Barrier to entry or sustainable competitive advantage?

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If you spend any time amongst investors you will no doubt hear the phrase “barrier to entry” quite often. Investors fixate on their companies building a barrier to entry. But what is a barrier to entry and how can you build it?

I think we all understand the concept of a barrier: a circumstance or obstacle that keeps people or things apart. It’s “entry” that seems unclear. Entry to what? The concept is that you have dominated a market niche and you want and need to keep other companies out of your market. Investors love monopolies! As one VC told me, We are always seeking an unfair advantage. There’s at least one problem with this concept. It assumes you have created a greenfield market, one that didn’t exist before like vaping, dominated by Juul. But often you will have a new and better idea for an established market, such as the MIT startup that invented a much better car shock absorber. There were already many companies in that market. So how can you create a barrier?

The other question you may also hear is how will you create sustainable competitive advantage. I find this a preferable way to think. A startup needs some kind of competitive advantage to get market traction in the first place. It may be the typical FCB – Faster, Cheaper, Better – or more to my liking, different. So let’s assume you built that better car shock absorber. How do you maintain your competitive advantage?

I tell startups that for every good idea there may be another half dozen or more companies working on the same idea at the same time. They need to worry less about the competition and more about their customer. It’s when a startup becomes successful that these hidden competitors come out of the woodwork. Failure is an orphan, success has a thousand imitators.  Investors worry that either another, better funded startup will copy your idea and overtake you with better marketing or sales or that an established company will decide to copy your idea and compete with you. The best known example of the latter is SnapChat. What originally differentiated SnapChat was its disappearing messages and photos. But Snap kept on innovating and developed stories, an easy way for users to link together images to tell a story about their life. This feature became a big hit. So what happened next? Instagram, owned by Facebook which has a history of attempting to copy startup features without success, added stories to Instagram. Whammo! Instagram took off and SnapChat was wounded seriously, though not fatally.

So how do you build a barrier to entry? How do you sustain a competitive advantage?

  1. IP – investors love patents, as a successful patent can ensure a monopoly, which they love even more. But filing patents can be expensive, it can take years to win a patent, and in the meantime the patent process forces you to disclose how you implement your idea. Then you may have the cost in time and energy of defending your patent! Patents seem to be more valuable in biotech than in the media, internet, publishing, and software fields where I mentor. Copyrights can be help in protecting you product name or other aspects of your business, but they are far less helpful in building a barrier. There are always workaround for competitors. And you don’t want to spend time in court suing over “copyright infringement.”
  2. Customers – there is a lot of debate over the so-called “first mover advantage“, means whichever company gets to market first with their idea will win. But there is no arguing with building up a large customer base. However, the old advertising phrase, I’d rather fight than switch! Should be your goal. Gaining customers is not enough, you need loyal customers. And it helps if you make switching to another product a non-trivial task.
  3. Strategic relationships – The most common reason to develop a strategic relationship is for distribution. At Course Technology not only did we have NACS – the National Association of College Stores – as our exclusive distributor, their parent company, NACSCORP was also an investor. This relationship helped us compete with much larger, better known, and entrenched competitors.  While the prime function of strategic relationships needs be creating value in your venture, the second function should be gaining that unfair advantage investors salivate over. While many big companies will tell you they can’t be your exclusive partner I would tell them the same thing. But that I believe in performance exclusivity. As long as you perform really well and deliver value to your partner they are unlikely to want to enter into a similar relationship with one of your competitors.
  4. Brand equity – brand equates to trust. If you can succeed in building your brand it will become a competitive advantage. Thus much advertising is not for products but to help establish brand awareness. But advice is save your money. Spend it on media relations. Stories about your company are far more credible and more valuable than ads. Too few founders have a PR plan as part of their go to market strategy. They just seem to think having the standard set of social media accounts is sufficient. Twitter, Facebook, Pinterest, etc. may be necessary, but they aren’t sufficient. Ignore the established media – print, radio, TV, direct mail – at your peril.
  5. Constant innovation – as a successful startup you will have a target on your back. Make that a moving target for competitors. The key is to constantly innovate. We saw this for years in the iPhone market. But the smartphone market has stagnated, basically because yesterday’s phone is just as good as today’s for all practical purposes. Recently there have been no innovations powerful enough to get users to upgrade their phones. Develop a product roadmap and observe your customers closely. Make sure the brilliant engineers who invented your first product have the company equity and resources they need to keep your competitive edge. I’ve seen too many startups become dominated by marketing and sales and their innovation dies on the vine.
  6. Capital – it is hard to raise money and it is time consuming. I was taught by VCs that the best time to raise money is when you don’t need it. When your product is hot and you have ample cash in the bank, raise more money. Capital can become a competitive weapon, whether in the war for talent or in funding new product development. We’ve seen this playbook with many high profile internet companies like Airbnb and Uber. Don’t worry about equity dilution, worry about creating a more valuable company. Capital is the accelerant for growth.
  7. Constant learning – I’ve written elsewhere that I consider startups to be learning machines. Don’t rest on your laurels if your product is a hit. The great football coaches criticize their teams more after a win than a loss. Keep in mind it’s harder to stay on top than to get on top. Constant learning will feed constant innovation – innovation not only in product but in business models, marketing methods, and even in sales and support. Learning and innovation should not be reserved for the engineering team.

