What's the impact of lean thinking on a startup's growth?
FEATURE - An initial look into the impact of lean management principles on the growth of young organizations hopes to encourage further analysis into why and how lean startups succeed.
Words: Arnaldo Camuffo, Professor of Lean Management, Bocconi University, Milan, and President, Istituto Lean Management; Alessandro Cordova, PhD candidate, Bocconi University, Milan
Helen is Chinese, lives in Italy and is a good cook. She has a talent for mixing recipes and flavors from the Italian and Chinese cuisines. Her family loves her food so much they start thinking about opening a restaurant. If they love it, other people will too!
Chinese customers will learn more about Italian traditions and enjoy the simple flavors of Italian products, and those Italians who already appreciate Chinese food will happily become clients and encourage others to do the same.
With this assumption and an idea that seems to show promise, Helen and her husband Chen begin to look for potential locations and estimate the costs of the restaurant premises, set-up and personnel. They eventually make the choice of tapping into their savings to rent and set up a nice, cozy place close to the town center.
Three months go by, and no clients walk in. Six months pass, and very few people do. One year since opening, the situation has not improved, and Helen and Chen sadly close the restaurant.
Now, let's rewind and imagine a different scenario.
Helen is Chinese, lives in Italy and is a good cook. She and her husband Chen realize they have never had anyone outside of the family circle taste Helen's food and decide to run an experiment: they organize a big dinner at their house, inviting all of their Chinese and Italian friends (families, young and adults).
At the end of the dinner, Helen and Chen observe that their Chinese guests were not enthusiastic about the Italian-Chinese mix, while Italian families were surprised to see how much their children enjoyed the food. As it turns out, they rarely go to Chinese restaurants because their kids don't know what to order – something Helen has found a solution for.
Helen and Chen then decide to open a restaurant in an area of the city with a large number of Italian families. One week passes and the restaurant is half full. Three months pass and Italian families need to book a table in advance if they are to eat at the restaurant. Six months pass and Helen and Chen realize they could open a second restaurant in another location.
While this story may bring back memories of the film Sliding Doors, it is actually taken from one of the interviews we recently conducted as part of an entrepreneurship research project.
Why were Helen and Chen successful in the second scenario and not in the first? Planet Lean readers and lean thinkers at large will already know the answer: it is because in the second scenario Helen and Chen applied lean startup ideas (discussed by Eric Ries in his 2011 book The Lean Startup).
Rather than starting out by engaging in time consuming and often-unreliable business planning, aimed at obtaining the necessary funding for product industrialization, startups focus on their value proposition and validate their hypotheses.
They do not need a lot of money to test their assumptions: they can use questionnaires, power point presentations, or run experiments with embryonic versions of their products or services (known as minimum viable products) such as Helen's dinner with friends. Once they obtain feedback, they can recalibrate their offer and therefore have higher chances of survival.
A lean startup approach is particularly important when an entrepreneur tries to launch a new idea, such as Helen's "fusion" Chinese-Italian restaurant, because there are no benchmarks that can help assess its potential. Getting "out of the building" and engaging with potential customers is the only way.
In fact, the lean startup concept may actually be more elaborate than the one presented in the example above; gathering feedback once may be sufficient, but more often than not several iterations are needed. For example, Helen and Chen could have gotten unclear feedback from their friends and needed to experiment on a larger sample. There are sophisticated ways of measuring performance and experimenting, such as cohort analysis and A/B testing. There are also a variety of alternatives for how a given business idea might evolve as the result of such tests. Ries, for example, discusses an entire catalog of pivots in his book, i.e. ways in which a startup can change over time when faced with negative feedbacks from customers.
But the essential contribution of lean thinking to entrepreneurship and startups is the idea of testing business assumptions early on in the cycle, making evidence-based decisions, and postponing unnecessary investment.
Examples like Helen and Chen's are now many and span from the most obvious web and B2C software industry - where market risk is high, minimum viable products can be cheaply built and experimentation is effective - to more traditional businesses like restaurants, laundries and even government organizations.
There is much interest and buzz about lean startups. Positions are often polarized among entrepreneurs, capital providers and analysts alike, with the enthusiasts on one side, who believe that the lean startup approach works wonderfully under any circumstances, to the skeptical on the other, who often comment with a simple "Nothing new under the sun."
Because of this growing interest and the associated lack of evidence about the actual effect that the application of this approach may have on the performance of startups, we have carried out an initial attempt to measure the impact of lean startup methodologies on revenue and user growth.
We submitted a Qualtrics-based lean startup survey to more than 3,000 newsletter subscribers of a web platform and online community for Italian startups whose objective is to facilitate fundraising, promote collaboration and share information among its members. More than 100 people responded to the survey over a two-week period, but only 45 of the respondents completed the survey with all the information. This low response rate was not unexpected, given the confidential nature of the data we tried to gather (performance data including revenue and user growth rates).
Checking for the size, age, industry, experience and funding availability of the analyzed startups, we ran regression analyses and found evidence that application of lean startup principles, such as MVP and pivoting significantly increase the magnitude and speed of growth in either user base and company revenue.
While our study may suffer from limitations relative to the sample size at hand and the self-reported measures of firm performance, we think we opened a new avenue of investigation - hopefully paving the way to further research on how lean startups actually perform and why they might perform differently.
In addition to refining the attempt to quantitatively establish the impact of lean on startup performance and survival, we conducted early qualitative analyses suggesting other important themes to investigate.
At micro level, possible explanations to why only some startups adopt lean principles may reside in certain psychological attributes of founders, such as their degree of open-mindedness, humbleness, ability to learn from mistakes, or courage. Startuppers have also reported that their learning is "increasingly lean" over time, suggesting that the extent to which startups are lean and the consequent impact of the latter on their performance should be measured repeatedly over their lifecycle and their entrepreneurial history.
At industry level, we observed that the higher the level of competition, the lower the incentive for startuppers to engage with potential customers, given the higher risk of being imitated. Also, while new ideas benefit from a lean approach, very radical ones that require time to be accepted by customers (e.g. the first mobile phone and PC) may not get to the market as they receive negative feedback during the experimentation phase. Seemingly, there is a risk in building a MVP: the latter may receive a negative customer feedback but potential customers may have liked features of the final product or service that the entrepreneur left out for the sake of showing potential customers only the essential ones.
Finally, at macro level, harsher economic conditions may actually lead more young enterprises to adopt lean practices as a way to cope with limited resources. The ongoing crisis in Europe might be, eventually, one of the reasons why the startup movement is flourishing.
Lean startup has grown into a community online where startuppers help each other in adopting these principles, more and more conferences and workshops are on offer to teach them how to become lean, and more books have been written extending lean concepts to startup specific operations like analytics and user experience.
We have just begun to understand the dynamics of the burgeoning lean startup world, a fascinating area that deserves further investigation.