Warner, Billion Dollar Startup?
November 29, 2007
Mathew Ingram paraphrased Edgar Bronfman’s comments about Warner Music’s latest financial results saying, “We’re totally screwed!” Matthew continues,
According to a rundown of the news and the related conference call at PaidContent, Warner’s revenue was essentially flat, while earnings fell by almost 60 per cent to just $5-million — and that’s on total sales of almost $900-million, which works out to a profit margin of about .5 per cent. In other words, virtually non-existent. And the near future looks as though it’s likely to be as bad or worse.
Update: According to Valleywag had it not been for a $12MM legal settlement Warner received their paultry profit would have been a $7MM loss.
Ironically this may be a huge opportunity for Warner. They have almost nothing to lose by funadmentally changing their business model. Doing business as usual has resulted in almost no profit for Edgar’s shareholders. Earlier this month Edgar suggested,
“We used to think our content was perfect just exactly as it was. We expected our business would remain blissfully unaffected even as the world of interactivity, constant connection and file sharing was exploding. And of course we were wrong. How were we wrong? By standing still or moving at a glacial pace, we inadvertently went to war with consumers by denying them what they wanted and could otherwise find and as a result of course, consumers won.”
When the numbers are this bad it can free you up to make changes an otherwise healthy business would never consider. My thoughts? Buy! Warner Music Group is listed on the NYSE:WMG (wait for the stock to drop tomorrow and start dollar cost averaging over the next 30 days). Good luck!
ServiceGuy Reaches 1000 Contractors
November 29, 2007
Over the last four months ServiceGuy went from and simple idea to a nationwide service with more than 1000 contractors in ten cities. The 1,000th contractor to sign up for the ServiceGuy referral system was Mike Fox from Norristown, PA who offers landscaping services.
I arbitrarily set our Phase One goal at 1,000 ServiceGuys. Now that we have met our Phase One goals we are ready for Phase Two. Phase Two is where we start getting business for our ServcieGuys. Imaginuity is developing interactive advertising for placement on Comcast’s ad network that is slated to start just before Christmas. We are also testing physical placement of ‘tear sheets‘ in grocery stores (400 stores per market) delivered on a weekly basis. Finally, we are testing Google Adwords in several markets. Our goal for Phase Two is to generate 2 calls per day per call queue.
Since early August Mike has made 27 major upgrades (some might be better termed bug fixes) to the system. The final items include some goofy things like allowing users to reset/retrieve their password, providing a method for news/announcements to users and finally an upgrade to the user profile pages. Once these last seven to-dos are finished Mike will be turning over day-to-day management/tweaking to Francis. Mike will be starting another pretty cool project that involves ACH, USB signature pads and data warehousing.
What do coups and snow have in common?
November 29, 2007
Newsflash: Another coup attempt in the Philippines, read more here. Our prayers are with our Filipino brothers and sisters. I don’t mean to make light of the resulting curfews and such, but I couldn’t help but comment.
We have employed Filipino engineers for several years and it seems as though every few months someone attempts to overthrow the government in the Philippines. Each time the government quashes the coup the president gives the people another holiday (i.e. a day off from work). The coups seem to be relatively bloodless and as a result our employees do not fear them, instead they seem to enjoy the added holiday. Internally we call these days ‘coup days’ in the tradition of ’snow days’ (i.e. neither make much sense to me).
When I was growing up in the Berkshires we would have fairly common snow storms and as a result school would be cancelled ~ we called them snow days. It always struck me as silly that we would drive by the school on the way to the ski slopes for a day of fresh powder. I didn’t complain, but I still never really understood the concept. I guess that is the hope of the Filipino leaders ~ distract your people from the instability by giving them a day off. It doesn’t make sense, but what do they say about ‘gift horses’?
Open Source Membership Organization
November 29, 2007
Peter Burns gave me a call earlier this week to discuss an organization he is building called Club E. Built along the lines of YEO (EO), he and his partners have launched Club Entrepreneur to ‘encourage the free exchange of ideas and resources; inviting local entrepreneurs to join together to synergize their talents.’
