business model innovation

Agenda

Business Model Innovation CAC and LTV

The SaaS/Recurring revenue business model

Reducing CAC (Cost to Acquire a Customer) The new rules of Customer Acquisition

Increasing LTV (Lifetime Value of a Customer)

Conclusion: Lessons Learned

Anatomy of a Startup

Unmet Need New Technology

The Old Model

The New Model

Unmet Need New Technology

EntertainmentNew Business

Models

Consumer Technology leads the Enterprise

Business Model Innovation:The Major Change Agents

The Internet

Web 2.0

Social Networks

Mobile Web

GoogleSEO/SEM

Enableslow-costcustomeracquisition

B2C Breakthrough Companies

The Fastest Growing Companies ever: Zynga Groupon Gilt

All use Social and Viral techniques for customer acquisition

The Key Elements behind “Business Model”

Web-based companies make this abundantly clear:Spend some money to drive traffic to your web site

Come up with a Monetization strategy Transactions Subscriptions Ads Virtual Goods Etc.

The Key Elements behind “Business Model”

Cost to Acquire the Customer (CAC)

Profit from that Customer For subscription revenue businesses = the value of that

customer over their lifetime (LTV) This number takes into account the COGS or cost to

serve

Startup Killer There is a common problem:

An out of balance Business Model

MonetizationMonetization(LTV)(LTV)

Cost toCost toAcquire aAcquire aCustomerCustomer

(CAC)(CAC)

Entrepreneurs are over-optimisticEntrepreneurs are over-optimistic

CAC for a Web driven business

Input VariablesTotal Web Visitors 10,000 SEM cost per click 0.50$ Conversion to Trial % 5%Trial conversion % 10%No of Sales & Marketing Staff 3Cost per employee per month 16,500$

Flow Qty. Conversion %Total Paid Web Vistors 10,000 Trials 500 5%Customers 50 10%

SEM Marketing Spend 5,000$ Total Headcount Costs 49,500$

Cost of Customer AcquisitionWithout headcount costs 100.00$ With headcount costs 1,090.00$

CAC for a Direct Salesforce

Sales Sales Eng Inside SalesTeam composition 1 1 0.5On target earnings 230,000$ 140,000$ 90,000$ Salary Cost 230,000$ 140,000$ 45,000$ Salary + Overhead 310,500$ 189,000$ 60,750$

Total Team Cost 560,250$ Avg. team Failure Rate 25%Adjusted Team Cost 747,000$

No. of Marketing people 0.5 Average cost per person 200,000$ Marketing Programs Spend 150,000$ Total Marketing Costs 350,000$

Total Sales & Marketing spend 1,097,000$ No of deals per team per year 10Cost of Customer Acquisition 109,700$

Annualnumbers

What we are looking for

MonetizationMonetization(LTV)(LTV)

Cost toCost toAcquire aAcquire aCustomerCustomer

(CAC)(CAC)

A well balanced business modelA well balanced business model

The Balancing Act

MonetizationMonetization(LTV)(LTV)

Cost to Acquire Cost to Acquire a Customer a Customer

CAC)CAC)

• Viral effects• Inbound Marketing• Free or Freemium• Open Source• Free Trials• Touchless conversion• Inside Sales• Channels• Strategic partnerships

• Field Sales• Outbound Marketing

• Recurring Revenue• Scalable Pricing• Cross Sell/Upsell• Product line expansion• Lead Gen for 3rd

parties

• High Churn Rates• Low customer

satisfaction

Business Model Disruption in B2B

Open Source Use Free Software to acquire customers cheaply

When done right, free creates viral spread Monetize a portion of the free customer base

Business Model Disruption in B2B

SaaS Rent software to customers monthly Remove complexity (no IT) Lower buying barriers

No big $ purchase decision Easy to cancel if not working No IT means that the business buyer can purchase

Business Model Disruption in B2B

The Low Cost Sales Model

The Touch-less Conversion

Freemium

Recurring Revenue

One Salesperson Selling 5 Customers a month @ $1000 per month each Means an additional $5,000 in new additive revenue

every month

Turbocharger: Adding Salespeople increases monthly

new bookings

Churn

Churn Rate plays a huge role in success

1% to 2.5% churn per month is acceptable

Higher than that, you are filling a leaky bucket Need to understand why you have low customer

satisfaction and address the problem

How Churn affects LTV

Customer lifetime in months = 1 / Monthly Churn Churn of 1% = 100 months lifetime Churn of 2% = 50 months lifetime Churn of 5% = 20 months lifetime

Impact on LTV for $1,000 average subscription Churn of 1% = $100,000 LTV Churn of 2% = $50,000 LTV Churn of 5% = $20,000 LTV

