The Rise Of Customer Development
The Dot-Com Bubble
In the United States, the 1990s were known as a period of utmost growth in the usage and adoption of the Internet, later described as the dot-com bubble. Many venture capital firms were interested in investments at comparatively high valuations in technology companies available around that era. Startup funding was relatively easy to raise. Investment banking firms, substantially benefiting from initial public offerings (IPO), strongly encouraged investments into the technology sector. At the peak of the bubble, it was noticeable that a dot-com company could go public and raise a large amount of capital without generating a proportionate amount of profit.
The burst of the bubble (also known as the dot-com crash), took place in the early 2000s and was a critical turning point for the technology industry. Some of the promising Internet companies such as Boo.com, Pets.com, and Webvan suffered tremendously and eventually shut down. Enterprises such as Qualcomm and Cisco lost some portion of their market share, while Amazon and eBay had declines in their company valuations. The period was also known for unsuccessful acquisitions. Yahoo bought several companies for billions of dollars, only to shut them down a couple of years later.
Due to the growing tendency of backing technology businesses, a software startup could raise millions of dollars of funding in their earliest stages of development. Many of those companies would spend that money on building their software without sufficiently interacting with their customers. A typical product development process would follow the Waterfall principles, taking quarters, and even a year to release a product to the market. However, since the initial investments were usually not enough for customer acquisition, startups needed additional funding to grow their operations.
Then those companies would raise more capital, trying to become public as early as possible. This seemed to be beneficial both for venture firms and the founders, guaranteeing them high returns. Due to the consistent pressure and need for additional cash, a company would eventually become public, attracting people to buy their stocks. However, since it would turn out that the business wasn’t generating as much profit as was expected, the company would suffer from a substantial and continuous decline in its valuation. This entire process was full of high risks and depression.
Aftermath
The decade after the dot-com crash was known as a period of limited cash investment and skepticism towards technology startups. The number of technology companies declaring initial public offerings declined dramatically. After the crash, venture capital firms started to look for companies that were actually building something worthwhile for customers, rather than spending an enormous amount of funding on things that would bring no significant value to the market. The importance of building products that customers valued and the limited amount of finances forced startups to take a different approach when building their products.
New movements such as agile engineering and lean product management became the core philosophy of lots of successful startups around that time. Many of them realized that following the processes known in the large enterprises, would not necessarily help them to build great products. The old-style Waterfall model was replaced with incremental and iterative development. Instead of implementing the entire product, teams started to engineer small increments and test them in the market. Moreover, to gain the confidence back from the venture capital firms, many startups adopted continuous interaction with their customers in their earliest stages of development.
This entire chain of changes and new approaches empowered the lean startup era. Alongside new product development processes, people realized that there is a need for a procedure that will allow product teams to learn from their customers consistently. One of the most common methodologies, called customer development, was evangelized by Steve Blank, who was a successful Silicon Valley entrepreneur in the 1990s. After the public launch of his last company, Blank decided to retire from the startup ecosystem and share his experience through teaching.
Throughout his experience, Blank had noticed that there are common patterns that many successful companies have followed when building products. In his book “The Four Steps to the Epiphany: Successful Strategies for Products that Win,” Steve introduces the customer development methodology as a strategic approach to iteratively learn about customers and their needs while building the minimum feature set of the product. The content inside the book provides valuable lessons to not only startup founders, but also modern-day product managers.
The Startup Transition Process
In his works, Blank highlights the importance of treating startups as organizations designed for searching. For a long time, a startup has been considered a smaller version of a large corporation. The processes that were common in big enterprises were also getting introduced to the startup environment. The approaches venture capitalists learned in enterprise settings were being implemented inside startups. Startups were expected to write long business plans, financial projections, and revenue forecasts, which in most cases turned out to be incorrect.
The single most important process startups should integrate into their cultures is the customer development methodology — when the product team gets out of the building (GOOB) and searches for facts backing their product hypotheses. As Blank likes to say, “in a startup no facts exist inside the building, only opinions.” On day one, when a product team brainstorms their idea, it’s all about guesses. All people have in their minds are just opinions, which yet need to be tested and verified. Hence, startups are in the process of searching for evidence behind their guesses.
Enterprises, on the other hand, have already figured out their business model. They are simply executing it. Large companies introduce standard processes to make their work more manageable, organized, and trackable. They use operational artifacts to analyze their business strategy and operations. They employ top executives to coordinate the processes and standards inside each department.
