What you can learn from success stories

Screen Shot 2019-08-20 at 10.01.57 AMThere’s a truism in Silicon Valley and elsewhere that the best way to learn is from your failures. I don’t totally agree with that, but you can read about that in another post. Today I want to dissect a success story for the lessons it can provide founders.

Ordinarily as a startup mentor I wouldn’t be reading an article featuring a large enterprise like like Airbus. And having very little interest in finance, I would have even less interest in a story about Airbus’s finance tasks. But the title of this Wall Street Journal article, Airbus Harnessing AI in Bid to Save Millions on Finance Tasks, caught my eye due to one acronym – AI. And as usual, the sub-title is a great summary of the article:
The aircraft maker’s Americas unit is digitizing the approval of expense reports and payment of invoices.

After reading the article I realized it is a good case study of how to succeed with marketing new technology to an “old” company. I’ve added my comments after each quoted section of the article.

Airbus SE is using artificial intelligence to squeeze cost out of its finance function, an experiment launched in the aircraft maker’s Americas division that could save the corporation millions of dollars annually if rolled out in other regions.

Notice how this is framed as an experiment, or as we mentors would call it, “a pilot.” Note this is a geographically defined pilot, which is a good way to run a pilot as you aren’t having to deal with multiple languages or currencies from an international pilot.

The new process was deployed first in the Herndon, Va., headquarters of Airbus Americas. It has since been rolled out in most of the division’s other offices in North America.

Note how the companies first did a pilot in a single office before deciding to roll it out across North America. You want to test in the smallest meaningful unit of the business. Meaningful to both you and the client. Beware of scope creep!

It’s one of the latest examples of how companies across sectors are digitizing operations to increase efficiency, reduce human error and free up employees for tasks that require more human judgment, such as strategic planning, analysis and audits.

The author has done a great job of summarizing the pilot’s benefits to Airbus in one sentence. You need to do the same for your pilots!

“Companies can now automate highly repetitive activity at a lower cost with a higher degree of accuracy,” said David Axson, head of the CFO consulting practice at Accenture Strategy, a unit of consulting firm Accenture PLC. “This especially applies to high-volume-use cases like accounts payable.”

AI is just beginning to be used in professional services like accounting, so the quote from David Axson is another example of encapsulating the benefit of using AI in finance from a domain expert.

Manually combing through every line of a single expense report could take about an hour—more, if the receipt was in a language foreign to the reviewer. More still if there were red flags, such as missing receipts.

Sometimes reviewers took shortcuts, such as going on trust and approving an expense associated with a foreign receipt they couldn’t understand, to get through a pile of reviews. That could lead to errors, Mr. Masci said.

These are two generic benefits of automation: far times faster than manual processing, with far fewer errors. Founders need to apply these generic benefits to the specific problems of their client, as Mr. Richard Masci, the head of financial system services and compliance, at Airbus Americas has done. Airbus has just become a reference client for AppZen! Make sure your pilot agreement gives you the right (but not the obligation) to publicize your pilot after its successful completion.

The average time between submission to approval has gone from a couple weeks to a few days, and the workload for human reviewers has been cut by more than half, Mr. Masci said. Over time, the system will detect patterns to process information faster and more accurately.

N.B. how Mr. Masci has quantified the benefits to his company. Clients need to understand both the qualitative and quantitative benefits of your product. It would be interesting to know if AppZen and Airbus set quantitative goals for the pilot. It sounds like if they did they were met or exceeded.

The success of the expense-approval project also could pave the way for other digitization efforts outside of its finance function, Mr. Masci said. Which is why the expense-approval process is so important—it helps the company grow accustomed to the technology.

This may have been the way the pilot was positioned, if not it should have been!

Airbus initially had to get comfortable with the idea that humans aren’t viewing every line of the invoices or expense reports they’re approving. But trust in the new system was quickly earned: Mr. Masci said there has been a 70% reduction of human-introduced errors. He’s shooting for 90% in 2020.

Again Airbus is focused on quantitative measures of success, not a surprise in a financial division. But also notice that there is a need for continuous improvement. Just because the pilot went well, AppZen can’t rest on their laurels.

“The AI is not here to lay off, but basically to reshuffle activities,” Mr. Masci said. “We’re planning on reusing resources in a smarter way.

Finally Mr. Masci assuages the fears of employees who may worry about losing their jobs to AI. Any founder selling products using AI needs to be aware of employee, and especially union, fears of layoffs and address them head-on from the get-go.

If I was AppZen I might try to recruit Mr. Masci away from Airbus, he seems to have a very high level of customer understanding of the benefits of their product and great ability to communicate it 🙂

 

Options for enterprise business models & pricing

flexera-1

Amongst the most common questions I get as a mentor are “What should my business model  be?” and “How do I price my product?”