The Big Issue with SaaS

Investments to acquire customers are all upfront

Revenue from each customer comes in slowly

Creates a cash flow problem in the early days

But once through the valley of death, cash flow is amazing

My rules for CAC/LTV balance in a SaaS model

LTV CAC> 3x

Months to

recover CAC

< 12 months

Required for Capital Efficiency

Another key SaaS benefit

Rapid development Only one version of your code base at all customers

Rapid customer feedback on new features

Immediate deployment of new features to all customers

Other Recurring Revenue Benefits

Predictability Highly valued by Wall St

Future revenue and cash flow for an acquirer

Buying Behavior has Changed

“Please understand that I get dozens of these types of messages a week. I simply do not have time to read them, dig into them, follow-up on them, or reply to them. The most effective solution to this problem is for me to ignore the messages, which is what I usually do. …

… Finally, a small comment. As a customer, I find this type of approach to sales to be largely annoying to me and unproductive for you. We learn far more about what we want to purchase by searching the web, looking for customer references in blogs and forums, word of mouth, and by finding white papers on your site that concretely describe solutions to problems we are having.”

CIO of Large Pharma Co.

Buying Behavior has Changed

Outbound Marketing: Annoying to your customers Expensive Increasingly less effective

What is the new process? Google Search Web Site Reviews Blogs & Social Media

Influencers Trials or Free software / services Avoid sales people

Requires Inbound Marketing thought processes

HubSpot: Inbound Marketing

Remarkable Content

Write a Blog

Create content that is REMARKable Educational Humorous Controversial

Optimize that content for Search Keywords used by your buyers

Use social media (Twitter, Facebook, etc) to build a following If the content is good it will spread virally

A Crucial Insight

Never sell or promote your product in your blog

Instead Educate and Entertain Focus on the areas of greatest interest to your buyers

The Power of Free

Wired Magazine: Free! Why $0.00 Is the Future of Business Free is dramatically different to even $1 If done right can lead to viral spread

Examples: Open Source software (JBoss, Asterisk) HubSpot’s WebSiteGrader

Monetize some portion of your free customer base Use of a free product/service develops a level of trusted

relationship Makes it easier to sell something to them

Using Engineering for Marketing

Freemium

Dropbox Example Get you hooked for free Storage slowly increases to the point where you need to

pay But by then they have established trust

And it is hard to move your data that is shared with others

Virality

Often hoped for, rarely achieved

The best businesses: Virality plus Monetization

Examples:– Google– Gilt.com– Zynga

Entire Blog post devoted to this topic: www.forentrepreneurs.com/lessons-learnt-viral-marketing/

Old World evolving to a New World

Charge foreverything(includingon-site trials)

Free Trials

Free ProductMonetize a Fraction of Custs

Old World evolving to a New World

New World Give things away to optimize spread Large Footprint of customers = Great brand value Price low to get fast decisions

Old world Optimize pricing to extract the most “But the customer is quite happy to pay that much”

Key realization CAC is one of the highest P&L expense items Optimal Pricing limits spread Optimal Pricing damages CAC

The Low Cost Sales Model

Web & Inbound Marketing Free product, or Free Trial

Insides Sales

Examples SolarWinds Constant Contact LogMeIn JBoss HubSpot

The Touchless Conversion

ZenDesk

Common Funnel Metrics: 10% of visitors do a trial 20% of trials convert to paid

Extraordinarily scalable

Extremely low cost

Free Trials require different Product Thinking

The product is your salesperson

Extreme focus on: Ease of installation Ease of use Clear instructions on how to test (short videos, etc.) Fast proof that it works

Enables you to reach the SMB market

Not economically feasible in the past

Now opens up a vast new market

In many ways a better business than Enterprise Software

Need to Build a Sales & Marketing Machine

Automated Top of the Funnel Middle of the Funnel (lead nurturing) CRM

Scalable

Instrumented

Clear understanding of Costs and Returns

Visitors

Trials

Campaigns to drive traffic

Closed Deals

Conversion %

Conversion %

Overall Conversion %

Metrics are crucial for success

(by lead source)

Experimentation and A/B Testing

Constant Experimentation New Lead Sources New Messaging New Pricing New Product Features

A/B Testing immediately reveals what is working

Sales Complexity

How I assumed the two would relate

A rough estimate of CAC versus Sales Complexity

Rough Estimates of Cost of Customer Acquisition (CAC)

The relationship is roughly exponential

Clearly adding Human Touch dramatically

increases costs

Sales Complexity

CAC (logarithmic)

10x

10x

10x

High CAC requires higher pricing

Higher pricing unfortunately leads to greater approval complexity

To get deals through requires high scores: Product value Customer Pain Urgency to get something done

Sales Complexity

Value / Pain / Urgency = LTV (logarithmic)

