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Summary:

One of the key concepts at the core of traditional marketing is the 80-20 rule — that some 80 percent of the effects (or in this case, profits) are the result of 20 percent of the causes (here, customers). Indeed, if you’re able to target just […]

self-service

One of the key concepts at the core of traditional marketing is the 80-20 rule — that some 80 percent of the effects (or in this case, profits) are the result of 20 percent of the causes (here, customers). Indeed, if you’re able to target just a small group of people in order to successfully yield most of your profits, there are all sorts of benefits — it’s easier to reach a small group, it’s easier to build them the right product, and so on. Most large technology sales and marketing organizations have taken the 80-20 rule to heart and focus on some small fraction of the tens of millions of businesses on the globe, often targeting just the Global 2000.

While the 80-20 rule can be very powerful, the reality is that many of the costs associated with building, supporting, distributing and selling technology products have dropped dramatically in the past decade. Yet many enterprise technology executives are operating as though the cost of distribution hasn’t changed since the early 1990s. In the coming years, I expect startups to increasingly target the massively underserved small- and medium-sized business (SMB) segment by taking advantage of the arbitrage between actual and assumed costs of sales. Self-service sales models will be a key element of these startups that will forever change the face of the enterprise technology business.

U.S. Business Statistics | The Economics of Sales

A quick look at Census Bureau statistics on business size reveals some startling information:

  • Of the 25 million U.S. businesses, only 5.9 million employ one or more people.
  • Of the 5.9 million employer firms, only 17,047 have 500 or more employees, yet those firms account for 49 percent of U.S. employment and 61 percent of revenue. That translates into well under 1 percent of U.S. firms accounting for 61 percent of revenue
  • Of the 17,047 firms with more than 500 employees, the 890 with 10,000 or more employees account for 26 percent of U.S. employment and 37 percent of revenue.

Let’s say you’re an enterprise software company and that your economic model requires each sales professional to earn $2 million-$3 million in revenue a year to cover the costs of your operation, including the cost of the sales themselves (salaries, commissions, travel and entertainment, sales support and operations, etc.). Each one of these representatives can only do so many deals every quarter, so the revenue per deal must be fairly high — let’s say that the average deal size per customer, per year, must be around $100,000. And that’s just your part of the solution. There are likely other software, hardware and consulting costs associated with the complete solution.

If we assume that the average pre-tax margin of a small business is 10 percent and we take revenue for the 98 percent of U.S. firms with 99 or fewer employees, divide their aggregate revenue by the number of firms to get average revenue per firm and then take 10 percent of that number to derive pre-tax profit per firm, we get $103,962. In other words, the direct sales model would require taking roughly 100 percent of pre-tax profit from firms with fewer than 99 people for just your component of the solution. These are back-of-the-envelope assumptions and are for illustrative purposes only — the point is that direct sales organizations cannot serve the vast majority of businesses on the planet.

Currently the most effective way to reach the SMB segment is via bundling, for example to have your software or hardware bundled (that is, OEM agreements) with some big-ticket item like a server; that vendor then distributes the combined product through a single or two-tier distribution channel. A very small number of products have the import to be sold through the channel on a standalone basis (such as backup hardware and software). If you compare what the large enterprise has in terms of technology vs. the small business, there is a massive gap. Most small businesses hack together solutions for many of their problems with Microsoft Excel, pen and paper, or nothing at all.

Enter the Web

In Figure 1, I’ve depicted the universe of potential customers in the U.S., from the roughly 300 million consumers at the base of the pyramid to the 17,000 largest enterprises at the top. Large enterprise IT companies have been created by primarily selling to the largest customers. And large consumer web companies have been created by targeting a large percentage of the total population. Far fewer businesses have been created, at least in high technology, by serving the small- and medium-size business segment as they were hard to reach. But that’s all changing rapidly.

Figure 1:  The Customer Segment Pyramid

the customer segment pyramid

In a web-based software firm, there isn’t a significant marginal cost of research and development (R&D). Cost of goods sold are often very small (especially in software), and CAPEX on a unit amortized basis is trivial. The biggest marginal expenditure is cost of sales. If a company can figure out how to simplify sales delivery and service by leveraging a self-service model, it can reach a large market segment hungry for better products and services.

Using techniques perfected by consumer web companies, a generation of enterprise IT companies will emerge that deliver a vastly superior user experience to IT professionals and employees alike. Improvements in ease of use will liberate employs from terrible software, server-side software development will increase the pace of product improvements and lower support costs, and the self-service model will change the economics of enterprise IT sales forever. Google’s success is as much about AdWords offering advertising services to the SMB segment as it is about serving consumers search services.

The dominant player in the SMB segment of the IT market today is Microsoft, as it’s been able to drive significant sales by riding Windows OEM agreements. If I were Microsoft, I would be more concerned about software-as-a-service solutions eroding my market share in the SMB segment than the threat of consumer web search, but I digress…

While the marginal cost of direct sales is very significant, the marginal cost of self-service looks more like the marginal cost of R&D — that is, very small.  With a low marginal cost of sales, the 99 percent of firms that are poorly served today will be served much better in the coming years. And over time, these solutions will likely work their way up the pyramid to penetrate the small group of very large firms that are currently being served by direct sales professionals. If you’re looking for opportunities to disrupt enterprise technology businesses, you would be well-served to start with the sales model.

