasn't been motivated to do anything more than paper over the symptoms. He may provide useful feedback about the type of problem he is experiencing, but more than likely he will not be first in line to buy a new product. Since these types of customers have an “active need,” you can probably sell to them later, when you can deliver a “mainstream” product, but not today.

If it's a good day, you may run into a bank president who says, “Yes, this is a heck of a problem. In fact, we're losing over $500,000 a year in business. I've been looking for a software solution that will cut down our check cashing and processing time by 70 percent. The software has to integrate with our bank's Oracle back end, and it has to cost less than $150,000. And I need it delivered in six months.” Now you're getting warm; this customer has “visualized the solution.” It would be even better if the president said, “I haven't seen a single software package that solves our problem, so I wrote a request for our IT department to develop one. They've cobbled together a solution, but it keeps crashing on my tellers and my CIO is having fits keeping it running.”

You're almost there: You've found a customer who has such a desperate problem he has had his own homegrown solution built out of piece parts.

Finally, imagine the bank president says, “Boy, if we could ever find a vendor who could solve this problem, we could spend the $500,000 I've budgeted with them.” (Truth be told, no real customer has ever said that. But we can dream, can't we?) At this point, you have found the ultimate customer for a startup selling to corporate customers. While consumer products usually don't have as many zeros in them, earlyvangelist consumers can be found by tracing out the same hierarchy of needs.

Earlyvangelists can be identified by these customer characteristics (see Figure 3.1):

1. The customer has a problem
2. The customer understands he or she has a problem
3. The customer is actively searching for a solution and has a timetable for finding it
4. The problem is painful enough the customer has cobbled together an interim solution
5. The customer has committed, or can quickly acquire, budget dollars to solve the problem

You can think of these characteristics as making up a scale of customer pain. Characterizing customers’ pain on this scale is a critical part of Customer Discovery. My contention is that earlyvangelist customers will be found only at points 4 and 5: those who have already built a homegrown solution (whether in a company by building a software solution, or at home by taping together a fork, light bulb and vacuum cleaner) and have or can acquire a budget. These people are perfect earlyvangelist candidates. You will rely on them for feedback and for your first sales; they will tell others about your product and spread the word the vision is real. Moreover, when you meet them, you mentally include them on your list of expert customers to add to your advisory board (more about advisory boards in Chapter 4).

Start Development Based on the Vision

The idea that a startup builds its product for a small group of initial customers, and builds the product iteratively, rather than devising a specification with every possible feature for the mainstream, is radical. What follows is equally revolutionary.

On the day the company starts, there is very limited customer input to a product specification. The company doesn't know who its initial customers are (but it may think it knows) or what they will want as features. One alternative is to put Product Development on hold until the Customer Development team can find those customers. However, having a product you can demonstrate and iterate is helpful in moving the Customer Development process along. A more productive approach is to proceed with Product Development, with the feature list driven by the vision and experience of the company's founders.

Therefore, the Customer Development model has your founding team take the product as spec'd and search to see if there are customers—any customers—who will buy the product exactly as you have defined it. When you find those customers, you tailor the first release of the product so it satisfies their needs.

The shift in thinking is important. For the first product in a startup, your initial purpose in meeting customers is not to gather feature requests so you can change the product; it is to find customers for the product you are already building.

If, and only if, no customers can be found for the product as spec'd do you bring the features customers requested to the Product Development team. In the Customer Development model, then, feature request is by exception rather than rule. This eliminates the endless list of requests that often delay first customer ship and drive your Product Development team crazy.

If Product Development is simply going to start building the product without customer feedback, why talk to customers at all? Why not just build the product, ship it, and hope someone wants to buy it? The operative phrase is “start building the product.” The job of Customer Development is to get the company's customer knowledge to catch up to the pace of Product Development—and in the process, to guarantee there will be paying customers the day the product ships. An important side benefit is the credibility the Customer Development team accrues internally within your organization. Product Development will be interacting with a team that understands customer needs and desires. Product Development no longer will roll their eyes after every request for features or changes to the product, but instead understand they come from a deep understanding of customer needs.

As the Customer Development team discovers new insights about the needs of this core group of initial customers, it can provide valuable feedback to the Product Development group. As you'll see, these Customer Development/Product Development synchronization meetings ensure once key customer information becomes available it is integrated into the product's future development.

To sum up the Customer Discovery philosophy: In sharp contrast to the MRD approach of building a product for a wide group of customers, a successful startup's first release is designed to be “good enough only for our first paying customers.” The purpose of Customer Discovery is to identify those key visionary customers, understand their needs, and verify your product solves a problem they are willing to pay to have solved—or not. Meanwhile, you start development based on your initial vision, using your visionary customers to test whether that vision has a market. And you adjust your vision according to what you learn.

If FastOffice had understood this philosophy, it could have avoided several false starts. As it happens, there was a happy ending (at least for some later-stage investors), as the company survived and lived to play again. The new CEO worked with Steve Powell (who became the chief technical officer) to understand the true technical assets of the company. The new leadership terminated the sales and marketing staff and pared the company back to the core engineering team. What they discovered was their core asset was in the data communications technology that offered voiceover data communications lines. FastOffice discarded its products for the home, refocused, and became a major supplier of equipment to telecommunications carriers. The Customer Discovery process would have gotten the company there a lot sooner.

The Customer Development Team

The Customer Development process gives up traditional titles and replaces them with more functional ones. As a startup moves through the first two steps of the process, it has no Sales, Marketing or Business Development organizations or VPs. Instead, it relies on an entrepreneurial Customer Development team (see Appendix A for the rationale for the Customer Development team concept).

At first, this “team” may consist of the company's technical founder who moves out to talk with customers while five engineers write code (or build hardware, or design a new coffee cup, etc.). More often than not it includes a “head of Customer Development” who has a product marketing or product management background and is comfortable moving back and forth between customer and Product Development conversations. Later, as the startup moves into the Customer Validation step, the Customer Development team may grow to several people including a dedicated “sales closer” responsible for the logistics of getting early orders signed.

But whether it is a single individual or a team, Customer Development must have the authority to radically change the company's direction, product or mission and the creative, flexible mindset of an entrepreneur. To succeed in this process, the team members must possess:

• The ability to listen to customer objections and understand whether they are issues about the product, the presentation, the pricing, or something else (or the wrong type of customer)
• Experience moving between the customer and Product Development team
• The ability to embrace constant change
• The capacity to put themselves in their customers’ shoes, understand how they work and what problems they have

Complementing the Customer Development team is a startup's product execution team. While Customer Development is out of the building talking with customers, the product team is focused on creating the product. Often this team is headed by the product visionary who leads the development effort. As you will see, regular communication between Customer Development and product execution is critical.

A. State Your Hypotheses: The Product

Product hypotheses consist of the founding team's initial guesses about the product and its development. Something like these were part of the company's original business plan.

First Product Development/Customer Development Synchronizaton Meeting

Most of the product brief is produced by the Product Development team. This is one of the few times you are going to ask the head of product execution and his or her partner, the keeper of the technical vision, to engage in a paper exercise. Getting your product hypotheses down on paper and turning them into a product brief, agreed to by all executives, is necessary for the Customer Development team to begin its job.

The product brief covers these six areas:

• Product features
• Product benefits
• Intellectual property
• Dependency analysis
• Product delivery schedule
• Total cost of ownership/adoption

Here is a short description of what should be covered in each area.

B. State Your Hypotheses: Customer Hypotheses

The process of assembling the customer briefs is the same as for the product brief, except this time the Customer Development team is writing down its initial assumptions. These assumptions cover two key areas: who the customers are (the customer hypothesis) and what problems they have (the problem hypothesis). In the course of Customer Discovery, you'll flesh out these assumptions with additional information:

• Types of customers
• Customer problems
• A day in the life of your customers
• Organizational map and customer influence map
• ROI (return on investment) justification
• Minimum feature set

Again, let's consider each part of the customer and problem briefs in turn.

