First-time technology entrepreneurs repeatedly make a common mistake: they don’t budget enough for customer acquisition relative to software development/engineering costs. Over the past five years I’ve talked to plenty of entrepreneurs that raised angel money ($100k – $1m), spent 90% of the money building the product of their dreams, and realized too late that it costs serious money to acquire customers. Unfortunately, they weren’t able to show enough traction to raise more money and shut down the startup. It happens more than you think.
There’s a distinct 3:1 ratio for customer acquisition (sales salaries, sales commissions, marketing salaries, and marketing expense) costs relative to engineering (software development, architecture, quality assurance, etc) costs. A typically software company budget might look like the following:
- 60% – customer acquisition (sales and marketing)
- 20% – software development/engineering
- 20% – general and administrative
Yes, some rare products have a self-service model resulting in the percent of budget to customer acquisition swapping with engineering but the majority of B2B software companies follow the 3:1 customer acquisition to engineering ratio. My recommendation is for entrepreneurs to pay close attention to these ratios when planning and building their company.
What else? How you seen this 3:1 customer acquisition to engineering ratio in your experience?
David Cummings on Startups 
Dave:
Great post. More SaaS founders need to heed this. The trouble I see with staying focused on this is the VC/Angel groups predisposition to IP and technology.
In my early days more potential investors asked if we had our own software engineers then how we planned to get customers! Their thought that only serious startups have their own developers. This was some unwritten gospel to market penetration.
In the reality the first question should have been: What is your customer acquisition strategy and metrics?
Looking to market leaders like Salesforce.com, many of SaaS leaders are spending way our in front of current revenues to acquire customers.
One other hurdle is probably the lack of good business plans or decks (at least that I have seen) to model founders thinking in their idea/business.
The only business plan or presentation that I have seen that ever hit this head on was Mint.com’s deck.
Your thoughts?
Great points. I agree the question “What is your customer acquisition strategy and metrics?” should be asked much more frequently.
Thanks Steven for Mint Pre-launch Pitch deck 🙂
Thank you David 🙂 Daily posts received via email are super helpful 🙂
Completely agree for commercial software vendors.
OTOH, I wonder how the rules might be different with an open-source strategy? I attended the open-source business conference back in 2003 and one of the things that was advocated was how open-source can significantly minimize the costs of sales. They were also lucid about the fact that an open-source software company’s sales are often lower than an equivalent commercial one, but that custom acquisition is not as difficult when open-source is in the mix.
Do you (or any of your readers) have any experience with this to confirm or deny this?
Thanks in advance.
-Mike
Open source is a strong counter example to the 3:1 ratio. I’d guess open source is closer to 1:1 depending on the maturity of the community around the product. WordPress is a great example of a company that spends much more on engineering than customer acquisition due to the mature community.
Do these ratios change during the life-cycle of a company? Should a startup invest proportionally more in its product during the first six-months?
Good question. Early on it is probably 1:1 and then over time as product/market fit is reached it rapidly becomes 3:1.