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If the Shoe Fits: Revenue vs. Hypergrowth

Friday, March 4th, 2016

matthew weeks

A Friday series exploring Startups and the people who make them go. Read all If the Shoe Fits posts here

I saw a great article in BI about Postmates CEO Bastian Lehmann’s attitude towards hypergrowth.

For years, venture capitalists have been pushing hypergrowth over profits, at least though the initial phases of investment rounds. Investors told Lehmann to reinvest the company’s money in pushing more growth over building a sustainable business.

That advice didn’t go far with the Postmates CEO. (…) Lehmann argues that it’s the CEO’s fundamental job to have looked at the margins and made decisions early on.

“Companies that run for the last two years in hyper growth are now wondering how to make money.”

I completely agree — hypergrowth without a hope of unit economics that lead to profitability has always been a fool’s errand with precious few exceptions, and even those had their “come to Jesus” realization points that the investors were getting nervous and were anxious for at least a hope of a repeatable, profitable set of unit economics. 

There has been a sense that pushing the bidding of sequential funding rounds at ever-increasing valuations would create a kind of de-facto “momentum” and crowd-out 2nd and 3rd and 4th place contenders, or at least amass a large enough war chest to drive pricing down as much as needed to push competitors out of the running (usually also by creating such a huge and dominant brand that customer acquisition in a noisy market is too expensive to make progress to catch up with the so-called leader).

This is ultimately as silly as the Texas and Miami and Las Vegas housing bubbles, that depended on “the next fool” to buy-in at a higher valuation, depending themselves on having a subsequent investor bail them out at a higher valuation, and so goes the escalator.  The problem is, the escalator gets to the top at some point and there has to be a “destination” where value exists and with it, a hope of profitability.

The unsteady IPO market of last year and the continued bearishness of the IPO exit market this year has effectively called-out that “top of the escalator” and there are no more “next fools” (i.e. large enterprise buyers at the >$1 Bil level and no robust IPO appetite from capital market leaders that demand value and cash flow and a hope of profits).

So now, once again we are back to reality.

The great news about being back to reality is two-fold.

1)  Sub-billion dollar valuations are no longer an “embarrassment” to VCs; and

2)  Entrepreneurs can reasonably weigh a variety of capital structures that include bank and trade debt as well as investment equity and debt structures, all supported by revenue and that means free cash-flow.

With this in mind, the VCs and the investment community in general must start to become “reasonable,” because they are suddenly back in the traditional capital markets and will have to compete with other capital sources and structures for the hot deals.

Middle and nascent deals will have to become cash-flow generating, and for this reason they will also (wisely) become more reluctant to give up huge chunks of equity just to bring in working capital (at least not until the enterprise value pops to a higher tier by using bank debt, trade debt and other creative capital structures).

Savvy entrepreneurs and founding teams will also be less excited about creating an early and dramatic bump in valuation just to bank growth capital, because a down-round will likely wipe out a giant proportion of their equity.  The giddy “we are a unicorn” has turned into “what happens in a down round?” reality check, that most people forgot about.  Early venture investors have protected their downside with special preferred terms that founders and exec teams rarely consider or can demand.  If this were real-estate, it might even start to look like over-aggressive venture investors that pump up valuations too early, only to have the market adjust to “reasonable” later, were “predatory.”  It is an interesting parallel that will not be lost on founding teams, angel investors and early exec team members that hope to be rewarded via their equity stake.

The reticence to of many of the younger venture investors (those with fewer than 20 years of experience) having yet to bring in a 5X or 10X much less a Unicorn, to invest in early stage deals, is now balanced by the abundance of crowdfunding and syndicate fundraising at the seed and angel level.  This is a great organic re-shaping of the investment and capital markets in favor of the early stage company and entrepreneur.  

