Learning from High-Potential Ventures: Entrepreneurial Marketing

http://hbswk.hbs.edu/item/2058.html http://www.entrepreneur.com/businessideas/index.html http://library.businesschairs.com/entrepreneurship-education-resource.html http://www.wickedstart.com/public_home http://www.hbs.edu/entrepreneurship/resources/ Professor Joseph B. Lassiter III's research explores entrepreneurial marketing in high-potential ventures. He describes entrepreneurial marketing as a mindset and a process, one that involves gathering specific evidence that convinces a specific group of individuals to act and react, exploiting breakthroughs and overcoming setbacks. New Business publisher Mike Roberts recently met with Professor Lassiter to discuss his work. New Business: As one thinks about a new venture moving from product development to actually marketing and selling, what are the keys to success? Joe Lassiter: I have tried to look at high-potential ventures that actually realize their potential. In these high-performance ventures, entrepreneurs leading the ventures look ahead and say, "Two or three years from now, this is exactly the customer and exactly the product, and this is exactly why they're going to be compelled to buy." They have a keen idea at the very beginning of the venture who their ideal customer is and what the ideal product is that they need to deliver. Then, they work back from that point in the future to the present, picking the customers who will buy and the subset of that ultimate product that they can actually build. They move from that initial starting point to their ultimate objective with remarkable efficiency. "Visionaries buy on the promise of a product; pragmatists buy when the product's benefits are proven." These entrepreneurs understand both the ultimate mainstream customer and the immediate customer, because the bulk of the orders are going to come from the mainstream customers. Therefore, a key issue is who do you do business with initially who lets the venture start moving down the "right" product road map? Who do you do business with initially who can help you on the path of having the right product for that mainstream customer? Visionaries buy on the promise of a product; pragmatists buy when the product's benefits are proven. But pragmatists usually control the bulk of the money. Understanding how a specific set of pragmatists and visionaries relate to one another in the application that the venture chooses to pursue is the key to rapid revenue growth; because, if you do business with the "wrong" visionaries, they'll lead you away from the very pragmatists you will need to turn a high-potential venture into a high-performance venture. It's very important not to think about adoption as either solely a selling problem or solely a product problem. If you try to sell what you can't deliver, you get in trouble. If you try to deliver what a mainstream buyer will not ultimately buy, you get in trouble. So the issue is how to get started as you go to market. Many of these ideas are explored more fully in Geoffrey Moore's book, Crossing the Chasm.

NB: Why do so many companies have a hard time getting traction during this phase? Lassiter: The art in this process is recognizing how you get from "today" to the mainstream market of "tomorrow," because you can't create that whole product at the start. Very often, that customer you would ultimately like to sell to is very reluctant to buy new, still-evolving products. So you have to get started with customers who have a desire for experimentation and who are not only willing but driven to try new things. If you think in terms of best practices, it's understanding the path to the mainstream market and being smart enough to, A, pick a good mainstream market and, B, assemble the people and partners who give you a disproportionate likelihood of getting there. NB: I imagine that doing a good job of picking that mainstream market is a function of the entrepreneur's own experience in an industry and his or her intuition about the future. Lassiter: Certainly in the cases I've studied, people who have deep knowledge about the world they're going after do a better job at picking fertile places and understanding which markets can be successfully attacked. Sometimes the entrepreneur can conceive of a compelling market, but in fact can't get there. So there is an iterative process of determining if the opportunity isgoing to be worth it, and can I get there? Somebody who has worked in a space gets a sense that the future is going to be moving in a particular way and understands how technology, customers, money, and marketplace dynamics will come together to create a compelling reason to buy. At the start, an entrepreneur usually has an idea of a product and a customer and the kind of featuresusually technical or product featuresand the operational advantages they'll convey to that customer. The entrepreneur either understands this opportunity from the product side of thingsa kind of feature/advantage/benefit view of the worldor understands it from the customer's point of viewthe customer really needs a particular benefit. The entrepreneur asks, "How can I accelerate the rate at which my product moves into the marketplace?" NB: How does this help in choosing an initial set of target customers? Lassiter: The answer is usually by recruiting the right people and partners around the core idea. NB: Can you give us an example that might provide a concrete picture of this process? Lassiter: I'll be teaching a case this year where an entrepreneur does this beautifully, selling, of all things, wool underwear. A young entrepreneur in New Zealand named Jeremy Moon created a company called Icebreaker. Everybody knows that wool underwear is terrible: it's itchy, it smells bad, it gets oilyjust a whole bunch of problems. So Jeremy Moon runs across a pair of wool underwear made not out of everyday sheep's wool, but from the merino sheep, whose long, fine wool is used for suits and ties at the high end of the market. He sees that a product can be created that's light, not itchy, and captures no odor. Of his first $200,000 in seed financing, he spends a $100,000 creating a "brand blueprint," an architecture for what the brand needs to look like some day to exploit this advantage in natural fiber. He then thinks "backward" to identify what he can do to get started building a global brand. Again, he sees the technology, what's available from the wool. He understands what outdoor athletic people or design-conscious people might want. He makes assumptions about how these are going to fit together over time, and in the end, he turns that strand of wool into the tapestry of a brand. You see that way of realizing the core product-customer link, and then going out and building an alliance with merino suppliers, so that he's got a steady supply of a rare product, and

