Your Company isn’t ‘Alive’ and it can’t ‘Die’ – But You Can

I recently advised a young entrepreneur to shut down his two year old business. This was despite being able to raise enough money to ‘survive’.  His company was generating revenue but was in a very small sector and the available financing wasn’t going to be enough to pivot his way out of it. It was only going to lead the entrepreneur back to the same situation in 6 – 9 months, except this time he’d be that much older.  It was the very essence of surviving for survival’s sake.

What struck me the most about our conversation was our use of language and how it didn’t serve us well. We talked about the company as if it were a living, breathing entity. We used words like ‘alive’, ‘survive’, ‘keep alive’, ‘time to live’ and ‘die’. This use of emotional language automatically put us in place where talking dispassionately about the business was difficult and if ever there was a time where dispassionate analysis was needed it was then.

I particularly remember the entrepreneur’s response to me telling him that the small amount of money he could raise wouldn’t get him anywhere except back to the same place he was. “Well it’s better than being dead” was his response.  

This anthropomorphizing of his company was automatically leading him to the wrong conclusion and if we continued to use language that suggested his company was ‘alive’ it was going to be close to impossible for him to accept that his company should be shut down. As humans, we find the ‘death’ of something to be tragic. However shutting a company that’s not going anywhere isn’t tragic – the founder continuing to expend more of his limited human capacity on it is.   

A business isn’t alive – it’s not even a natural thing, like rock or stone. It’s an artificial construct and it can’t be alive, dead, surviving or any of the other things that are the primacy of living things.  The only thing that’s alive about a company is the entrepreneur and the people working there. Use of language that suggests otherwise doesn’t serve founders.

It may serve investors but more on that later.

A Simple Process for Setting Priorities for a Startup Idea

Spoiler: Test the assumption that is cheapest to test first

Warning: This process is a ‘rule of thumb’ and needs to be adapted for every context. As always Context is King.

I’ve used this process (or variations of it) about a dozen times, both when launching my own company and when evaluating new revenue streams in existing businesses. The process is simple but encourages rigor and focuses the business owner on what is important and not on what’s exciting.

There are two goals to the process. The first is to discover flaws in the business idea as quickly as possible and thereby minimize the human and financial capital expended. The second is to maximise the the value of the business as efficiently as possible.

Process Outline

List out the primary assumptions of the business such that if they are all true then the business will meet your ambitions for the company. If you’ve got more than 7 assumptions then you’ve probably gone too deep. What we are after is primary assumptions – note in the below example that there is one primary assumption for customer acquisition, not several secondary assumptions (cost of a lead, conversion rate of leads, cost of sales reps, etc.)

Next order them by how much they cost to test (don’t forget your time is a cost too, it is normally far more significant than the financial capital). Finally, test the assumptions in that order – the cheapest one first, the next cheapest second, and so on.  That’s it, you’re done 🙂

Sample B2B SaaS Startup Assumptions

  1. There are 50,000 potential customers in our target market
  2. Average revenue per customer will be €3,000 per annum
  3. The cost of acquiring a customer will be €2,000
  4. We will be able to build MVP for €50K
  5. Annual retention rate will be 85%
  6. We will be able to acquire 20% of the market in 5 years

Typically there are two or three assumptions that can be tested cheaply and there are always a few assumptions that can’t be tested until you are in business for years (retention rate, market penetration, etc.). However each proven assumption radically decreases the risk of the overall business idea and therefore increases the valuation.  If you imagine that each assumption has a 50% risk factor then every one that you can validate halves your risk and doubles the effective valuation.

Building Product First is Nearly Always Wrong

In the above example the assumption that an MVP can be build for €50K is mid way down the list and this is a fairly typical priority for most startups. It is nearly always significantly cheaper and quicker to test customer acquisition and pricing. Yet it never fails to amaze me the number of startups that decide to build a product before testing the cheaper assumptions.

Imagine spending €50K on a MVP only to discover that customers are only willing to pay 10% of what you’d assumed.  You have now just wasted €50K and a year of your life when you could have tested this with a hundred phone calls completed in a couple of days.

Bring it to the Next Level

It is easy to bring this to the next level by incorporating other factors into the calculation of priorities. Risk level is a good one, where you heavily weight high risk assumption so they get tested sooner.  What you include will depend on your own context but should always be centered on creating a more effective prioritisation that minimises risk and increasing value rapidly.

Your Price Does not Equal Your Cost

Its economics 101 that when you increase the price of something the demand goes down (The Law of Demand). Unfortunately, like most 101 courses, this is a partial truth that needs either further study or practical experience to be useful and as the old adage goes – ‘a little bit of knowledge is a dangerous thing’.

