February 25, 2007

10 best ways to burn capital

Posted in Economic Model, finance, management, Planning at 6:35 pm by scottmaxwell

Sometimes seeing how best to achieve the opposite of what you want to achieve can help you to clarify what you should do:

10 best ways to burn capital

  1. Hire a complete set of senior managers ASAP after forming your company. The great thing about senior managers is that they will want to hire other managers and you will end up with more layers of management to spend money on!
  2. Hire the senior managers from large companies. They are even more inclined to spend money on additional management layers as well as many different staff functions.
  3. Locate your team in an expensive city. Your staff will need more cash comp to live, so your salaries will be higher. Also, your rent (and everything else) will be higher!
  4. Ramp up your staff quickly in anticipation of high demand. Your current staff will spend more of their time recruiting and training (lowering productivity) and your new staff will have a lower utilization as well. If you do this really well, you will build a long-term culture of not being productive that will last through all phases of your company’s evolution.
  5. Use your marketing resources on branding and try to brand what you don’t have. Focussing your marketing efforts on lead generation and product marketing will have too much capital efficiency to meet your goal of burning capital.
  6. Use your sales resources on field sales and large company partnerships. These are the activities that cost the most and take the longest to turn into revenues. Activities like telemarketing, inside sales, and developing the natural business partners are too capital efficient!
  7. Put a large development team in place and then focus your development staff on the core technology and ignore the packaging and UI considerations…then hire some professional services, training, and customer service staff to help your customers implement, configure, train, and resolve issues.
  8. Do not hold staff meetings or company-wide meetings or other communication methods to help focus your team (e-mail, IM, etc.). This will create too much clarity and resolve too many questions.
  9. Get backing from 2 or more VCs with very large funds…the larger the better! They have a need to deploy more capital and will own more of your company over time, so will be less resistant to these ideas.
  10. Never, ever, ever put in place management systems such as budgeting, metric management, or incentive systems that drive the right activities. If you do put in place the management systems, be sure not to focus them on the key drivers of your business.
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January 30, 2006

Show Me the Metrics!

Posted in customer service, Economic Model, Execution, management, Metrics, Sales at 11:57 pm by scottmaxwell

About 10 days ago I interviewed a VP Sales candidate for one of my portfolio companies. The more I think about our conversation, the more I like him. I walked out of our conversation thinking that he would be perfect for any B2B software or SAAS company. Why?

This particular candidate pulled out his personal operating report and explained to me how he knows what is going on every day (even when he is on the road with customers) and what he does when particular metrics drop below a certain level. He showed me the different levels of his report so that he could see his deals moving through the sales pipeline and how each salesperson and sales group was doing vs. their benchmarks. He also explained how predictable his system is in forecasting sales as well as determining when he needed to add resources at various stages of the sales process. Finally, he was able to explain how his system allows him to accurately predict the results of adding new resources and, just as importantly, how he is able to relatively easily recruit and train people to follow his system. Separately, he has relevant experience and success managing several models of distribution (including telesales, field sales, and channel sales), each of which has its own unique best practices. Also, we were able to get a reliable reference that echoed what the candidate had said.

He did not quite “have me at hello,” but he did have me about 10 minutes into our discussion. I knew going in that he had relevant experience and was known for making his numbers, but it was his approach of managing to metrics that got me. Why?

When you can accurately predict your results in each operating unit, it means less risk and a greater opportunity to scale your company without blowing your capital (missed quarters get more and more expensive as you grow!). Being able to make accurate predictions also means that:

  • You have an operating model (not just a collection of people), which allows you to scale better,
  • You understand the key drivers of output in your operating model,
  • You are consistently managing the unit to your operating model,
  • You have a set of early warning signs (your key drivers) that you can focus more attention on when they get below certain thresholds (i.e., it helps you to know where to spend your time),
  • You have a set of measures that you can benchmark against other companies to understand where you have opportunities to move to best practices, and
  • You know when you need to add staff or other resources well before you get caught short.

Finally, the understanding of the above gives you a solid platform for experimenting with new approaches and accurately evaluating the effectiveness of the new approaches (thereby allowing you to kill the approaches that don’t work and expanding the approaches that do work).