A single company may not be able to deploy all of these techniques to stay ahead of its competitors. While individuals at companies I worked for held patents, none of my companies ever earned one. But we were masters of strategic relationships. Find where your venture can exercise the most leverage and focus your energy there.

Occasionally I’d get into a disagreement over barriers to entry, usually with an angel, rarely with a VC. Then I’d ask them, “Tell me, what is Bruce Springsteen’s barrier to entry? What about George Lucas?” If a potential investor is fixated on barriers to entry he or she may not be the investor for you. They should be fixated on exactly how they will help you grow the company and trust that once you reach the top you’ll have learned how you can stay there.

 

Beware of a contract’s exclusivity clause

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Writing about strategic alliances brings up the issue of exclusivity clauses in distribution and sales agreements. Someday, I hope, someone will write the full story of Software Arts, Inc., the company that invented the first electronic spreadsheet, VisiCalc, and foundered on the shoals of its original distribution contract. In brief, the founders of Software Arts had no interest in sales, marketing or distribution. Upon the advice of a Harvard Business School professor, they entered into a contract with Personal Software, Inc. to distribute VisiCalc. That was in 1979 or 1980. By 1984 that exclusive distribution agreement resulted in a deadly embrace that ended up killing off both companies.

The period when VisiCalc was launched was the dawn of the personal computer era and attorneys who understood both intellectual property law and software were scarcer than women software engineers of color.  During my time working at Software Arts and after its demise I was often asked the question why didn’t they patent the spreadsheet? Then Lotus, Microsoft, and any other company would have had to pay the inventors royalties, making the founders multi-millionaires if not billionaires. They did consult an attorney who told them software could not be patented, so no filing was made.

But that’s a side note to the crux of the issue: Software Arts entered into an exclusive contract with Personal Software, later VisiCorp, to market, sell and distribute its invention. When the two companies wanted to go their separate ways a few years later litigation over that ironclad contract knocked both companies out of the game, leaving a clear field for Mitch Kapor to dominate the corporate PC software market with his
Lotus 1-2-3 spreadsheet, a brilliant blending of an advanced version of VisiCalc with Mitch’s first successful product, distributed through Personal Software, VisiTrend/VisiPlot.

When mentoring founders who are in discussions or preparing to sign a contract with another party I ask them one simple question: What is the most important part of any contract? The answer is in my post; it’s the termination clause. In my view contracts are analogous to insurance policies. You hope to never have to pull out your home insurance policy to refresh your memory for what it covers because that means you must have had some untoward incident in your home – fire, theft, vandalism, etc.  Similarly with a distribution contract, when all is going well you have no need to try to enforce its terms and conditions. But when the parties have a falling out you need to pull out that contract and read the termination clause, because if all else fails that’s your one and only recourse. Suing a large company is just slow motion suicide for a startup. Large companies have in-house attorneys – a sunk cost – who will litigate you to death as you pay legal fees to combat them. Stay out of court at all costs!

The trap that Software Arts fell into, and here I would definitely fault their legal counsel, was to make the term of the contract co-terminus with the copyright to the VisiCalc’s code.  That was a huge mistake,  as we are talking many years here! So that brings up to the nut of this post: how do startup companies deal with prospective partners who insist on an exclusive agreement? No one likes competition, let alone sales or distribution companies. They want the whole market and nothing but the market.

The VCs who trained me hated exclusivity and constantly reminded me of this as I entered into contracts with Lotus, Software Publishing Corporation, and other PC software pioneers. But if you are really desperate for the help a large partner can give you then their demand for exclusivity must be met or countered. Here’s how:

Term: the length of the period of exclusivity should be limited in time. And that time should range from about one to three years. Do not tie the term into some other exogenous factor like the length of copyright!