Peter pitched the idea of an ‘open source’ membership organization; something I had been thinking about since we organized the first Barcamp Dallas back in early 2006. I reviewed Peter’s material and decided that in its present form I wasn’t really interested in participating, but it did get me thinking about how to create something as vibrant and compelling as EO in an open source way.
My thought is that we help create a template for us in conjunction with Barcamp ~ i.e. offer an open source membership organization ‘API’ for communities that form around Barcamp. I agreed to talk to Peter about my concept in greater detail, but my next step will be to talk with Chris Messina (the water bearer for Barcamp) to get his thoughts and interest on the subject. Of course, as with almost all ideas I have, Chris et. al. are likely already working on something as we speak.
Trackbacks are Dead (at least to me)
November 29, 2007
Back in 2002 Six Apart implemented the trackback in their Movable Type blogging platform. What is a trackback? According to wikipedia,
"A Trackback is one of three types of Linkbacks, methods for Web authors to request notification when somebody links to one of their documents. This enables authors to keep track of who is linking to, or referring to their articles. Some weblog software programs, such as Wordpress, Movable Type and Community Server, support automatic pingbacks where all the links in a published article can be pinged when the article is published. The term is used colloquially for any kind of Linkback."
Well, I spent a little time counting the number of real trackbacks versus spam trackbacks and determined that less than 5% are ‘real’. The trackback idea is great, but it has been dead for sometime. There are a number of trackback spam solutions, but I simply don’t have the time to mess with them. I use Google Alerts to figure out who is linking to my posts and of course anyone who cares can do the same. Goodbye trackbacks…
Why blog?
November 28, 2007
In 2005 I began blogging about my experiences producing a reality television show called MotorSport Ranch. The title of the blog was ‘How to create, produce and air your reality television idea‘ where I decided to ‘open source’ the making of the show. I revealed all of our mistakes, failures, screw-up and even provided detailed buget numbers (fyi - this got me in a little trouble with some of our vendors). Eventually we finished the pilot episode and sold it to INHD (an HD only cable network now called MOJO). I learned quite a bit about television production as well as blogging. Ultimately I decided that I was much more excited about the opportunities that the new ‘wave’ of social media would bring. Ironically (ironic because I had lost interest in television production), because of the blog, we found a buyer for the first full season of MotorSport Ranch. This summer the 13 episode series aired on Dish Network’s RushHD channel.
Due to the blog, hundreds of people around the world emailed and called me about the show. I made a few friends and found a few investment opportunities that I would have never uncovered on my own. Based on this experience I decided to stop blogging about the show and focus my efforts on entrepreneurship starting this blog (The Texas Startup Blog). Since I began blogging about startups more than 500,000 people around the world have read one or more of my 1,300+ posts. Each month more than 25,000 people visit one or more of my posts about startups, entrepreneurship and our companies.
Through my blog I have met hundreds of people around the global. Whether I am attending a conference in San Francisco or Banglore, India I meet people who ‘know’ me through my blog. I have been able to time-shift my life (i.e. tell stories, explain ideas and make suggestions) to thousands of people at the same time. I couldn’t possibily reach the number of people I have through the blog via traditional means (conferences, email, phone, fax). Presidential candidates (or their staff members) have contacted me about my ideas about immigration after reading about them on my blog. It has been an amazing experience. Over the next few weeks I am going to be working with a few ‘experts’ to help me refocus my efforts on the blogging front. If you haven’t explored blogging I highly recommend giving it a try…
Global Warming ~ my son’s perspective
November 26, 2007
Last night the power went out, throwing our house into darkness. My six year old asked me why the lights and his Nintendo went off. I explained that the electricity went out. He then asked why electricity was so bad, especially if it allows us to see at night and play video games. I didn’t understand, but he went on to explain how electricity causes global warming and we must stop using electricity. He began to question the premise that he learned at school and suggested that he didn’t think electricity was so bad after all.
