1.3 Workbook Staying Lean

Starting Lean

Two important concepts have relevance for any organization: one is effectiveness, the other is efficiency. Effectiveness is achieving important goals; efficiency is doing it with as few resources as possible. Here’s a simple analogy. Suppose your goal is to get rid of a killer bee that’s buzzing around your kitchen. You can hit it with a sledgehammer, whack it with a fly swatter, or simply open the door and let it fly away. All three strategies eliminate the bee, but they range from costly to efficient: the sledgehammer wrecks the walls, the fly swatter is standard procedure, and opening the door is an effective and efficient solution.

Prosperous entrepreneurs learn how to open doors – they are masters of efficiency. They create new ventures from practically nothing, get more from less along the way, and keep costs below industry standards. These leaders have a real knack for finding and utilizing a host of resources other than money: they work on old desks, defer compensation, partner with their first customers, negotiate excellent terms, and use someone else’s plant rather than build one – they think resources first, cash last. Elon Musk, founder of Pay Pal, describes this process during his early days:

When you are first starting out you really need to make your burn rate ridiculously tiny. I had very little money so there really wasn’t any choice . . . Then my brother came down and he had a few thousand dollars. We rented an office for four or five hundred dollars a month – a really tiny little office in Palo Alto, which was cheaper than an apartment. We bought futons that converted into a couch, which was sort of like a meeting area during the day. We would sleep there at night and then shower at the YMCA which was just a few blocks away.

Most successful entrepreneurs create a low cost proto-type, test it, and prove that it works before spending and/or raising lots of money. Once a model is working, it is much easier to raise money to scale the business; and the entrepreneur has more leverage when negotiating with investors. This strategy flies in the face of some pundits who pound the “capital” podium: Don’t go into business undercapitalized! No Dough, No Go! Capital is King!

Our observation is different. Startup companies that have lots of money spend it; new ventures that don’t, create incredible efficiencies. In lean startups, the focus is on key customers and early sales. Consequently, the capital meter doesn’t tick very long before revenue is realized, which increases the odds the entrepreneur will have both a business success and a financial success. Having customers right out of the chute – a true business opportunity – aids this process.

Josh Coates has created two software companies, Scale Eight and Mozy. With Scale Eight, he raised $60 million, bought nice furniture, purchased elaborate signage, launched expensive marketing campaigns, grew to 200 employees, and opened offices in San Francisco, New York, Virginia, Tokyo and London. After four years, the company sold its patents to Intel and closed its doors – a modest business success, but a financial disaster.

In 2005 Josh started Mozy, a provider of online backup data solutions. In this venture, he leveraged the lessons he learned from Scale Eight: he raised very little money, created a working model, and focused on customers and sales. Two years after inception, he had 300,000 customers and sold the company to EMC for $76 million. Josh described the lessons he learned in a recent interview:

Too much funding makes you stupid. If you have an enormous amount of funding you tend to spend it . . . There is an expectation that if you don’t spend it you’re not doing your job . . . (With Mozy) I did everything differently . . . I did my homework and took the time to come up with the right model. I raised very little money, and I drove the boat myself . . . After your business machine starts working, you can step on the gas. But if you are not even sure your car runs, it’s not a good idea to get on the freeway.

Like Elon Musk and Josh Coates, the successful entrepreneurs we have interviewed have created amazing companies from practically nothing. While we have to praise them for their resourcefulness, their frugality was born out of necessity. Many of them approached banks, angel investors and VC funds only to be turned down. Blessed with rejection, they had to scramble to get started and consequently learned the all important lesson: You can make things happen even if you don’t have a lot of money! This awareness fosters creativity in problem solving, which serves the business well in the long run.

Of course, some will argue that you can’t take advantage of windows of opportunity if you are undercapitalized, which may be true in some businesses – particularly those in capital-intensive industries. But the fact remains: just as many “adequately capitalized” companies fail as those that are cash strapped. Many would-be entrepreneurs write a marvelous business plan and raise a great deal of money only to rent offices, lease phone systems, buy mahogany desks, pay themselves salaries and hire helpers – all before they have final products, customers, sales, cash flow and profits. Here is the challenge. New ventures usually take longer, cost more and earn less than anyone imagined. So if you have to achieve your best case scenario to succeed, you could have trouble. While you may eventually have some semblance of success, you cannot spend money indefinitely without producing revenue.

In sum, starting off lean has several real advantages. First, it forces you to develop a lower-cost prototype of your product or service. This process reveals magical strategies for reducing your overall cost structure. Second, it forces you to aggressively sell your product in order to survive. This effort gives you immediate customer feedback for product improvements and revisions, which lead to increased sales during your next cycle. So it’s important to get a product into the market quickly, even if it isn’t exactly what you want to sell in the long run. This process is depicted in the model below.

Successful business builders not only start off lean, they continue to orchestrate marvelous efficiencies while growing their business – apparently the lessons learned from early bootstrapping carry over. As illustrated in the model above, thriving entrepreneurs take their company through a series of upward spirals of growth. At each stage they test their products, adjust their business model and improve their processes before moving to the next step. Along the way, they continue to generate remarkable efficiencies and keep their costs below industry standards.

This sharp eye for getting more from less renders a tremendous competitive advantage over big bureaucracies, often fat with corporate and industry tradition. Being the low-cost operator in an industry has two huge advantages: (1) you can maintain market prices and reap larger margins than your competitors, or (2) you can lower your prices and quickly pick up market share. It is difficult to develop this “create more with less” mindset without wearing the entrepreneurial sneakers. Executives steeped in bureaucratic tradition may never comprehend the multitude of ways you can generate “big-time” results with miniature means.

This mind-set of constantly “Creating More with Less” will be critical to your long-term success as an entrepreneur. It is vital during every stage of business development: while creating your prototypes, proving your concept, and scaling and growing your company. A good place to start is to inventory all the resources you have available to you, particularly those other than money – although you will need money along the way as well. If you think about acquiring money first, you will overlook a host of assets that can help you get started.

In the exercise below, list all the resources you have available to you for launching and growing your new enterprise. Include three types of resources: (1) those you have right now, (2) those you have access to, and (3) those you can acquire with little or no cost. These resources might include mentors, advisors, network contacts, business partners, strategic partners, equipment, tools, supplies, facilities, computers, software, technology, your savings, credit cards, family members with money, a line of credit, a home equity line, etc.

Don’t rush this exercise. Take plenty of time to contemplate all those resources you might acquire with little or no cost. Continue until you have listed at least 20 valuable resources. You may be surprised at what is available.

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