Category: Strategy

Competing Definitions of Product/Market Fit

One of my favorite questions to ask seed/early stage entrepreneurs is “do you have product/market fit?” Then, naturally, it’s followed up by “how do you know and what are the metrics?” Of course, the answers, and rationale, are all over the place. While there are a variety of ways to define product/market fit, here are the three most common:

  1. By Unaffiliated Customers
    A simple, easily quantifiable definition is product/market fit is achieved when you have 10 unaffiliated customers that are passionate about the product. Unaffiliated, in this definition, is key in that the customers need to have bought the product based on its merit, not based on being a friend of the founder or an old colleague. Passionate customers are another important component in that there has to be a positive indicator beyond just paying money that there is a real need, one with authentic demand, being solved.
  2. By Positive Momentum
    A looser definition of product/market fit is when instead of feeling like everything is an up hill slog in the startup, things get easier and there’s palpable momentum. Examples include customers signing with significantly shorter sales cycles, PR opportunities popping up, and potential employees actively reaching out to join.
  3. By Distribution Scalability
    A later stage definition of product/market fit is when the cost of customer acquisition is favorable relative to the lifetime value of the customer. Here, the idea is that the solution is valuable and customers are being acquired in way that makes the startup indefinitely scalable.

While there are a number of competing definitions, it’s clear that product/market fit represents good things happening in the startup and the foundation for a successful company.

When the Startup Stalls

Last week I was talking to an entrepreneur with a stalled startup. After being in business for several years, getting to millions in recurring revenue, and having a great run, the business plateaued. What to do next? Of course, there are a number of areas that can be improved in the business, as is always the case regardless of growth, so I asked the bigger question: What do you want to do with the company?

After much back and forth, it became clear that the desire was to keep running the business and to get it back on a high growth trajectory. We talked about a number of different strategies and decided to focus on three areas: retention, customer acquisition, and the rule of 40.

Retention

Retention represents the core health of the business. Customers that are happy, successful, and finding value renew their contracts. The old adage that it’s more cost-effective to keep an existing customer than to find a new one still rings true. With a mature, no-growth business there’s even more time to focus on the existing customers and ensure they have a great experience and renew (see SaaS Enemy #1).

Customer Acquisition

Customer acquisition represents all aspects of acquiring new customers. Often, when a business slows, the customer acquisition channels haven’t scaled with the company and the law of large numbers kick in such that growth on an overall percentage goes down as the number of churned customers goes up (see Leaky Bucket). Now’s the time to analyze the customer acquisition channels deeper and look for opportunities to make improvements.

Rule of 40

The Rule of 40 states that the profitability, as a percentage, and the overall growth, as a percentage, when combined, should be 40 or higher. A business with 10% margins growing 30% annually meets the Rule of 40 while a business that’s breakeven and growing 10% annually is significantly below. Put another way: grow fast without making money or generate healthy cash flow with little-to-no growth. For a plateaued business, if it’s clear it can’t grow more, it’s time to meet the Rule of 40 by making it more profitable and focusing on operational efficiency.

Stalling startups is all too common and part of the normal course of business. By its very definition, a startup is a growth focused business, so if growth isn’t currently possible, it’s likely time to sell, look for new product ideas, or no longer be a startup.

Markets or Ideas for Startup Success

As I look for patterns in successful startups, the more I believe the market, inclusive of timing, is more important than the initial startup idea. People get so enamored with the idea — even putting it up on a pedestal as the be-all-end-all — that they don’t step back and spend enough time assessing the market.

An entrepreneur will research an idea for a few weeks before jumping into a journey that might take 10 years. Instead, spend several months in the market. Learn it. Study it. Look for trends and gaps. Really experience the market, however possible.

Take Pardot as an example. The initial Pardot idea was lead generation as a service, not marketing automation. We picked a great market — online lead generation — and had great timing — the shift of offline marketing dollars to online — making the pivot into marketing automation successful.

Take SalesLoft as another example. The initial SalesLoft idea was alerts and news about your contacts, not sales engagement. We picked a great market — productivity software for sales people — and had great timing — the shift of offline selling to online — making the eventual pivot into sales engagement successful.

Take any famous entrepreneur. I bet they picked a great market (and timing!), found an opening in the market (an initial idea), and then built a suite of offerings to service that market over many years.

Archimedes, the Greek inventor, has a famous quote:

Give me a place to stand and with a lever I will move the whole world.

Entrepreneurs with a tiny wedge into a large market can build a great business.

Pick a market, not an idea.

Start a Startup with Community

Recently I was meeting with an entrepreneur that’s early in the search for product/market fit. With a few paying customers, he was looking for scalable ways to find people that would both be potential customers as well as provide feedback on the product. Instead of just looking for potential customers immediately, I suggested a different approach: build a community of like-minded people that care about the problems and opportunities he cares about for his startup.

But how? Create a local meetup.

Find five people that care about the idea or topic. Don’t worry if they are potential customers or potential competitors. If they care about the common idea, get them together. Invite a guest speaker or develop some conversation starters for the group.