Territory: startups by their nature lack reach. That’s why they enter into distribution contracts with large partners. By granting your large partner exclusivity in a territory you would have trouble reaching anyway you can hope to satisfy their need to protect their investment in sales and marketing. Typically for a U.S. startup granting exclusivity to one or more international markets is a good strategy. Just keep in mind that you must also apply a restricted term, as in the future your venture may be big enough to serve international markets itself.

Type of customer: often startups will decide to negotiate exclusivity around the type of customer they target, believing that if they can maintain exclusivity for those customers they aren’t giving up anything by granting exclusivity for other customers. For example, if you have developed a new social media platform aimed at millennials you might rightly feel that you aren’t giving up anything by allowing your partner to have exclusive rights to sell to corporations. But there are two problems with this strategy. One, it can be hard to predict who will actually end up being the users of your product. By locking out a market segment like corporations you will never have the opportunity to discover if they would be good customers. The other issue is that there are other markets you may not even be thinking about, such as government or education. By ceding all other markets than consumers to your partner you may well be giving up great opportunities in unexplored or untapped markets.

Version of the product:  at Addison-Wesley Publishing Company, where I invented the student edition of professional software products, we were able to convince developers like Lotus to provide us with a different, more limited version of their crown jewels, in the case of Lotus it was 1-2-3. You can modify software in many different ways: capacity and features being two of the most common. But taking this tack puts a development, testing and support burden on your venture – a cost you might not want to bear. And your market may rebel against getting an older or less capable version of the software. So granting exclusivity to a different version of your product can work, just be careful of those two issues. An interesting twist on this idea is how Tesla sells their vehicles. All Teslas have the same basic features and performance. But Tesla can “turn on” new features and enhance performance through remotely unlocking software – if the customer is willing to pay. This clever tactic can be used in other markets to sell different versions of the same product at different price points.

Performance:  my preferred way to grant exclusivity is to make it performance based. Thus your distributor can only maintain exclusivity by selling X units in a set period, usually one year, or they risk losing their grant of exclusivity. A good twist to this is to enable your partner to “buy up” – meaning if they don’t meet the agreed upon sales targets they can pay you as if they did.  Performance is also the best way to manage term. Your partner can maintain exclusivity so long as they meet agreed upon targets, which should grow year by year. The trick to this is it is very hard to forecast sales of new products from a startup, so you need to be careful about how you handle this condition of the agreement.

The bottomline is to avoid exclusivity agreements whenever you possibly can. The main reason is that it is so difficult to predict who or where your best customers will come from and to forecast revenues for a new product. But exclusivity can be a strong motivator for sales and distribution companies – it gives them a monopoly, the best way for them to profit by selling your product.  But no matter what type of agreement you negotiate – non-exclusive, exclusive or conditionally exclusive – make sure you have an escape hatch if things don’t work out. Get a lawyer who is familiar with sales, marketing and/or distribution contracts and knows how to craft that termination clause. That’s really your only protection from entering into an agreement that you find significantly disadvantageous, but it’s vital as and those of us who lost out big-time through Software Arts’ bad contract with Personal Software learned the hard way. As the saying goes, “Those who do not learn from the past are condemned to repeat it.” And the first priority of all startup is to learn!

 

One simple tool for competitive intelligence

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While I totally agree with Jeff Bezos that ventures should focus all of their attention on their customers and how to surprise and delight them not on their competition. But if are just at the idea stage you really need to keep track of others who may be pursuing something similar.

Ive had at least half a dozen mentoring sessions where a mentor pulled out their smartphone and did a Google search and found several other companies pursuing the same idea we were discussing with the founder – much to the consternation of the founder, who obviously either hadn’t ever done a Google search or hadn’t done one recently.

As a blogger I’m constantly on the lookout for articles that may be of interest to readers so I rely on Google Alerts.

If you aren’t familiar with Google Alerts you should be! Google Alerts enable you to monitor the web for content of interest. Alerts is very easy to use. You simply enter what you want to create the alert about into the alert box.

Assuming your have a Google email address, Alerts will then give you a number of options for your alert, all with defaults : How often;Sources ,which include news, blogs, Web etc.; what language you want for your alerts; and what region. Region is very important because you may get a lot more alert emails than you care to wade through and if your venture is confined to the U.S. setting your region to United States will cut down the emails substantially. Google also gives you a choice between Only the best results and All Results – though how Google determines “best results” is a mystery. Finally you can chose the mailbox where you want your alerts delivered. If you get a lot of results in the Alert preview you might want to refine your alert terms or even create a new email address for your alerts.

