Tuesday, November 05, 2013

The Stanford Startup and the MIT Startup

Message from a Jedi to a Young Padawan
When I graduated and was considering pursuing startups, an alum from my fraternity gave me some advice. He was a successful entrepreneur and sent me a message about pursuing technology-oriented startups. He presented a maxim about an MIT company and a Stanford company building products for the same market. The Stanford company gets a product out quickly, they make money, iterate and then raise money. They use network effects to lock-in customers or viral growth tactics to get super-linear returns on marketing investment. The MIT company seeks to develop an unassailable technical advantage, optimizing their product or process in terms of kilojoules, units per second, and dollars. They either find a market-fit or sell their technology to the Stanford company.

The dichotomy is between a focus on technology development and a focus on market development.

Let me present an instance of this: two startups are selling environmentally-friendly ammonia (a real and big problem).

The Pitch
The MIT company: "Our unique chemical process allows us to produce ammonia with no environmental impact for 10 percent less cost than competitors. We can modify our catalytic nanoparticle process for the production of perchlorates and sulfates, and dominate the industrial chemical supply industry."

The Stanford company: "We sell premium household cleaning supplies and fertilizer that are produced sustainably and good for the environment. We sell in stores and offer a monthly subscription model; receiving a package will remind you to clean up your house and water your flowers."

Sales and Marketing
The MIT startup has no sales to customers, but possibly a DARPA grant to develop their technology. The team has 9 PhDs and just hired an MBA to start finding customers. They believe their technical advantage using solar-powered nano-crystalline catalysts will enable them to lower the cost of production of commodity chemicals and therefore dominate the market. Their customers will be the major fertilizer, pharmaceutical and consumer product companies. Google for the company name and you will find a landing page. They are still "in stealth mode" while they finish up some R&D and production optimizations for their nano-particle production. Team MIT needs funding to develop a manufacturing facility (and to survive as a company). Their vision for sales and distribution involves hundreds of payments for tens of millions of dollars each year for shipment sizes that look like something out of The Wire or Breaking Bad.

The Stanford startup has developed no new technology but has already validated its customer model selling sustainable branded cleaners and fertilizers at a local Whole Foods and Home Depot. Costs for sustainably produced chemicals are higher, but the founders maxed out their credit card buying a wholesale shipment and were able to sell a premium retail product at a small profit. They setup stands at farmers' markets to sign people up for monthly packages of cleaning supplies and plant food. After testing their market hypothesis, they decided to focus on cleaning products and limit marketing for the fertilizer product because that strategy generated more recurring revenue for less cost. Attrition rate for the cleaning product shipments is lower than growth and there are customers posting on the internet about how much they "appreciate the hand-signed note thanking them for supporting their mission to spread sustainable production." They have thousands of monthly customers, they know their cost per customer acquisition and they know their average revenue per customer. Team Stanford think they could get millions of customers to pay them $9 a month for their product; which includes rags in addition to ammonia and bleach. They are still tracking a growing market niche for sustainable home food growing systems including plant food and seeds. They think viral marketing strategies will help them reduce their customer acquisition costs so they want funding to expand logistics and distribution in other regions and try some other growth strategies like advertisements, and letting people choose scents in-stores before placing an order.

Investor Response
The outcome for either of these companies is non-obvious. The MIT company claims to have the successor to the Haber-Bosch process, a chemical process technology that won its inventors Nobel prizes and was the foundation for what was once the world's largest chemical supplier. However, they want to enter an established commodity market and need to prove that they can scale sales from zero. Investors will need to vet the technology before they can fund the company. Investors look for "order of magnitude better" when vetting technology companies to determine if the technology is defensible. Very few investors will have an understanding of the chemical supply market and fewer still will understand the founders' PhD work optimizing production of ammonia using nano-particle colloids. They will also need a lot of funding before they can serve this market.

On the other hand, the Stanford startup has traction in a market and will likely have a much easier time raising funding. Investors will understand their consumer market and they won't require technical vetting. It is unclear if their market position is defensible.  Someone else can replicate what they do especially since there are no network effects where the total value of the product increases with more users thus creating market lock-in. However, they don't need much funding to grow their sales and they are looking to scale from a solid profitable foundation, which decreases the perceived risk to investors.

The MIT startup could potentially be a $100B company in the chemical supply market. However, the Stanford startup can be reasonably valued at $10M today based on traction and will get term sheets from many investors. The MIT startup is much more speculative today and needs to find a wealthy individual to bankroll their first factory or take strategic investment from large potential customers.

There are many companies that fit both of these patterns and end up successful. The successful technology startups eventually develop a market approach. A lot of founders pivot from developing hi-tech to do entirely different market-focused ventures. Some founders have taken both approaches in separate companies and been successful at both. Conventional wisdom suggests the best startups develop technology and a market simultaneously. Many startups can operate with just a telephone and a spreadsheet on day one and then use technology to automate their operations. Technology is not a prerequisite for business success, but marketing is.