Customer Hypotheses: Types of Customers

If you've ever sold a product, whether it's to a consumer buying a stick of gum or a company buying a million-dollar telecommunications system, you've probably discovered every sale has a set of decision-makers who get their fingers into the process. So the first question to ask is, “Are there different types of customers we should approach when we sell our product?” Whether you're selling process control software into a large corporation or a new type of home vacuuming device, chances are there are a number of people in a number of categories whose needs you must satisfy to sell the product. During Customer Discovery you will spend time understanding these needs. Later, when you are ready to develop your first “sales roadmap” in the Customer Validation step, knowing all the players in detail will be essential. Right now, it's sufficient to realize the word “customer” is more complicated than a single individual. Some of the customer types I have encountered include (see Figure 3.3):

End Users

These are the day-to-day users of the product, the ones who will push the buttons, touch the product, play with it, use it, love it and hate it. You need a deep understanding of the end users’ needs, but it's important to realize in some cases the end user may have the least influence in the sales process. This is typically true in complex corporate sales where an entire food chain of decision-makers affects the purchasing decision. However, it's equally true in a consumer sale. For example, children are a large consumer market and the users of many products, but their parents are the buyers.

Influencers

Next up the sales chain are all the people who think they have a stake in a product coming into their company or home. This category could include the key techno-whiz in IT or the 10-year-old whose likes and dislikes influence the family's choices of consumer products.

Recommenders

These people influence product purchase decisions. They differ from the influencers in that they can make or break a sale. A recommender could be a department head saying any new PCs should come from Dell or the spouse who has a particularly strong brand preference.

Economic Buyer

Further up the decision chain is the economic buyer, the one who has the budget for the purchase and must approve the expenditure. (Don't you bet you are going to want to know who that is?) In a consumer purchase it can be a teen with a weekly music budget or a spouse with a vacation budget.

Decision-maker

The decision-maker could be the economic buyer, but it could be someone else even higher in the decision-making hierarchy. The decision-maker is the person who has the ultimate say about a product purchase regardless of the other users, influencers, recommenders and economic buyers. Depending on your product, the decision-maker could be a suburban soccer mom/dad or a Fortune 500 CEO. It is up to you to discover the ultimate purchase decision-maker and understand how all these other customer types influence his or her final decision.

Saboteurs

In addition to all these parties to the sale (and isn't it amazing with a process like this, anything gets sold?), one more group must be mentioned. You won't be looking for them, but they will see you coming. I call this group the saboteurs. In every large company, for example, there are individuals and organizations that are wedded to the status quo. If your product threatens a department's stability, headcount, or budget, don't expect this group to welcome you with open arms. Therefore you need to be able to predict who might be most threatened by your product, understand their influence in the organization, and ultimately put together a sales strategy that at worst neutralizes their influence and at best turns them into allies. Don't think saboteurs occur just in large corporations. For a consumer product, it may be a member of the family who has gotten comfortable with the old car and is uncomfortable about driving something new and different.

The first step in formulating your customer brief is to write down and diagram who you think will be your day-to-day users, influencers, recommenders, economic buyer, and decision-maker, including, in the case of sales to companies, their titles and where in the organization they are found. It's also worth noting if you think the economic buyer has a current budget for your product or one like it, or whether you will have to persuade the customer to get funds to buy your product.

Given you haven't been out talking to customers yet, you may have a lot of empty space in this part of your brief. That's fine. It just reminds you how much you need to find out.

Of course, not every product has so complicated a purchase hierarchy, but the sale of nearly every product involves multiple people. If it's a consumer product, these rules still apply. It's just that the influencers, recommenders, and so on are likely to have more familiar titles like “mom,” “dad,” and “kids.”

Customer Hypotheses: ROI (Return On Investment) Justification

Now that you know everything about how a customer works, you're done, right? Not yet. For purchases both corporate and consumer, customers need to feel the purchase was “worth it,” that they got “a good deal.” For a company this is called return on investment, or ROI. (For a consumer this can be “status” or some other justification of their wants and desires.) ROI represents customers’ expectation from their investment measured against goals such as time, money, or resources as well as status for consumers.

In our banking example, the ROI justification is relatively easy. From listening to your customer, you figure the bank is losing $500,000 in gross customer revenue per year. The profit on every customer is 4 percent. Therefore, at every branch $20,000 in profit leaves with those lost customers. (When you first construct your brief, numbers like these are just your guesses. As you get customer feedback, you can plug in more accurate amounts.) Now suppose you've found out 100 other branches have the same problem. That's a $50 million problem and $2 million in profit gone. Your software to solve this problem costs $200,000, plus $50,000 per year in maintenance fees. Integration and installation will probably take 18 person-months—say, another $250,000 in customer costs. The customers will need to dedicate a full-time IT professional to maintain the system; you budget another $150,000 for this. Finally, training all the tellers in 100 branches will cost another $250,000.

Let's round up all the direct costs (money the bank will pay you) to $500,000 and the indirect costs (money the bank spends on its own staff) to $400,000. As you can see from Figure 3.4, the bank would spend $900,000 for your solution. That seems like a lot of money just to make customer lines shorter. But because you understand how the bank works, you know installing your product will save the bank over $2,000,000 a year. Your product will pay for itself in less than six months, and every year the bank will have an extra $1.85 million in profit. That's an amazing return on investment.

Imagine having a slide showing this type of calculation in your customer presentation!

Most startups are unprepared to deal with the customer's ROI. At best, they ignore it, and at worst, they confuse it with the price of the product. (ROI, as you'll see, involves a lot more than price.) Now, most customers never directly ask a startup about ROI because they assume no outside vendor would be familiar enough with their internal operations to develop valid ROI metrics. Suppose you were the exception. Imagine you were able to help customers justify the ROI for your product. That would be pretty powerful, wouldn't it? Yep. And that's why you include the customer's ROI as part of the customer problem brief. To do that you have to decide what to measure in calculating ROI. Increased revenues? Cost reduction, or cost containment? Displaced costs? Avoided costs? Intangibles?

Your earlyvangelists will end up using your ROI metrics to help sell your product inside their own company! It's with that end in mind that you include an ROI justification in the customer/problem brief. Early on, it's a placeholder for the powerful tool you'll develop as you learn more about your customers.

C. State Your Hypotheses: Channel and Pricing Hypotheses

Your channel/pricing brief puts your first stake in the ground describing what distribution channel you intend to use to reach customers (direct, online, telemarketing, reps, retail, etc.), as well as your first guess at product pricing. As you'll see, decisions about pricing and distribution channels are interrelated.

Let's take distribution channels first. Distribution channels make up the route a product follows from its origin (your company) to the last consumer. If you are selling directly to customers, you may need additional partners to help you install or deliver a complete product (system integrators, third-party software.) If you are selling indirectly, through middlemen, you need channel partners to physically distribute the product. Figure 3.5 illustrates how this process works. At the far right are the customers who have a problem that can be solved by your company's product and/or services.

At the top of the figure, original equipment manufacturers (OEMs) and system integrators derive a relatively small percentage of their total revenue from the sale of your product, and a greater percentage from their value-add in business process and unique solutions to customer problems. At the bottom of the diagram, retailers and mass merchants derive most of their revenue from the sale of your product. The primary value of retailers and mass merchants is providing products that are accessible and available off-the-shelf. Between these two extremes are a variety of sales channels that provide a combination of products and services. All but one are “indirect channels.” That means someone other than your company owns the relationship with the customer. The exception is a direct sales channel, where you hire and staff the organization that sells directly to your customer.

A startup picks a sales channel with three criteria in mind: (1) Does the channel add value to the sales process? (2) What are the price and the complexity of the product? And (3) Are there established customer buying habits/practices? In a “value-added” channel the channel may provide one-on-one sales contacts, special services such as installation, repair or integration. In contrast, a “shrink-wrapped” product is often purchased directly from catalogs, online or from store floor displays. Typically, professional products are sold for higher prices than shrink-wrap products; hence channels servicing shrink-wrap products (such as retailers and mass merchants) can operate at lower margin points.