There is also a growing recognition that the early stage deals that do get picked up by venture investors have been in a long slow decline and “narrowing” of deals to known insiders and repeat successful (i.e. “brought a good exit to a venture fund’) founders.  I think that this is largely common sense (bet on the horse that won the last race for you), and also based on the reality that it is a rare and elite breed of entrepreneur that can see an opportunity and execute a successful solution.  That said, a close examination of the venture deals that have been funded in favor of known founders pales next to the stats behind the successful new ventures that have been founded by first time startup teams.  The difference is largely that part of the value-add from the venture investors is the addition of those “experienced” startup executives onto the exec team as soon as the big money comes into play.  Thus the risk of execution is somewhat reduced.

What does that mean to today’s startups?  It means that the old concepts of cash-flow, repeatable and scalable selling and service delivery models, the idea of managing customer acquisition, retention and lifetime customer value, are again in vogue.  

As they should have always been.  While there will continue to be many good reasons for companies to temporarily sacrifice cash flow and profitability for raw user or customer growth, the days of “just get 1 million users and we’ll figure out how to make money later” are – at least for the time being, gone.  And we celebrate that.  

Unit economics always wins.  This goes back to the days of “the lemonade stand” cash-flow exercise. It’s what built the world’s greatest capital markets.  And it will always remain the best place to start.  Water, sugar, lemons, cups and napkins.  And a sign and a cardboard box. “How many cups of lemonade must we sell at what price to pay for the supplies, time and sign?”  Simple.  One does not need an MBA or to be a dropout PhD candidate to start with those basic principles.  

In another parallel with the real estate (mortgage) market, today’s startup teams should be asking themselves the same questions that prudent investors will be asking them (kind of like the new mortgage market, where everyone has to go through “full documentation” to get a standard mortgage loan):

How can I make money?  How can I do it at scale?  What is my selling process and is it repeatable?  Who will pay for my service or product and what will they pay, and why?  How much money do I need in working capital to find my perfect product-market fit and establish the right selling model and price point/margin?  What are the unit economics of my business?  What drives retention and churn?  What prevents others from copying me and disintermediating my base?  Is there a brand value that creates loyalty, or is this market driven by other values and factors?  What are my logical exits?  Who are the logical acquirers?  Is there a realistic IPO path? 

Yes, we are back to reality.  It sucks for some people.  And that’s okay.  Those people should get with the program or get out of the startup business.  Disrupt and question everything.  Be bold, revolutionary, even bombastic and disrespectful of the incumbents and status quo. But don’t ignore the fundamental rules of business that underly the path all companies must tread to go from small to large, and startup to profit and successful exit.  After all is said and done, you have to make payroll. Sell to a customer a second time.  Own a brand people love and trust.

Reality only sucks because it makes you work harder to win, and forces you to confront inconvenient tasks and difficult questions.  Short cuts are nice but when they don’t work you end up falling off of a cliff.  Better to work harder than run headlong at a cliff you can’t see coming.

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Image credit: HikingArtist

If the Shoe Fits: How Mature Is Your Company

Friday, March 6th, 2015

A Friday series exploring Startups and the people who make them go. Read all If the Shoe Fits posts here

kg_charles-harrisHave you ever been taken aback by the dichotomy between a company’s excellent product and its amateurish website or product sheets?

If you have, you are face-to-fact with an immature company.

And while important for consumer sales, M&S maturity is absolutely critical when selling to business — no matter the size of the enterprise.

This immaturity has nothing to do with years in business and everything to do with an immature business process with regards to sales and marketing.

If a potential customer meets something that’s immature, i.e., incompetent, in M&S, they will jump to the conclusion that the company is also incompetent in other areas.  

That’s why look & feel are so important — we Americans, unlike most other countries, have grown up in a society where marketing is central, so in many ways looks are more important than substance.

Young companies are often immature; they hire sales people, but turn a blind eye to the need for doing the product marketing work first.

The shrug off lead generation/creation, lead nurturing, sales process, sales collateral that fit the process, key selling points against competitors, target user profile, target influencer profile, etc., and, worst of all, customer service.

