Why the Venture Pyramid changes how you think about innovation
Tldr: The Venture Pyramid is a new framework that allows entrepreneurs and intrapreneurs to track their progress on the way to venture success. It gives entrepreneurs the option to reduce the risk of premature scaling and functions as a guide when talking to investors.
There are many acronyms and new terms in the Lean Startup domain (e.g. MVP, Engine of Growth, Value Hypothesis, Growth Hypothesis, Assumptions, Problem-Solution-Fit), which are often not coming with context and it is very easy to get confused by them. Many great ideas exist, but they seem to be unconnected. Or do you know, what the relation between Product-Market-Fit, an MVP and the Build-Measure-Learn Loop is? When to run a smoke-test? When to start building a product? What is the optimum timing to get investment? How to set-up corporate innovation activities etc.? The Venture Pyramid is what I see as the key to unlock these closed doors. It helps to frame the discussions and to see everything with a little bit of structure. I will use the Venture Pyramid in upcoming articles as a frame. So, what is this new thing about?
What it is about
““[An Entrepreneur’s] job is to search for a repeatable and scalable business model.””
Like every new development, the Venture Pyramid also builds on the shoulder of giants and reconfigures already existing thoughts. It builds namely on the shoulders of Marc Andreesen, Sean Ellis, Dave McClure, Alexander Osterwalder, Ash Maurya and for sure Eric Ries. The Venture Pyramid is at first a guide for every venture to make and track progress, whether it is a startup or a venture in a mature company. And this is at the end progress in the market (‘traction’) and not progress from a technical or product development point of view. Many people that I have seen advising startups or leading innovation units are focused not on this venture progress, but on product milestones e.g. “Fill out the Business Model Canvas”, “Create a prototype”, “Develop the MVP”. At the end, these are only artifacts, that neither a customer nor an investor really cares about. If you are not creating value for people, it doesn’t matter that you are able to put text in a structured way into some boxes. This does not mean, that a Business Model Canvas, a prototype or the MVP are not necessary. They are really important in the process - they are just NO signals of the progress on a venture.
The progress of a venture can be best understood with the venture pyramid. The bottom of the pyramid is the base for everything that is built on top of it. If your venture is not built on a solid foundation – a big or growing market, it is very unlikely that your business will prosper. To validate if a market is attractive – because of growth and/or size - entrepreneurs can use Google trends or the Google Keyword-Planner. In a small or declining market, it is very unlikely, that entrepreneurs find problems that are relevant for many people. It is for sure only an indication, but a good one, that keeps you away from spending too much time a search field of little potential.
The following step in climbing the Venture Pyramid is Customer-Problem-Fit. This means nothing more than figuring out if a customer that you are thinking about really exists and has a problem that has high relevance and magnitude. Relevance and magnitude are important to determine, whether it is a problem that creates enough pain to gain traction in the market. Conducting problem interviews is the typical method to figure out, whether you reached Customer-Problem-Fit or not. The probability to gain traction is much higher, when customers are aware of having the problem. Ideally, interviewees name the problem unaided. This indicates you that there is really a pain and they don not have a proper solution to get it fixed.
Identifying the problem that exists with a high relevance and magnitude leads an entrepreneur to the question of how to solve the problem. An entrepreneur wants to get to Problem-Solution-Fit which is, that he/she has real market proof, that his/her solution is one that people see as valuable and are willing to exchange value to use it. This is where the famous smoke tests or landing page tests come into play. You are testing whether the value proposition gets grip in a market. If the value proposition does not get grip, it is very unlikely, that your customers would continuously buy the product. So, the development of the product would have been a waste of money. In B2B contexts getting LoI’s can show some traction. It is important to distinguish between Problem-Solution-Fit and Product-Market-Fit. In contrast to Product-Market-Fit, which entails repetitively selling an existing product to see how it performs in the market, the Problem-Solution-Fit is a test to pre-sell a product that is not developed yet. Problem-Solution-Fit tests are realized under objective conditions and focus on the question whether customers would buy the product.