B2B business models have been changing over the decades I’ve been in the technology business. In the very early days I remember the many struggles over how to deal with enterprises: volume discounts? Site licenses? Perpetual or time-limited licenses? Then came LANs (Local area networks) and more questions: license by the seat? by the number of users? By the number of simultaneous users? Microsoft and others solved these problems, only to have the arrival of the Internet and the Cloud disrupt business models and pricing yet again.

Today many SaaS companies rely on a subscription model which has many advantages, the biggest being predictable, recurring revenue. And the pricing model is often $XXXX per month but only ~85% of 12 months if purchased in advance. This is a win-win situation in which the customer gets a substantial discount and the startup gets terrific cash flow. While you can’t recognize revenue on your income statement until the service is delivered that really isn’t important, it’s payment in advance that helps growing companies with insatiable appetites for cash.

But today B2B business models have changed yet again as the article on ZDNet points out: Enterprise software vendors mix and match monetization models: What happens when subscription, usage and licensing converge? N.B. the sub-title: Enterprise software vendors are subscription happy, but they’re delving into usage plans for customers too. Toss in some perpetual licenses and your negotiations with strategic vendors are about to get more complicated.

According to a report by Flexera, enterprise software vendors are employing a variety of monetization models:

Flexera found that enterprise software vendors are using subscription models for 74% of their products compared to 64% using perpetual licenses and 59% following usage-based models. Forty-seven percent of vendors are using outcome and value-based models. Flexera surveyed 321 software suppliers.

The eternal challenge for software vendors is aligning price with value. This is particularly difficult for startups who have yet to establish the market value of their offering. The best approach for startups is to use the real estate model: look for comps. Comps are comparable offerings. But by all means avoid trying to undercut established vendors on price, as you risk getting into price war with cash-rich incumbents like Microsoft and Salesforce, who can drop their prices and put you out of business.

While the article’s many charts on various deployments of different business models and projections on how they will change over the next three years are valuable it skips quite lightly over a concomitant and perennial problem for software vendors: how to enable prospective customers to try before they buy? Options range from time-limited copies to the freemium model.

My advice to founders is to offer a very simple evaluation model and freemium fits the bill. It provides a zero friction option for prospects to evaluate the basic value of your offering while at the same time offering a strong incentive for customers to upgrade to the full product once they are comfortable adopting it widely. One well-known and successful freemium model is Slack. Slack enables users to try out Slack for an unlimited amount of time and then offers three pricing options, Standard, Plus, and Enterprise Grid with the latter being “For extra large businesses or those in regulated industries.” The action item for the latter being “Contact Sales”!

While once software vendors hid their pricing models behind “Contact Sales” today a startup can learn a great deal simply by searching the web for pricing models of comparable enterprise vendors. However, be aware that the freemium model can get very complicated with Slack having over two dozen features that vary by its four pricing tiers.  You will spend a lot of time arguing about what features should go into the freemium version and what type of upgrade paths you offer.

For startups I have three words of advice: Keep it simple. Economic decision makers can’t be bothered wading through pages of options for a brand new product. Make clear that whatever your model, it applies to version 1.0 only and keep any license agreements to one year. That way as you learn your market and better understand how customers value your product you have the flexibility to make changes with version 2.0.

I would strongly encourage founders to avail themselves of the experience of a freelance CFO with extensive experience in B2B software firms. They can help you craft a business model and pricing scheme that will be attractive to customers and will benefit your cash flow. And talk with your peers about their models as well. As usual, market research involves primary research, talking to customers, competitors, analysts and consultants, and secondary market research, scanning the web for research from firms like Flexera and comps from companies like Slack.

Here are the principles I advise you stand by:

  1. Keep your business model and pricing simple! Leave complex hybrid pricing models to the established vendors.
  2. Do not compete on price.
  3. Don’t box yourself in with long term deals.
  4. Get help from advisors and consultants.
  5. Invest your time in learning the market.
  6. Sell based on your customer value proposition, not your business model or price.
  7. Focus your innovation on your product, not how you sell or price it.

 

What makes for a successful business freemium model product?

freemium

Interest in the freemium model, where the venture gives away one version of its product in order to up-sell those users to a more feature-rich paid version, has had its ups in downs in the business market. But with freemium model companies like DropBox, Zoom, and Slack going public it’s definitely on the upswing now.

With the help of the article 7 markers of a viable freemium product by venture capitalist Matt Holleran on VentureBeat.com, let’s look at what will help founders be successful using the freemium business model.

1. The user’s first experience with the product is easy and awesome

Ease of use and simplicity are paramount to keeping technical support costs to zero and eliminating one major source of friction in product adoption. If you have a complex product with a steep learning curve that requires training, freemium is not for you. And you need to launch a Minimal Remarkable Product, not a Minimal Viable Product. A remarkable product with a flat learning curve has the best chance of going viral.

