infoChachkie » Strategic Planning

Unlike You, Mark Zuckerberg And Bill Gates Can Go Both Ways

John Greathouse — Mon, 12 Dec 2011 17:16:55 +0000

Karch Kiraly (pronounced “cartch kur-ai”) is an anomaly. He is the only person to win Olympic gold medals in both indoor and beach volleyball.

Just as Karch is a rarity, so are entrepreneurs who are equally facile at startups and Big Dumb Companies (BDCs). Many of these gifted few are household names, partly because they represent such a rare breed: Bill Gates, Michael Dell, Steve Jobs and Mark Zuckerberg. All of these Founders managed their startups from launch to BDC success.

Given the relatively small number of people who are proficient contributors at both startups and BDCs, it is worthwhile to explore the different skills required to succeed in each venue.

In partnership with Docstoc, I created the following video, in which I discuss the characteristics of beach volleyball entreprenuers and BDC indoor volleyball players. You can watch the embeded video below or at YouTube: http://youtu.be/R8I86HxUt7Y

Beach Volleyball

Startups are akin to the fast-paced sport of beach volleyball, while Big Dumb Companies (BDCs) are analogous to the less fluid, more structured game of indoor volleyball.

	BEACH VOLLEYBALL	INDOOR VOLLEYBALL
Objective	Survival	Avoid unforced errors
Strategy	Simple	Complex
Positions	Fluid	Conscribed
Bench	None	Plentiful
Visibility	Complete	Obscured
Results	Unequivocal	Debatable

Although similar in many respects, significant differences exist between beach and indoor volleyball

Objective – The primary objective in beach volleyball is to keep the ball from hitting the sand. This translates into players diving, running into each other and essentially doing anything necessary to avoid letting the ball hit the sand.

If you ensure that the ball is kept in play, you have an opportunity to score. The same is true at a startup, where survival is the most elemental objective. You must be willing to do anything to keep the ball in play so you can eventually score.

As noted in Founderitis, Founders and other early members of a startup are ideally suited to reacting instinctually and ensuring that the ball stays in play. Such entrepreneurs are comfortable simultaneously playing a variety of roles, just as beach volleyball players are capable of serving, setting, blocking and spiking.

Strategy – The strategy of beach volleyball is fairly simple. A handful of plays are called by the setter, based on the positioning and skills of the opposing team. However, such plays are not elaborate and often serve as the basis for improvisation, once the ball is served. The same is true at many startups, in which the initial strategy is straightforward and subject to change based on market conditions, as described in Point A To Point Z.

Positions – At both startups and beach volleyball, some degree of role differentiation exists. One player is typically a setter and the other a spiker. However, both players must excel at all aspects of the game in order to consistently win. As such, the positions are relatively fluid, as each player carries out the team’s primary objective, keeping the ball in play.

In gym volleyball, the six players on each team must navigate a slightly larger court (twenty one square feet). This requires a higher degree of coordination and communication. If one player consistently plays out of their position, they will disrupt their team’s ability to succeed, just like a rogue Bank Robber employee at a BDC.

Bench – There are no substitutes in beach volleyball. Both players must play the duration of the match. Thus, they must make mental and physical sacrifices, including playing when they are hurt, tired and sick. This requires the same sort of resolve typically found at successful startups, at which employees work through holidays, weekends, illnesses and various social commitments.

Like the CEO of a BDC, indoor volleyball coaches can rest their players and strategically replace a player during a match. For instance, in a close match, a coach may decide to substitute a weak server for a stronger one. This level of specialization is not a luxury that beach volleyball or startups enjoy.

Visibility – There is nowhere to hide on the sand. If you make a big play, everyone sees it. If you bungle an easy set, it is equally evident. In indoor volleyball, you can rely on your teammates to shore up your efforts if you are having an off day. In addition, if your performance is suffering, you can sit out all or a portion of a match.

Unlike a BDC, every startup employee must consistently contribute. Along with heightened visibility, entrepreneurs have the opportunity to make a huge impact on their organization, no matter their title or seniority.

Results – On the sand, there is no confusion between activity and results. No points are given for trying really hard; no trophies are awarded for simply showing up. Entrepreneurs who mistake activity for results will find it challenging to achieve sustainability.

It is more difficult to properly gauge each individual’s relative impact in a large organization, which often blurs the distinction between results and activities in both gym volleyball and at a BDC. This is evident in committees within large organizations that hold interminable meetings yet seldom accomplish anything meaningful.

Avoid Founderitis – Go One Way, Then Go Away

Karch was able to seamlessly move between the indoor and beach volleyball worlds because he understood both games intimately and he had the maturity and discipline to adjust his game, without compromising his effectiveness. Most people can modify their behavior for short periods to accommodate external circumstances. However, few people are able to consistently adjust their behavior over an extended timeframe, which is why entrepreneurs are typically not successful at a BDC in the long run. The same attributes that lead to entrepreneurial success, are often counterproductive within a larger organization.

Gates, Jobs, Dell and Zuckerberg all struggled with the challenges associated with leading a BDC. Each of these talented executives met with varying levels of success.

Mark Zuckerberg, like Karch Kiraly, has proven he can modify his game and maximize his ability to contribute to his adVenture, even as his role has evolved from a chaotic beach volleyball player to an indoor volleyball coach.

As you adVenture matures, honestly assess your skills, personality and proclivities, as it is unlikely you will be as gifted as Karch Kiraly or Mark Zuckerberg and excel both in the gym and on the sand.

Founder Zuckerberg photo via Business Week, CEO Zuckerberg photo via Arab News

Ten Rookie Startup Mistakes You Won’t Make

John Greathouse — Mon, 16 May 2011 15:00:51 +0000

“Learn from the mistakes of others. You can’t live long enough to make them all yourself.”
Eleanor Roosevelt – US Diplomat & Wife of President Franklin Roosevelt

As an entrepreneur and startup investor, I have helped create companies which achieved two IPOs which collectively raised over $100 million, as well as two acquisitions which totaled $385 million. During those same 25-years, I also made innumerable mistakes.

Entrepreneurship is best learned experientially. However, it is my hope that this article will help you avoid learning the following lessons the hard way.

1) Expect Independent Channel Sales Reps To Perform Missionary Sales
Rationale: I cannot afford to hire a direct sales force. Thus, I will recruit independent distributors and they will sell my new and innovative products on my behalf.

Fallacy: Third-party, OEM (Original Equipment Manufacturing) representatives succeed once the sales process is defined, proven and documented. Thus, you must first create the playbook by which an independent sales rep can readily sell your product, including: identifying objections and developing strategies to overcome them, creating reference accounts and establishing meaningful customer adoption.
2) Secure Your Intellectual Property Too Early

Rationale: My idea is so mind-blowingly fantastic that I must immediately spend a small fortune to protect it before I perform any market validation.

Fallacy: AdVentures tend to evolve once you begin speaking with pesky customers and demanding partners. Thus, follow the guidelines outlined in IP – Worthless To A Startup and only spend significant time and effort protecting your intellectual property when it is clear what you are trying to protect.
3) Attempt To License An Idea

Rationale: My idea is so mind-blowingly fantastic, I can sit back and count my money while someone else does all the heavy lifting to make my idea successful.

Fallacy: As discussed in Spilling The Beans, ideas are worthless, while skillful execution is priceless. Value is created through diligent hard work. Commercializing an idea involves defining and validating an economically viable value proposition. Once you prove that a substantial, addressible market segment is willing to pay a price for your solution that exceeds your costs, you can consider a licensing strategy.

4) Perform China Syndrome Market Analysis

Rationale: If I can sell my solution to just 1% of all the people in China, I will have a hugely successful adVenture.

Fallacy: Such abstract extrapolations are meaningless. In order to reasonably assess the size of your addressable market, you must perform a bottoms-up analysis which is based on a number of elemental assumptions.

For instance, if you are operating a subscription-based web service, you might estimate the reach of your proposed marketing budget by approximating the various points of friction in your customer acquisition funnel, such as: the percent of users who will click on your ads, the percent who will then complete a lead form, the percent who will download your solution and the percent of trial users who ultimately convert to paying customers.
5) Allow Partners To Write Your Agreements

Rationale: My company is small, I am super busy and I am not a lawyer. Thus, I will let my Big Dumb Company (BDC) partner write our agreement.

Fallacy: The very fact that your company is smaller and has fewer resources is the reason you should draft all of your significant agreements. As made clear in Kiss Of Death Contract Provisions, entrepreneurs can control the tempo of the contract process while ensuring that the agreement properly reflects the spirit of the respective parties’ discussions when they write the initial iteration of the contract and do not delegate the drafting process to dispassionate and uniformed lawyers.
6) Rely On A Public Relations Agency

Rationale: I am not an expert in public relations (PR). Thus, I will hire a firm which has the appropriate expertise and industry contacts.

Fallacy: The sad reality is that PR Firms value their relationships with media and industry gatekeepers more than the value their relationship with any single client. As described more fully in PR Passion, this causes even the most earnest third-party PR professional to champion your message only so far. Once they encounter resistance from a trusted media compatriot, they will invariably relent, in order to protect their long-term relationships.

