Find and Replace "Differentiation"
In my prior post, I proposed that capital-D Differentiation is an investor concept that’s overly relied upon during startup evaluations, but that can cause VCs to miss what’s most important about a startup’s potential. Reflecting more, I think I missed two important points:
When investors debate Differentiation, we incorrectly focus on whether a product is difficult enough to build1 rather than deeply internalizing the customer's POV. Startups (usually) don’t fail because investors didn’t believe in the Differentiation, they fail because customers don’t desperately need the product en masse2
Our job as investors is to evaluate startups across dozens of subsectors, so it takes us more time to paint a picture of how a given product transforms an industry. We’re never going to be as good as a founder at developing true customer empathy.3
Since we’re on the outside, we don’t live the root cause of demand and the pain points a customer is dealing with daily. We proxy that understanding in other ways, the easiest, and I think most dangerous, of which is to evaluate whether the supply of providers (i.e. competition) will increase. We point to the number of companies in a subsector raising venture rounds as a reason to wait and see things play out rather than validation that the customer problem is real and an opportunity to really dig in.
Which makes it ironic that when you ask one of us to describe a company with differentiation, we end up taking the customer’s POV! For Datadog, we might say it’s the best one-stop shop for observability that scales from small companies to large enterprises; for Stripe, it’s the developer experience and the ability to outsource the complex problem of payments to a third party; and for a consumer company, it's the size and power of the network.4
That being said, there are some consistencies between how investors and customers evaluate a product. We all tend to compare products at a point in time vs. considering the slope and rate of improvement. We give too much credit to products that won’t get someone fired rather than products that will get someone promoted. And we overly analyze how a product affects the person we’re talking to instead of whether it will transform the output of an entire organization.
So what’s the solution? One approach is Mike Maples’ concept of “forcing a choice, not a comparison.” If you’re an early-stage startup caught in RFP hell, you’re stuck in comparison land. But suppose you’ve built a capability so transformative that other companies look past temporary feature gaps, like all the customers switching from FloQast to Numeric*. In that case, you’ve successfully forced a choice.
Accordingly, we investors should ask questions that identify this dynamic. Instead of the standard ones - what a customer likes about a product, who they evaluated it against, and how they decided - we should be trying to tell a story of the buyer’s work life and goals, how they found the product, and the nuanced experience of using the product. Has the buyer of this product been given more internal responsibility because it was considered a great decision? Who are the lighthouse customers and tastemakers that customers are influenced by, and what are they saying/doing? How many times a day does the output of a given product get referenced? Etc.
To be more provocative: if you’re a founder and an investor relies on “What’s your differentiation?” to understand your startup, I think you should remove them from your list. Focus on investors who ask questions to really try and understand you, your business, and your customers. Perhaps a New Year’s resolution for us all to consider.
Amusing since most of us haven’t built or shipped products before!
Jack at Watchfire (a former professional musician) says it better: “If you want to make music for a living, your job is obviously dictated not by “artistic quality” but by making something that connects so deeply with people that they *need* to pay you to hear/see/be a part of it”.
Which is why, if you're building for the office of the CFO, you should probably try and work with my partner Ajay
These are of course generalizations