Book excerpt: What makes a great startup idea? Lessons from a veteran entrepreneur

Shirish Nadkarni.

Editor’s note: The following is an excerpt from a new book written by Shirish Nadkarni, a Seattle tech veteran who co-founded Livemocha (acquired by RosettaStone) and TeamOn (acquired by BlackBerry).

You think you have come up with a brilliant idea for your startup. You have spoken to your friends and colleagues, and they think that the idea has merit. You have even done the preliminary market research and spoken to many potential customers, and feedback has been positive.

But how do you really know that it will form the basis for a great company? Figuring this out is no easy task. After all, VCs are paid millions of dollars in management fees, and even then, for the most successful investors, only one out of ten picks is a major hit.

To consider whether a startup idea has the potential to become a hit, it is important to consider the idea from a number of different strategic perspectives discussed below.

Incumbents are hard to beat on their own turf

Most markets you will target have existing players and market leaders that have been around for years. Incumbents are extremely hard to beat unless there is a major transformation in the industry that you can exploit first. Incumbents typically have a strong industry reputation, a host of features, a fine-tuned sales engine, and customer lock-ins that make it difficult for customers to consider a new player in the market.

Everyone today is familiar with the success of Microsoft Office. What people don’t know is how difficult it was for Microsoft to gain a leadership position in the office productivity space before Windows became a popular platform.

Before the advent of Windows, WordPerfect and Lotus 1-2-3 were the de facto market leaders on the MS-DOS operating system. Microsoft had its own MS-DOS-based offerings called Microsoft Word and Microsoft Multiplan. However, Microsoft had very little success beating WordPerfect and Lotus 1-2-3. Users were just too used to the keystroke-based user interfaces of WordPerfect and Lotus 1-2-3 and were locked into the macros that they created in Lotus 1-2-3.

Once Windows 3.0 came on the scene in 1990 and started becoming popular, things shifted in Microsoft’s favor.

WordPerfect and Lotus made the mistake of simply porting their applications from MS-DOS to Windows, which meant that the applications didn’t perform well on Windows. Not surprisingly, Microsoft built new word processing and spreadsheet apps from the ground up that were designed to take advantage of the capabilities offered by Windows. Next, Microsoft made the brilliant move to package these applications along with Microsoft PowerPoint into a bundle called Microsoft Office and made it cheaper than purchasing each application individually.

Over time, Microsoft made sure that all the applications had consistent user interfaces and that it was easy to share data across these applications. It was no surprise that, as Windows became more popular, the market share leadership shifted to Microsoft Office as users wanted the best and most comprehensive suite of applications for Windows.

Global industry transformations

The best opportunities for disruption happen when the industry you are targeting is undergoing a dramatic transformation. At that time, incumbents are typically slow to move because they have existing investments and business models that they are unwilling to disrupt.

Microsoft, for example, failed to recognize how its hold on the PC industry would be disrupted first by the internet and later by mobile devices. It took a very expensive acquisition of Hotmail for Microsoft to get into the game with MSN.com, and it was soon eclipsed again by major players like Google and Facebook.

On the mobile front, Microsoft invested initially in its Pocket PC platform but failed to see the shift to mobile by early players like Research In Motion (RIM) with its iconic BlackBerry device. Later, Apple and Android completely upended the mobile market with their touch-based interfaces and application platforms. By the time that Windows mobile came on the scene, it was too late for Microsoft, and it never got beyond a 1 to 2% market share in the mobile market.

With TeamOn, my plan was to ride the wave of SaaS applications with the shift from IT-installed on-prem (on premises) solutions to applications that operated in the cloud. In the 2000 timeframe, when broadband internet was becoming more widespread among business users, SaaS-based applications provided performance similar to that of locally installed client-server applications. SaaS-based applications offered numerous benefits over on-prem applications — companies didn’t have to hire an expensive IT staff to install and upgrade the applications and back-up user data. It was also possible to access applications from any location with internet access — users were not limited to accessing an application only from within a corporate network.

Livemocha’s homepage in 2013.

When Livemocha was launched, the entire world was going through a globalization phenomenon with dramatic outsourcing of manufacturing and knowledge worker jobs. Global trade was also showing significant growth as tariffs and trade barriers were coming down. Worldwide travel between various regions was increasing significantly as employees at multinational corporations had to travel internationally to coordinate their activities with their employees, customers, and vendors. These transformations were all responsible for the significant interest in foreign language learning, especially English, throughout the world.

While the trend toward globalization was accelerating, a number of social networks began emerging and capturing end-user attention. Facebook and Twitter launched in the early 2000 timeframe, popularizing the notion of social networking. As a result, people started feeling more comfortable interacting with other like-minded people on the internet. A number of special community-focused social networks also emerged to leverage the trend toward social networking.