with machine providers so that the product can be spun and worked into outdoor gear. He builds up a worldwide supply chain by recruiting people who want to gamble that there is a customer need not being met by polyester. NB: For prospective entrepreneurs, what are the key lessons to be learned here? Lassiter: The key lesson is you need to have enough awareness of product alternatives that come from the technology, and of customer needs that come from pressures in the marketplace, to see where opportunity will emerge. What that means is that most MBA students should go to work in an area they think is going to be hotand they've got to anticipate where it's going to be hotand then build up a deep knowledge of who the good engineers are, who the interesting customers are, what the right channels are, and who the essential business partners are. So, when they go out on their own, they bring a rich and relevant Rolodex along with them on the journey. Turning high-potential ventures into high-performance ventures is always an elegant combination of know what, know-how, and know who! http://www.businessweek.com/small-business/to-sell-more-answer-these-questions12022011.html

Six Keys to Building New Markets by Unleashing Disruptive Innovation

Clayton M. Christensen, Michael E. Raynor, and Scott D. Anthony (March 10, 2003) Managers today have a problem. They know their companies must grow. But growth is hard, especially given today's economic environment where investment capital is difficult to come by and firms are reluctant to take risks. Managers know innovation is the ticket to successful growth. But they just can't seem to get innovation right.

When companies keep improving their existing products and services to meet their best customers' needs, they eventually run into the "innovator's dilemma." By doing everything right, they create opportunities for new companies to take their markets away. Established companies historically have struggled when trying to create new markets. Success seems fleeting and unpredictable.

Recent research indicates these problems are systemic. Most companies that are started fail. Of those that succeed, most cannot sustain robust growth for more than a few years. Companies need a way to unlock the process of innovation and create innovation-driven growth businesses again and again. How can managers increase the probability that their decisions will lead to success? Now more than ever, managers need robust theoriesstatements of what causes what, why, and in what situationto guide their decision making around innovation.

Managers typically grow impatient when we tell them this. "Theory?" they say. "That sounds like theoretical. That sounds like impractical." But theory is eminently practical. Managers are the world's most voracious consumers of theory. Every plan a manager makes, every action a manager takes, is based on some implicit understanding of what causes what and why.

The problem is, managers all too frequently use a one-size-fits-all theory. But the ground beneath them inevitably shifts. Strategies that worked so wonderfully in the past no longer suffice.

Drawing on the work of a number of thoughtful researchers as well as our own work, we are exploring a set of theories that can help managers respond to the ever-changing circumstances in which they find themselves. Specifically, these six lessons will help managers make the right decisions to successfully build new-growth businesses.

1. Disruptive innovations spur growth. Companies have two basic options when they seek to build new-growth businesses. They can try to take an existing market from an entrenched competitor with sustaining innovations. Or they can try to take on a competitor with disruptive innovations that either create new markets or take root among an incumbent's worst customers. Our research overwhelmingly suggests that companies should seek out growth based on disruption.

Sustaining innovations, whether they involve incremental refinements or radical breakthroughs, improve the performance of established products and services along the dimensions that mainstream customers in major markets historically have valued. Examples: a microprocessor that enables personal computers to operate faster and a battery that lets laptop computers operate longer.

All Innovative ideas start out as half-baked propositions. Clayton M. Christensen, Michael E. Raynor, and Scott D. Anthony

Companies march along a performance trajectory by introducing successive sustaining innovationsfirst to remain competitive in the short term. But, as noted in The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail (Harvard Business School Press, 1997), firms innovate faster than our lives change to adopt those innovations, creating opportunities for disruptive innovations. Although sustaining innovations move firms along the traditional performance trajectory, disruptive ones establish an entirely new performance trajectory.

Disruptive innovations often initially result in worse performance compared with established products and services in mainstream markets. But disruptive innovations have other benefits. They are often cheaper, simpler, smaller, and more convenient to use.

Consider the small off-road motorcycles introduced by Honda in the 1960s, Apple's first personal computer, and Intuit's QuickBooks accounting software. These innovations all initially underperformed the mainstream offerings. But they brought a different value proposition to a new market context that did not need all of the raw performance offered by the incumbent. They all created massive growth; to flip Joseph Schumpeter's famous phrase, creative destruction, on its head, this is creative creation. After taking root in a simple, undemanding application, disruptive innovations inexorably get better until they change the game, relegating previously dominant firms to the sidelines in often stunning fashion.

