My post Notes on Strategy; For Early Stage Technology Startups led to follow up questions from a handful of readers who asked for additional posts with more explanations and examples. ¹

In this post I will discuss Michael Porter’s 3 Generic Competitive Strategies. My goal in these posts is to provide concrete yet easy to use frameworks that founders of early stage startups can quickly learn and adapt as they work on moving their organizations through the discovery process that takes them from being a startup to becoming a company.¹

To ensure we are on the same page, and thinking about the issues from the same starting point . . . first, some definitions. You can skip past the definitions if you have already seen them in one of my previous posts.

Definition #1: What is a Startup? A startup is a temporary organization built to search for the solution to a problem, and in the process to find a repeatable, scalable and profitable business model that is designed for incredibly fast growth. The defining characteristic of a startup is that of experimentation – in order to have a chance of survival every startup has to be good at performing the experiments that are necessary for the discovery of a successful business model.² As an investor, I hope that each early stage startup in which I have made an investment matures into a company.

Strategy is about making choices, trade-offs; it’s about deliberately choosing to be different.

– Michael Porter³

Definition #2: What is Strategy? An early stage startup’s strategy is that deliberate set of integrated choices it makes in order to create a sustainable competitive advantage within its market relative to rival startups and market incumbents. It is the means by which a startup combines all the elements within its environment to create and deliver value for its customers, while simultaneously capturing some of that value for itself and its investors. Strategy answers questions about what the startup should do and what it should not do in order to find a repeatable, scalable and profitable business model.

In Competitive Strategy, Michael Porter describes The 5 Competitive Forces That Shape Strategy. Later on in the book he discusses 3 Generic Strategies that a business can apply in order to maintain its position relative to its competitors, and also to cope with the 5 forces affecting competition.

Before delving into the details of the generic strategies, one observation; Often, discussions about strategy get stuck in dogma – is it about creating a competitive position that a startup can defend, or is it about gaining market share? I do not think strategy can be an either/or proposition in that sense. It must be both. Good strategy protects a startup’s current market position, while attempting to reshape the competitive landscape such that it tilts overwhelmingly to that startup’s advantage.

Also, by definition a startup is still searching for a strategy . . . so many of the examples I will use are of companies, not startups. However, the idea is that this helps a founder go through the search and discovery phase of building a startup with these frameworks in mind.

The following generic strategies help a startup create a defensible position in its market, but they should also be thought of as a means for launching offensive moves to gain market share as market conditions evolve.

Overall Cost Leadership: A startup that has decided to pursue this strategy has chosen to maintain the lowest cost structure amongst its rivals.  One could think of “broad-based” cost leadership as a choice to become the cost leader amongst all a startup’s rivals in a given market. Alternatively, “narrow-based” cost leadership is a choice to become the cost leader among a select few rivals within the market.

A startup might choose a cost leadership strategy in order to cope with the threats posed by powerful buyers who can push prices down, but no further down than the cost leader in that market can bear. Also, cost leadership provides wiggle room for dealing with the threats posed by powerful suppliers who can increase the costs of inputs that the startup needs in order to develop its own products. Becoming the cost leader in a given market lowers the threat posed by new entrants to the market under the established rules of competition because the decision to enter the market under those conditions would be difficult to execute at a cost that is acceptable.

Startups exploring cost leadership as a strategy should consider making large upfront capital expenditure investments with an eye towards achieving economies of scale within a relatively short window of time. As they gain market share and scale, startups pursuing a cost leadership strategy will need to continue making relatively large CapEx investments that are aimed at keeping their overall costs low.

Additionally, cost leadership entails paying more attention to continuous process innovation, higher than normal labor-monitoring practices and pay-structures that might be described by outside observers as “below market”, and intense scrutiny of and discipline towards keeping overhead costs within a narrow band relative to revenues.

Examples:

1. Walmart
2. Toyota
3. Amazon
4. CraigsList

Risks: For technology startups as cost leadership strategy can be risky because of the pace of technological change and innovation. The pace of change requires ongoing CapEx investments in process improvements at a cadence that is higher than the alternative. As an example, think of all the different reports about the investments Amazon is making in trying to figure out how to get goods from its warehouses and shipping centres to its customers. Furthermore, blind focus on cost leadership can make startups inattentive to shifts in customer preferences that make cost leadership a losing strategy as time progresses. Lastly, cost leadership creates a competitive landscape in which there’s a constant race to the bottom and brand loyalty plays no significant role. Products and services become a commodity.