With Livemocha, we decided to disrupt the traditional CD- ROM-based learning model popularized by Rosetta Stone by offering a web-based social language-learning tool. Unlike Rosetta Stone, the offering was initially free. Later, we introduced a premium version that offered a more advanced set of learning courses with conversational video and grammar content.

It took a long time for Rosetta Stone to respond to Livemocha as it was wedded to the traditional CD-ROM model, which sold at a high price backed by expensive TV advertising. Because it was a public company, it was on the hook to meet quarterly goals and didn’t have the luxury of making a freemium offering like Livemocha.

COVID-19 impact

Looking ahead, the COVID-19 crisis is creating another global transformation in the way we work together, how commerce is conducted, and how experiences are delivered. In a matter of weeks, companies with white-collar office workers were forced to an all remote work situation. Use of virtual collaboration tools like Zoom accelerated dramatically and companies found that employees can be equally productive working from home. The use of workplace automation and collaboration tools like Slack, Microsoft Teams, Smartsheet, Asana, and others also increased significantly.

As a result, many companies like Twitter and Zillow indicated that they will let their workers work remotely on an indefinite basis. Given the prevalence of remote work, I fully expect that new collaboration tools will emerge that will allow employees to be more productive working from home.

As the COVID-19 crisis has dampened consumer demand, many companies have also experienced significant impact to their revenues. There is, therefore, significant pressure on companies to correspondingly reduce their expenses and make their workforces more efficient. As a result, there’s increased interest in digital transformation as a way for companies to create “Digital First” work from anywhere experiences with increased automation. Companies like UIPath, which provide tools for robotic process automation (RPA), have seen a dramatic increase in sales as RPA has become a key tool to reduce costs involved in repetitive office tasks.

Retail commerce is another area that is being disrupted because of the COVID-19 crisis. There has been a dramatic shift from physical retail sales to online e-commerce as shoppers are cautious about shopping at malls. Demand for delivery services like Instacart and DoorDash has also exploded.

These changes are going to create new opportunities for startups to deliver innovative products that satisfy the need for people to conduct commerce online as opposed to in person. A number of online-first consumer brands like Warby Parker, Allbirds, and Madison Reed have emerged in the last few years and have successfully captured consumers’ imagination. I expect that the category of online-only consumer brands will explode as people become more comfortable consummating their purchases online.

Technology platform shifts

Over the last three decades, we have seen new technology platforms emerge that have created tremendous opportunities for startups. We had the emergence of the PC platform in the 80s, followed by the internet platform in the 90s. Finally, mobile emerged as the broadest platform for computing in the early 2000s, enabling more than 4.5 billion users worldwide to gain access to the internet.

Each of these new technology platforms has allowed a whole new generation of companies to emerge and become massive players in the industry. Microsoft rode the PC platform wave, followed by Google and Amazon, which rode the internet wave, and, finally, Facebook and Apple rode the move to mobile.

A number of new companies emerged that disrupted existing market leaders that did not adapt fast enough to the emerging new platforms. Amazon disrupted Barnes & Noble before becoming a general purpose e-commerce platform. Netflix disrupted Blockbuster, and now it is disrupting traditional cable companies, which are losing subscribers by the millions as they cut the cord. In fact, neither of my adult kids has a cable TV subscription. Instead, they rely on Netflix, Amazon Prime, and Hulu to access made-for-TV content.

Looking ahead, the COVID-19 crisis is creating another global transformation in the way we work together, how commerce is conducted, and how experiences are delivered.

Over the last few years, we are seeing a significant opportunity for new startup creation with the emergence of artificial intelligence and machine learning (AI/ML) technology. The advent of cheap GPU-based computing power and AI/ML services offered by all the major cloud providers like Amazon Web Services, Microsoft Azure, and Google Cloud Platform has enabled a whole new generation of AI/ML-based startups to emerge and disrupt existing players in their market. Startups need access to a large amount of labeled data to build machine learning models that make useful predictions for specific use cases. The most successful startups are the ones that have gained early access to proprietary data that they can utilize to fine-tune their models.

KenSci is a Seattle-based company that is leveraging AI/ML technology in the healthcare space. The company was started by Dr. Ankur Teredesai, a computer science professor at the University of Washington, and Samir Manjure, the company’s CEO. KenSci’s risk prediction platform for healthcare is engineered to ingest, transform, and integrate disparate sources of healthcare data, including EHR, claims, admin/finance, and streaming. KenSci uses machine learning to recognize patterns in large volumes of data, helping healthcare systems view the granular details of the patient’s history and predict future risks for optimal care. For example, KenSci makes risk of readmission and end of life predictions to help health- care providers avoid adverse changes in their patients’ health. (Editor’s note: KenSci announced its acquisition to Tegria this week)

Network effects

According to Wikipedia, “A network effect (also called network externality or demand-side economies of scale) is the effect described in economics and business that an additional user of a good or service has on the value of that product to others. When a network effect is present, the value of a product or service increases according to the number of others using it.”

