Last week we talked about the importance of having a cogent distribution strategy even in the early stages of a startup. Investors want to know that you are thinking through sales and marketing because this is plays heavily into their view of your ability to scale. While building a great product is no easy task, many startups make the mistake of assuming that acquiring customers is easier.
The reality however is that distribution is significantly harder than building product. Think I’m full of it? Let’s take the mobile apps market, where Apple and Google have roughly 700K apps each in their respective app stores. A recent study found that just 25 developers in total account for 50% of the revenues. And here is this study on how the developer masses are doing in the iOS world:
…numerous developers that we spoke to agree that the results—59 percent of apps don’t break even, and 80 percent of developers can’t sustain a business on their apps alone—are close to accurate.
Not very promising for mobile developers (and the reason one outspoken fellow is switching back to the web). We can intuit this result even if we simply recognize how many startups fail every year. Why are they failing? It has nothing to do with the ability to build a product and everything to do with the fact that customers do not love your product.
Therefore, let’s start to lay down a framework for thinking about distribution. Part of the decision on strategy is largely based on whether your engagement model with customers is transactional, relational, peer-to-peer, or hybrid.
Once you know where you sit from a customer engagement model, you can map out acquisition methods. Consumer apps tend to use SEO and viral marketing techniques. Enterprise apps tend to use large direct salesforces. Hybrids like SMB tech apps straddle the two and lean on partners to either resell or drive traffic. Peer-to-Peer apps are largely based on the type of market as they can be a wide and open market or a much smaller niche market. In a later post, I will drill down deeper into these frameworks and how one might begin to create a more detailed distribution strategy.
Often you will hear this from investors, but what exactly does it mean? I wrote about the question of scale recently and laid out the discussion more from the investor perspective. Namely, VC’s might want to remember that they are in the business of scaling startups. However I figured I would come back to it from the perspective of what entrepreneurs can do to successfully counter this objection.
First however, we should get a clear idea of what we mean by “scale” in regards to startups. The best way to think about it is an inflection point in the where growth trends significantly upward. Most call this “hockey stick” growth where a graph of revenue (or other key business performance indicator) would go from near plateau to near vertical in a very narrow timeframe. The point is some conditions emerged to accelerate the growth of the startup.
That is what investors are probing when they look at your startup. They want to know that the money that they put in will have a significant impact on driving the startup towards or through a scaling event. Specifically, they are looking for conditions that would indicate that a large infusion of cash could trigger rapid growth. Thus, being content with your responses you provide to their objections is critical for your securing VC funding.
There are several reasons the scale objection comes up that I outlined in my previous post. However, taking apart some of my more snarky reasons and giving investors the benefit of the doubt, there are a few legitimate questions:
Is there an addressable market? A lot of startups usually breeze through this by citing specious “industry” numbers from a Google search. Most investors will see past that. You need to have a convincing argument as to why there is a market (that a problem exists) and how much of that market could be potential customers / users. Do more than just surface market research and really dig into those top end numbers. It is all too easy to be seduced by big, hairy numbers.
Is the product itself scalable? This goes beyond product-market fit and asks whether the product can cover a large enough market to be economically feasible. At first, the answer may be no because you are holding the whole thing together with smoke and mirrors. But you need to convince investors that your manual and labor intensive processes can become more automated over time. That is in fact a large reason many services oriented businesses like consulting never get venture funding (ironic given that most VC’s expressly want startups to go on a people intensive hiring binge right after funding).
Can you make the leap to that audacious goal and capture the market? There should be a logical path that leads from a small number of sales and users to huge numbers. That speaks directly to distribution, whether it is SEO based, direct sales based, reseller based, or some hybrid approach. Depending on how early you are, it may be hard to clearly delineate a clear approach or strategy, at least you can have some reasonable and educated assumptions in place. For example, showing that you have several good sized and a path towards closing them is a lot more convincing than simply saying you are merely planning to reach out to those customers.
