Case Study: kaChing, Anatomy of a Pivot

(The following guest post is a new experiment for this blog. It was written by Sarah Milstein in collaboration with kaChing CEO Andy Rachleff. kaChing has been very active in the Lean Startup movement. If you haven't seen it, Pascal's recent presentation on continuous deployment is a must-see; slides are here. In the interests of full disclosure: I am an advisor to kaChing but did not participate in the interviews that led to this case.

With case studies like this, we aim to illustrate specific Lean Startup techniques through the stories of current practitioners. It is written using the information that the company voluntarily shared, and therefore reflects their current thinking and recollections. I am particularly interested in feedback on this case study. Do you find it helpful? Please give us your feedback in the comments. Thanks, Eric)

You probably know that Flickr, the photo-sharing site, started out as an MMOG. And if you’re a regular reader of this blog, you may know that IMVU started out as an instant messaging add-on. It’s common, perhaps the norm, for startups to pivot like that—to discover that a product is catching on in unintended ways worth pursuing. Yet there’s a lot of mystery around pivots, and entrepreneurs ask all the time how you know it’s time to commit to a new direction.

To shed some light, I talked with kaChing, a destination that enables individual investors to find outstanding money managers to manage their money. The company’s audacious goal is to disrupt the $11 Trillion mutual fund industry. The startling part is that kaChing started out as a…Facebook game. That’s an epic pivot, like shifting from making solar calculators to powering the Space Shuttle. How’d it happen?

kaChing launched a virtual portfolio management game on Facebook in January 2008 and a similar version shortly thereafter on kaChing.com. The intent was to discover amateurs who could manage a portfolio as well if not better than professionals (think American Idol) and then facilitate individual investors giving them their real money to manage. In other words, the game would serve as a kind of minor league for the profession. Because kaChing prefers its portfolio managers to have a long track record, the marketplace launch (i.e., the version that would facilitate the investment of real money) was planned for late-2009.

kaChing deployed the game across a slew of platforms, including MySpace, the iPhone, and the Yahoo App Platform. The result? They attracted more than 450,000 portfolios—a decent number for a company that hoped a good percentage would prove out as capable managers. They also hoped a reasonable percentage would realize they were lousy money managers and would then convert to clients.

In the early fall of 2009, as kaChing prepared for its marketplace launch, the management team showed the app—which included real time market data, SEC-grade accounting, analytics, compliance and customer management tools—to a number of investment pros to get feedback and endorsements. One of those pros was John Powers, head of the Stanford endowment. He noted the platform would be good not only for amateurs who had proven themselves as outstanding portfolio managers in the game, but also for professional money managers —a group that had insufficient tools for managing and scaling their businesses.

The kaChing system was based on full transparency. A portfolio manager’s entire track record & holdings had to be disclosed. The company didn’t believe professionals would be willing to reveal that level of detail. But Powers’s reaction was intriguing enough to prompt Andy Rachleff, kaChing’s CEO, to call friends who were professional money managers and describe the idea. The response was surprisingly positive.

Andy Mathieson, a founder and managing member at Fairview Capital, was particularly supportive. He was unconcerned about transparency, noting the good have nothing to fear. Mathieson signed on to be a money manager in the marketplace launch, committing five years worth of prior transactional data. Mathieson’s firm has a minimum investment of $1 million dollars outside of kaChing. On kaChing, consumers could invest in Fairview Capital’s strategy with as little as $3k.

When the marketplace launched on October 19, it included seven amateurs who had risen through the game’s ranks and four professionals, including Mathieson. Within a month, kaChing observed several interesting things. First, because the amateurs weren’t SEC-registered, the site had to refer to them with awkward terms like “geniuses.” That was confusing for consumers, who already had to figure out what on kaChing.com was a game and what was real. Second, out of 450,000 gamers, only seven had qualified to become kaChing managers. Third, the company expected hundreds of amateurs who performed poorly in the game to realize they weren’t good at investing and therefore become customers. in fact only five people converted into paying customers. Finally, after launch, 30 professional money managers, having read articles on the company, contacted kaChing out of the blue. These managers weren’t concerned with transparency. They were interested in the tools and new distribution medium kaChing provided.