The image below, showing the startups that have been built by unbundling CraigsList shows another risk of the cost leadership strategy; namely that someone else can compete with some aspect of another startup’s business model by pursuing differentiation or focus as a strategic choice.⁴

Differentiation: A startup that has decided to pursue differentiation as the basis for its broad strategy has chosen to try to develop something that will be perceived as being unique, novel and difficult to copy within its market. The key to success pursuing this strategy is that differentiation must make the startup’s product more valuable to the customers who pay for the startup’s product. Successful differentiation involves a combination of some or all of technological innovation, branding, product features, and design.

A startup might choose a differentiation strategy because it helps insulate it against competition. When implemented successfully, differentiation creates a barrier to entry that is very hard for new entrants to overcome. Successful execution of a differentiation strategy has a strong positive correlation with brand value, leading to customers of the startups products becoming less sensitive to price since by definition a highly differentiated product has no close substitutes.

The cumulative effects over time of a successful differentiation strategy become apparent in a number of ways. The threat posed by buyers reduces over time since they do not have a very good alternative to the differentiated product. Pursuing a differentiation strategy often means that the startup can maintain and enjoy profit margins that are considerably higher than average for that market. Consequently, startups that pursue a differentiation strategy maintain room for maneuvers that would have been unavailable had they pursued a cost leadership strategy instead.

The organizational traits that make pursuing a differentiation strategy possible are; strong marketing and brand-building skills, continuous product innovation, relatively large R&D expense, and an organizational culture that emphasizes customer support.

Examples: Apple.

Risks: The primary risk of differentiation as a strategy is the risk of ceding market share in the terms most people customarily think about it to a competitor pursuing a cost leadership strategy. Perceived differentiation can erode with time as competitors imitate product features and certain innovations are adopted as industry standards. Also, customers might become more sensitive to price and start making trade-offs that put the startup pursuing a differentiation strategy at a disadvantage.

Focus: Most early stage startups should start life pursuing a focused or niche strategy. A startup pursuing this strategy makes a deliberate choice to pin-point its resources on a narrow customer group, a particular product segment, or a limited geographic market. Focusing its effort on that particular target customer, product, or geographic market enables the startup to become very good at serving that niche especially well while gleaning the lessons it needs to learn in order to avoid more costly mistakes if it later on decides to pursue market-wide cost leadership or differentiation. In other words, focus as a strategy for an early stage startup entails pursuing either cost leadership or differentiation in a very narrow market segment in order to create and defend its initial beachhead. Only once that is secured does the startup seek to expand its reach.

Examples: Every early stage technology startup that grows successfully after the search for a repeatable, scalable, profitable business model is complete.

Advantages: I got stuck at this point in the post, unclear how to tackle the rest of it. Fortunately, 5 or so meetings I have had over the past two days with NYC-based startup founders at different stages of progress through the search process helped to point me in the right direction. Each of them is struggling with this fundamental question:

What I am building is so attractive to so many potential customers in so many different industries and markets. What should I do? I do not want to say no to any potential customers.

I get it. I understand the dilemma. Capital is scarce, your burn won’t go away if you wish to keep working on your startup. All these potential customers come along with promises of potential revenues to ease the stress posed by your lack of capital . . . The temptation to “take as much revenue as you can get, from whomever is offering it” is nearly impossible to resist. I get it. I would have the same struggle too if I were in your shoes.

Yet, we have to pause and think about this for a few minutes lest we do something rash.

Paul Graham is often quoted as having said that early stage startups should “do things that do not scale.” I could not agree with him more, in fact there are times when more mature companies could use a modified version of that advice.

What is often not well understood by some investors, and many founders  . . . especially first time founders is why that advice is so important.

Here’s Paul in his own words:

Almost all startups are fragile initially. And that’s one of the biggest things inexperienced founders and investors (and reporters and know-it-alls on forums) get wrong about them. They unconsciously judge larval startups by the standards of established ones. They’re like someone looking at a newborn baby and concluding “there’s no way this tiny creature could ever accomplish anything.”

That initial fragility is why focus is the only strategy that any early stage technology startup ought to pursue. Focus allows the founders and the startup to do a few things in those early days;

1. Find, recruit, and gain an intimate understanding of the customers whose pain is most acute and for whom your solution is a highest priority item,
2. Satisfy the needs expressed by these early users, and build product features and a user/customer experience that delights them beyond their wildest expectations,
3. Use the lessons that you learn during this process of slow growth to figure out how to build the processes and procedures you will need to scale the excellence that should mark your execution at that scale to excellence as your startup exits the search and discovery phase, and lastly
4. To do all this without stressing the organization to the point of failure.

If you have not done so yet, you should read Paul’s post. He delves into the subject in a way only he can.

