Monday, February 29, 2016

The Signal

The opportunity was vast.

The product would enable hospitals to go all digital, eliminating paper records and improving physician's access to high-resolution images. Lower costs, better outcomes. No wonder the company had already closed on eight hospitals. The growth projections from there were obvious.

So it was that Arnold Parnassus left a soon-to-be fortune in Oracle stock options on the table to run this hot new start up in the digital radiology space. And then reality hit. The company stopped dead in its tracks, not selling another system, and Parnassus moved on.

What happened?

First let me assure you that this is a true story, although his name I changed. The post-mortem would find that the first eight adoptions were all by hospitals where the company's founders had close relationships. Once their network was tapped out, growth stopped. Apparently this product was not nearly as compelling as the initial returns implied. The team thought the market had given "the signal," but it was a false positive. The early returns were not really a signal of product-market fit.

But at the time, this diagnosis was not so clear. Parnassus and his team racked up the miles (and the burn rate) making sales calls and attending conferences. They even got a call from GE, which they rebuffed wanting to go it alone. After all, they thought the market had given them the signal, and now it was time for execution.

I see the problem of false positives all the time when I talk to executives. I typically ask "do you have product-market fit?" when I meet with an executive and her team. Normally she will say "yes," and then I'll ask "how do you know?" Then the hand-waving begins, featuring a lot of talk about "value propositions" and such. I listen for the evidence of product-market fit. Are the dogs eating the dog food? If so, can we be sure about why? Or are we like Parnassus, misreading the signal like an embarrassed suitor misreading a wink.

There are many ways of misreading a signal. For instance, just recently an executive told me, "BigCompany is a potential customer, and they want to invest!" OK, this remark raises the obvious problem that customers and investors have very different motivations. But the real problem is the executive. He's getting excited for the wrong reason. An offer to invest is not a purchase order. It is not evidence of product market fit. It is not "the signal."

What's more, an investment like this not only gets misread as the signal, it also buys the firm more time to keep doing what they are doing - even though the dogs are not eating the dog food. Investments often kill firms by cushioning their management teams, allowing them to feel like they are doing a good job even when they should be desperately reconsidering their strategy.

Can you tell signal from noise? What does that say about your leadership?

Marc Andreessen has an interesting article on product market fit.