There are two parameters with search: reach (ensuring that you are searching as many sources as possible) and relevance (how closely connected or appropriate the results are to your search term). Google does a fantastic job of mediating between these somewhat contradictory goals, but if you use a generic alert term like “mentor” you’ll end up with far too many alerts. And bear in mind, Google makes it even easier to delete or edit an alert than to create one so I recommend you start off with a substantial list of alerts and then whittle them down as you see how many hits each alert generates.

As to the content of the alerts, you will want to include your company name, your product name, the names of competitors and channel partners, your name and the names of your co-founders and anyone else in the venture who may have a public presence.

If you have an intern, handing off the task of reviewing the alert messages every day can be delegated to them, easily done if you’ve created an email address solely for alerts. In searching for Google Alerts I came across yet another Google tool that I was not aware of: Google Trends. If you are riding a trend like machine learning or the blockchain you may want to use Google Trends as well, they just added new features and a redesign.

But just like the Web itself it’s too easy to fritter away time following all the news stories Google Alerts delivers to you. So be disciplined. I recommend starting or end each day with a review of the day’s alerts email. Set aside ten minutes or so. And keep in mind why you are doing this: to track mentions of your company and product as well as competitors. However, think about what will you do with the new information Google digs out for you? If you are a blogger the answer is simple. But if you are a founder decide why you need to know this information and what you will do with it. For example, it may be a good way to track the efficacy of a public relations campaign. Or ascertain the impact of a new product release. Activity without purpose is just activity, founders need to focus on results, not activities.

The Top Reasons Startups Fail

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Nail McCarthy’s article in Forbes on the reason why startups fail joins a bevy of articles on this subject.  Bill Gross of Idealab pinpointed the single most important reason, and it isn’t even listed in the CB Insights chart! According to his research it’s timing. 

The chart above from Statistica is well worth studying by founders.

Either way you look at it the odds are against founders:

According to CB Insights, 70 percent of upstart tech companies fail, usually about 20 months after first raising financing. The failure rate is even worse for consumer hardware startups with 97 percent of seed crowdfunded companies failing or turning into “zombies”.

Let’s take a look at some of the reasons CB Insights discovered. The number one reason is No market need, at 42% it dwarfs all other factors This jibes with research done by NSA on why scientists and researchers fail to commercialize their inventions or discoveries.  MIT is one of several sites running the I-Corps program for post-docs.

The National Science Foundation (NSF) I-Corps program prepares scientists and engineers to extend their focus beyond the university laboratory, and accelerates the economic and societal benefits of NSF-funded, basic-research projects that are ready to move toward commercialization.

Through I-Corps, NSF grantees learn to identify valuable product opportunities that can emerge from academic research, and gain skills in entrepreneurship through training in customer discovery and guidance from established entrepreneurs.

Even if you are not a post-doc I highly recommend you study Steve Blank’s work on customer discovery which is a critical part of the I-Corps curriculum. He has several books, including The Startup Owner’s Manual: The Step-By-Step Guide for Building a Great Company. Steve’s web site has a wealth of resources for founders and many videos on YouTube about customer discovery.  So as they say, an ounce of prevention is worth a pound of cure. In this case you need a pound of prevention in discovering who your customers are and why they would want your product. Don’t be a solution in search of a problem!

The second big reason startups fail is running out of cash, at 29%. But this is misleading. Obviously you run out of cash because your expenses exceed your cash on hand, which could be an investment or customer revenue. Not creating a product the market wants means you have zero customer revenue, so ipso facto, you will run out of cash eventually no matter how big your investment. So my advice to founders is start charging from the get-go. Meaning if you secure a pilot, get your customer to pay, even if you have to offer a hefty discount. And make it clear that after X period, if the pilot is a success the price needs to go up so you can re-invest it in the company. I’m very pleased to say one of my mentee companies just landed a paid pilot that could lead to significant revenues if it’s successful. Don’t just do a pilot as a proof of concept. Pilots need to be step one on the best way to stay cash flow positive: generate customer revenue.

Not the right team comes in third at 23%. Since this data comes from post mortems with failed companies keep in mind all hindsight is 20/20. Founders have two major responsibilities. The first is customer discovery. But the second is building the right team. And because no one bats 1.000 in hiring realize your team is going to change, for a variety of reasons. One way to be prepared for changes in the team is what I call talent tracking.  One of the reasons for the enduring success of The New England Patriots is that they literally have a book on every single player in the NFL, including practice squads. So if they lose a player due to injury or cut him due to poor performance, they know exactly who to go after for a replacement.  Keep in mind that founders must be aligned tightly on their personal and company goals or your company will indeed fail if you can’t replace a founder who isn’t a fit.