We have seen many examples of how powerful network effects can be in creating unstoppable, winner-take-all juggernauts. eBay was an early example in the auctions market. Many later entrants like Yahoo failed to take on eBay because of the network effect it had established. Facebook and Airbnb are more recent examples where the value of the network has grown exponentially as more users joined their network.

In my case, with Livemocha, we saw our social networking capabilities create network effects that powered our growth to 15 million members in only a matter of a few years. As a result of our powerful network effects, we saw virtually no competitors that adopted our approach to language learning.

As you think through your idea, it will be useful to think about opportunities to create network effects as we did with Livemocha. Marketplaces and social networking apps are typically natural candidates for creating network effects. However, even enterprise apps have the potential for creating network effects.

Slack is a good example of a solution that has a network effect as more users get on to its platform within a large corporate environment. App Annie is another example of a solution that has created a network effect since it offers benchmarking features for app developers. As more apps utilize App Annie to track their usage, App Annie can provide more data on how an app compares with other apps in the same category.

Network effects are not insurmountable, as Facebook has seen. It was disrupted first by Instagram, which offered filters for photo sharing, and later by Snapchat, which offered the concept of ephemeral messaging to win the minds and hearts of teenagers. Fortunately, Facebook acquired Instagram as well as WhatsApp but failed in its effort to acquire Snapchat. Once you become an established player, you have to be on the lookout for young, hungry startups that are looking to disrupt you.

Virality

The term viral marketing was invented by Tim Draper, general partner at Draper Fisher Jurvetson, in the context of Hotmail. Tim introduced the idea by asking the Hotmail team to add a signature “Get your free email at Hotmail” to every email that a Hotmail user sent out. It was responsible for the dramatic growth of Hotmail following its launch in 1996. Hotmail’s rapid growth was one of the key reasons that Microsoft decided to acquire Hotmail in 1997.

Having a viral aspect to your application can dramatically reduce your overall cost of acquisition and drive rapid customer growth. It can be even more effective if your application is inherently viral. By “inherently viral,” I mean an application that causes its users to actively recruit other users.

As you think about your startup idea, make sure to think about whether you have an inherently viral application or if you can include viral elements in it.Hotmail was not an inherently viral application. It got free advertising every time someone sent out an email from a Hotmail account. However, the recipient didn’t need to have Hotmail installed in order to receive email from a sender using Hotmail.

Skype, on the other hand, was an inherently viral application because both parties to a Skype call have to be on Skype to make the call. As a result, an initiator of a Skype call is likely to recruit the other party to use Skype.

However, virality can die off because of technology changes. Skype, for example, has been displaced by WhatsApp, which originally started as a text messaging app. Since introducing video calling features in 2016, WhatsApp has become the de facto audio/video calling app for consumers all over the world.

Enterprise applications can also have viral characteristics. Slack is a great example of a viral application. Its users are motivated to recruit other users so that everyone can communicate easily using Slack. As you think about your startup idea, make sure to think about whether you have an inherently viral application or if you can include viral elements in it. Introducing virality will make it much more possible for your idea to become successful and reduce your overall cost for customer acquisition.

Aspirins, not vitamins

Once you have evaluated your idea from a strategic perspective using the attributes discussed above, it is important to understand how big a pain point you are addressing. As most VCs would say, they are looking to fund aspirins, not vitamins. Ideally, you are addressing a pounding headache where customers are knocking down your door to gain access to your solution. In addition, make sure that your solution is materially better than existing solutions in the market.

Slack is a great example of an “aspirin” solution that addressed the big problem caused by email overload that was destroying productivity for employees, especially in large enterprises. An email inbox is a serial list of communications of all kinds that a person has to wade through to find and act on email messages that are directly relevant to their work.

Unlike email, which is a one-to-many communication channel, Slack has a team-oriented communication architecture. With Slack, you can set up channels for specific projects. Communication and updates relevant to these projects can be routed into specific channels that team members can browse at their convenience. This can significantly reduce the communication that would normally go over email, thus allowing the use of email for more direct one-to-one communication.

Slack also makes it easy to have real-time conversations with any teammate. With direct messaging, it’s easy to grab someone’s attention when you need a quick response. Slack has made it very simple for corporations large and small to adopt its solution by making it free to get started. Slack was a dramatic improvement over email, which contributed to its rapid growth into a multibillion-dollar company.

In the consumer space, Livemocha was successful because it addressed the pressing need of people all around the world to learn English. In most developing countries, strong English-language proficiency can make a big difference in people’s livelihood, allowing them to gain access to better paying jobs. Language education in brick-and-mortar schools can be quite expensive in these countries, which created the demand for inexpensive language-learning tools over the internet. In addition, most English-language learners didn’t have access to native English speakers to develop English speaking proficiency.

Livemocha became very popular because language learners could connect with native English speakers and improve their English speaking skills. In addition, like Slack, Livemocha was free to get started, and consumers had to pay only to gain access to video and grammar content and certified tutors on its platform.