Category: Strategy

Earlier today I had the opportunity to meet with another entrepreneur in town that I hadn’t met before. We got to talking about what his ideal role would be once he made his FU money and he said it was to build a startup incubator or lab that created a number of companies where he helped get them off the ground but someone else would run them.

Interestingly, a story came out today where Kevin Rose, founder of Digg, took the acqui-hire route and sold his incubator to Google after their first product wasn’t successful. Rose is a guy who made his FU money, started a product incubator, and has now moved on to a giant company.

Here are some pros and cons with the incubator approach to startups:

• Idea to product won’t take much time at all since there aren’t any legacy customers to slow things down
• Hockey stick-like revenue growth often occurs several years in, assuming things are successful, so if you start five or 10 companies simultaneously, you still have a long time to see good cash flow even after killing the ideas that aren’t working
• Some startups are successful because they hang around a market long enough to find the pot of gold but with an incubator the staying power is less likely
• Timing a market is one of the most difficult things to do, so building multiple startups at the same time increases the chance that the timing for one of the markets is right

Idealab (great video) is one of the most successful incubators ever and should be closely studied by anyone thinking about doing their own startup lab. Building a successful incubator is hard, and I believe it’s even harder than building a successful startup (successful startup defined).

What else? What are your thoughts on the incubator approach and startups?

A few nights ago I was out with the kids and we headed over to Jimmy John’s near Terminus. As we were waiting for our sandwiches to be made I noticed a sign on the wall: Warren Buffet’s 10 Rules. Much like the Jimmy John’s sign How Much is Enough, this one is packed with wisdom.

Here are Warren Buffet’s 10 Rules:

1. Reinvest your profits
2. Be willing to be different
3. Never suck your thumb
4. Spell out the deal before you start
5. Watch small expenses
6. Limit what you borrow
7. Be persistent
8. Know when to quit
9. Assess the risks
10. Know what success really means

The next time you’re at a Jimmy John’s read the signs on the wall — they’re worthwhile.

What else? What do you think of Warren Buffet’s 10 Rules?

At yesterday’s Startup Riot I enjoyed talking with a number of entrepreneurs. One item that kept coming up was partnership opportunities that entrepreneurs were excited about. Here are some example partnership opportunities:

• Invite to be on someone else’s app store-like marketplace
• Desire to white label or OEM the product by a bigger company
• Exclusive reseller for a certain vertical or geography

Startups should say no to 99% of partnership opportunities. Most partnerships never go anywhere and don’t make sense for the startup to invest significant effort into the relationship due to being time and money constrained. Partnership opportunities do make sense when there is significant skin in the game on behalf of the partner (e.g. large up-front fees) or a super minimal way to work together (e.g. less than 20 hours of work to get something out the door that is useful).

Now, it isn’t that bigger companies are trying to take advantage of startups. Rather, bigger companies have more resources and less focus whereas startups are often looking for product/market fit and need to stay focused on work that’s applicable to 80% of their desired customers. The next time someone approaches you with a partnership idea, ask yourself the hard questions and assess the downside as well as the upside.

What else? What are other reasons startups should say no to 99% of partnership opportunities?

As a startup there are a number of different ways to invest precious capital. Some investments, like building a minimum viable product, are obvious whereas others like buying ads on Google vs LinkedIn aren’t obvious until some modest amount of money is spent. Well, there’s another area that needs more thought from entrepreneurs: investments that don’t have a short-term return but do create significant long-term enterprise value.

Let’s look at an example to see long-term enterprise value in action:

• On average it costs $500 to generate a new customer that pays $1,000 per year
• Revenue is recurring and has 70% gross margins, so $500 in customer acquisition gets $700 of gross margin in year one
• Customers stay for an average of four years ($4,000 in revenue at 70% gross margin results in $2,800) — customers staying for an average of four years implies a 75% per year renewal rate (1/.25)
• Enterprise valuation for the company is three times the annual gross margin
• An opportunity arises to acquire more customers at $1,500/each which results in a year one loss ($1,500 > $700 gross margin) but is profitable over the average lifetime of the customer ($2,800 lifetime gross margin) and increases the value of the business $2,100 (3 x the $700 gross margin)

In this example, assuming no cost of capital and no discount for future cash flow, spending $1,500 to acquire a customer that pays $1,000 per year, easily pays for itself when looking at the lifetime value of the gross margin of the customer and the long-term enterprise value of the business, assuming OK renewal rates and readily available access to capital. It’s important to get a complete picture of the value of a customer when determining the amount to spend that still generates a positive return on investment.

What else? What are your thoughts on startup investments for short-term ROI or long-term enterprise value?

Earlier this month I had lunch with an entrepreneur that described a situation I don’t hear about too often: after several very profitable years they wanted to transition from being profit-oriented to growth-oriented. The business was doing well and the market was continuing to mature around them creating a desire to gain more market share at the expense of near-term profitability. It seems pretty simple, right? Wrong.

Here are a few reasons why transitioning from profit-oriented to growth-oriented was more difficult than expected:

• Angel investors in the company had grown used to the nice dividends each year and didn’t want them to stop
• Internal team members were the operationally-focused type and not growth-focused (good people but not necessarily right for the change)
• Certain managers that excelled at their current size were viewed as not yet having the skills to take it to the next level, and would have to seriously improve or move on from the business

It was interesting to hear about these experiences first-hand as well as the challenges that come from making a dramatic strategic change.

What else? What are some other challenges with transitioning from profit-oriented to growth-oriented for a startup?

Last week I was talking to an entrepreneur about an idea-stage B2B startup. After a few minutes of casual talk I asked for the pitch: tell me about the idea. Now this wasn’t a technology idea, so I didn’t have much experience, but it still didn’t sound right. I wasn’t clear why a business would pay for it and how it would be distributed. A few minutes into the idea I went for the hardest question that represents the #1 failure of idea-stage B2B startups:

What did 10 potential prospects of this product say when you asked them about it?

Crickets.

The entrepreneur hadn’t talked to prospects yet. It’s much easier, and more fun, to get feedback from other entrepreneurs compared to talking to prospects. There’s a fear that the idea isn’t good enough and needs to be refined before talking to prospects. Unfounded. The number one failure of idea-stage B2B startups is not talking to prospects immediately and pursuing customer driven development.

What else? What are some other mistakes idea-stage startups make?

What if you were a retailer that operated like a Software-as-a-Service company whereby you barely marked up your products and you made the bulk of your profits off the recurring revenue subscriptions? Costco does it. Amazon Prime is doing it. Think about it for a second: would you rather break-even selling products and make good money off of predictable, high margin recurring revenue or make varying margins off products with less predictability?

Amazon Prime is really Costco delivered to your doorstep.

If Amazon Prime has 5 million subscribers (probably high) that pay $80 per year, and they mark up products barely enough to cover the expedited shipping, inventory, operations, etc, that’s $400 million per year of profit (assume the $80 per year is nearly all profit). $400 million per year of profit is solid. And they’re just getting started. And they’re giving consumers more reasons to sign up, like free streaming movies and TV shows.

Look for more services with an annual fee that sell their product or service near cost and make all their profit off the subscription fee.

What else? Are Costco and Amazon Prime more similar than you thought? What are some more examples of this model?