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To Get Big, You've Got to Start Small

A Benchmark Capital founding partner explains why, contrary to what you may believe, the secret to attracting a broad market is to appeal to a tiny, passionate one first.
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This fall I was fortunate to have John Morgridge guest teach one of my classes at Stanford's Graduate School of Business. The case study for the class, called Formation of New Ventures, focused on his challenges in his first 90 days as Cisco's CEO in 1988.

John, who took Cisco public in 1990, grew the company from $5 million to more than $1 billion in sales. He was CEO for seven years and chairman for 11.

He spent the beginning of the class talking about the benefits of spinning out a technology from a university, and of using universities as an initial market. Cisco's technology, like that of many of Silicon Valley's most successful companies, was created at Stanford.

To drive home his points, John held up a copy of Crossing the Chasm and asked the students if any had read the book. No one raised a hand.

John, my teaching partner Mark Leslie, the founding CEO of Veritas Software, and I were shocked. Just 15 years ago, Crossing the Chasm was looked upon as gospel in the technology entrepreneurship community, just as The Lean Startup is now. In my job at Benchmark Capital, I recommended Crossing the Chasm to many young entrepreneurs. And I apply its lessons to my own company now.

The book's premise is that every technology has an adoption life cycle. Start-up products initially appeal to "innovators," people who want to try every new thing but are seldom willing to spend very much, if anything, for products that interest them. Then come the "visionaries," early adopters willing to take a chance on a new product if it solves a burning problem. All they need is a proof of concept to take the leap of faith. After the visionaries come the "pragmatists." No matter how well a product serves their needs, they buy only after friends or colleagues have recommended it. Typically, the pragmatists or the "early majority" represent the largest market segment. The "late majority," conservatives who buy only after a product has become the standard, follow the early majority. Finally come the "laggards," who never buy.

 

 

The chasm lies between the early adopter and early majority stages. A whole product is required for a technology to cross the chasm. It includes the features, interfaces, and third party products and services needed to garner the references required to sell the new technology to a broad and demanding audience.

Geoffrey Moore, the book's author, argues that companies must first dominate a niche of early adopters and expand from a position of strength to succeed. This advice contrasts with the view, commonly held by today's entrepreneurs, that companies need to address a large market from the start. 

In their eagerness to win, entrepreneurs ignore the lessons of history. Name a successful tech company. The overwhelming odds are that it followed Moore's advice.

Facebook started with students at Ivy League universities. eBay focused first on collectibles. LinkedIn's initial target was execs in Silicon Valley. Google's early ads appealed to start-ups that couldn't afford the minimum buy associated with banner ads. Amazon started with books. Each company added functionality and addressed a broader audience--but over time, not from the beginning.

Over my long venture capital career, the biggest mistake I saw start-ups make was attempting to skip the early adopter stage to move directly into the early majority stage. Founders wanted to get big, fast. 

I understood the pressure they were under. Fewer than half of angel-backed companies attract venture capital, and the vast majority of venture-backed companies are not able to make the leap from early adopters to the much larger market associated with the early majority. Venture capitalists care deeply about the ultimate size of market the company addresses because it is typically the greatest determinant of outcome.

The hasty strategy seldom worked. Oddly, to get big you must first start by addressing a small market. (By the way, I know there are a lot of people who call themselves venture capitalists who advise the opposite. I doubt they have very good track records.) 

To create the aforementioned whole product, a start-up usually needs to attract a corporate partner to provide complementary products and services. Unfortunately, managers at large companies often consider small companies inferior and therefore not worth their time. The only way to attract them is to dominate a market the big companies want to enter. And the only way for a small company to dominate a market is to initially pursue a small one. Over time, the small market and the small company get big, together.

If you're like most people you will find this advice counterintuitive. I've experienced this reaction viscerally at Wealthfront, the software-based financial advisor I founded after I retired from the venture capital business.

The biggest challenge faced by financial services startups like mine is trust. In the investment management business, clients typically use assets under management--size--as a proxy for trust. How then do you attract assets if you don't have assets? Our solution was to focus initially on young people who work for tech companies. We thought they would be more interested in our user experience than our assets under management. 

Many bloggers and industry analysts don't understand that approach. Few have read Crossing the Chasm, so they think there must be something wrong with an initially narrowly focused service. They've read successful companies' revised official histories, which often leave out the early focus. Instead of emphasizing their first niche product, winners typically act as if they addressed a large market from the beginning. That makes it tough for us to get the point across.

Successful companies don't lie about the past; they just try to protect consumers from unnecessary details that will get in the way of people buying their products. Consumers want to believe the product they're buying has a broad appeal because that makes them feel more comfortable making an economic commitment to it.

Fortunately the Crossing the Chasm strategy has already started to pay off handsomely at Wealthfront, and I believe it's now the largest player in the space. The company's monthly growth rate of assets under management exceeds 20%, and is accelerating. 

To be a great entrepreneur, you must be non-consensus and right. Oddly, one of the bestselling business books of the last generation is now considered non-consensus advice. But as far as I can tell, Crossing the Chasm is just as relevant today as when it was published in 1991. There are very few exceptions to its two-step rule in the recent history of successful companies. First, you develop a focused product that appeals to a small, passionate audience. Over time, you build a whole product that attracts a broad one.

Last updated: Jan 28, 2013

ANDY RACHLEFF | CEO, Wealthfront

Andy Rachleff is president and CEO of Wealthfront, an SEC-registered software-based financial advisor, and teaches at the Stanford Graduate School of Business. Before Wealthfront, he co-founded and was general partner at Benchmark Capital.




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