Strategy Fundamentals for Early Stage Technology Start-ups

Purpose: The purpose of the blog post is to share fundamental lessons regarding strategy for early-stage technology startups. A key part of this attempt will be to provide tangible frameworks that the founders of early-stage ventures can use as they are going through the discovery and customer development process to transition from a startup to a company.

Scope: Early Stage Technology Startup and Pre-Product Market Fit

Inspiration: This blog post comes out of having experienced articulating strategy (not necessarily effectively but learned the hard way) for non-startup (i-e big companies) during my undergraduate studies and for two early stage technology start-ups. Similar to how I highlighted that startup ventures face unique challenges with selling, they also have unique challenges with strategy.

Credits: Upfront credits go to experience, mentors, Steve Blank’s Books for Startups, Michael Porter and others who I may have missed.

Key Early Stage Startup Strategy Lessons Learned

Before, I get into the theoretical breakdown. Here are the nuggets of lessons I have learned from experience;

  • Write it Downit is the key to learning fast for entrepreneurs.
  • Importance of Strategy – It is important to think about Strategy from Day One
  • Working Hard Vs Working Smart – Not all barriers of a market / industry can be “hustled” away
  • Leaking Bucket – No resource (even capital or talent) won’t get you to overcome a poor strategy
  • Relevance – Strategy is like breathing – its always there even if you pay attention to it or not.
  • Roadblocks to Implementation – constant thinking about strategy and its intangible nature is what makes it difficult to visualize its damage or advantage.

Overview

I understand the importance of actionable content for entrepreneurs, therefore, here are the table of contents;

How to Use This Strategy Guide
DefinitionsWhat is a StartupWhat is StrategyWhat is Game Theory?
Strategic Decision Making Tools
Market: Know Your Starting Positing
Industry: Porter’s 5 Forces that Shape Industry Competition
Game: Using Game Theory to Shape Strategy
Conclusion and Next Steps

How to Use This Strategy Guide

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Now, let’s start with some basic definitions.

Definitions

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Let’s cover some basics so we are all on the same page.

What is a Startup?

A startup of the temporary organization builds to search for solution to a problem via a scalable, repeatable, and profitable business model that can deliver fast growth. The defining activity of a startup is experimentation – to learn and iterate for the discovery of the profitable business model. (Definition Adapted from Steve Blank, Eric Ries, & Ash Maurya)

What is Strategy?

“Strategy is about making choices, trade-offs; it’s about deliberately choosing to be different.” – Michael Porter

Early Stage Startup Strategy Fundamentals

And early-stage startups strategy answers critical questions about what the startup should do and not do in order to find a repeatable, scalable, and profitable business model. It makes these integrated choices to create a sustainable (even if just temporarily) advantage within its market relative to rival startups and market incumbents.

Strategy as Integrated Set of Choices – From Playing to Win by Roger L. Martin
Strategy as Integrated Set of Choices – From Playing to Win by Roger L. Martin

Strategy helps a startup venture decide how to use its internal (HR, talent, knowledge etc.) and external capabilities to reach its goal.

Example of Strategy as Integration Set of Choices

  • Alibaba vs. Amazon – Alibaba took advantage of its external resources of government regulation and manufacturing hub to create a marketplace for consumers and wholesalers. Amazon used its external and internal capabilities to move towards same-day delivery etc.
  • Key Takeaway – different internal and external capabilities call for different strategic choices
  • Note: Example above have been simplified for demonstration.

Early Stage Startup Strategy Fundementals

Essentially, for an early stage venture the choices and trade-offs are in the following areas of the business model or lean canvas;

  • Customers – the segment and the relationship
  • Value Propositions
  • Key Activities
  • Key Resources
  • Key Partners
  • Cost Structure
  • Revenue Streams
The Business Model Canvas
The Business Model Canvas

Late Stage Startup Strategy Fundementals

As the start matures and enters growth (still a startup), effective strategy choices and trade-offs switch to the following areas;

  • Operations – creating a rhythm that produces results
  • Human Resources – getting talent to maximize innovation
  • Product Development – listening closely to the customers
  • Finance – using it to do “land grab” and expand
  • Supply Chain – to add strategic advantage i-e think apple’s outsourced supply chain
  • Distribution Channels – to offer unique business proposition i-e think amazon’s same day delivery

The good news is that most startups don’t struggle with later stage strategy as you have talent, investors, VC firms, and off-the-shelf books to guide you. Therefore, we will not dwell too much into this part.

What is Game Theory?

According to Wolfram Mathworld; “Game theory is a branch of mathematics that deals with the analysis of games (i.e., situations involving parties with conflicting interests)”. In addition to the mathematical elegance and complete “solution” which is possible for simple games, the principles of game theory also find applications to complicated games such as cards, checkers, and chess, as well as real-world problems as diverse as economics, property division, politics, and warfare.

Game theory has two distinct branches: combinatorial game theory and classical game theory.

