THE BUTTERFLY EFFECT

Introduction

In 1961, the mathematician and meteorologist Edward Norton Lorenz made a minor but fateful mistake. While re-running a weather prediction model, he used the line printer output from the previous run to reproduce an input value. What he didn’t know at the time was that the printer had rounded-off the number in question to three decimal places, which meant that he entered a value for the second run that was subtly different from the original run – 0.506 instead of 0.506127.

Much to his astonishment at the time, the resulting weather scenario for the second run was radically different to the first. So different, in fact, that he Initially thought it had to be a computer hardware fault – suspecting a weak vacuum tube or some other equivalent hardware failure as the culprit.

After further investigation, however, Lorenz realized that he had stumbled into something considerably more profound than a hardware failure. What he had chanced upon was empirical evidence that very small, seemingly trivial changes to the initial conditions of a complex system can have monumental downstream consequences – leading to the large-scale alteration of events.

In mathematical terms, this was a stunning revelation. And so, in 1963, after conducting further investigative research into the effect that he had first witnessed on that fateful day, Lorenz published a seminal theoretical paper, entitled Deterministic Nonperiodic Flow.

This work spawned an entirely new interdisciplinary area of scientific study and branch of mathematics known as Chaos Theory, which deals with the underlying patterns and deterministic laws of dynamical systems that are highly sensitive to initial conditions.

Concerning the publishing of his theory, Lorenz later recounted:

“One meteorologist remarked that if the theory were correct, one flap of a seagull's wings would be enough to alter the course of the weather forever.”

And it appears that this seagull metaphor may have initially stuck – as a helpful form of shorthand for visualizing the consequences of the effect on a more tangible, real-world scale.

But according to Lorenz, fate intervened once more, when he failed to provide a title in time for a talk he was giving at the 1972 meeting of the American Association for the Advancement of Science, and his friend Philip Merilees intervened on his behalf – suggesting the title, Does the flap of a butterfly's wings in Brazil set off a tornado in Texas?

Since this was clearly a much richer, more poetic version of the original metaphor, the renegade seagull transformed into a beautiful butterfly, emerging from its cocoon, and fluttering its pristine, delicate wings – with unimaginable downstream meteorological consequences.

And thereafter, the phenomenon became popularly known as “The Butterfly Effect”.

Outside of the world of the natural sciences, there is perhaps no better application for the concept of the butterfly effect than in the world of business startups and startup strategy, where every decision taken early on during the fragile startup phase - no matter how insignificant it may seem at the time - is destined to have an outsized, amplified impact on the business over time. In the world of software development, for example, a seemingly inconsequential “let’s fix that code later” decision may be the difference between going extinct and becoming a multibillion dollar company.

Startups are in a very literal sense deeply embedded within the context of this ‘sensitive dependence of solutions on initial conditions’ (SDIC) – which is another more scientific term for describing the butterfly effect. In the world of early startups, every hire, every pitch deck, every strategic partner, every infrastructure choice and ultimately every dollar spent may be considered to be the equivalent of a wave function collapse in the world of quantum mechanics – creating a ripple effect that stretches out across time and space, long into the future…

But how do we break this intriguing concept of the butterfly effect down into a meaningful framework for thinking about - and improving upon - decision making within the context of the entrepreneurial journey and the business of successfully launching startups? In other words: how do we triangulate this reality of a startup’s ‘sensitive dependence on initial conditions’ into actionable insights?

Creating the Right Frameworks for Decision Making Early On

Starting with the overarching, cultural stuff first: one of the central, structural issues impacting successful decision making is the fact that startup founders are constantly, often out of necessity, juggling multiple priorities, or spinning multiple plates. And there’s a tendency to try to fix problems in the heat of the moment, reactively – like a never-ending game of Whac-A-Mole.

This is especially true when resources are stretched and there’s a lot of multitasking going on. But decisions made reactively, in the heat of the moment - or ‘on the hoof’ as the saying goes - often result in a myriad of unintended consequences, simply because they’re not considered carefully enough at the time that they’re made.