Conversely, if you conduct PR in-house, you will not be so easily deterred. Public relations at a startup is a sales process. No one has heard of you, your company or your solutions. When you are unknown, creating marketing awareness requires passion and persistence, two attributes in short supply at most PR firms.
7) Hire A Consultant

Rationale: I am busy and do not have time to accomplish all of my critical tasks. Thus, I will hire a consultant to augment my efforts.

Fallacy: Frugal Is As Frugal Does makes the case that an entrepreneur’s two most important assets are time and money. Unfortunately, consultants typically cost you both. In addition to paying the consultant, you must invest time to educate them. In many instances, it is difficult to gain an adequate return on this time investment, as the knowledge transferred is “lost” once the consultant moves on to their next client.

Cash at a startup should always be spent as if it is in short supply, no matter how much money you have in the bank. When a consultant attempts to earn your business, they will tell you that they adamantly believe in you and your adVenture. Evaluate their sincerity by issuing the Blondin Test. Ask them to accept equity in exchange for all or a portion of their overall compensation. If they really believe in your business, you might be able to craft a deal in which you gain valuable, incremental bandwidth while mitigating your cash outflows. In Beware The Consultant, I describe how you can structure such equity-based relationships.

Note: There are clearly tasks which can be effectively outsourced at a startup, when: (i) they do not require a significant time investment on the part of the entrepreneur to educate the outsourcer or, (ii) the knowledge gained by the outsourcer is not critical to the adVenture’s operations. I am differentiating here between outsourced services that execute rote, routine tasks and consultants hired to performed ad hoc, mission critical engagements.
8 ) Grant Exclusivity

Rationale: If I can secure a deal with a BDC, they will “put my company on the map” and the resulting notoriety and market validation will help me solve many of my problems. Thus, if I have to grant exclusivity to gain a BDC’s love and affection, it is worth it.

Fallacy: Most BDCs are driven by the fear of failure, rather than hope for gain. Their motivation to work with you is typically heightened when they fear that your unique and compelling technology might fall into the hands of one of their competitors. Thus, you have negotiating leverage as long as this threat is legitimate.

Even benevolent BDCs lose interest in your solution once this competitive risk is eliminated. In many exclusive arrangements, the BDC will effectively place your solution “on the shelf” and move onto the next competitive threat

In the event you are forced into an exclusive relationship, there are several tactics you can deploy which minimize its potentially negative ramifications. I describe a number of them in Excludesivity, such as; limiting the length of the exclusive term or conscribing exclusivity to a specific geography. However, you will establish a more effective and mutually advantageous relationship if you can avoid exclusive terms outright.
9) Engage In Premature Deal Adulation

Rationale: The buyer/partner/prospective employee said “Yes.” Since I am busy (sense a pattern here?), I will celebrate my latest victory and then quickly move onto my next challenge.

Fallacy: It is not over when the fat lady sings, it is over when you leave the theater. At Expertcity (creator of GoToMyPC and GoToMeeting, acquired by Citrix), I would stop over-zealous salespeople in their tracks by reminding them that they were in a “PDA Free Zone.” Premature Deal Adulation is when you congratulate yourself once the other party agrees to your deal terms. In reality, when you hear “Yes,” it is time to get to work.

For instance, when you hire an A+ Player, be assured that when they announce their imminent departure, their current employer will go into DEFCON Five mode to keep them employed. They will be offered more money, a new stock grant and potentially even a promotion.

Inoculate your recruits from this inevitable win-back ploy, by telling them, “You know what is going to happen as soon as you tell your boss you are leaving? She is going to offer you more money, more stock – whatever she thinks it will take to keep you. If I were you, I would be thinking, ‘Great, but where was the love last week? Why are you just now noticing that I am worth keeping?’”

I routinely used this approach with key hires and in a number of instances, the new employee would later tell me, “You were right. As soon as I told them I was quitting, they offered me all kinds of stuff and I was like, ‘Hey, where was the love last week?!’”

The same phenomenon occurs in the sales process, as Mark Suster’s notes in THIS terrific entry. As soon as your new customer notifies your competition that they lost the deal, they are likely to lower their price, offer more value and do whatever they can to take the deal away from you.

Thus, no meaningful deal is done until the employee is sitting at her desk, your customer’s money is in your bank or the partnership agreement is being implemented.
10) Grant An Investor Anti-dilution Protection

Rationale: A particular investor brings invaluable expertise and credibility to my adVenture. Thus, I am willing to protect their investment from future dilution.

Fallacy: No investor is so vital as to justify shielding them from the effects of future funding rounds, granting options or issuing warrants.

In order to reduce the friction between you and your stakeholders, strive to keep everyone’s interests aligned. As long you and your stakeholders are figuratively in the same boat, your collective decisions are more apt to be in the company’s overall best interest, rather than that of a particular constituent. Granting anti-dilution protection can result in misalignment on a number of fronts. Maintain alignment by ensuring everyone equally shares the pleasure and the pain of dilutive events.
11) Over-promise And Under-deliver

Rationale: In order to gain the attention of investors, recruit A+ employees and strike meaningful partnership deals, I have to make my startup appear larger than life. Puffery works in marketing, so I will deploy it when I promote my startup.

Fallacy: Yes. Your commitments to investors must be significant enough to compel them to write you a check. However, keep in mind that investors are inundated by people who routinely overpromise and then apologize for not hitting their mark.

As eight-year olds who sell lemonade know, there is a certain charm associated with helping a fledgling startup. Thus, do not run from your startup status. Entrepreneurs who are confident yet humble, are rare and thus especially charming.

In Great Expectations, I describe the importance of maintaining a positive slope in your stakeholder relationships. For example, if you indicate that you will generate $1 million in sales and actually deliver $750,000, you will be viewed as having failed. However, if you forecast $500,000, your $750,000 outcome will be considered an outsized victory. Maintaining a positive slope requires sound judgment, as overly conservative prognostications will fail to Enchant anyone.

By the way, you may recall that at the outset of this article I “promised” you Ten Mistakes You Won’t Make, but I actually over-delivered by sharing the perils of eleven blunders.

Make Your Own Mistakes

Take Mrs. Roosevelt’s words to heart and learn from my mistakes. It took me twenty years of hard work to screw up so thoroughly and it only required a few minutes of your time to alert you to these potential pitfalls. You can avoid additional missteps by finding a qualified and experienced addVisor who is passionate about your adVenture.

Remember, the only people who never make mistakes are people who never do anything. Make a capacious number of mistakes which are not discussed here, but be sure to learn from each of them so you can later caution other emerging entrepreneurs what not to do.

Entrepreneurs Should Go For The Quick Buck – Then Stop

John Greathouse — Thu, 28 Apr 2011 15:00:26 +0000

Odysseus could not help himself. He knew the risks, but he had to hear the alluring sound of the Sirens’ song.

In Greek mythology, the Sirens were a combination of birds and women who sang to passing sailors, enticing them to approach the shore and crash on its hidden shoals.

To avoid wrecking his ship, Odysseus instructed his crew to plug their ears and ignore his orders, no matter how much he implored them to approach the Sirens’ island.

Many entrepreneurs encounter a similar dilemma. They often identify expeditious ways to make money in the early days of their adVentures, which allow them to reduce the amount of capital they must raise from outside investors. Unfortunately, such initially alluring business models can ultimately result in their ruin. Thus, entrepreneurs must decide when to stop listening to the Sirens’ song of a quick buck and position their company to take advantage of long-term, sustainable business models.

Bad Profits

WebEx learned the hard way that some profits are better than others. During a market’s formative period, there are often opportunities for a First Mover to extract outsized profits. In the short-term, such opportunities are enticing. However, in the long run, entrepreneurs always benefit from delivering Maximum Utility for a fair price.

WebEx was the early leader in web meetings. Perhaps in part due to its dominant market share, WebEx adopted telecom-style pricing, which effectively penalized their users. The more a customer utilized WebEx’s services, the more they had to pay. A typical 60-minute meeting with one attendee cost $54. The costs increased as the length and size of a meeting expanded. WebEx also charged exorbitant setup fees (again, much like cellular carriers), averaging about $4,000. Rather than encouraging users to maximize the value from their service, they effectively punished them for their increased usage.

WebEx’s predatory pricing made it vulnerable to a new entrant. As noted in Fast Followers II, when Expertcity (acquired by Citrix) launched GoToMeeting, we devised a straightforward, easy to understand pricing scheme, which we dubbed “All You Can Meet.” We charged $49 per month, irrespective of a customer’s usage.

WebEx’s management was understandably hesitant to modify their pricing because the company’s shares were publically traded at the time we launched GoToMeeting (the company was subsequently purchased by Cisco). They knew that price restructuring would significantly impair their gross revenues as well as their net income, which would dramatically impact their stock price. They were effectively hooked on the bad profits which were seductive when they initially launched their service. Even though WebEx eventually modified its pricing, it was too late. GoToMeeting took advantage of WebEx’s inhospitable pricing and emerged as the ubiquitous online meeting solution.

Arbitrage Is Fleeting

Below are descriptions of three companies which each faced short-term, lucrative opportunities. In each case, they successfully migrated their go-to-market strategies to one based on long-term sustainability. Even though such enduring strategies are often difficult and expensive to execute, they generally result in greater value creation for the company’s customers, founders, employees and investors.