Meetups like this promote idea sharing, help everyone develop personal relationships, and make great content for future blogs, tweets, and videos. The human connection shouldn’t be underestimated. Even with all the digital interactions, people want to be around other people, live and in person.

Then, how do you scale this? Go to another city.

Find a like-minded person or customer in a different location. Setup a dinner at a central restaurant or ask another company to use their board room. Build more relationships, share more ideas, and create more community.

Community starts with one other person. Then another. And another.

Like any overnight success many years in the making, community takes time. The best time to start is now.

What else? What are some more thoughts on starting a startup with community?

Characteristics of the Ideal SaaS Startup

Earlier this week I was talking with an entrepreneur about the ideal characteristics for a SaaS startup. Some characteristics can be identified at ideation and many of the characteristics emerge once the product is in market with customers. As more of the characteristics emerge, they drive how fast the startup grows and ability to raise capital (if desired).

Here are characteristics of the ideal SaaS startup:

  • Product Value – It can’t be repeated enough: every successful SaaS startup either helps the customer make more money in a quantifiable way or runs a function of the business that’s mission critical. Most startups fail and most startups have nice-to-have products.
  • Product Distribution – Getting the product into the hands of customers in a financially justifiable manner is one of the biggest challenges post product/market fit. Ideal go to market is either viral (like Calendly), high volume inside sales (like Terminus), or a combination of inside and enterprise sales (like SalesLoft). The more complicated the sales model, the higher the average order needs to be otherwise the business won’t scale efficiently.
  • Total Addressable Market (TAM) – Ideal startups serve small, fast growing markets that are going to be large (billions) in a few years but are too small currently for big incumbents to care. Tomorrow’s TAM should be dramatically larger than today’s.
  • Gross Margins – As the startup scales, margins should be in the 70% range at a minimum with 80%+ as the long term target. If the margins can’t be in the 70% range long term, the business likely isn’t SaaS.
  • Renewal Rates – Two of the most important metrics for SaaS startups are gross renewal rates (how many customers or dollars renewed in a time period divided by how many were up for renewal) and net renewal rates (how many dollars renewed and expanded in a time period divided by how many were up for renewal). Gross renewal rates should be in the 80% range, at a minimum, and net renewal rate should be above 100%.

The ideal SaaS startup has both great market fundamentals and excellent metrics across key categories. Most startups won’t achieve all the desired characteristics, but the ones that do have the opportunity to create large, enduring companies.

Develop a Specific Ideal Customer Profile

Recently I was reading The Mom Test about customer discovery and there was a section on the ideal customer profile. Generally, entrepreneurs approach the market with an ideal customer profile that is much too broad (find a niche to get rich!). Instead, start with a narrow slice of the market, go deep, and then expand or shift the focus as new information is learned.

At Pardot, our ideal customer evolved over time and was as follows at time of exit:

  • 20 – 200 total employees in the company or division of a larger company (typically a small-to-medium sized business)
  • 5 – 50 employees in sales and marketing (shows a dedicated team for acquiring new customers)
  • At least one full-time marketing manager (shows they have a person to run a marketing automation system)
  • Sales people listed in LinkedIn (shows they have a complex sale involving consultative sales reps)
  • Email newsletter signup on website (shows they are doing traditional email marketing)
  • Ads on Google (shows they are spending money on direct response lead generation)

Now, finding companies that meet this profile required effort through a combination of buying data, developing scripts to crawl sites, and manual labor. In the end, the results were tremendous.

Entrepreneurs should develop a specific ideal customer profile and continually refine it.

Rise of Parallel Entrepreneurs

Recently I was talking to an entrepreneur that had sold his company last year. Now, as his next act, he’s working on three new startups, simultaneously. Put simply, he’s a parallel entrepreneur.

Last week I was talking to another entrepreneur and I mentioned the parallel entrepreneur idea. Immediately, he perked up as well saying he had several ideas but things are going too well with his current company to take away any time or attention. Once the entrepreneurial itch has been scratched, and some level of success achieved, a wave of confidence emerges to take on multiple ideas.

Only, compounding scale with one product in a large market is always better than multiple products in lesser markets. Yet, it often takes time — years in many cases — to know just how good a market will or won’t be. Parallel entrepreneurship is so appealing, especially after selling a business, because successful entrepreneurs know how much luck, timing, and market selection plays in the outcome. If several of those characteristics have an uncertain element, and they do, the next logical thought is to start multiple companies at the same time. With several companies going, there’s time to see how things play out, and then double down on the winner(s) and quickly shut down the losers. Hence, parallel entrepreneurship.

For all startup communities outside a certain section of California, parallel entrepreneurship has a real opportunity to accelerate the growth of the startup community. Presumably, parallel entrepreneurship will result in more startups, more capital invested (especially if from successful entrepreneurs with a track record), and, hopefully, more positive outcomes.

Parallel entrepreneurship is on the rise and will continue to grow as more entrepreneurs have strong exits.

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.