Weekly reflection
Achieving escape velocity is essential for startups to deliver venture returns. Escape velocity is a compelling image for an entrepreneur, as it refers to the speed — 25,020 miles per hour — required to exit the earth’s gravitational pull. A startup faces its own gravitational pull. Startups that go too slow get pulled back into the peloton (what a great finish to the Tour de France last week!) and subsumed by incumbents. Startups must innovate quickly to overcome incumbent advantages afforded by its installed customer base and organizational resources.
Achieving escape velocity is a formidable task. Startup successes are highly visible, yielding an impression that defying the norms of physics is a routine occurrence. Yet success rates for venture-backed companies are bleak: 65% yield less than a 1x return, according to a ten-year study by Correlation Ventures. Reaching IPO status in the US is a black swan event: in 2019, 6,183 companies received venture funding in the US, while just 23 US venture-backed tech companies completed IPOs.
A “Winner Take Most” market persists among IPOs as well as startups. As of September 2020, Zoom accounted for 30% of the aggregate value among the 23 newly minted public tech companies in 2019. Normal distributions with kurtosis, or fat tails, characterize annual public-market price variations. Venture investing follows an entirely different system: a Power Law Distribution reflective of Winner Take Most markets.
Turning the Flywheel
According to Jim Collins in Turning the Flywheel: A Monograph to Accompany Good to Great, the chances of achieving escape velocity can be dramatically improved with a carefully designed strategy and disciplined execution that aligns key aspects of the business. Collins describes the flywheel process as follows: “In building a great company, there is no single defining action, no grand program, no one killer innovation, no solitary lucky break, no miracle moment. Rather, the process resembles relentlessly pushing a giant, heavy flywheel, turn upon turn, building momentum until a point of breakthrough, and beyond.”
Flywheels abound in the world around us. Bicycle wheels, CDs, fan belts in cars, waterwheels, and windmills are just a few examples. Jim Collins describes a heavy flywheel akin to the image below, designed for industrial use.
Large flywheels build kinetic energy slowly. The “moment of inertia” measures resistance to changes in rotational speed and the amount of energy required to achieve the requisite speed to perform the required flywheel function. Flywheels store kinetic energy well: the amount of energy stored in a flywheel is proportional to the square of its rotational speed, and the energy required to stop a flywheel equals the energy invested to achieve its initial velocity.
Applied to business, Collins describes the flywheel effect as a virtuous cycle achieved by a company when its key business elements align in an interlocking, mutually reinforcing set of business activities. The flywheel initially turns slowly as startups overcome static inertia, but gains speed with each successive turn. Winning the first customer is the hardest, but each successive customer win gets easier as the company delights initial customers, earns complimentary references, perfects best practices, reduces costs, improves unit economics, and attracts added talent and capital to expand the business. Breakthroughs occur when the company hits escape velocity — the business equivalent of the moment of inertia in physics.
Collins further notes: “Once you fully grasp how to create flywheel momentum in your particular circumstance and apply that understanding with creativity and discipline, you get the power of strategic compounding. Each turn builds upon previous work as you make a series of good decisions, supremely well executed, that compound one upon another. This is how you build greatness.
“Never underestimate the power of a great flywheel, especially when it builds compounding momentum over a very long time. Once you get your flywheel right, you want to renew and extend that flywheel for years to decades — decision upon decision, action upon action, turn by turn — each loop adding to the cumulative effect. But to best accomplish this, you need to understand how your specific flywheel turns.
“The flywheel, when properly conceived and executed, creates both continuity and change. On the one hand, you need to stay with a flywheel long enough to get its full compounding effect. On the other hand, to keep the flywheel spinning, you need to continually renew, and improve each and every component.”
The Flywheel Effect at Amazon
Amazon has adopted the flywheel concept as a core part of its business strategy. Brad Stone describes Amazon’s flywheel strategy in The Everything Store: Jeff Bezos and the Age of Amazon as follows: “Bezos and his lieutenants sketched their own virtuous cycle, which they believed powered their business. It went something like this: Lower prices led to more customer visits. More customers increased the volume of sales and attracted more commission-paying third-party sellers to the site. That allowed Amazon to get more out of fixed costs like the fulfillment centers and the servers needed to run the website. This greater efficiency then enabled it to lower prices further. Feed any part of this flywheel, they reasoned, and it should accelerate the loop.”