Incumbents almost always win battles of sustaining innovations. Their superior resources and well-honed processes are almost insurmountable strengths. Incumbents, however, almost always lose battles where the attacker has a legitimate disruptive innovation. To create a new-growth business, companiesestablished incumbents and start-ups alikemust be on the right side of the disruptive process by launching their own disruptive attacks.

2. Disruptive businesses either create new markets or take the low end of an established market. There are two distinct types of disruptive innovations. The first type creates a new market by targeting nonconsumers, the second competes in the low end of an established market.

In a new-market disruption, attackers take root in a new "plane" of competition or a new context of use outside of an existing market. Consumers historically locked out of a market because they lacked the skills or wealth welcome a relatively simple product that allows them to get done what they had always wanted to get done. These markets typically start out small and ill defined. They don't meet the growth needs of large companies. And the incumbent feels no pain at first. Because it creates new consumption, the disruptor's growth doesn't affect the incumbent's core business. But as the innovation improves, it begins to pull customers away from the incumbent. And the incumbent doesn't have the ability to play in this new game.

Managers must be patient for growth but impatient for profitability. Clayton M. Christensen, Michael E. Raynor, Scott D. Anthony

Transistors were a disruptive innovation. Mainstream suppliers of tabletop radios, which were made with vacuum tubes, couldn't figure out how to use transistors because they couldn't initially handle the power requirements of these components. Then in 1955, Sony introduced the pocket radio. It was a static-laced product with horrible fidelity. But it enabled teenagers to do something that they couldn't beforelisten to rock'n'roll out of their parents' earshot. Had Sony targeted consumers in established markets, the pocket radio would have bombed. But for teenagers, the alternative to a Sony pocket radio was no radio at all. By competing against nonconsumption, Sony set a very low technical hurdle for itself: The product just had to be better than nothing in order to find delighted consumers.

The second type of disruptive innovation takes root among an incumbent's worst customers. These low-end disruptions do not create new markets, but they can create new growth. The disruption of integrated steel mills by steel minimills demonstrates how low-end disruptors harness what we call asymmetries of motivation.

Minimills first took hold in the steel industry in the mid-1960s. They were very efficient. They had a 20 percent cost advantage over integrated mills. But the quality of the steel they produced was inferior. The rebar market at the bottom rung of the industry (rebar is small steel bars made from scrap and used to create reinforced concrete) was the only market that would accept the minimills' steel.

As the minimills entered the rebar market, the integrated mills were happy to exit it. Their gross margins in the rebar business were a mere 7 percent, and rebar accounted for only 4 percent of the industry's tonnage. So the integrated mills decided to focus on higher-profit steel products. The minimills made boatloads of money until they finally drove the last of the integrated mills out of the marketand then the price of rebar dropped 20 percent, because rebar had essentially become a commodity market. The minimills' reward for victory was that none of them could make money.

To make attractive money again, the minimills had to figure out how to make better-quality steel in larger shapesnot only angle iron but also thicker bars and rods. Profit margins in this market tier were 12 percent, almost double those of the rebar market; the overall market was also twice as large. So the minimills invested in equipment to make the larger pieces and worked to improve the quality and consistency of their steel. As the minimills began making inroads with better and bigger steel, the integrated mills were happy to exit this market tier to concentrate on more profitable products. When the last integrated mill left the market, the price of angle iron collapsed. Once again, the minimills had to move up to the next tier of the industry in order to survive. And so on.

At each stage of the minimills' climb up-market, an asymmetry of motivation was at work. For the minimills, the need to enter a more profitable market provided the motivation to solve the technological hurdles preventing them from producing higher-quality steel. The integrated mills

were happy to leave these markets because the lower tiers in their product mix were always less profitable than products targeting higher-end customers. Eventually, of course, the integrated mills ran out of markets to flee to.

3. Disruptive opportunities require a separate business-planning process. All innovative ideas start out as half-baked propositions. They then go through a shaping process as they wind their way through the organization to reach senior management. When firms have a single process for all the various forms of innovation, what comes out the other end of the process looks like what has been approved in the past, and it all looks like sustaining innovations.

Consider IBM's efforts to introduce voice-recognition software. Early iterations of IBM's ViaVoice software package featured IBM's "ideal" customer on the front: an administrative assistant sitting in front of her computer, speaking into a headset. It is easy to see why IBM targeted such customers. They constituted a large, obvious market, well aligned with IBM's needs and capabilities. But think about IBM's value proposition to this woman. She types 80 words a minute and almost never makes a mistake. IBM was telling her, "Why don't you change your behavior and use a system that gives you lower accuracy and slower speeds. We promise future releases will get better." The only way to attract great typists would be for voice recognition to be faster and more accurate than typing. This is a very high technical hurdle.