Exploring The Campus

In the spirit of Conventional Wisdom Isn’t, the founders of Campus Explorer did not, “flow with the go” when they founded their higher-education website.

Campus Explorer earns most of its revenue through lead-generation. When they launched the Company, the lead generation market was based almost exclusively on arbitrage. Companies purchased keywords, placed ads and sent emails in an attempt to entice users to complete a lead form. They then sold the leads for more than it cost to generate them. For several years, this was a lucrative business model – the sirens were singing loudly and many companies answered their call. The founders knew that such profits were fleeting, as market efficiencies eventually eliminate such “buy low / sell high” opportunities.

As the founders predicted, the market eventually became more efficient, causing the margins available to traditional lead generation companies to diminish. In particular, the Google AdWord market matured, making it increasingly difficult for lead generation operators to profitably purchase keywords that would motivate qualified users to complete a lead form.

Campus Explorer eschewed a pure arbitrage strategy and instead, focused their efforts on building a site that provided value-added content to users, which informed and shaped their college search. This approach was neither quick nor easy to implement.

However, as the arbitrage opportunities in the lead generation market diminished, Campus Explorer flourished. Their cost to obtain leads was extremely low (essentially the cost to create and maintain the content), while the quality of their leads was high, which made them more valuable to their college-lead purchasers. Campus Explorer created a classic trifecta win: one that was good for the students, the colleges and, ultimately, Campus Explorer as well.

Scaling Right

Cloud computing pioneer RightScale is a prime example of a company which utilized a consultative go-to-market strategy as a means of funding its initial operations. In order to create a SaaS platform which acts as the “last mile” to public clouds, RightScale began operations by providing consulting services to companies who wanted to access Amazon’s EC3 services.

However, the Founders understood the inherent limitations of a services business. The size and scope of law firms, medical practices and consulting firms are all constrained by the number of employees they can hire and keep gainfully billing hours. Although such service businesses can be highly profitably from the start, they are difficult to scale, hence they are often referred to by the derisive term “body shop.” You can only increase revenue by hiring more employees, yet each time you hire a “body” you incur a step cost before you invoice a client for a single billable hour.

As a Seed Investor and addVisor, I witnessed firsthand how RightScale’s Founders avoided the structural limitations of a body-shop business. The company artfully repurposed the tools, dashboards and scripts which it delivered to its initial consulting clients and created a SaaS solution. Management wisely retained the intellectual property associated with these “works for hire,” which they eventually combined to form the foundation of RightScale’s initial Minimally Viable Product.

Graph The Effect

As noted in my interview with GraphEffect’s Co-Founder, Clark Landry, GraphEffect is focused on leveraging Facebook’s API to provide advertisers with much more effective ad units, while maintaining the integrity of the Facebook users’ privacy.

As with many emerging markets, the Facebook advertising ecosystem is relatively inefficient. Similar to the state of the lead generation market at Campus Explorer’s outset, these inefficiencies have spawned profitable arbitrage opportunities. Despite the compelling reality of these quick-buck opportunities, Clark and his Co-founder James Borow are evolving their business into a SaaS offering. Thus, GraphEffect has largely foregone near-term arbitrage revenue in order to focus on building a software platform that can be effectively used by third parties to optimize their social media ad expenditures. This latter approach affords greater predictability and scalability while creating more enduring long-term value.

9 Women And A Baby

As Mark Suster noted in a recent blog entry entitled 9 Women Can’t Make a Baby in a Month, the allure of near-term profits is a powerful Siren song. However, successful entrepreneurs balance the need for immediate cash with the enduring necessity to create a self-sustaining company that will not crash upon the shoals of financial ruin. This requires the maturity to initially heed the Siren’s song and make a few quick bucks, while having the willpower to ignore it before the vagaries of the market shut it, and your company, off forever.

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Note: I am an investor in all three of the companies mentioned in this article via Rincon Venture Partners.
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How Do I Identify A Great adVenture Opportunity? The Answer Is Obvious, Yet Insightful

John Greathouse — Tue, 21 Sep 2010 17:28:35 +0000

Question: How do I identify a great adVenture opportunity?

Answer: (Passion + Solvable) * Sufficient Reward = Great adVenture

Venture Ideas are like hobbies. You do not discover a hobby, hobbies discover you. Hobbies arise from activities that you initially engage in casually and you eventually fall in love with.

Thus, adVenture opportunities will generally arise from your proclivities and interests. In the normal course of pursuing areas that naturally interest you, if identify a problem that you are passionate about solving and the resulting reward is sufficient to satisfy your desires, you will eventually realize that you have stumbled upon a great adVenture.

I am paraphrasing the above question and answer from an inspiring presentation by Dr. Larry Cox, Associate Professor of Entrepreneurship at Pepperdine’s Graziadio School. Larry’s talk was brilliant, my interpretation herein is a bit more pedestrian, so my apologies to Professor Cox.

The answer may seem self-evident, but it still bears analysis. Many obvious things are also insightful and are not apparent until a bright person articulates them in easily understandable terms. In breaking down Professor Cox’s answer, a number of interesting factors become evident.

Real Problem – When buying behavior is boiled down to its essence, it becomes clear that customers purchase solutions to problems. Even luxury goods solve a perceived problem, such as a customers need for enhanced social status. Ensure that whatever issue you are addressing is really problematic and not merely an annoyance. Real Problems must be solved; annoyances are only addressed if it is cheap and easy to do so. If the solution is too cheap and too easy, the Problem may not have an adequate associated Reward (as discussed below).

Solvable – The world abounds with unsolvable problems. However, just because a problem has not yet been solved, does not mean it is not solvable. In addition, other problems may be solvable, but not by you. Thus, you must be confident that you can solve the problem, even if it entails leveraging third party technology and/or resources.

Passion – Only you can answer this aspect of the question. You must have enough passion to sustain you through years of long hours and consistent rejection. As noted in What If?, you will face countless Dream Killers who will relish telling you all the reasons your adVenture will fail. You must have enough passion to ignore such advice and move forward with a smile.

Reward – Like passion, only you can determine what equates to a sufficient reward. Rewards are not solely quantified in monetary terms. Rewards can be intrinsic. For instance, at Computer Motion, we obtained significant psychic rewards from knowing that we were helping to establish the medical robotics industry. Nearly twenty years later, the industry has grown to nearly $20 billion in total capitalization value and has advanced the quality of surgical care globally. As long as the aggregate rewards are adequate to compensate you for your hard work, then the adVenture might be a great opportunity for you.

Inogen – Real World Example

An example of a compelling adVenture opportunity is Inogen. One of its Co-Founders, Alison Perry, stumbled on the opportunity that eventually spawned the company after spending Christmas with her grandmother, who had recently been housebound by Chronic Obstructive Pulmonary Disease (COPD). Alison returned to college determined to find a solution for her grandmother’s immobility.

Real Problem – COPD patients are immobile; to leave home they must carry large oxygen tanks and run the risk that the oxygen might be depleted before they return home

Solvable – Unknown at the outset, although conventional wisdom indicated that the problem was not solvable

Passion – Off the charts

Reward – Significant intrinsic rewards and the potential for large financial gains

The fact that numerous industry experts told Alison that it was impossible to build an oxygen concentrator smaller than the size of a small refrigerator was irrelevant. Her passion led her, and her Co-Founders, to devise a solution for a problem that all the “industry experts” said was impossible. Like the entrepreneurs described in Reinventing The Wheel, Alison and her Co-Founders ignored Conventional Wisdom and created the world’s first portable oxygen concentrator. Inogen is now the market leader and has allowed tens of thousands of previously immobile COPD patients to leave their homes without fear of running out of their life-giving oxygen.

Hobby Pony

Like hobbies, the key to indentifying a great adVenture is to have your eyes and ears open. As noted in Small Ideas, Big Business, condition yourself to see the world as fraught with solvable problems, not annoying challenges. With an open mind and open eyes, you will effortlessly solve the equation so eloquently articulated by Professor Cox.

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John Greathouse has held a number of senior executive positions with successful startups during the past fifteen years, spearheading transactions which generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses.
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Intellectual Property – Worthless To A Startup, Priceless To A Big Dumb Company

John Greathouse — Tue, 10 Aug 2010 21:57:29 +0000

“Good Lord Boyet, my beauty, though but mean,
Needs not the painted flourish of your praise:
Beauty is bought by judgment of the eye,
Not uttered by base sale of chapmen’s tongues”
William Shakespeare, British Playwright, from Love’s Labour’s Lost, 1598

Intellectual Property (IP) is an ugly thing at a startup. It requires you to expend your two most valuable resources, your time and your money. Yet, it does nothing to help you execute your business model.
However, to a Big Dumb Company (BDC), a startup’s IP is a thing of beauty. Although BDCs often act irrationally, in this instance, their perception of beauty is highly rational.

How can IP be worthless to a startup yet very worthwhile to a BDC? Because IP has intrinsic value, but only in the right hands.

Patents held by startups generally have a limited ability to reduce competition. The average time required to obtain a patent is 36-to-40 months, during which there is no guarantee your adVenture will ultimately receive patent protection. Even if you are granted a patent, the scope of your claims may be significantly denuded.

