A business is a system- and when it comes to systems, optimizing only parts will pessimize the whole.

That's the reason why applying principles of – “start small, solve for Product-Market Fit, and build iteratively in the market" – to new, unimagined market spaces often creates ventures with no path to profitability.

In this article, we’ll dive into Integrated Venture Engineering (IVE) – the emerging practice of engineering new business systems – that addresses this through a three-step approach: blueprinting the business system, enacting the business system, and then calibrating it in the market. At all three stages, the business system is engineered to fulfill all three functions of creating, exchanging, and capturing value.

Below you’ll find a summary of what Milan Samani (Partner at TIL Ventures), Tom Manuel (Co-Founder at Calmly), Robert Smith (Head of Behavioral Finance at Barclays), and Nick Miller (FinTech Partnerships and Strategic Programmes Manager at Barclays) shared during our recent Innov8rs Connect on Venture Building & Scaling.

Lean Startup: A Paradigm That Mis-Defines The Problem To Solve

In the context of new market creation – i.e., new products with new business models targeting entirely new customers – new ventures are created to bring transformation functionalities to large groups of people. Over the last decades, business founders, investors, and academics have defined the central challenge of entrepreneurship in the startup world as managing complexity and uncertainty and have coalesced around a ‘Lean Startup paradigm’.

This ‘Lean Startup’ paradigm defines complexity and uncertainty as the main challenges of creating blue ocean ventures. And there is a lot of truth to that: building new products with new business models for new customers is complex. And complexity does breed uncertainty. The Lean Startup proposes a seemingly sensible solution to complexity and uncertainty: start small, solve for Product-Market fit, build iteratively in the market.

In a nutshell, the paradigm suggests picking a part of the business, making it work, then figuring out the rest. It encourages the rapid creation of an MVP and iteratively building it based upon what customers actually do/buy (because what they say will do/buy and what they actually do/buy rarely matches up).

However, businesses are, in fact, ‘systems’ – i.e., complex arrangements of parts, people, and processes by which the three emergent functions of value creation, exchange, and capture are performed. As such, complexity and uncertainty are not the central challenge of entrepreneurship.

“If to manage a business is to manage a system, then to create a business is to create a system. And the central challenge of entrepreneurship is therefore creating a new business as a system”.

And when it comes to creating new systems, the “start small, solve for Product-Market Fit, build iteratively in the market” approach violates some fundamental principles of system engineering. And the result is that three anomalies, or repeated effects, manifest.

A Mis-definition Of The Problem Results In The Wrong Solution. The Result Are ‘Anomalies’

To introduce the anomalies, Milan draws on a car as an example. He says: “if I lay all the parts of a car out on the table in front of me, I have no emergent function of mobility. I have to assemble all the parts in just the right way for that function to manifest. Mobility does not exist in any one part. That's what a system is: parts coming together in just the right arrangement for an emergent property to manifest. And a business is the same: thousands of parts, people, and processes that must be arranged in the right way for the three emerging functions of value creation, exchange, and capture to be fulfilled. Just as a car is a system, a business is a system”.

“Do we really need to decompose the car to test a better radio? No, if you are improving a product feature, you can use A/B testing to see what different customers like. But if you are creating a new blue ocean venture, you are creating a complex system, where the interaction effects will jam everything up. And it will be impossible to create a profitable venture without first decomposing the system”.

The approach that Lean Startup proposes – “start small, solve for Product-market fit, build iteratively in the market” – is sequential in nature. It violates systems engineering principles – where the system must be defined and created ‘as a whole’. When a system is built up piece-by-piece, it invariably fails, and we observe this as three repeated effects, or anomalies:

  • Whac-a-mole. Every system engineer knows that determining one part of a system limits the options to the other parts and changes how they perform. Engineers know that a system should never be built up piece by piece. And the reason for that is interaction effects: a system is made up of interdependent parts – and the pattern of arrangement must be defined at the outset. The unique challenge of creating any system is interaction effects. And if you as an innovation leader start a new venture with an MVP, which is just a part of the larger business system, you’ll limit the design of all subsequent parts of the business model – i.e., the way it's produced, distributed, sales, marketed, priced, and so on. Seeking to optimize these later causes a cascade of interaction effects – and the innovation leader is constantly changing one part of the business, only to observe unintended consequences in other parts.
  • Testing Treadmill. Every systems engineer knows the importance of having a logic model. For example, a car will accelerate when power exceeds resistance. There’s no need to test that; it can be logically proven. But if you define the principal challenge of entrepreneurship as complexity and uncertainty, you don’t allow yourselves room for a logic model.Without a logic model, you only know if the customer wants the product when they buy it. So all you can do is test and experiment. And inevitably, research and experiments prompt more and more questions. And without a logic model, the only way to answer the rising questions is to perform more tests, which will continue until the money runs out. It's interesting to note that 80% of IPO companies were unprofitable last year. The money hasn't run out for them yet, but how many are still on that testing treadmill?
  • Dead-end Venture. The first thing every systems engineer does where there’s the need to innovate a new system is to perform ‘root cause analysis’ on existing systems. This helps identify the key constraint in the current systems, i.e., the critical limiting activity.When entrepreneurs directly focus on an MVP and grow sales, they will invariably import in the current business model’s critical limiting activity. Why? Because these are not obvious and without a root cause analysis, they slip in unnoticed. And when this happens, you have a dead-end venture that can grow to billions of dollars of revenue but will never be profitable without a hard pivot.