Over time, the nature of emerging growth companies is that they move from simpler approaches to more sophisticated approaches (more specialists, more channels of distribution, more products, more marketing channels, more approaches to customer service) and you want to make sure that you continue to evolve in the right direction (note: this is not an argument to get more sophisticated as an end to itself, just that getting more sophisticated leads to better operating results as you growl…you clearly need to keep your operation as simple as possible).

Metric driven management can and should be applied in every functional unit in an expansion stage company, from product development activities (e.g., project management, bug fix reports, usability testing) to marketing (lead generation ROI, website path analysis, shopping cart abandonment, number of daily quality leads) to sales (e.g., movement through the sales funnel, salesperson activity analysis) to customer service (response time, close rates, close times, etc.) to overall customer satisfaction measured both qualitatively (surveys, interviews, etc.) and quantitatively (usage reports, retention rates, etc.).

The key to getting the right metrics program in place is to eventually understand the minimum number of measure that give you an accurate understanding of the state of your company.

Some Caveats:

  • Many (most?) very early stage companies can get by without metrics-based management, as there are very few people in the organization, the processes you have are quite simple, and you can manage staff a lot easier. But as soon as you start getting any measurable number of users/customers, metrics-based management starts becoming useful, and as you grow more metrics become difficult to live without.
  • There is no sense building systematic operating models and a set of metrics if you are not going to manage to them. I have met many intuitive managers who don’t get (or don’t want to get) this approach. If you don’t believe in the approach, shoot me a note or comment to this post. If you don’t completely get the approach, hire someone to work for you who does (I have done this multiple times at my portfolio companies).
  • Once you lock into a set of metrics (it will take some time to determine the best most simple metrics), you should try to use the same metrics over time. I am amazed when I go into certain board meetings and see a different set of metrics each quarter…sometimes managers feel the need to present the metrics that show off the accomplishments of the company…I would rather see the metrics that show the improvement opportunities for the company…this is where the real upside is!

***

If you want to tell me about your results from or projections for your operations, my preference is that you show me the metrics!

December 22, 2005

How David Can Beat Goliath- Summary of Strategies

Posted in culture, customer service, David vs. Goliath, Economic Model, finance, management, marketing, Metrics, Product Development, Sales at 11:50 am by scottmaxwell

This post is an overall summary of the David vs. Goliath Series and meant to act as a pointer to all of the posts in the series. There are three overarching points for the series:

  1. Emerging growth companies have several natural advantages over larger companies that they can amplify,
  2. Large companies have several advantages that emerging growth companies can minimize, and
  3. Emerging growth companies can (and should) take a series of specific short-term actions that over time will accumulate into a long-term defensible competitive advantage (by amplifying their advantages and minimizing the large company advantages)

I can’t emphasize enough how important it is for emerging growth companies to think through these issues and develop a clear point of view on what they are trying to achieve. Regardless of the long-term goal (a sale of the company or remaining independent), building a defensible advantage will make life much better for you (easier time in the product markets, better growth, better bottom line, higher valuation, etc.). Of course, once you know what you want to achieve, you need to execute against it!

The Nine Major Themes:

