Category Archives: Business Models

November 30, 2009

Milestones to Startup Success

Update added to end of post

When your startup accepts outside money (such as venture capital), you are obligated to focus on maximizing long-term shareholder value.  For most startups this is directly based on your ability to grow (customers, revenue and eventually profit).  Most entrepreneurs understand the importance of growth; the common mistake is trying to force growth prematurely.  This is frustrating, expensive and unsustainable – killing many startups with otherwise strong potential.

Most successful entrepreneurs have a good balance of execution intuition and luck.  This was definitely the case at the two startups where I ran marketing from launch through NASDAQ IPO filings.  While we didn’t follow a specific methodology, our CEO was intuitive enough to know the right time to “hit the gas pedal.”  We didn’t accelerate until verifying that the team had created a great product that met real customer needs and we could generate sufficient user revenue to support sustainable customer acquisition programs.  It’s taken years for me to realize that our growth was less a function of clever marketing tactics than beginning with something that customers truly needed.  Some growth would have been automatic; the marketing team simply accelerated this growth.

Several startups later I have a much better understanding of the key milestones needed for a startup to reach its full growth potential.  These are based more on observing universal truths than inventing some type of methodology.  Reaching the full growth potential of your startup requires focus, specifically focusing on what matters when it matters.  In my post on the startup growth pyramid I talk about the high level milestones you must achieve in order to unlock sustainable growth.  This post looks at it on a more granular level with links to several of my previous blog posts and other resources that provide additional details.

Day 1: Validate Need for Minimum Viable Product (MVP)

Before any coding begins it is important to validate that the problem/need you are trying to solve actually exists, is worth solving, and the proposed minimum feature set solves it.  This can best be achieved by meeting with the prospects most likely to need your solution.  Steve Blank has published a great post on this.

Eric Ries offers more details on the minimum viable product concept in this post/video.

Where’s the Love?

Vinod Khosla, one of the most successful Silicon Valley VCs in history, once suggested to me that startups should think of their early users as a flock of sheep.  He explained “the flock always finds the best grass.”

For you this means you should start looking for a signal about who loves your product and why as soon as you release your MVP.  Most products have at least a few people that truly consider it a must have.  These people hold the keys to the kingdom.  Learn everything you can about them including their specific use cases and demographic characteristics.  Try to get more of these types of people.

A good place to start collecting this information is the survey I’ve made freely available on Survey.io. You can read more about this product/market fit survey in this blog post.

If you’re lucky you’ll be able to use this early signal to find the product/market fit.

Expose the Core Gratifying Experience

The majority of our project focus at 12in6 recently has been helping startups find their core user perceived value and exposing it in messaging optimized for response.  Your objective should be to remove complexity from the initial user experience and messaging in order to highlight this core user perceived value.  Often this means burying or even completely eliminating features that don’t relate to this gratifying experience.

Metrics

Metrics don’t matter until you achieve product/market fit – then they are critical to your success.  Dave McClure has a great video on startup metrics that matter (relevant part is at about minute 2:20).

Most of the tools out there provide way too many irrelevant metrics and miss the essential few.  Both Dave McClure and I are advising KISSmetrics on a solution to this problem.

Start Charging

Another key step before growing your business is to implement a business model.  The ideal timing for implementing your business model is discussed in this blog post .

I’ve often heard the argument that startups are focused on user growth and prefer to delay revenue in the short term.  I believe the fastest way to grow is with a business model and explain why in this blog post.

Extreme Customer Support

Now that you have a business model in place, your first marketing expense should be to expand the customer support team.  Anyone that cares enough about your solution to contact customer support is a great source of insight about your target market.  Also, customer support will uncover issues that will help you grow faster without spending.  And fixing these issues will make it much easier to grow when you do start spending.

If your customer support team is overwhelmed now, I don’t recommend trying to grow until you address the issues driving most support calls. Once you’ve addressed these issues you’ll have fewer barriers to adoption and will be able to grow without overwhelming customer support.

This will enable customer support to go above and beyond expectations, which is an important way to drive customer loyalty and enhance word of mouth.  This approach pays more dividends today than ever before – as I explain in this post on Social Media.

Update: See comments for additional thoughts on extreme customer support.

Brand Experience Over Brand Awareness

Back in the “Dotcom Bubble” days billions were wasted on brand awareness campaigns for startups.  Today most entrepreneurs understand that brand awareness campaigns are a waste of money for startups.

Instead, it’s much cheaper and more effective for startups to focus on creating a fantastic brand experience.  While startups often realize the importance of brand experience, they focus on it too early, fine tuning things that customers don’t care about.  Instead, wait until you understand why certain customers love your product; then obsess over every element of this customer experience.