Imagine of a team of 3 co-founders with 2 contract developers helping build a product, it could be an enterprise or consumer product . . . and let’s assume they raised $750K in outside capital. Now think of the stress that team would be taking upon itself if it were to try to serve 10 different enterprise customers in 8 different industries. Consider all the ways each of these industries might differ in terms of the business protocols that the startup would have to become subject to, now also consider the ways in which each of the 10 customers might differ from the others. With only a few exceptions, it would make more sense to win 10 customers in 1 or 2 industries . . . Gain experience, gather momentum in those markets, grow the team in step with the growth of the startup’s customer-base and revenues . . . . and only when business development in those initial markets has reached a tipping point, then the startup can begin exploring customer acquisition in other markets. An analogous thought process works for startups building apps for consumers, and reaches a similar conclusion.

Think of it as building a solid foundation before attempting to complete the structure which will rest on the foundation. What ever the size of the structure, it will not last if the foundation that is meant to hold it up is weak.

Most research about why early startups fails lists the top two reasons as some combination of “produced something for which there was no market” and “run out of cash” . . . The research is often not granular enough to enable us to say definitely what exact reason led to those conclusions, but . . . A failure by an early stage startup’s founders to adopt focus as the launch strategy makes those two outcomes inevitable. Why?

First, lack of focus means the startup spreads itself too thin and fails to find and devote its attention and resources to those customers or users with the highest propensity to use, and then pay for the product.

Second, a lack of focus can be exorbitantly expensive if the startup is selling a product that is far from fully-baked to multiple industries. Several rounds of customizations for a small number of customers in a given market without a sales process to increase the revenues from that market quickly results in expenses that can quickly get out of control. It is not difficult to think of how this plays out for startups building apps for consumers.

Closing Thoughts: Every early stage technology startup should start out pursuing a focus as its generic strategy. The time to make a choice between cost leadership and differentiation is once product-market fit has been established, which is the point at which the startups begins to transition from searching for a repeatable, scalable, and profitable business model to building out the organizational structures of a company. Also;

1. The highly fluid and dynamic nature of the markets in which technology startups operate requires founders to be willing to experiment with combinations of the generic strategies once product-market fit has been established. They crucial requirement is to execute any such hybrid of the generic strategies in a way that strengthens the startups competitive position rather than weakening it.
2. Strategy is not a “set it and forget it” proposition . . . One of the functions of a good board of directors is a semi-annual review of the startup’s strategy to determine if there’s reason to consider making an adjustment. I do not mean to suggest that the strategy should change every six months, but the board should examine the environment every six months or so in order to ensure that maintaining the current course is the right strategic choice.

1. My target audience is made up of  first-time startup founders who do not have any background in business, finance, economics, or strategy. ?
2. I am paraphrasing Steve Blank and Bob Dorf, and the definition they provide in their book The Startup Owner’s Manual: The Step-by-Step Guide for Building a Great Company. I have modified their definition with an element from a discussion in which Paul Graham, founder of Y Combinator discusses the startups that Y Combinator supports. ?
3. Keith H. Hammond, Michael Porter’s Big Ideas. Accessed on Jun 20, 2015 at http://www.fastcompany.com/42485/michael-porters-big-ideas ?
4. It is not clear to me if the unbundling of CraigsList arose from conscious choices made by others observing the markets it served, or if this is a phenomenon that has only become obvious after the fact. ?

When I started business school at NYU Stern in the fall of 2005 my plan centered on taking every class in Bankruptcy & Reorganization, and Distressed Investing that I could. I took 3 elective classes in that area; Bankruptcy & Reorganization with Prof. Ed Altman, Case Studies in Bankruptcy & Reorganization with Prof. Max Holmes, and Investment Strategies: Distressed Investing with Prof. Allan Brown.

By my logic, if I learned how to assess and invest in dying companies, and then nurse them back to health, analysing, valuing and investing in healthy companies would seem easy by comparison. I was so sure of this that I also tried to turn my Equity Valuation elective into a pseudo Bankruptcy & Reorganization course too, by opting to value a bankrupt company for my final group-project. I do not recommend trying that.

I was still in business school when the economy began to falter. I moved from UBS to Lehman Brothers in late March 2007. A few days later New Century Financial Corp. filed for Bankruptcy. I was let go from Lehman Brothers a year later, on March 12, 2008. Bear Stearns collapsed and was acquired by JP Morgan Chase on March 16, 2008. I graduated from Stern in May, 2008. On September 7, 2008 Fannie Mae and Freddie Mac were taken over by the federal government. Lehman Brothers collapsed on September 15, 2008. On September 16, 2008 the Fed bailed out AIG.

