How to Measure

• The financials in the business plan include projections of how many customers the company expects to attract, how much it will spend, and how much revenue and profit that will lead to.
• A startup’s job is to (1) rigorously measure where it is right now, confronting the hard truths that assessment reveals, and then (2) devise experiments to learn how to move the real numbers closer to the ideal reflected in the business plan.

Why Something as Seemingly Dull as Accounting Will Change Your Life

• Historically, accounting became an essential part of the method of exerting centralized control over far-flung divisions. Accounting allowed to set clear milestones for each of its divisions and then hold each manager accountable for his or her division’s success in reaching those goals.
• Unfortunately, standard accounting is not helpful in evaluating entrepreneurs. Startups are too unpredictable for forecasts and milestones to be accurate.
• Most milestones are built the same way: hit a certain product milestone, maybe talk to a few customers, and see if the numbers go up.
• How do we know that the changes we’ve made are related to the results we’re seeing? More important, how do we know that we are drawing the right lessons from those changes?
• To answer these kinds of questions, startups have a strong need for a new kind of accounting geared specifically to disruptive innovation. That’s what innovation accounting is.

An Accountability Framework that works across Industries

• Innovation accounting begins by turning the leap-of-faith assumptions discussed in Chapter 5 into a quantitative financial model.
• Every business plan has some kind of model associated with it, but they all measure growth differently. That model provides assumptions about what the business will look like at a successful point in the future.
• For example, the business plan for an established manufacturing company would show it growing in proportion to its sales volume. By contrast, a marketplace company that matches buyers and sellers such as eBay will have a different growth model.
• Though these two businesses have very different drivers of growth, we can still use a common framework to hold their leaders accountable. This framework supports accountability even when the model changes.

How Innovation Accounting Works - Three Learning Milestones

• Innovation accounting works in three steps: first, use a minimum viable product to establish real data on where the company is right now.
• Second, startups must attempt to tune the engine from the baseline toward the ideal. This may take many attempts .
• After the startup has made all the micro changes and product optimizations it can to move its baseline toward the ideal, the company reaches a decision point. That is the third step: pivot or persevere. The sign of a successful pivot is that these engine-tuning activities are more productive after the pivot than before.

1. Establish the Baseline ◦ MVP would test most of the startup’s assumptions and establish baseline metrics for each assumption simultaneously. ◦ Before building the prototype, the company might perform a smoke test with its marketing materials. ◦ A smoke test measures only one thing: whether customers are interested in trying a product. By itself, this is insufficient to validate an entire growth model. ◦ Smoke test is an old direct marketing technique in which customers are given the opportunity to preorder a product that has not yet been built.  ◦ These MVPs provide the first example of a learning milestone. An MVP allows a startup to fill in real baseline data in its growth model conversion rates, sign-up and trial rates, customer lifetime value, and so on. ◦ It makes sense to test the riskiest assumptions first. If you can’t find a way to mitigate these risks toward the ideal that is required for a sustainable business, there is no point in testing the others. ◦ For example, a media business that is selling advertising has two basic assumptions that take the form of questions: Can it capture the attention of a defined customer segment on an ongoing basis? and can it sell that attention to advertisers? The far riskier assumption is the ability to capture attention. Therefore, the first experiments should involve content production rather than advertising sales.
2. Tuning the Engine ◦ Once the baseline has been established, the startup can work toward the second learning milestone: tuning the engine.  ◦ Every product development, marketing, or other initiative that a startup undertakes should be targeted at improving one of the drivers of its growth model. ◦ For example, a company might spend time improving the design of its product to make it easier for new customers to use. This presupposes that the activation rate of new customers is a driver of growth and that its baseline is lower than the company would like. To demonstrate validated learning, the design changes must improve the activation rate of new customers. If they do not, the new design should be judged a failure.
3. Pivot of Persevere ◦ Over time, a team that is learning its way toward a sustainable business will see the numbers in its model rise from the horrible baseline established by the MVP and converge to something like the ideal one established in the business plan. ◦ When this is done right, even the most powerful reality distortion field won’t be able to cover up this simple fact: if we’re not moving the problems of our business model, we’re not making progress. That becomes a sure sign that it’s time to pivot.

Innovation Accounting at IMVU