In the business-school case study, the startup always begins with a brilliant insight. The founders perceive a gap in the market relative to incumbents, then build a product to fill it. It’s all very logical. In reality, we know that startups are messier than that. Founders usually start with a product idea. They know users will like it but may be a bit hazy on the exact market, buyer, or business model. Those details get filled in over time. By launching the product first and learning from its adoption, founders discover the market insight, then build the organization they need to operationalize it.
These thoughts occurred to me as I watched Lex Fridman’s recent podcast with Jack Dorsey about the founding of Square. It strongly resonated with my own experience at PayPal, which I’ve written about here. Here’s how Jack explained it (edited for length and clarity):
If there’s one word that represents what we're trying to do at Square, it's access. We weren't expecting this at all. When we started, we thought we were just building a piece of hardware to enable people to plug into their phone and swipe a credit card. And then as we talked with people and dug in some more, we found a consistent theme: many of them weren't even allowed to process credit cards. A lot of them would go to banks or merchant acquirers and waiting for them was a credit check looking at a FICO score. Many small businesses don't have good credit or a credit history. They're entrepreneurs who are just getting started, taking a lot of personal financial risk.
It just felt ridiculous to us that for the job of being able to accept money from people, you have to get your credit checked. As we dug deeper, we realized that wasn't the intention of the financial industry, but it's the only tool they had available to them to understand authenticity of intent, a predictor of future behavior. So the software really came in terms of risk modeling. We started with a very strong data science discipline because we knew that our business was not necessarily about making hardware. It was more about enabling more people to come into the system. [To do that] you have to lower the barrier of checking that that person will be a legitimate vendor.
I think a lot of the financial industry had a mindset of distrust and just constantly looking for opportunities to prove why people shouldn't get into the system. We took on a mindset of trust and then verify, verify, verify. When we entered the space, only about 30-40% of the people who applied to accept credit cards would actually get through. We took that number to 99% because we reframed the problem. We built models and had this mindset of we're going to watch, not at the merchant level, but at the transaction [level]. So come in, perform some transactions. And as long as you're doing things that feel high-integrity, credible, and don't look suspicious, we will continue to serve you. If we see any interestingness in how you use our system, that would be bubbled up to people to review, to figure out if there's something nefarious going on.
Let’s unpack that, to understand the process that led to the creation of a $60 billion market-cap company. It has three steps:
Step 1: Create the product hook.
Jack’s starting point was not an understanding of how the legacy incumbents were broken or how that brokenness created a huge gap in the market. That understanding would come, but the starting point was to conceive of a simple product that would create tangible value: “When we started, we thought we were just building a piece of hardware to enable people to plug into their phone and swipe a credit card.” The original Square reader is a great example of what I’ve called a “product hook” -- a simple repeatable transaction (in this case, a swipe) that entices users to engage with a larger product. It also came with a “distribution trick”: its distinctive design, underscored by the Square logo and brand, created real-world virality. PayPal started in a similar way: our product hook was to “email money,” which also created the first distribution trick (email virality).
Step 2: Discover the market insight.
The market is discovered as a result of seeing who uses the product and why. Square discovered that there was a huge under-served portion of the market -- small business owners and entrepreneurs that didn’t have the credit history necessary to get a traditional credit card merchant account. At PayPal, we stumbled onto a similar insight with eBay sellers, who didn’t conceive of themselves as professional businesses and were unable or unwilling to go through the lengthy underwriting process that eBay had set up with its payment partner Wells Fargo. Both Square and PayPal realized that they could increase access to a new and under-served market by eliminating the upfront requirements and approaching fraud detection in a different way. While PayPal was originally confined to payments that could take place on a desktop PC, Square was built for the online-to-offline era, where ipads and iphones have extended apps to every nook and cranny of the physical world.
Step 3: Operationalize the insight.
To operationalize the market insight, Square (like PayPal before it) built fraud expertise at the transaction level to replace hoops at the merchant level. It built a data science team, predictive models, and a team to review suspicious transactions. Over time these efforts grew more sophisticated and became a moat. Undoubtedly, it helped that Square brought on two PayPal Mafia veterans -- Keith Rabois as COO and Roelof Botha as board member. Hiring people who have done similar things in the past can provide a tremendous shortcut. Historically, this was a big advantage of starting a company in Silicon Valley. Even as technology companies become more geographically diffuse, it is worth spending the time to find talent who can help you avoid reinventing the wheel. Finally, Square deserves a lot of credit for expanding its product line over time. Once it discovered the theme of access, it had the “north star” to continually expand its offerings.
Square and PayPal are both examples of the philosophy that “if you build it, they will come.” But users will only come if you build it the right way: The company starts with a product hook to grab users and a distribution trick to find them, pays attention to the organic use of the product to discover the market insight, then leans into that insight to build the company. It helps that Square and PayPal are consumerized, broadly horizontal products; the strategy would be less suitable for hyper-vertical or deep-stack enterprise products. But with the consumerization of the enterprise, the product-first approach is increasingly relevant for SaaS as well as consumer apps.