2. Rely of WOM (Word of Mouth) and viral marketing

Customer acquisition is the number one variable cost in virtually all tech companies in the enterprise market. By relying on WOM and viral marketing, millions of dollars can be saved on traditional marketing, dollars which can then be spent on converting free users to paid users.

3. Your product is not single-user only

Products like Slack and Zoom are inherently multi-user, in fact the value of Slack in particular goes up with the size of the active user base. Multi-user apps have two benefits: one, they become attractive to teams and thus can charge a higher price; and two, these products, like Zoom, can be inter-company, not just intra-company, thus selling themselves as users from one company invite another.

4. The freemium model should be built-in, not slapped on

If you plan on using the freemium model you need to plan for it before you start product development. First how will you build virality into the product? Second, what features, functions or even performance will be included in the paid version but not included in the free version? This decision is the core and the art of the freemium model. If the free version is not useful on its own you will never have the large user base needed to convert to the paid version. On the other hand, if the free version is so useful most users don’t see a reason to upgrade, you won’t generate significant revenue. This is where the need for customer discovery, A/B testing, and lots of trials are investments that will pay off.

You also need to make it virtually painless to upgrade. That means keeping the upgrade to the paid version very simple; don’t confuse users with a plethora of payment plans – for a subscription offer monthly or yearly payments, period.

5. Don’t rely solely on the freemium model – it’s not a panacea

Products like Slack, Zoom and DropBox are all very solid products that filled an unmet need. While their freemium business model no doubt drove rapid adoption, these products could have succeeded with a different business model, though perhaps not as quickly.

6. Study the winners and the losers

While there is a lot to be learned, especially from public companies like Slack and Zoom that have to disclose much more about their financials and operations than private companies, don’t restrict yourself to companies that have gone public or been acquired. Since freemium companies offer a free version, your only cost of studying their products will be company time. Remember as Picasso said, Good painters borrow, great painters steal. However, you can’t simply ape a winning freemium formula from another company. Your freemium model needs to be customized to your market and its users.

7. Understand the bottoms-up sales process

The freemium model stands the typical business sales process on its head. Users first adopt the product because of its fast on-ramp and value provided to them. They then exert upward pressure on the economic decision makers to upgrade from the free to the paid version. Help them out! Provide case studies, testimonials, webinars and other ways the economic decision makers can quickly and easily see and buy into the reasons to upgrade. Don’t try the standard field sales force, face-to-face selling process with the economic decision makers – that’s the antithesis of the freemium model.

8. Establish and track your metrics

Freemium companies must set goals for upgrades – what percentage of users must upgrade for you to break even, for example. You should track actual vs. projected on no longer than a monthly basis. Collect as much data as possible and establish what is the profile of your ideal customer. What drives customer engagement? What works best to incentivize upgrades to the paid version? And be careful of churn. Winning the customer is winning the battle; retaining customers is winning the war.

Freemium is not for every company nor for every product. If you can’t follow a majority of these best practices then freemium is probably not for you.

Lessons learned by Adobe in selling software by subscription

adobe

Adobe is one of the most venerable software companies extant. They had their start in life courtesy of Steve Jobs, who invested in Adobe.  Adobe created the Postscript driver that made Apple’s Laserwriter a breakthrough success, as the Apple/Adobe alliance launched the desktop publishing industry last century (along with Aldus’ Pagemaker).  And as a venerable software company Adobe mov from system software (Postscript) to consumer and professional software entailed shipping their software on disks, packaged in boxes and sold in computer stores.

For those of you, like me, interested in technology history, the VentureBeat article by , Adobe’s path from $200 million to $5 billion in recurring revenue presents the lessons learned as Adobe transformed itself from selling boxes to selling subscriptions – software as a service.

You can’t get close enough to your customer

When Adobe went from shipping software in shrink-wrapped packages to distribution through the cloud they went from customer-blind to seeing the full customer experience, namely their usage.

Adobe SVP of go-to-market and sales Rob Giglio said. “We’re taking signals from customers in real time.” Now, the product is part of the marketing — perhaps even the biggest part.

You can’t have enough data

Adobe now uses predictive modeling  based on usage data  to deliver the right tutorial at the right time. From usage data Adobe can tell which customers are having usability or learning issues, and which ones are at risk of churning.

You can’t stand still

Adobe has gone from yearly updates of their software to continuous improvement –  every day is launch day. “You can make the product better, easier, faster, and more bug-free. Accumulating enough incremental value over time means you not only keep existing customers, but add new ones.”

Test, test, and test again

Adobe runs about 200 tests on Adobe.com each week and wants to up that by an order of magnitude to about 2,000 tests each week.

Automate, automate, automate

There’s no way you can run 2,000 tests every week manually. You can’t interact with millions of customers in totally manual fashion either. So the answer has been automating these tests.

What’s been the business impact of moving from shrink-wrapped boxes to a subscription licensing model? Adobe has gone from $200 million a year in recurring revenue to over $5 billion! And their stock is up 300% in five years. So while some people say cash is king and other say content is king, I say the business model – how you make money – is king. At least that has proven true in Adobe’s case.

