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What PayPal's Rocky Beginnings Can Teach You About Startup Success

What PayPal's Rocky Beginnings Can Teach You About Startup Success
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As CEO of a startup in launch mode, you could build a product or service and sell to any customer. Make a list of all the possible market segments and specific measures used to evaluate these segments and you might run out of resources before you even get started.

How should you narrow down the list of options to make the best choice?

The answer is: you can't make the best choice. If you are trying to do something new, there is no evidence of historical success or failure that might provide you with sufficient guidance to make an informed decision. Fortunately, you can make a series of guesses that may lead you to a good-enough answer.

Consider how PayPal got started. Max Levchin, one of its co-founders explained to me that PayPal did not start off as the online auction currency for which it is rightly famous. It was originally called Confinity and delivered security software for handheld devices such as PalmPilots.

Levchin did not achieve enormous success with that business model. He and his colleagues got to thinking about handheld devices, which led them to focus on wallets. They got funding to develop an electronic wallet and when they delivered the product, they began to get emails from people who were using part of their service as an eBay auction currency.

Levchin thought this was a terrible idea because it was not the purpose for which they had designed the product. However, they decided to scrap their original idea after six months to focus on serving the eBay community. In 2002, PayPal, which formed two years earlier, went public, giving Levchin an easy way to turn his 2.3 percent stake into cash.

Levchin's bumpy journey to PayPal success suggests three principles that you should follow to help you choose the right product and customer segment:

1. Work on a problem you are passionate about solving. Only start a company if you are willing to spend 80 to 100 hours a week working on it without getting paid. When you get started, you will probably need to do this and convince others to do it as well. Without passion, you won't last.

Levchin and his team loved working on operating systems, so when they started Confinity, they were doing what they loved. While this was a good way to start, it did not initially lead them to picking the right market.

2. Build a prototype. Think about your startup's product and then build a quick and inexpensive version of it. Building such a prototype will help you communicate what you are trying to accomplish with potential customers.

Finding that first customer -- your foot in the door to targeting a market – depends on how people respond to your prototype.

In Levchin's case, the prototype mostly revealed that he was targeting the wrong customers with his focus on a PalmPilot operating system. You may succeed at your first try, but usually startups have to use the prototype to help them adjust their product or the customers they should target.

3. Find customer pain. As much as you believe you will be the exception, most startups fail. That's why startups must focus on targeting customers with significant pain that competitors are not addressing. Then the startup must create a low-risk way to encourage customers to try the product.

Levchin stumbled on the need for an eBay auction currency -- a small part of Confinity's service -- but a large pain point for customers. With help from Xoom, PayPal created a solution that enabled customers to pay for online auctions and did it better than the competition.

Using these three principles, you should be able to find a product and market segment from which your startup's growth will spring. Most importantly, the only way to get customers to give your venture a chance is to offer them a solution to a problem that they can't get anywhere else. Find many such customers and you have picked the right market.
 

The author is an Entrepreneur contributor. The opinions expressed are those of the writer.

Peter Cohan is president of Peter S. Cohan & Associates a management consulting and venture capital firm. He is the author of Hungry Start-up Strategy: Creating New Ventures with Limited Resources and Unlimited Vision (Berrett-Koehler, 2012).

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