Using Assumptions for Pivoting in Lean Startups

Using Assumptions for Intelligent Pivoting

In an earlier blog post, I talked about the types of key business assumptions that you want to define as part of your business planning (see https://www.offtoa.com/wp/?p=218). However, as shown in the figure below, those assumptions play just as critical a role for you once you launch the company. Here’s why. As you lead your company, you will at the same time be verifying the validity of your assumptions. In some cases you will do this in response to an explicitly designed experiment (as suggested by Eric Ries in The Lean Startup). In other cases you will do this as the result of simply running the business. Regardless of origin, every time you determine a correct value for a key assumption, the risk associated with your company decreases. However, when you refute a key assumption, an alternative plan of action is called for. Before we explore what these actions might look like, let’s take a quick look at some examples of what refuting an assumption might look like:

Refuting an Assumption

  • You build an minimal viable product (MVP). You learn more about what the market really needs. This changes the number of units you expect to sell.
  • While interacting with potential customers, you learn about a target market you had not previously envisaged that needs your product even more than the market you originally were aiming for. This causes you to redefine your original market as your secondary market, and define the new market as your primary market.
  • You had originally guessed that customers would be willing to pay $5 for your product. You ran some experiments offering the product at $4, $5, and $7 to three geographic regions. In all three cases, 5% of those receiving an advertising email from you ended up purchasing. Therefore, you have decided that $7 will work as well as $5.
  • Your product development effort took 2 months longer than expected. You may need to lower your burn rate (by changing the number of employees) and add an additional investment round.
  • Your first year product demand far exceeds your wildest dreams. You cannot just enjoy the ride. Instead you need to build infrastructure, hire employees, purchase raw materials, and on and on, all in a manner that keeps your cash positive. The only way to do that is by changing many of the assumptions and verifying that you are still heading for financial success.

Plan Perform Pivot

Plan Perform Pivot (click to enlarge)

At first glance, the situation in each of the above cases looks different, but your response should be identical. Although Ries defines eight types of pivots in The Lean Startup, they are all just instances of the same general pivot process, as shown in the Pivot box in the above figure:

  1. Change the key assumption that you just refuted.
  2. Analyze the pro forma financials to see if the company’s future is still financially sound (it likely will not be).
  3. Alter other assumptions to accommodate until you are back on the right path.
  4. Redirect the company toward the new strategy, i.e., the strategy defined by the newly defined assumptions.

Pivot Types

Here is a summary of Ries’ eight specific pivot instances and how they affect assumptions:

  1. Zoom-in pivot. After use by customers, we learn that a subset of features is a more ideal product for the customer than the full product. Immediate changes to assumptions are:
    • Name of the product might change.
    • Price of the product might change. It might be lower because the product is smaller, or it might be higher because the product is better targeted to a customer pain.

Once the decision is made to focus the product, we need to maintain consistency across all assumptions, and thus we should adjust:

    • Units sold should remain the same or increase. One’s initial reaction might be to lower expectations because of a smaller product, but more than likely the reason we decided to zoom in is because customers want this smaller product more than they want the broader product. As a result, the product is better targeted to market needs and the marketing organization can focus its campaign on more specific pains. Thus, units sold likely would increase, not decrease.
  1. Zoom-out pivot. After use by customers, we learn that features we are providing are insufficient to sustain the customer base and we must expand features considerably. Immediate changes to assumptions are:
    • Name of the product might change.
    • Price of the product might change.

 Once the decision is made to expand the product, we need to maintain consistency across all assumptions, and thus we should adjust:

    • Units sold should remain the same or increase. More than likely the reason we decided to expand the product is because customers were not interested in buying the product in quantities we had originally envisioned. By expan­ding the product, it is better targeted to market needs and marketing can focus its campaign on more generalized pains. Although we would like units sold to increase, in most cases where I have seen zoom-out pivots, it has been to get “back on track,” so units sold often decrease, at least in the short term.
  1. Customer segment pivot. We learn that we want to target a new market either because (a) we were targeting the wrong market, or (b) we want to now expand the market. The immediate changes to assumptions are:
    • Name(s) of the market will change.
    • Size(s) of the market will change.
    • Growth rate(s) of the market will change.
    • Price of the product might change because this new market might feel the pain differently or may have different economics. 

Once the decision is made to retarget the product to a new market, we need to maintain consistency across all assumptions, and thus we should adjust:

