Category Archives: Budgeting

March 18, 2011

Ideal Ratio of Product Vs Marketing Spend for a Consumer Startup

Below is an answer I recently put on Quora… Since I haven’t posted on my blog for so long, I figured some people not on Quora might find it useful.

Your marketing spend should be very minimal until you validate that you have created a product that people want or need (an important exception is for network effect products, which I’ll cover later). I would suggest 95/5 ratio between product and marketing. You don’t necessarily need a marketing person on the team to do this early validation.

Once you’ve validated that people want or need the product, you should spend as much as you possibly can on customer acquisition as long as the value of each user exceeds the cost of acquiring them. Often this requires raising additional funding, but if you can present proof of profitable, scalable marketing channels then it should be easy to raise the additional funding. Of course you should complement this paid customer acquisition with free sources if possible (and you can start these early in the validation process). If your product really does a good job solving an important need, you should also have strong organic growth. At this point the spend ratio generally tips toward marketing. I’ve seen it as high as 80% to marketing and 20% to product.

The exception for network effect businesses mentioned earlier is for the following reason… The user experience for a network effect product improves with each additional user. You may need to reach a critical mass of users before you can validate that the product is important for users.

April 20, 2010

A Lean Start is Smart

Lean Vs Fat Startups
When I read Ben Horowitz’s article “The Case For The Fat Startup” http://bhorowitz.com/2010/03/17/the-case-for-the-fat-startup/ I expected to be in violent disagreement with most of it.  However, I was surprised to find myself mostly nodding in agreement.  Many of the moves he describes that led to the survival and success of Opsware/Loudcloud were similar to the ones I advocated as an executive in a post dotcom bubble public company (Uproar.com).  Cutting was important, but it was even more important to protect and build on the value that we had created.
So how can I find myself agreeing with Horowitz, when he seems to be such a vocal critic of Lean Startups?
Well first, he’s not against running leanly.   He simply suggests that lean shouldn’t be the end goal.  Instead, he claims startups should be focused on survival and market leadership – both of which benefit from more money.  However, his examples mostly center on companies that have significant traction.  Take Facebook, which he touts as a “fat startup” because they have raised over $700m.  The fact is that they didn’t start out fat; in their first year they only raised $500,000.
This mirrors my experience at multiple successful startups.   Most maintained a very low burn in the first year, investing funds carefully to create a valuable product.  Only after early users validated that it was a must-have product, did we start loosening the purse strings.  Speed of execution to fully capture the opportunity became the primary objective.  At this point, most of the companies were able to successfully attract additional financing (often very large rounds).
Perhaps the most important realization that I’ve made as a result of this debate is that: Lean Startup principles are most critical in the early stages of a startup before product/market fit.  If you have not created a “must-have product” your ability to attract future rounds of financing will be limited if not impossible.  Your best chance of survival is to create a must-have product on your first round of financing – with the overwhelming majority of funding going into R&D.  Once you have created a must-have product, it will be much easier to raise enough money to capture and lead the market.
Of course, this could be an argument for a big first round of financing.  I rarely advocate raising a small round if you can raise a big one.  But it’s important to recognize that the best VCs invest small before traction and big after traction.  They realize that overinvesting up front rarely improves a startup’s ability to create a must-have product.  If you are fortunate enough to raise a substantial round up front, you’ll need discipline not to spend in areas that aren’t essential to creating a must-have product.  If you have the right discipline, your only important risk of raising a big early round is limiting the potential for lucrative small early exits.  But more likely you won’t be able to raise a substantial round until you have created a must-have product.  Once you can prove an ability to scale cost-effective growth for this must-have product, smart VCs will be knocking down your door to invest as much as you can realistically absorb – and often more.

When I read Ben Horowitz’s article “The Case For The Fat Startup” I expected to be in violent disagreement with most of it.  So I was surprised to find myself mostly nodding in agreement.  Many of the moves he describes that led to the survival and success of Opsware/Loudcloud were similar to the ones I advocated as an executive in a post dotcom bubble public company (Uproar.com).  Cutting was important, but it was even more important to protect and build on the value that we had created.

So how can I find myself agreeing with Horowitz, when he seems to be such a vocal critic of Lean Startups?

Well first, he’s not against running leanly.   He simply suggests that lean shouldn’t be the end goal.  Instead, he recommends startups should be focused on survival and market leadership – both of which benefit from more money.  However, his examples mostly center on companies that have significant traction.  Take Facebook, which he touts as a “fat startup” because they have raised over $700m.  The fact is that they didn’t start out fat; in their first year they only raised $500,000.

This mirrors my experience at multiple successful startups.   Most maintained a very low burn in the first year, investing funds carefully to create a valuable product.  Only after early users validated that it was a must-have product, did we start loosening the purse strings.  Speed of execution to fully capture the opportunity became the primary objective.  At this point, most of the companies were able to successfully attract additional financing (often very large rounds).

Perhaps the most important realization that I’ve made as a result of this debate is that: Lean Startup principles are most critical in the early stages of a startup before product/market fit.  If you have not created a “must-have product” your ability to attract future rounds of financing will be limited if not impossible.  Your best chance of survival is to create a must-have product on your first round of financing – with the overwhelming majority of funding going into R&D.  Once you have created a must-have product, it will be much easier to raise enough money to capture and lead the market.

Of course, this could be an argument for a big first round of financing.  I rarely advocate raising a small round if you can raise a big one.  But it’s important to recognize that the best VCs invest small before traction and big after traction.  They realize that overinvesting up front rarely improves a startup’s ability to create a must-have product.  If you are fortunate enough to raise a substantial round up front, you’ll need discipline not to spend in areas that aren’t essential to creating a must-have product.  If you have the right discipline, your only important risk of raising a big early round is limiting the potential for lucrative small early exits.  But more likely you won’t be able to raise a substantial round until you have created a must-have product.  Once you can prove an ability to scale cost-effective growth for this must-have product, smart VCs will be knocking down your door to invest as much as you can realistically absorb – and often more.

Note: Eric Ries clears up some of the common mis-perceptions about lean startups in this post.

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.