Mike Speiser is a Managing Director at Sutter Hill Ventures. His thoughts on technology, economics and entrepreneurship will appear at this time every week.

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By Mike Speiser

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  1. Seems like the debate you’re getting at is 80/20 Rule vs. The Long Tail. Owning the SMB hill seems to have worked for Microsoft!

    However, I don’t know if the issue is easy to address. Targeting F1000 companies seems to be an addiction where I work in Silicon Valley. My employer boasts that their software is used by 100% of the F100 and damn-near all of the F1000, but in terms of corporate culture, they just don’t get SMB, much less the consumer market. Granted, they are an IT infrastructure company, but Microsoft has managed to do in 2 years (with a crappy product) what we couldn’t accomplish in a decade: create widespread awareness around virtualization while clearly articulating the value proposition to small businesses. Oops, I guess I just sort of gave away the name of my employer.

    1. While Microsoft may not be great at understanding the needs of the SMB, the average Silicon Valley enterprise IT company is far worse. The problem is that the biggest customers ask for a command line interface (using a GUI is for wimps), advanced management tools, and a bunch of high-end features. The SMB often has limited IT help and is more than happy to use a GUI, has limited needs for advanced management tools, and would prefer simple too feature-rich. It’s hard to have two masters…

      Having said that, I’m with you. Which is why I think there is real opportunity to go after the SMB segment — they have been so poorly served and the cost of serving them is lower than ever.

      1. I totally agree with your comment in re: SV companies being bad at serving SMB needs, I actually think Microsoft is pretty good at it in part because they avoid the traps you mention (CLIs, expensive features, etc.). My employer (VMW), on the other hand, is guilty of these sins to the nth degree.

  2. I think chasing the Fortune 100/500/1000/2000/etc is highly responsible for so much failure. Few can resist the allure of big dollar contracts. But ultimately, these are not great customers. The small/mid market is where it’s at. It should be noted that Google AdWords was first and foremost an advertising outlet for the “small guy”.

    1. Mike Speiser pwb Sunday, June 28, 2009

      I agree with you 100%. The low hanging fruit is so tempting, but you may want to think twice before taking a bite of that apple ;–)

  3. Girish Bhat Sunday, June 28, 2009

    There is this old school of thinking (from shrinkwrap S/W days) that to reach SMBs it will cost $15-$25M.
    Accordingly, teams adopt the Fortune500 mantra, hire a preoven sales guys, get disillusioned when sales do not materialize…

    1. Love it. And when the “proven” sales guy fails, I guess you assume that it’s not the product or the strategy by him, so you fire him and find another ;-)

  4. Peter Sisson Sunday, June 28, 2009

    Mike, this is one of the most well though-out and interesting posts I’ve seen on gigaom – and that’s high praise considering how great this blog is. You are absolutely right. Walk into most VC’s offices and say you want to target small business, particularly SOHO, and all you get back is some horror story about some company in their porfolio that tried to target SOHO in the past and failed miserably. But what they don’t understand is that things have changed now.

    We are right in the thick of this with Toktumi, which offers a suite of cummunications services to small business for very little money – $14.95 for hosted PBX with mobile phone integration, another $6.95 for desktop share, and another $9.95 for fax. Less than $30 bucks a month yet if you try to purchase those items separately,well you’ve got eFax $19.95, webex is $59.95, and most hosted PBXs start at $24.95 and up for unlimited calling.

    So how can we survive offering such low prices, to such small companies? Because the cost of acquiring customers when you offer SaaS services has simply plummeted. I can’t reveal our precise numbers, but I can tell you that even at our prices, our gross margins pay back the cost of acquiring a paid suscription for one line in less than 6 months. If the customer gets more than one line, or adds fax or desktop share, it can be in less than 60 days.

    So what has changed?

    -As you point out, self-service models are key. The key to making this work is to finesse simplicity and ease of use. UI really matters here. Toktumi customers can set up new phone lines in just a few minutes, and although we offer live customer support, seldom need it.

    -Customers are more familiar with online-services and now have the skills to do most of what is needed themselves, without IT support. Can you imagine the first reaction of the airline industry to customers actually booking their own tickets and picking their own seats via the Internet?

    -Broadband penetration has made the responsiveness and capabilities of hosted SaaS applications viable on a broad scale for the first time.

    -The number of people working out of their homes or on the road in “virtual office” environments is growing dramatically as the power of smartphones and ubiquitous wifi let people set up office anywhere. We call this new segment VOHO.

    -Google adwords, referral programs, affiliate programs, and word of mouth are the dirvers of growth for acquiring customers targeting these markets. These types of programs are easier to set up and manage than ever before, and the metrics allowing them to be optimized to perfection are available for free.

    IMHO, this is the perfect storm. Shunned for years by investors because they couldnt make the economics targeing small business work, now they do, and I believe you’ll see explosive growth of companies targeting these types of customers. We’ve certainly seen it for Toktumi.

