10/21/2013 09:57 am ET Updated Dec 21, 2013

From Concepts to Companies: Creating High Growth and Wealth

Harvard Professor Clayton Christensen, the leading authority on disruptive innovation, says the creation of new businesses that grow entirely new markets is the only source of long-term growth and wealth creation. That is easy to say but hard to do, because it's impossible to predict which startups will be the big winners. Many people analyzing disruptive innovations experience Christensen's paralyzing innovator's dilemma. Developing the capability to start new high-growth businesses is crucial to entrepreneurs, investors, universities and corporations.

Too often a startup entrepreneur starts a new business based on an intuitive insight about an emerging market. To raise an initial round of capital, investors require a long-term business plan with a multi-year financial forecast. Once this looks compelling, the investors write their checks.

The leading evangelist of the lean startup movement, Stanford Professor Steve Blank, anticipates that happens next: "Business plans rarely survive first contact with customers." The entrepreneur finds that some of her assumptions aren't correct, but she's now out of cash. So she revises her business plan and goes back to her investors for more money. They're none too happy but begrudgingly invest more. Then rinse and repeat. Months later the entrepreneur is still finding her way in the market. Out of cash once more, the entrepreneur revises her business plan again. This time the investors balk. The first two plans failed, so the entrepreneur's credibility is shredded.

A similar result occurs if the entrepreneur finds a corporate partner. Corporations have to make large bets to be worth the trouble. So the executive team vets the entrepreneur's detailed, multi-year plan with the operationally excellent, data-driven management tools that work so well in the existing business. This is signed off by multiple layers of management. It doesn't take long to find out that some of the assumptions are off, but the plan is locked in by the big commitment and management sign offs. Now nary can an executive be found who thought this was a good idea as fingers point in anticipation of heads rolling.

The lean startup is an entirely different approach. It acknowledges, as Blank does, that "no one other than venture capitalists and the former Soviet Union requires five year plans to forecast complete unknowns." All involved must acknowledge that at the beginning the entrepreneur doesn't have a business plan, but a business hypothesis.

Startups are not small versions of large corporations. Existing businesses execute a business model. Startups discover one. The lean startup is a systematic, robust process for testing and validating assumptions about how to provide what customers really want. The entrepreneur needs investors or corporate partners willing to fund this discovery process -- the scientific method applied to business models.

The seed capital should be enough to fund the first phase of experiments, where the entrepreneur meets with prospective customers and vendors to test her hypothesis. While as expected some assumptions prove inaccurate, she discovers what is true in the marketplace and revises her hypothesis. Pleased with her progress, the investors agree to fund enough for the next phase of more narrowly focused experiments. After several iterations, the entrepreneur has sufficient validation to recruit a proven team and raise a large round of capital to shift from discovery to execution of a scalable business model. Even though the business the entrepreneur ends up with is profoundly different than the entrepreneur's original intuition, investors are thrilled with her success.

We need to nurture a community of entrepreneurs, investors, universities and corporations well versed in lean startup principles. Investors too often ask startup entrepreneurs what revenue will be in five years. Investors need to let the entrepreneurs know what they would like for revenue to be so entrepreneurs can plug that into their spreadsheets. Not only don't startup entrepreneurs know what their businesses will be years out, it is unknowable. There is no way entrepreneurs can account for all the serendipitous connections that will cause their businesses to morph in unpredictable ways. Forcing entrepreneurs to write the great American novel is a waste of time and resources.

A long-time corporate VP of Research client frequently emphasizes he can't invest millions of dollars in every early idea I bring him. Instead of placing big bets on a few ideas, a corporation should make small investments in a portfolio of early ideas aligned with their priorities. Then cull many of the ideas after the first milestone and invest a larger amount in the rest. After several rounds, the corporation has invested most of its resources in the winners without knowing at the beginning who the winners will be.