These are the real underpinnings for success.

A lot to cover; a lot to do, but the payoff is significant.

After all, you don’t want your target customers to dismiss you because you look immature, do you?

Entrepreneurs: Riot Games: Against Prevailing Wisdom

Thursday, October 16th, 2014

https://www.flickr.com/photos/chris-yunker/5689436382

When Riot Games was founded in 2006 by Brandon Beck, and Marc Merrill it was done out of frustration. They wanted a game that would embrace fans desire to engage in that game, rather than being forced to dump it for a new version.

League of Legends was launched three years later; it was launched ignoring prevailing wisdom about how to make a game pay, i.e., no hardware, free download, players couldn’t buy extra power or skill for their avatars and time to grow organically.

“People told us when we started that if you don’t charge up front, or if you’re not selling extra power or stats, it won’t work,” Mr. Merrill said. “But that fails to account for the coolness factor. If you’re really into cars, you don’t mind spending $50,000 to soup up your Honda. That’s the player we’re tapping into.”

Riot now has 1500 employees and is on target to break the billion dollar revenue mark.

The company says there are now 67 million active monthly players around the world, and in August alone this crowd spent $122 million, according to SuperData.

Riot Games doesn’t have advertising on its site; it focuses totally on its users believing that if they are happy revenues will come.

“Whenever I talk to executives at Riot, it’s like a mantra: ‘Revenue is second, the player experience is first,’ ” said Joost van Dreunen, chief executive of SuperData. “The paradox is that by putting revenue second, League will be one of the very few games to bring in $1 billion in 2014.”

Moreover, although it isn’t paying off immediately, Riot Games is working diligently to build LoL into a major e-sports presence.

Dozens of those players are now in Seoul, at the fourth world championship. On Oct. 19, the finals will be held in a stadium built for soccer’s World Cup, with 40,000 fans expected and many times that number watching online. Last year, Riot Games says, 32 million people around the world saw a South Korean team win the Summoner’s Cup, along with a grand prize of $1 million, in the Staples Center in Los Angeles. That’s an audience larger than the one that tuned in to the last game of the N.B.A. finals that year.

And while most of Riot Games’ 1500 employees are in Santa Monica, the bulk of its players are in Asia.

Sometimes it pays not to listen to the experts.

Flickr image credit: Chris Yunker

Entrepreneurs: SIIA Maximize, Day 1

Thursday, May 22nd, 2014

kg_charles-harrisYesterday was the first day of the SIIA Maximize Conference (Software and Internet Industry Association) and it was fantastic, in spite of starting with an apparent mistake.   Mine, not theirs…

I thought I had registered for Software Pricing’s 4-hour seminar with Jim Geisman, an expert in how to price software products, both SaaS, on-premise, embedded and other models.  Apparently I hadn’t, since I wasn’t on the list, but In spite of that I was allowed to participate.

The session was intimate and excellent and Jim provided a lot of deep information and practical advice for how to think around the price-setting challenge.   The audience was comprised of CEOs, CFOs, VPs of Marketing and Sales from large companies and startups alike.  It was exceedingly interesting to see how pricing is a problem across several different sizes of companies and industry segments.

There is no question that Jim and his partner Chris Mele are the most knowledgeable people with regards to software pricing I’ve come across after more than two decades building software companies.  The importance of pricing optimally—setting the price in a way that entices the highest number of customers without leaving money on the table—is a discipline that I’ll definitely pay more attention to in the future and I’m sure to use Jim’s services to ensure we don’t make any mistakes in this important area as we go to market.

SIIA’s Rhianna Collier and her team from the software division put together tremendous networking opportunities with both arranged meetings and speed dating sessions.  It was some of the best networking I’ve experienced, yielding several additional companies to round out a set of initial test users for the system we’re launching in September.  This is very exciting, as finding initial customers is one of the most challenging parts of releasing an enterprise product. 