I laughed, but realized that most people are thinking and acting on global temperature data on the same level as my six year old. Anyone who dares to question any aspect of global warming is written off as a fool immediately. No one wants to look like a fool so we all play along. But at what cost? Our planet is on course to spend trillons of dollars over the next decades not on improving life for humans, but in an attempt to cool the planet. I like the studies that suggest that if human life was eradicated from the face of the earth it would result in a 1% decrease in global temperatures over the next decade.
According to recently published satellite figures, global temperatures have fallen over the last decade. By this year we reached lows not seen since 1983. Turns out the 1930s had four of the ten warmest years in the last 100 years, the warmest was in 1934. I will admit that I don’t understand the global warming/cooling issue, but what bothers me the most is that everyone else seems so certain about a topic that is so complex. Whenever everyone has something figured out, I start to think that they might have it wrong. Hopefully my son won’t be ridiculed for thinking critically about the issue ~ I know I will be…
Why the BlogJam? Renovation!
November 25, 2007
Earlier this summer, soon after we learned we were having another baby, we decided it was time to find a bigger house. By June we found a new house and began renovating it just after the forth of July. This ‘little’ project resulted in a serious ‘blogjam’, greatly reducing the number and quality of posts I have been able to produce. Well, the project is finally over (or at a stopping point anyway). Here is a flickrstream of the process and here are a few before and after photos:
Unlimited Ideas, Limited Time…
November 16, 2007
OMG, we have so many ideas and so little time. For example, we hired a comic artist to create a comic called The Hall of Social Media a while back. I ran across the drawings earlier this afternoon and thought, ‘that was a cool idea, wonder why we dropped it?’ If I only had more time, the Hall of Social Media could be born!!!
Data Center Risk: CHILLERS!
November 12, 2007
Last night’s outage at at Rackspace data center at Heritage Business Park IV in Grapevine should be a wake up call to colocation customers around the country. Why? First, we need to look at what happened. Yesterday evening a truck drove into a power transformer near the building causing the power to go out. The backup generators started up and presumably allowed the facility to power its equipment. Despite the fact that the Liebert HVAC systems were running, the facility began to get hot ~ VERY HOT, VERY FAST! Rackspace had to make a quick decision to power down their servers, despite the fact that hundreds of customers would go offline including 37 Signals, Laugh Squid, and GigaOm to name a few. Why did it get so hot so fast?
It turns out that in most multi-tenant commercial property in the United States, the building owner provides chilled water so that tenants can run their HVAC systems. In general, most buildings do NOT put these chillers on power with generator backup. Tenants pay millions of dollars (and I mean millions) for backup power systems on the rare chance (rare in the U.S.) that the building might lose power. Most of them don’t realize that they won’t be able to cool their space after the power goes off. When Rackspace subleased the space Grubb & Ellis (Qwest’s representative) made representations that the design and construction of the building would allow for operation for up-to two weeks after a power failure. Robert Fulford told the the Dallas Business Journal that, "The good news for Rackspace is they got it for pennies on the dollar. Qwest spent a huge amount of money building out the space — I think around $900 per square foot. It’s unbelievable. If the world would end this center could run on its own for two more weeks."
Of course, as Robert notes, RackSpace didn’t build out the space, Qwest subleased 60,000 square feet of their 144,000 square-foot commitment in the park to Rackspace back in 2004. The building is owned by ING Clarion. Why is this important? Simple, no one is responsible. Was ING supposed to ensure the chillers were backed up? Did ING represent to Qwest that they were? Was Qwest responsible? By the time 37Signals sold me their hosted project managment service (BaseCamp) they assumed they were doing everything right. They paid EXTRA for top quality space, power and pipe. Rackspace paid EXTRA for a top quality facility. Qwest paid EXTRA for a great building and so on. You get it? Everyone made quarantees, promises and representations about the power ~ did anyone think to ask about the air conditioning? Is 37 Signals responsible to me for the outage? This one incident likely resulted in millions of dollars in loses, who is going pay?