Once the startup finds a repetitive and scalable business model, it enters its transition phase for becoming an enterprise. In this process, the startup learns all the skills it needs to execute the business model. The company hires top managers, so they set up teams that eventually become fully functional departments responsible for different aspects of the business. At this point, it becomes vital to find the right advisors and consultants who will guide the team towards becoming a sustainable business.
Startups are designed to search; enterprises are designed to execute.
According to Blank, many startups fail because instead of searching for the right business model, they are constantly trying to execute just one version of it. The truth is that oftentimes a startup has very little knowledge about its customers and their needs. It has a vision and belief that whatever it is building will solve real customer needs. However, if those beliefs aren’t replaced with valid facts as soon as possible, the startup will follow a wrong business model, and eventually, go out of business.
Business Plan VS. Business Model
Despite their actual differences, people confuse the concepts of a business plan and business model a lot. A business plan is a document written by a company or product executives to describe operational aspects of the business, such as product strategy, financial projections, and go-to-market strategy. In other words, it is the written description of the company’s or product’s future, usually for the next three or five years. It indicates all major steps a company needs to achieve its desired goals from its current stage.
Business plans are very common in an enterprise setting. Executives tend to require business plans from teams to understand their product strategy in the near future. Writing a business plan is a common technique when a team knows exactly who their customers are and what exactly they need to build for them.
The ugly truth, however, is that business plans don’t work as expected for startups, where the customers and the product features are more or less unknown. As Blank likes to highlight, “no business plan survives the first contact with the customer.” Instead of spending days writing documents full of hypothetical guesses, startups need to search for the right business model.
A business model is a mechanism that describes how the company creates value for itself while delivering another value for its customers. This is the central part of the business plan. However, it is the most crucial thing that a company needs to figure out to be able to transform itself into a profitable business.
The business model describes how the company positions itself in its market, what value propositions it provides, and what customer segments benefit from those value propositions. It also describes the key partnerships, activities, and resources a company needs to accomplish its goals. Notably, a business model describes how the company plans to generate revenue from the products and services it provides to its customers.
The truth about business models is that they tend to change very rapidly in a startup setting. It might take quarters and even a couple of years for an early-stage company to realize what works best for them and what does not. However, the sooner the company understands its business model, the better its chances of success are. In the case of not being able to find the right model, products eventually fail. In the case of finding problems, startups can go back to make adjustments in their business model.
The Business Model Canvas
An integral part of the product’s discovery process is understanding its business model. A common approach is using the business model canvas designed by Alexander Osterwalder and Yves Pigneur. It is a discovery artifact designed for product teams to structure the business model for new products. The artifact consists of nine building blocks, each describing different aspects of the business.
The value propositions section expects the product team to list the benefits the new product or service will give to the customers. Here the product team should list the exact customer needs they are going to fulfill. It is important to also think about the unique value propositions — delighters that will differentiate their product from the competitors. This section is basically the core of the product.
Under customer segments, a product team discusses who their actual customers are. The product team should be able to answer questions such as what their customer persona or personas are. Moreover, the team should have some idea why each customer segment would choose to buy their product.
Note that the combination of these two blocks — value proposition and customer segments, creates the well-known concept of product/market fit. It basically shares what value our product or service provides to our customer segments. As can be seen,
the product/market fit is virtually the heart of the business model. Achieving it is an important milestone in building a repeatable and scalable business model.
Under channels, the product team lists its sales channels. This mainly talks about how the company is going to get its products to customers, for example, by presenting the products via the web, direct sales, or by participating in technology expos. This is product-specific and can even include multiple channels.
Next, the product team should specify its customer relationships. This talks about how the product team is going to acquire, retain, and grow customers. We won’t be able to grow our business just by acquiring customers if they don’t stick with us. Hence, the team needs to have a good understanding of how they are going to retain their customers.
Afterward, the team needs to figure out the product’s revenue streams — what the revenue strategy for the company is. The product team should understand what product value the customers will be paying for. There could be multiple revenue streams, as well. For example, Amazon generates revenue from multiple sources.
The key resources section lists all the resources the product team needs to achieve their product goals. This could include an experienced engineering workforce, physical infrastructure, and financial support from outside organizations.
