The Lean Startup - Eric Ries [67]
Let’s take a look at this process in action in a dramatic pivot done by a company called Wealthfront. That company was founded in 2007 by Dan Carroll and added Andy Rachleff as CEO shortly thereafter. Andy is a well-known figure in Silicon Valley: he is a cofounder and former general partner of the venture capital firm Benchmark Capital and is on the faculty of the Stanford Graduate School of Business, where he teaches a variety of courses on technology entrepreneurship. I first met Andy when he commissioned a case study on IMVU to teach his students about the process we had used to build the company.
Wealthfront’s mission is to disrupt the mutual fund industry by bringing greater transparency, access, and value to retail investors. What makes Wealthfront’s story unusual, however, is not where it is today but how it began: as an online game.
In Wealthfront’s original incarnation it was called kaChing and was conceived as a kind of fantasy league for amateur investors. It allowed anyone to open a virtual trading account and build a portfolio that was based on real market data without having to invest real money. The idea was to identify diamonds in the rough: amateur traders who lacked the resources to become fund managers but who possessed market insight. Wealthfront’s founders did not want to be in the online gaming business per se; kaChing was part of a sophisticated strategy in the service of their larger vision. Any student of disruptive innovation would have looked on approvingly: they were following that system perfectly by initially serving customers who were unable to participate in the mainstream market. Over time, they believed, the product would become more and more sophisticated, eventually allowing users to serve (and disrupt) existing professional fund managers.
To identify the best amateur trading savants, Wealthfront built sophisticated technology to rate the skill of each fund manager, using techniques employed by the most sophisticated evaluators of money managers, the premier U.S. university endowments. Those methods allowed them to evaluate not just the returns the managers generated but also the amount of risk they had taken along with how consistent they performed relative to their declared investment strategy. Thus, fund managers who achieved great returns through reckless gambles (i.e., investments outside their area of expertise) would be ranked lower than those who had figured out how to beat the market through skill.
With its kaChing game, Wealthfront hoped to test two leap-of-faith assumptions:
1. A significant percentage of the game players would demonstrate enough talent as virtual fund managers to prove themselves suitable to become managers of real assets (the value hypothesis).
2. The game would grow using the viral engine of growth and generate value using a freemium business model. The game was free to play, but the team hoped that a percentage of the players would realize that they were lousy traders and therefore want to convert to paying customers once Wealthfront started offering real asset management services (the growth hypothesis).
kaChing was a huge early success, attracting more than 450,000 gamers in its initial launch. By now, you should be suspicious of this kind of vanity metric. Many less disciplined companies would have celebrated that success and felt their future was secure, but Wealthfront had identified its assumptions clearly and was able to think more rigorously. By the time Wealthfront was ready to launch its paid financial product, only seven amateur managers had qualified as worthy of managing other people’s money, far less than the ideal model had anticipated.