The Lean Startup - Eric Ries [46]
A startup’s job is to (1) rigorously measure where it is right now, confronting the hard truths that assessment reveals, and then (2) devise experiments to learn how to move the real numbers closer to the ideal reflected in the business plan.
Most products—even the ones that fail—do not have zero traction. Most products have some customers, some growth, and some positive results. One of the most dangerous outcomes for a startup is to bumble along in the land of the living dead. Employees and entrepreneurs tend to be optimistic by nature. We want to keep believing in our ideas even when the writing is on the wall. This is why the myth of perseverance is so dangerous. We all know stories of epic entrepreneurs who managed to pull out a victory when things seemed incredibly bleak. Unfortunately, we don’t hear stories about the countless nameless others who persevered too long, leading their companies to failure.
WHY SOMETHING AS SEEMINGLY DULL AS ACCOUNTING WILL CHANGE YOUR LIFE
People are accustomed to thinking of accounting as dry and boring, a necessary evil used primarily to prepare financial reports and survive audits, but that is because accounting is something that has become taken for granted. Historically, under the leadership of people such as Alfred Sloan at General Motors, accounting became an essential part of the method of exerting centralized control over far-flung divisions. Accounting allowed GM to set clear milestones for each of its divisions and then hold each manager accountable for his or her division’s success in reaching those goals. All modern corporations use some variation of that approach. Accounting is the key to their success.
Unfortunately, standard accounting is not helpful in evaluating entrepreneurs. Startups are too unpredictable for forecasts and milestones to be accurate.
I recently met with a phenomenal startup team. They are well financed, have significant customer traction, and are growing rapidly. Their product is a leader in an emerging category of enterprise software that uses consumer marketing techniques to sell into large companies. For example, they rely on employee-to-employee viral adoption rather than a traditional sales process, which might target the chief information officer or the head of information technology (IT). As a result, they have the opportunity to use cutting-edge experimental techniques as they constantly revise their product. During the meeting, I asked the team a simple question that I make a habit of asking startups whenever we meet: are you making your product better? They always say yes. Then I ask: how do you know? I invariably get this answer: well, we are in engineering and we made a number of changes last month, and our customers seem to like them, and our overall numbers are higher this month. We must be on the right track.
This is the kind of storytelling that takes place at most startup board meetings. Most milestones are built the same way: hit a certain product milestone, maybe talk to a few customers, and see if the numbers go up. Unfortunately, this is not a good indicator of whether a startup is making progress. How do we know that the changes we’ve made are related to the results we’re seeing? More important, how do we know that we are drawing the right lessons from those changes?
To answer these kinds of questions, startups have a strong need for a new kind of accounting geared specifically to disruptive innovation. That’s what innovation accounting is.
An Accountability Framework That Works Across Industries
Innovation accounting enables startups to prove objectively that they are learning how to grow a sustainable business. Innovation accounting begins by turning the leap-of-faith assumptions discussed in Chapter 5 into a quantitative financial model. Every business plan has some kind of model associated with it, even if it’s written on the back of a napkin.