The rest of 2008 was a bloodbath.

It was in that environment that I joined KEC Holdings, KEC Ventures parent company, in December 2008. I was employee #2. I had been hired into a new role that had not existed before at the company. My responsibilities encompassed any direct and indirect investments the company had made, or might make in the future.

Most notably, the company had already made 2 private equity investments; one in a private jet charter company and another in a fine-dining restaurant group – they were struggling to stay afloat given the economic environment. My first order of duty was to “make sure they don’t die” and “help them come out of this mess stronger than they were going into it.” There would be no financial engineering gimmickry. No tried and true business school textbook “indiscriminate” cost-cutting shortcuts. I had to roll up my sleeves and work with each company as intimately as necessary to achieve the objectives.

This post is about how we navigated that period. It is also about what that period between December 2008 and August 2013 has taught me about the challenges startups face, and my role as a venture capitalist.

Every day is a journey, and the journey itself is home.
– Matsuo Basho

Further Background

Both companies were generating top-line revenues in the range of $20,000,000 – $30,000,000 per year.1 Both had fallen short of budgetary expectations in 2008, but the aviation company had a more prolonged string of losses than the fine-dining restaurant, partly because the restaurant was a more recent investment at that point. I functioned as an “external management consultant”; I was not a full-time employee of either company, but I worked with employees across the hierarchy of both companies. The restaurant company employed between 400 and 500 people while the aviation company had between 30 and 40 employees after several previous rounds of downsizing.

Both companies had watched as some of their competitors ran into strong headwinds, and subsequently shut down operations because the economic environment was so bleak.

Lesson #1: Understand The Business

Once a company is in financial distress investors have to decide if it is worth saving, and they also have to answer the accompanying question; can it be saved given current known constraints? The only way to do this is to develop a deep understanding of the business, and the context within which it is operating.

Between 2008 and 2012, confidence in the economy was very low. People simply were not splurging on expensive meals or luxury jets. An economist would say that private jet charter and fine-dining both have a high elasticity of demand.

I had no prior experience working at, let alone helping to run a restaurant or a private jet charter company. So I decided to spend the first six months in learning mode. I studied everything I could about both markets while I helped the executives and managers at both companies deal with day-to-day nuts-and-bolts issues.

This was important if I was going to build personal credibility, and if I wanted to win buy-in for my ideas from the executives and managers later on. I had to be able to influence them into doing things they probably did not believe in at the outset, and I had to do this with little real influence.

How this applies to early-stage startups: Today, I look for founders who embrace their expertise, and demonstrate a knowledge of their business that surpasses mine. However, the founder also has to demonstrate an ability to assist me learn enough about their industry to make a decision, and act as a useful sounding board for decisions that have to be made in the future.

Lesson #2: Understand The People

During those six months, I also tried to understand the protagonists in each situation. I relied on a technique I had learned in my Literature in English classes during secondary school in Ghana; character analyses.

A character analyses involves performing an in-depth study of the key characters in a drama, and trying to figure out each character’s story; What motivates that person? Why is that person who they are? What is the person afraid of? What drives that person? How does that person communicate? How does that person respond to pressure and stress. What does that person gain the most satisfaction from? What’s the state of that person’s family life? How does that person perceive me? How do I perceive that person? Does that person buy into the need for a turnaround? Is that person willing to commit to the turnaround? What biases does the person exhibit that I can identify? How does that affect things?

I had to be honest, and to contend with the pleasant and the unpleasant, especially around the perceptions other people had of me at the outset.

I took copious notes, and added to them until I felt I had a decent understanding of each of the people with decision-making authority that I would be dealing with most often; executives, managers, and front-line employees.

Perhaps an important, but often overlooked insight is that an investor should strive to understand the people within the context of the business. For example, is this person a leader or a manager? The distinction matters because it can spell the difference between beating about the bush with no results to show, or getting to the heart of the matter and fixing the problems that need to be solved at a tactical and granular level. Fred Wilson writes about this problem in: Leaders and Executives.

How this applies to early-stage startups: We make seed stage and series A investments. That early in a startup’s life, the people make all the difference. The market is important, so is the product. However, at this stage the future is still so nebulous and difficult to envision that the team that has decided to embark on that journey matters more than anything else. So, I have learned to focus on questions like; How did this team come together? Do the founders take responsibility for outcomes, or do they have a habit of passing blame? Do they have the intestinal fortitude to withstand the difficulties they are bound to face as individuals, and as a team on this difficult path they have chosen or will they wilt under pressure? What evidence do I have to support my answer to this question. What is their approach to learning, as individuals and as a team? Have they faced crises together? How did they fare when the going got tough? I will not ask most of these questions directly, but I will be processing every interaction, every bit of information I get, to determine answers to questions along this line of reasoning.