Does your team have what it takes to succeed? While the idea and the market might be intriguing, much of the decision to back a startup comes down to the team. If you cannot show that you have the relevant experience and/or gumption to carry through to the end, then there is little chance any investor will back you. It takes more than simply a bunch of smart people with fancy degrees. You got to show entrepreneurial grit, and that comes in how you engage with investors and how you can generate traction in the early stages.
Can you overcome the entrenched incumbents? This is something that I feel is a lazy argument from investors, but nonetheless one that needs to be addressed. Some of the easier ones to tackle are of the “if Facebook/Google/etc enters the market, how are you going to survive”? Well, are they in the market, and have they proven to be startup killers when they did expand into other markets? The answer is generally no, so focus your response on your value in understanding the market and the evidence of your early traction. What is harder to respond to however are obstacles of the industry, regulatory or governmental variety. As we can see with the Uber fiasco, taking on the powers that be is not necessarily the best approach. When it comes to music or other content startups, paying the licensing fees can be a margin killing proposition. Therefore lay out a clear understanding of the risks involved and your plans for addressing them that does not involve something akin to “screw them”.
If you get the scale objection, do not fret. Just keep in mind these points and figure out in your conversations how exactly they view scale and be ready to address those concerns head on. It is not a deal killer if you are asked these questions, but it is a killer if you cannot answer them with confidence.
I noticed an interesting tweet by Dave McClure the other day that talked about startup pitch decks and the general lack of information about distribution:
He is absolutely right. Most pitches I see are all focused on product and team. There is the requisite slide about the big market opportunity. Usually it ends meekly with some sheepish ask for funding by presenting seed round terms. But the stuff that goes missing time and time again is how you are going to connect said product to that awesomely large and eager market. Basically, it is the nuts and bolts of getting your product in the hands of real users.
Product and team are easy things to talk about. They are the most real thing you can grasp in the early days of your startup. They are easy to define and see and explain. Market is also easy in that you can do some quick research over the course of a day or two and snag the most relevant (and impressive sounding) industry numbers. The stuff about funding needs is a bit of pixie dust and unicorn shit, but generally is standard fare. But the meat that gets lost in many startup pitch tomes is the process of acquiring customers.
No doubt the customer acquisition strategy is hard. You might get some initial customers and traffic just within your own limited universe of social and industry connections. You might convince a tech blogger to write about your little startup. What you really need however is a way of scaling up your business in a big way, and often that tends to be the most murky and swishy of pitch topics.
As I mentioned yesterday, the earlier the startup, the hazier the details are on how one scales the business. The main goal of the early stages of a startup is to create a worthwhile product and demonstrating initial traction that is promising enough to warrant further exploration. Thus it is fair that most of the focus is on product and customer feedback and market validation. You are tackling the first hurdles of product-market fit. However, the hallmark of a sustainable business is one that considers the means by which one is going to not just identify, but acquire, those users in large numbers for the least cost.
This is not to say that you have to have all the answers. You are so deep in the throes of making the initial product solid for your earliest users that acquisition is usually a second thought. But you should at least have a reasonable clue as to your strategy and tactics once you are at the point to scale. This is what VC’s will want to understand; can you take your hypothesis and make it work in the markets at large? If a VC gives you a boatload of money, how are you going to spend it so that you can achieve a high rate of sustainable growth? Are you going to hire a massive direct salesforce, are you depending on SEO, can you leverage network effects, or do you have some other strategies? Are your current tactics used to achieve initial traction sustainable? What are the costs of user acquisition before, now, and projected? You need to sound credible when responding which requires some effort and details on your part to create a well thought out acquisition plan.
Do not ignore the distribution question when pitching investors! Do not simply blow off the questions with a “we will get Amex as a partner” or “product is so awesome users will come”. That simply shows ignorance, laziness, and/or hubris. Early on, have some informed insights as to how you are going to get people to hear about and use your product or service. It is okay if it all seem nebulous at first, because the more mature your startup is, the more concrete the answers become and the more focused your sales and marketing strategies become through various experiments. If you show you are serious about understanding the challenges of distribution early on, you have a better chance of investors taking you seriously.
The team is awesome and the product is great, we are just not sure it can scale.
