April 30, 2009

Fast Vs Careful Decision Making in Startups

Reversible or Irreversible Decision?

Fast decision making is often the mark of a great entrepreneur. But as Steve Blank points out in a recent blog post: decisions have two states: “those that are reversible and those that are irreversible.” Entrepreneurs should take the time to make careful decisions when they are irreversible (such as accepting money from a VC). For reversible decisions, he recommends starting “a policy of making reversible decisions … before a meeting ends. In a startup it doesn’t matter if you’re 100% right 100% of the time. What matters is having forward momentum and a tight fact-based feedback loop (i.e. Customer Development) to help you quickly recognize and reverse any incorrect decisions.”

This is awesome guidance considering the countless hours I saw wasted at my first startup where people debated decisions that had little impact on results. On my marketing team I quickly ended these debates with “test it.” When debates extended across departments I abdicated the decision to others but measured the results to make sure they weren’t negatively affected.

Higher Velocity Testing Better than Perfect Certainty

At LogMeIn (my second startup) the goal was to start a testing and analytics culture on the marketing team right from the beginning. Rather than hiring someone with a traditional marketing background, my first marketing hire had an actuarial background (the people that assess insurance risk). Next we hired a super fast web designer/developer and an equally fast copywriter. This team was able to rapidly iterate everything to determine combinations that generated optimal conversions.

One warning before hiring a math wizard to lead your analytics is that they will often want sample sizes that almost completely eliminate doubt that you are making the right decision. With the volume of users at most startups, this would limit you to very few tests. When I suggest the following mental exercise to a mathematician, they usually come around to high velocity testing with lower certainty. I suggest that they try modeling the results of 25 tests with 80% certainty compared to 5 tests with 95% certainty. I also explain that we can always go back and test it again when we have higher volume.

Understanding User Motivations

But some decisions are a lot harder to test and require more up front traditional research. For example, when trying to understand the motivations behind users’ actions (or lack of actions) I generally interview and/or survey them. But as Robert Cialdini points out in his latest book: “We know that people’s ability to understand the factors that affect their behavior is surprisingly poor.” So in the past, this research often confused rather than enlightened me.

It wasn’t until I read Four Steps to the Epiphany that I realized you could take a more scientific approach to understanding user motivations. Steve Blank recommends starting with hypotheses around the key factors that will be important for building your business – such as the real problem you are solving and the people who are most motivated to solve this problem. By engaging prospective and actual users you can validate and/or refine these hypotheses. Unlike the previous approach to surveying, we now gain clarity with more user input.

Still I know there is a lot of room for improvement in my scientific approach to understanding user needs and motivations, so I recently brought on someone to help me take my research and analytics to the next level. He is Molecular Biologist as well as an entrepreneur who earlier in his career spent 10 years in biotech research. It should be interesting to see what happens when he applies his rigorous research approach to customer development. He’ll be joining me for my two projects that start next month.

At early stage web startups we have the distinct advantage over established companies of starting with a blank slate, making it possible to set up much more controlled experiments. In addition to making better use of tight startup time and money, we also hope to leverage the blank slate to challenge some long held marketing beliefs regarding what really works.

April 20, 2009

To Pay Or Not To Pay To Acquire Users?

I recently heard a VC say that startups “should spend the least amount of money possible on marketing.” This is a healthier attitude than the opposite prescription of undisciplined land grab, but a better approach is pure ROI marketing. Marketing opportunities that offer a fast payback with additional profit margin are a key component for reaching your startup’s full market potential.

Work from Free to Paid Drivers

Ultimately my goal with any startup is to acquire the highest number of qualified users possible – at a positive return on investment. But it often takes several months after “launching” to transition to aggressive scaling.

I like to start with free customer acquisition channels since they obviously offer the best opportunity to generate a positive ROI. Free drivers may include viral marketing, self-implemented SEO and listing with any directories that are appropriate for your product. Leveraging this early user flow we optimize the first user experience for the right target users and introduce a business model that generates sufficient revenue to fund future paid user acquisition. When we start developing paid channels, we work our way through the lowest hanging fruit first, beginning with demand harvesting channels, later adding demand creation channels.