Of course, this issue is not unique to Rackspace, Qwest or 37Signals ~ it is going on EVERYWHERE. Just last month the power to our building’s chillers was interrupted for more than a day and we learned that despite our expensive UPS system and generator, our HVAC system was going to blow hot air until the power could be restore (several hours later). You might as well not bother installing a millions of dollars worth of generators and UPS systems if you are not going to put ALL of your systems (servers, lights AND the entire HVAC system) on generator power. You can’t run servers in the heat, period. My advice to data center operators (and data center customers), talk to your landlord today and ask him if your HVAC system is using the building’s chiller and if it is is the chiller on a generator? Get him to show you, test the system and put it in writing. Just my two cents…
UPDATE: One of my readers passed along Rackspace’s Zero-Downtime Network Guarantee, talk about making promises you can’t keep:
100% Network Uptime Isn’t Wishful Thinking, It’s A Guaranteed Reality
We know that every second your network is down you’re losing opportunities, revenue and the confidence of your users and visitors. So we decided to do something about it. We designed and built the Zero-Downtime Network to minimize downtime and we are so confident about its capabilities that we guarantee we will give you money back if it goes down. And it works so well that we guarantee it.
Our 100% Network Uptime Guarantee — Every aspect of our Zero-Downtime Network makes it real:
- We use the network only for our customers’ managed hosting needs, never sharing it with telecom services or cable TV services that would negatively affect your service.
- The only bandwidth we use is high performance bandwidth, which usually isn’t the case with cheaper hosting providers.
- To provide multiple redundancies in the flow of information to and from our data centers, we partner with nine network providers.
- Every fiber carrier must enter our datacenters at separate points. This is to protect you from complete service failures caused by an unlikely network cut.
- You get the fastest and most reliable network connections because our Proactive Network Management methodology monitors route efficiency and end-user performance, automatically improving the network’s topology and configuration in real-time.
- We purposely underutilize the network, making it resilient to even the largest Internet routing issues.
- The network’s configuration, co-developed with Cisco, guards against any single points of failure at the shared network level. We even provide you with the option to extend it to your VLAN environment.
- Cisco and Arbor Networks continually work with us, creating ever-improving ways of monitoring and securing our network.
If we didn’t own and operate our four US and four UK data centers, we could never engineer them to the standards required to support the Zero-Downtime Network. We engineered them to never compromise security or redundancy. Ever.
Physical Security
- Keycard protocols, biometric scanning protocols and round-the-clock interior and exterior surveillance monitor access to every one of our data centers.
- Only authorized data center personnel are granted access credentials to our data centers. No one else can enter the production area of the datacenter without prior clearance and an appropriate escort.
- Every data center employee undergoes multiple and thorough background security checks before they’re hired.
Precision Environment
- Every data center’s HVAC (Heating Ventilation Air Conditioning) system is N+1 redundant. This ensures that a duplicate system immediately comes online should there be an HVAC system failure.
- Every 90 seconds, all the air in our data centers are circulated and filtered to remove dust and contaminants.
- Our advanced fire suppression systems are designed to stop fires from spreading in the unlikely event one should occur.
- All cables are securely tied down with cable racks suspended from ceilings, providing dual routes for all cables.
Conditioned Power
- Should a total utility power outage ever occur, all of our data centers’ power systems are designed to run uninterrupted, with every server receiving conditioned UPS (Uninterruptible Power Supply) power.
- Our UPS power subsystem is N+1 redundant, with instantaneous failover if the primary UPS fails.
- If an extended utility power outage occurs, our routinely tested, on-site diesel generators can run indefinitely
Core Routing Equipment
- Only fully redundant, enterprise-class routing equipment is used in Rackspace data centers.
- All routing equipment is housed in a secured core routing room and fed by its own redundant power supply.
