The following is the second excerpt from The Lean Startup: How Today’s Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses by Eric Ries. To read the first installment, go here.
The decision to pivot is so difficult that many companies fail to make it. I wish I could say that every time I was confronted with the need to pivot, I handled it well, but this is far from true. I remember one failure to pivot especially well.
A few years after IMVU’s founding, the company was having tremendous success. The business had grown to over $1 million per month in revenue; we had created more than 20 million avatars for our customers. We managed to raise significant new rounds of financing, and like the global economy, we were riding high. But danger lurked around the corner.
Unknowingly, we had fallen into a classic startup trap. We had been so successful with our early efforts that we were ignoring the principles behind them. As a result, we missed the need to pivot even as it stared us in the face.
We had built an organization that excelled at creating minimum viable products to test new ideas and running experiments to tune the engine of growth. Before we had begun to enjoy success, many people had advised against our "low-quality" minimum viable product and experimental approach, urging us to slow down. They wanted us to do things right and focus on quality instead of speed. We ignored that advice, mostly because we wanted to claim the advantages of speed. After our approach was vindicated, the advice we received changed. Now most of the advice we heard was that "you can’t argue with success," urging us to stay the course. We liked this advice better, but it was equally wrong.
Remember that the rationale for building low-quality MVPs is that developing any features beyond what early adopters require is a form of waste. However, the logic of this takes you only so far. Once you have found success with early adopters, you want to sell to mainstream customers. Mainstream customers have different requirements and are much more demanding.
The kind of pivot we needed is called a customer segment pivot. In this pivot, the company realizes that the product it’s building solves a real problem for real customers but that they are not the customers it originally planned to serve. In other words, the product hypothesis is confirmed only partially.
A customer segment pivot is an especially tricky pivot to execute because, as we learned the hard way at IMVU, the very actions that made us successful with early adopters were diametrically opposed to the actions we’d have to master to be successful with mainstream customers. We lacked a clear understanding of how our engine of growth operated. We had begun to trust our vanity metrics. We had stopped using learning milestones to hold ourselves accountable. Instead, it was much more convenient to focus on the ever-larger gross metrics that were so exciting: breaking new records in signing up paying customers and active users, monitoring our customer retention rate—you name it. Under the surface, it should have been clear that our efforts at tuning the engine were reaching diminishing returns, the classic sign of the need to pivot.
For example, we spent months trying to improve the product’s activation rate (the rate at which new customers become active consumers of the product), which remained stubbornly low. We did countless experiments: usability improvements, new persuasion techniques, incentive programs, customer quests, and other game-like features.
Individually, many of these new features and new marketing tools were successful. We measured them rigorously, using A/B experimentation. But taken in aggregate, over the course of many months, we were seeing negligible changes in the overall drivers of our engine of growth. Even our activation rate, which had been the center of our focus, edged up only a few percentage points.
We ignored the signs because the company was still growing, delivering month after month of "up and to the right" results. But we were quickly exhausting our early adopter market. It was getting harder and harder to find customers we could acquire at the prices we were accustomed to paying. As we drove our marketing team to find more customers, they were forced to reach out more to mainstream customers, but mainstream customers are less forgiving of an early product. The activation and monetization rates of new customers started to go down, driving up the cost of acquiring new customers. Pretty soon, our growth was flatlining and our engine sputtered and stalled.
It took us far too long to make the changes necessary to fix this situation. As with all pivots, we had to get back to basics and start the innovation accounting cycle over. It felt like the company’s second founding. We had gotten really good at optimizing, tuning, and iterating, but in the process we had lost sight of the purpose of those activities: testing a clear hypothesis in the service of the company’s vision. Instead, we were chasing growth, revenue, and profits wherever we could find them.
We needed to reacquaint ourselves with our new mainstream customers. Our interaction designers led the way by developing a clear customer archetype that was based on extensive in-person conversations and observation. Next, we needed to invest heavily in a major product overhaul designed to make the product dramatically easier to use. Because of our overfocus on fine-tuning, we had stopped making large investments like these, preferring to invest in lower-risk and lower-yield testing experiments.
However, investing in quality, design, and larger projects did not require that we abandon our experimental roots. On the contrary, once we realized our mistake and executed the pivot, those skills served us well. We created a sandbox for experimentation and had a cross-functional team work exclusively on this major redesign. As they built, they continuously tested their new design head to head against the old one. Initially, the new design performed worse than the old one, as is usually the case. It lacked the features and functionality of the old design and had many new mistakes as well. But the team relentlessly improved the design until, months later, it performed better. This new design laid the foundation for our future growth.
This foundation has paid off handsomely. By 2009, revenue had more than doubled to over $25 million annually. But we might have enjoyed that success earlier if we had pivoted sooner.
Pivots come in different flavors. The word pivot sometimes is used incorrectly as a synonym for change. A pivot is a special kind of change designed to test a new fundamental hypothesis about the product, business model, and engine of growth.
In this case, what previously was considered a single feature in a product becomes the whole product. This is the type of pivot Votizen made when it pivoted away from a full social network and toward a simple voter contact product.
In the reverse situation, sometimes a single feature is insufficient to support a whole product. In this type of pivot, what was considered the whole product becomes a single feature of a much larger product.
In this pivot, the company realizes that the product it is building solves a real problem for real customers but that they are not the type of customers it originally planned to serve. In other words, the product hypothesis is partially confirmed, solving the right problem, but for a different customer than originally anticipated.
