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.

Update to 12in6 Methodology Presentation

Here are the latest updates to my presentation on Slideshare giving an overview of my go to market approach. I simplified the overall presentation and contrasted the 12in6 Methodology to the typical approach taken by startups.

For those who are new to the Startup-Marketing.com blog, this is the approach that I’ve used to launch several successful startups including two that have gone on to file for NASDAQ IPOs (Uproar in 2000 and LogMeIn in 2008 – pending).  Recent startups using the methodology have included Dropbox (runner up for best startup in 2008 at the Crunchies), Xobni and Eventbrite.

Looking forward to any feedback.

6-Month News Vacation

I’m a news junky and have been since college.  Recently I’m finding the damage of paying attention to the news far outweighs the benefits. 

For the past two weeks I made a concerted effort not to read or watch the news.  By this past Friday night I had reached my most optimistic outlook in years.  The companies I helped take to market in 2008 are performing beyond my wildest expectations.  Earlier in the week Xobni raised a $7 million Series B round and that evening Dropbox had been awarded runner up for best startup in 2008. 

My H1 2009 workload is quickly filling up with fantastic group of well-funded startups.  And most important – I’m really having fun helping startups figure out how to drive massive customer adoption.  Through it all, I’ve managed to spend more time with my kids than at any other time in their lives. 

What could possibly screw up this optimistic mood?  The news.  I woke up Saturday morning and decided to check in while I drank my coffee.  Big mistake.  After a few minutes of gloomy economic reporting, murders, and war I felt the pessimism creeping in.   Then I picked up the remote and turned it off. 

I decided I’d give it a break for 6 months.  I’ll bet that I won’t even know there is a recession if I don’t watch the news.  On July 11th I’ll check back in and see if there is any sign of the recovery that economists are predicting in H2 2009. 

Y Combinator is Dead?

This post by Jamie Siminoff (CEO of PhoneTag) claiming “Y Combinator is Dead,” offers a good alternative view to my earlier post praising the Y Combinator model. 

In my experience with both Xobni and Dropbox, I stand by my earlier claim that “Y Combinator hatches brilliant entrepreneurs.”  Both have been funded by very reputable VCs and continue to thrive.  But both started before the major economic meltdown.

Today all startups are having difficulties raising Series A funding – including Y Combinator startups.  Jamie offers an interesting alternative model in his post that suggests incubators should provide more/longer help for their startups.  Venrock’s Quarry is similar to the model that Jamie is proposing.  The additional benefit offered by Venrock is that they often provide the Series A round of funding to the startups that they incubate. 

Hindsight will tell us which model is best in the current economy – but for now I have no clue.

Is “Go To Market” Mastery Really Possible?

I had an interesting comment from John Gillett yesterday in response to my 10,000 hour post.  As I understand it, the essence of his question is really: is it possible to master the go to market process for startups?  In other words, are there enough similarities between startups for a universal approach to be relevant?   And if possible, does it really take around 10,000 hours to master it?  Others have also asked me similar questions.  Since developing an effective, repeatable process is the core goal that drives my hyper focus on taking startups to market, I thought it would be useful to highlight our interaction. 

Here is John’s comment:

10,000 hours seems a bit arbitrary, particularly when there are so many different types of tech startups.

Becoming an industry leader may rely more on perception than actual hours spent perfecting the craft. A powerful PR firm may be able to accelerate a launch 100 fold.

I can understand the typical startup cycle being close to 1,000 hours, but it still seems like a relative benchmark that is somewhat useless.

Here is the reply I posted:

John thanks for the comment. I would probably have had a similar reaction before reading Outliers, but Gladwell presents some pretty compelling evidence that mastery often happens around 10,000 hours of practice. I’m not sure if/how this specifically applies to startup marketing, but I do know that I’m still learning a ton with each new startup I take to market and each startup is making faster customer development progress than the last; Eventually this steep learning curve will flatten.

There are similarities in the optimal go to market process at each of the startups – particularly in the sequence in which marketing projects should be executed. It’s important to begin by generating an early flow of users and uncovering how they are gratified when using the product/service, who is gratified and how to position the product to attract more of these types of people. The process for uncovering this information is similar at each company I’ve worked with. Also the metrics systems and process for reducing barriers and improving conversion rates are similar. These and many other projects should all be completed before trying to scale the business. Here’s a snapshot of the current sequence I’m using http://www.slideshare.net/seanellis/marketing-plan-for-web-20-startups-presentation . For the foreseeable future, the process will keep changing as I discover better ways to make faster customer development progress.