Where has voice-recognition technology begun to take off? Kids love the ability to tell their animated toys to "stop" or "go." "Press or say one" menu commands are another obvious application. In these contexts, people are delighted with a crummy voice-recognition product. Another good market for the technology may be all those executives you see standing in airport lines, trying to punch messages into their BlackBerries. Their fingers are too big to enable accurate typingthey'd be more than happy with a voice-recognition algorithm that's only 80% accurate.

Not surprisingly, disruptive ideas stand a small chance of ever seeing the light of day when they are evaluated with the screens and lenses a company uses to identify and shape sustaining innovations. Companies frustrated by an inability to create new growth shouldn't conclude that they aren't generating enough good ideas. The problem doesn't lie in their creativity; it lies in their processes.

Only by creating a parallel process for developing and shaping disruptive ideasone that acknowledges their distinctive featurescan companies successfully launch disruption after disruption. Such a process relies more on pattern recognition than on data-driven market

analysis. After all, markets that do not exist cannot be analyzed. Even when numbers are available, they are never clear.

An intuitive process can still be rigorous if managers use the right tools. For example, discoverydriven planning lets you create a plan to test assumptions; aggregate project planning helps you allocate resources between sustaining and disruptive opportunities; the "schools of experience" theory informs hiring decisions.

4. Don't try to change your customershelp them. Faulty market segmentation schemes help to explain the stunningly high rate of failure of newproduct development. Most companies define markets in terms of product categories and demographics. We just don't live our lives in product categories or in demographics. When companies segment markets this way they often fail to connect with their customers. How do we live our lives? During the course of the day, problems arise, jobs we need to get done. We look around to hire products to get those jobs done. Products that successfully match the circumstances we find ourselves in end up being the real "killer applications." They make it easier for consumers to do something they were already trying to accomplish. Some manufacturers pushed digital cameras based on the value proposition that they made it easy to edit out the red eyes from all your images and create an online album of your best photos. Research shows, however, that 98 percent of all photos get looked at only once. Only the most conscientious of us prioritized editing images or creating albums. Where digital camera makers found success was in marketing their products to consumers who used to order double prints of their photos and mail them to relatives. The digital technology enables consumers to use the Internet to do more easily what they already wanted to do. A business plan predicated upon asking customers to adopt new priorities and behave differently from how they have in the past is an uphill death march through knee-deep mud. Instead of designing products and services that dictate consumers' behavior, let the tasks people are trying to get done inform your design. 5. Integrate across whatever is not good enough. One critical decision firms face when creating an innovation-driven growth business is determining its optimal scope. Specifically, which activities need to be managed internally and which can be safely outsourced? The answer often is driven by the fad of the day. During the 1960s, everyone thought IBM's integration was an unassailable point of competitive advantage. Because IBM controlled such a wide swath of the industry's value chain, it could make better products than anybody else. So companies copied IBM and tried to integrate. In the 1990s, everyone thought that Cisco's disintegrated business model that made extensive use of outsourcing was an unassailable point of competitive advantage. So companies jumped on this new bandwagon and sought to disintegrate.

The critical question is: What are the circumstances in which my firm should be integrated and what are the circumstances in which my firm can be a specialist? Integration provides advantages whenever a product is not good enough to meet customer needs. Proprietary, interdependent architectures allow companies to run multiple experiments, pushing the frontier of what is possible. Engineers can reconfigure their systems to wring the best performance possible out of the available technology. Think about the computer industry. In its early days, you simply couldn't exist as a specialist provider. There were too many unpredictable interdependencies across every interface in the first mainframes. The manufacturing process depended on the design of the computer and vice versa. The design of the operating system affected the design of the logic circuitry. IBM had to be integrated across the entire value chain to produce a mainframe that came close to meeting its customers' needs. By contrast, the modular architectures that characterize disintegration always sacrifice raw performance. Stitching together a system with partner companies reduces the degrees of design freedom engineers have to optimize the entire system. But modular architectures have other benefits. Companies can customize their products by upgrading individual subsystems without having to redesign an entire product. They can mix and match components from best-of-breed suppliers to respond conveniently to individual customers' needs. But even in a modular architecture, successful companies still are integratedjust in a different place. Consider the computer industry in the 1990s. The computer's basic performance was more than good enough. What did customers want instead? They wanted lower prices and a computer customized for their needs. Because the product's functionality was more than good enough, companies like Dell could outsource the subsystems from which its machines were assembled. What was not good enough? The interface with the customer. By directly interacting with customers, Dell could ensure it delivered what customers wantedconvenience and customization. Value flowed to Dell and to the manufacturers of important subsystems that themselves were not good enough, like Microsoft and Intel. In short, companies must be integrated across whatever interface drives performance along the dimension that customers value. In an industry's early days, integration typically needs to occur across interfaces that drive raw performancefor example, design and assembly. Once a product's basic performance is more than good enough, competition forces firms to compete on convenience or customization. In these situations, specialist firms emerge and the necessary locus of integration typically shifts to the interface with the customer. 6. Be patient for growth but impatient for profitability. Managers inside new-growth businesses often feel tremendous pressure to quickly ramp up sales volume. But disruptive businesses can't get big very fast. The only way to make them grow quickly is to cram them into large, obvious markets. In established markets, customers don't care about the disruptive innovation's strengths. They only care about its weaknesses. This is a recipe for disaster, and one reason why company-backed disruptive ventures can have a leg up. Venture capitalists have become increasingly impatient for businesses to get huge. As long as their core businesses are growing healthily, companies will find it easier to wait for the disruptive businesses to find a foothold market and slowly build commercial mass. Managers must be patient for growth but impatient for profitability. When you are willing to put up with a lot of losses before a disruptive business turns profitable, that means you are trying to