I often hear some version of this quote from conversations with investors. Just the other day in fact this line came up almost verbatim with a VC partner. Generally I ignore it as some trite brush off of a startup they are just not interested in. However, I have heard this line used enough times that I am seriously wondering if VC’s have completely forgotten what business they are in, namely to help startups to SCALE their businesses.
You could be forgiven for thinking VC’s have become utterly confused about what exactly their purpose is in the startup ecosystem. Partly this stems from the fallout of the first Dotcom era and partly from the new startup economics. In the day, VC’s used to issue $5 million Series A checks as seed funding for entrepreneurs to build out something based on little more than an idea. When the bust came, VC’s ran from early stage to find safe harbor in later stage startups with product, revenue, and hefty business plans with voluminous financials. There was less risk and operational execution was the focus. Thus VC’s were not in the “funding ideas business” anymore, they were in the “scaling startups business”.
This left a gaping hole in the early stage startup funding ecosystem. Over the decade, that hole has been filled by angel investors, seed stage micro funds, super angels, accelerators, crowdfunding, and the like. We now have this active and vibrant early stage startup funding ecosystem to fill in for the funding ideas business that VC’s abandoned over a decade ago. With the addition of communities like AngelList and Kickstarter, the funding marketplace has grown significantly and become much more efficient and transparent in the process.
The key reason this gap was filled is that technology became way cheaper and more accessible. We are all well versed on the benefits that cloud computing and cheap Internet has provided. However, the key implication of that shift was that what used to take $5 million to build could now be built for $500K or $50K or even less. This made taking on angel investors or joining an accelerator a no-brainer option since the checks no longer had to be millions to have enough runway to make a real go of things.
But something strange happened along the way. VC’s were feeling left out. They jumped back into the seed stage business throwing around $25K chip shots. They were slumming with early stage startups as a way to getting in on the next big thing. Problem was they were coming in with the late stage mentality. They expected things like high traffic numbers and hockey stick growth and significant traction, but that is provenance of more mature companies that have product-market fit and have a well baked customer acquisition strategy. At the seed stage, all of this is merely a hypothesis and speculation.
Now to be fair, when shopping around for Series A funding, it behooves entrepreneurs to at least show a working product and some traction (by traction, we mean showing positive progress that demonstrates the likelihood of a successful product). Things have shifted so that what used to be the Series A of old is now the seed round of today where ideas turn into something real. Some accelerators are even casting aside ideas altogether and bringing on smart teams to figure it out during the course of the program. Regardless huge questions still remain when approaching a Series A round, the most important being how this simple 1.0 product with modest traction is going to evolve into a world beater company. That requires the talent to build out the product vision and identifying low-cost/high-value customer acquisition channels, or in other words, SCALE.
Therefore I am left to believe that an early stage investor that cites scale as the issue either:
The whole reason most early stage companies are seeking a Series A round in the first place is because they need the money to scale their business. That is money that goes to experimenting with various customer acquisition strategies in order to discover the scalable model. It is the rare startup that goes from Series A to owning the market like an Instagram. Most folks have to slog through a few rounds of funding to get it right. Whether you get a next round of funding is largely based on hitting growth metrics and getting a handle on the scale question.
This does not mean that investors should not probe founders on thoughts about customer acquisition, business development, and marketing strategy. Those are certainly valid questions, but the answers are purely speculative the earlier the startup is. What can be intuited through such discussions is how the team has logically thinking about these issues and the amount of hustle in tracking down some of their hunches. There should be some reasoned opinions on what can work from a sales and marketing perspective. There should be some grounded analysis on customer acquisition costs and customer lifetime value. Again, it is not a matter of having it nailed down and getting it right, it is about have a thought process, an initial game plan, and the flexibility to switch things up.
The question of scale is certain an important one, but only at the appropriate stage. When evaluating a late stage deal, there has been plenty of cash, time, resources to legitimately explore the scale of the business, which really comes down to the fact that either the product was not too niche or the team did not execute. For early stage startups, if you believe in the team, the market, and the product, then scalability is a question that is best addressed when there is enough money to plug into the business to help accelerate grow in a sustainable manner (e.g. not through specious growth hacking techniques or spammy user acquisition methods). Looking for evidence of scalability any earlier simply does not make much sense.