The next most frequently cited reason for failure is Got outcompeted. This is why virtually ever investor I’ve ever talked with asks “What is your barrier to entry?” The good news about startups is that it’s never been so cheap or so easy to pull together a team and build a product. And that’s the bad news as well. So you need to start thinking about how you will fend off competitors, which come in two flavors: incumbents and copy cat startups. You need a different strategy for each. Back in the last century every VC would ask me: But what if Microsoft decides to do this, how will you ever compete with them? Then the subject of that sentence became Google. Today it’s probably Facebook or Amazon. The reality is that the bigger the company the harder it is for them to justify going after what they think is a small market. The classic case of this was mobile apps. Both Microsoft and Facebook ignored mobile for years. The difference was Facebook woke up sooner and to Mark Zuckerberg’s credit he drove everyone in a mobile-first direction quickly and very successfully. Here’s where reading a book may help: Blue Ocean Strategy, Expanded Edition: How to Create Uncontested Market Space and Make the Competition Irrelevant by W. Chan Kin and Renee Mauborgne. 

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Rounding out the top five reasons startups fail is Pricing/Cost issues. This does not surprise me. For after customer acquisition the most common problem brought into mentoring sessions is How do I price my product or service? Obviously books have been written, seminars conducted, research papers published, etc. on this subject.  I’d refer you to Steve Blank’s book mentioned above for help here. But one question should be answered: are you pricing to gain market share (which was Microsoft’s strategy for years) or to generate high margins (which was Apple Computer’s strategy, and still is despite their name change to Apple.) Get your customers to help you. Once you have captured their imaginations you need to ask them: “Ok, but what would you pay for this product? How does $XXXX a month sound?  And would you prefer we offer on a monthly subscription basis or on a one-time sale basis, with charges for new versions? Like real estate, the best way to price a product is to look at comparables. And more specifically, the comparables purchased by your prospective customer. If you have enough prospects A-B testing can help you find the pricing sweet spot. In my experience startups under price their products and services, which leads to reason two for failure: running out of cash. Do not try to compete on price – it’s a race to the bottom. Keep a tight rein on your costs and make sure your pricing will cover your costs before you run out of cash!

One last comment. You’ll notice that Product mis-timed comes in at number 10 at only 13%. This is certainly contrary to Bill Gross’ finding that it’s the number one reason. From my experience many companies are too early and the market infrastructure wasn’t their (I was doing mobile apps in 2000) or you are too late and the market has a dominant player (Search – Google). So I believe timing is something founders need to look at as their startup is gestating.

One question I often ask founders is “If your company fails 2 years from now, what will be the major reason?” This bar chart can be turned into a checklist for founders – review it weekly and ensure that you and your team are taking the right steps to avoid these reasons for failure.

 

Dealing with exclusivity agreements

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Felice Gammella looked at the Ofo bike at a T-stop in East Boston by Lewis Street DAVID L. RYAN/GLOBE STAFF

The article in The Boston Globe entitled Is Boston headed for a bike-business border battle? by   got me thinking about the issue of exclusivity in contracts for emerging companies. Once you’ve achieve product/market fit and a customer base you may well start entering into agreements with third parties for distribution of your product.

Here’s what happened in Boston, Cambridge, Somerville, and Brookline: they all signed an agreement with Hubway, a provider of rental bikes that are dependent on docking stations. So bike renters have to return their bike to a docking station. This might have seemed like a good idea at the time. But like giving taxis a monopoly it has proven to be an impediment to providing biker riders in these cities with a much better way to rent bikes: dockless systems that enable riders to leave their bikes almost anywhere.

And typically bureaucrats defend their decision to create yet another monopoly. As after granting taxis monopolies, cities and towns followed up this practice by granting monopolies to cable TV and Internet providers. After all, when you think about it, government is itself a monopoly, so they find it perfectly natural to enter into exclusive agreements with companies large (Comcast) and small (Hubway).

Cara Seiderman, a transportation planning manager in Cambridge, argued that since Hubway is publicly owned, there is greater accountability. And Denise Taylor, a city of Somerville spokeswoman, brushed off the lack of competition to Hubway in her city.

Our Hubway contract precludes other bike-sharing options, but we don’t see this as a hindrance, as Hubway has been a great partner and is working well here,” Taylor said.

Taylor’s defensive statement is particularly uninformed, as clearly dockless systems like Ofo provide a better solution. Seattle, rather than handing out a multi-year monopoly to the new dockless bike sharing companies, wisely “allowed three companies to launch dockless systems for a one year test.”

Transit director Andrew Glass Hastings said dockless systems are easier to manage. Rather than pay to operate a traditional system, Seattle now regulates the dockless companies — which pay the city a fee.

