“Our industry does not respect tradition— it only respects innovation.”
That’s what Satya Nadella wrote in his opening email to the company shortly after becoming Microsoft’s new CEO. It was a clear call to arms that Microsoft needed to reignite innovation in order to scale the company after roughly 15 years of stagnation. The price of Microsoft’s stock has increased ~3x since he came back because the market seems pleased with Microsoft’s sharpened focus, progress made in the cloud business, and willingness to change how it used to do things in order to compete in the future. Some of this could be window dressing or marketing speak, but the changes happening at Microsoft seem genuine.
Satya said nothing about doubling down on what’s already working in order to get more juice out of the squeeze. Rather, he ended the email by emphasizing the need for clarity of focus on new innovations and on changing the culture which, for the most part, was focused on preserving the status quo for over a decade. It’s not unheard of that a large company often forgets how to innovate.
I haven’t spent enough time at companies with 1,000+ employees to speak deeply about the dynamics of large company stagnation, but I can speak to it happening at early-stage startups. In particular, I find it interesting that the same two problems Satya outlined for Microsoft often appear within early stage startups as well: i.e. the culture becomes comfortable with the status quo and the company loses its ability to innovate.
How does it happen? When a startup becomes obsessed with and designed around data and optimization. Today, every 50 - 100+ person startup has multiple business intelligence tools, off-the-shelf A/B testing tools, a data science team, and product managers who know much more about writing SQL than they do about interviewing customers.
In fact, I kept score while interviewing PM candidates in 2017. I spoke with 67 product managers. About 50 of them were reasonably proficient in SQL and could write a few queries on the spot. Guess how many knew how to conduct customer development? Three. That’s it. Only three product managers could proficiently describe the purpose, process, and outcomes from customer development. 75% could write SQL, but only 4% knew how to properly interview a customer. It’s a small sample size, but the gap is large.
Here’s why that’s bad: Most startups, just like large companies, need to go through continuous phases of innovation in order to create 2x+ step changes in the potential for their business. The process of going from 0 to 1 with their first product is an innovation. It’s what allows the company to get off the ground. Sometimes, that original innovation is enough to carry them from seed to IPO. But that is incredibly rare. What’s more common is that startups need to innovate several times over in order to create step changes that help them scale from early stage to growth stage and from growth stage to a publicly traded company.
Over the last 10 years, there has been a massive overcorrection in the direction of optimization based on broad availability of data, leading me to find that most PMs are incapable of effectively deriving insights from customer conversations and most startups are incapable of producing new product innovations beyond the initial product that they take to market. They’re great at A/B testing, but not great at creating new features based on customer insights and a leap of faith.
To put it plainly, growing through data analysis and A/B testing isn’t the only path to future growth. While it seems obvious, I see very few startups designed for innovation, which may be the biggest driver to new growth for your business. Do you think Facebook would be at its current scale without innovations like News Feed? Community-driven translations to expand globally? Or the developers platform? The answer is obviously “no”. Take a look at MAU acceleration beginning in 2007 / 2008. That coincides with the launch of the international translations app, which allow Facebook users to crowdsource the translation of the product. It took several months to build and a few years of ongoing maintenance and development to mature the product. That innovation led to a boom in active user growth.
The point I’m making is that today’s startups very quickly fall into the optimization trap where they think future growth will largely come from optimizing their existing product. The better approach is finding the right balance between optimization and innovation since both methods can produce future growth.
By the time you’re done with this series of blog posts, you’ll have the knowledge and tools you need to do the following:
We should first start with a more detailed explanation of the difference between optimization and innovation. Optimization is when a startup iterates on its existing products or services to squeeze more juice out of the orange. Typically, the results of optimization are incremental in nature.
If they are incremental in nature, then why do them? Well, because many small optimizations can accrue into large long-term results when you allow those optimizations to compound.
