CHAPTER 1
The Path to Disaster: The Product Development Model

. for the gate is wide and the road broad that leads to destruction, and those who enter through it are many.

- Matthew 7:13

EVERY TRAVELER STARTING A JOURNEY MUST decide what road to take. The road well traveled seems like the obvious choice. The same is true in the search for startup success: Following a path of common wisdom-one taken by scores of startups before-seems like the right way. Yet for most startups, the wide road often leads straight to disaster. This chapter looks at how and why this is so.

Let me begin with a cautionary tale. In the heyday of the dot-com bubble, Webvan stood out as one of the most electrifying new startups, with an idea that would potentially touch every household. Raising one of the largest financial war chests ever seen (over $800 million in private and public capital), the company aimed to revolutionize the $450 billion retail grocery business with online ordering and sameday delivery of household groceries. Webvan believed this was a "killer application" for the Internet. No longer would people have to leave their homes to shop. They could just point, click, and order. Webvan's CEO told Forbes magazine Webvan would "set the rules for the largest consumer sector in the economy."

Besides amassing megabucks, the Webvan entrepreneurs seemed to do everything right.

The company raced to build vast automated warehouses and purchased fleets of delivery trucks, while building an easy-to-use website. Webvan hired a seasoned CEO from the consulting industry, backed by experienced venture capital investors. What's more, most of their initial customers actually liked their service. Barely 24 months after the initial public offering, however Webvan was bankrupt and out of business. What happened?

It wasn't a failure of execution. Webvan did everything its board and investors asked. In particular, the company religiously followed the traditional Product Development model commonly used by startups, including "get big fast," the mantra of the time. Its failure to ask, "Where Are the Customers?" however, illuminates how a tried-and-true model can lead even the best-funded, best-managed startup to disaster.

The Product Development Model

Every company bringing a new product to market uses some form of Product Development Model (Figure 1.1). Emerging early in the 20th century, this product-centric model described a process that evolved in manufacturing industries. It was adopted by the consumer packaged goods industry in the 1950s and spread to the technology business in the last quarter of the 20th century. It has become an integral part of startup culture.

Figure 1.1 The Product Development Model

At first glance, the diagram appears helpful and benign, illustrating the process of getting a new product into the hands of waiting customers. Ironically, the model is a good fit when launching a new product into an established, well-defined market where the basis of competition is understood, and its customers are known.

The irony is that few startups fit these criteria. Few even know what their market is. Yet they persist in using the Product Development model not only to manage Product Development, but as a roadmap for finding customers and to time their sales launch and revenue plan. The model has become a catchall tool for every startup executive's schedule, plan, and budget. Investors use the Product Development model to set and plan funding. Everyone involved uses a roadmap designed for a very different location, yet they are surprised when they end up lost.

To see what's wrong with using the Product Development model as a guide to building a startup, let's first look at how the model is currently used to launch a new product. We'll view the actions at each step in two ways: in general practice and in the specific example of Webvan, which managed to burn through $800 million in three years. Then we will dissect the model's toxic consequences for startups.

What's wrong with the old model in general, and how did Webvan compound those wrongs in their billion-dollar implosion? Let's look at the model stage-by-stage.

Concept and Seed Stage

In the Concept and Seed Stage, founders capture their passion and vision for the company and turn them into a set of key ideas, which quickly becomes a business plan, sometimes on the back of the proverbial napkin. The first thing captured and wrestled to paper is the company's vision.

Next, issues surrounding the product need to be defined: What is the product or service concept? Is it possible to build? Is further technical research needed to ensure the product can be built? What are the product features and benefits?

Third, who will the customers be and where will they be found? Statistical and market research data plus potential customer interviews determine whether the ideas have merit.

Step four probes how the product will ultimately reach the customer and the potential distribution channel. At this stage companies start thinking about who their competitors are and how they differ. They draw their first positioning chart and use it to explain the company and its benefits to venture capitalists.

The distribution discussion leads to some basic assumptions about pricing. Combined with product costs, an engineering budget, and schedules, this results in a spreadsheet that faintly resembles the first financial plan in the company's business plan. If the startup is to be backed by venture capitalists, the financial model has to be alluring as well as believable. If it's a new division inside a larger company, forecasts talk about return on investment. Creative writing, passion, and shoe leather combine in hopes of convincing an investor to fund the company or the new division.

Webvan did all of this extremely well. Founded in December 1996, with a compelling story, and a founder with a track record, Webvan raised $10 million from leading Silicon Valley venture capitalists in 1997. In the next two years, additional private rounds totaling an unbelievable $393 million would follow before the company's IPO (initial public offering).

Product Development

In stage two, Product Development, everyone stops talking and starts working. The respective departments go to their virtual corners as the company begins to specialize by functions.

Engineering designs the product, specifies the first release and hires a staff to build the product. It takes the simple box labeled "Product Development" and using a Waterfall development process makes detailed critical path method charts, with key milestones. With that information in hand, Engineering estimates delivery dates and development costs.

Meanwhile, Marketing refines the size of the market defined in the business plan (a market is a set of companies with common attributes), and begins to target the first customers. In a well-organized startup (one with a fondness for process) the marketing folk might even run a focus group or two on the market they think they are in and prepare a Marketing Requirements Document (MRD) for Engineering. Marketing starts to build a sales demo, writes sales materials (presentations, data sheets), and hires a PR agency. In this stage, or by alpha test, the company traditionally hires a VP of Sales.

In Webvan's case, Engineering moved along two fronts: building the automated warehouses and designing the website. The automated warehouses were a technological marvel, far beyond anything existing grocery chains had. Automated conveyors and carousels transported food items off warehouse shelves to workers who packed them for delivery. Webvan also designed its own inventory management, warehouse management, route management, and materials handling systems and software to manage the customer ordering and delivery flow processes. This software communicated with the Webvan website and issued instructions to the various mechanized areas of the distribution center to fulfill orders. Once a delivery was scheduled, a route-planning feature of the system determined the most efficient route to deliver goods to the customer's home.

At the same time, planning began for a marketing and promotion program designed to strengthen the Webvan brand name, get customers to try the service in the first target market, build customer loyalty, and maximize repeat usage and purchases. The plan was to build Webvan's brand name and customer loyalty through public relations programs, advertising campaigns, and promotional activities.

Alpha/Beta Test

In stage three, alpha/beta test, Engineering works with a small group of outside users to make sure the product works as specified and tests it for bugs. Marketing develops a complete marketing communications plan, provides Sales with a full complement of support material, and starts the public relations bandwagon rolling. The PR agency polishes the positioning and starts contacting the long lead-time press while Marketing starts the branding activities.

Sales signs up the first beta customers (who volunteer to pay for the privilege of testing a new product), begins to build the selected distribution channel, and staffs and scales the sales organization outside...