Death by premature marketing

graveyard

There used to be a saying back in the day that “the best way to kill a bad product was to market the hell out of it.” Perhaps related to the Ulysses S. Grant quote, “The best way to get rid of a bad law is to enforce it.”

The Forbes article For Even Hot Startups Premature Marketing Can Mean Premature Death by Derek Lidow is a case study of how way too much VC money enabled companies like Munchery to overrun their headlights by marketing their services before they were fully baked.

I’ve referred previously to the firm CB Insights and how they analyzed 100 defunct startups to identify the top 20 reasons they failed. As noted, “no market need” was number one. That jibes with the findings of NSF (The National Science Foundation) that the number one reason post-docs’s startups failed was because they built products no one needed. The number two CB Insights’ reason was “ran out of cash.” Spending millions on marketing to try to buy marketshare and catch the elusive “first mover advantage” is a fast way to run out of cash.

Munchery raised $120 million in equity financing and more than $11 million in venture debt financing before declaring bankruptcy. In between they pivoted so often the employees all got motion sickness.

Mr. Lidow outlines what he sees are the three distinct stages that almost every successful startup must navigate: customer validation, operational validation and scale-up. Only in the scale-up stage does marketing come seriously into play. I’ll add my comments to his three stages. However, before I do that I should point out that he skips the all-important first stage: customer discovery. Before you can validate your customer you must discover them through dozens of interviews based on your initial hypotheses. Pivoting during customer discovery costs nothing! And as you work your way through various customer types and segments you will be setting yourself up to later validate your business proposition with your target customer. Skip this stage at your peril!

Customer validation Here’s where having a robust prototype can pay off as you wear out shoe leather going back to those customers you identified during the customer discovery phase to ascertain if your solution fits with the problem you discovered that your target customers all share. As Mr. Lidow says, “Stage one ends when you can describe, with a high degree of certainty, who will buy your product or service and how you will deliver it.” Though I believe “how you deliver it” better fits in the operational validation phase. Thus I’d change this to “… who will buy your product or service and why.”

Operational validation. Too much startup literature is focused on product and not enough on process. But if you do not build the proper processes: financial, distribution. customer service, technical infrastructure and administration you will fail to scale. The canonical example of this is Friendster, inventor of the social network. Friendster failed as it never built enough infrastructure to prevent its site from crashing due to the unforeseen tsunami of users. Like changing a product, once you have launched, it can be painful and expensive to change your operations well. Before attempting to scale you need to stress test all of your operations to shore up any weaknesses you find.

Scale-up. This is why the VCs invest – they want growth. Why do they want growth? Simple, because it’s  the only path to either world domination (very, very rare); an IPO, rare but doable; or an acquisition, the most common exit for VC-backed companies. Here’s where you take your foot off the brake and hit the marketing accelerator to drive demand. If you have kept your gun powder dry through the previous three stages you will be able to go after the business holy grail: economies of scale.  Which not only drives down your unit costs, but give you a pricing advantage over competitors.

This advice does not mean you wait under launch to hire your marketing and sales team! What it means is you don’t unlock their budgets until you are in a position to scale. Before that they are participating in customer discovery, validation, and operations – working on such mundane but critical issues as pricing and returns policies, and planning the traditional media and social media pr and marketing efforts. Trying to paste marketing onto an existing product is almost as dangerous as spending money on marketing before you are in a position to scale.

The key issue in marketing spend is timing. Too soon and you waste money; too late, and you will lose customers to competitors.

 

 

 

Better, faster, cheaper

pie chart

Life Cycle provides a helpful visual timeline for estimating how the average consumer spends each hour in a day. NORTHCUBE.

Shawn Carolan of Menlo Ventures does a great job of giving examples of BFS, the Better, Faster, Cheaper ways that startups can differentiate themselves in the Forbes article Nobody Cares About Your Big Idea. People do care about one thing: What’s in it for them?

What sets successful consumer tech startups apart from the fads is how their products impact customers’ two most precious commodities: time and money. We’ve all heard the saying better, faster, cheaper; this is how to apply it with precision.

He gives a lot of great examples, like how Spotify successfully entered a market dominated by iTunes. However, one point he doesn’t make is that there are two ways to impact customers money: help them save it or help them make it. Obviously the former is for the consumer market, but the latter can be critical for the enterprise market. Salesforce is a great example of a successful startup that helped enterprise companies make more money by providing a much better CRM (Customer Relationship Management system) to their sales force, thus making them more productive. All of the successful companies Shawn lists are B2C, which are great for B2C startups; you are left to find your own B2B successful startups, a good exercise for you, if you are targeting the enterprise!