Apple is probably the best tech company out there on coordinating a perfect brand experience for its target users. I cover more on brand experience in this blog post.

Driving Growth

Once you’ve achieved all of the previous milestones, then you can focus on driving growth.  CEOs must take an active role in driving customer growth whether or not they have an interest in marketing. Nearly all of the risk and upside in a startup is in your ability to gain customer traction and then drive scalable customer growth. The CEO should not abdicate this responsibility to the marketer.

It’s important to stay aggressive and take all slack out of the market (make it completely uninteresting to pursue the market for any other competitor).  Your early advantage is the ability to iterate on the customer feedback loop and leverage strong customer loyalty to drive word of mouth.

While ROI lets you know if a user acquisition channel is sustainable, the key focus should be on exposing lots of the right people to your fantastic product experience.  It’s much easier to get passionate and creative about this than purely thinking about things from an ROI perspective. Of course positive ROI is essential for any customer acquisition program to remain in the mix.

When it’s time to hire a marketing leader to partner with the CEO, this post explains my recommendations for an ideal startup marketing leader.  The most effective startup marketers are relentless about experimenting with channels until finding things that work.

Start by building out free channels such as listing in directories and basic SEO.   When you begin building paid channels, extra effort should be put into channels that show strong potential for scale.

Unfortunately you can’t count on effective online tactics working forever.  I’ve seen many hot online marketing tactics lose their effectiveness over time.  This is because online tracking makes it easier for marketers to quickly figure out what actually works.  As a result we start piling into the most effective tactics.   Eventually online tactics get saturated, as explained in this post.

Business building

Fast growing businesses are difficult to manage.  This is the point where you should bring in some experienced operations people if they aren’t already on the team.

It Won’t be Easy

Finally, the top three risks to growing via these milestones are:

  1. You lose patience and decide that one or more of the milestones really aren’t that important.
  2. VCs and/or board of directors lose patience because you did not achieve conceptual agreement on this approach from beginning.
  3. You delude yourself into believing that for “our type of business” customers really don’t need to consider our product a “must have”.  For us, “nice to have” is good enough.

Building a successful business is hard.  Hopefully this milestone driven approach to growing your startup will make it a bit easier.

Update: It’s hard to write a blog post on “milestones to startup success” that covers every type of startup.  Some startup types may need to reverse the order of some of these milestones.  For example, with marketplaces (EBay, social networks, dating sites, etc.) user gratification increases with more users so there is a bit of chicken and egg here…  Ad supported sites also benefit from early scale. Many of the articles linked to from this blog post also cover exceptions such as when a startup should start charging (it’s different for enterprise targeted startups).

September 2, 2009

When Should a Startup Start Charging?

I’ve recently changed my long held belief that all startups should charge immediately upon the release of a new product.  I now believe that non-enterprise targeted startups should only charge once you have achieved product/market fit.  As explained in this earlier post, I define product/market fit as at least 40% of your active users saying they would be “very disappointed” if they could no longer use your product.

The evolution in my thinking to charge only after product/market fit is based on finally working with some “normal startups.”  The first five startups I helped take to market all amazingly achieved product/market on the initial release.  For these startups it was right to encourage a quick implementation of the business model.  However, for startups that haven’t yet found product/market fit, a business model can hinder the process of figuring out how to deliver value.  Users are forced to quickly decide if the product is worth the financial investment (and we already know it’s probably not since most wouldn’t be “very disappointed” without the product – when free).

It is safest to assume you won’t have product/market fit right out of the gate.  If your initial release hits (think winning the lottery), then you can quickly implement your business model as you transition to a growth company.

If however, you are like most startups, you will spend an undefined period of time engaging users and evolving your product to better meet their needs.  When surveys tell you that you’ve reached product/market fit, the final validation is charging for your product (or a version of it).

It’s Different for Enterprise Targeted Startups

For startups targeting enterprises, it actually does make sense to charge before reaching product/market fit.  This is the best way to help the enterprise figure out how to get value from your product (somebody on the inside will be motivated to work with you to unlock value since they’ve already spent the budget).  If you haven’t charged anything, your attempts to engage the customer and find value are likely to be perceived as an aggressive sales annoyance rather than genuinely helpful.

Growing Your Startup with a Business Model

Startups often delay implementing a business model claiming “we’re focused on growth right now.” But once you’ve achieved product/market fit, most startups will grow faster with a business model (I wrote a post on this earlier).  A business model gives you rational constraints within which you can execute very aggressively – otherwise you are held back by fear that you may be wasting money on paid marketing programs.

Without a business model, you don’t know if your business is real.  Of course some prefer to hope that a business model implemented in the future might work rather than know that one implemented today doesn’t work.  If you are truly offering value (have achieved product/market fit), then there is a business model that will work.  The only way to find it is to start experimenting.