In November, kaChing held an all-hands meeting, circling up chairs in their small Palo Alto office, to discuss whether they should focus solely on professionals and abandon the systems for proving amateurs. “Some people weren’t comfortable because it wasn’t as fun, and one senior engineer thought we’d be losing the part of kaChing that was an enabler for anyone who wanted to make it as a pro,” Rachleff recalls. “But what we really wanted to change was not who manages the money, but who has access to the best possible talent. We’d originally thought we’d need to build a significant business with amateur managers to get professionals to come on board, but fortunately It turns out that wasn’t necessary.”

The staff agreed they could better fulfill their goals by working just with professional managers. In December, they removed the game from kaChing.com. In February, they held another all-hands meeting to talk about shutting down the legacy Facebook game, which still had 60,000 active users. “Everybody felt the burden of supporting all those transactions every day,” says Pascal-Louis Perez, kaChing’s CTO. “It took a ton of our time, and just wasn’t contributing to our long term vision.” That all-hands lasted five minutes.

Which is a nice story. But when kaChing actually shut down each game, hundreds of angry players spewed venom. “We had to ignore them, because they weren’t our target audience – and were never likely to become customers.” says Rachleff.

kaChing says they had the fortitude to make quick decisions and stay the course not just because they’d observed how people were using the marketplace, but also because they’d spoken with hundreds of potential and past customers. To acquire new money managers, the company makes traditional sales calls, which means they’ve interviewed many, many professionals and gotten a strong sense of their needs. At the same time, whenever a customer closes an account, kaChing contacts the person to find out why; most agree to a short phone interview. (The site has about 700 active paying customers.

Perez says this level of contact, synthesized with their own observations, has given them confidence to make bold decisions. Of the money managers they’ve interviewed, he notes, “The feedback is consistent; we solve big enough problems for people that we believe they’ll come on board.”

With 21 employees today, kaChing is devoted to recruiting professional managers and finding product/market fit, first for money managers, then for consumers. Thus far the results are encouraging. More than 30 qualified professional money managers have been attracted to the platform and more than $190 million of customer assets have been committed as well.

The kaChing team is quick to note that because they’re still closing-in on product/market fit, they’re less data-driven than they plan to be once they’re in optimizing mode. “We create hypotheses, and test them,” says Rachleff. “If something fails, we cut it off. If something seems to succeed, we pursue it aggressively. You have to have the courage of your convictions. With limited data, you have to make tough decisions.”

Special thanks to Pascal-Louis Perez for sharing information and making this post possible.

Some IPO speculation

Inspired by Steve Blank’s post today about the “lost decade” of IPO’s, I’d like to make some predictions. Let me be clear: Steve is the historian. His posts are born of tremendous research into the secret history of Silicon Valley, and if you haven’t read those essays, you should. By contrast, what I’m about to say is pure speculation.

The fact that IPO’s are disappearing makes intuitive sense to me. And the fact that the effects of this IPO vanishing act are being felt first and foremost in the software business also makes sense to me. In fact, I believe that the software business is the canary in the coal mine: increasingly, all businesses are going to look more and more like software businesses.

My belief is that the root cause of the IPO shortage is that successful startup companies cannot find productive ways to invest large amounts of money to scale anymore. For software companies especially, scaling distribution and development is comparatively cheap. The old ways aren’t working. Large capital investments simply don’t have the ROI they used to. The world is changing too fast. New products become commoditized too fast. Increasingly, the only profitable thing to invest in is innovation, which means investing in people. And we don’t yet know how to do that on a consistent, scalable, basis.

Ironically, the VC’s who depend on IPO’s and the CEO’s who are supposed to be creating them are struggling with the same basic problem. They do not have a comprehensive theory of entrepreneurship that allows them to consistently invest in innovation that can create long-term value.

The only way I can see to achieve sustained growth is to create an innovation factory. The modern CEO needs to build an organization that is truly diversified: it is continuously investing in successful sustaining innovation and disruptive innovation. Such an organization should be able to deploy large amounts of capital effectively, by investing in its people. But this is a very different kind of diversification from the old-school GE model. We can’t just diversify across industries or geographies. We can’t even rely on a suite of line-extension products. We have to continually invent new categories of products, new platforms, and new business models – all extremely risky bets. Oh, and by the way, we still have to execute flawlessly. (Even the smallest flaw with an antenna can derail the whole train.)