Integrated Venture Engineering: A Solution To Lean Startup That Builds Up a Business As A System

The solution to the fatal flaw of The Lean Startup is to adopt a systems engineering approach to venture creation – called Integrated Venture Engineering (IVE).

IVE is grounded in the insight that a business is a system made of hundreds of parts, people, processes arranged in such a way that what emerges is a product and an operational model that fulfills the functions of value creation, exchange, and capture simultaneously.

IVE uses the Business Architecture Plan as a logic model to:

  1. Define minimum business system specifications and synthesize a ‘Business System Blueprint’. This involves using careful logic to solve for system interaction effects on paper through setting out the requirements that every business must fulfill and the mechanisms to meet those requirements.
  2. Simulate, stress-test, and evolve a Business System Blueprint. This involves performing at-scale venture simulation - where the business activities are modeled at scale. The whole-cost structure of the business is established using activity drivers, which in turn determines the price that must be charged for profitability.
  3. Physically enact (build) and calibrate (through pilot) the Minimum Viable Business System. Just as a physical prototype of a car is tweaked and calibrated on the road, the venture is calibrated through a physical build and pilot. But just as no car company would build a car that they weren't sure would actually move, the venture engineer does not start building a venture that cannot be logically determined to create, exchange, and capture value. Hard pivots become the exception, not the norm.

The described process requires practice and skill – just like learning how to engineer a car. Steps one and two take several months to do properly and don’t involve physically building anything, and little to no cost investment occurs. If those are performed well, in step three the investor has a far higher degree of confidence that the venture will generate profits in the long run.

Actionable Tips

As discussed, every business is ‘a system’ that fulfills three functions simultaneously – creating, exchanging, and capturing value. Every part of the business – the product itself and how the product is made, sold, and delivered – contributes to fulfilling all three functions.

Take the example of a car – a ‘system’ that fulfills functions relating to speed, safety, and comfort. The approach of “start small, solve for Product-Market Fit first” is akin to building a car optimized for speed, then turning attention to safety, and comfort.

Every engineer knows that parts that relate to speed, safety and comfort interact with each other significantly (e.g., a Formula 1 engine creates great speed but doesn’t create a comfortable ride) – and the car must be designed with all three functions in mind from the outset.

Accordingly, below are three actionable tips you as an innovation leader may find useful:

  • Switch your focus from ‘getting the product right first’ to defining the business ‘as a whole’ in the first place. Starting a new venture with an MVP, which is just a single part of the larger business system, will limit the design of all subsequent parts of the business model. Instead, you should define the minimum specifications for the entire ‘business system’ from the outset – being mindful of interaction effects.
  • Identify the key constraint in current business models. 'Critical limiting activities’ are activities in current business models that are essential to the business ‘working’ but also carry a cost that cannot be lowered beneath a certain floor. These should be identified at the outset and the new business model that is created must eliminate that ‘critical limiting activity’, i.e., achieve its objective but using an entirely new mechanism. Absent that mechanism, the new business model will likely never be profitable – regardless of scale.
  • Use the logic model of the Business Architecture Plan. The principal challenge of entrepreneurship is not complexity or uncertainty. It is creating a business that can simultaneously create, exchange, and capture value. The Business Architecture Plan allows such a business to be designed from the outset.

In summary. The current ‘Lean Startup’ approach to blue ocean venture creation appears sensible but its sequential nature often results in ventures being launched that are not designed to create, exchange, and capture value and import key constraints into their business models.

A business is a ‘complex system’ that can only fulfill its three functions if the underlying arrangement of parts, people, and processes is aligned. The Business Architecture plan is a logic model that allows for this to be defined.

Integrated Venture Engineering (IVE) is the emerging practice of engineering new business systems. IVE applies a rigorous systems engineering approach to innovating Minimum Viable Business systems that work around critical constraints and ensure the underlying pattern – or business architecture - is aligned.