Lesson #3: Create A Sense of Urgency, But Provide Hope

Unlike a startup, a company in financial distress already has a product that it has sold successfully in the past, it also has a sense of who its customers are and where to find them. It is easy for the people within the company to succumb to status quo bias. This is identifiable by statements such as;

1. “Everything will be fine, we just need to close this one sale.”
2. “I feel confident it will happen, we have this sale in the bag.”
3. “They are not our competitor, they do not do what we do!”

In the face of incontrovertible evidence that “they are up shit’s creek without a paddle” people will still choose to do what feels comfortable.

It was my responsibility to shake them out of that rut. As John P. Kotter says in Leading Change: Why Transformation Efforts Fail; 75% or more of a company’s management has to buy into the need for change, otherwise the chance that the change effort will fail is unacceptably high.

How did I do this? In both cases I did not shy away from asking questions that I expected to generate conflict. Indeed, on several occasions I had to have unpleasant and difficult conversations with the top managers and executives in both companies. I did this even if it appeared that I was “meddling” in areas where I had no business poking around. Of course, the idea that there was a part of either company’s operations that I “had no business” exploring was a fallacy only someone keen on maintaining the status quo would believe.

The message, delivered by the investors and the board, and reiterated by me during my frequent field trips, was simple; “The status quo is unacceptable, and failure for lack of effort is out of the question.” We had one chance to get it right, and we had to make the most of that chance even if it meant discomfort some of the time. We could get there with or without conflict. It was entirely up to us to make that choice.

How this applies to early-stage startups: The time for the whole team to start thinking about the Series A Round of Financing is the night before the Seed Round closes. Some one on the team should always be thinking about what it will take to raise the next round.

The time to start thinking about revenues is yesterday, even if you do not implement those plans immediately. Always have a plan. Always test your plan.

Lesson #4: Investors Have Ideas, But Management Runs The Business

Investors will always have ideas about how a business should be run. Sometimes investors know more about a certain topic than management. It is okay for investors to make suggestions, and to offer ideas to management. However, responsibility for choosing which ideas to accept and which to reject has to rest on the shoulders of management, and management has to accept accountability for the outcomes.

There are a number of ways this aspect of the relationship between investors and management might unfold;

1. Investors can dictate to management what investors think management should do, or
2. Investors can teach management how and why things should be done a certain way.

I chose the latter. That approach takes more time, but it is also more likely to lead to permanent change in behavior than the former. Also, once the lessons had taken root that approach allowed me to gradually pull back my involvement without jeopardizing the progress that management was making in improving results. It is an approach that builds self-sufficiency.

As part of the process, we cultivated the practice of communicating:

1. Why a certain goal or strategic initiative was important for the company’s near term goals and long term vision.
2. What had to get done in order for that goal or strategic initiative to be successfully executed.
3. Who specifically was primarily responsible for seeing that it got done, and which executive they could go to as often as necessary in order to navigate what ever obstacles they might encounter.
4. How it would get done, not in excruciating detail, but in broad terms. For example; Which teams needed to collaborate with one another in order to make it happen?
5. When the team expected to be able to report back periodically on their progress, and importantly, when the project needed to be complete.

To do this successfully, I had to focus on asking questions and encouraging deeper levels of inquiry than was the custom beforehand. Asking probing questions helped us cut out the “bullshit” of conventional wisdom that is seductively easy to accept.

Each time I heard; “You do not understand, that is not how it is done in our industry.” I would ask; “Why?” That would lead to an examination of the assumptions behind the choices that had been made in the past. Often there was no good reason to refuse to try something different even if it seemed out of step with accepted industry convention.

How this applies to early-stage startups: I am looking for founders at the seed or series A stage whose judgement I can trust enough to feel they do not need me to opine on every decision they ever have to make. That does not mean I am passive. It means I need to trust their decision-making skill and maturity enough to feel confident they will consistently make the right choices for all the startup’s constituents without the need to run everything by investors.

From the investors’ perspective, a policy of “show, don’t tell” goes a long way. To paraphrase the oft quoted saying; “Give a founder a fish and . . . . ” If I feel there’s something a founder ought to learn, I’d rather provide a guide to enable that founder learn the applicable frameworks and how to apply them in day-to-day decision-making situations.