  • Combinatorial game theory – involves two-player games of perfect knowledge such as chess or checkers. Notably, combinatorial games have no chance element, and players take turns.
  • Classical game theory – players move, bet, or strategize simultaneously. Both hidden information and chance elements are frequent features in this branch of game theory, which is also a branch of economics.”

With these definitions in mind, let’s go through some fundamental strategic decision making tools – chronologically.

Strategic Decision Making Tools

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Strategic decision making should follow a chronological order. Always start by analyzing the market, industry, and then craft your game.

Analyzing the market is like assessing the environment (industry dynamics) before planting your crops (product) so you know what kind of soil, water, and seasons you (resources) you need for your startup to sustain.

Analyzing your startup's environment for ensuring survival.
Analyzing your startup’s environment for ensuring survival.

Market: Know Your Starting Positing

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One of the very first decisions that shape your strategy is which market you decide to operate in. Unfortunately, this “decision” is not made consciously due to a lack of understanding of the founders. Therefore, they are not able to focus on key requirements to succeed in their market.

These are the four types of startups markets (as defined by Steve Blank):

Why is market type so critically important? Because market type changes your initial positioning, key activities, adoption rate, launch strategy and the market size. Yes, essentially everything.

In summary, here is a chart point out what is different;

Market Types Affect Everything
Market Types Affect Everything

Source: The Four Steps to Epiphany

This is how each type of startup market has different customers, customer needs, performance factors, competition and risks.

Market Type Characteristics
Market Type Characteristics

For example, a new product in an existing market is purely about the product – product features and performance. Whereas, a new product in a re-segmented low cost market is about providing good enough value for the price (Dollarama, Chinese Phones etc).

Therefore, it is essential for a startup to answer the question “What kind of startup are we?” before any sales initiatives. However, that does not mean that you should not revisit this once you begin customer discovery, customer validation, and customer creation through entrepreneurial selling.

Now, with an initial hypothesis of which market you serve in, it is a good type to understand which industry you are operating in.

Industry: Porter’s 5 Forces that Shape Industry Competition

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Porter’s 5 forces remain the most popular framework for business strategy – yet very poorly utilized by the startup community. Entrepreneurs having the “hustle” mentality (including me in the past) prefer to learn it in the playing field. Unfortunately, that is like planting seeds and hoping it will rain tomorrow.

The true power of the framework lies in understand the industry holistically using the five forces of – threats of new entrants, bargaining power of buyers, threat of substitute products or services, and bargaining power of suppliers.

Source: MindTools – Porter 5 Forces

Threats of New Entrants

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This defines the degree to which a startup can expect competition because number of new companies or startups it faces keep increasing. Direct competitors are rivaled are other startups that enter the market with a value proposition that is nearly identical to that a given incumbent startup is offering its customers.

The high threat of new entrants limits how much of value and incumbent startup can capture for itself, a limitation on profitability, and high operational costs for competing within the industry. Therefore, it is important for start of founders to think critically about how they might compete in a hot new sector.

The seven major sources of barriers to entry are;

  1. Economies of Scale – You are able to product large quantity which drives the unit costs down. Think of Walmart – its bully cost advantage and its ability to keep small business out … even take them out!
  2. Product Differentiation – Products or services with differentiated enough offering are able to sustain their market leadership. Many compete heads on (aka red ocean) – think online hotel book (hotels.com, hotwire.com, trivago.com etc) vs alternative room rentals (aka blue ocean) Airbnb.com.
  3. Customer Switching Costs – think about changing your email address from gmail to outlook.com and vice versa. The harder the switching costs the better it is for an existing startup.
  4. Capital Requirements – the higher the requirements the better it is for existing startups but not new ones.
  5. Cost Advantages Independent of Size – Incumbents usually have significant cost advantages that cannot be replicated by a potential entrant.
  6. Unequal Access to Distribution Channels – Think about the diamond industry and its almost monopoly over supply and hence prices. Incumbents can have channels that are controlled and locked up by them.
  7. Restrictive Government Policy – Think about the Alibaba example above. Startups in highly government regulated industries will find that incumbents are uniquely positioned to abide by the regulation – the state of almost all copy-cat china startups.

When to Consider Threat of New Entrants

  • Initial Positioning for Early Stage Ventures – If you establish yourself in high barrier to entry place, you will inevitable put your startup on a path that requires very different resources (see market type). You must be absolutely sure what you are getting into.
    • For example: Elon Musk starting a rocket company made some sense as he had financial backing and connections with NASA. You starting it in your garage, not so much.
  • Market-Leaders for Late Stage Ventures – Startups that are early and become iconic in their category must understand how to protect their position by building barriers to entry.
    • For example: Dropbox being the “household name” for cloud storage is beginning to offer seamless integration and API to build a unique advantage over hundreds of other cloud storage solutions.

Examples – Threats of New Entrants

  • Think Uber and “Uber-Copy-Cats” there are hundreds of startups even in North America and in the east offering identical services. This is another reason why uber realizes the need for cash for speedy land grab.

Bargaining Power of Suppliers

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Suppliers become powerful when there are only a handful of them and do not rely on startups for majority of their revenues.