Three years is a lifetime at a startup. Given that the average lifespan from startup to exit is five to seven years, the first half of a startup’s life is lived without explicit patent protection. Thus, if a startup team asks, “What is this patent worth to us?”, the answer is likely, “Not much.”

However, this is the wrong question. A more appropriate question is, “What is this patent worth to a BDC?” When answering this question, consider the following:

Wherewithal To Defend and Prosecute – IP litigation is immensely expensive. Most startups do not have the financial means to either defend the veracity of their IP or prosecute potential infringements by others. According to a 2003 survey conducted by the American Intellectual Property Lawyers Association, the average cost of patent litigation was $2 million, while trademark litigation averaged $600,000.

BDCs Are Risk Adverse – In general, BDCs are often more concerned with loss aversion than with pursuing potential gains. As such, they are hesitant to acquire a company which has not sought formal protection of their IP for two reasons. One is obvious, without protection, such IP might prove to be of little worth, as other companies can mimic the technology without recourse.

The second reason is more subtle. The very nature of formal IP approval process ensures that some level of vetting has been performed to assess whether the IP is infringing on another company’s technology. Although patents can, and are, granted which explicitly infringe on the rights of others, there is some comfort in the knowledge that a particular piece of IP has been approved for a patent or registered as a trademark. Even though such official sanction by the PTO does not guarantee that the protected IP does not infringe another party’s IP, it does provide a convenient excuse by which BDC executives can cover their butts, thereby reducing their perceived downside risk.

Complimentary And Derivative IP – In many instances, the IP created by a startup is a subset of a larger solution. It is often a feature or set of features which enhances the overall efficacy and value of a more comprehensive technology. As such, formally protected IP can have significant value in the hands of a BDC which may own or otherwise have access to complimentary IP.

In addition, a BDC may have developed derivative IP that on a standalone basis infringes on the startup’s IP. In such instances, acquiring the startup may be the shortest path to unmitigated IP ownership. This was the case when Intuitive Surgical purchased Computer Motion. This acquisition resolved the surgical robotic IP landscape and allowed Intuitive to dominate the market.

Even if your company is not acquired and you elect to access the public capital markets via an IPO, the above tenets remain valid. Once the IPO proceeds are in your bank account, your adVenture will have the ability to leverage and defend your IP and thus its intrinsic value will increase, just as it would in the hands of a BDC.

Not All Patent Types Are Created Equal

Another factor that impacts a patent’s value is its type, of which there are essentially two: utility patents and design patents. Note that I am ignoring other, far less common patent types, such as plant patents.

Utility patents represent 90% of all patents granted. They remain in effect twenty years following the filing date and, according to the Patent and Trademark Office (PTO), they protect: “the invention of a new and useful process, machine, manufacture, or composition of matter, or a new and useful improvement thereof.”

Utility patents generally offer more protection than design patents and are thus usually more valuable. They also often take longer to secure and are more expensive to obtain and prosecute.

An emerging subset of utility patents is business method patents. Such patents were especially popular when the Internet spawned new ways to solve old problems during the late 1990’s and the first decade of the 21st century. However, in most cases, the courts have not upheld business method patents and thus startups should not expend resources pursuing such broad and pervasive patents.

Design patents make up the majority of non-utility patents. They remain in effect fourteen years from the filing date. Per the PTO, such patents protect: “A new, original, and ornamental design for an article of manufacture.”

An example of design patent is shown at left. It would not be difficult to emulate the design of these sunglasses without violating the patent. As such, the protection afforded design patents is generally limited and difficult to defend. However, they are usually easier and less costly to obtain, as compared to utility patents.

As seen in the patent at left, you can obtain a patent on virtually anything. PTO examiners consider a very narrow set of criteria which does not include the commercial efficacy of an idea.

Thus, the answer to the question “Can we get a patent on that is generally “Yes”, assuming the invention is remotely novel. However, a more appropriate question is “Should we get a patent on that?”

Return To Sender, IP Unknown

There is a common misconception that an idea can be protected by documenting it, placing it in an envelope and then mailing it to yourself. Underlying this presumption is the belief that if the envelop is unopened, the postmark will “prove” the date the idea was conceived (or at least when it was documented).

Although such a letter might make an interesting plot point in a movie, in the real world, it provides you with absolutely no protection of your idea. Unlike an unregistered copyright, which you gain automatically by expressing an idea in written form, you cannot gain intellectual property protection by simply being the first person to describe an idea in writing.

For instance, if you document a novel, commercially viable idea and never file a patent to protect it, the only thing you will own is an unregistered and worthless copyright on the text describing the idea. However, anyone and everyone is free to exploit your idea and to even obtain a patent on it, if they are the first to file for such protection.

Provisional Approach

Most US high-tech companies begin the utility patent process by filing a provisional patent application. The PTO allows one year to elapse after filing a provisional application before you must submit a formal patent application. This approach makes sense for the following reasons:

You gain a year to write a thoughtful, defensible patent without delaying your filing date. The filing date is often the deciding arbiter in IP disputes

It is relatively inexpensive, thereby minimizing your sunk costs if you later decide to not pursue a formal patent filing

You can describe your technology as “patent pending”, which may or may not be worthwhile, depending on your product and target customers

Your solution will likely evolve as you gain market feedback and validation. As such, the additional time will help ensure that your patent claims accurately reflect the technology underlying your solution.

Know Thou Prior Art

As noted in Roping In The Legal Eagles, you have the responsibility to write the layman’s description of your patent claims. In order to do this effectively, you must understand the prior art germane to your application. Patentcafe defines Prior Art as: “the total body of knowledge, which teaches or otherwise relates directly to an invention. This is the primary criteria in determining the patentability of a new invention.” If you do not fully understand the prior art associated with your intellectual property, your patent request may be denied.

Just as you should anoint someone within your adVenture to be Watson and monitor your competitors’ activities, you should also explicitly assign someone to manage your adVenture’s IP portfolio. If you leave this to a committee, you risk your IP becoming a priority which no one person has adequate time to address.

It Ain’t The Number Of Patents, It’s The Number Of Defensible Claims That Matter

Some companies take pride in the number of patents they own. However, there is no direct correlation between a patent portfolio’s value and the number of patents which comprise the portfolio. A single patent with a number of comprehensive yet defensible claims can easily be worth far more than a legion of vague and narrowly defined patents. As such, focus on creating a manageable number of patents, each with multiple clear and defensible claims.

Patent examiners generally ask for clarification during the review process. The multiple claim approach provides you with greater flexibility to augment your claims when you address the PTO examiner’s objections and questions. Any accepted changes are subsumed within the original filing date of your provisional patent. This is especially important when your patent addresses an emerging technology that significantly changes during the course of the typical, multi-year review.

No Patents, No Interest

In addition to witnessing BDCs overvalue patents, I have also been a party to transactions in which the lack of formal IP protection caused BDCs to shy away from a potential acquisition. In one instance, I was on the Board of a small software company that declined to file any patents as the Founders felt they could not afford to take the time required to craft a meaningful application. This proved tragically shortsighted, as the company developed valuable augmentations to various open source technologies that likely qualified for patent protection.

After an extensive period, we eventually sold the company. However, the acquirer was a relatively small company that essentially purchased our install base of customers so they could sell them additional products. We received almost no value for our technology, even though it was effective and held in high regard by our customers. Little explicit value was affixed to it, because we did not have formal protection over it.

Mind Thine Eye of The BDC

As Shakespeare aptly notes, the beauty of a startup’s IP is bought by the judgment of the BDC’s eye. As such, when managing your IP portfolio, base your decisions on the understanding that the ultimate value of your IP will be determined by an acquisitive BDC or the public capital markets, not its worth in the hands of a capital-challenged startup.

Legal Caveat: I am NOT a lawyer. This advice is from a layman and it may be inappropriate and/or in conflict with the local laws of your county/state/province/country, etc. You should always seek local, qualified, legal counsel when addressing intellectual property issues.

Maximize Your Exit By Not Selling Your Company

John Greathouse — Tue, 16 Mar 2010 21:16:19 +0000

In 1987, a representative of Michael Jackson approached the modest Sycamore Valley ranch house and knocked on the door. The owner of the ranch was shocked by the visitor’s message. He told the homeowner that he represented someone who wanted to purchase the ranch at a substantial premium over its current fair market value. He also indicated that the offer was non-negotiable and the home owner had to respond either “Yes” or “No” in a matter of hours.

Although this is a somewhat unusual real estate transaction, it reflects a surprisingly common scenario in the world of mergers and acquisitions, with one important distinction.

My House Is Not For Sale

When someone knocks on your door and tells you they want to buy your house, it is not appropriate for them to then ask, “So how much do you want for it?” Even the eccentric King of Pop communicated the price he was willing to pay.

However, in many cases, acquiring companies behave in a less rational manner than Mr. Jackson. When we sold Expertcity to Citrix, we experienced this awkward, yet common situation. Citrix politely approached us, told us they had an interest in acquiring our company and then asked us, “How much?”

Our response was that there was no “price” as our company was not for sale. We were not rude nor indignant. We simply stated the truth. As we were not engaged in selling our company, a “price” was nonexistent. At the same time, we made it clear that we were flattered by their interest and that we were happy to continue our discussions and further explore if a reasonable deal could be crafted. We then turned Citrix’s question around by saying, “You knocked on our door with an intent to buy so you obviously have some idea of the price you are willing to pay. What is that price?”