Here’s his last words on the consumer market:

Ultimately, the hardest part can often be picking a small, single challenge to get started on. Many opportunities remain for consumer tech to make a positive impact, including addressing key issues in transportation, housing, lifelong learning, mental health and much more. None can be solved easily, but by having a crystal-clear picture of your product, it’s still possible to capture customer attention in a busy and distracted world. Consumers will always look out for their own best interests, rather than yours. When both can be met simultaneously, great new companies are born.

There are many issues not covered in this relatively short post, of course. One of the major ones is are you a vitamin (nice to have) or a pain pill (must have)? This makes all the difference in the world in the B2C market, though it must be said that vitamins did become a billion dollar market!

It’s great to see advice for startups from someone who is both a founder and an early stage venture capital investor. Menlo Ventures was the first VC investor in Roku in 2008. Roku recently changed their business plan and that change, from just selling hardware – which is where they started – to selling subscriptions to streaming services, is a great example of an early stage company migrating to an adjacent market.

It is easy to figure out what cheaper is. And it’s usually not hard to figure out what makes a product faster. But Better needs to be defined. Amazon did a great job of providing better in two dimensions: ease of use, with their One-Click buying option, and a huge selection of products, far beyond what any brick and mortar store could possibly carry.

So the exercise I leave B2C founders (aside from reading Shawn’s post) is to determine just how you are better. Because I’m a firm believer that being cheaper means competing on price, which can result in a race to the bottom. Being faster may or may not result in a sale. But better to me is the sales maker. How is your product better than competitors or the current way customers are solving their problem?

 

 

Companies with great go-to-new-market strategies

As I’ve no doubt mentioned before, a very common problem with the founders whom I see is that they always want to boil the ocean. I encourage them to start by boiling a teaspoon! If they succeed there they can move up to a cup, then a pint, and so on. There are three mega-successful companies who have expanded to adjacent markets over time with brilliant go-to-new-market strategies.

Microsoft

In 1975 Paul Allen and Bill Gates founded Microsoft with a grand vision of Microsoft products in every business and in every home. A great vision that, of course, missed mobile. And interestingly enough forty-four years later, they are still missing in action in the mobile market.

But Bill and Paul started with the proverbial teaspoon: focused exclusively on programmers, for what were then called microcomputers. Being programmers themselves then knew their market cold. And they started with a single and relatively simple product, porting the BASIC programming language, developed by John Kemeny for Dartmouth students, to the first microcomputer, the Altair. Microsoft dominated the market for programming languages for microcomputers, in fact they had a monopoly. I can’t even remember who was in second place. Bill Gates was incredibly shrewd. When IBM came calling for an operating system for their then secret PC, codenamed the Peanut, instead of turning IBM away because they hadn’t developed an OS themselves, they cleverly purchased an OS from a developer practically down the street, did some polishing around the edges, and created PC-DOS for IBM. But brilliantly Microsoft managed to keep all rights to the software and thus created MS-DOS, which they licensed to all the IBM clones. Talk about a monopoly! For decades no one challenged Microsoft and MS-DOS. The point of the Microsoft story is they took what they learned from developing and selling programming languages to a huge adjacent market, operating systems; from which they expanded to yet another gigantic adjacent market, tools for knowledge workers, AKA, Microsoft Office. The rest was history – you can read it elsewhere, which I recommend you do.

Facebook

Microsoft is ancient history to virtually all my mentees who weren’t even born when Microsoft was founded, let alone when IBM helped make them a colossus. So what’s another example of a more modern go-to-a-new-market company? How about Facebook? Mark Zuckerberg saw how overwhelming demand from customers overwhelmed social network pioneer Friendster, constantly crashing their servers, and angering users to much that they were primed for another, robust social network. So Zuckerberg carefully expanded from his beachhead at Harvard, first to the Ivy League schools; then to other elite universities, like Stanford; then to high schools, and then to anyone with a .edu email account. This phased-in strategy enabled Facebook to build up their data centers in advance of demand, thus ensuring their users a robust app and picking up those users from Friendster as well as those from MySpace, who got tired of the personalized pages that looked like crazed graffiti walls. Of course, Zuckerberg was far from done.  Finally, confident that his data centers had the capacity, he let in anyone with an email account who was willing to use their real name – no anonymity was allowed on Facebook. Again, the rest is history (though some of it has proved to have a very dark side).

Netflix

Another great example of a company that found a niche and dominated it before they expanded to a new market, or in Netflix’s case a new mode of delivering its products to its customers. Netflix was founded in 1997 by Reed Hastings and Mark Rudolph. The niche they chose to start with was heavy users of video disks who were getting tired of paying late return fees to Blockbuster and other video stores that rented movies and TV shows on video disks. Again, my mentees might not be old enough to remember Netflix’s ubiquitous red envelopes they used to mail their rental disks back and forth to users.  Netflix solved a huge problem for users – no more late return fees! And you could keep those movies as long as you wanted. My family had a subscription for three movies at at time each month. When we returned one movie we could get another. But Netflix was not satisfied with this clunky way to deliver movies and TV shows to its users. The MP3 file format had enabled first downloads, then streaming for music. Video streaming was not that far behind and Netflix jumped on that technology with both feet. Now their users could get instant gratification, and no more fussing with those red envelopes! And while Netflix focused only on the U.S., the advent of streaming has enabled them to expand into the huge international market.