As a result of getting to know customers extremely well, it sometimes becomes clear that the problem we’re trying to solve for them is not very important. However, because of this customer intimacy, we often discover other related problems that are important and can be solved by our team. In many cases, these related problems may require little more than repositioning the existing product. In other cases, it may require a completely new product. Again, this a case where the product hypothesis is partially confirmed; the target customer has a problem worth solving, just not the one that was originally anticipated.
A famous example is the chain Potbelly Sandwich Shop, which today has over 200 stores. It began as an antique store in 1977; the owners started to sell sandwiches as a way to bolster traffic to their stores. Pretty soon they had pivoted their way into an entirely different line of business.
A platform pivot refers to a change from an application to a platform or vice versa. Most commonly, startups that aspire to create a new platform begin life by selling a single application, the so-called killer app, for their platform. Only later does the platform emerge as a vehicle for third parties to leverage as a way to create their own related products. However, this order is not always set in stone, and some companies have to execute this pivot multiple times.
This pivot borrows a concept from Geoffrey Moore, who observed that companies generally follow one of two major business architectures: high margin, low volume (complex systems model) or low margin, high volume (volume operations model). The former commonly is associated with business to business (B2B) or enterprise sales cycles, and the latter with consumer products (there are notable exceptions). In a business architecture pivot, a startup switches architectures. Some companies change from high margin, low volume by going mass market (e.g., Google’s search "appliance"); others, originally designed for the mass market, turned out to require long and expensive sales cycles.
There are many ways to capture the value a company creates. These methods are referred to commonly as monetization or revenue models. These terms are much too limiting. Implicit in the idea of monetization is that it is a separate "feature" of a product that can be added or removed at will. In reality, capturing value is an intrinsic part of the product hypothesis. Often, changes to the way a company captures value can have far-reaching consequences for the rest of the business, product, and marketing strategies.
In this type of pivot, a company changes its growth strategy to seek faster or more profitable growth. Commonly but not always, the engine of growth also requires a change in the way value is captured.
In traditional sales terminology, the mechanism by which a company delivers its product to customers is called the sales channel or distribution channel. For example, consumer packaged goods are sold in a grocery store, cars are sold in dealerships, and much enterprise software is sold (with extensive customization) by consulting and professional services firms. Often, the requirements of the channel determine the price, features, and competitive landscape of a product. A channel pivot is a recognition that the same basic solution could be delivered through a different channel with greater effectiveness.
Whenever a company abandons a previously complex sales process to "sell direct" to its end users, a channel pivot is in progress.
It is precisely because of its destructive effect on sales channels that the Internet has had such a disruptive influence in industries that previously required complex sales and distribution channels, such as newspaper, magazine, and book publishing.
Occasionally, a company discovers a way to achieve the same solution by using a completely different technology. Technology pivots are much more common in established businesses. In other words, they are a sustaining innovation, an incremental improvement designed to appeal to and retain an existing customer base. Established companies excel at this kind of pivot because so much is not changing. The customer segment is the same, the customer’s problem is the same, the value-capture model is the same, and the channel partners are the same. The only question is whether the new technology can provide superior price and/or performance compared with the existing technology.
Although the pivots identified above will be familiar to students of business strategy, the ability to pivot is no substitute for sound strategic thinking. The problem with providing famous examples of pivots is that most people are familiar only with the successful end strategies of famous companies. Most readers know that Southwest or Walmart is an example of a low-cost disruption in their markets, that Microsoft an example of a platform monopoly, and that Starbucks has leveraged a powerful premium brand. What is generally less well known are the pivots that were required to discover those strategies. Companies have a strong incentive to align their PR stories around the heroic founder and make it seem that their success was the inevitable result of a good idea.
Thus, although startups often pivot into a strategy that seems similar to that of a successful company, it is important not to put too much stock in these analogies. It’s extremely difficult to know if the analogy has been drawn properly. Have we copied the essential features or just superficial ones? Will what worked in that industry work in ours? Will what has worked in the past work today? A pivot is better understood as a new strategic hypothesis that will require a new minimum viable product to test.
Pivots are a permanent fact of life for any growing business. Even after a company achieves initial success, it must continue to pivot. Those familiar with the technology life cycle ideas of theorists such as Geoffrey Moore know certain later-stage pivots by the names he has given them: the Chasm, the Tornado, the Bowling Alley. Readers of the disruptive innovation literature spearheaded by Harvard’s Clayton Christensen will be familiar with established companies that fail to pivot when they should. The critical skill for managers today is to match those theories to their present situation so that they apply the right advice at the right time.
Modern managers cannot have escaped the deluge of recent books calling on them to adapt, change, reinvent, or upend their existing businesses. Many of the works in this category are long on exhortations and short on specifics. A pivot is not just an exhortation to change. Remember, it is a special kind of structured change designed to test a new fundamental hypothesis about the product, business model, and engine of growth. It is the heart of the Lean Startup method. It is what makes the companies that follow Lean Startup resilient in the face of mistakes: If we take a wrong turn, we have the tools we need to realize it and the agility to find another path.
[Reprinted from The Lean Startup: How Today’s Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses (copyright © 2011 by Eric Ries. Published by Crown Business, a division of Random House, Inc.) Above Images: dipego, Stephen Chung, Peter Jochems, Sergej Razvodovskij, and Arkady via Shutterstock]