When selling to organizations, the challenge is to have managers and executives allocate their and their teams’ time and resources to iron out the wrinkles in a new product.  This is not a trivial challenge for a startup. 

The networking was valuable not only for me, but also for people from companies such as HP, InformationBuilders and SAP, with whom I spoke.

I’ll end with a story that proves once again just how small the world really is.  As I was standing in the first part of the arranged networking I started speaking to Shannon Murray from Totango who was surprised when I knew of the company.  It’s a small series B company that just raised 15.5m and are in an interesting space called Customer Success software. 

I explained that I followed their blog, as probably thousands of others do.  The blog is written by Ellis Luk who, together with their CEO Guy Nirpaz, has created a company blog that is helpful and instructive by enabling their customers to speak about their problems and how they are dealing with the challenges around enabling their customers.  This is crucial for a SaaS business to get right as renewals are completely dependent on this.

The first day was very good and I’m looking forward to the following two.

Steve Ballmer’s Lack of Content

Wednesday, July 24th, 2013

http://www.flickr.com/photos/kamikura/192323509/When Microsoft announced its much ballyhooed new strategy and resulting management changes I commented that you can’t change culture, especially an intentionally siloed culture, by edict.

I didn’t go into what seemed to me a strategy with a serious lack of solid content; these days we all know that not only is content king, but the it’s source of authenticity.

I assumed that it was my unwillingness (boredom) to read the analysis offered by media, let alone Steve Ballmer’s actual long-winded statement to the Microsofties, that made me miss it.

As has been said over and over by experts, “culture eats strategy for lunch” (breakfast, in come cases), and while clear communications is as great a focus for me as culture, I just couldn’t make myself read it.

Fortunately, Wally Bock at Three Star Leadership has more patience and he offered some great analysis and comments, which are reposted below with his kind permission.

Microsoft and the Strategy of Everything

On July 13, 2013, Microsoft’s CEO, Steve Ballmer sent a lumbering, poorly edited, 2600 word email to Microsoft employees, announcing the company’s new strategy. As awful as the memo was, the strategy is worse.

When I read some of the news accounts, I felt like I was experiencing an updated version of Akira Kurosawa’s classic, Rashomon. In that film, people who participate in the same event each describe it differently. In this case, news organizations that got the same information each describe Microsoft’s new strategy differently.

The New York Times wrote about how “Microsoft Overhauls, the Apple Way.” The Wall Street Journal looked at the same announcement and said that “Microsoft Shake-Up Aims to Speed Products.” And the Mercury News told us that “Microsoft unveils major overhaul in effort to focus on mobile.”

Those very different reports sent me to the Microsoft site and the text of Steve Ballmer’s email. There, he tells us that “We are rallying behind a single strategy as one company.” Sounds good. And what might that single strategy be? Here goes.

“Going forward, our strategy will focus on creating a family of devices and services for individuals and businesses that empower people around the globe at home, at work and on the go, for the activities they value most.”

Try reading that without taking a breath or tripping over tangled syntax. Doesn’t exactly have the ring of “A PC on every desk and in every home” does it?

As I interpret it, Microsoft will make products and provide services which they will sell to individuals and businesses in the US and other countries. Egad! Is there anything Microsoft has chosen not to do?

There’s no focus at all. Being everything to everyone is usually a pretty sure way not to be much of anything to anybody.

And there’s nothing to fire up the passions that drive engagement. Would you really leap out of bed in the morning all charged up to “focus on creating a family of devices and services for individuals and businesses?”

This is not a strategy to build long term, sustainable competitive advantage. It is a strategy for rotting slowly from the inside out.

Thanks, Wally.

Flickr image credit: Masaru Kamikura

Smartphones and Customer Engagement

Monday, December 10th, 2012

Customer loyalty is a top priority no matter what you are selling—especially in retail.

Just ask Tony Hsieh, whose focus on Zappos’ workforce created the platinum standard of customer service that yielded a storied (and envied) level of customer engagement and loyalty.