- Fiber carriers can only enter our data centers at disparate points to guard against service failure.
Network Technicians
- We require that the networking and security teams working in our data centers be certified. We also require that they be thoroughly experienced in managing and monitoring enterprise level networks.
- Our Certified Network Technicians are trained to the highest industry standards.
Cash on Cash Returns at VCs are Horrible?
November 12, 2007
Fred Wilson has an interesting post that looks at the performance of venture capital funds in the aggregate from a cash on cash return basis instead of the more common IRR basis. Here is the chart from his post:
The chart shows that the venture capital business was a lucrative investment from the mid-80s to the mid-90s, offering a return between 2.5x to 5x on your money. Of course, starting in 1999 the industry has been a horrible place to invest your money. Fred sees light at the end of this tunnel explaining, “My expectation is that this chart will look at lot differently in three or four years and we’ll see a return to a money making business. But I doubt the numbers will get to where they were in the early/mid 90s.”
Happiness is a Business Decision
November 11, 2007
Most people don’t realize that happiness is a decision. Think about it, the hundreds of decisions you make each day can lead to happiness, sadness or more frequently something in between. When you run your own business the people you decide to do business with can have a big impact on your happiness.
When I was a young sales guy I would close every deal I could. It didn’t matter if the prospect was an SOB or a complete horses ass. To be honest, it really didn’t matter to me as I was just the “sales guy” and did not have to deal with the prospect after he became a client. Had my boss “nixed” a deal just because the prospect might be an unreasonable client I would have been furious ~ I might have considered quitting.
Two years ago we instituted a policy at Architel that the CEO (me at the time and now Scott) would have to meet the owner/ceo/partners of each prospect before they became a client. The idea was to limit the number of unreasonable people we had to deal with on a day-to-day basis. At that same time we took a hard look at our existing client base and made the decision to stop working with two clients who required a tremendous amount of patience to deal with. Almost immediately the management workload decreased and our level of happiness increased. It was more fun to come to work each day knowing that we were pleasing our clients instead of showing up each day wondering who was going be upset or angry.
Get it? If you stop doing business with unreasonable people going to work can be a lot more fun. Make sure you do the same ~ i.e. be reasonable to work with. We may give up a little revenue each month in exchange for happiness, but I guarantee it is worth it.
Pricing revisited: Lessons Learned
November 9, 2007
- Cash is king. Absence of cash is death.
- Gross margin is good. More gross margin is better.
- Gross margin is the best source of growth capital.
Perhaps not explicitly stated, but implied, the value of your company is heavily influenced by:
- The quality of your earnings.
- The rate of growth of your earnings.
All of this leads us to focus on one particular aspect of your business – pricing. Considering how important it is, you might anticipate that I have sage advice for you. Surely with over twenty years in this arena, and having participated in hundreds of pricing decisions, I must know the answer. I only wish that were so. What follow are some pricing decisions that didn’t quite work out as intended.
Case Study #1: The Inconsequential Add-On
An engineering software company developed and sold a package that added utility to the workstation for which it was intended. At the time, that fully loaded workstation cost about $35,000. We priced our product at $3,400. The rationale for this was two fold.
First, we sold the product through value-added resellers (VARs), and we gave them a 60% margin on our product compared to the industry-standard at the time of 40%. An extra 20% of $3,400 was thought to be a pretty enticing incentive.
Second, by pricing the product at less than 10% of the system’s price, we believed that the VARS would be able to tack it on to a workstation order, with an “Oh, by the way, we suggest that you [the customer] add this product to the order. It doesn’t cost much compared to the system price, and you will get more than your money’s worth from its added functionality.” Compelling logic. Severely flawed in the real world.
VARs want to close deals. VARs do not want to jeopardize a deal that can close, by trying to “nibble” a few more dollars from a customer. If a VAR can close on a $35,000 order, he will do so.