    1. Thank you for the nice comments and for adding so much to the content of the post. Can’t wait to see what you all do with Toktumi. Good luck and I hope we’re both right that things are about to get a lot better for SMB customers.

  5. Kent England Sunday, June 28, 2009

    I work in the K-12 education sector now, but before the telecom bubble burst, I was an engineer in the telecom equipment sector and this article struck a chord with me. From my telecom experience, I know the author’s point of view regarding the Fortune 500 is accurate and I trust his view of SMB self-serve.

    My question is this: “Could this work in the state-county based K-12 educational sector?” Each K-12 district is pretty “small” by Fortune 500 standards, but the system is bound-up (at least in CA) by state law and Federal mandates.

    Is it worth thinking about K-12 as small business and trying to apply these principles to this market? Heaven knows, with budgets the way they are, anything to save money while improving service would be wonderful.

    1. Wow, telecom equipment providers were at the tip of the 80-20 rule spear — rather than the Global 2000 you probably had a market with 10’s of customers. And I’m sure they wrote huge checks…until they didn’t.

      Very interesting points with respect to K-12. I’m not familiar enough with the education market. Would love to hear from others who know more about the market?

  6. Gadget Sleuth Sunday, June 28, 2009

    It’s what i’ve thought all along…targeting small businesses is easier, less expensive, and they tend to be more loyal to a company or provider as well.

    1. Certainly from a marginal cost perspective. The only issue is that it’s easier to call a few buddies and get a few big checks at the start of a company. Which is why I think so many people take the low hanging fruit rather than make the long-term strategic decision to build a scaleable alternative…

      1. THIS is the main challenge – reaching out and converting the hundreds of thousands of SMBs cost effectively vs the few hundred enterprises. While self-service implementation works, self-service purchase of complex offerings is definitely not there yet. You still have to have a direct sales force to asnwer their questions, establish the fit, share the ROI and close the deal. The self-service sales model works for simple ‘point’ tools nto for complex offerings – even though they cost less than $100/seat. The potential in SMB market is big but winning from it is hard.

  7. Targeting Small Business Is Good Business! | Phone.com Sunday, June 28, 2009

    [...] very thoughtful post today by Mike Speiser in Gigaom. Mike presents a detail analysis showing why targeting small [...]

  8. Ernest Nova Sunday, June 28, 2009

    The technology products that could be sold this way should match the technology needs of the targeted firms. It would be useful to do a gap analysis of the opportunity.

    If I carry your back of the envelope calculations further – it implies the average revenue of the US small firm is about $1M and that would imply 15-20 employees (even less in Silicon Valley).

    A firm like this has likely already cloud-sourced low hanging fruits like email,communications and ecommerce web hosting. It is probably using a payroll provider or a PEO, outsourcing its core HR needs. It has a lawyer on retainer or on a a needed basis and a part-time book keeper using QuickBooks (by the way, Intuit is the other large SMB player). If it is manufacturing, it is relying on the ERP resources of its manufacturing partner and using a drop-shipper for product fulfillment.

    The opportunity may be in creating software that helps providers and vendors to the SMB, rather than the SMB directly.

    1. Very good points Ernest. And you are right that the core of Intuit is the SMB-focused QuickBooks. I should have noted that.

  9. Adam Vincent Gilmer Sunday, June 28, 2009

    In my opinion you are correct, small to medium sized business are key to growth and new brands and business development. Recent history and the study of products in the marketplace over the last 2-5 years have shown merchandisers must keep up with old and new generations. Moving forward this will also be expected.

    Just because we have high touch technology doesn’t mean smaller categories. In fact new items/products and existing brands have to adapt to the market change. (The 8020 Rule operating in various areas of business like you pointed out in your article). This allows new startups with ideas and big business to come together creating opportunities.

    A new breed of gazelle companies challenging the older dinosaur way of thinking. Statistics show more and more people are working from home with mobile phone. Only 10 years consumers were timid about using their credit cards to purchase form a site. Today it’s the norm. The “Star Trek” generation of yesteryears meets the “Matrix” and Neo is living in “Back to the future”.

    Adam Vincent Gilmer

    1. Great pints Adam. It sure does seem like the web, VOIP, mobile, and the like will lead to many more people working from home. I wonder if that will translate into more small businesses accounting for a larger percentage of aggregate private sector revenue though? I suspect it will, but I don’t have any hard data to support that point…

  10. Rethinking target markets | Nitin Badjatia Sunday, June 28, 2009

    [...] Self-Service Nation: Why Targeting Small Business Is Good Business While the 80-20 rule can be very powerful, the reality is that many of the costs associated with building, supporting, distributing and selling technology products have dropped dramatically in the past decade. Yet many enterprise technology executives are operating as though the cost of distribution hasn’t changed since the early 1990s. In the coming years, I expect startups to increasingly target the massively underserved small- and medium-sized business (SMB) segment by taking advantage of the arbitrage between actual and assumed costs of sales. Self-service sales models will be a key element of these startups that will forever change the face of the enterprise technology business. [...]

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