I then had several discussions with my Board and fellow Senior Executives. We all agreed that we needed to fully explore all the viable alternatives available to us, in order to ensure that we maximized our liquidity event.

We realized that we had to define our Best Alternative to a Negotiated Agreement (BATNA). Fortunately, we had several alternatives available to us, including:

Access the public capital markets via an initial public offering (IPO)

Open up a “sales process” and solicit bids from multiple companies

Do nothing – continue to run our business “as is”

IPO

To bolster our negotiating position, we engaged an investment banking firm to explore the IPO market. Although this option was not attractive to the management team, it was a viable alternative circa 2005 and it would have allowed our institutional investors to liquidate their investments. However, due to the SEC’s onerous regulations, management’s liquidity would have been severely constrained. At public entities, insiders are effectively limited to selling their shares during the middle month of each calendar quarter (i.e., February, May, August and November). Most importantly, our ability to run the business in an autonomous manner would have been significantly compromised, as we would have been relegated to answering to Wall Street on a quarterly basis.

Auction

Establishing a sales process was the least attractive option, even though this approach might have resulted in a bidding war that could have driven up the purchase price. Senior management was more concerned with ensuring a cultural fit with our acquirer, rather than squeezing the last dollar out of the deal. Citrix promised to operate Expertcity as a separate division and maintain its offices in Santa Barbara and it was unclear if other potential acquirers would have been willing to make, and keep, similar commitments.

There is a well-worn adage in the M&A world that, “companies are not sold, they are bought.” In other words, the most attractive companies generate unsolicited buyers which can often lead to premium purchase prices. Companies that seek buyers are often viewed as “damaged goods” which cannot otherwise succeed as self-sustaining entities. Such companies, if they are able to complete a transaction, often sell at a discount. We avoided the risk of the deal becoming shopworn by not initiating a bidding process.

Do Nothing

Doing nothing was the most realistic and potent competition faced by Citrix. Both parties knew that due to the rate of our revenue growth, Expertcity would become too expensive for Citrix, if an acquisition did not occur in the relative near-term. Doing nothing became our BATNA.

We eventually sold Expertcity to Citrix for $230M. I am proud to say that Citrix lived up to all of its commitments and Expertcity, renamed Citrix Online, went on to become one of the largest employers in Santa Barbara county.

Get Out Of The Zone

As shown above, every negotiation entails a buyer and seller comfort zone. In order for a deal to be consummated, an intersection of these zones must exist. In this example, agreement is achievable between $145M and $185M. In general, an agreement cannot occur outside of this range, unless new data, coupled with a persuasive argument, are introduced in order to drive the buyer or seller outside of their initial comfort zone.

Brian Epstein Had No Clue, Let Alone A BATNA

The Beatles’ Manager, Brian Epstein, was a 30-yr old, former furniture salesman when Beatlemania hit America in 1964. When he was approached by savvy New York businessmen to license the Beatles’ name and likeness for various novelty products and toys, he firmly stated that he would not accept a penny less than 10%. The businessmen had a difficult time hiding their surprise, as the expected range for such licenses was between 20% to 40% of the product’s price, as shown below.

Speaking from ignorance, Mr. Epstein effectively moved the negotiations outside of the expected shared comfort zone, costing the Beatles tens of millions of dollars in the process.

If you attempt to assess the value of your company within that of a larger organization, you too will be speaking from a position of ignorance. While ignorance may be bliss, it is a bloody awful foundation upon which to negotiate. When in doubt, keep your mouth shut and allow the other party to establish one of the boundaries of the shared comfort zone. If you are unsure of the fairness of their initial proposal, you can then seek additional information to determine where it falls within the expected range.

If a seller names a price at the outset of a negotiation, they effectively establish the upper bound of the negotiations. Once a sale price is communicated, the buyer is then incentivized to negotiate your initial proposal downward.

If you name an outrageously high price, you may scare away the would-be buyer, as they may feel that you do not have a realistic opinion of your adVenture’s value. If you set an initial price that is too low, you effectively shift the comfort zone in an unfavorable manner.

RedMojo Alternative

When I assisted the CEO of RedMojo in the sale of his company to Novell, our BATNA was to accept funding from venture capitalists.

This alternative would have precluded an acquisition for several years, as most institutional investors are not interested in a small, short-term returns in lieu of a larger, longer-term exits. At the same time, RedMojo’s management was not inclined to accept venture funding, as it would have required the team to work several additional years to generate a return sufficient to warrant the dilution caused by an institutional investment.

Fortunately, there were multiple companies interested in acquiring the company, which negated the need to establish a sales process and risk the deal becoming shopworn. The combination of multiple bidders and the legitimate BATNA of venture funding allowed us to maximize the price we obtained for the company’s assets.

Who’s There?

It is impossible for you to fully understand the potential strategic value of your adventure once it is part of an acquiring company’s organization. A fair response to the question, “How much do you want for your company?” is, “What would our assets be worth as part of your organization?”

Once the potential buyer states the expected value of your assets within their organization, you can then focus your arguments on the combined value the two organizations can jointly create, rather than allowing the acquirer to drive down the standalone value of your company via comparisons with other companies or by assigning a multiple to either your revenue or net income. Attempting to determine the combined value of the entities is a worthwhile exercise because it forces both parties to think through the acquisition and contemplate how the combined company would work together.

When someone knocks on your door and asks how much you want for your house, your response should be, “Thank you, I am very flattered that you like my house. I like it too. However, as there is no For Sale sign in my yard, I have no price in mind. I know what it is worth to me, but the important question is ‘What is it worth to you?’” If they want your house as much as Michael Jackson wanted the Sycamore Valley ranch, they may be willing to pay you a very, pretty penny indeed. But the only way to find out is to get them to make you an offer and define the low-end of their purchase price comfort zone.

Coda

After Michael Jackson’s financial and personal demise, Neverland Ranch was “sold” not “bought”. After it had languished on the market for years, it was finally acquired, at a below market price.

Past Is Prologue As New Industries Emerge: It Ain’t Gonna Be Different

John Greathouse — Tue, 02 Mar 2010 19:00:11 +0000

In 1933, baseball card collectors were frustrated. For some reason, they found it impossible to complete their Goudy Gum 240-card set. No matter how many packages of cards they purchased, they failed to find card number #106, which featured Napoleon Lajoie.

Enterprising collectors who wrote Goudy and voiced their frustrations were rewarded by receiving the Lajoie card in the mail. All other collectors were out of luck.

What was behind the mystery of the missing Lajoie card?

Capital Cards

In 1976, at the age of 14, I Co-Founded a Sports Memorabilia company with my friend (and future brother-in-law). We pooled our resources and each invested $50 into the adVenture, which we named Capital Cards, due to our proximity to Washington, DC. Over the next six years, we grew the company into a thriving mail-order business, with assets conservatively estimated at approximately $250,000. Not a multimillion dollar exit by any means, but a fantastic learning experience and a lot of fun as well.

Our strategy was simple. Each week, we placed a small classified ad in the Washington Post, simply stating, “Turn your cards into cash. We will purchase your old baseball cards.” During the mid-1970’s, the sports memorabilia industry was nascent and highly inefficient. It was a great time to start a sports memorabilia company. The hobby was driven principally by collectors who were primarily interested in completing sets. There were very few card dealers and no card investors. There were no price guides, standardized rating systems or baseball card stores. People with vintage cards essentially had no means to convert their cards into cash.

We quickly built upon our meager initial capital by buying and selling cards that otherwise would likely have ended up in landfills. Each weekend, we drove all over the Washington beltway in search of lost treasures. In many cases, we came across cards which we had never seen and had no way to estimate their value. This ambiguity put us on a level playing field with the card sellers.

We were also one of the first card companies to purchase cases of cards directly from Topps, the only company that produced sports cards at that time. Our parents had to sign on our behalf, as we were not of legal age to execute purchase orders.

Each case contained 12,000 randomly sorted cards. We enlisted the help of our families and friends and arranged the cards into complete sets. We then sold the sets at card shows held in small towns all along the East Coast. At each show, we were far and away the youngest participants. Fortunately, my brother-in-law was old enough to drive, so we were able to attend the shows without our parents’ involvement.

Because our labor was essentially free, we undersold all the other dealers at the shows. In fact, in one instance, a dealer purchased all of our sets in order to “take them off the market.” We were happy to accommodate his request, as the money derived from the sale of the sets allowed us to purchase vintage cards via our weekly newspaper ads.

As noted in Small Ideas, Big Benefits, Capital Cards was an exceptional experience for both me and my brother-in-law, as it allowed us to hone our business skills, while competing with people who were more than twice our age.

At heart, we were idealistic and somewhat sanctimonious collectors. We loved sports and valued the cards because of the players’ achievements. Card collectors and card investors have very different motivations. Card investors seek cards which they believe will increase in value and are often indifferent regarding the players and teams depicted on the cards. My Partner and I eventually closed down Capital Cards when baseball card collecting morphed from a hobby into an investor-driven industry.