Y Combinator Hatches Brilliant Entrepreneurs

Y Combinator may be the most important driver of high tech entrepreneurism ever.  While smart software engineers have historically dreamed of becoming successful entrepreneurs, insurmountable hurdles often stood in the way.  The biggest hurdle was fear: “Am I really good enough to do this?”    Getting accepted into the Y Combinator program is enough to push many aspiring entrepreneurs off the fence. 

The second major hurdle is execution.  Y Combinator entrepreneurs are “hackers,” which is another name for scrappy software engineers.  Engineers typically thrive on the challenge of “can it be done?”  Before Y Combinator, this challenge spawned many useless companies.  Y Combinator refocuses “hackers” on a new target which is closer to “should it be done?”  Their mantra “make something people want” helps entrepreneurs create useful stuff that solves real problems. 

Unlike overly exclusive VCs, the Y Combinator model is heavy on general guidance and light on cash.  This makes it much more scalable – they can afford to make decisions after a 10 minute interview.  Sure there will be more failures, but many more brilliant minds will be willing to take a chance on starting a company.  In fact Y Combinator founders are among the smartest entrepreneurs I’ve met in 15 years of startup life.

Y Combinator gives these aspiring entrepreneurs the tools and subsistence funding to actually get a product to fruition.  This significantly increases the likelihood that they can eventually get the funding necessary to build a company.  Some will have the skills to lead this company while others will pass the leadership baton to a more capable CEO.  But regardless, they will have executed the most important part of creating shareholder value – and if the company thrives, they will receive enormous financial benefit. 

If you missed the Startup2Startup interview with Y Combinator founding partners Paul Graham and Jessica Livingston, I recommend you read my guest post recap on the Startup2Startup blog.  There are also plans to post the full video of the interview.

Exploratory Project – Best Approach for Both Sides

UPDATE: I no longer offer an exploratory project.

I keep waiting for startup activity to slow down, but it remains strong. Several new VC intros to portfolio companies continue to roll in every week.  Still the best new source of interesting startup introductions is from the CEOs of the companies I’ve helped take to market.

Given the breadth of opportunities, I’m very focused on trying to pick winners.  Beyond the obvious benefits of more valuable equity, the other rationale is that I’ll get a bit more credit than I deserve for each success – but suffer more blame than I deserve for the failures.  Of course if I had the ability to take a company that would have failed and make it a massive success, I’d be asking for a lot more than $40,000 for a six-month go to market project.  The reality is that I’m trying to find startups that already have strong potential for success and help them reach even higher levels more quickly and with less burn.

While Series A VC funding is still flowing into startups, everyone recognizes that success is going to be tougher as businesses and consumers cut back their spending.  I became so concerned in recent weeks that I began passing on projects I’d have been happy to take only 8 weeks ago. 

It’s pretty easy to make a case for why startups will fail, but the winners find a way to succeed anyway.  Success is based on a combination of access to financing, market need, exceptional product and marketing execution, tenacity, and let’s face it – luck.  All these success factors are impossible to evaluate over a couple of lunches; and a full six-month go to market project is a big commitment on both sides. 

So a few weeks ago I decided to start offering a mini starter project I call an Exploratory Project. For a quarter of the cost of a full project and no equity I assess marketing progress to date, conduct some research into target customer needs/product satisfaction and run an all-day executive workshop to draft the startup’s ideal go to market approach.  This Exploratory Project gives both parties the opportunity to assess chemistry and determine the potential fit for a full six-month go to market project.  If we decide to move forward, the entire Exploratory Project fee is credited toward the cost of the six-month project.  And since there is no equity on the Exploratory Project, the contract is much simpler. 

I’ll probably go forward on a full six month project with less than half of these exploratory projects.  But even if we don’t move forward, startups still receive substantial benefit.  In this short assignment I essentially hand over the keys discovered through 11+ years and millions spent marketing successful startups (and help them avoid the many costly mistakes we made along the way).  While the six month project offers a more customized plan and guidance with execution, the exploratory project still provides a very actionable plan and defines metrics systems needed for the startup to focus time and resources on the highest impact projects.  The ultimate result is stronger momentum with less cash burn – which is well worth the $10,000 investment. 

But for those projects we do decide to extend to six months, I’ll be able to offer more focused execution guidance.  And because of the selective filtering, I’m confident these startups will be the most successful. 

