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Summary:

After closely controlling burn rate through the first two phases of a startup’s life cycle, the third phase is the time CEOs are waiting for — though they may not yet be ready for it. VC David Skok explains how CEOs can spend to grab market share.

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In my two previous blog posts, I’ve discussed the first two of three key phases in a startup life cycle: finding a product/market fit, then determining a repeatable and scalable sales model.

Once you’ve determined that the sales funnel process you’ve designed is working in a repeatable and scalable way, with a viable business model — i.e. for SaaS businesses, the cost to acquire a customer (CAC) is less than a third of customer lifetime value (LTV), and CAC is recoverable in less than 12 months — then you’re ready to scale the business.

At this stage, you should ramp the company up as fast as you can possibly afford.  If your cost of acquiring a customer is less than the customer’s lifetime value (based on gross profit, not revenue), then you have a clear return on investment for sales and marketing expenditures. To be clearer, you know now that every dollar you spend on sales and marketing will result in more dollars in gross profit flowing into the business. You need to press the startup accelerator pedal down hard, and invest as fast as you can.

Recognize, then Seize the Moment — and Control of the Market

Strangely enough, most startups fail to recognize when they hit this milestone, and don’t invest aggressively enough. If they’ve made it to this point, they’ve usually avoided the temptation of overspending during the early phases, and have conserved cash wherever possible. After that, it’s tough to suddenly start hiring aggressively and spending money freely.

As an example, HubSpot was lucky enough to reach this stage very quickly. However, once it got there, the board had to give management a nudge to help them recognize that the company had a proven model and needed to start hiring additional salespeople as fast as it could find and train them.  Every expense had been so carefully scrutinized up to this point that the idea of hiring two salespeople every month was foreign to the team.

Why is it so important to be that aggressive at this time? Basically, you need to grab as much market share as you possibly can before a competitor enters your space. There’s a clear tipping point when you’re suddenly recognized as the market leader. At that point, you can shut out your competition. In every tech market, the market leader enjoys an unfair advantage. The press, analysts and blogosphere pay far more attention to the market leader, and the early and late majority customers prefer to buy from the market leader. It becomes a powerful, self-reinforcing phenomenon, and the faster you can get there, the better.

Expect Some Management Changes

The rate at which you can invest is determined purely by the amount of capital you have available. Fortunately, it’s generally easy to raise capital when you’ve reached product/market fit and have a repeatable and scalable sales model.

At this stage, you’ll find  there’s enormous value in having experienced executives who know how to execute and manage operations at scale. This phase requires different skills than the first two phases require, and you may need to make some changes to the management team.

Stay Focused on the Next Milestone

While you’re searching for product/market fit, or a repeatable, scalable sales model, it’s important to stay focused on solving that problem and avoid any other distractions. That next milestone is the only thing that matters. Watch out for the many distractions that can take you off path.

Where to set the startup’s accelerator pedal?

A key challenge for the startup CEO is understanding how to allocate resources, and where to set the accelerator pedal. My hope is that this three-part series has shed some light on this important topic. The diagram below summarizes the investment strategy.

So what have we learned in this three-part series? The most useful lessons are:

  1. Recognize what stage your startup is in, and adjust your investment/burn rate accordingly.
  2. You can’t predict how long it will take to find product/market fit. My own startups typically took between one and two years longer to find product/market fit than I originally thought. Not surprisingly, I’d presented the usual optimistic plans to my VCs showing revenue growing in a nice linear way from the moment we shipped version 1.0 of the product. Only one of my five startups worked as planned.
  3. Keep burn rate low while you’re still searching for product/market fit and a scalable/repeatable sales model.
  4. Recognize the point where your startup reaches both the product/market fit and repeatable/scalable sales model milestones. That’s the moment where all the prior rules need to be thrown out the window, and you should do a 180, aggressively pushing that accelerator pedal by investing in sales and marketing to scale the business as fast as possible. It’s truly surprising how many startups I work with today that have passed that point, but missed opportunities because they never changed gears.

Image courtesy of Flickr user tonylanciabeta

  1. http://www.bvp.com/saas/default.aspx

    Bessemer’s put out the best “Rules of Saas/Cloud Computing” I’ve seen. I’d imagine a good number of people on this site have already read BVP’s documents.

    Check out the link below if you want a more detailed version of the article above:

    http://www.bvp.com/downloads/saas/BVPs_10_Laws_of_Cloud_SaaS_Winter_2010_Release.pdf

  2. William Mougayar Sunday, November 28, 2010

    Indeed, the search for the repeatable model is by trial and error, and the fun part starts when the frequency of customers success signals accelerates.

    And so true about the leader being at an unfair advantage because it’s less expensive to defend a position than to attack one.

  3. Peter Cohen, SaaS Marketing Strategy Advisors Wednesday, December 1, 2010

    David, Thanks for 3 useful articles.

    You make an especially good point that under-spending on sales & marketing can be as perilous as over-spending. Most markets will shake out to 2, maybe 3, dominant vendors, and the window to be one of those leaders closes quickly. Once you’ve built an effective customer acquisition machine, there’s no point in conserving cash and ending up among the “also rans.”

    As you point out, spending the cash can be tough to do, particularly for companies that can’t cover the CAC within a 12-month window. Along with deeper pockets, in those cases heavier spending takes a lot of courage.

    By the way, I love the picture of the racing red Alfa. I assume it’s a track in the UK…driver’s on the right.

  4. Excellent. Many start-ups fail to exploit the momentum.

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