In your channel/pricing brief, you spell out your initial hypotheses about how your product will reach customers. In the example of the $200,000 banking software described earlier, the first question you must answer is, how will customers initially buy from you? Directly from your company? From a distributor? Through a partner? In a retail store? Via mail order? Via the Internet?

The answer depends on a number of factors, beginning with the product's projected price, its complexity and the established customer buying preferences.

There are a few questions you can ask yourself to help understand what pricing best fits your product. If there are products somewhat like yours, how much do customers spend for them today? If users need a product like yours, how much do they pay to do the same thing today? In the case of your new banking software, suppose you discovered banks were already buying products with fewer features for over $500,000. This would give you a solid data point that your $200,000 price would be well accepted. In the case where there is no product like yours, ask how customers would solve their problem using piece-part solutions from a variety of vendors. How much would the sum of those multiple products cost?

Two final thoughts about pricing. The first is the notion of “lifetime value” of a customer; how much can you sell to a customer not just from the first sale, but over the life of the sales relationship? For example, having decided to sell your banking software direct, your first thought might be to sell the bank a single product, then charge annual maintenance fees. However, once you thought about all the work it would take to sell a single bank, it might dawn on you that you could offer this bank a suite of products. This would mean you could go back and sell a new product year after year (or as long as the new products met the needs of the bank). By thinking dramatically about the lifetime value of your customers, you can affect your product strategy.

The second idea is one I use with customers all the time in this phase. I ask them, “If the product were free, how many would you actually deploy or use?” The goal is to take pricing away as an issue and see whether the product itself gets customers excited. If it does, I follow up with: “OK, it's not free. In fact, imagine I charged you $1 million. Would you buy it?” While this may sound like a facetious dialog, I use it all the time. Why? Because more than half the time customers will say something like, “Steve, you're out of your mind. This product isn't worth more than $250,000.” I've just gotten customers to tell me how much they are willing to pay. Wow.

D. State Your Hypotheses: Demand Creation Hypotheses

Some day you will have to “create demand” to reach these customers and “get” them into your sales channel. Use the opportunity of talking to them to find out how they learn about new companies and new products. This brief reflects your hypotheses about how customers will hear about your company and product once you are ready to sell.

In the course of Customer Discovery, you'll flesh out these assumptions with additional information on creating customer demand and identifying influencers.

E. State Your Hypotheses: Market Type Hypotheses

In Chapter 2, I introduced the concept of Market Type. Startup companies generally enter one of four Market Types and ultimately your company will need to choose one of these. However, unlike decisions about product features, the Market Type is a “late-binding-decision.” This means you can defer this final decision until Customer Creation but you still need a working hypothesis. In the next two chapters, I'll come back to the Market Type your company is in and help you to refine and deepen your analysis after you have learned more about your customers and your market.

However, because the consequences of the wrong choice are severe, you would be wise to develop initial Market Type hypotheses you can test as you move through the Customer Development phase. To do this, the Customer Development team should record its initial Market Type and brainstorm with the Product Development team. In this brief, you will seek a provisional answer to a single question: Is your company entering an existing market, resegmenting an existing market or creating a new market?

For some startups the choice is pretty clear. If you are entering a market where you are in a “clone business,” such as computers or PDAs, the choice is already made for you: you are in an existing market. If you have invented a radically new class of product no one has seen before, you are likely in a new market. However, most companies have the luxury to choose which Market Type to use. So how to choose? A few simple questions begin the process:

• Is there an established and well-defined market with large numbers of customers?
• Does your product have better “something” (performance, features, service) than the existing competitors? If so, you are in an existing market.
• Is there an established and well-defined market with large numbers of customers and your product costs less than the incumbents’? You are in a resegmented market.
• Is there an established and well-defined market with large numbers of customers where your product can be uniquely differentiated from the existing incumbents? You are also in a resegmented market.

If there is no established and well-defined market, with no existing competitors you are creating a new market. Don't worry if you waver among the four Market Type choices. As you start talking to customers, they will have lots of opinions about where you fit. For now, go through each of the market types and pick the one that best fits your vision today. Table 3.1, which you saw in Chapter 2, is a reminder of the trade-offs.

Market Type Hypotheses: Entering An Existing Market

If you believe your company and product fit in an existing market, you need to understand how your product outperforms those of your competitors. Positioning your product against the slew of existing competitors is accomplished by adroitly picking the correct product features where you are better. Summarize your thinking in a brief. If you believe you are entering an existing market, good questions to address in your brief include:

• Who are the competitors and who is driving the market?
• What is the market share of each of the competitors?
• What are the total marketing and sales dollars the market share leaders will be spending to compete with you?
• Do you understand the cost of entry against incumbent competitors? (See the Customer Creation step in Chapter 5)
• Since you are going to compete on performance, what performance attributes have customers told you are important? How do competitors define performance?
• What percentage of this market do you want to capture in years one through three?
• How do the competitors define the market?
• Are there existing standards? If so, whose agenda is driving the standards?
• Do you want your company to embrace these standards, extend them, or replace them? (If you want to extend or replace them, you may be trying to resegment a market. However, if you truly are entering an existing market, then you will want to ensure you also fill out the competitive brief discussed in Step F. It will help shape your positioning further.)

One way to capture your thinking on an existing Market Type is to construct a competitive diagram. Usually a company picks two or more key product attributes and attacks competitors along axes corresponding to these attributes, such as feature/technology axis, price/performance axis, and channel/margin axis. The competitive diagram used in an existing market typically looks like Figure 3.6, with each of the axes chosen to emphasize the best competitive advantage about the product.

Picking the correct axes for the basis of competition is critical. The idea is that in entering an existing market, positioning is all about the product and specifically the value customers place on its new features.

Market Type Hypotheses: Resegmenting An Existing Market

An alternative to going head to head with the market leaders in an existing market may be to resegment an existing market. Here your positioning will rest on either a) the claim of being the “low-cost provider” or b) finding a niche via positioning (some feature of your product or service redefines the existing market so you have a unique competitive advantage).

If you believe you are resegmenting an existing market, good questions to address in this brief include:

• What existing markets are your customers coming from?
• What are the unique characteristics of those customers?
• What compelling needs of those customers are unmet by existing suppliers?
• What compelling features of your product will get customers of existing companies to abandon their current supplier?
• Why couldn't existing companies offer the same thing?
• How long will it take you to educate potential customers and grow a market of sufficient size? What size is that?
• How will you educate the market? How will you create demand?
• Given no customers yet exist in your new segment, what are realistic year one-through-three sales forecasts?

For this type of startup, you need to draw both the competitive diagram (because, unlike startups in a wholly new market, you have competitors) and the market map (because you are in effect creating a new market by resegmenting an existing one). Taken together, these two diagrams should clearly illustrate why thousands of new customers will believe in and move to this market.

I have always found it helpful in a resegmented or new market to draw a “market map” (a diagram of how this new market will look) as shown in Figure 3.7. The map shows at a glance why the company is unique. A standing joke is that every new market has its own descriptive TLA (three-letter acronym). Draw the market map with your company in the center.

A resegmented market assumes it is going to get customers from an existing market. Draw the existing markets from which you expect to get your customers (remember a market is a set of companies with common attributes.)

Market Type Hypotheses: Entering a New Market

At first glance, a new market has great appeal. What could be better than a market with no competitors? And no competition typically means pricing is not a competitive issue but one of what the market will bear. Wow, no competitors and high margins! Yet even without competitors the risks of market failure are great. Without sounding pedantic, creating a new market means a market does not currently exist—there are no customers. If you believe you are entering a new market, good questions to address in your brief include:

• What are the markets adjacent to the one you are creating?
• What markets will potential customers come from?
• What compelling need will make customers use/buy your product?
• What compelling feature will make them use/buy your product?
• How long will it take you to educate potential customers to grow a market of sufficient size? What size is that?
• How will you educate the market? How will you create demand?
• Given no customers yet exist, what are realistic year one-through-three sales forecasts?
• How much financing will it take to soldier on while you educate and grow the market?
• What will stop a well-heeled competitor from taking the market from you once you've developed it? (There is a reason the phrase “the pioneers are the ones with the arrows in their back” was coined.)
• Is it possible to define your product as either resegmenting a market or as entering an existing one?

