SaaS Winners and Daily Newspapers in the 1980s

After reading Buffett: the making of an American capitalist by Roger Lowenstein I couldn’t help but equate Warren Buffett’s views on daily newspapers in the 1980s with the SaaS winners of today.

After Buffett bought The Buffalo News he was sued by the other daily paper for launching a Sunday edition and initially lost on the grounds that it was anti-competitive (which was patently false). In the trial, a number of statements came out including the idea that owning a daily newspaper with no competitors was like having an exclusive toll bridge that crossed the main river in town. Buffett was focused on businesses that had pricing power such that they could raise prices and continue to thrive even in an inflation-heavy environment (a.k.a. a strong moat!). Eventually, the other daily newspaper in Buffalo went out of business and The Buffalo News generated a tremendous amount of cash for many years until the Internet disrupted it.

SaaS winners demonstrate many of the same characteristics as monopoly daily newspapers in the 1980s. Only, instead of being specific to a geography, they are specific to a market and a segment. People love to comment how marketing automation had many success stories, but it really was a winner per segment at time of market consolidation:

  • Eloqua – enterprise
  • Marketo – mid-market
  • Pardot – low mid-market
  • HubSpot – small business

Just like New York is a market and Buffalo is a segment for daily newspapers, there are hundreds of SaaS markets and thousands of segments that will produce winners. Let’s look at some more comparisons between daily newspapers pre-Internet and SaaS winners:

One question I’ve been asked many times over the years is, “Why can’t Google take 10 software engineers and just copy XYZ product?” The answer, it seems, is the similar to trying to be the number two or three daily newspaper in the 1980s: the scale, expertise, product/market fit, and accumulated brand value was too much for an upstart. Put more simply, the market and segment coalesced around one winner and that momentum steamrolled everyone else. Google took 1,000 software engineers and tried to compete with Facebook as a new social network, only to lose miserably.

Now, in this comparison, one type is a monopoly media provider to consumers and the other type is a business software provider to businesses, but many of the same desirable characteristics that Buffett looks for applies to both. Winning a SaaS market and segment is incredibly valuable, just like monopoly newspapers in the 1980s.

Two Routes to Starting Great Startups: Audience Building and Consulting

Earlier this week I was at SalesLoft’s annual Rainmaker conference and couldn’t help but be in awe of the palpable energy from 1,000+ attendees. People were smiling, talking (go figure with a bunch of sales people attending a sales conference!), and genuinely excited to be there. After reflecting on the event, it reminded me of the early days of SalesLoft at the Atlanta Tech Village.

From the start of SalesLoft, Kyle Porter, the founder/CEO, focused on building a passionate audience of modern sales professionals through public speaking, blogging, and interviewing of sales leaders. Site traffic, email subscribers, and Twitter followers grew tremendously. Only, the company didn’t have a product sales people wanted — the first product was a nice-to-have and not a must have.

Despite limited commercial success with the first product, the passionate audience was there and growing. So, if the product isn’t working but there are a ton of fans of the company, the next step is to ask the them what they want. After many conversations, and more product iterations, sales engagement was identified as the next major opportunity in the sales technology market. Today, SalesLoft has thousands of paying customers and is one of the fastest growing startups in the country.

Now, contrast it to another amazing startup: Terminus. Terminus is the leader in account-based marketing and was founded by Eric Spett. The first year of Terminus was completely focused on consulting for marketers with an eye towards finding a product opportunity and turning it into a SaaS platform. And, that’s exactly what happened.

Consulting is generally a tough way to start a startup because it’s easy to get comfortable with a decent paycheck and not have the time to build a compelling product. Yet, consulting actually works well in that there’s a professional that needs a problem solved, and is willing to pay money to solve it — the perfect environment to do customer discovery. In the case of Terminus, as soon as the market opportunity was clear, the shift was made away from consulting and to full-on product development. Today, thousands of marketers use the Terminus product.

Ultimately, there are many different paths to success. Too often, entrepreneurs get enamored with their initial idea and don’t evolve it fast enough to meet the needs of the market. Building a passionate audience and doing consulting work are two different routes that get close to the customer and help accelerate success.

Venture-Backed SaaS Must Have a Fast Path to $100M Revenue

Rory O’Driscoll just published an excellent post titled Understanding the Mendoza Line for SaaS growth where he argues that the minimum requirement for a SaaS company to raise venture capital is a path to $100 million of revenue growing at least 25% at that milestone. Of course, as a startup grows the law of large numbers kicks in and fast growth becomes harder and harder. Historical data from SaaS companies that have gone public (considered best-in-class) shows that they typically grow between 80 and 85 percent of the prior year once past $10 million of revenue.

From the post, here’s an example with numbers:

  • Year 1 – Grew 120% from $4.5M to $10M
  • Year 2 – Grew 98% from $10M to $19.8M
  • Year 3 – Grew 81% from $19.8M to $34.8M
  • Year 4 – Grew 66% from $34.8M to $59.6M
  • Year 5 – Grew 54% from $59.6M to $91.9M
  • Year 6 – Grew 44% from $91.9M to $132.8M

SaaS entrepreneurs need to understand the calculus for raising venture capital and have the requisite growth rate to make it worthwhile.