No doubt you’ve all seen the law of demand used to justify low prices. It is particularly dangerous to a startup as it can be used as logical proof to an emotional decision to have rock bottom prices. We all fear rejection and we emotionally want to do everything we can to minimise our chances of it. So we tend to lower our price to a level where it can no longer be an issue.  

However for startups your price, no matter what you set it at, is almost never the issue. The problem is your total cost to the customer and price is just one small element of this.  Your total cost is a long list but for most startups the largest cost to the customer is the personal risk to their career of doing business with an startup as opposed a known quantity.

“Nobody ever got fired for buying IBM’. While obnoxious, this 1980’s slogan this hit upon a core business truth – not only are we, as sellers, ruled by emotion (fear of rejection) so is the buyer (fear that their purchasing decision will be perceived as a failure). If the project fails because they chose a startup rather than an established player, even if vastly more expensive, their choice will look unjustified and unnecessarily risky to their boss (and everyone has a boss).

There are many other costs that go into the total cost born by the customer and I won’t go into them at length, but they include evaluation, training, support, change control, hardware etc.. For IT solutions these costs can frequently outweigh the actual price 10 to 1.  A 50% reduction in your price may only represent a 5% reduction in the total cost of ownership. Similarly a 50% increase in your price may only represent a 5% increase in the customer’s total cost.

Remember, as a startup, if you are going to be rejected, it is almost a certainty that it’s not your price that’s the problem – it’s your cost. Even if you are told by the lost customer that its your price, it still probably isn’t. Most people shy away from hard conversations and a potential customer telling you that you are rejected is a hard conversation. In these circumstances people tend to use the easiest way to end the conversation quickly – saying your price is too high is nearly always the easiest.

A final thought: unless you are a commodity, you either have a lot of value or no value. Unless you have a lot of value, your solution will never overcome the other costs that have to be borne by the customer, and you effectively have no value. It’s not a linear scale, its binary.

Next Blog Post I’ll explore how high pricing can increase demand rather than reducing it.

Don’t Pre-Solve Secondary Problems

We all do this, its human instinct. Novice engineers build scalability into Alpha versions of product where the primary problem is getting user number one. Office managers research and buy new equipment when there is little downside to letting the old equipment finally break and then buying a new. Sales Managers agonize over commission plans for pricing plans that have never sold (and may never sell) when the primary problem is hiring a team.

The amount of effort and opportunity cost wasted in solving problems that will never occur or will occur much later than people think is immense. This is most evident in company that are scaling as all processes are being pushed to their limit. This problem is difficult to spot and rectify as the people involved in wastefully pre-solving problems think and can justify that they are being productive … but they are not.

Why

  • People’s ability to predict the next most important problem is poor. Typically it’s an entirely unpredictable unkown unkown opportunity or problems that reveals itself.
  • The longer you leave a secondary problem the more information you gather allowing you to create a better solution for when you have to solve it.
  • The context of the problem and the solution frequently change making the original solution defunct.
  • The longer you leave a problem the more likely you will be able to leapfrog solutions

Your job, as CEO, is to resist pre-solving secondary problem. Now don’t take this too far, there are lots of secondary problems that have to be pre-solved. For example don’t wait until you run out of office space before you start looking for a new premises. In general, let secondary problems break before you fix them.

Primary and Secondary Problem

This only applies to secondary problems. For example a Sales Manager’s primary problem might be getting new business sales in, a secondary problem might be the CRM.  Delivering value to customers is always a primary problem but your telephony system that creaking but not broken is a secondary problems.

Fintech Week Hong Kong – Day 1

I’m at FinTech week in Hong Kong, partly for work and partly for my own education. With day one nearly over I’m feeling a little overwhelmed. I’m not sure how much of that is the jet lag and how much of it is the ton of interesting companies that I met, particularly the ones with a focus on China.  Anyway here’s a selection of more European relevant companies that I either met or saw present at day one.

DMarket has built a decentralised platform for exchanging virtual goods, typically those virtual goods are issued to players of online massively multiplayer games. Now for those you who don’t know there are 2.3 billion who people play games and loads of them get virtual items in their games and most have no way to trade them. In fact only 6% of gamers trade virtual goods – 94% don’t. Dmarket’s plan is to give the remainder the ability to start trading. They use the blockchain to secure every virtual assets and allow it to be traded. They have two APIs – one for the game developer and one for businesses to allow for virtual items to be sold. With €10 million invested they are  launching Q1 2018 with 10 games and access to 10 millions users.