Therefore, to counterbalance this tendency to operate reactively when juggling multiple priorities, it's crucial for startups to implement clear structures well in advance – in order to allow the necessary breathing space to make more informed, self-aware, strategic decisions from the outset. This includes carefully weighing up the potential longer-term impact of all consequential decisions and actions – not just their immediate impact on a startup’s near-term priorities.

In summary: startups need strategic thinking baked into the mix from the get-go. Because the decisions that companies make early on are often hugely impactful – and very difficult and costly to change later on. It may at times seem counterintuitive to both slow down and become more deliberate at the same time, and we acknowledge that it runs contrary to the fashionable clarion calls to “move fast and break things” and not to sweat the small stuff. But it should be self-evident that things can wind up seriously broken if you choose to move fast and break things, and if you don’t sweat the small stuff.

Admittedly, procrastination may be the sworn enemy of startups, especially in the context of the business world increasingly moving at near-lightspeed. But the flip-side is that seemingly trivial decisions, made early on, can have truly devastating downstream consequences – as illustrated by the principle of the butterfly effect. So, finding ways to act both deliberately and strategically from the outset is key.

The Butterfly Effect In All Directions: Positive and Negative Scenarios

It is perhaps self-evident, but the first headline point worthy of note in relation to the butterfly effect is that decisions made early on by startups can have far-reaching implications in all directions – the good, the bad and the downright ugly. While some decisions may lead to entirely positive outcomes, others can have extremely detrimental effects. And yet others will result in net positive outcomes, but with negative unintended consequences to contend with downstream.

StartStak has conducted a comprehensive analysis of data from some of the world’s most reputable analyst firms, including Gartner, Forrester, McKinsey, PwC, IDC, and Frost & Sullivan, and examined some of the key early decisions made by startups across various sectors – decisions that have created the initial conditions that lead to their subsequent success or failure. As expected, the impact of these early decisions is amplified considerably over time, creating a butterfly effect that dramatically influences performance and, in the final analysis, business success or failure¹.

We present the results within the context of a series of broad strategic areas, with the intention of providing some key pointers or takeaways for founders and investors. In doing so, we hope it serves as a kind of cheat sheet, by identifying some of the core focus areas where startups may need to take some time out to re-evaluate or strengthen their existing strategies and operations, as well as identifying the areas where they are already performing above par.

The common thread is that these are all critical areas – where small decisions, taken early on, have business-defining consequences over time.

The Primacy of Market Research

Many startups fail to conduct comprehensive market research before launching their product or service. And many more fail to acknowledge its ongoing importance as their business starts to spread its wings. High quality market research is a fundamental component in the vast majority of business success stories, and should therefore be considered not as an end point, or something that you do to ‘spruce-up’ a business plan or to establish broad first principles – but rather as a living, breathing, dynamic and ever-evolving process. And because of the strategic importance of the market research function, small decisions and actions made early on can and do have a considerable influence on future outcomes.

Neglecting to conduct proper market research in advance - or perhaps worse still, conducting it, but ignoring the insights, relying instead on confirmation bias or magical thinking - is one of the biggest and most avoidable mistakes a startup can make. Poor initial market research leads to a lack of understanding of target audiences, competition, and market trends. Over time, this results in a product-market mismatch, leading to low sales and eventually business failure.

For the sake of clarity, it’s worth noting that market research tends to fall into two distinct categories. Firstly, there’s the more academic side, which deals with researching and breaking down relevant geographical and sectoral markets, evaluating the competition, quantifying market opportunities, and getting a feel for the total addressable market (TAM), as well as other key metrics, such as product/service pricing and total cost of sale. Secondly, there’s the more people-focused side of things, which is often based on organizing focus groups, customer feedback research, communications and outreach, etc. This second aspect could simply be expressed as communicating with, listening to, and ultimately understanding your customers.

Critically, startups that do not prioritize customer feedback find themselves developing products or services that do not meet customer needs or expectations. Over time, this leads to a loss of customers and decreasing revenue. Understanding your customers is virtually a prerequisite for long-term business success. And as a startup founder, without a clear customer feedback strategy in place, you’re undoubtedly heading into stormy seas.

