“You can’t get into the trap of paying for customer acquisition.” – Aileen Lee
If you google Aileen Lee, chances are you will find her sporting her famous cowboy hat in homage to the values (and the name) of the VC firm she founded almost ten years ago, Cowboy Ventures.
Lee is famous for at least two things. Firstly, her tireless push for more diversity in VC—she’s the first female Founder of a VC firm, and 80% of the team are women. Secondly, her 2013 analysis of Unicorns, a term she was the first to use to describe startups valued over one billion dollars.
You Can’t Pay Your Way To Product Market Fit
A typical Series A firm based in the Silicon Valley, Cowboy sees first-hand the mistakes most startups make on their way to product/market fit. What is the customer acquisition trap Aileen Lee refers to?
Founders paying for customers too early run at least two risks:
- Wasting money on a product or service that is not the right iteration of what it should be;
- Getting misguided on who your real customers are.
If you serve desperate customers with a product they need, you won’t have to pay to get them on board. They’ll find you, and they’ll recruit more users. The first power-users will spread the word and, in many cases, even make the sale for you. Recent B2C successes such as Canva and Calendly are cases in point. Hubspot would be a good B2B illustration.
The beachhead strategy of entering markets is built on this dynamic.
Adding more money to a situation of lack of product market fit rarely works.
— Justin Kan (@justinkan) January 6, 2021
Counter-examples, i.e., startups that try to pay their way to product market fit, abound.
Quibi is the most spectacular example in recent times. After raising $1.8 billion to make and distribute high production-value mini-series, the company stopped operations months into its launch. A damning post-mortem article framed the failure in a lack of market understanding by Quibi’s Founders: “On top of that, neither Katzenberg nor Whitman truly seemed to understand how people use their phones, what people want from streaming services, or why something like TikTok and Netflix worked.”
Justin Kan, the co-Founder of Twitch, a streaming service sold to Amazon for nearly $1 billion, drew a list of mistakes when his second endeavor, Atrium, failed in 2020 after raising $75 million. Near the top of his advice list: no amount of money can spare Founders the test-learn-adapt loop necessary to get to product market fit.
Attracting customers organically has two additional advantages: these customers tend to stick longer (lower churn, higher retention), and VCs will take a favorable look at your funding opportunity. A business built on capital efficiency has, on average, better odds of getting financing.
Why Do So Many Entrepreneurs Believe In A Market That Doesn’t Exist?
Given how widespread the notion of product market fit is, why are so many Founders still starving their company’s resources by spending too much cash too early? Or trying to raise too much money too soon, with harmful consequences on the startup’s future (and the Founders’ mental health).
A strong undercurrent must be at play because even people who know about this trap fall into it. (Raising my hand). This question strongly influenced my doctoral research on the psychology of entrepreneurs.
Other personality traits often found with entrepreneurs may explain the phenomenon, such as:
- Optimism: “It will work, I’m sure of it”
- Perseverance: “It’s not working now, but if I keep at it, it will”
- Impatience coupled with arrogance: “Let’s not waste time trying to understand what people want, I know already”
The question is all the more pressing that failing to find a market for their product is the first cause of startup death. (Not raising cash or running out of it are consequences of not having clients.)
Success is the ability to go from failure to failure without losing your enthusiasm.
Winston Churchill
Before I go further, let’s examine the “need for failure” in entrepreneurship. It has become cliché to say that entrepreneurs learn more from failure than success. The maxim has been repeated so frequently that voices have emerged reminding us that failure was not the goal of entrepreneurship.
Churchill’s quote doesn’t clarify that failure may lead to success if entrepreneurs learn optimally from it. Can a theory of entrepreneurial learning explain why Founders make the same mistakes about the market opportunity?
How Successful Entrepreneurs Learn
How entrepreneurs learn is a significant focus for someone managing an e-mentoring platform. I’ve closely followed entrepreneurs since 2008 as an investor first, then as an advisor and mentor. Some of them became widely successful, others never emerged.
Motivation—a stronger feeling than Churchill’s enthusiasm—or passion, a quality often put forward, was not the deciding success factor.
Yoav Yechiam, who’s experienced both failure and success as a startup CEO, points to the need for Founders to better manage themselves. The legendary VC Brad Feld points out that “durability” in these difficult moments is a condition of success, as failure occurs in many forms even when startups ultimately win.
Every success I’ve ever been in had multiple points of failure, some of them near-death experiences for the company.
Brad Feld. Source: The Twenty Minute VC
My thoughts on this subject are not definitive as I write this post. Based on my experience, I believe that successful entrepreneurs are exceptional at adapting newly-acquired knowledge to a specific action plan.
(As a side point, since I’ve started training entrepreneurs on the e-mentoring platform, I get a better glimpse into their learning habits: when and how frequently they access content, how much they engage with it, and how quickly they apply the advice provided to their endeavors. Some entrepreneurs have an exceptional ability to focus on a specific point and come back with much-improved thinking—and a better fundraising pitch deck, in many cases—at impressive speed.)
This trial-and-error learning pattern, decrypted here a decade before Eric Ries’s book The Lean Startup made it widely known, may lead to sub-optimal results. Entrepreneurs who find solutions working reasonably well may settle for them instead of looking for optimal ways.
This theory of entrepreneurial learning may help answer this post’s central question: why do so many Founders make the same mistake in believing their product has a market?
I sense that those who fail, apply the wrong method to the problem they face.
They rely on past knowledge for a novel issue. Instead of recognizing that their market is unknown and engaging in a trial-and-error process to reach product market fit gradually, they resort to past knowledge. Instead of asking, “Is there a market for my product?”, they affirm that there is demand based on an erroneous assessment of the market and what prospective clients want.
Subscribe to our newsletter (see below) for more VC Quotes and their background. We publish a new one once a week. You can read all our quotes here.
Subscribe to our Newsletter
Join 12,000+ VCs & Founders globally who enjoy our weekly digest on Venture Capital. We keep your information confidential and you can unsubscribe at any time. Sweet!