As I noted in Chapter 2, you compete in a new market not by besting other companies with your product features, but by convincing a set of customers your vision is not a hallucination and solves a real problem they have or could be convinced they have. However, “who the users are” and the “definition of the market” itself are undefined and unknown. Here the key is to use your competitive brief to define a new market with your company in the center.

F. State Your Hypotheses: Competitive Hypotheses

Next, the Customer Development team assembles a competitive brief. Remember, if you are entering an existing market or resegmenting one, the basis of competition is all about some attribute(s) of your product. Therefore you need to know how and why your product is better than those of your competitors. This brief helps you focus on answering that question.

(If you are entering a new market, doing a competitive analysis is like dividing by zero; there are no direct competitors. Use the market map you developed in the last phase as a stand-in for a competitive hypothesis to answer the questions below as if each of the surrounding markets and companies will ultimately move into your new market.)

Take a look at the market you are going to enter and estimate how much market share the existing players have. Does any single entrant have 30 percent? Over 80 percent? These are magic numbers. When the share of the largest player in a market is around 30 percent or less, there is no single dominant company. You have a shot at entering this market. When one company owns over 80 percent share (think Microsoft), that player is the owner of the market and a monopolist. The only possible move you have is resegmenting this market. (See Chapter 5 for more details.)

• How have the existing competitors defined the basis of competition? Is it on product attributes? Service? What are their claims? Features? Why do you believe your company and product are different?
• Maybe your product allows customers to do something they could never do before. If you believe that, what makes you think customers will care? Is it because your product has better features? Better performance? A better channel? Better price?
• If this were a grocery store, which products would be shelved next to yours? These are your competitors. (Where would TiVo had been shelved, next to the VCRs or somewhere else?) Who are your closest competitors today? In features? In performance? In channel? In price? If there are no close competitors, who does the customer go to in order to get the equivalent of what you offer?
• What do you like most about each competitor's product? What do your customers like most about their products? If you could change one thing in a competitor's product, what would it be?
• In a company the questions might be: Who uses the competitors’ products today, by title and by function? How do these competitive products get used? Describe the workflow/design flow for an end user. Describe how it affects the company. What percentage of their time is spent using the product? How mission critical is it? With a consumer product, the questions are similar but focus on an individual.
• Since your product may not yet exist, what do people do today without it? Do they simply not do something or do they do it badly?

A natural tendency of startups is to compare themselves to other startups around them. That's looking at the wrong problem. In the first few years, other startups do not put each other out of business. While it is true startups compete with each other for funding and technical resources, the difference between winning and losing startups is that winners understand why customers buy. The losers never do. Consequently, in the Customer Development model, a competitive analysis starts with why customers will buy your product. Then it expands into a broader look at the entire market, which includes competitors, both established companies and other startups.

This brief completes your first and last large-scale paperwork exercise. The action now moves outside the building, where you will start to understand what potential customers need and thereby qualify your initial assumptions.

A. Test and Qualify Your Hypotheses: First Customer Contacts

The first step in qualifying assumptions is to leave the safe confines of your office and conference room and venture out to the real world where the people who will pay your bills live. Regardless of whether you are selling to large corporations or consumers at home, your friendly first contacts are the people who will start your education about customers and their problems. Better yet, they may become your customers.

Start by making a list of 50 potential customers you can test your ideas on. Fifty names sounds like a lot of leads, but as you'll soon see, you'll go through them quickly. Where do you get these names? From your social networks, friends, investors, founders, lawyers, recruiters, trade magazines, business reference books, accountants, and any other source you can think of. For these visits, even if you're selling to businesses your customers’ titles and their level in their organization are irrelevant. And if you're selling to consumers, whether they currently have the slightest interest in your product is also inconsequential. What matters is what you want to learn from them. At this stage, you are less interested in big names and titles or the “exact right” consumers. You are interested in individuals who will give you some of their time and who you think even loosely fit the profile embedded in your customer hypotheses.

At the same time you're building a contact list, you begin to develop an innovators list. Innovators are the companies, departments in a company, or individuals in your field who are smart, well-respected and usually out in front of a subject. For consumer products, they may be the “gadget freak” everyone asks for advice or the group of people others look to spot a trend. You'll use this list two ways. First, you need to find and meet with the visionaries who are known to “get” new ideas. Some people view innovation as a dangerous virus that must be kept out of their companies. Others look forward to hearing about and understanding what's new. Those are the ones you'll talk to. Second, your innovators list will give you a great contact list for advisory board members and industry influencers.

Keep in mind the goal of this initial flurry of calling is not only to meet with people whose names you collect but also to use these customer contacts to network your way up “the food-chain of expertise.” Always keep asking your contacts, “Who's the smartest person you know?” Remember, the ultimate goal in this Customer Discovery step is to make sure you understand the customers problem(s) and to ensure your product as spec'd solves that problem.

The first step in this phase is the hardest—contacting potential customers who don't know you and convincing them to give you some of their time. But this step gets a lot easier if you do two things: (1) get a referral and (2) carefully prepare a reference story that gets you in the door.

In a business, since secretaries exist to block your calls, you want to reference someone else, if possible: “Bob at BigBank Inc. said I should talk to you.” Recall you got your list by asking everyone you know who they know. You reference the people who supply the leads. The best introduction to a prospect, when you can manage it, is through a peer within his or her company. A consumer product at times can be just as challenging— how do you get ahold of someone you don't know? Use the same technique—a reference from someone they know.

First, create an introductory email. Include a one-paragraph description of your company, a general description of what you are doing, and a statement of what's in it for your contact to spend time with you. No, you aren't going to send cold email; the people who gave you the leads are. Forward your email to them and ask them to send it on to the contact they gave you.

Then follow up with a phone call. Before you pick up the phone and talk to someone you don't know, it's a good idea to know what you want to say. What you don't want to say is, “Hi this is Bob at NewBankingProduct Inc., and I'd like to tell you about our new product.” (Well, if you are a passionate founder that is exactly what you want to say, but restrain yourself.) Instead create a reference story that explains why you are calling. This story emphasizes the problems you are trying to solve, why it's important to solve them, and the solution you are building.

Start with an introduction: “Hi this is Bob at NewBankingProduct Inc., and as you remember I was referred to you by [insert helpful reference name here].” Now give them a reason to see you: “We are starting a company to solve the long teller line problem, and we are building our new Instanteller software, but I don't want to sell you anything. I just want twenty minutes of your time to understand how you and your company solve your own teller problem.” What's in it for your contact? “I thought you might give me some insight about this problem, and in exchange I'll be happy to tell you where the technology in this industry is going.” Exhale.

Obviously, you will need to vary and tweak the story, but the goal remains the same: Get meetings scheduled. This may sound easy on paper, but if you are not a professional salesperson, it can be very hard. I hated calling people I didn't know. I would stare at the phone, walk around it, pick it up, and put it down without calling. But eventually I placed the calls. And you know what? There is nothing more satisfying than a potential customer saying, “Why, yes, that's exactly the problem we have. I can spare twenty minutes to chat—why don't you come in Tuesday.” Yes!

To make this work, you and your co-founders need to make 10 (yes, 10) phone calls a day. Keep calling until you have your schedule booked with three customer visits a day. Get used to being turned down, but always ask, “If you're too busy, who should I talk to?” It's helpful to keep hit-rate statistics (were any reference stories better than others, were any lead source better, were you more successful calling on managers, directors, vice presidents?) And by the way, while this works for calling on companies, the same holds true for consumer products.

As a rule of thumb, your 50 follow-up phone calls should yield five-10 scheduled visits. You will use these visits to test your customer/problem hypotheses—who your customers are and why they will use your product. These visits are a first step toward achieving a deep understanding of how customers work, their problems, their organization, and how they fit in their company. Before you go out to visit customers, though, carefully plan how you're going to break the ice and elicit the information you need. The place to start is with the development of what I call a “problem presentation.”

