What Corporates can Learn from Startups – Part 1

My favorite startup author, Eric Ries, write some very interesting points for corporate innovators in his book ‘the startup way’. He explains what makes silicon valley startups special. In bigger enterprises that try to build innovation programs or corporate startups, leaders can use these ideas to create the right culture and structure. Let’s have a look at some of the characteristics of startups:

• It’s all about the team
• Small teams are better than big teams 
• Every team has a cross-functional structure at its core
• Every project starts with the customer in mind
• Silicon valley startups have a specific financial structure
• We focus on leading indicators
• Metered funding stages risk
• Board/investor Dynamics are key
• We believe in meritocracy. Unlike in a corporate setting, where everything has to be right in order to proceed, a startup doesn’t need to have everything figured out yet.
• Our culture is experimental and iterative
• We believe in entrepreneurship as a career choice

It’s all about the team

This is what most investors will tell you: they invest in the team. A strong team can work on any idea and make it successful. So the leading ‘thing’ are the people, not the idea. I have been engaged in entrepreneurship for all my life. Most people believe that ideas are the magic ingredients. If enterprises run corporate startup programs, their natural inclination is to ‘manage’. They are used to looking at business cases and metrics to track progress on its execution. I believe it is important to look at plans, strategy, ideas and metrics. But it’s more important to look at the people, the founders and have ‘metrics’ to assess their performance. Most successful startups started with a completely different idea than what brought their success.

Corporates and Startups: Small teams are better than big teams

In the agile world, people say the team should be between 3 and 9 people. I think that holds true. Below 3 is not a team. Above 9 makes things too complex. There are too many relationships to manage and too many communication lines that can cause trouble. A small, agile team, can experiment fast, can align fast, can get things implemented right away. In corporates, however, the bigger the team, the more status and the more important the project seem. Corporates need to create structures to scale down team size. Teams get autonomy to act on their own product or territory. We then need to develop coordination mechanisms that don’t imply hierarchy and chains of command that kill autonomy. An example of a company that has experimented a lot with such structures is Spotify. They created a structure of tribes and squads that many companies try to adopt (but often by just changing the names from team to squads instead of implementing a wider change in structure).

Corporates and Startups: Every team has a cross-functional structure at its core

In large enterprises, we develop functional silos. People work in departments and identify with their role in that department. A startup is by nature cross-functional. It usually starts with a CTO, CMO and CEO. Three people with different backgrounds collaborate to launch their new venture. If we want to replicate that model, corporates should rethink their functional silos. In Agile software development, we have cross-functional teams (programmers, testers, designers, architects) that collaborate to get their user stories done.

As a wider structure, we can create startups as teams and gather the functions required to build the next iteration of the startup product or service. This means we have people from marketing, sales, IT, finance and other roles in the team. Together they decide what work needs to be done to service their (potential) customers.

Every project starts with the customer in mind

Many entrepreneurs think ‘inside out’. They believe that their idea is very strong and they must bring that idea to the world. They forget one of the foundations of startup success: if nobody buys it, you won’t get anywhere. In enterprises the same thing happens: usually some executive gets a great idea or gets a ‘great idea’ from an expensive consultant. They ask their subordinates to execute and people forget to validate the idea first (especially when it comes from their boss).

In the startup world, we use the adagio ‘get out of the building’. We must speak to our imagined users before we build anything. If we build something, we build as little as we can (a minimum viable product) and then go out to collect data to validate our assumptions. So the only thing that matters to a startup team is the customer. In a corporate environment, putting all the fancy terms together, this may look like below graph:

Silicon valley startups have a specific financial structure

This might be one of the most challenging points to replicate in a corporate, highly regulated environment. Startups usually have many shareholders as they move forward. The initial equity is held by the founders and potentially an angel investor. As more investment rounds are added, the equity of the original shareholders grows smaller and more shareholders are added. In the early stages of a startup, people focus on the outcomes. We measure ‘learning’ or ‘user acquisition’ as opposed to ‘revenues’ or ‘profit’. And based on those metrics, we ascribe a valuation to the startup. That’s based on the potential we see for the future. This type of ‘gambling’ makes traditional managers very nervous.

To replicate this model in a corporate, we must reinvent many elements. Some examples: we must look at the possibility of giving corporate founders equity (or options, or ‘virtual equity’). The most important thing here is to give people a stake in the outcome. If someone creates the next WhatsApp or Facebook, he’d probably like to share in the proceedings. Owning something is a great incentive for people to do the best they can. We should also look at the metrics we use to evaluate startups through the different phases. Career options need to be looked at (entrepreneurs might want to get their own job title instead of moving through the traditional ladder).  

In Eric’s own words:

Startup equity is a complex financial derivative that powers the entire venture/startup ecosystem. It’s not profit-sharing. It’s not a union. But it is the greatest tool of employee empowerment I’ve ever seen. What is startup equity worth? This question bedevils outsiders and not a few insiders too. Every time a startup raises money, investors and founders negotiate a valuation. Although this is expressed as a single number, it’s really the product of two components.

One is the asset value of what’s been created so far: product, team and vendor relationships, and revenue. This is easy to assess. The more difficult part is the probability-weighted distribution of future outcomes: the experiment. A 1 percent chance to become a $100 billion company is worth $1 billion – right now! That’s the part that is hardest for most people to wrap their minds around. So what can make a startup more valuable?

1. Acquiring valuable assets, such as developing new products, hiring new people and gaining more revenue
2. Changing the probability of future success (the 1 percent that achieves $100 billion above)
3. Changing the magnitude of future success (the $100 billion above)

This helps explain why startups sometimes go through such dramatic changes in valuation, wildly out of proportion to their externally visible signs of progress. When they experiment, they both reveal how large the impact could be and also increase the probability of it happening – and often increase their asset value too, by acquiring and serving real customers. These factors sometimes – rarely – combine exponentially.

You can only see the asset value from the outside. But a rapidly growing startup is a double win from the investors’ point of view: the asset value is increasing at the same time as what the startup is learning is clarifying the probability and magnitude of future success. The value of innovation lies in the future impact it might have.

By giving employees access to equity, startups directly incentivise learning in the most dramatic way. Equity ownership is not a cash bonus. It’s a measurement of what the startup has learned about far future profits. It’s a way to financialise learning.

Because early-stage equity compensates every employee based on the company’s long term growth and success, it creates a much closer alignment between the financial incentives of employees and managers and the organisation’s long term health.

Read More : What Corporates can Learn from Startups – Part 2