Lesson #5: Create Internal Value By Increasing Organizational Capacity

The way we defined it; Organizational capacity is the harnessing of a company’s human, physical and material, financial, informational, and intellectual property resources in order to enable the company to continually perform above expectations and strengthen its competitive position.

In difficult times especially, it is important that companies do not lose sight of the need to continue to find ways to increase organizational capacity.

One way we did this, in both cases, was to shift both companies off MS Exchange Server and onto Google Docs for Work. This was not easy because of cultural attachments to MS Exchange and fear of having to learn something new. Both companies made the shift, eventually. The immediate benefit they experienced was a dramatic reduction in the costs they incurred for IT assistance. A more important, though less tangible benefit was that both businesses could then afford to give every full-time employee a corporate email address and access to a corporate intranet portal. The benefits were enormous; easier collaboration, easier information transfer and sharing,  and increased security of corporate information and trade secrets. Quicker turnaround on tactical decisions because people could now communicate by chat.

Given the improvements in tools for collaboration, we encouraged the formation of cross-disciplinary teams to tackle some of the problems that each company was dealing with. This allowed people from one area of each business to interact more closely with their colleagues from another area of the business. They developed a better understanding of one another, and of the challenges and constraints that they each faced in trying to execute their day-to-day responsibilities. In turn this fostered a more collaborative relationship across the entire organization. It also enhanced the learning environment for all employees.

How this applies to early-stage startups: It does not take a lot by way of resources to create an environment that is rich in opportunities for cross-functional collaboration and learning. This comes in handy during due diligence because every member of the team will be able to speak knowledgeably about the startup’s immediate and long term plans.

Lesson #6: Direction Must Be Set From The Top, But Engagement Must Begin at The Bottom

We started working on trying to develop a strategic plan for both companies in summer 2009. Before this time, neither company had previously had a coherent strategy.

In consultation with the executives in each company, the board of directors set out the broad areas that the strategic plans ought to cover; Finance, Operations, People, Demand Creation, and Expansion.

Once those had been agreed on, it was my job to meet with front-line employees as well as managers in the field in order to obtain data and insight about how the strategic plan would have to be set up in order to function effectively for them given what each company was trying to accomplish.

That sounds easy. It is not. It took multiple meetings, of several hours each. The restaurant had multiple locations in NYC, one location in NJ and another in CT. I did not visit the location in Chicago, the CFO held discussions with them during his quarterly visits. I had to sift through everything I heard during those meetings, and I had to extract broad themes. Then I had to reconcile that with the strategic framework established by the board. Finally, I had to interpret that information from the perspective of the competitive landscape for each of the two companies. Finally, I had to synthesize it all into digestible chunks for the board, the executives, the managers and rank-and-file employees.

The goal of spending so much time on having these meetings with people across all ranks in each company was to ensure that once the strategy was developed and implemented, there would be complete alignment behind the vision embodied in the strategy, and just as important that every employee would be engaged in and committed to executing the tactical initiatives required to make the strategy succeed.

How this applies to early-stage startups: The founder creates the vision that investors and the startup’s team buys into. The team executes to turn that vision into a living, breathing, growing reality. Investors hopefully act as a positive catalyst to help the process unfold more quickly.

Lesson #7: Do Not Ignore The Soft Issues, Emphasize Both Hard and Soft Issues Simultaneously

My experience might as well be called The Tale of Two Turnarounds. In one company leadership admitted things were awful. They also admitted that they could use whatever help I could offer. They readily admitted their limitations as a team. We had many instances of conflict, but starting from a position of optimism and a willingness to try, the process moved along slowly, but steadily. We created a survey that we administered twice a year to get a sense of how employees were feeling, data that might not be captured in the key performance metrics we monitored weekly, monthly, quarterly, and annually.

We launched the strategic plan in January 2010 after 9 months of work specifically focused on that task. A year later the company made its first ever payments from a new profit-sharing plan that we had created as part of the new strategy. The payments were not huge, but they were evidence that the team’s hard work was paying off. It also created a feedback loop about how actions by employees affect the bottom-line performance of the company.

In the other company the founder, who was also the ceo, was grumpy and relatively uncooperative with investors. To cut a long story short, we launched the strategic plan in April 2010, after about 9 months of work specifically focused on that assignment. Within 6 months 75% of the managers with whom we had worked to develop and launch the strategic plan had left the company or had been fired. It was a classic case in which we would take two steps forward only to take four steps backward.

Morale dipped ever lower. The founders incessant talk about “a vision” and “a mission” became the butt of jokes among rank-and-file employees. It became clear that employees were becoming disillusioned with what the company stood for. While the company fared better than it would have if there had been no attempt at executing a turnaround and developing a strategy, it continued to perform well below its potential.