So while each of these three companies started with different customers and then expanded to new markets very differently, they all moved strategically into adjacent markets only when they had dominated their initial niche market.

You too can find a unserved niche market. My mentee venture Candorful helps returning veterans nail the job interview, even though most vets have never even had a job interview before. Candorful started with a focus only on returning vets, but soon realized that the spouses of those vets were also needed help landing jobs. So you don’t have to be a Microsoft, Facebook, or Netflix to find a niche and start by serving it extremely well. Candorful is just the most recent example I can give, some others are still in stealth mode. But if they can do it so can you: focus on a niche market before you expand to an adjacent market. Only expand to a new, adjacent market when you dominate your niche.

 

The pros and cons of channel sales for startups

channel

There are two types of B2B sales: direct and indirect. In the direct sales model the company has one or more sales reps who call on customers, to use the antiquated term, either in person or via video conference. (The latter is far less expensive and can actually be preferred by customers, as it is more time efficient.)

The indirect model means the company uses another party or company to sell its product or services to their customers. The typical term for this model is channel sales. 

What are the pros and cons of channel sales for a startup company?

Pros

First, I urge all startups to study channel sales, as all startups are resource-constrained and channel sales reduces the need to add resources, namely one or more sales people. Sales people are typically compensated by a base salary, incentive payments based on how much they sell – termed meeting or exceeding their quota or sales projection- corporate benefits, and equity. A large additional cost for sales people calling on customers in person is T & E, another antiquated term meaning travel and entertainment. Thus sales people can be very expensive. However, if they meet or exceed their quotas they should be a net benefit to the company.

By selling through another company you incur none of these expenses. Nor do you incur the time and possible cost (advertising, recruiters) of hiring a sales person and the responsibility of managing them.

But the biggest pro for channel sales is that your partner already has customers for your product. The channel partner is already in contact with potential customers for your product by dint of having sold them their own product. Here’s a simple example. Let’s say you have invented a new type of high performance tire for sports cars. You could sell directly to owners of sports cars and keep 100% of the sale. But imagine the difficulty and time and effort needed to reach individual sports car owners. It would be much more efficient to offer your new tire to existing tire companies, who already have customers, such as auto repair shops, tire stores, etc. Or you could target a specific car, like the Corvette and try to sell your tires through Corvette dealers.

Time to first revenue can be dramatically shorter by selling through a channel. Your product may be such a good fit with your channel partners that you enhance the sales of their product! That’s truly a win-win.

Finally you typically pay for performance: if the channel partners sells your product, they get a sales commission. No sales, no commission. However, some channel partners may ask for upfront payment to cover their expenses in taking on your product.

Cons

Number one: where do you find a channel partner? How do you determine that they can successfully sell your product? Way back in the last century when I was in the PC software industry there were established channel partners. They were called VARS for Value Added Resellers. Their value might be training, support or even customization of their partners’ products to make them a better fit for the customer. Today consulting companies often act as channel sales partners. The best way to find channel partners is through the customer discovery process. First you define a market you have evidence (beta tests, focus groups, surveys, successful pilots, etc.) your product will fit. You need to add a question to your customer discovery interview: “What products or services do you or your colleagues purchase from a third party rather than directly from the manufacturer or developer?” and the natural follow up is, “Why? Is that the only way to buy the product? or do they provide some service not provided by the manufacturer, like training?”

If you conduct enough interviews you will be able to compile a list of channel partners or resellers. Say you have invented a new medical device for people with sleep apnea. Rather than attempting to find people who have this medical problem and then selling them to them directly you might well try using a channel partner. But what if the channel partners sales reps don’t like your product? They might find it too complicated to explain. Or maybe it’s so inexpensive that the commission they’d gain is very small compared to other products they sell. Or perhaps they perceive there is too much competition for your product so they don’t make an effort.

After finding and contacting potential resellers you need to perform due diligence on the company. What is their reputation? What do their customers say about their sales reps? Are the well informed and helpful? Or bothersome and don’t know much about the products they sell? How does the company handle problems and complaints? How responsive are they? What other companies do they act as a channel for? What do these companies say about the channel’s performance?

Channel partners aren’t cheap. You may need to give up as much as 50% of your net sales price to incentivize them. You will have to train the reps on how to sell your product. Sales people travel constantly, just scheduling a training session can be a huge headache. Turnover at your channel partner may be a problem, resulting in you constantly having to train new reps.