lay the foundation for a huge new business. Insisting on early profitability pushes the new disruptive business to find the markets where its unique capabilities will be uniquely valued. Forced to keep its fixed costs low, the new business can serve small customers who would not meet the needs of a high fixed cost structure. Managers in large companies who read The Innovator's Dilemma may have finished the book thinking they're destined to fail, no matter what they do. We hope to shift their sentiment from despair to hope. If managers understand the theories of innovation, they have the ability to create new-growth businesses again and again.

David, Goliath, and Disruption

Author: Martha Lagace (February 26, 2001)

As elegantly described by HBS professor Clayton M. Christensen in his 1997 bestseller, The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail, so-called disruptive technologies are upstart innovations that manage to penetrate the market share of some apparent business Goliaths, despite formidable odds. A Cyberposium discussion devoted to the phenomenon, titled "Uncovering Disruption: Moving Your Company Several Steps Ahead of the Incumbents," had several executives weighing Christensen's principles (see sidebar) against their own real-world experiences. While "disrupting" is of course the goal of their business activities, panelists said, it is also no small trick to cut through the entrenched practices surrounding established incumbents. Nor is it simple to prevent others from dislodging their companies, too in effect, neatly turning a disrupter into a disruptee. Learning to chicken-scratch If a technology is to succeed, in theory at least, it should not require people to radically change their behavior. Instead, companies that promote the technology should hope for a gradual evolution of behavior, according to panel moderator Michael Overdorf (HBS MBA '99), CEO of Innosight, LLC, a company founded by Christensen in January 2000 to advise other firms about dealing with disruption. However, countered a panelist, citing the Palm Pilot as an example, some technological innovations requiring a behavioral change do turn out to be extremely popular, in a way no one might have predicted. "It just depends on what behavior you're changing," said Michael Schreck (HBS MBA '96), principal of the venture firm General Catalyst, which attempts to fund potential disrupters. "How many of us knew how to write graffiti on a Palm? How many of us ever said we wanted to do that?" Schreck asked the room. "I'm sure I didn't wake up one morning saying, 'I just want to write chicken-scratch, slowly, on a Palm.' It's just a horrible behavioral change. But we all do it." Intelligent, handheld devices that hold basic information such as personal calendars and statistics have been around for some time, Schreck reminded the group. The great innovation of the Palm, he offered, was that it allowed anyone, with the push of a button, to synchronize select information from a desktop to the device.

Once the capability became clear, he said, he too wanted to learn chicken-scratch graffiti. That push-button capability linking to a vast array of information from a desktop, he indicated, had fired people's imaginations about the possibilities of handheld devices. That simple step, in Schreck's opinion, "changed the nature of where we're going, I think, with global computing. It depends on what behavior you're asking [people] to change, and what the incentive and benefit is to change." Companies can go about disruptive activities in very different ways, added Jeffrey Miller, president and CEO of content management firm Documentum, Inc. In the 1980s, Miller told the group, he'd been a marketing manager at Intel when Intel management made the radical decision to throw over their memory business on which they'd founded the entire company in favor of concentrating on a future in microprocessors. Not every company head, Miller noted admiringly, would have had the chutzpah of Intel chairman Andrew Grove to do just that: throw out what had made their company disruptive in an industry, and introduce yet another disruption. After relating the story, Miller said, "I believe in Christensen's fundamental premise that you find very few of those guys who are actually successful at disrupting the market, and [then disrupting] themselves." How to not miss the boat Another of the criteria for disruptive technologies, pointed out panelist Bharat Sastri, should be the ability to create entirely new markets. "It's not always an evolutionary process," he said, referring to his 20-year background in various technology companies as both a manager and engineer.