Want to learn more? Head over and read Understanding the Mendoza Line for SaaS growth.

The Winner Effect in SaaS

One important component of SaaS that isn’t talked about enough is the “Winner Effect.” Simply put, the Winner Effect is all the benefits that accrue to the winner in a specific market that ultimately results in a significantly more valuable company. SaaS is well known for its high quality business model: substantial recurring revenue, high gross margin, and tremendous predictability. The Winner Effect makes the model even more profound.

Here are a few elements of the Winner Effect:

  • Sales Opportunities – Instead of hunting to find the potential deals in the market, the Winner Effect results in being in almost all the sales opportunities by default. Every prospect brings the winner in and it’s up to the upstarts to try and unseat the leader.
  • Public Relations – The #1 in a market gets 10x the number of media mentions than the #2. This PR results in even more separation between first place and second place, which compounds over time.
  • Third-Party Integrations – Even with all the middleware tools out there, integrating products is still a challenge, especially for the deep, more comprehensive integrations. As the winner in the market, more third-parties write integrations back into the platform creating an even larger moat for the next set of challengers.
  • Valuations – Ultimately, category winners get a valuation premium both when raising money from investors and when going public or selling to a strategic. Look at the some of the high end SaaS valuations to see investors that believe they’re betting on winners.

Another way to put it is that SaaS has a real network effect that snowballs as the business gets larger and larger and becomes the de facto winner in the market.

The Winner Effect is real. Entrepreneurs would do well to understand it and seek it for their business.

What else? What are some more thoughts on the Winner Effect?

Startup Success: Team, Stream, and Not a Meme

Over the years I’ve spent many hours trying to figure out why some startups are successful, and most are not. The goal: distill startup success down into as simple a framework as possible. Of course, startup success is hard and messy, but it’s helpful to have a high-level context for the over-arching components of success.

Alright, let’s get to it. The three components of startup success:

  • Team
  • Stream
  • Not a Meme

Team represents the group of people working together to achieve the mission. Some of the most important attributes are resourcefulness, grit, and determination. Startups are an environment of limited resources, repeated failure, and long odds. Most people don’t thrive in a startup. The best teams figure out what needs to be done and makes it happen.

Stream represents movement and speed whereby disruption is happening, and it’s clear that a new, better way is possible. The best streams are large, major shifts where entire industries are transformed. The more disruption, the more opportunity for startup success. Examples include the shift from offline advertising dollars to online, the shift from telephone lines to voice over the Internet, and the shift from field sales to inside sales.

‘Not a meme’ represents things that are must haves, not nice-to-haves. Memes are funny or witty quips that represent a cultural phenomenon. As an example, Chuck Norris has a number of memes around things he can do that no one else can. One of my favorites: Chuck Norris gets Chick-fil-A on Sundays.

Most startups build nice-to-have products and fail. Nice-to-have can be a product that isn’t valuable, a product that’s useful but in an over crowded market, or something that’s too far ahead of its time.

Let’s take AirWatch, an Atlanta success story that VMWare acquired for $1.5 billion. The original team was comprised of the Manhattan Associates (NASDAQ:MANH) founder and another executive that had worked together before. The stream was the rise of the smartphone and people bringing their own devices to work (major transformations). The ‘not a meme’ was companies needing to enforce security rules and policies across thousands of employees’ smart phones. All three components — team, stream, and ‘not a meme’ — were combined with a massive market.

The next time you evaluate a startup idea for yourself, or meet with an entrepreneur, ask these three questions:

  • Why is this team going to win in this market?
  • What fast moving stream is shaking things up and causing disruption?
  • How is the product ‘not a meme’ such that it’s a must-have for customers?

Answer the team, stream, and ‘not a meme’ questions correctly to predict startup success.

Video of the Week – Rapid Prototyping: Sketching & Paper Prototyping

For our video of the week, watch the Google for Entrepreneurs Rapid Prototyping: Sketching & Paper Prototyping. Enjoy!

From YouTube:
Mariam Shaikh and Melissa Powel talk about sketching and paper prototyping. Have you ever struggled with how to get from an idea to a high fidelity prototype? Every design has to start somewhere and even at Google we often start with low fidelity prototyping options such as sketching and paper prototyping. After all, the fidelity of your prototype should match the fidelity of your idea, so stop worrying and start sketching.

Build a Competing Company, Internally

Forbes has an excellent article titled Starting Over: How FreshBooks Reinvented Its Online Accounting Service On The Fly. FreshBooks is a popular online accounting app (think major competitor to QuickBooks and Xero, but more focused on micro and small businesses) that’s been around for over 15 years. After 10+ years with the original application, it was clear that the product architecture and user experience wasn’t going to scale for the next 10 years.

We all know that the a full product rewrite is the kiss of death. What to do?

FreshBooks created a separate company, with a separate team, in a separate office, to build a new competitor called BillSpring. BillSpring’s goal was to build a real business with it’s own customer base, that if successful, would replace the original FreshBooks product. After two years, BillSpring was working well and customers loved it. FreshBooks made the BillSpring product the new FreshBooks product while maintaining the legacy product and not forcing customers to switch. Now, FreshBooks has a platform for the future.

Need to reinvent your company? Consider building a competing company, internally.

What else? What are some more thoughts on building a competing company to reinvent the business?