Today’s management reality is just plain harder than that of the past. General managers need to know how to manage the execution-oriented "twentieth century" general managers that work for them. But they also need to know how to manage the new entrepreneurial managers that, increasingly, are essential to their growth. In other words, the old “manager vs. entrepreneur” dichotomy is breaking down. You cannot be a competent general manager in today’s economy if you do not understand entrepreneurship.

We are living in a transitional moment. The last of the old-school IPO companies are behind us (at least in software), and yet we have not yet witnessed the new-style IPO companies. Despite Google’s reputation as an innovative company, they seem to me to be counted as one of the last of the old breed. Their entrepreneurial successes are mostly to be found outside the organization, in the form of ex-Googlers who became entrepreneurs. Their internal “startup” projects seem, at least to my eye, to have a success rate only marginally higher than Microsoft’s (perhaps with Android – an acqusition – as a major exception). Certainly a large proportion of them end in failure.

The new breed of company currently finds itself satisfied with private capital, and has no need for an IPO. I think Zynga and other games companies may be the earliest exemplars for us to look at. Game companies naturally lend themselves to a “studio” model, with semi-autonomous teams building out their own franchise of sequels and spin-offs. From public reports, it seems like Zynga has really mastered a formula for innovating repeatedly and relentlessly across segments, platforms, and genres. And there are plenty of imitators and fast followers on their way. Will that cohort of companies need an IPO?

When private capital is available in sufficient quantities to satisfy investor and founder liquidity needs, why go IPO? The only reason I can think of is when you need dramatically more capital to grow your business, at a magnitude only available on the public markets and therefore worth the loss of control that going public entails. Our leading crop of pre-IPO web companies apparently do not need that much capital – yet.

It’s a debatable proposition why they don’t need IPO levels of cash. I freely admit that I have no inside information, no unique insight into what they are thinking. But I am nonetheless confident in my prediction: they don’t yet have the ability to manage an innovation factory at that scale. That’s not a criticism; nobody knows how – yet.

We need a new generation of managers trained in a comprehensive management theory of entrepreneurship. Comprehensive means it has to address all aspects of a startups life: marketing and product development, especially. It has to address all stages of startup growth and development – especially including the evolution into a true innovation factory. Tomorrow’s managers will need to know how to build a learning organization (where progress is measured by validated learning) and an execution organization (where progress is measured according to traditional value streams). They will need to know how to combine those organizations into one coherent whole.

I believe that the Lean Startup is the first such comprehensive entrepreneurship theory. But these are still early days. We have much work to do. We face problems today that would have bewildered the earliest management theorists. Their struggle was to use management to create enough productivity to feed, clothe, and house the world. Our civilization has excess capacity everywhere. We can build anything we can imagine. But the ranks of highly educated unemployed and the abysmal failure rates of new products both speak to the same question that needs answering: not, “can it be built?” but rather, “should it be built?”

The sum total of all we know about entrepreneurship is just the tip of the iceberg. We need to be disciplined, to study what works scientifically, and – above all - to introduce scientific methods into the practice of entrepreneurship itself.

When we master that, I think we’ll know what to do with IPO’s again. At least, that's my speculation. In the meantime, it’s going to be fun.

Founder personalities and the “first-class man” theory of management

At any given time, something like four percent of the US population is engaged in some form of new-company-creation. And that narrow definition of entrepreneurship doesn’t count all of the managers inside established companies who are effectively engaged in the same process of building an internal startup (see What is a startup? for my more expansive definition).

What motivates all these entrepreneurs? Typical explanations tend to focus on the well-known anecdotes and larger than life archetypes we have in mind: the twenty-something college dropouts (men, of course) from Stanford inventing some radical new technology. The academic research tells a very different story.

What do entrepreneurs look like? Are they born or made? This is a hard question. I think the root cause of that difficulty is that we tend to conflate two different questions into one. First, what causes someone to attempt entrepreneurship instead of a more traditional career path? And second, what attributes make someone likely to be a successful entrepreneur?