A self-professed "nerd" who cofounded HelloBrain.com, a company that functions as an "intellectual capital exchange" for technology, inviting online collaboration, Sastri said that in his career he had also witnessed a great company commit a serious misstep by failing to recognize potential demand for a new market. I'm sure I didn't wake up one morning saying, 'I just want to write chicken-scratch, slowly, on a Palm.' It's just a horrible behavioral change. Michael Schreck, General Catalyst "I worked at SGI [Silicon Graphics] during the golden years, on big monster machines that did amazing stuff," Sastri told the audience. "But some of us arrived at the conclusion that the future of 3-D was not in CAD, but in entertainment. "The popular wisdom around the company was, "'Who's going to play games?'" he related. "'And why would they need 3-D?' ... Of course, 10 years later, companies like Sony and Sega and Nintendo have a combined market cap that's 10X of SGI's. "To me, that's a classic example of drinking your own bath water and not realizing it. SGI had the technology; they were 10 years ahead of everybody. But that simple what I call arrogance, you know and denial of the obvious, cost the company just a huge, huge opportunity," Sastri concluded.

Technology for business's sake In courting venture capitalists for funding, Miller advised the audience, it's best to play up with "a number of compelling ways" what the technology can do to serve customers. "I would not highlight the technology for the sake of technology," he cautioned. "Most VCs in Silicon Valley are enamored with technology. But at the end of the day, they really don't give a damn about it. They are more enamored with money." "There's an over-breeding of innovation right now," even a surplus of technology, added Schreck. In Schreck's opinion, so much venture capital and corporate capital is pouring into technology for technology's sake, he said, that "the last thing a venture capitalist wants to see is world-class technology. They see it a lot, and that's great." Better, he said, aiming his remarks at entrepreneurs, is to focus on what a technology can be used for in order to create a viable business. "When we talk about what it takes to bring a disruptive technology out, it may seem daunting and it is," Miller told the audience. "But it's also a hell of a lot of fun. If you have something that truly is new and different and better, if you can focus it on a market ... you can do amazing things against some awfully big competitors." "Disruption often comes in service delivery packages," observed Schreck. "There are only so many major innovations that change our lives radically: the light bulb, the television, the automobile, the telephone. "That's not where I'd be looking for disruptive technology. I'd look for innovation in service. Look for innovation in small packages, in the way innovation is delivered to the customers. "Technology combined with those things can really disrupt industries," he added, "and can do it much quicker than to try and reinvent entire categories."

Lessons of Successful Entrepreneurs

Author: Sean Silverthorne (March 21, 2005)

Successful businessmen told a roomful of students that ultimately, the world outside the classroom will be their best teacher in entrepreneurship. "If you are taking an entrepreneurship class, you want to be a venture capitalist," said Andrew J. "Flip" Filipowski, chairman and CEO of Silk Road Technologies. For the true entrepreneur, he continued, reality is the superior teacher; and school is an excuse to delay failure. Although their topic was "Post Boom Internet Opportunities," panelists spent most of the time at the 2005 Entrepreneurship Conference, held March 3rd at Harvard Business School, discussing their successes and failures as entrepreneurs. The common themes: Jump in, take risks, challenge yourself, trust your instincts, and learn from both experience and the experienced. I've got an idea!

If he were starting up a new business today, said David Fialkow, managing director of General Catalyst Partners, he would first employ the "earnest young man routine" to get an interview with an old guy in business who could explain the ins and outs of the industry. "Keep your hand out of your pocket, show up, and be prepared to listen," said Fialkow, a college dropout who helped create UPromise and a number of other successful ventures. The goal is to get to market as quickly as possible, Fialkow continued. If you have a good idea, put smart people around a table for a few days, give them good food, and let them figure out the business model, he continued. He also said start-ups should spend more time on market verification and market feedback than on the "front office" issues of building a business. Fialkow's lessons included trust your instincts; develop solid mentors; hire young, smart people; and pick industries that are going through a sea change. He recalled how a two-dollar ATM fee he once paid at an airport spurred him to start his own ATM network featuring out-of-town banks. Other ventures he helped create were a credit card processing center for supermarkets, dutyfree shops on cruise ships, and his current stint at General Catalyst, a private equity fund. Filipowski, who founded software maker PLATINUM Technology and sold it to Computer Associates International in 1999 for approximately $4 billion, said one ingredient for his entrepreneurial success was doing enough deals to get lucky every once in a while. He still receives royalty checks in the millions of dollars each year from a $40,000 investment he made in a pet business, which he thought had no chance of succeeding. HBS professor Thomas Eisenmann, who moderated, asked panelists about the "Get Big Fast" strategy popular in the 1990swhich essentially meant buying or otherwise acquiring many customers as quickly as possible. "You don't want to be in a business model that acquires customers cold," said Fialkow. His UPromise received some $100 million in financing and spent half of that in customer acquisition activities, he said. "That's nuts." Steve Hafner, founder and CEO of Kayak.com, an online travel information site, said an alternative to growing your own customers is to secure distribution through partnerships, such as Kayak's partnership with AOL. But there are times when a customer acquisition strategy might be sound given the circumstances of the moment, said Filipowski. "I believe in assessing the current environment and taking advantage of it." In a discussion on the pluses and minuses of receiving venture capital, Hafner said his company sought funding not so much for the money as for the expertise"We wanted adult supervision." Entrepreneurs run incredibly fast and focused, leaving little time for thinking about strategy and tactics to respond to events happening in the industry. Entrepreneurs should be wary if they decide to go the VC route, said Fialkow. "They're smart, but not smart about what you're talking about." The best source of information and funds, he added, is angel investors with domain expertise.