Kill the Opportunity for the Competition

If your growth is accelerating, you will attract competition. And this competition will likely be savvy enough to replicate the customer acquisition and monetization approaches that you worked hard to invent. So it is important to make it as difficult as possible for them to get traction. I know some of you are saying “but your recent post told us to ignore the competition.” My point was not to ignore the competition forever, simply to ignore them while you are figuring out a repeatable, positive ROI way to acquire customers. Competition (especially those that are spending irrationally) will distract you from this critical task.

But once you have optimized the first user experience and introduced a business model that generates sufficient revenue to fund user acquisition, it’s time to focus your marketing efforts to aggressively build new customer acquisition channels and scaling existing channels – both free and paid.

April 14, 2009

Indifference is Your Real Competitor

Your Competitors are Clueless (initially)

If you are creating a new market (as is often the case for tech startups) your best chance of success is taking the time to figure out how to become relevant to the right people. Most startups spend way too much time obsessing over their clueless competition. If the competition is going for a land grab, they feel compelled to do the same. The likely result is mutually assured destruction.

Take the Time to Understand Early Users

It’s OK to passively monitor your competition (in case they figure something out), but spend the majority of your time getting to know your early users. They hold all the answers for reaching your full market potential. If you don’t have any users, get some. Acquiring several hundred users is relatively easy for a funded company. Don’t worry too much about the acquisition cost on these initial users (but don’t go too crazy either).

Once you have around 1000 users, shift all your energy to engaging/understanding them. Who is most/least satisfied with your product and why? What is the primary benefit they are getting from your product? Why did they decide to try your product? Did they have a problem that they thought you might be able to solve? Or are they early adopters that often try interesting new software even if it isn’t likely to have a real practical application?

Context Creates Relevance

The key to effectively scaling customer acquisition is applying this understanding through the entire customer acquisition process. And remember, a person isn’t actually acquired until they have a gratifying experience with your product. Start by trying to reach prospects when they’ll be most receptive to your message. Obviously the most receptive users are the ones that are actually searching for a solution like yours. Of course if your solution is truly creating a new market, don’t expect much relevant search volume.

Next, look for other contextually relevant ways to reach prospects. Getting their attention through the clutter is much easier if you reach them at a time they are likely to be experiencing the problem you are solving.

Be sure to have the relevant messages through the entire acquisition process (from landing page to actually using the product). This post gives more insight on getting the full user acquisition flow right.

April 7, 2009

User Growth Vs Revenue (Why “Free Only” May Limit Growth)

Last week I wrote about finding the right business model for your startup. But many startups aren’t convinced they should even have a business model (yet). They claim “our current priority is growth.”

In my experience, the right business model not only supports sustainable growth in the long run, it can drive faster growth today. I’ve found three primary reasons for this:

“Free only” offering freezes prospective users Site visitors often face a “what’s the catch?” moment when downloading free software that doesn’t have a visible business model. This is particularly the case when users respond impulsively to an advertisement – without the assurance of press or a trusted referral from a friend. I discovered this dynamic a few years ago when I sent visitors to a landing page that made no mention of our premium product. I had no idea why these users were dropping out of the acquisition funnel at such alarmingly high rates. Bigger download buttons and snappier headlines didn’t solve the problem. It wasn’t until we surveyed users from impulse sources that we realized the primary problem was that people didn’t trust our claim of having a free product. Once we knew the cause, solving this problem was easy. By simply giving these users the alternative to download a trial of the premium product we were able to triple the download rate of our free product. This experience demonstrates the risks of a startup that makes no mention of a premium product anywhere on their site.
Business customers looking for sustainable solutions It takes time for a business to implement a new IT product or service throughout an organization. This implementation cost often exceeds the direct financial cost of buying the product. So when a business sees that you have free offering, they will be hesitant to standardize on your offering if they worry you don’t have a sustainable business. Even worse, they may fear that you are generating revenue through more nefarious ways such as selling their information. Business buyers are usually more concerned with eliminating risks than saving the company a few dollars on a free offering.
Hard to get aggressive on unproven assumptions Committing to aggressive acceleration is difficult when your business is loaded with unproven assumptions. For example, imagine you get an opportunity to bundle with the next release of a popular complementary product. They want you to pay $4 per user (free or paid) and your Excel model predicts upgrade rates that will give an average lifetime value of $6 per user across your entire free and paid user base. Great, this looks like a safe bet. But when the company tells you they’ll drive 1 million new users per month, you start worrying. If your assumptions are right, you’ll generate $24 million in annual ROI – enough to put you well on your way to an IPO! However, if your assumptions are wrong, you’ll probably go out of business. Generally you won’t decisions on this scale, but the example demonstrates why it’s a lot harder to aggressively grow your user base on unproven monetization assumptions.