Perhaps the most poignant example of a company failing epically on this front is BlackBerry. The company, renowned for its secure email services and physical keyboard design, dominated the smartphone market until the arrival of the Apple iPhone. As the market shifted towards touch-screen devices with advanced multimedia capabilities, BlackBerry neglected to grasp the importance of this consumer shift – a failure that it never really recovered from²⁺³.

Market selection is also worthy of specific note. Successful market selection is contingent on high quality market research. And in terms of butterfly effects, getting the market selection right at the beginning may be the difference between success and failure. For example, startups that enter high-growth markets early on are more likely to achieve long-term success, whereas those entering saturated or low-growth markets tend to struggle to achieve significant growth⁴. Without conducting extensive research, you’ll never be able to identify the sweet spots for your business – you’re essentially just playing a game of ‘pin the tail on the donkey’.

Unfortunately, many startup founders approach this fundamental area somewhat haphazardly – as a bolt-on, or even as an annoying hoop they have to jump through, simply because it’s expected, rather than as a core aspect of their strategic business plan. Top-flight market research - including incorporating ongoing customer feedback research - is worth its weight in gold¹. And as a founder, it's about as close to a crystal ball as you’re ever likely to get.

In conclusion, for early-stage startups, systematizing or formularizing an approach to conducting comprehensive market research and continual customer feedback research should be a key priority from the outset.

Financial Planning: Failing to Plan is Planning to Fail

It’s a harsh reality that when it comes to financial planning in startups, many do not have a solid strategy in place from the outset. As a result, undercapitalization is a very common early mistake – i.e. underestimating the amount of capital required to grow the business to get it to the next stage. This is a major blunder, leading to cash flow problems, severe stress and demoralization, an inability to scale, insufficient revenue to support debt payments, and ultimately bankruptcy⁵.

Underestimating the importance of cash flow is also a continually recurring theme. Poor cash flow results in the inability to meet operational costs, settle invoices and keep suppliers happy, retain top-flight employees, and invest in growth opportunities. It is worth noting that even profitable companies can fail because of cash flow problems – a harsh reality that seems to be a blindspot for many startups.

A crucial factor in addressing these financial planning problems is understanding the importance of building a comprehensive, fully functional financial model from the outset – something that essentially serves as the complete business plan and strategy in numbers – encompassing all relevant operational areas, including sales, marketing, IP, legal, offering pricing, and operations.

Unfortunately, many startups naively regard such in-depth financial modeling as being more about playing a kind of game to keep the suits happy – for example as a means of securing VC funding, bank loans, or high-level strategic partnerships. Numbers and projections are sometimes even reverse-engineered to look good on spreadsheets, rather than being used as a vital truth-telling tool and a pathfinder for securing the future success of the business. Startups without adequate financial planning systems in place are like ships going to sea without a compass or a GPS system – and when they do, you really don’t want to be onboard!

One key takeaway, in addition to the vital importance of robust financial planning, is that startups should carefully consider the impact of relying too heavily on venture capital in the early stages, since it may put too much pressure on the business to force the pace before the time is right. Extending the pre-seed phase, and avoiding unnecessary expenditure on swanky offices and other non-essential items seems like pure common sense, and may ultimately be the difference between success and failure.

The Perils of Premature Scaling: Walk Before You Run

Many startups attempt to scale too quickly – long before establishing a solid customer base or proving out their business model and achieving Product Market Fit. This often leads to a waste of resources, and ultimately business failure. Realistically speaking, rapid scaling shouldn't even be part of the conversation for early-stage startups – but the reality is that it’s a major cause of failure, as evidenced during the research.

A startup’s impulse to scale way too early is often driven by external factors and pressures, including inadequate financial planning (as detailed above) and the concomitant expectations of early investors, who may be preoccupied with sticking to unrealistic time frames and exit strategies – which often drives aggressive expansion. The bottom line: expanding too quickly in the early stages of a venture can have seriously deleterious long term consequences.