At a board meeting one day, the founder/ceo went into a vituperous rant about all the areas where the company was falling short. This was in early to mid 2012. I had to burst out in laughter. He might as well have been reciting problems whose solution formed the core of the strategic plan we created in 2010. Implementing that plan would have started the process of solving those problems he was so exercised about that day. We had lost two years for no good reason.

No amount of emphasis on key performance metrics made a difference. Without the founder’s full embrace of the strategic plan, nothing else mattered. I should point out that he had been intimately involved in crafting the strategic plan. This was not a plan that was forced down on him “from on high.” It became clear how badly things had deteriorated when a long time employee quit, this individual was the only employee at the company who had been there as long as the founder.

How this applies to early-stage startups: I am of a firm belief that the team is really important at the seed and series A stage, or at least until uncertainty around product market fit has been largely eliminated. So, I need to develop a sense that a founder is someone I can work with over the long haul . . . Actually, the kind of founder I am happy backing has to be someone I could envision myself working for if circumstances were different. Age, race, gender, religion . . . That is all irrelevant. Early in my process for assessing a startup I focus almost entirely on soft issues.

In one example, I sensed something amiss about the body language between 2 Spanish co-founders pitching a startup to my partner and I in 2013. I decided to tune out what they were saying in order to better observe their body language. There was something about their body language towards one another that did not align with what they wanted us to believe, in my opinion. We passed on their seed round, and decided to watch them till we could get more data about the relationship between the co-founders. That was nearly 3 years ago. I have heard no reports to suggest we made an error in that case.

Let chaos reign, then reign in chaos.1

– Andy Grove, Only The Paranoid Survive

Lesson #8: Be Prepared For Chaos; Harness, Focus And Direct It, Empower People

Once employees understood the strategic plan as well as the tactical initiatives that accompanied it, they began developing ideas related to the various functional areas in each company and making suggestions to managers and excutives.

At first this was overwhelming . . . Managers had to do their own work, manage the work of the groups of people that they managed, and now . . . . They also had all these ideas being thrown at them from “left, right, and center.” The initial knee-jerk reaction was to try to “make it stop.”

That would have been a mistake. Among the deluge of ideas were some real gems.

For example, a maintenance department team member at the aviation company noticed that the company could cut down on its electricity usage by changing all the bulbs in its main hangar . . . No one had thought about that over the years, but our discussion about the strategic initiative around improving the product while reducing costs prompted him to take another look at the company’s hangars in search of opportunities to reduce operating costs. Thanks to improvements in technology over the years this was now a measure that could be implemented relatively easily.

In another instance, the team at our restaurant in CT had observed that on certain days of the week large groups of Chinese tourists visited the casino resort in which they are located. They had been thinking of a way to capture some of that business, but had assumed the corporate office would object to the menu changes they thought they had to make in order to execute that plan. As part of our implementation of the strategic initiative around increasing revenues, I suggested they conduct an experiment, analyze the outcome, and then seek assistance from the corporate office if the results looked promising. They did that, and saw a jump in revenues on two days of the week when business would otherwise have been slow. The corporate office gave its blessing, and assisted in making that practice more entrenched by using corporate resources to give it the polish required for company-supported initiatives.

How this applies to early-stage startups: A startup stops being a startup once its search for a repeatable, scalable, and profitable business model is complete. While that search is in process it is important that every member of the team feels empowered to contribute to the discovery of that business model. It can’t be the job of only some members of the team, it has to be part of everyone’s job. The faster a startup gets through the discovery process the better.

Lesson #9: The Turnaround Should Be Its Own Reward; Incentives Should Reinforce Change Not Drive It

It was nice to be able to make payments from the profit-sharing plan that we instituted. The payments were relatively small, yet they were tangible evidence to the employees, managers, and executives that they were collectively well equipped to make it through the ongoing turbulence and correct the mistakes of the past.

The sense of accomplishment employees felt translated into a number of things, among them;

1. Newfound and increasing pride in being associated with a company that was succeeding where many of its rivals had failed.
2. High levels of morale and optimism about the future of the company, and their place at the company. Less stress about employment security.
3. A greater willingness to take the initiative in situations where the possibility of generating business for the company exists.

Basically, every employee was empowered to function as a salesperson on the company’s behalf. We arranged training sessions to equip every employee with the vocabulary they needed to understand in order to do that effectively. We also developed simple tools that they could use. They did not replace the company’s professional salespeople . . . They became an auxiliary sales force.