But Our Hobby Is Different…

During the early 1980’s, the popular press discovered baseball card collecting and began to publish articles touting sports memorabilia as a great “investment”. Many baseball card collectors believed that the sports memorabilia hobby would not follow the evolutionary path of other hobbies which became investor centric, such as stamp and coin collecting.

However, as the number of non-collectors entering the sports memorabilia market in pursuit of financial gain increased, the dynamic of the industry changed and evolved in a manner similar to other mature collectible markets.

For instance, the range between what a collector could sell a card for versus what they had to pay for the same card from a dealer diverged significantly. In addition, rigid grading systems were established by professional grading services. This dramatically increased the value of the highest graded cards and depressed the prices of all other cards which did not meet the exacting standards of the grading services.

In the early days of collecting, the various grades, Mint, Excellent, Very Good, Good and Poor, were highly subjective. As such, the relative difference in value between a Mint and an Excellent card was not significant. Many collectors, whose primary goal was to complete their collections, were content to have an Excellent or even a Very Good card, which ensured broader demand for lesser grade cards. The advent of investors and grading services drove up the demand for near-perfect cards while suppressing the value of all other cards.

As the industry matured, several new companies began competing with Topps by producing their own sports cards. In the collector days, Topps would generally issue a single set of cards each year. As the collector centric hobby morphed into an investor-driven market, several card companies began producing multiple sets annually. This resulted in a saturation of new cards which eventually suppressed the value of all non-vintage cards.

Eventually, card buying speculation drove prices ever higher. A prime example is rookie cards, which were priced like Initial Public Offering shares of stock. Investors were willing to pay a premium for a card of an unproven rookie in the hopes that his future performance would cause the price of the card to increase over time. Conversely, collectors tended to value the cards of proven, Hall of Fame players.

No Really, Our Industry Is Different…

Card collectors were in denial during the late-1970’s. Even as we saw our hobby began to change, we believed it would never become an investor oriented industry. Over time, our belief dissolved into hope, which eventually became dismay. Despite our desires, the sports memorabilia hobby changed in the same, predictable manner as other popular hobbies.

It is not uncommon for the pioneers who drive emerging industries to believe that their industry will not follow the “rules of the road” of related more, mature industries. Gary Kildall, who refused to Conform To His Customers’ Realities, felt that the parameters of the personal computer industry would be defined by the passionate PC hobbyists who drove its early development. He failed to realize that the industry would eventually attract mainframe and minicomputer industry veterans who would bring market strategies and doctrines based on the legacy industry’s orthodoxy.

In the early days of the Internet, the ad market seemed to be completely different from any media which had preceded it, primarily due to the unprecedented ability for advertisers to track the effectiveness of their campaigns, as discussed more fully in Managing Your Cost Per Customer. However, as the Internet advertising industry matured, it became populated with traditional media veterans who infused old-world jargon (e.g., Insertion Orders, Trafficking, Flight Dates, etc.) as well as old-world pricing, such as cost-per-thousand views, which was based upon print advertising metrics. Eventually the industry matured and hybrid pricing schemes were developed, such as cost per action, cost per click, etc. However, the fundamental tenets of the online ad industry are akin to those established in the pre-Internet world.

Hoping your industry does not change is unrealistic. Instead, anticipate how your emergent industry will mature by analyzing the structure of adjacent and legacy markets. As your industry grows, it will attract refugees from these related markets, who collectively will strongly influence your industry’s transformation. The challenge is to anticipate which innovative aspects of your industry will survive this inevitable maturation.

The Joy Of Lajoie

Napoleon Lajoie’s scarcity was the result of Goudy Gum intentionally not including the card in retail gum packs. They knew that collectors are driven by the desire to complete sets and that a missing card would cause them to purchase additional packs. Ironically, in the modern, investor-driven baseball card industry, Lajoie’s card is prized not because it is key to completing the Goudy Gum set, but because of its propensity to appreciate. Few modern-day card investors attempt to complete a Goudy Gum set, but all of them long for the rare Lajoie card, as its scarcity ensures it is an investment that will increase in value over time.

Pour And Stir II – Managing Your Cost Per Customer

John Greathouse — Wed, 02 Dec 2009 23:52:45 +0000

“I know half the money I spend on advertising is wasted, but I can never find out which half.” John Wanamaker

If Mr. Wanamaker had access to the Internet, his oft-repeated quote, would have never been uttered. In the “good old days”, pre- 1999, advertising dollars were largely gambled away.

As noted in Pour and Stir Part I, the key to the successful execution of this strategy is managing the following equation:

The cost to acquire a customer < lifetime value of a customer

This entry focuses on how you can minimize your cost per customer acquired by systematically establishing the infrastructure necessary to track the results obtained from a variety of online and offline marketing vehicles.

Decreasing Your Customer Acquisition Costs

There are two ways to decrease your cost per customer; (i) optimize the amount of money you pour into the top of the funnel and, (ii) increase the rate by which you convert potential customers into actual customers and thus increase the effectiveness of your marketing dollars. For instance, if you enhance your conversion rate by ten percent and your historical cost per customer is $50, your revised cost per customer will decrease in direct correlation. This is equivalent to being handed a free customer for every ten customers you acquire.

Ultimately, your overall customer acquisition costs should calculated as an average of a variety of marketing channels. Some channels will be expensive but highly scalable, such as direct response radio, while others will be less expensive, but more difficult to scale, such as search and affiliates. By tracking each channel and managing your overall acquisition costs such that they are less than the customers’ lifetime values, you will maximize the growth of your Pour and Stir business. For instance, if your average lifetime value is $250 and the average radio acquisition costs is $300, it may still make sense to implement a radio campaign if both: (i) your other acquisition channels are optimized and further growth is limited, and (ii) the inclusion of $300 radio customers does not drive your overall customer acquisition costs beyond your customers’ $250 average lifetime value.

In addition, you must consider your customers’ lifetime value by channel, as there can be a great deal of variance between various clusters of customers. In the example above, you may find that although radio listeners cost $50 more than your average cost per customer, they may correspondingly have a longer life and thus a higher lifetime than your average customer. Tactics which can increase your customers’ lifetime value are discussed in Pour and Stir – Part III.

Unattributed – There is no such thing as organic customers. No one wakes up and says to themselves, “I need to buy that product I have never heard of before.” It does not happen. Thus, include these unattributed customers in your overall calculation of customer acquisition costs. However, there are inevitably customers for whom it is difficult to attribute to a specific source. Your marketing dollars paid for these unattributed customers, but like Wanamaker, you cannot identify when or how. If you benefit from true word-of-mouth marketing, consider yourself lucky. As Marketing Guru Guy Gabriel of Idea Engineering points out in Max Brand, viral marketing has made many an entrepreneur terminally ill.

Unpaid Search – Never pay a consultant to help you achieve a higher search ranking. Such Search Engine Optimization (SEO) is modern-day snake oil. No one, including the engineers who work on Google’s constantly evolving search algorithms, fully understands how to reliably and consistently boost search results via artificial means. Thus, avoid link farms, mindless keyword content and similar techniques designed to make your site more Google friendly. As long as you have a well architected site that allows Google to properly spider your content, spend the rest of your time and money focusing on maximizing the remaining marketing tools listed below.

Paid Search – Customers which click on sponsored ads associated with search keywords fall into this category. Google’s market capitalization is in the stratosphere for a reason – keyword search advertising is highly effective. However, Search Engine Management (SEM) is not a “set and forget” exercise. If you simply define a list of keywords, establish maximum bids per word and walk away, your efforts will fail. You must apply dedicated resources to your SEM efforts, either in-house or via a trusted third-party partner, in order to maximize customers acquired from this channel.

Affiliate Network – Affiliates are third-parties which are only compensated when they perform a particular action on your behalf. Affiliates invest the up-front marketing expenses required to attract customers. If you have the proper mechanisms to accurately calculate your Cost Per Customer / Lifetime Value Equation, you will happily purchase as many customers from affiliates as your cash flow constraints will allow, as long as the average acquisition price is less than the customers’ average lifetime value.

To put yourself in an affiliate’s shoes, consider that you have ten billboards and you can advertise anything on each of them. However, you are only paid for ads that generate sales. Given your opportunity costs, you will carefully evaluate the ads you place on your billboards, because a poorly performing ad will result in a significant loss of revenue.

Instead of billboards, affiliates own websites, many of which contain meaningful content associated with the products they advertise. For instance, a travel site might contain travel tips, along with ads for great deals on vacations. The affiliate is only paid by the vacation advertiser when someone clicks on the ad and completes a lead form. They are paid nothing for simply displaying the ad.

The downside of the affiliate channel is that affiliates tend to be relatively small publishers, which are inefficient for most advertisers to work with individually. As such, a number of marketplaces have arisen to address this issue, such as Commission Junction, Google Affiliate Network and LinkShare. Although such networks are effective, they attach a fee to the affiliate payouts, ranging from 20% – 30%. Such fees must be factored into your cost per customer calculation.

Cost Per Action (CPA) – Similar to Affiliate Marketing, CPA advertising dollars are not spent until a particular action is achieved, as defined by the advertiser. Such actions include sales, trials, leads, downloads, etc. For instance, an advertiser might pay $45 per sale, irrespective of how each are particular sale is generated. Some might be from banner ads and others may arise from an email campaign.