Partners like big cities will demand exclusivity. If you are a small startup it’s highly likely that you’ll be dealing with a bigger, more powerful company that has far more leverage with you. I found this many times in negotiating with companies like Apple, IBM. Microsoft, and Fujitsu. Exclusives are rarely viewed as beneficial to startups. However, if you are expecting your partner to expend signifianct resources to help you distribute your product, as Hubway does in Boston, then it can be beneficial to have your partner focus 100% on you rather than other companies.  Whereas in Seattle three companies will be competing for the city’s assistance.

So assuming you are faced with an exclusivity demand, how do you handle it? The best path is to determine how to put bounds on the exclusivity. Here are the most common methods.

  1. Time: limiting the term of the contract is the most common method. Generally one year, as in Seattle, is the minimum period. Partners may push for more and three to five years, as in the case of Boston, is standard. The big issue here is the rate of change in products and markets. The faster the rate of change, the shorter the term limit you should try to negotiate.
  2. Geographic area: we see this in the city by city agreements for Hubway. However, both parties will have to realize there will be “leakage” – either customers from other geographic areas coming into the agreed upon territory or products being resold outside the agreed upon territory. This is quite common in consumer electronics and products sold outside of the negotiated territory are called “gray market.” Companies try to combat the gray market by not covering these products with a manufacturer’s warranty or otherwise restricting access post-sales support.
  3. Customer type: here we start to get into the “gray areas” – areas that may be more difficult to define. A typical distribution agreement may forbid direct sales to consumers, but permit sales to retailers. And the gray market may raise its head as retailers may “dump” excess inventory to unauthorized resellers.
  4. Product type: at Software Arts, our distributor, Personal Software (later renamed as VisiCorp) had exclusive rights to the electronic spreadsheet, VisiCalc, that we developed. But we were free to develop other software for PCs, as was VisiCorp. But exclusivity can rapidly get muddy, as VisiCorp developed an all-in-one product that included a spreadsheet, called VisiOn. Was that a violation of the exclusivity agreement? Well it ended up in court and eventually both companies died due to their deadly embrace.

So the obvious bottomline with exclusive agreements is that they require policing, otherwise the bounds become meaningless. Emerging companies lack the resources to police a distribution agreement. Your best option is to avoid exclusives if possible, but if not, to put the burden for enforcing any restrictions on the larger partner.

The best way to handle this type of negotiation is to get both parties to focus on the customer and customer benefits, rather than their own benefits. The Hubway/Ofo issue is a great example.

Chris Dempsey, director of the nonprofit advocacy organization Transportation for Massachusetts, likened the bicycle conflict to a two-wheeled version of the Uber-versus-taxis dispute. He encouraged the Hubway municipalities to be open to dockless bikes “as an opportunity to give people more choices, just as Uber and Lyft did.”

How the disrupted are trying to defend themselves

 

ny times

It’s a truism that startups are disrupters, by creating something new, usually faster, better, and cheaper, they attack the incumbent companies. You can read all about it in Clayton Christensen’s classic The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Management of Innovation and Change). Highly recommended for founders. 

Three years ago The New York Times commissioned an internal report on how they were going to compete with all the new digital native publications that were eating their lunch, like The Huffington Post. The report is entitled, of course, “Innovation.” Surely the most over-used word in the English language.

At almost a hundred pages it takes a while to wade through, but it’s worth reading for any founder, as it gives a clear picture of the problems incumbents face in fighting off startups and of the many techniques startups have used to take on The Times and other legacy print publications. While this report was aimed at executives at The Times, it’s fascinating reading for anyone in the entrepreneurial ecosystem. (Disclaimer: I have been, am now, and probably will continue to be, a subscriber to the print edition of The Times.)

The reason The Times can’t compete with new digital only publications is quite simple, their business structure totally hamstrings them. Over and over again the report talks about “The Newsroom” – the hollowed ground trod only by journalists and “the Business Side” – where the dirty business of the newspaper is conducted, things like graphic design, technology, and of course, advertising. Believe it or not, journalists have to ask their boss’ permission to even talk to someone from “the other side” – the untouchables! And woe be the serf from the business side who would dare to venture into the Newsroom uninvited. The other term that is used throughout the report – with no explanation is “The Masthead” – which is newspaper-speak for the executives who run the paper and whose names appear at the top of the editorial page.

