November 26, 2012

The Logic of Agile Development & Lean Start-Ups: Validation Trumps Verification

Launching a technology start-up involves two basic processes: 1) identifying customer needs and 2) creating a product which satisfies them. The “lean” start-up philosophy states that we can accelerate product development and minimize waste by viewing these two processes as interacting parts of a feedback loop. Lean Start-Ups elicit customer needs by releasing product prototypes, and then use the collected customer feedback to re-design a new iteration for re-release, which begins another cycle of the loop.  This process can be conceptualized as a 3-step sequence of build-release-revise:  build a beta prototype, release it to a small set of customers to elicit feedback, and then apply insights extracted from that feedback to revise hypotheses about customer needs and develop a new prototype.  The iterative nature of the build-release-revise cycle allows product development teams to experiment with alternative designs and gradually tailor a product to fit customer needs.

This “agile” development approach is  well-suited to the mission of start-ups: to search for a new way to satisfy customer needs. Start-ups’ main barrier to growth is not in writing the code necessary to build a working product. Rather, their main challenge is to gain a unique insight into customer needs which enables them to design a product that satisfies those needs in a novel way. The engineering approach of start-ups must be modified to reflect that the product’s design cannot be specified before development begins. In the terminology of systems engineering, this means that start-ups must focus on “validation” rather than “verification” in new product development. Validation is checking that a system satisfies customers’ actual needs. This is hard to accomplish because customer needs tend to entail nuances that are difficult to capture explicitly. Verification is the process of checking that a system functions as described in its technical specifications. It is comparatively easier to accomplish because fairly well-established procedures exist for testing software’s functionality.

The agile approach leverages the relative simplicity of coding multiple iterations in order to overcome the primary challenge of validation.  Articulating off the top of our heads what we need and want out of a new technology is so difficult that we have to assume it will require some trial and error. Allowing potential customers to interact with a functioning prototype of a system is one way to elicit feedback and quickly recognize errors. Once we validate products through this cycle, we can transition our focus to verifying the system’s conformance to technical specifications and reliability standards.

By repeating the build-release-revise cycle until product-market fit has been confirmed, we acquire the evidence we need to justify pumping cash into marketing. The lean start-up model thus allows management to be more deliberate in picking the right moment for the mass-release of a new product.

November 21, 2012

Using Real Options to Build Flexible Companies

The premature pursuit of rapid expansion is one of the most common and easily preventable downfalls of failed start-ups. Entrepreneurs tend to get very excited about their chance to “make it big”, and then overinvest in aggressive growth strategies before first securing the necessary funding or revenue streams to sustain operations beyond the immediate-term. This myopic behavior is understandable in light of the psychological biases associated with launching a new business. The seductive allure of big profits captures the entrepreneurs’ attention, causing her to hyperfocus on upside opportunities, and underattend to downside risks. Singular fixation on big profit then detracts from critical assessment of the business’s vulnerabilities, and unpleasant contingency situations go unexamined, even if they are highly predictable. As an illustrative example, consider planning the launch of a new product. Suppose the big launch event generates slower-than-projected revenue growth. Will enough resources be left afterwards to take another shot at customer acquisition? Unpleasant contingency scenarios like this are easy to overlook and difficult to contemplate. Real options is useful for this task because it forces us to explicitly express our assumptions about these situations.

Real options theory is a financial framework that can be used to quickly identify weaknesses in the cost structure of a business model. The theory’s guiding principle is that the value of a company is greater if that company can flexibly adapt to changing business conditions. The future is difficult to predict, so there is risk associated with relying on specific predictions about how the future will unfold. To build a flexible business that is capable of adaptively responding to changing conditions, it is useful to think about the company in terms of its “real options”.

The following three “real options” are particularly useful to consider:

1) The Option to Scale
If demand or production capacity fluctuates, can management expand/contract the scale of operations gradually and suddenly?

2) The Option to Delay
If continuous non-stop operation of the business is infeasible, can management completely halt and then later resume operations?

3) The Option to Abandon
If the business must be abandoned, can management liquidate the assets for some salvage value?

Asking these questions reveals important information about a company’s capability to survive adverse business conditions. Consider real options early in the planning stages to help build a balanced financial outlook, and prepare for unanticipated speed bumps on the road to profit.

November 19, 2012

Educational Technology is Transforming Higher Ed

Online learning is finally disrupting the outmoded structure of American higher education. The value proposition of American universities has been rightfully called into serious question after the introduction of Massive Online Open Courses, (“MOOCs”) most notably Coursera, Udacity, and EdX. This marks the beginning of a fundamental restructuring of higher education which will bring significant economic, educational, and social benefits to society at large in the years ahead.

The economics of online education make sense because information is costly to produce, but cheap to reproduce. Once instructors have done the initial work to create a course, lectures can be redistributed to the global public for a marginal cost that approaches zero. The incremental cost of scaling up computer infrastructure to support extra users is only a tiny fraction of the tuition fees that universities now charge for on-campus classes. The vastly superior economics of online education are increasingly difficult for traditional brick-and-mortar schools to refute.

Demand for online education is likely to grow steadily as people dispense of preconceived notions about low-cost online learning and realize that it entails virtually no downside relative to expensive in-person instruction for students in most academic fields. With the exception of science and engineering labs that involve physical activities, most student-teacher interaction which currently happens in person could just as easily occur via videochat.

Another major upside is that educational technology facilitates learning by giving students a choice about how they interact with course content. MOOCs are most commonly organized as a series of modular 10-minute microlectures which can be viewed at accelerated and decelerated playback speeds. This flexible organization and feature set enables students to learn at their own pace and navigate through the course as they please. Student usage data can then be logged and analyzed to extract important insights about how people learn online. As learning patterns are identified, instructors will be able to adopt a data-driven approach to pedagogy.

Educational technology also has huge potential to ameliorate social problems, such as poverty. In a time when power increasingly depends on knowledge and access to information, free/low-cost online learning resources enable disadvantaged individuals to get ahead economically, without redistributive mechanisms.

My own sense is that online education carries too many positive social, financial, and educational benefits to slow down in the near future. As educational technology continues to evolve, outmoded institutions will be forced to update their practices, and students around the world will rejoice.

September 15, 2010

Deal Terms for Equity Financings of Start-up Companies

Some  sophisticated law firms in the venture capital space  recently released “model” deal documents for equity-based financings of early-stage start-ups. Presumably, these documents are intended to establish industry standards for commonly negotiated terms, purportedly to expedite the capital-raising process. These terms are probably pretty lopsided to favor investors. Interesting to get a glimpse of the inner-structure of these fabled transactions.

Techstars Seed Funding Documents By Cooley Godward & Kronish

Series AA Equity Financing Documents by Wilson Sonsini Goodrich & Rosati

Equity Compensation by Orrick

Model Legal Documents by National Venture Capital Association

October 22, 2009

The Purpose of Blogs

Establishing a blog or some alternative form of web presence is crucial to professional success in the modern business landscape. Writing regularly on a blog helps to establish credibility, and it also provides potential contacts with a good sense of how you think.

May 5, 2009

The Tinyfoot Company

I work for a web application development business called The Tinyfoot Company.

April 10, 2009

Hey Everybody

This is the first post on my new blog.