The most important component by far is customer engagement. “Retailers should ask themselves, ‘how do I create a partnership with the consumer?’ instead of pulling one over on them,” says Harvard Business School senior lecturer José Alvarez. Many customers see loyalty programs as a way of being ambushed by the retailer.

Many retailers see smartphones as a successful way of engaging customers—but are they?

I have to wonder if they are taking into account the real numbers.

50.4% of the US population uses smartphones

  • Asian Americans 67.3%
  • Hispanics 57.3%
  • African Americans 54.4%
  • Whites 44.7%

Now take a look how the money breaks down.

48.5% of all smartphone handsets are Android, while Apple is at 32%, yet I constantly see product and service offers that require an iPhone.

Stop & Shop recently rolled out Scan It! Mobile, an app that turns a customer’s iPhone into a mobile scanner and checkout.

Gender-wise, smartphone use is nearly identical, 50.9% women 50.1% men, but age is a different story, with two out of three 25-34 year-olds having smartphones.

Marketers consistently target the younger demographic, but do they really have the money or are “Millennials the most screwed generation?”

The median net worth of households headed by someone 65 or older is $170,494, 42 percent higher than in 1984, while the median net worth for younger-age households is $3,662, down 68 percent from a quarter century ago, according to an analysis by the Pew Research Center.

I’m a long way from being any kind of expert, but it seems to me that basing a loyalty/customer engagement model on smartphones, let alone iPhones, doesn’t make much sense when viewed through the lens of actual usage and related income stats.

The Start of Planning Season

Friday, November 19th, 2010

winners

Every year I spend time with clients helping them understand the kind of planning they need to do now in order to be on the road to success the following year; I also like to share an outline of the process with you.

You have to have a plan
Anyone leading a company, even a company of one, needs to know

  • what you want to do, and
  • how you’re going to do it.

This brings you to the crux of the matter—how do you plan for a sustainable business?

Choose your approach

  • SOP (seat of the pants): Used frequently throughout business history, and extensively in the late Nineties. The CEO (top dog) discusses her desires over lunch with other (hopefully) senior staff members. Separately, each manager prepares a budget, including headcount for his department based on
    • what he thinks is needed to accomplish what the head honcho says she wants and
    • increasing his own leverage within the company (although these two are frequently reversed).
  • PBO (operating plan w/budgets and objectives): Requires more thought and effort, but is the approach of choice for well-run companies. It requires the
    • creation of a viable operating plan to achieve the objectives; and a
    • detailed budget by which to implement it.

SOP, in all its glorious variations, spells chaos (which can be accomplished with no help from me), so we’ll focus on PBO.

What’s PBO?

Three interlocked pieces—each critical to success.

1. A budget that states

  • how much is available to spend during the upcoming year and
  • who is responsible for spending it.

2. The specific objectives that the company needs to accomplish during the year,

  • financial, e.g.,
    • increase revenues 10%
    • increase services to 25% of revenues; and the
  • quantified managerial, e.g.,
    • raise productivity 8%
    • reduce turnover 15%

3. A description of how the company plans to achieve the objectives in order to move forward on accomplishing the company’s long-term twin goals of profitability and success.

The end result is a detailed business roadmap for the coming year.

Where’s the rocket science?
The three parts are interrelated and must be tightly linked, so changing one affects all.

That’s it. Simple, right? Unfortunately, many executives treat them as separate entities wreaking havoc on their subordinates. They don’t get, or don’t care, that it’s a domino effect and that when one changes they all must change.

Which are you?

  • The boss who can’t be bothered to do the hard work and make the tough decisions and doesn’t worry about jerking his people around because ‘they’ll get over it’; or
  • the boss who believes that with a good plan, known objectives and a viable budget all the managers—executives to the lowliest supervisor—will buy-in and execute intelligently throughout the year?

As always, it’s your choice.