The difficulty lies in this paradox: many of the attributes that increase the likelihood of becoming an entrepreneur actually impede startup success.

Let’s start with the startup personality attributes. The academic research here is extraordinary. Here are the personality traits that are positively correlated with likelihood to pursue entrepreneurship: extraversion, skepticism, need for achievement, risk taking, desire for independence, locus of control, self efficacy, overconfidence, representativeness (the tendency to over-generalize from small samples), and intuition.

I think most of those factors correspond to our shared image of what an entrepreneur is supposed to look like. But many other attributes (especially demographic realities) cut against that stereotype. For example, Vivek Wadhwa and others have shown that most entrepreneurs are much older than we expect. Career experience and industry expertise are both positively correlated with entrepreneurship: contrary to stereotype, most entrepreneurs are not young and inexperienced outsiders. And unlike some psychological factors, these experience-based factors also increase the odds of the subsequent venture being successful.

It is in the psychological factors that we find the most paradox. For example, consider the propensity for risk-taking. Research has demonstrated the obvious: that people who have greater tolerance for risk or ambiguity are more likely to attempt entrepreneurship. That’s not too surprising. But does a risk-taking attitude actually lead to more startup success? The studies that have looked at this question in particular have found a negative correlation between risk-taking behavior and startup success.

That doesn’t strike me as shocking. And, although this hasn’t been subjected to a great deal of study (yet), I believe this same pattern will be found in a variety of other entrepreneurial characteristics: overconfidence, determination to succeed, perseverance, and even the desire to be in control. All of these factors are helpful in getting people to take the plunge, but all of them cause serious impairment of decision-making down the road. Think of the startups you know who are caught in a reality distortion field, heading full-speed off a cliff. Most likely, you will find the above attributes in excess supply.

I believe this is also why breakthrough success stories in entrepreneurship often feature a “classic” zany entrepreneur paired with someone you wouldn’t expect to be taking those kinds of risks. We often talk about this as the “visionary” and “the quant” or the “leader” and the “manager.” But I’m not convinced those labels are right at all. I think it much more likely that we’re seeing the embodiment – in the form of personality - of the “problem team/solution team” organizational structure. One team is in charge of carrying out the vision as currently specified, and one team is constantly asking the skeptical questions: who is the customer? Are we solving the right problem?

Although we have historically viewed this structure in startups by focusing on the personalities of the founders, I think that reflects our current, relatively poor, understanding of how startups work. We can do better by focusing on process instead of personality. We can consciously organize startups to become much more resilient organizations. Otherwise, we risk having them degenerate into cults of personality.

In the early twentieth century, before the advent of scientific management, the overriding management philosophy was that of the first-class man (and they were always men). The idea was, for any job, if you can simply find an individual with just that right combination of virtues, talents, and experience, you could safely delegate all decisions to them. Sound familiar? This kind of reasoning is almost impossible to disprove. If you empower someone to make decisions and then something goes horribly wrong, does that disprove the first-class man theory? Probably not; it’s much easier to blame the particular person who made the mistakes. In fact, making mistakes is seen as “proof” of being second-class.

In management jobs related to operations – that is, the people tasked with actually making and distributing physical products – this kind of thinking is now considered ludicrous, thanks to a century of progress. Our modern philosophy of management has this core belief (taken straight from scientific management) at its heart: that the performance of companies is determined by the systems they create, not just the people they hire. No amount of individual superstardom can overcome a badly organized factory, because the weight of the system eventually overwhelms any well-intentioned but poorly organized resistance.

Yet we tolerate our modern version of the first-class man theory in the management of more “fuzzy” topics, especially innovation and entrepreneurship. When we look back on this period in history, it will seem just as ludicrous to future entrepreneurs as pre-scientific management looks to us.

I am determined to do everything I can to hasten the arrival of that day. If you’re part of the Lean Startup movement, then you’re actually making it happen. Thank you.


All of the academic research alluded to in this essay is drawn from Scott Shane’s General Theory of Entrepreneurship which is a fantastic and wide-ranging overview of the state of the art in academic research on entrepreneurship.

