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Failing Cheaper: Good for Who?

Josh Kopelman from First Round Capital blogged “Failing Cheaper” which makes some very good points. It is cheaper these days to try a new business idea. It is easier to try and then fail than ever before. He says the role of seed funding is to validate or disprove the working business hypothesis, so as to remove risk (thus enabling more funding or justifying a cease of operations). All good stuff from a VC guy with a significant history of successful startup involvement. He encourages an agile approach to innovation. He suggests that, with the right team, an entrepreneur can push quickly towards testing the market (trying to remove the risk of investment) in an agile way, and he suggests that most ventures will be failures.

“Although the aggregate number of failures may seem higher (due to the increased number of companies being launched) the ratio of early stage failures to successes is probably still the same. What has changed is that you can now fail faster and cheaper than ever before. While I’d much rather invest in a company that succeeds, if a company is going to ultimately fail I’d rather it fail quickly.”

By my read he’s acknowledging that you need to fail a lot in order to succeed, and that we should try and be as efficient at failing as possible (he is a seed funder himself, of course, so he may have an internal conflict between funding innovative high risk ideas and sure things).

Josh notes how start-ups become successful at things they never intended, with Paypal starting as a way to move money between Palm devices, and YouTube starting as a video dating site. So under the new funding model, seed money enables the entrepreneur to iterate towards a successful approach to market:

“In the new funding model a startup is able experiment/iterate over an extended period of time for very little capital. Only once some of the venture’s risk has been eliminated through accelerating adoption does the company raise more money to further refine the model and expand. Overall the time and cost between the founding of the company and knowing whether both the entrepreneurs and investors should continue to pursue the opportunity is greatly decreased.”

I’ve never been involved in VC funding but I still wonder what this does to valuations… if the seed funding is kept to a minimum through efficient entrepreneuring, do the seed investors still get as large a portion of the final pie? On the other hand, this enables seed funders to get their fingers into more pockets with the same overall investment (by spending less on each and encouraging efficient elimination of risk). If you ask me, this extra hard work for the entrepreneurs should be rewarded with a bigger share of the pie.

Anyway that’s not why I am commenting on Josh’s quality post. I am commenting because I think he’s got heavy emphasis on the funding side (efficiency of spend to minimize risk) but makes some assumptions about operations that I don’t often see, especially in agile environments. If seed funders follow his advice, but don’t recognize the operational issues, they might kill projects prematurely. They will label projects as failures not because the market wouldn’t prove the hypothesis and not because the entrepreneur’s couldn’t iterate to a better hypothesis fast enough, but because of a disconnect between agile development and practical reality. Innovators will develop ideas elsewhere, rather than within the start-up. Agile development withholds knowledge and information (options) as a means towards efficiency in execution along a prescribed path. Get to market fast without all the bells and whistles, and iterate as you go to test the market. Much of operational innovation (development stuff) is left on the sidelines because of the need to get something to market quickly so leadership can iterate.

With this described method of less funding over a longer period of time, would there even be a sideline to collect those ideas?

If you want to iterate along a prescribed path, then I agree agile development is a good tactic. But if you are seeking an opportunity in the market that may be on a different path (as PayPal did when it somehow shifted from Palm devices to online transaction processing, and YouTube did when it went from dating to publishing) then the agility needs are in leadership/management, not development operations. The only way tech startups can be agile with respect to the market opportunity is if it has resources beyond what it is using to efficiently test the working hypothesis. How else can it explore an observation or get more data when more data is necessary to properly attribute an observation to reality?

So what happens when you squeeze innovation to be efficient, so it can fail more quickly? You are basically unit testing your approaches to market. A smart group of dedicated people chasing one idea (beaming money between palm devices) can discover a better opportunity (online transaction processing) as they pursue to goals together. But if squeezed for efficiency, could they afford to consider things outside the unit path set by leadership? If funding is lower and extended over more time, would they even stay together long enough to test the original idea? When I work with an agile team, everyone is also doing something else at the same time. The better the pay, the less likely that the “other work” will interfere, but it’s always a possibility. They get the best and brightest working on the project, but without fat resources they don’t get exclusivity from those brains. My biggest wonder when working on agile software/web site development is what the team would think of each of the ideas I encountered on the way to the last build. There was no time to introduce them, because they are off the path. There are few meetings outside the immediate working group (for efficiency) and so what does get discussed is discussed mostly outside of that company environment (at conferences, pub meetings, or geek dinner type get-togethers). At HP or Johnson & Johnson or IBM or even UPS these “little ideas” would be evaluated and possibly tested within the company. At minimum they are passed by the patent team and documented.

In an environment of innovation, I think you need waste to foster innovation. I think the replaceable nature of the “inefficient” middle management actually encourages the retention of intellectual property within the company. If an innovator knows the company is bigger than her immediate supervisor, e.g. that her manager is a placeholder and not an ultimate arbiter of intellectual value, then she is more likely to trust the company with ideas that are off the obvious path or perhaps likely to be of secondary importance to her immediate supervisor. More likely to dream, if you will. Under a scenario of “failing efficiently”, failing quickly and on a limited budget, I doubt very much the innovators will iterate very far from the path defined by leadership. I accept that this can deter analysis paralysis and prevent sunk cost effect syndrome, but I also suspect this “new funding model” would simply churn ideas (and “companies”) through seed funding, and would not foster iteration to workable, lower-risk hypotheses as Josh suggests it might (at least not at the same company or with the same team?).

Disclaimer: I have no significant start up experience, as funder nor fundee. If I didn’t publish my own blog, these opinions would probably never get published. What do you think? Comment below.

One Comment

  1. IncrediBILL wrote:

    Having been in quite a few startups I can’t say he’s wrong.

    The obvious upside to startups failing faster is that other more qualified product ideas get a shot at reality.

    I’ve witnessed from great innovative products destroyed by bad management that had access to too much cash. The more cash that was infused into the project, the more the company just kept going in the same circles making the same mistakes.

    Sometimes investors need to escalate booting the top management and bring in someone more qualified to take the company to the next level yet it didn’t happen.

    FWIW, there are still people out there bootstrapping their own projects to get past the seed round, which gives you all the time you want to innovate without pressure to perform other than the strain on your own bank account limitations.

    Thursday, March 15, 2007 at 9:02 am | Permalink