GatCoin allows merchant, retailers to issue discount coupons and loyalty points on the Etherium Blockchain. Gatcoin changes tradition discount coupons, loyalty points and shopping vouchers into a tradable cryptocurrencies. The system that looks like shopify and allows any merchant can create currencies. They can then target consumers  on the basis of region, customer demographic and customer interests. Consumers then get ‘airdropped’ cryptocurrency which they can spend, save or trade them. They have there own wallet, but the encrypted private key is stored centrally allowing for recovery if the wallet is lost (by losses your phone). DK Planet Japan is their first customer.

Stellar Development Foundation is somewhat similar to Ripple which shouldn’t be a huge surprise as they share a co-founder. Stellar is a non-profit that has created a platform that connects banks, payment system and people with the goal of enabling fast, cheap cross border payments. The remittance market is a truly massive market characterised by slow transactions and high fees (typically 7% but can be as high as 20% for some African countries). Stellar has built is own blockchain that can process 1,000 transactions a second and doesn’t use proof of work or stake but some other mechanism that I don’t understand (yet).  Using the platform a cross border payment takes 2 to 3 seconds and costs almost nothing. They’ve signed a partnership with IBM and have some banks in India signed up as customers.

Dreamteam is platform for recruiting and managing esports teams. The platform uses blockchain and smart contracts, which is interesting as it seems to solve the problem of ensuring that people/teams get paid correctly for tournaments and engenders trust in the overall industry.  This is a company that seems to be playing in peak buzzword territory with esport and blockchain- if only they could get ‘machine learning’ in there. They’ve only just launched the platform but they have a user registering every minute.

Velotrade is a marketplace for invoice discounting. There is a large unfulfilled demand for credit by SMEs despite there being an excess supply of liquidity.  This clearly demonstrates a market inefficiencies that Velotrade is going to try and address.  Using their platforms business can immediately release 80% of the value of their yet due invoice with the remaining 20% less fees releasing when the invoice is paid. At the low end this seems to be focused at invoices between €20-€50K.

Vadim Sobelevki CEO FutureFlow gave a talk on using big data to analysis the  the flow of money . Their vision is that money not only has monetary value but also information value. He explained this by showing work done on passenger flow on the London tube and how only by analysing the flow of passenger where inefficiencies revealed (such as people who changed trains more often than they needed to). This wouldn’t have been revealed by simply looking at where people were coming from and where they were going.  They plan on doing the same for monty. Privacy is maintained by focusing on the topology which turns out to be more interesting that the identities of the people transferring the money.   Currently this helps banks spot suspicious transaction patterns.

KapitalWise Targeting millennials to get them into investing – only 6% of millennials invest. KapitalWise is a B2B solution, white label micro investment platform. It features an interesting rules based investment – for example I could set it so that everytime I get paid it automatically invests,  or every time I spend invest, etc. They have white label robo advisor. Launching in South Africa

A Great ROI is Not Enough

It’s easy to think that all you have to do is provide a big enough ROI to your customer. However this is not enough on its own – you also have to move the needle for the customer’s business. Your ROI might be fabulous but if you don’t move the needle for your customer then it’s going to worth your customer’s effort dealing with with you.

For example let’s say you are selling sales leads for second hand cars. You are selling the leads for €25 euros each and you expect 10% to convert to sales, so it costs about €250 for each car sold. The dealership makes about €750 per car, so the ROI of 300% is great. You’d naturally think that you could sell these leads to anyone, after all you are effectively selling €750 for €250.  But there is another dimension – volume.

Let’s say you only have 20 leads a month to sell. A small regional dealership that only sells 20 cars a month will happily do business with you because you are likely to boost their sales by 10%. However for a large chain dealership that sells 1,000 cars a month you are only going to grow sales by 2%. You don’t move the needle for them, and it’ll be hard to get them to do business with you because the potential upside isn’t interesting enough.

So how much do you need to move the needle by? I’m sure this varies a lot from industry to industry but in my experience it needs to be about 5%. That’s not necessarily 5% of the whole businesses revenue or cost – it’s the individual’s personal target. So if you are selling into a sales manager then it’s 5% of their new business, if it’s the facilities manager it’s 5% of the cost that they are trying to reduce, etc.

Below 5% you simply don’t move the needle enough to warrant their attention. However, your importance increases the more you move the needle.  I have found that at 20% you can even insist on fundamental changes to the customer business, such as changing their procedures or even business model. Simply put, at 20% you are so important that they can’t afford to lose you.