Also, VARs rarely (never?) do missionary sales. This is when something “new” is introduced to the market that requires nurturing and educating customers, with the time to close a sale measured in multiple months, if not years. At the risk of oversimplification (and the wrath of VARs everywhere), VARs like to take orders from existing customers. That immediately puts money in their pockets.
Case Study #2: When Is a Sale not a Sale?
Same company. Same conundrum. How do we motivate VARs to sell our product? Since there had been pushback on the price of $3,400, we decided we needed to increase the financial incentives for the VAR without actually lowering our MSRP, since we had deals in the pipeline at the stated price.
The answer? A limited-time six-for-five sale. We would give the VAR six products for the price of five, effectively a 17% discount. Also, we believed that if the VARs carried an inventory of our product, they would have additional incentive to sell it.
Again, compelling logic, and this time product began to move. Our sales were increasing on a month-to-month basis for four consecutive months. There were notable sighs of relief in the boardroom.
Then we started to notice an alarming trend. Our sales were growing, but our cash was declining, and upon inspection, accounts receivable (money our customers owed us) were increasing at an alarming rate.
What had happened was that the VARs saw a discount and took it, but had no intention of paying the invoices until they had sold the product to their customer (and in some cases, gotten paid by their customers). What we had counted as sales, the VARS looked at as consignments. In effect, we had created a rather expensive field-based inventory.
When this was all unraveled (and write-offs taken), less than 10% of the orders received during that time period were “real” orders. The remaining orders had been solely for the discount. While we were in the right legally, since the VARs were in clear violation of the terms of the sale, what were we to do? Sue our only customers? Not going to happen.
Case Study#3: Leaving Money on the Table
As you’ve seen, it’s pretty amazing how a bunch of relatively bright people, who have quite a bit at stake, can convince themselves of their collective brilliance, and be so wrong. I could continue along this path of self-flagellation, but I think you get the point, and dredging up these memories is starting to get painful for me.
I will now share a case study with you that started the same way, but had a much better outcome.
Establishing the initial price
In past articles I’ve talked about Automated Healthcare (now McKesson Automation), founded by Sean McDonald. The company was the pioneer in selling barcode-reading robots to hospital pharmacies. Since this was a new product in this space with few meaningful comparables from which to glean a reasonable pricing strategy, the management team had to make it up as it went along.
With that in mind, we had several objectives that at least helped us frame out thoughts. First, we would never sell a robot for less than what it cost us to make it. That meant that our alpha customers were going to have to agree to pay over $200,000 for something they’d never seen before, and that they knew was going to be a work-in-process, but I digress.
We also knew that the tipping point at which capital spending decisions in hospitals received intense scrutiny, and thus even longer selling cycles, was $500,000.
Further, we wanted to get $1 million of cash flow from each robot transaction over five years, and that provided guidance for pricing our maintenance contracts.
With those boundary conditions, we priced the two alpha products at $240,000 each. The initial beta product was priced at $320,000 and the last one, $430,000. The list price of the robot was established at $472,900.
Customers were willing to pay that (often with great reluctance, but pay they did, nonetheless). Our boundary conditions were met. We were happy and confident campers.
Changing the pricing strategy
About this time, we raised a significant amount of institutional venture capital in a round led by two out-of-town investors. They were much savvier about the ways of Wall Street than we (or so they claimed and we believed, at the time). They insisted that the large dollar value of our sales would likely make our quarter-to-quarter results relatively unpredictable, and that that profile would depress the valuation that the financial markets would give us at exit.
Therefore, Automated Healthcare shifted its entire pricing strategy to doing leases exclusively. While revenue would ramp up more slowly, and profitability on a GAAP accounting basis would be pushed back, this created a recurring revenue model that would have predictability and could support higher exit valuations.
Not wanting to get too far off track, the only way this could work is if a financial company were willing to buy our leases, so that we could get cash up front, even though we were recognizing the revenue over five years. Don’t let these details distract you.