The Entrepreneur’s Guide to Customer Development

Brant Cooper and Patrick Vlaskovits have written a new book, The Entrepreneur’s Guide to Customer Development, which builds upon the foundational work of The Four Steps to the Epiphany, while improving accessibility, updating the ideas, and making it more actionable. I believe it is the best introduction to Customer Development you can buy.

As all of you know, Steve Blank is the progenitor of Customer Development and author of The Four Steps to the Epiphany. I have personally sold many copies of his book, and continue to recommend it as one of the most important books a startup founder can read. 

I used to give copies of Four Steps out to my employees, in the hopes that it would instantly indoctrinate them into the methodology of Customer Development. I just assumed that everybody would love the book as much as I did, and would instantly change their behavior based on what they read in a book. You can imagine how well that worked. Instead of that naive approach, I wish I'd had a book like this one, to help me figure out how to get started with customer development step-by-step. 

When I wrote a review of Four Steps on this blog in November, 2008, I did my best to be candid and warn of a few shortcomings:

And Steve is the first to admit that it's a "turgid" read, without a great deal of narrative flow. It's part workbook, part war story compendium, part theoretical treatise, and part manifesto. It's trying to do way too many things at once. On the plus side, that means it's a great deal. On the minus side, that has made it a wee bit hard to understand.

Brant and Patrick undertook a difficult challenge: to provide a generally accessible introduction to Customer Development, without diluting its impact or dumbing-down its principles. I think they've succeeded.

The Entrepreneur’s Guide is an easy read.  It is written in a conversational tone, doesn't take itself too seriously, and avoids extraneous fluff. It does a great job of laying out general principles and suggesting specific, highly actionable tactics. You can easily take from it whatever makes sense for your business, and leave the rest. And it's incredibly to-the-point: you can digest this book in a couple of hours.

While the customer development framework of Four Steps is universally relevant, The Entrepreneur’s Guide updates its practices for modern startups. Four Steps primarily centers its stories and case studies on B2B hardware and software startups. This new volume also tackles examples from the Internet and wireless startups of today, both B2B and B2C. And throughout, they maintain a thoroughly realistic take on the power - and limitations - of an entrepreneurship methodology:

Successful implementation of Customer Development, let alone simply believing in it, will not guarantee success for your business. Customer Development will help you – force you – to make better decisions based on tested hypotheses, rather than untested assumptions. The results of the Customer Development process may indicate that the assumptions about your product, your customers and your market are all wrong. In fact, they probably will. And then it is your responsibility, as the idea-generator (read: entrepreneur), to interpret the data you have elicited and modify your next set of assumptions to iterate upon.

Many “airport business books” urge entrepreneurs to never give in. They tell them to persist in their dream of building a great product and/or company, no matter what the odds are or what the market might be telling them – success is just around the corner. They tend to illustrate this sort of advice with inspiring stories of entrepreneurs who succeeded against all odds and simply refused to throw in the towel. While maintaining persistence and willpower is certainly good advice, Customer Development methodologies are designed to give you data and feedback you may not want to hear. It is incumbent upon you to listen.

The Entrepreneur’s Guide to Customer Development includes four powerful case studies/interviews with successful entrepreneurs who have taken iterative approaches to their respective startups that very much resemble the spirit of Lean Startups and Customer Development.  I found these to be particularly interesting and worthwhile.

At the heart of Brant and Patrick's interpretation of Customer Development is their belief that its fundamental teaching is to question assumptions. This gives them a hook with which to apply their ideas to a wide variety of situations. In other words, if particular examples in the book don’t apply to you directly, Brant and Patrick show you how to figure out what might work for you.  This is important, since every situation is different.  I'll give them the last word:

You are already skeptical of Customer Development and Lean Startups and the slew of emerging buzzwords and supple-to-the-point-of-meaningless terms. That’s great, more power to you; we applaud your skepticism. But be philosophically consistent: periodically take the time to question your own expertise and that of your friends, partners and investors. Make the effort to test your assumptions.

If there’s a shortcoming to this book, it’s that it focuses primarily on the Customer Discovery step in The Four Steps.  Here’s hoping they soon tackle Customer Validation. Well done, Brant and Patrick. I can't wait to see what's next. In the meantime, go buy a copy of The Entrepreneur´s Guide to Customer Development right now.