Image credit: http://www.sxc.hu/photo/914885

Taking the Temperature of Venture Capital

Friday, August 6th, 2010

kg_charles-harrisLast week I again attended the AlwaysOn 2010 Summit at Stanford, held at Stanford University in California.  It was a beautiful setting with people from all parts of the technology ecosystem—from very large companies such as Hewlett Packard to small 2 person startups, banks, venture capitalists, angel investors and consultants.

One of the most interesting takeaways from the conference was the very different views that people had on how the venture capital industry was developing in the present environment.  On the one hand, there were strong assertions that the VC industry was in good health and that there was a lot of money looking for investment.  Most of the VCs I encountered asserted that they were very much interested in early stage investments and that they provided a unique service to founders and early stage management.

However, this was in stark contrast to the intense frustration many startups were expressing when describing their hunt for capital.  They felt that VCs were far from interested in early stage investments and were mostly focused on follow-on investments in portfolio companies or syndicated deals.  Some (probably about 70% of the people with whom I spoke), who had received investments felt that the VCs were often a distraction on the Board and either were micromanaging or otherwise not helpful.  Yet these founders and executives have little choice but to continue to seek venture money to fund their growth.

Could these developments be due to the fact that many of those running the largest firms are no longer the seasoned operating managers that brought forth the storied companies of old, like Apple, Cisco, Fairchild Semiconductor, Silicon Graphics, etc.?  Many have the impression that the generation of VCs that joined when the names on the door wanted to kick back are simply bankers; portfolio managers unable to take risk or understand a vision.

The industry has always been prone to “herd mentality,” where a lot of VC firms invest in similar startups; as was blatantly obvious during the dot com debacle.

A preference for financial manipulation and unwillingness to take risks combined with a lack of operating experience and little vision could signal a death knell for the kind of leaps that created high tech in the first place.

The upside is found in younger VCs and angels; men and women who founded or worked in startups and are putting their money where their mouth is to help create the next wave.

The question is there enough of them or will it be a case of too little too late?

KG Charles-Harris is CEO of Emanio and a special contributor to MAPping Company Success.

Book Review: Reorganize for Resilience: Putting Customers at the Center of Your Business

Friday, March 19th, 2010

How many times have you heard it—focus on the customer blah, blah, blah?
How often does it prove to be true?

How many times have you said it— it’s about what the customer wants blah, blah, blah?
How often do you practice it?

For too many companies being customer-centric happens when it’s convenient—if it happens at all.

Reorganize-for-ResilienceEnter Reorganize for Resilience: Putting Customers at the Center of Your Business by Ranjay Gulati, the Jaime and Josefina Chua Tiampo Professor of Business at Harvard Business School, who offers a comprehensive, practical and inplementable guide to creating a customer-centric business.

Utilizing an outside-in approach means focusing on delivering something of value to customers, as opposed to focusing on products and sales.

Gulati discusses 5 key levers from both “why” and “how”:

  • Coordination: Connect, eradicate, or restructure silos to enable swift responses.
  • Cooperation: Align all employees around the shared goal of customer solutions.
  • Clout: Redistribute power to “bridge builders” and customer champions.
  • Capability: Develop employees’ skills at tackling changing customer needs.
  • Connection: Blend partners’ offerings with yours to provide unique customer solutions.

Gulati is blunt and his approach isn’t for those who prefer incremental change to revolutionary, but it is MAP that will stop many leaders from embracing Reorganize for Resilience—because you can’t implement that in which you don’t sincerely believe.

Since the advice to be customer-centric isn’t new, following it isn’t easy and may actually require difficult, even painful changes to your MAP, so why bother with Reorganize for Resilience?

Because it carries the biggest bottom-line payoff, both short and long-term, in any economy and for any company—from Fortune 50 to the neighborhood copy shop.

Image credit: Harvard Business Publishing

Wordless Wednesday: Leaders Set Strategy

Wednesday, March 3rd, 2010

strategyImage credit: HikingArtist on flickr

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