The report’s key recommendation is sad, as DJ Trump would say. Rather than biting the bullet – which would probably have gotten the authors fired – and recommending a massive reorganization that would get rid of “The Newsroom” and “The Business Side” and integrate journalism, tech, graphics and other functions as is done at Buzzfeed, The Huffington Post, Vox, and virtually all of The Times’ digital competitors, the authors recommend that The Newsroom create a strategy group to help the Newsroom cope with changes driven by the world going digital! What a typical legacy company solution! Create more bureaucracy to avoid facing the music – their business structure is archaic and needs to be totally revamped. After reading this report I can now see that The Times problems are deeply seated in its 100+ year old culture and Mark Andreesen’s simplistic solution of selling off the printing presses wouldn’t work. The problem is not the printing presses, it is the firewall between journalism and “business” (all functions that are NOT journalism) which ensures that The Newsroom will never get social, mobile, AR/VR or even the Web.

While the conclusion of the report is pitiful, the report itself is a master work of competitive analysis, excellent writing, good ideas, and frank assessment of the paper’s problems. If you have any interest in the world of news and media it’s a remarkably interesting read. But it points out all too clearly one of the key competitive advantages of startups: the ability to collaborate across functional lines. I guarantee you that no reporter at a digital outlet has to ask his or her boss’ permission to talk with a programmer or graphic designer!

Here’s a great quote from the report that applies to almost every legacy company:

Culturally, I think we have operated as if we had the formula figured out, and it was all about optimizing, in its various constituent parts, the formula. Now it’s about discovering the new formula.” Satya Nadella, Microsoft’s CEO.

I can assure you the new formula is NOT creating a newsroom strategy team! Three years after this report was written (it’s dated March 24, 2014) I can’t see any dramatic, structural changes at The Times.

Another amazing oversight in the report is the sanctity of the Times’ content. Nowhere in the report does it recommend any changes to the output of The Newsroom. It simply assumes that what has worked for 100 years in print will now work equally well on mobile, social, VR/AR and any new delivery technologies to come. It’s the “old wine in new bottles” problem so many legacy companies suffer from. Even though there are comments on how poorly the Times mobile app performs, nowhere are their recommendations about tailoring the Times content to social and mobile – as their upstart competitors have done. (One of the funniest and saddest recommendations is that one individual in the Newsroom be tasked with viewing The Times web site on their mobile phone each day!)

So there you have it, many person-years of work on this “Innovation” report and it misses the two most important “innovations” a company like The Times must implement: changing their organizational structure to inculcate organic collaboration across disciplines and changing their journalism to fit the new types of delivery media.

No doubt about it, The Times is still the newspaper of record. It’s journalism is unsurpassed. But it continues to lose advertising revenue and it’s still trading digital dimes for print dollars. It’s made many smart moves, like selling off The Boston Globe and all other non-journalistic assets to focus on The Times, but it refuses to make even the most straightforward competitive moves, like paying market rate salaries to programmers, designers, and other digital experts whose skills are in great demand.

The saying goes “hardware companies die hard, software companies die soft.” I don’t think it’s been updated for print publications. But they too will die, just more slowly and perhaps more painfully. There are many worthwhile recommendations in this report on how the Times can develop it’s audience and better compete with the digital upstarts, but until the basic structural and cultural issues are addressed they are just going to prolong the life of The Times, not save it. In fact I would venture to say that so long as the Sulzberger family controls the Times the Newsroom will remain sacrosanct and “the Business Side” will be a second class citizen – to the profound detriment of both.

But if you are reading this post you are not a defender of a legacy business you are an attacker and there is a lot to be learned from the “Innovation”  report about the structural and cultural weaknesses of legacy incumbents and it’s almost a playbook on how startups can and do take advantages of these inherent weaknesses.

The_New_York_Times_Innovation_Report_-_March_2014

Wired magazine has a great article about The Times and it’s efforts to keep up with the times.

What’s the single most important question to ask your mentors?

question

I don’t recall where I came across this question, but it’s stuck with me for years:

If my startup fails, what will be the reasons?

I tend to like working backwards – see my posts on pitching and product development – and this is yet another example. Look a few years out into the future and imagine your startup has failed. Then try to work your way backwards to out what contributed to your startup failing.

Traditionally there are three types of risks associated with startups: team, technology, and market.

Let’s take a look at each one for leading indicators that a few years from now these could cause your startup to fail.