Cost Per Click (CPC) or Download (CPD) – As the name implies, advertisers pay only for clicks on its advertisements or when a user downloads its software, case study or whitepaper. Such ads must be carefully vetted by the advertiser in order to avoid generating unqualified clicks that do not convert into the intended action. Ideally, such ads should clearly articulate the value proposition including the price.

Co-Registration (CoReg) – CoReg opportunities arise once a user has registered for a third-party product. Once this process is complete, they are exposed to your offer. As with all marketing techniques, the more contextually relevant the co-registration offers, the higher the attach rate. For instance, if a user registers for a firewall, subsequent offers for anti-spam or anti-spyware solutions will generally fare better than random solicitations for Netflix, Geico or the secret to whiter teeth. In most cases, the advertiser only pays per valid registration obtained. As such, you must view the registration process in its entirety, including what incentives are being offered and what other co-registration products are offered. For instance, if a user is rewarded for selecting multiple offers, then their intent is clearly lower than a non-incentivized user who registers for a complimentary product.

Direct Response Email and Newsletters – Although rightfully vilified due to the irresponsible actions of Spammers, targeted, opt-in email lists can be lucrative sources of customers. In many cases, editorial content in an email newsletter is an effective manner of acquiring customers. For instance, if you sell a software security solution, you might write an article that describes ten ways consumers can protect themselves online, highlighting your solution as one potential tool. As described more fully in Thrill The Messenger. Note: be sure to always disclose your association with any products included in such lists.

Another economical manner to utilize email marketing is to conduct reciprocal email campaigns with partners in which both parties agree to send a minimum number of emails to individuals within their respect databases. As with co-registration offers, the respective products should be complimentary so the emails provide value to the recipients.

Cost Per Thousand (CPM) – CPM ads are a throwback to the days of offline advertising. The advertiser is guaranteed nothing, other than a prescribed number of “impressions”. Such impressions might appear on a website below the fold at 3:00 AM, but they still count toward the publisher’s fulfillment of the Insertion Order (IO). Avoid CPM ads unless you are able to negotiate an extremely aggressive rate, which may be possible if you are willing to commit your advertising dollars to a future calendar quarter or if you purchase remnant inventory. CPM deals can be optimized by identifying the most relevant locations to display the ads on the publishers’ sites, daypart the ads and specify frequency caps. You can significantly lower the risk of a CPM deal, and effectively convert it into a CPA arrangement, by negotiating a guaranteed minimum number of referred visitors or customers from the CPM impressions.

Given the breadth of the various online marketing mechanisms, it is typically difficult for startups to maximize each of them. Although I generally despise the involvement of consultants during a venture’s early stages (see Beware The Consultant), consider securing a risk – reward relationship with an outsourced marketing firm. Although such agencies are relatively rare, they do exist. For example, RevUpNet, an online marketing agency I Co-Founded with Ben Kiblinger in 2007 and currently act as an addVisor, prides itself in establishing revenue sharing relationships in which it is rewarded when it drives incremental revenue for its clients.

Direct Response (DR) Radio

In the early days of marketing GoToMyPC, circa early 2002, I was highly skeptical regarding the use of offline channels. I was concerned that very few radio listeners would hear a URL while driving, arrive either at work or home, get online and then be motivated to enter “gotomypc.com” to access our offer. As such, we took an incremental approach, starting with online streaming radio, then highly targeted endorsement radio by tech gurus, followed by slowly rolling out a direct response campaign on terrestrial radio (satellite radio was not a mature medium at the time). I was dead wrong. DR radio proved to be one of our most effective customer acquisition channels.
DR radio comes in many forms, as described below. In each instance, the intent of the message is to initiate a particular action by the listener, such as picking up the phone or visiting a website. Similar to online ads, a particular radio ads’ trackability is highly correlated with its relative cost and effectiveness.

Online Streaming Radio – Online radio can be a particularly effective advertising medium for products which lend themselves to online sales. For instance, if an audio ad describes a security software solution, the listener can open the browser (which most listeners generally minimize while the radio plays in the background) and click on an ad displayed in the radio player in order to learn more about the offer. Such sales are highly trackable, because the clicks can be measured like any other online ad. Several companies have aggregated smaller Internet radio stations, in a mode similar to Affiliate Networks, most notably Jetcast.

Remnant Auction Radio – Brand oriented advertisers tend to hold remnant advertising in disdain, as they fear they cannot control the context in which their marketing messages will be communicated. Such brand-focused, non-call to action advertising is appropriate for some products and services, but not those which qualify for the P&S business model. If you are in the midst of a branding campaign, you likely work for a Big Dumb Company which has a large budget, no ability to track its marketing spend and hold its advertising investments accountable. However, remnant radio can be a viable option for direct response marketing campaigns, where the primary concern is performance, rather than branding.

Remnant radio has become extremely sophisticated in the past several years. Users can now target their ads in the same manner as with traditional radio, including geographically, demographically and dayparting (i.e., selecting the time of day ads run). In addition, advertisers can specify the maximum amount they are willing to pay per spot, via weekly reverse auctions.

As with any offline medium, tracking remnant radio’s results is challenging. One way to maximize such trackability is to tailor your website and search campaign to facilitate radio’s success. For instance, include a visual callout on your website’s front door welcoming radio listeners and inviting them to enter the promo code announced in the call to action portion of the ad. Alternatively, create a vanity URL that is only communicated in specific radio spots. For instance, if your primary website’s URL is Attachmore.com, you might encourage radio listeners to visit Attachmoresales.com while ensuring that your keyword search campaign includes all the logical variants of this vanity URL.

Satellite Radio – The abundance of stations offered on satellite radio allows for effective demographic targeting. Unlike satellite music stations, talk radio shows include commercials and the audience tends to be affluent, professional and relatively sophisticated.

Terrestrial Radio – Despite its limitations, old-school radio can also be an effective direct response channel. However, it requires significant money, time and attention, primarily because terrestrial radio listeners are generally passive; using the radio as background, ambient noise. Thus, the most effective direct response vehicles tend to be talk shows, as these listeners are more prone to act upon the marketing messages they hear as opposed to tuning them out as “noise” to be ignored between the musical interludes.

Endorsement Radio – Although it is generally expensive, personal endorsements by a radio show’s host can be highly effective. A key advantage to such campaigns is that once you contract with a particular radio personality, the host will not offer personal endorsements of your competitors’ solutions. At GoToMyPC, our first foray into radio was a series of personal endorsements by Kim Komando. Nearly 10-years later, Kim continues to sing the praises of GoToMyPC and has yet to endorse an alternative remote access product.

In addition to ranking these marketing tools from cheapest to most expensive, the above list also reflects the approximate order in which each should be pursued. For instance, it does not make sense to develop an Affiliate Market presence until you have established an effective SEM campaign. In addition, it generally is not prudent to establish a terrestrial radio campaign before addressing the tracking issues associated with online, remnant and satellite radio.

In 1995, the surviving 15-stores from John Wanamaker’s once thriving retail chain were sold and the Wanamaker brand ceased to exist. However, Mr. Wanamaker’s name lives on, due to his once lauded quote, which has become an anachronism in today’s highly trackable advertising age.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses. He is also the author of an award-winning entrepreneurial blog infoChachkie.com. You can learn more about his experiences at johngreathouse.com
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Pour And Stir I – In Pursuit Of The Ideal Business Model

John Greathouse — Tue, 20 Oct 2009 20:22:59 +0000

Note: This is Part I in a three-part series on The Perfect Business Model. Click here for Part II, and Part III

Authentic, hand-crafted Persian rugs always include intentional imperfections. They are said to be, “Perfectly Imperfect, and Precisely Imprecise.” The same is true with many crafts and architecture created in Muslim cultures.

I am not a Muslim scholar, but a layman’s interpretation of this tradition of intentional errors is that it arises from the belief that attempting to emulate God’s perfection is sinful.

Fortunately, entrepreneurs need not fear running afoul of this sin when crafting their business plans, because all of them are inherently imperfect and imprecise.

Attributes Of The Perfect Business Model

Although entrepreneurs need not fear offending God with their flawless business plan, it remains a worthwhile ideal. Falling short of perfection may result in a business with enough positive attributes to succeed.

At the most basic level, the ideal business model is simple: Pour and Stir (P&S). As is true with most business axioms, this formula is straightforward – the more money you deploy, the more money you generate. As shown at left, pour your money into a customer acquisition funnel, apply a bit of gentle stirring to generate a steady flow of mo money, mo money, mo money.
A number of online business models lend themselves to such P&S wealth generating chicanery.

No matter how well honed your P&S business model, every money making machine has its limits. If you pour too much money into the top of the funnel too quickly, it will be wasted, running over the sides and never reaching the bottom. If you fail to deposit adequate cash into the top of the funnel, your results will be suboptimal. The trick is to modulate the inflow of cash with the ever changing market conditions in order to maximize your financial return.
The essence of the Pour and Stir model is represented by the following simple formula:

The cost to acquire a customer < lifetime value of a customer

Although the P&S formula is clear-cut, it presupposes that you have insight into your customer acquisition costs, as well the revenue generated by each customer.