How this applies to early-stage startups: As startups grow, founders and early team members need to get better at the art and science of “managerial leverage” . . . What is managerial leverage? It is the process by which a manager creates output that far supersedes that manager’s input by using all the resources at the manager’s disposal to influence the work that is done by the group of people whose on-the-job effectiveness and work-output is affected by interactions with the manager.

What is a manager’s output? According to Andy Grove, co-founder and former CEO of Intel “The output of a manager is a result achieved by a group either under his supervision or under his influence.” Great managers create positive output that far exceeds expectations. Below average managers create output that fails to meet expectations given superior resources. Average managers? The team’s output would not be any different if the manager were absent.

The art of managerial leverage is in determining; how to apportion time, where to pay more attention, where to pay less attention, who to pay more attention to, who to pay less attention . . . . etc etc. The science of managerial leverage is in determining; what to measure, when to measure it, how often to monitor what is being measured, where bottlenecks are most likely to occur and why, and how to eliminate them . . . . etc etc.

Managerial leverage drives output. Output drives results. Results are measured and reflected in the KPI’s that founders and investors measure. Getting that order right is critical to a startup’s success.

Lesson #10: Learn To Listen, And Communicate Effectively

It is amazing how many problems can be solved relatively quickly if people would communicate more effectively internally and externally. Communication involves two actions; first listening actively in order to understand what is driving the actions of other people. Second, responding to what other people have said in a way that gets to the root cause of the problem being discussed.

During one of my field visits, I spent 8 hours on my first day listening to the executives talk about all the problems they each perceived, and how they felt the issues ought to be tackled. I spent that day with the CEO/President, the CFO, the Head of HR, and the Head of Sales. I encouraged open disagreement and debate.

On my second day I spent about the same amount of time speaking with the middle managers; again we discussed the problems they each perceived, and how they each felt the issues ought to be tackled.

On the third day I brought both groups together, and moderated an all day discussion about the problems the company was facing. Once again, I encouraged open disagreement and debate. Also, I put the inter-personal issues and conflicts that I had uncovered on the table. Things often got heated. It was my job to function as a pressure-release valve during those episodes. It was not pretty.

For example, I explained to the entire group how the CFO who was disliked by a large number of people within the company had made payroll on too many occasions by dipping into his personal 401(K) savings for example. The irony, the folks who disliked him routinely failed to provide the finance team with the data they needed in order to collect on accounts receivable from the company’s customers.

The outcome of this exercise was that;

1. Everyone felt they had been given a chance to speak and be heard by the rest of the leadership team, and
2. We discussed expectations in a fair amount of detail, enough so that more work could be done laying them out in adequate specificity rather than vaguely wondering what people could expect from one another, and finally
3. Created an environment in which each member of the leadership team contributed in creating a communication framework against which they agreed to be held accountable

Our goals for the communication framework were that;

1. Every employee should know what is expected of them, as individual team members,
2. Every employee should know what to expect from every other member of the team,
3. Employees should know what to expect from executives and managers, and lastly
4. Accountability should be about improving team and company performance, not punishing individuals.

As Rosabeth Moss Kanter says in Four Tips for Building Accountability; “The tools of accountability — data, details, metrics, measurement, analyses, charts, tests, assessments, performance evaluations — are neutral. What matters is their interpretation, the manner of their use, and the culture that surrounds them. In declining organizations, use of these tools signals that people are watched too closely, not trusted, about to be punished. In successful organizations, they are vital tools that high achievers use to understand and improve performance regularly and rapidly.”

How this applies to early-stage startups: Startups typically have to move quickly, especially if they have taken in capital from institutional venture capitalists. A culture of blame, lack of cohesive teamwork, and a lack of organization-wide accountability is an insidious tumor that will eventually lead to failure. The founders who are most successful in the long run are those who do not shift responsibility when things are difficult, but instead serve as a model that other team members can emulate.

Closing Thoughts

Executing a turnaround and getting a startup through the phase of discovering a business model are really just two sides of the same coin. That experience has led me to the belief that it is when things seem bleak that great early stage investors prove their worth.

Further Reading

Blog Posts, Articles, & White Papers

1. The Psychology of Change Management
2. Motivating People: Getting Beyond Money
3. The Irrational Side of Change Management
4. The CEO’s Role in Leading Transformation
5. The Role of Networks in Organizational Change
6. All I Ever Needed To Know About Change Management I Learned at Engineering School
7. Changing an Organization’s Culture, Without Resistance or Blame

Books

1. High Output Management
2. Only The Paranoid Survive
3. How Did That Happen?
4. HBR’s 10 Must Reads on Change Management
5. HBR on Turnarounds