I realize it can be a bit nerve-racking to implement your first business model, particularly if you have strong organic growth. But it’s not a moment of truth you should dread – instead it is a baseline that you will work to improve over the life of your company. Business models can and should be honed over time to increase the value of your users whether or not the first iteration is fruitful.

Of course, if you have an extremely viral product, then a business model may in fact hamper your growth. But ultimately you’ll still need a business model to monetize this growth, so you might as well figure it out early.

April 2, 2009

The Right Business Model for Your Startup

The right business model is critical to sustainably drive scalable adoption of your startup’s product or service. Typical business model choices for software, web services, and online media startups are advertising or direct monetization (licensing, subscription, virtual goods, ecommerce, etc).

I generally avoid customer development roles with advertising supported startups because it is very difficult to self-fund (via arbitrage) early growth. I faced this challenge at Uproar in the mid 90s when building an ad supported business was arguably easier. We had created very engaging online games that we were certain would eventually attract a large user base. In the first month after launch I presented the games to the big Madison Avenue advertising agencies and they were initially excited about the integrated advertising opportunities. However, when I explained we only had a few thousand users interest quickly faded.

These guys had multimillion dollar monthly advertising budgets. Even if we could offer a strong ROI on their advertising investment, it wouldn’t be worth their time setting up and managing the campaign. Our potential contribution to overall results was a rounding error on their typical campaign. And considering the custom integration work, it wasn’t going to appeal to anyone but the most “visionary” advertiser.

It was at this point that I realized the life savings I invested in Uproar was in serious jeopardy. I asked our CEO for the opportunity to focus on user growth so that we could eventually attract big budget advertisers. We managed to generate a substantial audience (becoming the world’s biggest game site), but even then still suffered from rapidly dropping ad rates that plagued the entire web. It seemed each time we doubled traffic, the online advertising rates cut in half.

What I like least about an advertising supported business is that it is almost impossible to always do the right thing for your customers. Your two primary customer groups have opposing needs. Each time you try to please your advertisers, you damage the user experience – and vice versa.

Of course it is possible to build a valuable advertising supported company that overcomes this challenge – just look at Google. Google reconciled the needs of advertisers and users, improving the user experience and advertiser results with perfectly targeted advertisements. In fact Google’s advertising results were so good that later as an advertiser I was able to scale a profitable marketing spend to millions of dollars without ever speaking to a sales person (the results sold the ads).

Today most online marketers buy on tracked ROI. So if you are considering an advertising model, I highly encourage you to develop one that delivers results that will minimize the need for a sales team. I do not envy the salesperson that has to make a case on the abstract branding value of their web property. As tracking continues to improve, it going to be a much harder to incubate a startup with advertising. Long-term success will require years of high burn.

In my experience, it is much easier to build a lean startup using a direct monetization model such as subscription, software licensing or ecommerce. With these business models, your customer acquisition can be self funded from the beginning because it works at a very small scale. For example, if your users have an average lifetime value of $100, your breakeven acquisition cost is $100 less any direct costs of serving this customer (such as storage or bandwidth). Of course if you can acquire the user for $50 and there is no marginal service cost, then you’ll generate a $50 marginal profit on this user. With a good arbitrage model, it becomes much easier to sustainably build a customer base from day one keeping burn at a minimum. And eventually enough marginally profitable users offset fixed costs – creating an overall profitable business.

Arbitrage supported customer acquisition can even work on a freemium model, but your allowable acquisition cost for a free user will be much lower when you average revenue across the whole free user base. Still, over time you can add additional monetization channels to boost your allowable acquisition cost and expand the number of viable acquisition channels. Ultimately freemium businesses become more defensible than “premium only” businesses, because you’ve built the premium portion of your business to compete in the toughest economic scenario. I’ve blogged about freemium several times already, but have a lot more thoughts to share as I’ve helped several additional startups implement the model since my last freemium post. Look for a more comprehensive post soon, but in the meantime here is a link to my earlier freemium posts.