Amazon Flywheel
Amazon executives often refer to the flywheel to describe how their business activity propels broader corporate strategy. Amazon’s Alexa has adapted the above flywheel for a cohesive, comprehensive strategy to win the voice user interface (UI) war. Amazon competes with Google and Microsoft to produce the most accurate core voice UI algorithms and sells its voice UI algorithms as a consumer application through Alexa devices. The Alexa Fund attracts and funds developers to design additional voice UI applications on the Alexa platform. Meanwhile, Amazon facilitates partnerships in the auto, home, health and other industries to build Alexa use cases and drive user adoption.
Bain & Company: The Founder’s Mentality
Bain & Company studied over 3,500 companies over five years and found that only 9% of companies grow sustainably. Successful founders start with an insurgent mindset focused on developing a repeatable business model that accelerates growth through relentless experimentation, employee empowerment and customer obsession. Successful startups, however, face common scaling challenges: revenues grow faster than talent, complexity and bureaucracy erode accountability, and lower customer engagement stifles feedback from the front line.
Bain identified three stages and distinct skills sets that that startups must develop as a business grows: (1) a “disruptive community” that drives innovation through agile best practices, (2) a “scaling community” to build expertise and integrate winning innovations across the company, and (3) an “execution community” to perfect best practices and improve operating performance.
Bain arrived at a Founder’s Mentality that incorporates a Win/Scale flywheel intended to lock in the Insurgent Mindset while ensuring scalability through strong execution. This framework complements Turning the Flywheel, which inculcates both continuity and change.
The Flywheel and Product Market Fit
The flywheel teaches important lessons as companies search for product market fit. The energy required to overcome the moment of inertia is geometrically proportional to the weight and breadth of a flywheel. A sleek sports car goes from 0 to 60 miles per hour in under four seconds. A tractor-trailer truck may take a minute to reach the same speed.
For startups, speed and agility are essential for survival. The Lean Startup model highlight the importance of validating product market fit before scaling a business. As Steve Blank noted in The Four Steps to the Epiphany: Successful Strategies for Products that Win , “The number one problem I’ve seen for startups, is they don’t actually have product/market fit, when they think they do.” “Startups need 2–3 times longer to validate their market than most founders expect. This underestimation creates the pressure to scale prematurely… In our dataset we found that 70% of startups scaled prematurely along some dimension. While this number seemed high, this may go a long way towards explaining the 90% failure rate of startups.”
Sam Altman, founder of Y Combinator, agrees: “In general, hiring before you get product market fit slows you down, and hiring after you get product market fit speeds you up. Until you get product market fit, you want to a) live as long as possible and b) iterate as quickly as possible.”
The Flywheel & the Pandemic: Survive & Thrive
Like a tornado, COVID-19 has touched down across the technology landscape, haphazardly impacting businesses in different ways. In some sectors, the pandemic has accelerated digital transformation. E-commerce, digital services, business automation, and telemedicine are a few of the notable beneficiaries. Other tech sectors have suffered, most notably travel and smart mobility.
Much as COVID-19 has disproportionately impacted lower income communities, the pandemic widened the divide between high performers and underperformers in the digital world. For sectors experiencing accelerated digital transformation, the prime beneficiaries are companies where the flywheel is already spinning fast.
For sectors suffering with COVID-19, the top priority is to survive and preserve cash. Survival is necessary but not sufficient. In sailing, they say that races are won at night and in still wind. Companies that use this time to perfect their flywheel will be best positioned to thrive post-pandemic.
Turning the flywheel may be painstaking work at the beginning and progress may seem frustratingly slow, especially when facing industry headwinds. But as Jim Collins noted in Upward Bound: Nine Original Accounts of How Business Leaders Reached Their Summits, more companies succumb mentally before they expire physically. Have faith in your model and confidence in your process. Victories are sweetest in the gravest moments.
Make a difference and be the best you this week!