A few months back, someone on the YC email list asked the question “What tips do you have for becoming better at BD”. I tried to summarise some of the things that I’ve learned doing much of Songkick’s BD over the years, and thought I’d publish them here too.
When we started Songkick I’d never done any BD before and had an engineering background. Since then we’ve had some successes with medium to big deals (Foursquare, Spotify, Yahoo!, YouTube etc) as well as building a self-serve API that services hundreds of other partners. Here’s a few lessons I’ve learned. This mainly focuses on BD as distribution for consumer products…
Business Development. Both the word and thought brings up cold sweats for most tech startup founders. Simply put, there are no easy answers for how to best do business development, but these tips by Songkick’s founder Ian Hogarth are an excellent starting point. But the single most useful tip is learning to do business development yourself first BEFORE you bring someone else on board to be the “BD person”.
Taking an idea from an initial inkling of a thought to a full-fledged business enterprise takes time. It usually takes way more time than you expected, even beyond your most conservative estimates. The easiest part is generally when you are starting up, but as the grind and the daily ups and downs wear on you, questions and doubts start to surface. You find yourself asking the most annoying of childhood road trip questions, “Are we there yet?”.
Any startup takes time, but some have more visible markers and more prominent milestones than others. Consumer web and mobile apps and games garner much of the attention have the easiest path when it comes to early traction. The simple fact that the audience is consumer, which is large, diverse, and more flexible, gives those types of tech startups a leg up, and with the greater visibility of these apps and their metrics, much of the tech press centers on the consumer tech plays. This is by no means to say consumer is easy, just that the gains seem more tangible.
SaaS startups on the other hand have much different uptake. These companies sell to businesses and usually focus on a narrow segment of a market, such as construction or medical or legal. Businesses require a sales cycle, identifying budgets and buyers, navigating decisions by committee and internal politics, negotiating price and terms, and then delivering a solution that may require training, implementation, integration, etc. But before you get to any of that, you need to find customers to even validate whether you have a solution that both addresses a real pain point and solves it to an extent that the solution is significantly cheaper than doing nothing. Oh, and that product better be secure, available, reliable, and scalable, backed by a rigorous SLA.
Some SaaS startups thus attempt to short-circuit the enterprise sales and service process by targeting small and mid-sized businesses. They are generally less rigorous in the requirements, decision makers are easier to reach, the population of customers is greater, and these customers are also willing to pay for software. The challenge however is not so much finding willing customers. You see, you simply exchanged the problem of finding the right few customers to a problem of finding enough customers quickly enough. Because you cannot (generally) charge SMB’s what you would change enterprise customers, you need to close that many more customers to make up the revenue shortfall. Furthermore, SMB’s are much less inclined than consumers to try new software and want to see tangible benefits upfront before making a commitment.
Neither customer acquisition route in the SaaS world is an easy one. However the one common thread is that the process takes time. You cannot growth hack your way to logarithmic growth. The average tech startup takes over seven years to reach an IPO, if it does not flounder or get acquired before that. Workday, which recently had a successful IPO, was founded in March 2005. Jive Software was founded in 2001 and went IPO 10 years later. Cornerstone Ondemand took even longer. It takes time regardless of the company or the industry or the credentials. In the meantime, you are in what Ben Horowitz eloquently described as “The Struggle”:
The walls start closing in. Where did you go wrong? Why didn’t your company perform as envisioned? Are you good enough to do this? As your dreams turn into nightmares, you find yourself in The Struggle.
When I compare those founders that succumbed to the struggle to those that made it through, the one trait that seems to define the successful ones is patience. You look at great athletes perform and you will notice how they hold the ball of a half second longer or let the route go just a few yards longer or how the batter will hold back on pitches. They are not trying to rush to make things happen or getting panicked no matter what the game may be going. They stand firm against the odds and against the onslaught. They observe the situation and are constantly assessing their position, much like a great chess player, and figuring out their next moves. They have “The Patience”.