If you are interested in discussing an exploratory project, contact me at sean (at) startup-marketing.com. Please note that the startups I work with have a full time person who’s sole focus is customer development (rookie OK, I can train), at least 1000 users, funding to last 12 months (about $500K for companies with cash flow, $1m for companies with no cash flow) and are still relatively early stage in customer development.

Eric Ries on The Four Steps to the Epiphany

I often recommend The Four Steps to the Epiphany as the best book available on taking a new startup to market.  However I’ve never captured the essence of the book as well as Eric Reis did in his blog post this weekend.  In addition to a great summary, he also relates the book back to his own experiences and provides practical guidance for applying the books lessons.  If you don’t have time to read the book, at least read Eric’s post.

Using Web 2.0 Marketing Tactics to Thrive in an Economic Downturn

After seeing behemoth financial firms struggling to stay afloat, a startup seems like a relatively safe bet.  But don’t be fooled – new businesses are still the most fragile part of the economy.  The situation for startups is only more precarious given the mistakes of these once renowned financial institutions.  

We must quickly shift our focus from market domination to survival.  This economic crisis is going to result in a ton of startup road kill.   The eventual survivors will be in a great position to dominate their markets – if they continue to attract users and build great products while cutting their burn. 

Instead of racing to achieve critical mass at any cost, startups must now patiently work to eliminate marketing mistakes and waste.  In frothy times, conservative marketing execution can sometimes result in being overtaken by a more aggressive competitor.  Today you can forget about that competitor – they are racing toward their demise.  The more time you spend implementing metrics systems and optimizing conversion rates, the less you’ll waste when you eventually start spending money.  And many Web 2.0 companies have shown that it’s possible to achieve critical mass with little or no marketing spend. 

Unlike the first dotcom boom when traditional mass marketing was the norm for attracting users, web 2.0 entrepreneurs have been much more adept at leveraging the network to tightly track online marketing and even build user-get-user viral marketing programs.  Websites like Facebook and LinkedIn have grown almost entirely through address book scraping – because they built social invites into the overall product experience.  Other services like YouTube make user generated content so easy to share that many visitors are compelled to become free distributors of their content.  And we’ve only begun to scratch the surface of marketing tactics that leverage the network effects of the internet.  

Of course Web 2.0 marketing tactics can’t guarantee success.  Startups still need to create a product/service that people need and take the time to understand who needs it and why they need it.   They also need to be able to monetize it.  But with a massive user base, even micro monetization starts to become an interesting business.   Those startups that get these pieces right and combine them with efficient web 2.0 marketing execution will reach the level of excellence needed to rise out of the ashes of this recession. 

Surviving The Financial Meltdown – Three Tips for Early Stage Startups

For months we’ve heard that startups should prepare for a recession that is looming in the future.  But it always appeared to be around some distant corner.  Well, it seems we’ve arrived.  Giga Om is reporting that Sequoia (considered by many to be the top VC) held an emergency meeting yesterday warning their portfolio companies to buckle down.    B rounds are already a wasteland – at least that’s the sentiment of the VC with whom I had coffee yesterday.  He claimed that money is still rolling into A round startups and that companies needing a C round often have solid financial metrics.  It’s the companies that are approaching a B round that are suffering.

So how can early stage startups weather the storm?

  1. Raise as much money as possible on the A round.
  2. Measure everything from day one.  Last week’s Startonomics conference has sessions on using a metrics driven approach to execute all the key parts of a startups.  Watch these videos .  Resources should only be invested into development and marketing initiatives that deliver measurable results.
  3. As soon as you have raised your series A, figure out the financial performance you’ll need to be considered “a safe bet”.  The best time to raise money is when you are near cash flow positive and have identified several scalable positive ROI marketing programs.  If you need the money to fund these programs and reach your full growth potential – you’ll raise the money.  During frothy times you can raise money on hype; don’t count on hype valuations during a recession.

A recession is when the real entrepreneurs emerge.  Those who think it would be “neat to start a company” generally prefer the safety of a stable job during a recession.  LogMeIn was born in the last recession.  While we had a really hard time raising our $10m A round, twelve months later our $10m B round was much easier based on our proven metrics.   We then went on to build a company that now has its software on 50 million devices and is still on deck for an IPO.  Google also emerged during the last recession.  While the stock has suffered recently, it remains one of the most successful tech companies ever.