In the two previous articles I presented, David Skok 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 according to Skok 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.
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.
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.
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.
A key challenge for the startup CEO is understanding how to allocate resources, and where to set the accelerator pedal. Mr. Kok's 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 according to David Skok 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 have passed that point, but missed opportunities because they never changed gears.
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