Next, the team needs to input their thoughts on the last three fundamental aspects of the business model. Under the key activities section, the team lists the major activities that need to be completed for the implementation of the value propositions of the product. This could range from writing software to building physical infrastructure.
Following this, the team needs to provide their input under the key partners section, which generally asks who the key partners of the business are. For instance, a sports data provider company could be a key partner for your betting product. It also expects the team to understand what the key activities they are going to run with your partners are. Are those partners only going to provide some specific services or is the team planning to cooperate in other ways as well?
Lastly, the product team needs to understand its cost structure. Here the team should know what their operational expenses are. These costs could be fixed or variable. The team should also be aware of what the most expensive key resources are, and what key activities require the most funding.
I always recommend product teams building products from scratch to print the business model canvas, put it on their wall on day one, and brainstorm their initial thoughts about each of those nine building blocks. Note that, even when you put all your thoughts under those components, they are not facts yet. They are just hypotheses, which is actually fine since, in the beginning, your thoughts are mostly backed by opinions.
The business model canvas can ultimately describe the operational model of any company. That is why it is such a powerful tool. It can be very helpful if used properly. Once you finish your brainstorming session, you have practically created your business model theory, which still needs to be verified. Otherwise, the listed points are just opinions and don’t have much value. You can’t expect your business model to be finalized simply by listing hypotheses on the paper. This will not make the business model canvas worthwhile for the product discovery process.
The truth is that the points you have listed under each component will remain guesses if you stay inside the building. The customer development methodology encourages teams to get out of the building once they have created the business model theory. The idea is to test each component of the business model canvas. If the team learns that one or several of their hypotheses were incorrect, it should go back and update the corresponding component of the canvas. This process should continue once the team finds a repeatable and scalable business model for their product.
The Customer Development Methodology
The customer discovery methodology is NOT designed to guarantee success for early-stage products. Unfortunately, no known technique will guarantee such success. However, methodologies exist that can at least teach product teams how to avoid colossal failures.
The customer development methodology was created to ensure that product teams get enough interaction with customers.
The best way to test your product ideas is by talking to your prospective customers.
Customers will reveal everything you need. Sadly, most of the time, they are not sitting next to you. You need to find them as soon as you have your product idea and start brainstorming their needs with them.
Blank highlights that many processes were known to manage product development, but very few processes were available for early-stage product teams to manage customer development. In fact, most of the time, startups fail due to the lack of customers, not technology. This signifies the importance of the creation of a methodology that would help product teams to reduce their waste — building products that a very small number of customers truly need.
The goal of the customer development methodology is to test the business model theory that the product team has created. It is essentially one of the most efficient methodologies that helps product teams to achieve their product/market fit. Combined properly, customer development and agile delivery will help the product team to find their business model in the fastest way possible.
Note that it would be hard to organize the customer development process if your team is not functioning agile. Customer development expects incremental and iterative delivery of small product components, rather than a large product. If you are not operating that way, it will be nearly impossible to follow the customer development processes.
The entire customer development process consists of four notable subprocesses, each designed to allow the product team to effectively build a product that customers need, while efficiently searching for a business model that fits their company best. The first subprocess, customer discovery, is designed to allow the product team to design their business model theory, and then interact with customers to test their reactions to the theory and eventually turn those guesses into tangible facts.
The customer validation subprocess helps the product team check if the chosen business model is repeatable and scalable. This is an essential requirement for building a successful business. The customer creation subprocess is basically where the company starts executing its business model. Here, the company builds customer demand while using sales channels to acquire more customers to scale their business.
In the last subprocess, called company building, the startups get fully transformed into an enterprise, designed to execute the repetitive and scalable business model. Since my discussion targets product managers, I am only going to talk about the first two subprocesses. These are the activities where the product managers’ involvement is crucial.
The Customer Discovery Subprocess
The customer discovery subprocess consists of five major steps. In the first step, called business model design, the product team starts putting their initial thoughts on the business model canvas. The end goal of this step is to create the initial business model theory. Note that this theory might change in the near future, but we always need to start from somewhere.
In the second step, called product artifact creation, the product team creates a low fidelity minimum viable product or a prototype corresponding to its business model theory. The goal here is not to build a fully functional product with all possible sets of features. All the product team needs to do is to build a minimum group of features that can be tested in the later stages, showing customers enough meaningful value. It can also be an interactive design prototype, as long as it gives the potential customer some sense of how the product works.