B. Test and Qualify Your Hypotheses: The Customer Problem Presentation

In Phase 1, you came up with hypotheses about what problems your customers have. In our corporate example for banking it was long teller lines. Now based on those hypotheses, develop a presentation about this problem and test it in an ongoing dialog with customers.

In contrast to a product presentation, a problem presentation isn't designed to convince customers. Instead, you develop it to elicit information from customers. The presentation summarizes your hypotheses about customers’ problems, along with some potential solutions, so you can test whether your assumptions are correct. This presentation is your icebreaker when you meet customers.

Developing a problem presentation is easy. You have already done the hard work of articulating the customer problems and some solutions, including your own, in Phase 1. Now put these assumptions into slides. For a corporate presentation, consider a simple one-slide presentation. In this slide (see Figure 3.8) the list of the problems as you understand them go in column 1, today's solution to the problems in column 2, and your company's solution in column 3. (In meetings with consumers where slides are inappropriate, a simple flip chart presentation will do.)

When you have the slide done, be prepared to present it using a whiteboard, or simply one-on-one across a table. Remember, though, “presenting” in this context really means inviting the customers’ responses. So, after describing your assumed list of problems in column 1, pause and ask the customers what they think the problems are, whether you are missing any problems, and how they would rank-order the problems.

What if a customer tells you the issues you thought were important really aren't? Realize you've just obtained great data. While it may not be what you wanted to hear, it's wonderful to have that knowledge early on. Do not—I repeat, do not—try to “convince” customers they really have the problems you describe. They are the ones with the checkbooks, and you want them to convince you.

If they agree with you about the problems, get them to explain why they think it is important to solve them (there is nothing better than playing validated customer needs back to them). Casually ask, “How much does this problem cost you (in terms of lost revenue, lost customers, lost time, frustration, etc.) today? You'll use this number later in the Customer Validation step when you develop an ROI presentation.

With agreement on the problems and their cost, you can display column 2, the solutions available today. Again pause, ask the customers what they think the solutions to the problem are, whether you are missing any, and how they would rank-order the viability of the existing solutions. What you are looking for is an understanding of how customers solve this problem today, or how they think others solve it (for example, more tellers, faster software, bigger server). If the problem is painful or important enough, you will usually get a set of interesting answers. While you're at it, another critical piece of information is, who shares these problems? In our corporate banking example, is it other branch banks? Other consumers who do x or y? Other people in the same company? Others in an industry? Others with the same title? A set of people with common problems equals a common value proposition. This means you can describe the value of your product in a message understood across a broad audience.

When RoboVac, a consumer products company, was researching a robot vacuum for the home, the results of their problem presentations to customers surprised them. They initially thought their robot was going to be used as a simple replacement for vacuuming. As they talked with more and more potential customers, those who got most excited were not the ones who vacuumed their floors on a regular basis. In fact, they were the opposite—they were single men who barely knew where their vacuum was and would buy a robot vacuum for the novelty, the technology and the “leave and forget it” nature of its use. RoboVac's earlyvangelists wanted to leave their vacuum running, and come home and find a completely clean floor. For some earlyvangelists the connection was even stronger. Some treated the RoboVac like it was a family pet. Some scientists believe that robot pets trigger a hard-wired nurturing response in humans. It appears robot vacuums tap into the same instincts. The point is no discussion around the conference room table would have discovered these responses.

Finally, for both corporate and consumer products, display your company's solution (not a set of features, but only the big idea) in column 3. Pause and watch the customers’ reactions. Do they understand what the words mean? Is the solution evident enough that they say, “Aha, if you could do that, all my problems would be solved?” Alternatively, do they say, “What do you mean?” Then do they have to listen to you explain for 20 minutes and still not understand? Ask how your solution compares to the current solutions you just discussed. Once again, the point is not to give a sales pitch. You want their reaction, and a discussion.

My favorite summary of this discussion is to ask two questions I alluded to earlier: “What is the biggest pain in how you work (or in RoboVac's case—how you clean)? If you could wave a magic wand and change anything in what you do, what would it be?” I call these the “IPO questions.” Understand the answers to these questions and your startup is going public.

Of course, what you learn from these discussions depends on what sticks with you when you walk out the door. After you meet with a series of customers, their responses tend to blur together. Therefore, it's helpful to take your hypothesis briefs with you when you make these visits. Look at all the information you want to gather. Then, before each call, shorten the list to “What are the three things I need to learn before I leave?” Make sure you get at least those three questions covered. Over time, as you get confirmation on the key issues, begin to ask different questions.

The problem presentation facilitates the collection of the critical information you need early on—why customers buy and what they would buy. However, it's not the entire purpose of your first meetings with customers. You want to probe deeply in order to understand customers’ needs.

C. Test and Qualify Your Hypotheses: In-Depth Customer Understanding

In addition to checking your assumptions about customer problems and your solution, you need to validate your hypotheses concerning how customers spend their day, spend their money and get their jobs done. Regardless of whether it's an esoteric product for corporate customers, or a new type of lifestyle product for consumers, you want to understand in detail how their life/job works and how the workflow/design flow happens. If they are in a company, is their job done in isolation? If not, how do they interact with other departments? What other products do they use? Is the problem they've identified limited to them, or do others in the company share it? Is it possible to quantify the impact (dollars, time, costs, etc.) across the entire organization? The same questions work for consumers. Will they use the product themselves? Does it depend on their friends and family using it?

You also want to check your assumptions about whether people will pay for your solution. What would make customers change the current way they do things? Price? Features? A new standard? In our banking example, would bank tellers change their behavior if they had a portable device they could use to walk up and down the line of waiting customers and service them before they got to the teller window?

If your customers’ eyes haven't glazed over yet, dip your toe into the hypothetical product spec. “If you had a product like this [describe yours in conceptual terms], what percentage of your time could be spent using the product? How mission critical is it? Would it solve the pain you mentioned earlier? What would be the barriers to adopting a product like this?”

Since some day you are going to have to create demand to reach these customers, use this opportunity to find out how they learn about new products. Who are the visionaries in the press/analyst community they read? That they respect?

Finally, you never want to pass up an opportunity to spot talent. Can these customers be helpful in the future? For the next round of conversations? For an advisory board? As a paying customer? To refer you to others?

Your goal, after enough of these customer conversations, is to be able to stand up in front of your company and say, “Here were our hypotheses about our customers, their problems, and how they worked. Now here's what they are saying their issues really are, and this is how they really spend their day.”

I've said that your goal is to understand the customer in depth. What do I mean by “in depth?” I don't mean you know their jobs as well as they do. How could you? I mean being so thoroughly conversant with what truly matters to them that you can discuss their issues convincingly.

Here's an example: I once worked in a startup building a new type of supercomputer. One of the markets we had picked was the arcane field of production geology. Since I knew nothing about the field, I realized before I could even hire a domain expert to manage this market, I needed to get educated in depth. I traveled to all the petroleum geology trade shows and conferences, I spoke to customer after customer to understand their needs. I spent days in the Houston petroleum engineering library. Just when I thought I knew enough to fake it as a technical expert in this area, I convinced Chevron's La Habra research center to allow me to offer their research group a two-hour course on the use of graphics supercomputers in petroleum applications. I promised it wouldn't be a sales pitch, just an update on what advances were occurring in computing that were relevant to petroleum geologists. In front of an audience of 30 or so, I spoke about the state of the art in computational reservoir simulation and what could be accomplished on the new class of machines that were coming from companies like ours.

During the question-and-answer session my heart was in my throat, since my depth of knowledge, like any good marketer, was no more than one level away from being a complete idiot. At the end of the talk, the head of the research facility approached me and said, “That was a great presentation. We're glad your company hired real petroleum engineers to come speak to us. We hate it when the sales and marketing types show up and try to get us to buy something.” For one of the few times in my life I was at a loss for words, and I was completely unprepared for what came next. “Here's my card. If you ever want to consider a career in Chevron research, we'd be happy to talk to you.” That's what I mean by understanding your potential customers and problems in sufficient depth.