Monthly SAAS Contracts Suck

The appeal is obvious – anything that lowers the barrier for a potential customer to sign up has to be a good thing, right? It’s attractive when you are scrambling for sales, any sales, that month to month subscription without a long term contract has become the default business model for young B2B SAAS businesses.  Unfortunately it’s the wrong model for nearly all of them.  Personally I blame the Signal 37 guys at Basecamp for embedding this in start-up culture, but that’s another story.

Why is it such a Bad Model?

  • No upfront cash means as sales scale so does the level of investment required to fund the sales channel
  • Lack of customer validation creates an onboarding bottleneck and high early churn rates
  • The customer is not invested in your mutual success leading to more failed customers
  • Commission modelling and payment become messy leading to salesperson disatisfaction
  • Revenue modelling is more uncertain meaning that financing becomes more difficult especially debt

Caveat – Month to month contracts can work well if there is a purely automated sales channel.

Fund the Sales Channel with Sales or Investment

Imagine it costs you €1,200 to make a sale, i.e. it costs you €1,200 to find a potential customer and complete a sale. Now imagine that you only have €1,200 and your monthly subscription is €100. On Day 1 you spend your €1,200 and make your first sale. When do you make your second sale?

You make your second sale in Month 13, when you have collected the €1,200 to fund it from your first sale

Now think about the exactly the same scenario, except this time you charge a €1,200 annual subscription upfront. On Day 1 you spend your €1,200 to make your first sale. When do you make your second sale?

You make your second sale on Day 2 using the subscription collected on your Day 1 sale. By the time month 13 rolls along you’ve made about 230 sales – a 23,000% improvement over the first example.

I accept this is contrived, however the core message is valid – you either finance your sales channel with investment cash or your customers’ cash and it’s nearly always preferable to do it with your customers’. After all, earning money from customers should be your company’s core competence, not getting investment.

Lack of Customer Validation

If a salesperson closes a month to month subscription, then what exactly have they sold? Maybe they sold a three year revenue stream or maybe just one month’s fee that won’t even pay the sales person comp.  The only thing that’s definitely validated is that the customer is willing to pay for the first month. Should you even regard them as a customer at all? Maybe it would be best to think of them as being on a trial until they have paid a certain number of invoices and are actively using the product. This makes a difference because your customer success and onboarding teams will get frustrated and will rightfully demand that they not be handed half completed sales.

The Customer is not Invested in your Mutual Success

Okay, I’ll admit that getting a months subscription off of a customer isn’t nothing. It’s a lot better than a free trial. But what proof do you have that they are committed to your mutual success? The first month fee is a trivial amount and there is no long term commitment.  No wonder your onboarding team have difficulty getting them on the phone and engagement is weak.

Contrast this to the customer that signed up to a one, two or three year contract – there’s a committed customer. There’s a customer that will call you angry when things aren’t working. There’s a customer that will fight to make sure they receive value. There’s a customer that you want.  

Comp Models Become Messy

What are you going to comp a salesperson selling month to month subs on and what money are your going to use to pay them their comp? If you comp them just on the month’s sub then you’re incentivising them to find customers who are willing to pay a one month sub – not customers that will be with you for the long term.  If you comp them on revenue from the customer as it comes in then the reward is disconnected from the actions you want to incentivise. If you advance comp on the basis of future revenue you create a cash flow issue and de-motivational claw backs when the customer cancels.

Comping on an annual contract is easy, and paying the comp is easy if the customer pays upfront.

Revenue Models and Investment Become Difficult

Month to month contracts have no committed revenue stream by definition. Revenue models have to use average churn rates to calculate the following month’s revenue with ever increasing levels of uncertainty the further out you go. In contrast annual contract business only have to use average churn rates for revenue a year out. Having this contracted revenue stream makes financing, especially debt financing, easy when compared to month to month contract. This is all the more important as month to month contracting needs more financing to fund the sales channel.

So why do start-ups almost invariably opt for the month to month sub? Its because they are afraid to ask for the sale, so they attempt to minimise it. They don’t charge what they’re worth (more on this in a later blog post) and then they split the sale into the smallest segment possible in an attempt to make their pricing irrelevant to the customer – I’ve even seen companies split it into a weekly fee.

What if customers won’t sign up for an annual contract?

If you’re a B2B company with a manual sales process then there is a good chance that you just have to accept that you’ve got a longer sales cycle than you think you have. If you are sure that your potential customer will only sign up to month to month then accept that this is a trial period and after the trial period ends they move onto an annual plan. This division makes it very clear that during the trial period the sales process is still ongoing and you don’t count the client as a customer until they sign up to the annual plan. In this way your customer numbers stay clean and responsibility for the sales cycle is clearly defined.   

Usual disclaimer: Context is king, actual results may vary, etc.