Top Ten Legal Mistakes Made by Entrepreneurs

March 3, 2003 "I've heard many war stories," says Harvard Business School associate professor Connie Bagley, reflecting on conversations with former students who have started business ventures. To prepare current students for the HBS Business Plan Contest, Bagley gives a seminar in which she shares these war stories with the prospective entrepreneurs, in the form of a list of "top ten" legal mistakes often made by the unsuspecting. In addition, Bagley teaches the second year elective course, "Legal Aspects of Entrepreneurship," which covers the waterfront of issues typically faced by entrepreneurs in starting and running a business, including securities and intellectual property law issues. Bagley's teaching and research focus on legal aspects of entrepreneurship and corporate governance. Before coming to HBS in 2000, she taught at Stanford Business School, and prior to that she was a corporate securities partner in the San Francisco office of the law firm of Bingham McCutchen. She is author or coauthor of several textbooks, including the just-published second edition of The Entrepreneur's Guide to Business Law. Bagley recently met with Harvard Business School's New Business magazine, and talked about the legal issues commonly faced by entrepreneurs, as well as her thoughts on how to successfully deal with them. In Bagley's view, there is a tendency on the part of many entrepreneurs to think that the lawyers can handle the legal issues and to delegate too much to the attorney. "While the language of the law can be intimidating, the concepts are usually quite straightforward," she says. "Lawyers tend to be risk averse, and if you delegate to them you will usually stay out of legal trouble but can often compromise your business objectives. My goal for the courseand for the coaching I give entrepreneursis to give them sufficient comfort with the legal concepts to feel confident in driving the process, to understand the ways in which the law is a constraint, but also the ways in which it is a tool that can help you create and capture value." Lawyers who have no experience working with entrepreneurs and venture capitalists will most likely focus on the wrong things. Constance Bagley # 10: Failing to incorporate early enough. One problem that arises here is the so-called "forgotten founder": a partner involved in starting the venture subsequently drops out. When the venture gets financing or is ready to go public, this partner returns, perhaps with an inflated view of what his or her contribution was, demanding equity. This problem can be eliminated by incorporating early and issuing shares to the founders, subject to vesting. As partial consideration for their shares, each founder should be required to assign to the new corporation all inventions and works related to the company's proposed business. Incorporating earlybefore significant value has been created and well in advance of any financing event that establishes an implicit value for the sharesalso helps prevent potential tax problems for "cheap stock." Incorporating too late, and issuing inexpensive stock to the founders at the same time that much more expensive stock is being sold to investors, can create tax

problems when the IRS argues that the difference in stock price is actually income to the entrepreneur. # 9: Issuing founder shares without vesting. Simply put, vesting protects the members of the founding team who take the venture forward. If people remain on the team and are productive, their shares will vest. If they leave earlier, that stock can be retrieved and given to whoever is brought in to replace them. #8: Hiring a lawyer not experienced in dealing with entrepreneurs and venture capitalists. Many venture capitalists say that they often rate the judgment of entrepreneurs by their choice of legal counsel. Lawyers who have no experience working with entrepreneurs and venture capitalists will most likely focus on the wrong things while failing to recognize some of the more subtle potential traps. It's better to hire someone who has played the game, who knows what's standard and what isn't, and who will get the deal negotiated and closed promptly. #7: Failing to make a timely Section 83 (b) election. If the advice in #9 is followed, then shares will be issued, subject to vesting, to the founders as well as new employees. If stock is acquired and it's subject to what the IRS calls a substantial risk of forfeiture, then the IRS doesn't view the purchase as being closed until that risk goes away. When the stock vests, that risk evaporates, so the IRS considers the deal closed. The IRS then calculates the difference between the price paid at the outset and the fair market value at that later date, then taxes this difference as ordinary income. An 83 (b) election allows the tax computation to be made based on the value at the time the shares are issued, which is often pennies per share. A no-name firm offering the highest valuation is often not the best source of equity. Constance Bagley # 6: Negotiating venture capital financing based solely on the valuation. Valuation is not the only thing one should consider when selecting a venture capitalist or when negotiating the deal. There are many other ways for venture capitalists to get compensated if they end up paying a high price for shares. These include requiring participating preferred with a high cumulative dividend, redemption rights exercisable after only several years, and ratchet anti-dilution protection with no cap.

