Thoughts on Reid's Rules
Reid Hoffman, the Founder and CEO of LinkedIn is a very successful entrepreneur and investor. I am a big fan of LinkedIn and support Reid's efforts to encourage entrepreneurship. But let's look at his three rules for investing closely in order to make them useful for entrepreneurs.
His rules, in order, are: 1. reach a mass audience, 2. have a unique value proposition, and 3. be capital efficient. All good rules, but the question is how do you actually accomplish these goals? Reid's view (and the view of most venture investors I know) is that an entrepreneur has to figure out how to reach these goals.
I have always found it curious that venture investors will openly tell anyone that what they do is "pattern recognition". They look for similar patterns in opportunities and solutions that have worked in the past in order to predict success in the future. And this is true with Reid's rules: he is looking for distribution patterns, value proposition patterns, and capital efficiency patterns.
But if venture investors are good at pattern recognition (even if 63% of all their investments return less than 1x), wouldn't it be better to explicitly state what those successful patterns are and then (i) devise ways to acquire the data about the patterns and (ii) a objective, quantitative system to validate the patterns? Then entrepreneurs wouldn't waste time guessing about the patterns (e.g. "do we have a good value proposition") and investors would reduce their failure rate.
Let's look at the most important pattern: the value proposition. Without a value proposition distribution and capital efficiency don't matter (so I think Reid should have put value proposition first in his rules). Of course, every company needs to have a unique value proposition. But what is "value"? Reid states that "a product needs to be sufficiently innovative to distinguish itself from the pack, but not so forward thinking as to alienate the user." What does that mean? What quantitative criteria can be used to determine if a product is "sufficiently innovative" and "not so forward thinking"? And what is "innovation that is categorically distinct"? Without a rigorous definiton of what these terms mean, they are almost useless to the entrepreneur.
Here's an example of the confusion: Reid states that Facebook used a "University-centric approach" to be successful. You might call this strategy "Friendster, but for college students". And yet, Reid criticizes "pitches that sound like 'It's a dating site, but for senior citizens.'" Without rigorous definitions for "sufficiently innovative" and "categorically distinct" it is almost impossible to see a priori what is different about "Freindster for college students" and "dating for seniors". How is an entrepreneur supposed to tell the difference?
What is needed is a definition of value from the perspective of the customer. What is a customer need and how do you know if the need is satisfied or not - this is the pattern that matters. All products must meet customer needs to be successful, and "sufficiently innovative" means that a product meets customer needs better than the existing solutions. So customer needs must by rigorously defined and quantifiable in order to be useful for the enterpreneur. The "pattern" (the customer needs) must be explicit and knowable in advance.
If the customer needs are defined, solutions can be generated to meet customer needs and the value of the solution (from the customer's perspective) can be quantified. If the solution does create enough value for the customer (and the value chain), it is much easier to figure out if you can reach a mass audience and if the business model will be capital efficient.