  1. Create an Information Advantage. The emerging growth company has the natural advantage of being closer to the customer that the large company. You can truly capitalize on this advantage by taking steps to increase the information flow into your company even more.
  2. Create the Time Advantage. The large company has a disadvantage as it grows, as solid communication between employees gets much much more difficult as companies grow. This communication difficulty turns into a time advantage for emerging growth companies, as larger companies have difficulty doing anything quickly, while emerging growth companies, with their smaller staffs, can turn on a dime. The emerging growth company can take several steps to capitalize on this natural advantage.
  3. Create the Scope Advantage. The emerging growth company has the ability to focus on one product market. The larger companies naturally need to increase their scope in order to sustain growth. The emerging growth company can exploit this natural advantage by staying focused and continuously improving “ownership? of its product market.
  4. Create the Scale Advantage. Large companies have difficulty seeing and/or addressing small markets, even if they are very high growth. This gives the emerging growth company time to establish a foothold in the market as well as create some level of defensibility before the large company enters the market.
  5. Create the Innovation Advantage. Large companies have difficulty executing against certain types of innovation (for example, innovations that cross department boundaries, such as new products with new channels of distribution and new customer service approaches). If emerging growth companies innovate against these natural advantages, they can create an edge against the large companies.
  6. Set Your Operating Point Closer to the Funnel Singularity. This is the strategy of allocating your resources against nailing the customer experience at low price points to the customer instead of allocating significant resources against sales and marketing activities. If you do this well in the right markets, you can create a large, profitable business that is very difficult for the large companies to compete against. This is a classic strategy, but the internet-based sales and marketing approaches now allows the strategy to be executed more aggressively.
  7. Attenuate Goliath’s Strengths. The large company does have some natural advantages itself. The posts below address each of the large company advantages as well as what the emerging growth company can do to minimize the large company strengths (and in many of the cases, create an edge):
  8. Defend Against Goliath’s Attack. No matter what you do, if you are successful then Goliath will eventually attack. These posts address the nature of Goliath’s attacks as well as how the emerging growth company can set up in advance to defend against the attack. I point out that the results of the attack will be determined well in advance of the attack! The two posts are:
  9. Execute Against Execution. All of the prior posts are about what the emerging growth company can do to create a strategic advantage. This post is about how to maximize the pace of your company toward the series of goals that you have set for your company. The higher your pace toward your goals, the faster your company will develop into a large profitable company with a defensible competitive advantage.

I am going to take a breather from this series for now, but I do intend to put together the implications for each department so that some of the more esoteric points will be made more tangible for each functional group. When I post each of the functional implications, I will place a link on this post below so that this post will act as the index of the major strategies in addition to the specific implications for each function.

November 8, 2005

Extreme Funnel Economics- Aiming Toward the Economic Singularity

Posted in Economic Model, management, marketing, Product Development, Sales at 7:12 pm by scottmaxwell

As I have been working on trying to frame out some of the strategies related to Funnel Economics over the last few years, my favorite is the strategy of companies putting much more energy into building better, simpler products (from the user perspective), charging less for them, and using very efficient sales and marketing approaches (rather than building an acceptable product and trying to have as high a price as possible through a value-based sale and aggressive sales and marketing efforts).

The Strategy Has Help Shape Many Success Stories…

Some notable example companies deploying the strategy are Microsoft and Intuit, which have been successful for a long time, and Google, Skype, Salesforce.com (and many others) more recently (the internet has been an important recent enabler).

How it Relates to the Funnel

Funnel Economics is essentially the (inflowing) cash flow generated by “sales and marketing” activity divided by the “sales and marketing” expenses. If you shrink the denominator faster than the numerator, the limit is a singularity (the singularity is actually zero in the denominator, but try dividing a really small number by a really really small number on your calculator and you will see that you get a large number). From a business standpoint, if you aim for this economic singularity in a very large market, it could be a formula for a very successful company and huge wealth creation (i.e., take the previous number on your calculator and multiply it by a very large number and you get an even larger very large number).

The strategy has some really basic, but powerful elements

  1. Make something useful and make it really, really, really easy to install, configure, use, and update. This approach increases the value to the user base, increases use, and reduces product abandonment. (The idea works with all technology products including, but not limited to, appliances, server applications and both browser applications and rich client applications so long as they follow the “really easy” principle)
  2. Constantly make the product better with rapid development cycles. Economically, this continues to increase the value to the user base (by better meeting their needs), gives the users something to “sing” about, and reduces the cost of customer service (the customers don’t need service, as the product works and is easy to figure out!).
  3. Design into the package one or more “features” that will compel users to tell people about it and influential people to write and talk about it. The most prevalent approaches either build in the network effect or have unbelievable usability or other characteristics that make people want to talk about them (see Jeremy Levine’s posting for a pretty amusing extreme example of this). If you can’t come up with any ideas here for your product, focus on points 1 and 2 (above) even harder. Economically, this leads to very low sales and marketing expenses, as others are doing the selling for you!
  4. Give it away free for beta and trial purposes, and price it competitively once the free period ends. No one wants to be oversold these days. Give it to the users and let them see if it is worth using, and make sure that they feel they are getting a great deal when you actually charge them for it (note that looking at advertising counts as payment here)! This approach increases conversion rates of prospects to customers (assuming the product works!).
  5. Make the “purchase” transaction as simple and easy as possible. For consumers, the extreme version of this seems to be the “micropayment” vehicle called “advertising” (at this point in time), although SkypeOut allows you to make a single credit card purchase that will last for a very long time and Amazon.com has one-click purchases, both of which are very simple and easy. For business customers, the credit card model or simple contract/billing model seems to be acceptable, although it would be great if something better came along. (Perhaps my friends at IPCommerce will create something to address this issue better for both consumers and businesses!). Economically, this approach increases value to the user and conversion rates of prospects to customers.
  6. Keep the sales and marketing expenses (the denominator) as low as possible, and put your resources toward the first five elements of the strategy, which should drive customer adoption. Economically, bringing this cost to zero creates the singularity! (Note: I expect that most B2B and many B2C companies will still need sales and marketing, at least in the current environment. The key is to keep pushing for the efficiency and to keep this cost as low as possible relative to the gross profit generated by the activity).