    •  Units sold should remain the same or increase. The most likely reason we decided to redirect the product toward a new market is because we found a market containing customers who were more excited (or as excited) as our current target markets. On the other hand, the customer segment pivot could also be a down-pivot from an originally targeted market that was not meeting our expectations to another market that we expect to perform better but still not meet our original assumptions . . . in which case our new units sold assumptions would actually decrease.
  1. Customer need pivot. We learn that customers in our target market have a pain, our current product does not address it, but we could build a business based on a new product. This likely requires an entirely new financial model with a new set of assump­tions; perhaps the characteristics of the market are salvageable. Based on the specifics of the business and the pivot, some other parts of the financial model could be salvageable, e.g., the loans and investments might be; the sales model might be.
  2. Platform pivot. Ries differentiates between two kinds of products: those that are sold to end users vs. products that are sold to companies (or other intermediaries) who tailor your product or build atop your product to create products for end users. The pivot is changing from either one to the other. From a business perspective, we believe it is just a specialized case of a customer segment pivot. The platform pivot is simply one techno­logy-specific way to reposition a product or refine a product’s features in response to the recognition that a particular target market (in this case, platform tailors or application builders) have a need for a different product.
  3. Business architecture pivot. Many dozens of basic strategies exist for start-ups to follow; these include product strategies (see blog post https://www.offtoa.com/wp/?p=164), pricing strategies (see blog post https://www.offtoa.com/wp/?p=213),  personnel strategies (see blog post https://www.offtoa.com/wp/?p=192), target market strategies (see blog post https://www.offtoa.com/wp/?p=176), and so on (see blog post https://www.offtoa.com/wp/?p=158). What Ries calls a business architecture pivot is what most business leaders call a “change in basic corporate strategy,” so we would prefer to call it something like a corporate strategy pivot. Although Ries discusses only size of market and margin, our past blogs have pointed out that strategy spans every aspect of a business. And thus the deci­sion to execute this type of pivot could affect all assumptions drastically. The most important consideration when performing this pivot is to ensure that all assumptions remain consistent with the new strategic direction; very few will remain unchanged.
  4. Engine of growth pivot.  Fundamental to the philosophy of The Lean Startup is the notion of maintaining a sustainable engine of growth while running the business. In essence, this means that the company can grow organically, from actions performed by current customers. Ries isolates the three basic ways for a start-up to sustain its growth: viral (see blog post https://www.offtoa.com/wp/?p=185), sticky (see blog post https://www.offtoa.com/wp/?p=182) and paid (see blog post https://www.offtoa.com/wp/?p=179).  

Although Ries seems to stress that successful start-ups emphasize just one engine of growth, and of course the most famous billion dollar e-business success stories have emphasized just one engine, our experience has been that most successful start-ups use a combination of paid and sticky or paid and viral to sustain their growth.

As an entrepreneur, you execute an engine of growth pivot when your current engines of growth are not providing you with sufficient growth to achieve your goals, or when other engines of growth will provide you with even better growth. To execute this pivot, you change the way it will grow (and the way it will measure its growth) from a combination of these 3 ways to another. The immediate change to assumptions is:

    • If changing to a primarily viral growth engine, you would focus your corporate energies on implementing the viral spread of the product and you would focus your goal-setting on the following sales model assumptions: viral coefficient and length of viral cycle.
    • If changing to a primarily sticky growth engine, you would focus your corporate energies on retaining customers and you would focus your goal-setting on the following sales model assumptions: average order size and annual retention rate.
    • If changing to a primarily paid growth engine, you would focus your corporate energies on attracting new customers at the lowest cost per customer and you would focus your goal-setting on the following sales model assumptions: customer acquisition cost, sales cycle, ratio of dollars spent to units sold, ratio of employees to units sold, and ramp up.
  1. Channel pivot.  Ries describes a channel pivot as changing the mechanism used to reach the end user, e.g., selling direct to end users vs. using a distributor vs. using a whole­saler. In our experience here at Offtoa, every sale involves multiple levels of “customers.” Every sale must accommodate needs of individuals who pay the check, who physically use the product, who need information produced by the product, who acquire (whether pur­chased or not) the product from individuals who pay for it. The decision to sell your product to a wholesaler vs. distributor vs. retailer vs. the end user is both fundamental to strategy and nontrivial; but it is identical to the decision to sell to one target market vs. another. Thus, we consider a channel pivot to be just a specialized case of a customer segment pivot.

Start-ups can detect the invalidity of any assumption, not only the ones implied by the above eight. Although we prefer the concept of a generalized pivot, you may prefer to assign names to specific types of pivots. If so, we offer the following list (this is just a small sample of the possibilities). These are all easily derivable be simply assigning a name to the refutation of each assumption:

  1. Renegotiate payment terms pivot. This pivot is executed upon either of two events: either we discover that customers are not paying us as quickly (or as slowly) as we had planned, or we take the initiative to renegotiate payment terms with our suppliers. The immediate changes to assumptions are:
    • Customer payments to you will change.
    • Your payments to vendors/suppliers will change.
  1. Financing pivot. When we initially plan a company, we have expectations for certain cash needs and where that cash will come from. Typically it is some combination of loans and investments for certain amounts at certain times. Many events occur that make reality different than the plan: we spend more (or less) than anticipated, our revenues exceed (or fall short of) plan, an investment round is not completely sold, a bank does not approve the full amount of a loan, and on and on. Whenever any of these events occur, we must pivot; we must replan our company and devise a new strategy that enables the company to reach its next milestone on existing resources, or, alternatively, accelerate the next cash infusion step. The immediate changes to assumptions are a subset of:
    • Expenses should change if expenses differ from plan.
    • Units sold should change if revenues differ from plan.
    • Investment amount if investment round fell short.
    • Loan amount if lower than anticipated.
  1. Price pivot. We determine we have the right product for the right market, but the price point is wrong.
  2. Sales cycle pivot. We determine we have the right product for the right market, at the right price but it takes 90 days to convert a lead into a customer instead of the anticipated 30 days.
  3. And so on 

The above is extracted from my latest book, Will Your New Start Up Make Money? Buy your copy in Kindle at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE or paperback format http://www.amazon.com/Will-Your-Start-Make-Money/dp/0996028307