July 27, 2009

The Startup Pyramid

Here is a link to an updated version of this post

Every six months I rethink the optimal startup go to market approach based on new insights gained at recent startups. Lately I’ve been using a pyramid to represent the process I’m using. Startups require a solid foundation of product/market fit before progressing up the pyramid and scaling the business.

Achieving Product/Market Fit

Product/market fit has always been a fairly abstract concept making it difficult to know when you have actually achieved it. Yet many entrepreneurs have highlighted the importance of creating a product that resonates with the target market:

  • Paul Graham: The mantra at Paul’s successful startup incubator YCombinator is “make things people want.”
  • Steve Blank: In Steve’s book Four Steps to the Epiphany he writes: “Customer Validation proves that you have found a set of customers and a market who react positively to the product: By relieving those customers of some of their money.”
  • Marc Andreesen: A couple years ago Marc wrote the following on his blog: “…the life of any startup can be divided into two parts – before product/market fit and after product/market fit.”  He goes on to write: “When you are BPMF, focus obsessively on getting to product/market fit.  Do whatever is required to get to product/market fit. Including changing out people, rewriting your product, moving into a different market, telling customers no when you don’t want to, telling customers yes when you don’t want to, raising that fourth round of highly dilutive venture capital — whatever is required.”

I’ve tried to make the concept less abstract by offering a specific metric for determining product/market fit. I ask existing users of a product how they would feel if they could no longer use the product. In my experience, achieving product/market fit requires at least 40% of users saying they would be “very disappointed” without your product. Admittedly this threshold is a bit arbitrary, but I defined it after comparing results across nearly 100 startups. Those that struggle for traction are always under 40%, while most that gain strong traction exceed 40%. Of course progressing beyond “early traction” requires that these users represent a large enough target market to build an interesting business.

You should measure your product/market fit as soon as possible because it will significantly impact how you operate your startup. If you haven’t reached product/market fit yet it is critical to keep your burn low and focus all resources on improving the percentage of users that say they would be very disappointed without your product. Avoid bringing in VPs of Marketing and Sales to try to solve the problem. They will only add to your burn and likely won’t be any better than you at solving the problem. Instead, you (the founders) should engage existing and target users to learn how to make your product a “must have.” Sometimes it is as simple as highlighting a more compelling attribute of your product – but often it requires significant product revisions or possibly even hitting the restart button on your vision.  For more on getting to product/market fit, I recommend reading Marc Andreesen’s full post via archive.org (it has been removed from his blog).

Race up the Pyramid

Once you have achieved product/market fit, it’s time to accelerate through the next steps of the pyramid and then begin scaling your business. Here’s a brief description of what to do at each of the steps before scaling:

  • Promise: Highlight the benefits described by your “must have” users (those that say they would be very disappointed without your product).
  • Economics: Implement the business model that allows you to profitably acquire the most users.
  • Optimize: Streamline a repeatable, scalable customer acquisition process by testing multiple approaches and tracking to improve the right metrics.

Effectively executing these pre-scale steps often improves the conversion rate to transactions by 5X or more. This directly boosts the effectiveness of every future marketing initiative by the same proportion. Just don’t rush into this fine-tuning phase until you have first achieved product/market fit.

I recommend reading this post on Milestones to Startup Success for additional details.

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:

  1. “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.
  2. 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. 
  3. 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.

January 30, 2009

What Makes A Great Startup?

That’s the zillion dollar question.  And no one knows the answer definitively.  Even the most successful VCs have major duds in their portfolios.  But every startup that becomes a large profitable company has the following two elements in common. 

1) Product/service people really want or need

A “product/service people want” is the starting point for any successful startup and part of the reason that I love working with Y Combinator startups.  They drill the mantra “make something people want” into hackers’ heads who are actually capable of executing the vision. 

MBAs often spend way too much time obsessing over the business model before they’ve figured out how to create a useful product. A great business model can never make up for a product that doesn’t meet a want or need. 

I don’t really consider myself an expert on creating useful products.  In fact, I’m not sure anyone is an expert.   Steve Jobs may be considered the world’s best product visionary, but NeXT Computer was hardly a smash hit.  And the executive behind Microsoft’s lucrative Xbox business has added much less value with the Zune. 

I was lucky in my first two startups to work with great products – the original founder’s vision really resonated with users.  I helped both companies reach their potential, but I didn’t create that potential.  Luck of stumbling into great products can’t last forever, so I now obsess over finding better ways to figure out if a product has potential before committing to take it to market.  Every launch program starts with a discovery phase where we dig into how well the product is resonating with users, who really needs it, and why it’s resonating.  Then we decide a timeline for going to market.