Don’t confuse this approach with just eliminating sales and marketing and calling it a day. If a company sets the right operating point in the right market situation, the company should still be growing, possibly explosively, just growing for reasons other than a purely aggressive sales and marketing effort.

To perfect the execution, you need to determine the optimal operating point…

I am a strong believer in the six themes outlined above, but there are four major issues that every company needs to address:

  1. The larger the market, the better the strategy works. Companies that sell to consumers and the universe of small/midsized businesses will have a better outcome than companies that only have a few hundred (or fewer) possible customers.
  2. Each company needs to find its optimal “operating point.” The best way to think about this is that each of the six elements above have knobs controlling them that company management can rotate to set the “level” for each element. The optimal set point for each element has to do with how sensitive user response is to that element (this gets more complex when you build in the issue of path dependent outcomes, which I won’t cover here). The ultimate goal is to have the right set points for each of the knobs. The core assumption that needs to be tested is that you can improve your results by decrease sales and marketing resources, increase resources spent on the product, and reducing the price (or eliminating it for a period of time).
  3. Once you set your initial operating point, it is easier to move away from the singularity than toward it. That is, it is easier to move from a simple product to a complex product than a complex product to a simple product and it is easier to add sales and marketing activities and expenses than it is to subtract them! As an example of an extreme starting point, the concepts around Web 2.0 are essentially the extreme version of the strategy aimed at consumers. (I particularly liked Charles O’Donnell’s posting “10 Steps to a Hugely Successful Web 2.0 Company” as an example of the web 2.0 themes). In my view this is a great starting point for these types of companies, as it is the extreme from which to start turning the dials to tune in the optimal operating point.
  4. You can use this strategy against your competitors (and they can use it against you). Some people say that Google is out-Microsofting Microsoft. Essentially, the point is that Google has set its operating point closer to the singularity and it will be difficult for Microsoft to respond (harder to move toward the singularity!)…It will be interesting to see what happens. It will also be interesting to see if someone eventually out-Googles Google (perhaps Microsoft?)!

    I have seen these themes in place in companies selling to consumers, small businesses, and large enterprises in all areas of information technology (infrastructure, applications, software as a service, etc.) and entertainment (particularly gaming). The strategy can be deployed in different forms at different operating points by every company selling to any customer segment (so long as it is a large enough segment!)…All you need to do is focus on aiming toward the economic singularity (also, make sure that you start closer to it than your competitors do)!

November 1, 2005

Is the Need for Venture Capital Changing?

Posted in Economic Model, finance, management, VC Roles at 5:29 pm by scottmaxwell

I met with Jan Hichert, CEO of Astaro, over breakfast yesterday morning. As we were catching up on industry gossip, he asked me the question if VCs were becoming unecessary for internet start-ups. We had a good discussion on the topic and then I came back from breakfast and read Rebecca Buckman’s article, Many Internet Start-Ups Are Telling Venture Capitalists: ‘We Don’t Need You,’ in today’s Wall Street Journal (October 31, page C1).

The article was about Venture Capital effectively becoming superfluous. The basic argument of the article, and the question posed by Jan, was that the cost of getting to “product” release in an internet start-up has gone down considerably over the last decade (which it has by at least an order of magnitude) and many companies, therefore, do not need Venture Capital. It cites Flickr as an example (which was sold to Yahoo for an estimated $25 million). Clearly a good payoff for the management of the company and it looks like a wise purchase for Yahoo. Everyone involved won. And no VCs involved…cased closed. Right?

