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.  

Let your Managers own their Successes and Failures

There comes a stage in every growing start up where CEOs have to do more than just delegate tasks to their managers. Once the business reaches a certain scale these managers need to become leaders in their own right, making different decisions to the CEO as long as it is aligned with strategy.

Your managers are not mini-yous and they have different perspectives, experiences, relationships and personalities. If you are going to leverage these capabilities it has to mean that they will reach different conclusions to you. Building your managers into leaders requires that you allow them to reach these conclusion and put their plans into place with your full support EVEN IF YOU THINK THEY ARE WRONG!

The caveat here is that the company must be able to afford the mistake if one is made.

Failure to do this and every decision will be deferred to the CEO, leaving the CEO overloaded and suffering from decision fatigue. Your managers become little more than problem reporting robots rather than empowered, innovative problem solvers and will soon become disillusioned as you make poor decisions in areas of THEIR specialisation and supposed responsibility.

CEO / Manager Discussion
Manager: There is a problem/opportunity and here’s how I plan on addressing it
CEO: Why, why, why, why, why
Manager: provides rationale and backing information
CEO: Provides overall business context/resources that manager may not be aware. Suggests a different approach that the CEO think has merit.
Manager: Explains why their approach is superior.
* At this point the CEO doesn’t agree with the manager’s approach, however it falls within the company’s overall strategy and the company can cope with the impact if the manager turns out to be wrong
CEO: Okay, great – let me know how you get on

The important aspect of this conversation is that the CEO never tells the manager that they disagree. There is no undermining of authority, just support. If the planned course of action fails, the CEO should never disclose that they disagreed in the first place. It’s not important that the CEO was right, it is important that the manager knows that it is their responsibility and that they had the CEO’s support.

In this way the manager owns the success and failure of their decision. It will only be through their mistakes that they learn and grow. If you don’t do this then every mistake will be your mistake not theirs and that will only create a dysfunctional leadership team.

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.

Only Hire ‘A’ Players

“Only Hire A Players” said the immensely successful woman on stage.  I was at the Web Summit, a few years ago – back when it was still in Dublin. But this wasn’t the first time I’d heard the advice. It had become so standard in the tech industry that it was the mantra of everyone who’d exited for north of €100 Million.

This advice just serves to show how far these CEOs have travelled. The advice is so lacking in empathy with the typical startup that it can only be described as out of touch and useless.

This isn’t surprising. In general successful CEOs who have managed to exit their company have come a long way. The early years are a blur of endlessly retold, self serving narratives that makes the reality of those years elusive even for the most grounded of CEOs. That’s why the best advice from other CEOs comes from people who are at the next stage of growth to you – the memory of where you are is still fresh.

Back to the main theme – why is ‘Only Hire A Players’ such bad advice?

  • A Players don’t want to work for most startups. We represent high risk, low immediate reward and long hours and to top it all of  the history of successful Irish exits making employees rich is less than stellar.
  • Startups are in a hurry. We can’t spend forever hiring – sometimes the right person to hire is the only one that’s in front of us. Unfortunately, it’s frequently better to do the job now moderately well than brilliantly in 6 months – because if we don’t do it now …. We’re dead!
  • Finally, if your company requires A Players to be successful then you’ve built a shit company.

It is your job as CEO to build a company that brings the best out of B and heaven forbid C Players (whoever those unfortunate souls are) so the overall performance is at the top of your field. Of course, this is difficult and it’d be a lot easier if you just had A Players – but that’s dreaming.

We’ve all seen great talent destroyed by poisonous working conditions and similarly seen mediocre talent shine brighter than the brightest lights when incentives, opportunity, culture and support is aligned. We want everybody to have the right culture and ‘can do’ attitude but that is at least as much a factor of the culture that you create as of their core personality or skills.

There are no extraordinary people out there – there are only people that do extraordinary things. If you put in place the right environment you’ll be surprised how many people can do extraordinary things.

A huge win for startups can be deliberately targeting B Players that have obvious failings that make them unattractive to companies looking for A Players and bringing out the very best in them.  The challenge then becomes “How many of my B and C Players can I make A Players?”.

What can Startups do?

  • Hire the best you can in a reasonable time frame
  • Provide a working environment and create a culture that brings out the best in people
  • Zero tolerance for negativity and undermining

When you’ve done that then maybe one day you’ll be on stage saying you only hired A Players. Then you’ll have made all of your employees feel special – after all, that’s a much simpler narrative..