Adwords is like poker: If you can’t see the sucker, you’re it

When it comes to effective advertising methods Google Adwords rules the roost. You get to display your advert at exactly the right time to exactly the right prospect – the moment your potential customer is looking for it. This is astonishingly powerful and will generate over $100 billion in revenue for Google in 2018. However, all that revenue comes at the expense of the advertiser.  Most categories are now so competitive, making the cost of advertising very high, and when the costs are so high, advertisers need to live and breathe the figures in order to turn a profit.

In a competitive space Google will eventually take all the profit. Imagine:

  • There are four identical competitors
  • Each sell a digital book for $10 which they have written with no associated cost of sales
  • 10 clicks from Google Adwords are required to generate a sale
  • There are only 3 advertising slots available from Google.

How much will each advertiser bid per click?

Game theory tells us they will bid up to $0.99 cents. Any further and they won’t turn a profit. Any less and the other three competitors will out compete for the three slots and revenue goes to zero. So in for $10 sales, Google will take $9.96 – all but $0.04. In effect, Google takes all the money!

But it’s much worse than that. In the above example we limited the number of competitors to 4 and assumed they were all logical actors with complete knowledge and skills. Unfortunately this is rarely the case.

Most competitive markets have a few ill-informed actors. These actors will frequently outbid all the competition in order to maximise their traffic and resulting revenue. Imagine the above scenario with a couple of these ill-informed actors. Each bid $1.05 a click, resulting in Google taking $10.50 for each $10 sale. Google takes more than all the money!

But won’t the ill-informed actor eventually exhaust their budget, realise the error of their ways and either amend their bidding strategy or exit the market? Well yes, but there is an ample supply of ill-information actors ready to take their place.

So if you’re newish to advertising on Google, take a good look around at what your competitors are doing and if you can’t spot the one who is over bidding then chances are it’s you.   

Feedback Easily Given is Nearly Worthless

Ever received a cold call? Ever said the first thing that came into your mind to get rid of the person? Now imagine that salesperson meticulously compiling that feedback into a report. 42% of people are too busy, 30% already have a solution, 15% are driving and about to go into a tunnel and 13% of people are rude. Further imagine a company actually making business decisions on this data, confident in the knowledge that they are doing so on the basis of real market knowledge.

Ridiculous isn’t it? Yet we all do this.

No one likes to give difficult feedback. That’s why employee reviews are hard. It’s the same for customers. They don’t want to tell you that your baby is ugly – so they make something up – just so you go away.

You should always view feedback through the lens of how difficult it was to give.  If the feedback was easy to give you should regard it warily and probe for more. Conversely if the feedback was difficult you should really value it. Someone just went through an emotionally difficult time to give it to you. It has real value – do something with it.

When a prospect decides not to proceed with you, they will typically respond to your request for feedback. However, for the most part they just want to get rid of you and will tell you whatever is easy and end the conversation, not the real reason.

Be suspicious of:

  • You were too expensive
  • We decided not proceed with any vendor
  • Our budget got pulled
  • Corporate rules only allow us to do business with companies in business for over 5 years

Your job is to delve deeper and force feedback that’s difficult to give – that’s where the value is.  

Feedback Gold

  • We don’t think you can do the job
  • Your product sucks
  • Your lack of sales process worried us
  • We think you are going to go bust
  • Our engineering team hates your engineering team

Parking One Side of a Marketplace

Building a marketplace is hard. It’s difficult because you’ve got two different customers: buyers and sellers who are typically two different people (exceptions include classified ads and dating apps).  Two different customers implies:

  • Two different value propositions
  • Two different routes to market
  • Two different products
  • Two different support structures
  • Two different EVERYTHING!

Marketplaces are two businesses running simultaneously and both have to succeed for the overall operation to prosper.  This results in marketplace failure rates that are much worse than a normal startup, however they have the benefit of being able to scale wildly if they are successful.

I’ve dealt with a lot of marketplaces over the last year. Everything from a private tutoring market in the Middle East, rental accommodation in Ireland to dog boarding in Europe. After ten years in WhatClinic, people think I’m some sort of expert. I don’t have any secret sauce, however I do know a lot of the pitfalls.

The first pitfall is trying to build both sides of the marketplace before you have sufficient resources / team. Even in a successful marketplace with teams supporting both sides of the business, it’s hard for the CEO to wear two hats; it’s nearly impossible when resources are very limited. Focus your resources on one side of the market first.