High CAC, requires high scores for: Value, Pain, Urgency

Sales Complexity

Value / Pain / Urgency = LTV (logarithmic)

Unprofitable:LTV < CAC

Blue Zone 1Blue

Zone 2

Sales Complexity

Value / Pain / Urgency = LTV (logarithmic)

Red Zone 1Red

Zone 2

AmberZone 2

Amber Zone 1

Sales Complexity

Value / Pain / Urgency = LTV (logarithmic)

Green Zone 1

Green Zone 2

Green Zone 3

Sales Complexity

Value / Pain / Urgency = LTV (logarithmic)

Sales Complexity

Value / Pain / Urgency = LTV (logarithmic)

How SaaS changes Sales Complexity

Levers you can use to move from Red to Green

Make it easy for customers to sell themselves

Make the first decision to work with your product easy Simple product Free versions, Free Trials, Open Source

Remove Complexity from closing the Sale Remove IT (SaaS) Eliminate committee decision making

Make the first financial commitment easy $10,000 or below for enterprise sales $250 per month for very small business SaaS

Sales Complexity

Value/Pain/Urgency

Able to leverage the Internet revolution

Human Costs dominate:Old world business model

What can happen when you get this right

SolarWinds 2009 Revenues: $116 million EBITDA: $60 million

Others: JBoss, LogMeIn, Constant Contact, Salesforce.com, etc.

52% operating margins

The Balancing Act

MonetizationMonetization(LTV)(LTV)

Cost to Acquire Cost to Acquire a Customer a Customer

CAC)CAC)

• Viral effects• Inbound Marketing• Free or Freemium• Open Source• Free Trials• Touchless conversion• Inside Sales• Channels• Strategic partnerships

• Field Sales• Outbound Marketing

• Recurring Revenue• Scalable Pricing• Cross Sell/Upsell• Product line expansion• Lead Gen for 3rd

parties

• High Churn Rates• Low customer

satisfaction

The Highlights

Breakthrough Business Model Open Source A great example of the power of Free 5 million downloads

The first challenge: How to monetize

The second challenge: Conversion While keeping CAC low Solution: Build a Sales & Marketing Machine

The Original Brainstorming Session

The First Blockage Point

5 million users had downloaded JBoss But none had given their names

The problem: email registration in front of download reduces

conversion rates significantly

The Solution Look for something that those developers really wanted

JBoss had been earning $27k per month for documentation Solution: give this away, in exchange for email address

JBoss - Sales & Marketing Machine

PhoneCall

LeadNurturing

InsideSales

WebLeads

WebScoring

EnterpriseEnterpriseRolloutsRolloutsEnterpriseEnterpriseRolloutsRolloutsSuspectsSuspectsSuspectsSuspects Closed DealsClosed DealsClosed DealsClosed Deals

Metrics: The End Goal

WebWebactivityactivityscoringscoring

Tele-Tele-marketingmarketing

Tele-Tele-salessales

Using the model to work backwards

To do $4m in the month: If Average Deal Size is $10k Need $4m divided by $10k deals to reach target = 400 deals Means 1,200 deals being worked in Inside sales (400x4)

Know that each rep can work 60 deals at a time, means 20 reps Means 3,600 telemarketing contacts (1,200x3) Means 14,400 Raw Leads (3,600x4)

WebWebactivityactivityscoringscoring

Tele-Tele-marketingmarketing

Inside-Inside-salessales

The next challenge: Increase LTV

Multi-pronged approach Add services to the subscription (beyond just support)

Key service was JBoss Operations Network Broaden the product line and upsell

JBoss Enteprise Middleware Suite (JEMS) Scalable Pricing

4 axes to drive pricing higher

Result Drove average deal size from $10k to $50k While maintaining the same pipeline flow and

conversion rates

The Results

Before venture financing 2003 $2m

Early 2004 – venture round closes

Revenue Growth: 2004 $11m 2005 $26m 2006 on plan to do $65m

JBoss Summary

Business Model disruption Gave the product away entirely free Monetized support & management

Low CAC Leveraged free and virality to acquire non-paying customers

Sales & Marketing Machine Careful study of customer motivations Low cost Sales model Excellent Metrics

Scalable pricing model

Lessons Learned

Business Model Innovation The new trigger for startups

Understand the CAC / LTV balance Look for the breakthrough techniques for acquiring

customers Free products / services

– Use R&D as a marketing tool Free Trials Viral Social Etc.

Lessons Learned - (continued)

Understand the new buying behaviors Think Inbound versus Outbound

Build a Sales & Marketing Machine

Look for the breakthrough techniques

Look for the next evolution in the business model

This is all obvious

Vision is easy

Execution is the hard part

All comes down to hiring great teams

For More information

Visit my blog at www.forEntrepreneurs.com