D. Test and Qualify Your Hypotheses: Market Knowledge

Now that you have a good understanding of the customer and their problem you want to round out your understanding of the overall marketplace. You need to meet with companies in adjacent markets, industry analysts, people in the press, and other key influencers. Going to industry trade shows and conferences is also key to help you understand the shape and direction of the market you are in or about to create.

When I start a company, I buy a lot of lunches. I typically have some vague notion of what companies are in adjacent markets or are part of the infrastructure or ecosystem of my business. Through my own contacts, and through introductions, I take my peers out to lunch. In exchange, I want information—not competitive information, but answers to questions such as: What are the industry trends? What are key unresolved customer needs? Who are the key players in this market? What should I read? Who should I know? What should I ask? What customers should I call on?

Why will these people meet with you? Most won't out of the goodness of their hearts; they will meet because you will offer a trade. In exchange for information, you will share a little about the problem you are solving and the product that will solve it.

Just as you did with your problem presentation to potential customers, don't present, don't sell; just listen and learn. Spend the time to take a few of the friendliest customers to lunch and ask them who they see as potential competitors, both internally and externally. Who do they think has similar products? Who else is an innovator in this space? Has this solution been tried elsewhere in their company? Is anyone else inside their company trying to build this product? It's amazing how much you can learn from the people who eventually will buy your product.

Ask the same questions of peers in adjacent markets. After practicing on them, try to make contact with the key industry influencers and recommenders you listed in Phase 1. Ask them the same set of questions.

Next, start gathering quantitative data about your market. More than likely Wall Street analysts issue reports on your market or adjacent markets. Get copies of all these reports. More important, read them. You need to understand what the analysts believe are the trends, the players, business models, and key metrics.

Finally, industry conferences and trade shows are invaluable and essential. Never say, “I'm too busy to attend.” Attend at least two key conferences or tradeshows (you picked the important ones in Phase 1). Not only will you get to take home some great trinkets for your kids, but conferences and trade shows are prime areas for talent-spotting and trend-spotting. Ask your usual questions about trends and players, but this time you want to accomplish a few things you can't anywhere else. You want to get demos of competitive and adjacent products. You want to get your hands on them, get competitors’ literature, talk to their salespeople, and generally immerse yourself in the business you are entering. Attend as many conference sessions as you can, listening to others describe their products. What are their visions of the future, and how do they compare with yours?

A. Test and Qualify the Product Concept: First Company Reality Check

Now that you have a deeper understanding of customers and their problems, it's time to come back to the company for a reality check. To start this phase, gather as much of the company management as you can (not just the VPs but directors and managers) for your Product/Customer Development synchronization meeting. (You had the first of these meetings in Phase 1 when you put together your product hypotheses.) In the reality check the Customer Development team shares what was learned in the field and reviews customer feedback on the assumptions made in Phase 1. Then the Customer Development and Product teams jointly adjust their assumptions, product spec's, or both.

Before the meeting, the Customer Development team gathers all the customer data and builds a workflow map of the prototypical customer. At the meeting, the spokesperson for the team diagrams and describes how customers do their jobs and who they interact with. This is your reality check on your customer hypotheses. Keep diagramming and drawing until you can explain how customers’ businesses and lives work today, including how they spend their time and money. Compare this description to your initial hypotheses. (While corporate customers may have a more formal organization to diagram, a consumer will have more external influencers to track.)

Once the customer workflow and interactions are fully described, you can get into the real news. What problems did customers say they have? How painful were these problems? Where on the “problem scale” were the customers you interviewed? How are they solving these problems today? Draw the customer workflow with and without your product. Was the difference dramatic? Did customers say they would pay for that difference? In general, what did you learn about customers’ problems? What were the biggest surprises? What were the biggest disappointments?

Once the Customer Development team has presented its findings, the fun begins. You can now ask the most difficult question, “Do we have product/market fit?” Given all you have learned talking to customers, how well do your preliminary product specs solve their problems? Dead on? Somewhat? Not exactly? If the answer is somewhat or not exactly, this meeting becomes a painful, soul-searching, company-building exercise. Is it because you haven't talked to the right people? To enough people? Because you haven't asked the right questions? This assessment is critical because of a fundamental assumption of the Customer Development model: Before changing the product, you need to keep looking for a market where it might fit. If, and only if, you cannot find any market for the product do you discuss changing the feature list.

This rigor of no new features until you've exhausted the search of market space counters a natural tendency of people who talk to customers: You tend to collect a list of features that if added, will get one additional customer to buy. Soon you have a 10-page feature list just to sell 10 customers. The goal is to have a single paragraph feature list that can sell to thousands of customers.

What do you do if you believe you are talking to the right customers but their feedback tells you you're building the wrong product? Something has to change. Don't continue building the product and think miracles will happen. Either get back outside the building and find a different set of customers who will buy the product or consider changing the features or how the product is configured.

Assuming your product is at least a partial fit for customers’ problems, continue examining your product assumptions and specs. Based on customer feedback, review the Phase 1 feature list. Prioritize the features in terms of importance to the customer. Can the Customer Development team match each feature to a customer problem? If not, why not? While figuring out what features to ship is important, knowing which features don't matter is equally important. Which features did customers not care about? Can any features on the product spec be deleted or deferred? Remember, in a startup the Customer Development team is not supposed to add features; it is supposed to find out the minimum feature set for the first release, based on input from visionary customers.

Next, review and get agreement on the delivery schedule, again revising your Phase 1 assumptions as necessary. As I noted earlier, visionary customers, particularly in corporations, will be buying into your entire vision, not just your first product release. They will need to hear what your company plans to deliver over the next 18 months. The agreement between the Product and Customer Development groups must be that:

• All features past the first version are up for grabs
• Features spec'd in the first release are subject to change/deletion to get the product out;
• Product Development will provide a one-page 18-month or 3-release product schedule
• Finally, as a group, review your other phase 1 hypotheses. (Now you can see why you took the trouble to write them down.) Given all the feedback from customers, which of the four Market Types are you in? Why are you different? What will be your basis for competing? Do your pricing and delivery channel assumptions hold up? What did you learn about influencers?

B. Test and Qualify the Product Concept: Product Presentation

Once your Product and Customer Development teams agree on your revised assumptions, the next step is to assemble your first product presentation. This product presentation is emphatically not the presentation the company used for fundraising or recruiting. Nor is it the problem presentation you used when you visited customers in Phase 2. Toss those slides out and start over. The goal of this presentation is to test your revised assumptions about the product itself. This goal has two parts: To reconfirm your product will solve a serious customer problem and to validate your product and its features.

Along the way, you will further test your understanding of customers’ pain, their workflow, and the organizational impact of your product. Accordingly, develop a solution-oriented presentation that describes the product in terms of solving the customer's problem. If it's too early for a real product demo, the product presentation should cover the five (no more!) key product features. Include a story about “life before your product” and “life after your product.” Draw the customer’ workflow or consumer's day with and without your product. Leave out all the marketing, positioning and fluff. Finally, detail the future of the product at least 18 months out, broken down into features by release.

As before, rehearse how you will give this presentation to customers. Keep in mind you are still not selling in this phase. Instead, you are trying to discover whether you have a salable product. You are gathering enough information so when you do try to sell something, you will be confident there is a group of customers who will buy.

C. Test and Qualify the Product Concept: Yet More Customer Visits

When your product presentation is ready, decide which customers you will visit. Ideally, you'll give this presentation to everyone who heard your first presentation on the “problem” (at least those who are willing to see you again). In addition, your earlier visits should have netted you more names to call on. Accordingly, expand your original set of customer contacts to include a second set with at least five new potential customers for enterprise software, (for consumer products this might mean 50 customers). These new contacts allow you to keep the momentum going and start laying the groundwork for actually selling something in Step 2.

Just as in Phase 1, to get enough visits, make a list of 50 potential customers. However, in this phase you want to test your assumptions about the titles of the people who will make the purchasing decision. In our banking example, they would include bank CIOs and vice presidents of branch operations. Try to target the appropriate titles and roles as if you were selling. Once you have your list, create an introductory email, reference story, and sales script as you did before.