Recognise who your primary customer is. In general, this is the side that has fewer problems finding the other party . This is the side of the market that you have to crack. It’s where the real risk is in the business – if you can crack this side of the market, the other side is simple in comparison.  

So for WhatClinic the primary customer was the consumer not the clinic, for Google Ad Network it’s the advertiser not the partner website, for Amazon it’s the consumer not the seller. Uber, HostelWord, Hotels.com & Opentable all built supply first, parking the consumer side until they were ready [Note some edits made here from original posting thanks to comments from Ronan Percival)

  • If Amazon has has loads of consumers it is safe to assume they’ll be able to sign up vendors
  • If Google Ad network has loads of advertisers then partner websites will flock to them.
  • Uber reckoned that if they sort out supply that demand would exist

But it’s a chicken/egg (horse/cart) problem. It’s difficult to build one side without the other because no value is being delivered. What’s the answer? Try and park away the second side of the marketplace by directly addressing the primary side’s value proposition without building a market on the other side. 

Can you park away one side of the market?

  1. Offer the service directly yourself. So if you are an online babysitting marketplace you can directly hire a few babysitters in your first city. Once you have proven the value proposition for the parent and have more demand than supply, you can switch your attention to building the other side of the market, targeting the sitters.  Amazon was an online store before it became a marketplace.
  2. Seed the market. Get one prestigious name on the secondary market that will drive large volumes from the primary market. For example if you are a jobs board then a job for Ferrari or Dolce & Gabbana can drive tens of thousands of CVs.
  3. Build the supply without the relationships. For example if you are a real estate marketplace you can simply list properties without developing the paying relationships with the real estate agents. Once you have the primary audience you can start to build the relationships
  4. Build the primary audience for a directly related informational need. If you are an investment real estate marketplace you could build your primary customer audience by publishing research information before building the market.

My final thought is try and recognise when the marketplace exists because of a customer need for a market or because of internal business requirements. Uber’s riders & drivers don’t want a market (the rider just want a ride and the driver a fare) but Uber does. They don’t want the hassle and legal liability with directly employing drivers. However the consumer clearly wants a marketplace for homes to buy as they want to compare lots of options.  Having clarity on exactly who the marketplace serves should give you insight on how to get it started.

Investor & Founder Alignment is a Myth – Maintaining the Fantasy is Important to Both

It’s a common refrain among professional investors that founder and investor interests need to be aligned. The theory is sound – as long as the investor’s interests are also in the founder’s interests then the investor is protected by the self-interest of the founder. The problem is that this theory ignores reality. An investor’s success is only partly dependant on the success of the company whereas the founder’s success is solely dependant on it.

An investor’s success depends on the blended return of a number of investments. While they are generally over exposed to a market segment, they have their risk diversified within that segment. The founder’s return, on the other hand, can be thought of as binary. They either lose or they win, and there isn’t much of a middle ground.

I’ve seen this innate misalignment between investor and founder cause problems several times. Generally it only happens at the extremes – when the company is going very well or very badly. These are the moments where alignment matters most, as misalignment can come at a huge cost to the founder or investor.

Where the company is doing very well it often makes sense for an investor to increase the company’s chances of failure but also increase the potential returns. For an investor managing a portfolio this is a sensible action. As long as they increase the potential return by more than the chance of failure then the value of their portfolio improves. For the founder, with a binary outcome, this makes little sense – they should be more focused on minimising the chance of failure.

Example: Company ABC is worth €20M and the investor and founder own 50% each. The founder has no other notable assets whereas the investor has 30 identical investments (obviously a very contrived example). It is in the investor’s interest to try and 10X the company’s value even if there is an 80% chance of failure. Ideally the investor would do the same with every company in their portfolio.  However, for the founders, introducing an 80% risk of failure into their only asset of value is clearly a foolish thing to do.

This is a real problem. Investors have blocked the sale of companies that would have made their founders very happy because they thought a better sale was possible, and founders have pushed through sales that aren’t in investors’ best interests. Investors have encouraged and promoted courses of action to ‘pour fuel on the fire’ of promising companies even when doing so increased the chances of bankruptcy.  

When companies are doing extremely poorly and the only way forward is for the founder to continue spend more of their time in the venture, it’s in the investor’s interest for the founder to continue. The investor doesn’t suffer the cost of the founder’s ongoing investment, but gets to keep their investment ‘live’. Meanwhile the founder suffers the full brunt of the cost of continuing to work at the enterprise. From the founder’s perspective, a dispassionate analysis frequently suggests that shuttering the company would be the best course of action. Once again, different investment exposure results in misaligned interests.