A Starsight study found that startups that expanded too quickly in their early stages often faced negative long-term effects. This over-expansion led to a dilution of resources and focus, resulting in poor product quality or customer service.

One example of an aggressive expansion strategy leading to dire downstream consequences is Zynga. The social gaming company - which at its peak was valued at $9 billion due to the huge popularity of its early blockbuster games, including Farmville and Cityville - experienced a rapid downfall because of unbridled expansion, its over-reliance on a few successful titles, and its failure to adapt to market changes. Zynga expanded way too rapidly, acquiring studios and launching numerous games without adequate market testing – leading to a decline in both revenue and stock price. This precipitated layoffs and restructuring, with CEO Mark Pincus later acknowledging that the focus had been too heavily on growth rather than sustainability. The Zynga story underscores the critical importance of balancing rapid execution with market learning and adaptation – and the risks of depending too heavily on a limited number of high-performing products⁶.

The Ostrich Factor: Ignoring Legal and Regulatory Compliance

It’s no great secret that lawyers tend to be expensive. And therefore regulatory and compliance issues are - perhaps understandably - regarded by startups as burdensome cost centers rather than profit centers. Hence, there’s often a tendency for startups to kick the can down the road – electing to deal with such issues as and when the company gets big enough for anyone to give a damn.

This is the equivalent of the proverbial ostrich burying its head in the sand. Startups that neglect legal and regulatory compliance issues in the early stages of operation can often face severe downstream consequences. The decision can lead to toe-curlingly expensive legal proceedings (often considerably more expensive than dealing with the issues up-front); eye-popping penalties; loss of reputation; forced business closure; and even, in some extreme instances, criminal proceedings.

The digital asset sector is an excellent contemporary example of the risks of burying your head in the sand and ignoring legal and regulatory compliance issues. In the United States particularly, with a persistent lack of regulatory clarity, and a hostile regulator in the form of the U.S. Securities and Exchange Commission (SEC), which currently has a modus operandi of bringing enforcement actions as opposed to publishing clear guidelines, a company’s failure to deal with legal and regulatory issues up-front can prove fatal – especially if it can’t afford to defend itself against a litigious, well-funded regulator in a protracted legal battle.

Major, well-resourced blue chips such as Coinbase may choose to fight their corner rather than throwing in the towel – and indeed will have done their due diligence and risk appraisals long in advance of any such litigation. But there have been multiple recent examples of companies falling afoul of SEC enforcement actions in recent months, including: the American arm of the centralized digital asset exchange, Bittrex, which filed for bankruptcy protection in May 2023 – three weeks after the SEC accused it of operating an unregistered securities exchange⁷; and LBRY, a blockchain-based content sharing platform, which closed its doors after a lost judgment to the SEC – on the basis that it could no longer meet its financial obligations⁸. In the digital asset space alone, there are many more such examples of companies receiving Wells notices (a letter that the SEC sends to people or firms, at the conclusion of an investigation, which states their intention to bring an imminent enforcement action against them) – with many more likely to follow in the coming months and years. Indeed, since we first began compiling this article, Consensys, the owner of the popular Ethereum wallet, MetaMask, has announced that it recently received a Wells notice from the SEC⁹.

In summary, ignoring legal and regulatory compliance issues in the early stages of a startup venture can land you in seriously hot water later on. In many cases, it’s the equivalent of rolling the dice - or playing Russian roulette - with the future of your business. Undoubtedly, it’s a burdensome cost to take on, but it invariably pays for itself in spades over time – so the logical conclusion is that the costs should be built into the business plan from the outset.

Making sure you’re fully compliant in all jurisdictions in which you operate is obviously optimal. And not entering those territories where there is a high degree of ambiguity is a no-brainer, unless you are able to quantify the risk and are comfortable with the worst case scenario – i.e. as a cost of doing business.