Now get out of the building and talk to customers. You will get more information if you start by reminding your audience what problem your product is designed to solve. Describe why your company believes it is important to solve this problem. Pause here and see if you get agreement on the value of solving the problem. You should, since your presentation is based on what you've already learned from customers about their issues. With any luck, no surprises will pop up but if they do, go back to Phase 2.

With agreement on the problem and its significance, you finally get to describe the product (you've probably wanted to do this since day one, so you should be ready by now). Demonstrate the product if you can; even a prototype of a key concept can help a customer understand your solution. Pause here to gauge the customer's reaction.

Next, draw the customer workflow with and without your product. Pause again to see if you get agreement on the “before and after” workflow. Describe who else in the customer's organization you believe your solution might affect. Listen here and see if you get agreement.

The whole product presentation should take no more than 20 minutes. Now it's time to listen. What are the customers’ first reactions? Does your product solve a painful problem for them? Would the customers buy a product to solve this problem? Do they believe others in their company feel the same? How about in other companies?

Ask about the features you've described. Do they match the customers’ needs? What features must you have on day one? What features could wait until later? What features are simply missing? What is a “complete product” in the customer's mind? What other features are needed to move the product into the mainstream? Are third-party products or services needed to make your offering a mainstream product?

Since your company will be spending a ton of money and lots of time trying to figure out how to position your product, why not ask these customers what they think? After hearing your product description, how do they think your product is different? Do they think you are creating a new market? Or do they think the product is a better version of an existing product (and, if so, better in what way)? Or do they shrug and say, “It's somewhere in the middle, comparable to others, but it doesn't change the rules of the game”?

Check your other hypotheses. What do customers think about your pricing? What do they think are comparable prices for this kind of product?

When I found visionary customers who were truly interested in our products at E.piphany, an enterprise software company, I would ask several questions to test the pricing boundaries. They included the IPO questions I mentioned earlier, the first of which was, “Would you deploy our software enterprise-wide if it were free?” I used this question to test the seriousness of a potential customer. If the customer wasn't ready to deploy the software even if it was free, then I was talking to the wrong person. When I found customers who would go through visualizing the pain of actually rolling out our product, I would ask them how they would deploy it, how many users would use it, what groups would get it first, what criteria would they use to measure its success, and so on. By the end of this visualization exercise I had potential customers who had mentally installed and deployed our software. Then I asked, “Would you pay $1 million for our software?” The answer was usually instructive. Suppose customers said, “Steve, we couldn't see paying more than $250,000 for the first set of applications.” In their minds they had already bought the product and now the bill just came due. The first number out of their mouths usually was what they had in their immediate budget and would be the first purchase price. Once I got a first number, I always asked, “How much more would you expect to pay for professional services (the customization and installation)?” Most of the time they would say that cost was included in their budget number, but every once in a while someone would add more dollars. If they were still interested in brainstorming, I would push and see whether they would spend those dollars every year on our software. Then I would ask, “What would we have to do to get you to spend twice that? Three times that?”

After a few of these customer exercises I understood the average selling price of E.piphany software could be $250,000 and the lifetime value of a customer could be close to a million dollars. (I arbitrarily set a customer “lifetime” as three years.)

OK, you've talked about pricing. Now, what about distribution? Test your assumptions by asking customers what channel they would most likely use to buy your product. Retail store? From the Web? Direct sales?

From there, ask customers how you would reach them via marketing: “If you were interested in a product like this, how would you find out about it? How do you find out about other new products like this? Do you ask others for their opinions before buying? If so, who? Do you or your staff go to trade shows? What industry-specific magazines or journals do you read? What business publications?” If it's a consumer product, what general interest publications, newspapers, and websites would best connect with them?

Next, probe the customer's product acquisition process. If a corporate product, try to understand how a purchase order is approved in their company: “Let's assume for a minute I built a product you really wanted to buy. How does your company buy products like this? Could you walk me through the approval cycle? Exactly who is involved?” If it's a consumer product, understand the buying process. Is this an impulse buy? Do they buy only known brands? Items advertised on TV?

Be sure to get to the “who has the money” question. There's nothing more frustrating than having a series of great customer meetings for months only to find out way late in the sales cycle that no department wants to cough up the dough for a product. Ask questions like “By the way, is there a current budget for a product like this? Which department or individual would have the budget for this product?” The information you get will be critical as you put together a sales roadmap.

On your way out the door, take another look at the customers you just met with. Are they candidates for a customer advisory board? Could you learn much more from them? Do they have great industry connections or insight? If so, ask them if you can follow up with some questions later on.

Of course, it's optimistic to expect your first customers to share all of this with you on your first product presentation. However, try to get answers to every one of these questions over the course of all your visits. Leaving this phase means you not only understand customers’ problem in depth but have a solid grip on their level of interest in your product.

If you believe you will be using any form of indirect sales channel, there is one more group you need to present the product to before you get to go home: your channel partners. Earlier, in Phase 1, you hypothesized a distribution channel for your product. While it's too early to sign up channel partners with formal commitments, you want to meet them and understand what it would take to get an order. What do your channel partners need to hear or see from early customers? What do they have to have before they will give you access to their channel, and then volume orders? Is it articles in the business press, product reviews, and customers calling and asking for the product? Or is it financial inducements such as shelf-stocking fees or a guaranteed returns policy? Note that channel partners won't magically know how to position or price your products. For products in an existing market, it's easy to tell them, “It's like that other one you sell, but faster.” For resegmented and new markets, indirect channels have a harder time understanding how to position your product. Make sure you spend the time helping them.

To make progress, you need to be sure you understand their business model. Why? There is no way you can understand how much product your channel partners should order or how much they should charge you and your customer unless you understand how the money flow works. A good way to understand how you might work with these partners is to see how other companies do. Are there other companies similar to yours? If so, it's time to have lunch again. Take other executives to lunch and ask about margins and discounts. The worst that could happen is that they won't tell you.

Keeping all this in mind, assemble a channel/service partner presentation with your business concept and what's in it for your partners. Then hit the street and present to them. Your goal is to start a dialog and learn about their business. How do companies like yours establish a relationship with them? How do they hear their customers asking for a product like yours? How does your potential partner make money? (By project? By hour? By reselling software? By profit on reselling?) How does their business model compare to others in their business? What is the minimum dollar size of a transaction interesting to them? The goal is to understand your channel partner's business model well enough to draw it on a whiteboard.

D. Test and Qualify the Product Concept: Second Company Reality Check

With your latest customer feedback in hand, it's time to come back to the company for another reality check, this time on the product. This is your third Product Development/ Customer Development synchronization meeting (the first occurred in Phase 1a, the second in Phase 2a.) You'll be discussing what Customer Development has learned about the product's features, pricing and distribution, once again testing your assumptions and revisiting your product spec.

Now that you have tested the product in front of customers, you can probably sort the reactions into four main categories:

• The customers unequivocally love our product; no changes are needed
• Customers like our product, but we've heard consistently they want this or that additional feature at first customer ship
• The customers can understand our product after a long explanation, but no one was jumping over the table to get us to sell it to them
• The customers don't see a need for our product

In this reality check meeting, the Customer and Product Development teams need to balance customer reactions with development time. The goal of Customer Discovery was to find a market for the product as spec'd. If most of the customers fall into category one, congratulations! You can move on to the next phase. However, that rarely happens the first time around in Customer Discovery.

The most dangerous customer responses are those in category two: “We need more features.” As I have emphasized, knowing which features do not matter is just as important as knowing what features to ship the first time around. Why? Because the joke, “Normal people believe if it ain't broke, don't fix it. Engineers believe if it ain't broke, it doesn't have enough features yet,” is true. The natural instinct of Engineering is to keep adding more.