We found such a finance company and we learned the art of crafting leasing deals that qualified for being purchased. How did we price the leases, you may ask? We took the $472,500 that we were getting from the sale of a robot, applied the various leasing company discounts, etc., and reverse-engineered a lease price that would yield us $494,000 in cash from the leasing company!
Note several things. We didn’t really pay much attention to our customers in doing all of this. We used the few data points of purchases at $472,500 to assume that an “equivalent” lease would be accepted. Second, we got more upfront cash out of the leases than we did when we sold the robots! [There were some short-term cash flow consequences of this abrupt shift in strategy, but that is another story for another time.]
Setting a new sales price
In fact the leasing program was well received and we began taking orders on that basis. What we found, though, was that some hospitals needed a purchase option so that they could prove that the lease was the way to go. We pulled out our handy-dandy calculator, took our lease and calculated a sale price that clearly made the lease the preferred option. That price was $612,000, but we didn’t really care since we weren’t going to sell the robot anyway.
The revelation!
As many of you know, one of the appeals of the leasing option to a customer is that its expense can go through the normal operating budget and avoid the scrutiny of the capital spending approval process, staying below the radar screen so-to-speak. We found that some hospitals had found this practice running rampant and had prohibited leases.
When we approached these clients, we explained that we only did leases. They explained that they were only allowed to make capital equipment purchases. They asked for the price of our robot, and all we had to provide was that fictitious, reverse-engineered, ridiculous selling price of $612,000, since we “knew” that the sensible and supportable sales price was $472,900, based upon what we had been doing only months ago.
They bought the robot without batting an eye!
Where had we gone wrong? We had accepted the conventional wisdom that we needed to keep the price under $500,000 in order to get through the hospital’s purchase approval process. We never challenged that assumption. Shame on us! We were leaving at least $140,000 on the table!
With that insight and the superior execution of the Automated Healthcare team, the quality of our earnings made a significant contribution in justifying a $65 million price when the company was sold to McKesson in 1996.
Advice to entrepreneurs
- When establishing your price, talk to customers and others in the know to find out what “the traffic will bear.”
- If you need to sell through channels (like the VARs above), my experience says that you need to focus your efforts in getting the end user to “pull” your product through the channel member. I essence, you will need to do direct selling to prime the pump. Once the VAR is having some success (albeit because of your efforts), he will be much more likely to sell your product.
- Don’t get so enamored by the brilliance of your pricing strategy that you don’t get customer confirmation before you make a company-wide commitment to it.
- Always challenge conventional wisdom, accepted industry practices, and all other assumptions. Rarely are they as firm as you might first think.
- Gross margin is good.
Frank Demmler is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University.
Are you a start-up person?
November 8, 2007
Last year I asked, “Did you know, ‘A’ people join startups, ‘B’ people join big companies?”
According to Auren Hoffman “…big high tech companies are losing the talent war.” He suggests,
Big companies are losing their “A” players and they’re struggling to attract “B” players. In an industry where everything is about people, large tech companies are in trouble because they are losing the talent war. And keep in mind, an “A” player in an organization can usually produce the same results as three “B” players.
Auren goes on to explain that it is “irrational” for “A” players to join big companies such as Yahoo, Microsoft, eBay or Cisco. Instead “A” players are joining small companies where they can “have fun, pursue their dreams and actual get things done.”
His thesis is true for me personally (not saying I am an “A” player), but perhaps not for all “A” players. He goes on to explain that you will earn 10-20% less at the startup ~ if you work for me think 30% less (but of course there are the stock options). He suggests that if you
“…want to work less (or eat free gourmet food). If you are content with working 35-40 hours a week and are not interested in growing your career at this point in your life, then working for a large company is a good short-term decision.”
Interesting article from Auren (he is CEO of Rapleaf). What do you think?
Getting Small Fast Revisited
November 7, 2007
As a first-time entrepreneur, you must be able to look at yourself and your business from the perspective of those from whom you want assistance, particularly investors. You’ve read the business planning books, and you know that you need to develop a plan that shows that you can become a big business. In your mind,
big business = big market
which in turn leads you to build your plan around penetrating a market potential of hundreds of millions, or even billions, of dollars. Sound familiar?