By using a channel you are giving up the vital link to the customer. How will you get feedback on how your customers are using your product? Their ideas on how to improve the product? Even their ideas on complementary products? You will need to hammer out an agreement with your channel partner on how they will gather and share market intelligence. Negotiating a contract with a reseller may be time consuming and expensive (legal fees). Even if they have a standard contract, you may well need modifications.

In Summary

One way to think about channel partners is that they are your customer: you need to find them, qualify them, convince them that your product should be carried by their sales reps, train the reps, provide support, and of course negotiate a price and contract with them. But I urge startups to explore the channel sales option in enterprise sales. Fielding your own sales force can be very expensive and consume a lot of management resources. On the other hand using in-house reps who can sell via video calls can cut that expense.

The two major variables are cost of customer acquisition and the lifetime value of a customer. You need to model that out for direct and channel sales. The other critical item is access to customer data and feedback. How will you get that if a partner is selling your product?

There’s a lot more to channel sales, but hopefully this short post will get you started in exploring you options in bringing your product to market.

Beware of a contract’s exclusivity clause

contract

Writing about strategic alliances brings up the issue of exclusivity clauses in distribution and sales agreements. Someday, I hope, someone will write the full story of Software Arts, Inc., the company that invented the first electronic spreadsheet, VisiCalc, and foundered on the shoals of its original distribution contract. In brief, the founders of Software Arts had no interest in sales, marketing or distribution. Upon the advice of a Harvard Business School professor, they entered into a contract with Personal Software, Inc. to distribute VisiCalc. That was in 1979 or 1980. By 1984 that exclusive distribution agreement resulted in a deadly embrace that ended up killing off both companies.

The period when VisiCalc was launched was the dawn of the personal computer era and attorneys who understood both intellectual property law and software were scarcer than women software engineers of color.  During my time working at Software Arts and after its demise I was often asked the question why didn’t they patent the spreadsheet? Then Lotus, Microsoft, and any other company would have had to pay the inventors royalties, making the founders multi-millionaires if not billionaires. They did consult an attorney who told them software could not be patented, so no filing was made.

But that’s a side note to the crux of the issue: Software Arts entered into an exclusive contract with Personal Software, later VisiCorp, to market, sell and distribute its invention. When the two companies wanted to go their separate ways a few years later litigation over that ironclad contract knocked both companies out of the game, leaving a clear field for Mitch Kapor to dominate the corporate PC software market with his
Lotus 1-2-3 spreadsheet, a brilliant blending of an advanced version of VisiCalc with Mitch’s first successful product, distributed through Personal Software, VisiTrend/VisiPlot.

When mentoring founders who are in discussions or preparing to sign a contract with another party I ask them one simple question: What is the most important part of any contract? The answer is in my post; it’s the termination clause. In my view contracts are analogous to insurance policies. You hope to never have to pull out your home insurance policy to refresh your memory for what it covers because that means you must have had some untoward incident in your home – fire, theft, vandalism, etc.  Similarly with a distribution contract, when all is going well you have no need to try to enforce its terms and conditions. But when the parties have a falling out you need to pull out that contract and read the termination clause, because if all else fails that’s your one and only recourse. Suing a large company is just slow motion suicide for a startup. Large companies have in-house attorneys – a sunk cost – who will litigate you to death as you pay legal fees to combat them. Stay out of court at all costs!

The trap that Software Arts fell into, and here I would definitely fault their legal counsel, was to make the term of the contract co-terminus with the copyright to the VisiCalc’s code.  That was a huge mistake,  as we are talking many years here! So that brings up to the nut of this post: how do startup companies deal with prospective partners who insist on an exclusive agreement? No one likes competition, let alone sales or distribution companies. They want the whole market and nothing but the market.

The VCs who trained me hated exclusivity and constantly reminded me of this as I entered into contracts with Lotus, Software Publishing Corporation, and other PC software pioneers. But if you are really desperate for the help a large partner can give you then their demand for exclusivity must be met or countered. Here’s how:

Term: the length of the period of exclusivity should be limited in time. And that time should range from about one to three years. Do not tie the term into some other exogenous factor like the length of copyright!

Territory: startups by their nature lack reach. That’s why they enter into distribution contracts with large partners. By granting your large partner exclusivity in a territory you would have trouble reaching anyway you can hope to satisfy their need to protect their investment in sales and marketing. Typically for a U.S. startup granting exclusivity to one or more international markets is a good strategy. Just keep in mind that you must also apply a restricted term, as in the future your venture may be big enough to serve international markets itself.

Type of customer: often startups will decide to negotiate exclusivity around the type of customer they target, believing that if they can maintain exclusivity for those customers they aren’t giving up anything by granting exclusivity for other customers. For example, if you have developed a new social media platform aimed at millennials you might rightly feel that you aren’t giving up anything by allowing your partner to have exclusive rights to sell to corporations. But there are two problems with this strategy. One, it can be hard to predict who will actually end up being the users of your product. By locking out a market segment like corporations you will never have the opportunity to discover if they would be good customers. The other issue is that there are other markets you may not even be thinking about, such as government or education. By ceding all other markets than consumers to your partner you may well be giving up great opportunities in unexplored or untapped markets.