People Power: The Importance of Founding Team Composition

In the realm of startups and butterfly effects, the founding team’s composition is perhaps the most consequential of all early ‘initial conditions’ set. Since companies are ostensibly human enterprises, and at the beginning their pool of talent is necessarily concentrated, each individual has a tremendous impact on the future direction and success of the company. Each team member’s skills, experience, aptitude, perspectives, energy, personality, and capacity to gel with other team members will all have huge downstream consequences – in either positive or negative directions. This is why choosing the right founding team members is perhaps the single most important factor in the early stages of any startup venture.

Startups with diverse founding teams in terms of skills, experience, and perspectives are more likely to adapt to changes and challenges, leading to long-term success. A study by Boston Consulting Group, for example, found that companies with more diverse management teams have on average 19% higher revenues due to innovation. So this early decision - to aim for diversity in team composition - can lead to butterfly effects of increased creativity, innovation, and ultimately greater profitability.

It’s important to strike the right balance, and to know what you’re looking to accomplish in advance, as well as to remain flexible. If you’re an aggressive, financially-driven enterprise, for example, your ideal founding team composition is going to look very different from a startup with an arts, gaming or media focus. So it helps to have a clear picture of exactly what you’re looking for before you start the hiring process in earnest.

Uber's aggressive and competitive founding team was instrumental in its rapid growth, but it also led to a toxic work culture that resulted in several scandals. Slack's founding team had a background in game development, which influenced their decision to focus on user experience, leading to a product that users loved. These two examples illustrate how founding team members can have a huge impact on the culture and direction of the company over the longer-term.

The founding team of Airbnb, composed of Brian Chesky, Joe Gebbia, and Nathan Blecharczyk, brought together a rich mix of design and technical skills. McKinsey's research suggests that such diverse founding teams tend to outperform, since they can tackle a wide range of challenges capably. However, the research also points out that, in such cases, decision-making can be slower due to differing viewpoints, which may take time to resolve.

And if you’re a founder who’s involved in the process of hiring a team, it’s worth noting that getting the right mix of people on board should be considered a vital investment, and it shouldn’t just be farmed out to external recruiters, or measured purely on the basis of salaries and packages. Harvard Business Review highlights the fact that startups that invest in hiring and retaining top talent early on see very positive long-term effects. These companies are able to innovate and adapt to market changes much more effectively than their competitors.

In summary, your people are everything – so choose them wisely, and don’t count the pennies at the expense of assembling the best team for the job.

Business Model Selection

The vast majority of entrepreneurs understand the critical importance of getting the business model right up-front, but it can be a complicated process if you lack experience as a startup founder – i.e. if it’s your first rodeo. Selecting the correct business model is critical for any enterprise, not only because it is central to generating revenue and making a profit, but also because it must align the company’s value proposition with customer needs and a competitive strategy – ultimately defining how the business captures value and stays the course.

Startups that have a clearly defined business model from the outset are more likely to succeed in the long term. This is because they are able to articulate their value proposition and revenue generation strategies effectively to investors, employees, and customers. Furthermore, startups that choose scalable business models, such as software as a service (SaaS), are more likely to achieve long-term success.

Aligning the business model with a startup’s core vision and values is fundamental. This alignment helps to ensure that the model reflects the longer-term goals of the company, as well as its ethical considerations – which enhances both brand integrity and customer loyalty. If, on the other hand, the business model selected is incompatible with the company’s vision and values, the company’s brand doesn’t resonate or harmonize – and the downstream consequences can be extremely dire.

It is therefore essential to have a deep understanding of the target market before selecting a business model. And needless to say, this cannot be accomplished without conducting proper market research (as detailed in the earlier section above). Knowledge of customer behaviors, preferences, pain points, and spending habits can all inform the selection of a winning business model that genuinely resonates – addressing customer needs and standing out in the marketplace.

The business model should also be both fit-for-purpose in the short-term and flexible enough to adapt as the market evolves and the business grows – without sacrificing the core value proposition.

Identifying multiple revenue streams and diversifying income across multiple different sources in the early stages can also help to provide more stability and lessen risk – which are often particularly crucial factors in the volatile early stages of a business venture.