Some Good Points…

The article (rightly) points out that the current issue is at least true for a subset of companies that, perhaps, focus on the consumer market. We also have seen many B2B companies bootstrap themselves with services revenue or low cost product downloads and get to a level of revenue and profitability with very little capital consumption before we invested in them.

But…

My view on this issue is that it all depends on the goal for the company. If your goal is to build something useful (a feature that belongs in another company’s hands, for example) and make a reasonable amount of money from a sale (or create a lifestyle business), then clearly partnering with a VC is not for you (it is also not for the VC). But if your goal is to build a meaningful long-term enterprise, I would surround myself with as many smart, helpful, networked people as I can (good VCs fit in this category), and you will most likely need and/or want outside capital.

Expanding a Company- Uses of Capital

If you want to build a meaningful long-term enterprise, there are several uses of capital, even for profitable companies (yes, there are extreme outliers, but the following simple math is generally true):

1. As your revenues grow, your receivables grow, creating the need for working capital (cash turns into receivables). This point is generally true, but not true in certain consumer businesses that take credit cards and receive customer payments prior to paying suppliers (the negative working capital companies such as Amazon.com). If you run a financial model on your business including the balance sheet, you will get a good idea of the relationship.
2. As you grow your Sales and Marketing, the expenses are generally paid before the revenue/gross profit is received. Most great companies have the opportunity to grow (with a positive Net Present Value using a high discount rate) their companies faster than they can self-fund (that is, using the free cash flow of the business to fund this expense) sales and marketing. Again, the credit-card payment model is less sensitive to this point (due to days receivable outstanding being 3-5 days), but it still exists. On the other end of the spectrum, the B2B Software as a Service (A.K.A. On-Demand or ASP) “subscription” model (Salesforce.com is my best example), uses a lot of capital as the sales and marketing ramps up, as the timing for cash flowing out is much earlier than the timing for cash flowing in (btw, this is an extremely attractive business and economic model as Salesforce has been demonstrating in the public markets…my point is that it used capital to grow).
3. Experiments and “mistakes” use capital. Generally, as companies build-out, there are two major areas of expansion, one on the product development side and one on the product distribution side. I think of these build-outs as “grand experiments,” as you can do all of the up-front analysis that you can, but it is all theory until you put it into practice and see the results. Long-term sustainable businesses need to continue evolving their products’ feature/functions, build new products, and build out their channels of distribution. All of this takes capital, as the uses come before the benefits…even more capital if you make a few “mistakes” (and everyone does).
4. Missed Quarters (sometimes) Use Capital. Most emerging growth companies miss their quarters at some point. You want to make sure that you have “rainy day” money on the balance sheet to be used in circumstances like this.
5. Acquisitions use Capital. Several companies that I have been involved in have made small “tuck in” acquisitions, mostly to expand their product footprint. Generally, these types of acquisition candidates want at least a portion of their consideration in cash.
6. Large Enterprises want to see Capital on the balance sheet. If you are selling to a large enterprise customer, they generally are spending a large chunk of change on your product and many times will be integrating your product with some of their systems. They do their analysis and want to make sure that you are going to be there to serve them several years from now. Once of the items that they ask about is your company’s capitalization (note: my sense is that this issue peaked about 18 months ago and is now on the decline. I do still here about the issue periodically, however).
7. Finally, Founder Liquidity uses Capital. Many founders of great companies find themselves in the situation where a significant portion of their net worth is tied up in the business. Some VCs (including my firm) will make investments in a company to partially/fully liquidated certain shareholders (the key is that all key employees have enough of a financial stake in the company post the transaction that they remain highly incented). These types of transactions are useful to founders, as it allows them to take more risk (that make business sense) without worrying about their nest eggs.

I believe I have captured the major uses of capital as companies grow. I did not get into things like the company being subscale, but this implies that a company is unprofitable, which clearly requires capital.

I am actually a strong believer that VC is more about the help than the money, but given the question of capital need was raised, I thought I would direct my comments in that direction.

Is the need for venture capital changing? My answer for companies that want to build meaningful businesses over time, regardless of sector, is “no”…