The same goes for great entrepreneurs. Patience was something Bijan Sabet mentioned and I expounded upon earlier in the year. Much of that post was focused on the comparisons with competitors and the fear of missing out. Patience however is more than keeping your head together when your rival lands a mega financing round or gets high profile tech blog coverage. It is the exhibiting poise in adversity and persevering through challenges. It is keeping cool when you probably have every right to freak out or get defensive. And most of all, it is holding on to one’s vision when your startup journey seems more like a war of attrition.
SaaS startups do not tend to receive the glitzy press coverage or widespread attention. They fly under the radar as they try to attain customers and find markets and iterate on product. As such, it becomes harder to recruit talent, harder to identify milestones worthy enough to celebrate, and harder to keep morale positive. At the same time, there is no magic solution for attaining customers. Some hire large telesales forces fed by VC rocket fuel, some play the SEO and targeted ads game, and yet others go the partner route. You are constantly moving all sorts of pieces and trying all kinds of strategies in order to find the right combination that will get you the proverbial hockey stick. But until that day happens, you better have the patience to get through today and prepare for the next.
As an early stage SaaS, B2B startup, I get the reasons why selling to other startups might sound like a good strategy. They are more empathetic to the startup plight, decision makers are easier to reach, there is no bureaucracy, and startups after a fund raise actually have coin to burn. There is also little risk as a failed implementation is not as big a reputational hit while a successful one can lead to a very enthusiastic evangelist. Selling to startups would therefore sound like a no lose strategy with all upside; faster sales, easy revenue, and loyal supporters.
There is a huge downside that most startups do not see coming. The short-term thinking that pervades the minds of many entrepreneurs causes startups to only look at the results as they come in. The issue here though is long-term growth and viability of the business. Ask yourself this question; if there were no startups to sell to anymore, could you realistically sell your offering to a larger company within the next three months? If not, you will be toast.
The key problem when you focus your sales on startups is that it runs against the Law of Easy Pickings. When you first enter a market and gain traction, you become lulled into thinking that you are at a high growth inflection point. All you have managed to do however is find a population of early adopters. For a startup to find success, it needs to cross beyond those early adopters to mainstream users and markets. The allure of the easy sales to enthusiast users that “get it” in the beginning clouded the reality that you are still a non-entity to the broader market.
The concept of “Crossing the Chasm” is nothing new. It has been something of a bible for technology entrepreneurs since Geoff Moore wrote the tome some two decades ago. It has taken a bit of a back seat however to Lean Startup in the pursuit of product-market fit in the earliest stages with the earliest adopters. What this has done is create a mentality that shifts all strategy and execution towards those earliest iterations.
You may have noticed that we have come to a bit of a founder’s dilemma. Do you focus on the narrow constraints of product-market fit for a small cohort of users or aim towards a path that leads to mainstream adoption and sustained growth? There is no conflict here and in fact I recommend that you pursue both paths. You may think I am crazy (which is understandable), but it is actually a trait of the most successful entrepreneurs. They marry laser focused execution to long-term strategic goals in achieving an overarching vision. Evaluating product-market fit at the early stages without a wide enough audience merely guarantees that you have a product that fits a really narrow market.
Selling to startups is not a bad short-term strategy. It simply needs to be supported by a long-term strategy that allows your startup to cross that chasm eventually. Your goal should be to either dominate an existing market or establishes a new market that is large enough and dynamic enough to sustain growth. You might “dominate” in selling to startups, but it fails in the “large enough of a market” criteria. How many startups are there that could even be customers and in a position to pay you enough to make it a growth business? Given that few startups ever get funding, are quite volatile to work with, and the overwhelming majority fail, that is a rather large gamble to make strategy wise.
Make sure that you are building a product that has a chance to achieve broad applicability and a wide enough market. Using startups as part of a larger cohort of larger, more stable businesses when assessing product-market fit is a much more sound strategy. What it comes down to is making sure you set yourself up to continuously expand your market to prevent a plateau which could destabilize your business (and your investors). The plateau is like the zone of death for VC backed startups and when most startup CEO’s get replaced.