Validating the existence of Problem-Solution-Fit shows an entrepreneur that the solution would gain traction. This is the point of starting the development of a MVP. But launching the product does not mean that you have reached Product-Market-Fit. It is only the starting point to run various iterations on the way to Product-Market-Fit, which is the validation that your product is there to stay. It is the validation, that you create repetitive retention, revenue and referral. If your product is not creating sufficient retention, revenue and referral, it is very unlikely, that you reached Product-Market-Fit. Great products are built on virtuos cycles/positive feedback loops. Designing these positive feedback loops are the essence of the quest for Product-Market-Fit.
After reaching Product-Market-Fit an entrepreneur validated the “demand-side” of the business and is now able to focus on the Business-Model-Fit. A coherent business model will lead to profitability. This is the point, where you optimize your operations, where you optimize your channels, where you start automating internal processes to cut down costs etc. You will for sure also try to optimize e.g. your CAC (Customer Acquisition Costs) before that point, but it is all about focus. If you are CAC are exceeding your revenues/retention/referrals on the way to product-market-fit, it is very improbable, that you are on a healthy course. At the end, it is all about the focus of your time and money. If you do not have a product that has enough traction, it does not matter, that you are optimizing your costs – you are already in a vicious cycle.
At the top of the pyramid, there is the step into geographical scaling of operations, in case you are not a born-global. This geographical scaling comes best after your business model has proven to work in at least two different geographical contexts. There are many challenges that come with scaling a business model geographically. You hear many stories, of companies that scale worldwide without having reached profitability (e.g. Uber). At the end, Uber has great traction in the market, that’s why investors believe in the company which makes them able to scale. I would say that a business that scales to other geographical contexts should have reached at least the state of positive gross margin.
The more an entrepreneur climbs the pyramid, the more certainty he/she gets about the business. It will be easier to repeat things. And his/her focus will change from exploring an opportunity to exploiting this opportunity. This needs to happen with caution, if you do not want to fall into the trap of premature scaling.
Premature Scaling is why you should care
An entrepreneur and an entrepreneurial organization should be aiming to scale efforts in consistence with the reduction of uncertainty. This is indicated with visualization on the right. Why would someone scale a product internationally, when there is no proof that it sticks in one region? Why would someone start building a product and spend money on it, when there is no proof, that people care? Why would someone hire data scientists without having data? Why would someone invest millions in marketing, if customers are not willing to tell their friends about the product etc.?
The list of examples how companies scale prematurely is endless, but although we think it is logical to avoid premature scaling, it happens very often. And it is very easy to fall into the trap. 74% of high-tech startups fail due to premature scaling and 70% of all startups scale prematurely. Scaling prematurely is the number one cause of startup-death (Source: Startup Genome Report) and it is the single reason, why so many corporation innovation activities create a massive amount of waste. If you put real time and money into this calculation, it’s going to be an incredible amount of resources that is wasted. See below some other subsequent outcomes that are just another indication for the creation of waste through premature scaling. Premature scaling is at the end nothing else than jumping over one level of the pyramid and starting to create something that is built on the belief, that it is e.g. a valid problem or a valid solution. The examples from above show that startups that scale prematurely are writing more code and are bigger in team-size than other startups. It is impressive that no startup that scaled prematurely passed the 100.000 user mark or broke the $100k revenue per month threshold. (Source: Startup Genome Report)
The Venture Pyramid functions like a list of progress milestones that you want to check on the way to a successful business model. You should validate every step on the pyramid before increasing your efforts at the next level. Reaching this validation is not only important for you, but it also results in investor buy-ins. Dave McClure points out that you have the different levels of traction that an entrepreneur should reach and that there are also different reasonable investment needs associated with these levels. It is very unlikely to find an investor who invests millions, if your venture does not have a single customer.
The Venture Pyramid gives you a great understanding on your venture progress. It also avoids that you scale prematurely. Furthermore, the venture pyramid helps you to prepare investor talks.
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About Lutz
Dr. Lutz Göcke is the founder of the innovation consultancy Swan Ventures which offers services and SaaS-tools that help you climb the Venture Pyramid with speed and at low cost. Lutz is a Serial-Intrapreneur, Startup-Mentor and a Lecturer on Entrepreneurship, Innovation and Strategic Management.