The cost implications of business models should also be carefully considered in advance. An effective model should provide a clear path to profitability by balancing cost-efficiency with the potential for high-quality service or product delivery.

Founders must consider how the business model can create and sustain a competitive advantage. Whether through unique value propositions, first-mover advantage, superior technology, or customer relationships, the business model should help the company carve out and maintain its market share.

And finally, rather than jumping in with both feet, a ‘test and adapt’ strategy should be implemented – testing the business model through minimal viable products (MVPs) and pilot programs in order to gather real-world feedback. This iterative process allows startups to refine their approach before scaling up – minimizing initial investment risk and enhancing the model based on actual customer responses.

Business Model Selection: Some Real-World Examples

Uber and Airbnb chose a sharing economy business model early on. This decision has amplified over time, creating a butterfly effect that has disrupted traditional industries and allowed these flagship companies to scale rapidly. The sharing economy model has proven to be a very positive butterfly effect, enabling these startups to leverage existing resources and reduce overhead costs.

Amazon's early decision to start as an online bookstore before expanding into other product categories was a key factor in its success. Jeff Bezos, the founder, had a clear vision of making Amazon the "everything store". This decision allowed Amazon to gradually build its customer base and logistics network, which later facilitated its expansion into other product categories. Studies from McKinsey and Deloitte have shown that this gradual expansion strategy has been a key factor in Amazon's success.

Facebook's early decision to focus on college students before expanding to the general public was a key factor in its success. Mark Zuckerberg and his founding team decided to initially launch Facebook at Harvard before expanding to other colleges. This decision allowed Facebook to build a strong user base among college students, who were more likely to use the platform regularly. Over time, this decision has amplified to make Facebook the leading social media platform worldwide.

Conclusion

In conclusion, the early decisions made by startups can and do have profound butterfly effects that amplify over time. While decisions such as choosing the right business model, investing heavily in people and processes, and focusing on the customer experience can have extremely positive effects, over-aggressive expansion, poor financial and business modeling, and ignoring regulatory compliance aspects can have devastating impacts on business success. Therefore, it's crucial for startups to make strategic decisions early on to keep them on the right track – decisions that will positively impact their long-term business performance.

The startup journey demands a balanced approach to decision-making, emphasizing both nimble-footedness and thoughtful consideration of long-term effects. Early choices about business models, market entry, and financial planning are not just operational necessities but strategic imperatives that ultimately determine long-term viability and success. As startups navigate these decisions, the awareness of their potentially outsized impacts guides the need for a strategic, informed, and adaptable approach – ensuring that the early ripples align with the desired future state of the enterprise.

In many respects, startups are themselves like delicate butterflies: struggling, often against the odds, to emerge from their chrysalis - their protected stage of development - ready to breathe life into the formless, to harden their wings, and gather their strength before they take flight. And when they do become airborne, just like the precious butterfly, they can change the world in unimaginable ways.

References

¹ Mckinsey: “Fintechs: A new paradigm of growth”, cited in April 2024 (Source)

² BGR: “BlackBerry lost 4 million subscribers in Q1 despite new launches” cited in April 2024 (Source)

³ Investopedia: “BlackBerry: A Story of Constant Success and Failure” cited in April 2024 (Source)

⁴ Deloitte: “From tech investment to impact: Strategies for allocating capital and articulating value”, cited in April 2024 (Source)

⁵ CBInsights: “The Top 12 Reasons Startups Fail”, cited in April 2024 (Source)

⁶ Medium: “When Companies Execute too Fast: Real-World Failures and Consequences”, cited in April 2024 (Source)

⁷ Reuters: “Crypto exchange Bittrex files for bankruptcy after SEC complaint”, cited in April 2024 (Source)

⁸ Blockworks: “LBRY ends operations, cites feud with SEC and mounting debt”, cited in April 2024 (Source)

⁹ Blockhead: “Consensys Sues SEC Over "Unlawful" Ethereum Authority Following Wells Notice”, cited in April 2024 (Source)

¹⁰ Mckinsey: “From start-up to centaur: Leadership lessons on scaling”, cited in April 2024 (Source)