With that premise, your business plan may contain a declaration that looks something like this:
“By capturing 0.5% of the market, we will achieve our conservative sales forecasts. At the same time, we won’t be on the radar screens of the major players and won’t be subject to any competitive pressures.”
Red flags are raised! Alarm bells go off! Risk meter pegs out! Ding! Ding! Ding! Plan goes into the wastebasket! That was quick (perhaps less than 20 seconds). What happened?
Investor Requirement #1: You’ve got to know your market
An investor will want to be comfortable that you understand the dynamics of your chosen market and that you can successfully build a business. How do you capture 0.5% of a market? If the investor were to provide you with the requested capital, what are the first three things you would do? Advertise? Hire a field sales force? How do you measure your progress?
The point I’m trying to make (and probably doing it poorly) is that a target of 0.5% market share tells an investor that you don’t really understand your market. In addition, it doesn’t give you the kind of focus that he knows you’ll need to be successful.
All of this adds up to risk that in the opinion of the potential investor may be enough to reject the investment opportunity without going any further.
Investor Requirement #2: You’ve got to have a practical business development strategy
You do need to build a case that your overall market is of a significant size so that you have an opportunity to build that big business that investors seek. You need “sex and sizzle” to attract the attention of the sophisticated investor. But once you’ve done that, you have to think small to get big. Let me explain.
Your challenge at this point is to determine meaningful market segmentation parameters so that the overall market can be divided into market segments. Next you have to define the niche within that segment that you will successfully penetrate because the members of that niche have specific needs that you can uniquely satisfy.
Bear with me. I’ll walk through an example that I think will help you “get” this.
Investor Requirement #3: You need a plan that you can execute
As noted above, a target of a market share of 0.5% doesn’t give you much help in conceiving of and developing a plan that you can execute. But, if you do a good job of identifying your niche, you can develop such a plan.
An investor will want you to be able to answer the following questions:
- Who are your immediate prospects, by name?
- Why is each likely to buy from you?
- What individuals in the prospect company will be involved in the purchase decision and what role will each play?
- How long will it take to receive a firm order?
- How many prospects will become customers in the first three, six, nine and twelve months?
You can answer these questions if you are focused on a niche. You can’t if you’re trying to get 0.5% of a market.
An Example: Automated Healthcare, Inc.
Sean McDonald, founder and former CEO of Automated Healthcare and current CEO of Precision Therapeutics, taught me these lessons. When I think back on those early days of the company, I marvel at his audacity and wonder how the heck he ever convinced me to lead the investment in his company. In essence, Sean said, “I’m going to sell robots to hospitals for $1 million,” and I believed him!
In 1990 there were close to 8,000 hospitals in the United States (or so I recall, perhaps in error). That’s a pretty well defined market, but not very useful. Of those, less than 1,000 had more than 400 beds, which meant that they were big enough to justify and use a robot. And so it went, until he had defined a universe of perhaps 25 hospitals that met the company’s requirements. Among those requirements were:
- Hospitals in which the director of pharmacy was a significant player.
- Hospitals in which pharmacy directors would “get it” (the inherent benefits of automation and barcodes).
- Hospitals whose purchase of the AHI product would give the company credibility and would serve as references to other hospitals.
Of the company’s first ten customers were four of the past five presidents of the American Hospital Pharmacy Association. Now, that’s a niche! The company’s success with this initial batch of customers provided the foundation from which a broader market segment could be accessed.
The company was sold to McKesson in 1996 for $65 million, and I believe that McKesson Automation has over 800 hospital customers today.
To get big, you have to think small.
Summary
- The identification of a large market is necessary to attract institutional investors.
- Identifying a niche is necessary to formulate an effective commercialization plan.
- You build your business one customer at a time.
- Initial customers need to enhance your ability to attract future customers.
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