Examples – Bargaining Power of Suppliers

  • Intel and Windows – Almost all PC manufacturers struggle to cut a profit yet Intel and Windows (as suppliers) collect a fat paycheck.
  • Academia Publishers – Having dealt with the educational industry, there are only a few players that are determined to protect their copyrights and intellectual property.

Bargaining Power of Buyers

Power buyers can impact the profitability of a group of startups that supply them with goods or services.

Here are the factors that contribute to powerful buyers;

  • A small number of buyers with each purchasing large volumes as compared to others
  • Buyers don’t have any switching cost between one supplier and the other
  • Quality and reliability in products is not a priority and neither is the relationship (think Walmart)

Examples – Bargaining Power of Buyers

  • Ford Motor Company – In its early stages got a huge cash injection from the government to manufacture vehicles for the war.
  • Military Startups – the same is true for startups that focus on fraud i-e very powerful buyers.

Threat of Substitutes

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Many early stage entrepreneurs (I am guilty too) are quick to say “We have no competition!”. Cute answer but wrong. There are always substitutes even when there are no direct competitors.

Substitute is something that serves a similar function as the main product. For example, coffee and tea – both have caffeine. Or videoconferencing is substitute for traveling.

To identify substitutes ask yourself the following questions;

  • How are customers currently solving the problem?
  • Where is the customer spending less money because of this purchase?

Examples – Threat of Substitutes

  • Chat Applications – Social Networking websites such as facebook has been facing growing competition from instant messaging apps – whatsapp, snapchat, imesssage etc.
  • Physical Products – Health conscious people resorted to Tea over coffee.

Rivalry Among Existing Competitors

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Any evidence of high rivalry among existing competitors usually comes in forms of price cuts, common sales and marketing campaigns, and relatively short product and service upgrades. Think of iPhone and Samsung, Internet Explorer and Google Chrome, Apple iOS and Google android, Uber and Lyft. All of them are in the “new products in existing markets“.

A critical mistake scared rivals make is that being gauging mutually destructive activities. For example, competing on feature front or price cuts.

Factors to Consider when Making Strategic Decisions

Michael porter highlights that “It is especially important to avoid the common pitfall of mistaking certain visible attributes of an industry for its underlying structure”

For example;

  • Industry Growth Rate

    People are quick to assume that fast-growing industries are always attractive. For example, fast-growing business of personal computers or smart phones have been among the least profitable industries. Why? Because suppliers have power and cost-cutting rivalry among pc manufacturers. Therefore, consider the unique play of the fiver forces in addition the industry growth rate.

  • Technology and Innovation

    High pace of technological innovation alone does not make the industry attractive or unattractive either. In fact, low-technology industries with price-insensitive buyers, high switching costs, or high entry barriers arising from scale economies are often far more profitable than sexy industries of software and internet technologies.

  • Government
  • Complementary Products and Services – For example the car industry has gas stations and road side assistance that makes the use of the product attractive. The presence of compliments are not good or bad – but need to be analyzed to see their affect.

Game: Using Game Theory to Shape Strategy

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Note: Please start with the definition of Game Theory

Startup is a very high stake and a risky game. Yet, many entrepreneurs do not view strategy (this is the intangible part) of much importance. Just like in real life we tend to de-prioritize intangible things such as relationships or health only to realize in the long run that we were playing the wrong game.

However, there is some good news;

“Unlike war in sports, business is not about winning and losing. Nor it is about how well you play the game. Companies can succeed spectacularly without requiring others to fail. And they can fail miserably no matter how well they play if they make the mistake of playing the wrong game.”

The essence of business success lies in making sure you’re playing the right game.” – Adam M. Brandenburger and Barry Nalebuff

Brandenburger and Nalebuff published an important piece of work on Strategy conveniently named – “The Right Game: Using Game Theory to Shape Strategy” which has the following gems for startups;

Value Net

Given that business is all about value creation and capturing it, Value net is a framework that represents all the players in the game and how they are connected. It asks the simple question of “Who are the players in your company’s value net?” and then prompts you to think about value creation via all of them. For examples, see coopetitions.

Who are the players in your value net?
Who are the players in your value net?

Formulating Strategy

The start of founders must think into the foreseeable future to make predictions about how the game might unfold by analyzing all the players in the value net. In other words, reason forward then go backwards to the present in order to determine what key actions to do today to bring future into existence.

Seek “Coopetition”

Startup founders should seek and create opportunities for “coopetition” using the value net – that is create win-win situations for all (or as many as possible) instead of just win-lose opportunities. In coopetition, you study your competitor’s strengths in order to thrive together.

Examples – Coopetition among Value Net Players

Many (including myself in the past) entrepreneurs come with the mentality that their success must come at the other competitor’s expense. Wrong.

“[No] one can success by themselves. The only way you can achieve something magnificent is by working with other people. There [are] lots of coopetitions.”

Conclusion and Next Steps

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These strategic decision making tools should act as a compass for early stage startups. Luckily, for later stage startup strategy you won’t have to deeply reflect and question your fundamental strategy as much – hard (but smart) work pays off!

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