The next step is designed for testing the problem. This is when the product team gets out of the building and starts talking with prospective customers. However, before demonstrating the product, the team needs to make sure that the customer personas that they have created are valid and that the problems they think customers have are a reality and not an illusion. It is critical that customers themselves agree with the problem the team thinks they have, and that the problem truly is severe enough for the customer to pay money.
Next, the team should be ready to test the solution. The product team starts to demonstrate the minimum viable product/prototype to gather initial feedback from prospective customers. The goal here is to understand customer behavior when interacting with the product or prototype. Make sure that you are not trying to sell your product to your customer. It’s better to see whether the hypothesis you have made in the first step matches reality. This stage will help you gain a lot of insights about your customers and your business model theory.
After thoughtful analysis, you decide to pivot or proceed. You pivot when you think that the assumptions you have made at the first step were incorrect. In this case, you go back to the business model design step again and update your business model canvas based on your learnings from previous steps. Once updated, you restart the customer discovery subprocess. Otherwise, you proceed to the customer validation subprocess.
The Customer Validation Subprocess
Once the product discovery subprocess is completed, the team needs to ultimately make sure that they have a somewhat good understanding of their business model. This often means that the product team is on its way to the product/market fit. Now it’s a good time to try getting actual orders from customers. Note that in order to accomplish this, you don’t need to have a complete product yet. In the case of real demand, you can get orders with a minimum viable product as well. The right approach is to target the early adopters — the first people who are willing to try using your product even if it’s incomplete and buggy.
If you can’t even get early adopters, it means there is something wrong with your business model. You need to go back and fix it.
In the first step of customer validation, you get ready to sell. You finish the high-fidelity version of your product and make it public for early adopters. Additionally, you set up all the required metrics to analyze your acquisition, engagement, and operational performance. Once everything is ready, you can start onboarding your first customers.
In the next step, you want to try to sell your product or service to your customer segment. In an ideal case scenario, you start getting orders from your customers. This is the best time to analyze your metrics and test the demand for your product.
Afterward, you develop product and company positioning. In this step, you gather all customer feedback to be able to analyze their true needs and desires. Customers are the ones who position your product and company in the market. All you need is to listen to them and understand what the core product advantages are that customers find truly valuable for them. This process will be relatively easy if you listen to your customers.
In the final step, you decide to pivot or proceed. Now you have collected enough data and evidence to measure how effective your customer creation process is. You might realize that you haven’t clearly understood what your customer needs were. You were probably close to figuring out their needs, but you were not in the correct position. Note that it could relate to any of the nine components of the business model canvas. In that case, you need to go back to your customer discovery subprocess and fix what you were missing during your journey.
The Power Of Pivoting
When you are in the customer discovery and validation subprocesses, you are searching for a repeatable and scalable business model. Your goal is to pass those two stages with the minimum effort possible. A minimum but viable set of product features is usually enough for validating your theories. Once you successfully finish those two processes, you essentially enter the transition process, where you prepare your startup for the execution phase of your business model.
However, this journey is not as smooth as it sounds. It might take a couple of iterations, both in customer discovery and validation subprocesses, to figure out the right business model for your product. Wherever you go back to make substantive adjustments in any of the nine components of your business model, it is called a pivot. A pivot becomes necessary when your business model theory doesn’t meet reality.
I often notice negative annotations towards the concept of a pivot. Some people associate a pivot with failure, which later causes severe issues inside the product team. However, there is an important lesson that we should remember.
A pivot is not a failure. It is the path toward success.
A pivot is an essential component of the customer development methodology, allowing the product team to stop concentrating on the wrong strategy and go back and fix the problems within their business model.
A pivot allows the company to utilize its past learnings to create a better business model. When pivoting, you want to be as agile as possible. There is an important term called pivot cycle time, which is the time you spend to go back and fix your business model. Fast cycle times keep your burn rate low, which is essentially one of the most important metrics when the product team is in its earliest stages of development.
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About The Author
Rafayel Mkrtchyan is a product management advisor who helps companies improve their product discovery and delivery processes. He teaches teams how to set up a winning product strategy, run customer and product development processes, develop outcome- and data-driven mindset, as well as robust their lean, agile, and design thinking skills.
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