Here’s a simple example. In the below graph, I compare the 12 month growth in monthly active users (MAUs) in 4 hypothetical cases. The blue line is the base case where the monthly growth rate is slowly declining, leading to flattening growth. The red line is for sustained 10% month-over-month growth (MoM), yellow is sustained 12% MoM, and green is sustained 14% MoM. If a startup can optimize its way towards a slightly higher and sustained rate of growth, the compounded outcome is very different relative to the base case. In fact, this is what we did in 2009 at Facebook. Our growth team focused on optimizing our way towards a sustained 2% week-over-week growth rate because we knew that we would grow from ~100 million MAUs to ~300 million MAUs in 12 months if we did so. This happened to be the company-wide goal for that year.
nnovation is when a company embarks on building entirely new products or services for existing customers or for a new segment of customers. Innovation can also involve expanding into an entirely new business line. However, this happens so rarely (hello, Amazon!) that I won’t focus on this definition for the time being. Additionally, innovation can create step change improvements in the trajectory of the company, although they are much more difficult to discover and successfully execute on.
I’ve taken the same scenario above, but added in a 5th option which is labeled as “with innovation” in the below graph. What this does is take the base growth rate scenario and applies a 2x multiplier to growth midway through the year (e.g. you build a new feature, such as Facebook’s News Feed and it leads to a step change in monthly active usage). This assumes no optimizations along the way.
The point isn’t that you should pick one approach to growth over the other. Rather, the ideal outcome (and most realistic) is a healthy combination of both optimization and innovation. In the below scenario, I assumed that a segment of the company is working on optimizing the existing products and services to sustain 10% MoM growth and another segment is working on new product innovation that leads to a 50% bump in MAUs midway through the year. This scenario is plotted as a black dashed line on the graph.
The appropriate question to ask is, “For my company, should I be innovating or optimizing?”
For Seed and Series A startups the practical reality is that you are headcount constrained into picking one over the other because you’ll have less than 20 employees. Prior to establishing product market fit, you’ll be entirely focused on innovation because you’ve yet to figure out the new technology that delivers something better, faster, cheaper, and more convenient relative to the alternatives in the market. Consequently, you’ll have very little growth or customers to optimize on top of, so don’t waste your time optimizing if you don’t already have exponential organic growth.
As a company matures to the point of Series B and beyond (sometimes with a large Series A) it can hire enough people that it can contemplate doing more than one thing at a time. From my experience that’s at the point in which a consumer software company has 30 or more employees. On average, about half of the employees will be engineers, so that means you’ll have 15 people that can do the building. With 15 people doing the building you can divide them amongst 3-4 teams— e.g. 2 product teams, an infrastructure team, and a floating pool of engineers needed for miscellaneous tasks and on-call work.
When a company reaches 100 employees it can certainly multi-task. Its 50 engineers can be subdivided amongst 2-3 well-staffed product teams, 2-3 infrastructure teams, and still be able to manage on-call support and miscellaneous tasks.
Assuming a company is able to reach the scale of 30+ employees and is now capable of walking and chewing gum at the same time, the question becomes, “How do you allocate those people in terms of optimization versus innovation?” I like to use investing analogies when thinking through this decision.
Most investors should have an investment portfolio that maximizes their returns given the amount of risk that is appropriate for them to take (this concept is known as Modern Portfolio Theory). Put in simple terms, it stipulates that you’ll want a diversified portfolio comprised of a mix of higher risk, higher return investments (e.g. stocks) and lower risk, lower return investments (e.g. bonds). Depending on the level of risk you can afford to take, you’ll want to shift the allocation towards certain investments and away from others. For example, if I’m 70 and ready to retire, I should be taking very little risk and will want a portfolio weighted heavily towards low risk, low return investments (bonds). If I’m 30 and putting money into a retirement account that I’ll use 30 to 40 years from now, then I should be taking on more risk to generate more returns during that long time horizon (i.e. more stocks).
I hope you are starting to see how this investing analogy applies to your startup thinking. Innovation is your stocks and optimization is your bonds. The question to ask is, “What proportion of my company’s focus should be on optimization versus innovation?”
If you’re building a seed stage startup, then you’ll solely be focused on innovation (all stocks and no bonds) because you’re trying to build something new and innovative that finds product market fit. If you’re working on a series A or series B startup with clear indicators of product market fit (i.e. exponential organic growth), then you should be considering the trade-off between optimization and innovation.
Facebook is a good example of optimization and innovation at play. While I was at the company (2008-2010), we did a bit of both. The Growth Team was focused predominantly on optimization by improving sign up conversion rates, new user onboarding, reactivated user onboarding, getting people to add more friends, and a vast library of miscellaneous A/B tests for the sake of getting more users. Meanwhile, several of the core product teams were pushing out big innovations like the first smartphone app, various News Feed innovations, large enhancements to photos, and the developer’s platform.