Ideal Business Model Attributes

Some of the market and product attributes which lend themselves to the P&S business model include:

No Inventory – Inventory sucks. It must be manufactured and shipped, it becomes obsolete, employees steal it, it must stored, customers break it, it malfunctions, and it tends to injure your most litigious customers.

Not A Service – Services suck. They must be carried out by humans, who require pesky things like paychecks, vacations, sick time and personal days. Services do not scale, as the more services you provide, the more humans you have to hire. As noted in Pressure, you can create a comfortable lifestyle business by delivering services, but services preclude you from utilizing the P&S business model.

Highly Trackable – Trackability does not suck. If you cannot track the cost required to acquire your customers and their lifetime values, you will be unable to take advantage of P&S. The more aspects of your business that you can quantify and measure, the closer you will come to perfection.

The stirring process involves a bit more than a simple hand crank. To properly operate the P&S model, you need a dashboard akin to a 747 control panel. The more dials you monitor, the greater your insight regarding how market factors impact your business (i.e., competitors, customers, costs, technology, etc.). However, for the dials to be meaningful, you must have the means to accurately track a variety of real-time data.

A bias toward trackability will force you and your team to justify each marketing dollar in highly quantifiable terms. If you cannot mathematically demonstrate that a particular dollar spent on customer acquisition yields more than a dollar in revenue, then do not spend that dollar.

Salient Value Proposition – The more clear and concise your value proposition, the cheaper it will be to communicate. With GoToMyPC, we honed a very clear message, “Access Your PC From Anywhere”. As discussed in How Much For A Rib, understanding your customers’ perception of your value proposition is vital to crafting a profitable business model.

Click, Click, Try, Buy – Ideally, customers should be comfortable purchasing your solution online, without picking up the phone. If this is not possible, offer customers a risk-free trial to utilize your solution before purchasing it. If you cannot offer a trial, capture enough information online so an inside salesperson can readily contact your prospects.

More complex sales, as well as those involving higher price points, are well served by soliciting trackable calls. Companies like RingRevenue offer advertisers the ability to track calls like clicks and thus extend the P&S model to a broader array of products and services.*

At its most elemental level, there are two macro dials you must control to execute the P&S strategy; lowering your customer acquisition costs and increasing your customers’ lifetime values. These issues are explored more fully in Parts II, and III of the P&S Series.

Perfect Imperfection

Unlike a Persian artisan, there is no need to intentionally include imperfections in your business plan. No matter how hard you try, your adVenture’s constantly evolving business will always fall short of perfection. However, by understanding the principles of the P&S approach, you may create a business in which you consistently convert a dollar into a dollar and change. Once you accomplish this, your P&S business will create significant wealth for you, your employees and the remainder of your Stakeholders, إن شاء الله.

Full Disclosure: I sit on RingRevenue’s Board in my capacity as a Partner at Rincon Venture Partners.

Fast Follower III – First Mover Disadvantage

John Greathouse — Tue, 29 Sep 2009 22:49:01 +0000

This is part III of a three part series. Click here for Part I and Part II

John Fitch was first. He spent the majority of his adult life fruitlessly attempting to capitalize on the novelty and uniqueness of his invention. Unable to raise funds from wealthy individuals, he solicited $300 from a hodgepodge of small businessmen, including tavern owners, grocers and physicians.

In a matter of months, he developed technology that was superior to that created by the world’s leading scientist over the prior 15-years, despite his lack of a formal education.

He debuted his technology in Philadelphia at the 1787 Constitutional Convention. It exceeded his expectations and thrilled those who witnessed it, including a number of prominent Founding Fathers. However, he was still unable to secure adequate funding to commercialize his technology.

Fitch spent the next three years traveling the country repairing clocks as a means of surviving, all the while saving money for the eventual launch his venture. In 1790, he began offering a service that eventually transformed world commerce and generated trillions of dollars of wealth. Unfortunately for Fitch, his adVenture folded 18-months after it began.

In 1798, at the age of 55, a frustrated, destitute Fitch scrimped together enough money to purchase a handful of opium pills, which he used to end his life. His suicide note was prophetic:

“The day will come when some more powerful man will get fame and riches from my invention, but no one will believe that poor John Fitch can do anything worthy of attention.”

First Mover Disadvantage

The alleged First Mover Advantage asserts that companies which are the first to exploit a new technology and/or market have an inherent advantage. Clearly, the allure of being first is significant. Who remembers the second man on the moon, the second person to fly an airplane or the second person to reach the North Pole? However in business, being first is often a disadvantage.

As noted Fast Followers II, fast-follower entrepreneurs must have a solid point of differentiation in order to succeed. In most instances, small companies do not have the financial wherewithal to bludgeon the competition and establish market share through brute force. Thus, it often pays to develop points of differentiation which are not based on product features. In fact, it is often more advantageous for an entrepreneurs to differentiate their offering through an alternative disruptive means.

In long-distance foot races, some teams deploy the “rabbit” strategy. A runner who has no chance of winning the race is designated as the rabbit and is instructed to set a very fast initial pace. The intent is that the runners from the opposing teams, not sure whether or not the rabbit can maintain her aggressive pace, will push themselves to keep up, while the rabbit’s teammates conserve their stamina and eventually pass the rabbit and their exhausted competitors.

Many first mover companies are rabbits. Unfortunately, they do not have teammates who can win the race on their behalf. It is important to identify such rabbits in business, as well as on the racetrack, so that you do not exhaust your company’s resources attempting to maintain pace with such competitors which have no chance of winning.

As discussed in Competing From The Fringe, a fast-follower strategy requires patience and ego containment. The following chart details a number of factors which determine whether you should attempt to exploit a first mover advantage or bide your time and enter the market as a fast follower.

Fitch To Fulton

John Fitch’s invention was the steamboat. He did not just create an esoteric, proof-of-concept prototype. Rather, during its first season, his ship travelled over 2,000 miles. In commercializing his technology, Fitch perfected the tubular boiler (some claim he and his partner outright created this invention) which decreased the weight of a conventional boiler by over 7,000 pounds. During a publicly witnessed time trial, his first steamboat travelled an astounding 8 miles-per-hour in still water.

In contrast, Robert Fulton, who had an advanced education and significant financial backing, was only able to achieve a speed of 3-miles per hour 13-years after Fitch’s maiden voyage. Another 3 years later, Fulton’s famous maiden voyage of the Clermont between New York and Albany traveled at less than 5-miles per hour, with a handful of passengers and no cargo. If Fitch and Fulton had raced to Albany, Fulton would have lost by 52-miles. It was not until 1812, 25-years after Fitch, that Oliver Evans, creator of the high-pressure steam engine, eclipsed Fitch’s speed record, by achieving a sustained speed of 9-miles per hour.

If Fitch’s technology was first to the market and was so vastly superior to that which came before (and for a long time after), why did he fail while Fulton succeeded? Some of the key factors which lead to Fast Follower Fulton’s success include:

Competition – The topography of the Hudson Valley in which Fulton launched his first commuter steamboat made land travel more difficult than travel by boat. In contrast, Fitch’s Delaware River Valley was relatively flat and the high-quality roads allowed land commuters to travel more quickly than those who traveled by boat. As such, Fulton’s market offered consumers fewer competitive substitutes.

Technology – Unlike Fitch, Fulton did not spend his time or financial resources building a steam engine. He used his political connections to export a top-of-the line engine from England, which generally maintained a tight embargo on the exporation of its leading technologies. In addition, craftsmen and metallurgists had made significant advancement with respect to machining capabilities and mechanical materials in the 20-years after Fitch’s failure.

Capital – Fulton secured adequate financial backing early in his adVenture’s life, thus allowing him to focus on perfecting the then state-of-the art technology and not waste time or management attention raising money.

Pragmatism – Fulton was more skilled organizer & a better mechanical designer than Fitch. Fitch was a visionary inventor, as described more fully in Inventors vs. Innovators, while Fulton was a practical innovator.

Theft – As Harold Evans declares in They Made America, Fulton “realized the promise of the known” by canvassing the discoveries made by others and selectively adapting them to apply to the specific requirements of water travel. In contrast, Fitch was forced to develop many of the core aspects of his technology.

Market Segmentation – Fulton capitalized on the novelty of river excursions and catered to wealthy individuals who valued their time and wanted to travel in luxury. The glamour associated with the riverboats of the late 19th century originated with Fulton’s gaudy, garish accoutrements. Conversely, Fitch targeted a utilitarian market, charging 50% of comparable land travel and placing no emphasis on passenger comfort.

Corporate Structure – Fulton created an organizational structure akin to a modern corporation, with department heads reporting to him. Fitch, along with his partner, were effectively a two-man-band, carrying out all the responsibilities of the organization.

Social Optimism – Fulton expected people to like him…and they did. As described in PsyBlog’s The Acceptance Prophecy, individuals who assume people will like them tend to have positive social interactions. By Fitch’s own account, he was, “wretched, haughty, imperious, insolent and petulant”, hardly personality traits which would result in a socially optimistic proclivity. Hudson has been described as “confident”, “handsome” and “charming”, traits which lend themselves to a socially optimistic outlook.

John Fitch’s dying prophecy was not entirely correct. He has not been completely forgotten. Although they may not realize it, the thousands of commuters of the Philadelphia and Trenton corridor honor the inventor of the steamboat daily, as they traverse the John Fitch Parkway.