Version of the product:  at Addison-Wesley Publishing Company, where I invented the student edition of professional software products, we were able to convince developers like Lotus to provide us with a different, more limited version of their crown jewels, in the case of Lotus it was 1-2-3. You can modify software in many different ways: capacity and features being two of the most common. But taking this tack puts a development, testing and support burden on your venture – a cost you might not want to bear. And your market may rebel against getting an older or less capable version of the software. So granting exclusivity to a different version of your product can work, just be careful of those two issues. An interesting twist on this idea is how Tesla sells their vehicles. All Teslas have the same basic features and performance. But Tesla can “turn on” new features and enhance performance through remotely unlocking software – if the customer is willing to pay. This clever tactic can be used in other markets to sell different versions of the same product at different price points.

Performance:  my preferred way to grant exclusivity is to make it performance based. Thus your distributor can only maintain exclusivity by selling X units in a set period, usually one year, or they risk losing their grant of exclusivity. A good twist to this is to enable your partner to “buy up” – meaning if they don’t meet the agreed upon sales targets they can pay you as if they did.  Performance is also the best way to manage term. Your partner can maintain exclusivity so long as they meet agreed upon targets, which should grow year by year. The trick to this is it is very hard to forecast sales of new products from a startup, so you need to be careful about how you handle this condition of the agreement.

The bottomline is to avoid exclusivity agreements whenever you possibly can. The main reason is that it is so difficult to predict who or where your best customers will come from and to forecast revenues for a new product. But exclusivity can be a strong motivator for sales and distribution companies – it gives them a monopoly, the best way for them to profit by selling your product.  But no matter what type of agreement you negotiate – non-exclusive, exclusive or conditionally exclusive – make sure you have an escape hatch if things don’t work out. Get a lawyer who is familiar with sales, marketing and/or distribution contracts and knows how to craft that termination clause. That’s really your only protection from entering into an agreement that you find significantly disadvantageous, but it’s vital as and those of us who lost out big-time through Software Arts’ bad contract with Personal Software learned the hard way. As the saying goes, “Those who do not learn from the past are condemned to repeat it.” And the first priority of all startup is to learn!

 

How startups can sell to large enterprises

libeskind

I often find myself mentoring startups who are selling to large, established companies. But my enterprise sales experience has been limited to selling equity in my startup companies. In addition to selling to venture capital firms like Highland Capital, Greylock and Sigma, we sold equity to market leading firms including Apple [Computer], Silicon Valley Bank, Ernst and Young, Softbank, and Reed Elsevier.

What I learned from selling to these companies is you aren’t selling what you’ve done. And that’s not what they are buying. They are buying what you can do – for them. And most importantly they are buying what you can and will do that they can’t do themselves. They are betting on the future and betting on your startup.

I often find when mentoring B2B startups that they tend to try to sell on what they have accomplished and worry they don’t have enough traction to convince large companies to buy what they are selling. They tend to worry about what they haven’t done rather than focusing on what they can and will do. These entrepreneurs are looking in the review view mirror, not through the windshield.

My advice is always to be very frank and straightforward when questioned about their limitations. Whether it’s how long they have been in business, how many customers they have, or the years of experience of the management team. Be honest, but don’t be apologetic! You’re a startup, of course you aren’t going to have the customer list or years of experience of a large enterprise and that’s not why they are talking with you.

I still remember John Avalon, our contact at Ernst and Young, marveling at how quickly and cheaply we had built a web site that was far superior to their’s in 10% of the time and 5% of the cost. Big companies are talking to you because you have the magic! That’s what you are selling!

Reading The Wall Street Journal the other day I came across a great story of how David Libeskind, now a world famous architect, but then a teacher at Cranbrook Academy of Art in Michigan, in 1989, won a contest to design the Jewish Museum in Berlin.

As part of the interview process, a German senator asked about his prior experience. “I hadn’t built a single building, not even a garage,” Mr. Libeskind recalls today. But instead of telling that to the senator, he responded: “If you go by the past, Berlin’s not going to have any future.”

Mr. Libeskind outlined his vision for the building: “There is no door…You have to go underground…to penetrate through the darkness of the Holocaust to understand how the future would function.” He won the commission and went on to live in Berlin for nearly 12 years.

Keep in mind that like Daniel Libeskind, you are selling the future, not the past. You need to capture the imagination of your customers and their wallets will follow.

You can read more about Mr. Libeskind in the WSJ article Daniel Libeskind Thinks Buildings Should Tell Stories and in his new book Edge of Order, which tells stories about his buildings and the life experiences that inspired them. I’ve ordered my copy.

 

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