It’s nice to think we stand together and together we fall/succeed but both investors and founders should be working on a different set of calculations and assumptions and recognising that they have different interests.  

Even though investor and founder interests aren’t aligned, it is still in everyone’s interest to pretend that they are. Founders want potential investors to think their interests are aligned so that the investor will put money in the company. Investors want founders to think they’re aligned so they can convince founders to take a course of action that is not in the founder interest.  Normally everyone maintains this fantasy for as long as possible but when things go very well or when the shit hits the fan, make sure you know what your interests are and don’t rely on the other party.   

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.

Increase your Pricing to Increase Your Sales Volume

Spoiler: Because you can spend dramatically more on Sales and Marketing

As I explored in the previous post – very frequently your price is only a very small aspect of the total cost to your customer. For many IT solution is can be as little as 10%. Therefore a increase in your price may not make a noticeable effect on your customer’s cost and therefore the Law of Demand may have a negligible effect in reducing demand for your product, however it can have a dramatic positive impact on your business.

Worked Example

Startup AAA is selling a product for €10,000 and makes 5 sales a month. Startup AAA has a sales and marketing budget of €3,000 for each sale – so they can spend €15,000 a month on acquiring new customers. Startup AAA’s price is 20% of the total cost of ownership for the customer.

If Startup AAA increase their price by a modest 20% to €12,000. This only increases the total cost to the customer by 4% (since price is only 20% of the cost). While unlikely, this small increase in cost may impact on minorly on demand, however the impact of this extra funds has on sales and marketing can be dramatic. In this example the amount spent on sales and marketing can be as much doubled to €6,000 per sale. With the additional resources that this spend allows, sales and marketing should easily be able to increase the total volume of sales.

So price increases disproportionately positively affect your sales and marketing budget (or alternatively profit) while disproportionately minimally impacts on the total cost for your customer.

It should go without saying that price increases like this only apply if your competitive advantage is not price, but then again if you are a startup competing on price then you’ve got bigger problems.

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.

Rule of Thumb for the Direct Sales Channels that are Viable for Different Revenue Levels

So these are very general rules of thumb: there are loads of exceptions and as always context is king. That said, I find these rules a useful shortcut when analysing possible direct sales models for companies. The rules are based on the annual average net revenue that your typical customer is responsible for:

  • Below €500 annually you can’t afford to call a customer and you must have a 100% automated sales channel
  • Below €5,000 annually you can’t physically meet a customer and you must either have an automated or inside sales channel
  • Below €50,000 you can’t get on a short haul flight to meet a customer
  • Below €500,000 and you can’t get on a long haul flight to meet a customer

Each of the different direct sales channels has radically different costs, and companies need to structure their sales operation so that they can expect to recover the cost of making a sale in well under a year.  

A typical inside sales rep will have an OTE between €40K and €70K and a fully loaded cost of roughly 150% of that. If they close 10 deals a month then the cost of making the sale is going to be somewhere between €550 and €950. Clearly if the resulting customers are only going to bring in €500 in net revenue it’s going to take a long time to cover the cost of making the sale.

A typical field sales rep will have an OTE of €60K to €100K with a fully loaded cost of double that due to the cost of travel. They should be closing about 7 deals a month, but they typically require a full time inside sales rep to source the leads and set up the appointments, taking the total cost of making the sale to somewhere between €2,300 and €3,500. So while it’s possible to run a field sales channel at under €5k net revenue, it’s difficult.

Once you have to get on a plane the whole dynamic and cost base changes dramatically. Now we are realistically starting to look at enterprise based selling. OTEs range from €70K to €150K (and up) with a fully loaded cost of about 250%. You can expect a maximum of a deal a month. Typically one meeting a week is reasonable – more can be done if you have particularly high customer density, but in that case you should probably be considering a local field sales force. So your total cost of making a sales ranges between €15K and €34K although it likely to be higher as a deal a month is on the high estimate.

Inter-continental travel makes everything even slower and even though OTEs aren’t much different, the number of meetings possible in a month shrinks to about 1 a month and resulting sales to maybe three a year. This results in an cost of sale ranging between €60K and €130K.

I find this a useful ready reckoner to quickly evaluate the available direct sales channels when analysing a company. It’s a shortcut, and I know that if something is anywhere close to the boundary it merits further in depth analysis as the peculiarities of a particular business or context may make a sales channel that initially seems implausible possible.