One must ask, what's the reputation of this firm? Do they have a history of standing by the entrepreneur if the entrepreneur stumbles? Do they have good contacts in the industry? In trying to build alliances, do they know the big players? A no-name firm offering the highest valuation is often not the best source of equity. #5: Waiting to consider international intellectual property protection. Patents are granted on a country-by-country basis (with a single application available for the European Union). In the United States, if an invention is sold or made public, there's a year's grace period to file a patent application. Everywhere else, if the invention is sold or publicized prior to filing the patent application, the invention is unpatentable in that country. For example,

if the invention is publicly disclosed to a Japanese national visiting a tradeshow in the United States, then under Japanese patent law, if no patent application has been filed, that disclosure makes the invention unpatentable in Japan. The same is true with trademarks. A tremendous amount of money might be spent in developing a brand in the United States, yet when the product is shipped overseas it could violate trademarks of companies dealing in similar goods outside the United States. One must make intelligent choices of where they think their markets are, and how much money to spend at an early stage in order to insure that the brand is available in those markets. #4: Disclosing inventions without a nondisclosure agreement, or before the patent application is filed. If patent protection hasn't been obtained, or in cases where a patent is not available, the only protection is to maintain something as a trade secret. To do so, one must show that they've taken reasonable steps to keep it secret from competitors. Is it wise to get potential venture capitalists to sign a nondisclosure agreement? In the best of all worlds, yes, but most won't. Before disclosing to anyone, one must learn who has a reputation for integrity in the industry. In dealing with most people, it's wise to require them to sign nondisclosure agreements. It needn't be elaborate, but it should say that they acknowledge they may be exposed to trade secrets, and they agree not to use or disclose them without permission. Business plans should expressly state on the cover page that they are confidential and proprietary. That's not as strong as a nondisclosure agreement, but laws in some states suggest that if a person knows they have been exposed to a trade secret, they can't use it or disclose it without permission from the owner. Can entrepreneurs be sued by their funders for fraud? Yes. Constance Bagley #3: Starting a business while employed by a potential competitor, or hiring employees without first checking their agreements with the current employer and their knowledge of trade secrets. The law is clear that if someone is currently working for a company, particularly if her or she is a key employee, they cannot operate a competing business. Even just incorporating may spark a lawsuit from the current employer. Would-be entrepreneurs should first go to their current employer and either resign or tell them what they're doing and ask them if they'd be interested in investing. Amazingly, that's often a very smooth way of ending that relationship. Under no circumstances should they misrepresent the nature of the new business. Even after leaving the current employer, one still cannot use or disclose the company's trade secrets. Under the so-called inevitable disclosure doctrine, if someone has been exposed to trade secrets at their job and leaves to work for someone else, and if their responsibilities in the new job are sufficiently similar, some courts will conclude that it's inevitable that they will use the information that they had from the earlier position. They could face an injunction prohibiting them from working for the new employer until a number of months go by and whatever trade secrets they had are stale. It also helps to know whether potential recruits are subject to covenants not to compete. States vary in terms of how enforceable they are, but one shouldn't assume they are not. One should also check to see what assignments of inventions might have been signed. Personnel files should

be reviewed, and recruits should check theirs, to be certain that a covenant not to compete or an assignment of inventions wasn't tucked into a signed non-disclosure agreement. #2: Promising more in the business plan than can be delivered and failing to comply with state and federal securities laws. If someone promises to do something and knows that they can't perform that promise, that's considered fraud. In a business plan, one must make an honest appraisal of what's doable and set forth their assumptions, so the person putting up money can judge whether they are realistic. Can entrepreneurs be sued by their funders for fraud? Yes. Trying to squeeze out a little extra valuation by fudging the numbers erodes credibility, makes investors less trusting, and ultimately impairs the ability to get subsequent rounds of financing. Finally, anyone selling stock or other securities must comply with both the federal and state securities laws by either registering the securities (rare for a start-up) or meeting all the requirements for an applicable exemption. Ignorance of the law is no excuse. As one judge put it in a decision upholding criminal convictions for violating the securities laws: "No one with half a brain can offer 'an opportunity to invest in our company' without knowing that there is a regulatory jungle out there." #1: Thinking any legal problems can be solved later. There's a tendency to think, "Once I get my funding, once I'm up and running, then I've got time to hire the lawyers; right now, I'm running as fast as I can to get my business plan done and raising money." This is shortsighted logic. Many of the points made here are problems that can't just be patched up later. Does that mean that one should devote all of their time, effort, and money to the legal issues? No. That's a good reason to hire a competent lawyer. Excellent legal talent can be retained for relatively little money up front at the early stages. It will cost much less to get it right at the beginning than to try to sort it all out later and correct it.