I am sure you do not want to visit the “Startup Zone of Death”. Therefore balance your customer acquisition and put enough bets out on the table to ensure you are covered across a number of different market scenarios. You want to seed markets so that you can transition when your cash cow hits a wall and stalls out. Selling to startups is not a bad idea, but only relying on startups is a recipe for disaster.
Over enough conversations and reviewing enough pitches, certain patterns begin to emerge. There are some signals that tend to make up the components of a startup success. These indicators do not necessarily translate into success, they simply point towards a path that has a higher likelihood of success. Then there are indicators that scream impending startup disaster and a warning to run for cover and hide. These are not mere probabilities we are talking about, but sure fire bets for epic failure.
Sometimes I wonder to myself if these folks are truly serious. Not serious in regards to one’s demeanor, but serious in terms of commitment to be wholly invested in taking an idea from thought to reality to sustainable business. A startup is not something you do because it is cool or because you do not have something better to do. So when I see those warning signs appear, it speaks directly to the motivations of the entrepreneur.
So what are some of those warning signs? Here are a few of the more common ones that come to mind:
Startups requires a ton of time, energy, and responsibility, so you better be clear about your objectives and personal situation. Remember that it is not just yourself that is spending time on the startup, but each person you connect with to join you or invest in you or to buy your product. If you are not serious, then you have just wasted a lot of people’s time.
There are a lot of thoughts on the small-midsized business (SMB) technology space. Unfortunately they mostly lead to lots of questions. Why are SMB’s such a tech backwater? Do SMB’s even want to embrace technology? How come technology companies run into major challenges reaching SMB’s? What does it take for tech startups to find success in the SMB market?
The SMB market is one that I am passionate about and have spent the better part of several years analyzing. It is a core part of my investment thesis and tech startup portfolio like Onepager. Some ventures have failed, some have stalled, and some are still navigating the turbulent straits of a little understood market.
Why do I believe in the SMB tech market? It is not because I look at SMB owners as tech poor or ignorant Luddites. These owners have high powered smartphones and tablets, use social sites like Facebook and Twitter, and are readily familiar with spreadsheets and other office tools. In fact, the businesses I have spoken with are thirsting for technology that they can readily use by themselves and their staff. The challenge is making that technology that not just fills a need, but does so in a way that is easy to use for their business and demonstrates a return on their time and investment. It is about cutting the business friction and time wasted during their day.
This desire for better tools and the size of the SMB market make it a prime opportunity for disruption. Outside of a website (usually a poor one at that), accounting software (Intuit rules this roost), and an office software package (almost exclusively Microsoft Office), and an order/register system (highly industry dependent), that pretty much covers the technology imprint for most SMB establishments. Given the advances in technology and SaaS coupled with new device formats such as smartphones and tablets, this is a greenfield market ripe for taking.
Yet we have astonishingly few success stories. Google has had the most success with SMB’s with their ad sales and the small yet growing Apps business. File sharing vendors like Box have gotten a lot of recent attention. That is followed by email marketing firms like Constant Contact and Mailchimp that have effectively mined the SMB space. Then you have collaboration folks like 37 Signals, job posting sites like Craigslist and Monster, and the group deals space with GroupOn and Living Social’s of the world.
So what is holding back this market if the need is there and the opportunity is available? I am glad to see that tech publications like Pando Daily shining a light on small business tech. While the analogy they use is absurd, they are right to point out the market is simply too large and diverse to tackle all at once while the payoff is small for each deal. However, there is a deeper level of nuance that is missed here. There are two issues any SMB tech startup needs to tackle if they are to find success:
The opportunity is still very wide open. Startups are finally beginning to understand the challenges faced by small businesses and are delivering great technologies for small businesses that are easy to use without significant cost or complexity. However, it requires more than great technology to survive and startups need to have the conviction to set a higher price and to be much more creative in developing quality partnerships to drive awareness and signups.