Team

As noted elsewhere on Mentorphile, the CEO is the most important person on the startup team. So there are several ways you can get into problems with your CEO:

  1. The CEO can’t grow with the company. There’s really nothing wrong with this. Many entrepreneurs are much better are starting a company than running a public company, for example. The key is to recognize this issue before it hurts the company. Either there’s got to be another person on the team who can step up or more likely your investors will have to bring in a seasoned CEO who has a track record of running (not necessarily starting) growth companies.
  2. The team is not aligned in their objectives and goals for the company. 
  3. The team is missing a vital player. For example, channel sales can be critical to an enterprise company, as selling direct is very expensive. Without a channel sales manager with major league experience a company may have a great enterprise product but not be able to sell it. It’s important to note that a channel sales manager is different than a VP of sales – it’s a more specialized position focused on selling through other companies, what were once called VARS – Value Added Reseller.
  4. There is too much overlap between team members’ expertise and responsibilities. Engineers tend to know other engineers and may not know sales, marketing or financial executives. In the early days of the company it’s easiest to hire your friends. One way to guard against this is to develop an org design: one that is architected to how you will develop, sell, and support your product or service, not tuned to who your friends are.
  5. The team gets into a fight over equity ownership. Dividing up ownership is one of the most potentially contentious tasks in a startup. What might have seemed fair on day one may be perceived as highly unfair two years later. Equity should be based on contribution to the success of the company, not where you went to school, how many degrees you have or even your title. The best way to handle this is to get good advice from founders who have been through this before. Also leaving a large pool of stock for employees can enable some mid-course adjustments. And don’t let team members leave with stock – they need to sell it back to the company.

There are probably as many potential pitfalls for a team as there are teams. Building a team with a core of people who have worked well together before, or at least known each other well makes a huge difference. Watch the video with Jessica Livingston of Y-Combinator for her take on founder teams.

Technology

  1. Inability to scale.  Friendster was the first social network. But it was so popular its servers couldn’t keep  up with demand. As Yogi Berra once said of a night club “It’s so popular nobody goes there anymore.” Part of the brilliance of Mark Zuckerberg’s rollout of Facebook from Harvard, to other Ivies, to other top schools, to all colleges, etc. gave the company time to build and rebuild their infrastructure to keep up with demand.
  2. It’s a solution in search of a problem.  I founded my company PopSleuth to help me keep up with the latest releases from my favorite musicians, directors, authors and other creatives. But while this solved a problem for me it didn’t seem to be a problem for too many other people. The technology worked, but it just didn’t solve a widespread problem.
  3. Buggy or ugly.  While early adopters will put up with both, you’ll never cross the chasm unless your tech is fast, reliable, and easy to use – and preferably elegant to boot.
  4. Choosing the wrong platform or tools. It took a while, but Flash has finally been killed off.  A friend built an enormous program in Java, but issues with Java doomed it to fail.

I’m not a technologist, so when you ask the question “If my startup fails what will be the reasons?” make sure you are getting a good cross section of technical and business expertise along with founder experiences.

Market

According to Bill Gross, founder of Idealab, the biggest reason startups fail is poor timing. After watching his Ted talk I can’t find any reason to disagree with him, but there are other reasons besides timing.

  1. Competition. When I started Throughline to supply operating products and services to startups I totally missed out on a local company called BuyersZone. They ate my lunch. It was founded by a bunch of former purchasing agents and they used their contacts and experience to help all small companies with purchasing products and services, not just startups. As famed baseball pitcher Satchel Paige said, “Don’t look back, they may be gaining on you.” Before you start your company make sure you do a very thorough market scan for competition, afterwards task someone on the team with competitive analysis, and stay ahead via constant learning, constant innovation, and constant hard work!
  2. Size. There’s a reason VCs not just like, but insist on, large markets. They much prefer a small fish in a large pond to a large fish in a small pond because that small fish can grow. There are at least two important attributes to market size: absolute size and growth rate. If you choose too small a market or a stagnant one, your startup may fail.
  3. Too much need for customer education. We used to call this “missionary marketing.” If your product is so complex it needs a lot of hand-holding or training you better have plenty of margin, otherwise these costs will eat you up.
  4. Government regulation stifles innovation. There are two markets that have proven very difficult (but far from impossible) for founders to penetrate: education and healthcare. Both are heavily funded by governments and even more heavily regulated. As Herbert Hoover once said about education, “It’s easier to move a graveyard than to change education.”

Make sure when you ask your mentors for reasons why your startup might have failed that you don’t take generic answers like the above as sufficient! It’s quite possible that some idiosyncrasy of your technology, team, and/or market is what will end up bringing you down. The better they know your company the more likely they are to spot fatal flaws.

Many organizations do postmortems on failed projects or even failed companies. You can avoid this painful process by doing a pre-mortem on your company with your mentors and advisors. Don’t ask them to look out more than 3 to 5 years or allow them to tell you that sentient robots will have taken over your market – no one can predict the future. What you are looking for are structural issues, tiny cracks in the organization, that could spread, open up and split open the organization over time, not new magic technology that will upturn not only your startup, but the entire world.