Spend time “unpacking” the customer responses in this category. As a startup, your goal and battle cry should be “fast to market.” Fast to market simply means getting your first release in the hands of paying customers as quickly as you can. The teams should constantly remind themselves the first release is not the ultimate product. A series of compromises is necessary to get the product in the hands of earlyvangelists. Accordingly, ask yourselves whether any of the requested features can be deferred (are they “nice to have” or “must-have” for your visionary customers only?). Once your first release ships, you are going to listen carefully to those visionary customers to find out what features and key pieces of functionality to add to your next release. If you keep listening to the right customers carefully, you will end up executing a successful product strategy.

This fast-to-market strategy is distinctly different from a first-to-market strategy. First-to-market emphasizes competing with other startups to win market share quickly by low price, discounting, and the liberal use of marketing dollars in establishing a brand. Its key theme, whether explicit or not, is “get customers at any price.” In contrast, fast-to-market says if a new market is large, whoever wins the first few sales is not going to matter. What matters is learning how to make money from day one.

Answers in categories three and four—customers aren't jumping over the table, or don't see a need for your product—are typical during a first round of Customer Discovery. However for technology products, they can be indicative of a profound problem, sometimes referred to as positioning, but more accurately described as “technology packaging.” Technology packaging is a pitfall most technology startups have to deal with at some point in their lives. A technology-driven startup's first product is usually determined by the founding Product Development team. There is not much research about how the features and functionality get put together. The thought, if any goes into it, usually is to hand the product to Sales and Marketing saying, “Hey, here's what we are building, go write the datasheets, price it, and go sell it.” Sometimes this works. Sometimes the Product Development team has a perfect feel for what the customer needs are and how the customers want to buy the product. Most of the time they don't. Most of the time, the product as initially configured by Product Development needs further refinement by the Customer Development team. While the core technology might be spot-on, its match for customer needs and how customers want to buy can be off. Imagine the product as delivered to Customer Development was a single monolithic software package. It may be too expensive or too complex to sell that way. Technology repackaging would look at the problem and say, “Perhaps it can be sold as modules, or as a subscription service, or some other permutation, without requiring Product Development to completely reengineer the product.” If this problem is not caught and dealt with in Customer Discovery, it will continue to grow until it affects your company's ability to survive as a viable enterprise.

Our story at the beginning of this chapter about Steve Powell at FastOffice illustrates this point. The core technology he had designed was a data communications chip and software that offered voiceover data communications lines. It was Steve's idea to wrap an entire office system around this unique invention. As Steve said later, “I thought it would be cool if I could have one of these systems for myself. So I thought I understood the customer's problem.” Unfortunately, few other customers thought so. In hindsight, there were alternate ways the chip could have been used: sold to other office systems manufacturers’ as part of their product, sold to data communications companies, etc. If Steve had spent the time thinking about those up front, or at least after he received customer feedback, FastOffice would still be in business.

E. Test and Qualify the Product Concept: First Advisory Board Members

As good as your founding team is, there are invaluable people outside your company you can't hire as full-time employees, but who will be willing to help in an advisory capacity. These advisors can help solve technical problems, introduce you to key customers, provide you with domain-specific knowledge, and share business expertise and wisdom. Early in Customer Discovery, as you began to meet customers and analysts, you began to think about who might fit on an advisory board. Your Product Development team should engage some advisors for specific help designing and building the product, and you may want to find a business mentor, someone who has been through the startup grind before. And as you begin to talk to customers, you'll realize that out of the morass of meetings you've been having, one or two voices stood out from the crowd. In this phase, you informally engage these people by asking them for advice, taking them to lunch and seeing if they are interested in helping you and your company. Later, in Customer Validation, you'll formalize the advisory board process.

A. Verify the Problem

By now, you have talked to at least 10 or 20 customers, more if you have traveled the Customer Discovery loop more than once. “Verifying the problem” simply means summarizing everything you have learned and checking to see whether you have the problem nailed or need to go around the loop again.

Review the answers you've obtained on all the dimensions of your customer problem hypotheses. Capture them in a Problem Statement document. Make the statement clear, concise, and precise. Be sure to ask the hard question: Are you confident you've nailed a customer problem people will pay you to solve? If yes, proceed. If not, go around the loop again.

B. Verify the Product

“Verifying the product solution” means summarizing everything you've learned about your product hypotheses. The short test for exiting Customer Discovery is to gather your executive team in a conference room. Raise your left hand and in a loud voice yell out the top three customer problems. Then raise your right hand and yell out the top three product features. Look at the faces of your team and see if the shock of the two hands not matching is evident. If so, you lack product/market fit and need to get back in front of customers; if not, go to the next step.

Of course, there's more to it than that. Review all the questions you have been asking customers about the product and the conclusions you have drawn about first-release features, subsequent features, pricing, distribution channel, and so on. Be sure to address questions like these: Given the customer feedback to date, do your current product plans meet the needs of the market? Do you want to emphasize different features? If you reconfigured or repackaged the product, do you think you would get a different customer reaction? Should you consider doing so? Capture what you've learned concisely in an Expanded Product Requirement document. This is your latest, greatest vision for your product (for now).

C. Verify the Business Model

If you have gotten this far, you're probably feeling pretty cocky. You understand the customer's problem, you believe you've nailed the product features, and the resulting vision matches significant customer needs. However, there is the small matter of making money. When you originally put together your business plan, that wonderful multipage spreadsheet you gave your investors was your financial hypothesis. Now you get to rerun that financial model based on customer feedback and test how real your business model is.

The outcome of this testing process consists of two documents: an updated sales and revenue plan, and a sound business and product plan. Without trying to be exhaustive, here are some of the key issues to address as you prepare these documents:

• Is the projected selling price (taking into account what customers will pay) different from your initial business plan assumptions? Over the next three years, how many units will a customer buy? What do you believe the lifetime value of each customer will be?
• How will you sell the product to your customer? What will the cost of the distribution channel be? Are there new costs you had not originally planned on? What about your initial view of the sales cycle: Will a sale take more or less time than you originally planned?
• Does the product require any third-party installation, configuration, or technical support? How much will this cost you per customer? How much direct support will you need to provide? Was this service model accurately built into your business plan?
• Based on what you've learned from customers, what is the acquisition model? How will customers know about and ask for your product? How much will it cost to acquire each customer? How does that number compare to the original business plan?
• What is the market size? If you are creating a new market, what is the size of the closest adjacent markets? Can you be that large? Larger? If you are expanding an existing market, what is the size of the current market? Is the market still large enough for your revenue projections?
• Now that the Product Development team has a better understanding of customer needs, are the Product Development costs still the same? How much will it cost you to develop the first version? How much will it cost to implement the complete vision of the product?
• Is there any manufacturing involved in building the product? How much will the product cost to produce? How does the cost compare to your original plan? What manufacturing partners will you use?
• When you add up all the components of the business model, is it profitable enough for your needs?

D. Iterate or Exit

This is either the beginning of the end or, more likely, the end of the beginning. You have put a stake in the ground with a series of hypotheses, you've gone out and tested assumptions, potential customers have validated your product, and you have a base of potential visionary sales prospects. And you've captured all your learning in writing.

Now it's time to honestly assess if your modified hypotheses provide a sound foundation for moving forward.

• Have we identified a problem a customer wants solved?
• Does our product solve these customer needs?
• If so, do we have a viable and profitable business model?
• Can we draw a day in the life of our customer before and after purchase of our product?
• Can we create an organizational chart of users, buyers and channels?

Exhausting as the Customer Discovery process is, you may need to iterate it multiple times. Do you understand the market and have customers who cannot wait to buy? If not, take everything you learned in Phases 1 through 3, modify your presentations based on feedback, go back to Phase 1 and do it again. Try out several markets and users. Do you need to reconfigure or repackage the product offering? If so, modify your product presentations and go back to Phase 3 (product presentation) and do it again.

If you are ready to move to the next step, hold on to all the information you have collected from your customer interviews. You will find it is essential to help you move through the phases of Customer Validation, where you actually sell the product as the basis for developing a sales roadmap for the company.

I've spent quite a few pages on Customer Discovery because it is the foundation of everything you do in Customer Development. The summary chart on the next page recaps the phases of this step, the goals of each phase, and the deliverables that prove you've met the goals.