The only way to know if a product will resonate is to get actual users on it – and the sooner the better.   If the product isn’t striking a nerve, it’s better to delay an aggressive go to market push.  Many startups succeed with a refined vision rather than their original product.  See this list for examples.  

Sean O’Malley’s blog and Eric Ries’ blog are both great resources for helping you hone your product.  But remember, the only way to know if you’ve succeeded is to trickle some users onto it.  Sean O’Malley’s slideshare presentation below is also very helpful.



2) Business model that works

Ultimately startups get VC funding based on their potenital to create a thriving business.  This requires combining a needed product with a business model that pays the costs of building a lucrative business.  There is as much art in creating a strong business model as there is in creating the perfect product.  It is a thing of beauty when all the pieces fit together in a perfectly tuned economic engine.  Each ingredient is relatively simple, but making them work together at scale is extremely difficult.  

These are the key variables to consider when developing a business model that supports profitable, scalable user acquisition channels:

  • Lifetime value of a user
  • Cost of acquiring a user
  • Marginal costs (besides acquisition cost)

The lifetime value of a user must exceed the cost of acquiring the user and any marginal material/service costs (costs that increase incrementally with each customer).   This is generally pretty easy to achieve if you have low marginal costs.  Most traditional software has zero marginal cost, which is why freeware is possible (it may not be profitable, but it is sustainable).  If you’re lucky, the lifetime value of each user is significantly higher than the marginal cost.  In this case you have a lot left over to spend on profitable customer acquisition.  On the other hand, if you have marginal costs that exceed the lifetime value, then this is a non-starter, no matter how useful the product is. 

If your product is useful and the basic business economics work, then the next part of the business model puzzle is figuring out “customer acquisition channels.”  VC funded businesses must have very scalable customer acquisition opportunities.  No VC is interested in funding a business that maxes out at $1 million/year in revenue – even if it has 90% profit margins. 

Once you have a basic engine that works, keep tuning all pieces to make it work better (improve conversion rates, bring marginal costs down, find ways to increase LTV…).  This will open additional profitable customer acquisition channels.  And obsessively tuning all these areas has been a major factor in my ability to attract 10’s of millions of users for startups that ultimately filed for NASDAQ IPOs. 

The Ultimate Startup

The ultimate startup would be one where the product meets a critical need for a huge addressable market, users have a very high average lifetime value, there are no marginal costs  and there are very scalable user acquisition channels that are completely free  (ie viral).  Unfortunately I don’t know any businesses like this.  Facebook comes close, which helps explain their valuation of $15 billion (who knows what it is now??)…  The only piece they are missing is a high lifetime value per user. 

The science behind viral marketing has rapidly evolved in recent years, so I’m axiously waiting for this ultimate startup to launch. Hope I can get some of the early equity in it.

March 3, 2008

Chris Anderson "Gets" Freemium Business Model

There has been a lot of attention this week on an article called Free! Why $0.00 Is the Future of Business published by Chris Anderson in Wired Magazine. It is an excellent overview of the drivers behind the important trend of companies offering free versions of their products. He plans to release a full book on the subject next year.  For those who aren’t familiar with Chris Anderson, he’s the author of The Long Tail, a book that kicked off a frenzy among internet entrepreneurs and VCs a couple of years ago. It highlighted the impact of unlimited online shelf space.

Every time I start reading this “Free…” article I interrupt myself to write down more thoughts on free business models.  It’s bringing back years of thinking about the best ways to execute these models.  In fact I’ve spent most of the last 13 years in the “free” space.  I plan over the next few weeks to make several “brain dump” blog posts on the subject.

A quick recap of my specific experiences with free business models.  In 1995 I made an angel investment in a “free” company call Uproar.com.  When the service neared launch in mid 1996, I joined full time as VP Marketing.  Our business model was to require users to complete a detailed registration form to be able to win cash and prizes in “free” online game shows.  We used this detailed registration information to target advertising.  While “free games for cash and prizes” was the hook, we created a very sticky site through community and a great game playing experience.  Ultimately this free online experience combined with a systematic approach to customer acquisition propelled the site to the 8th biggest web property worldwide in terms of total usage time (a key metric for ad supported websites).  Uproar was acquired by Vivendi Universal in 2001 for $140 million but the bubble valuation peaked at about $1 billion.

From March 2003 until Dec 2007 I led marketing for a more classic “fremium” service called LogMeIn.  For confidentiality reasons I won’t go into details about the executing the model, but the LogMeIn home page states the service has “Over 30 million devices connected worldwide for remote support, access & backup”.

Through both opportunities I gained lots of insight in executing this model.  I especially learned that, in a competitive category, it’s much better to be the fremium player than the premium only player.