I did a lot of complaining last week on the hurdles of selling products and services to SMB’s. Typically, I hate people who spent most of their days trying to tell entrepreneurs why their business won’t work (“cause I’m so smart”) rather than working with entrepreneur on calibrating and sometime overhauling their strategies (“honest but helpful”). As a result, I wanted to put a lot more detail on this post than the previous one (btw this post is really long and not for the casual reader). Despite of the title, calling it a “solution” is a bit of an overreach. A solution implies a “cure” – we are far from finding a solution that any local startup can apply to be successful. Instead, think of the following as generic guide on making some key decisions that will improve the chance of success. Every company will face different constraints and thus will need a customized go to market strategy – simply read this post as generic “rule of thumb”. If you want someone to work through the problem – I’m happy to help – just email me.
The majority of companies selling to SMB’s have a recurring subscription business model (unlike Groupon). This is for couple reasons:
• The high cost (and sales cycle) of acquiring a new customer require a revenue model in which a sales person can build a “book” of revenue where existing customers (with no incremental acquisition cost) are a significant majority of that book. Hopefully creating a situation where sales cost can be amortized across the whole book rather than just the new customers.
• A recurring pricing model also reduces the upfront cost and thus risk of purchasing a product or service from the SMB’s perspective. Ideally helping to lower sales cycle and increase conversion.
Unfortunately this also creates a couple death traps for local startups.
• Customer Retention – Retention rate (or churn rate) will make or break a company. If the retention rate is too low, the company will end up with a “leaky sieve” where customers are churning out at the same or faster rate than it is adding new customers. The very goal of building a “book of business” never happens.
• Capital Intensity – Adding in COGS with sales cost; in almost all cases, the company is losing money on each and every customer it acquires initially and not breaking even until 6 or 12 month later (if ever!). To achieve growth expected in the internet industry, startups selling locally need to invest significant capital to build sales forces (which translates needing to go beg for lots of VC money) even in the best case scenario. In a capital constrained environment, like we are now, once promising companies might never get the capital they need to achieve scale.
The exceptions to the subscription business model rule are companies selling a product with gross contribution margin of over $10K per sell and extremely short sales cycles (e.g. daily deals in the early days) or retail products with huge scale & market presence (like QuickBooks). In most cases, the subscription business model is the most prudent solution, and the only way out of the death strap for a local startup is to first prove the “product – market fit” through comparatively high retention rate and low sales cost with a small set of customers and use those metrics to raise venture capital for additional capital to increase sales scale. Yes, quaint (and obvious) but true – don’t invest for scale until you know the business model works.
So the question now is how do you go to market? It all depends on bunch of contributing factors.
Self Service – As I alluded before, self service is really hard to pull off, but it’s not totally impossible. QuickBooks, GoDaddy, ConstantContacts are all large, profitable, franchises. More recently, Web.com, Webs, and Weebly (I am so confused by these names) have made self service a key part of their strategies as well. The single commonality between all these companies is that they are selling seemingly “commodity” products that all SMB’s need (so the education hurdle is low) but focusing differentiation around usability and ease of use in order to drive higher conversion rate. Furthermore, they either have disportionately large brand equity compared to competitors and/or a way to generate significant organic traffic through the top of the conversion funnel. Lastly, more often than not, the average monthly selling price for these products is in the sub $100 range so that credit card payments is possible (no invoicing) and risk for trialing the product for the SMB is low. Given the relatively lower cost of customer acquisition without a sales force, annual retention rates for self service companies can be comparatively lower than other channels. And vice versa, given the lack of a “high touch” approach to selling and servicing customers, retention rates are naturally low as well.
Monthly Price: <$100
Monthly Net Margin Contribution (Gross Revenue – COGS – Sales Cost – all other variable cost): $20 – $80
Direct, Phone – Telesales (aka inside sales, phone sales) should always be the first channel a local startup attempts to enable and perfect. Inside sales people are significantly cheaper than an on-the-ground sales team; furthermore, an inside sales person, on a good day, can contact over 15 potential prospects per day while on-the-ground sales team might cover 6 prospects at best. The other advantage of inside sales is that you can actually run through enough pitches (and control the messaging enough) to create a large enough sample size to do A/B testing on collateral, messaging, consultation question, and script. Also, use either an easy screen sharing solution, or have an easy url to share to prospects that quickly communicate value proposition and demo the product. Be forewarned though, with daily deals companies burning up the phone lines, its really hard to get someone on the phone for more than 5 minutes (hanging up is easier than telling someone to leave the office). Plus the more complicated the value proposition the harder it is to properly sell & close over the phone. Any product that charges more than $300 per month will also have a hard time since very few people will purchase services or products over the phone for more than $300 per month. My other advice is to treat these calls as an exercise in lead generation & nurturing – atleast get an email address that one can email offers and additional education to – you never know when someone is ready to buy after a product achieve additional market mindshare.
Monthly Price: $100 – $300
Monthly Net Margin Contribution: $50 – $240
Direct, “Feet-On-the-Street” – Feet on the street local sales forces are quickly becoming extinct. The main driver of this trend is the continued fragmentation of product & services sold to the SMB. In local advertising, for example, the only media with enough scale used to be the print YellowPages and maybe the local newspaper – today, to cobble together the same reach & conversion – a SMB might need to advertise in 3-5 different medium from multiple companies in order to achieve the same scale. And ofcourse with the same spend split between multiple companies – none of the companies are able to maintain high enough profitability to continue to grow their sales platforms. Local on-the-ground sales forces are expensive – step function more expensive then telesales. As a result, creating somewhat of a Bermuda triangle for products providing net contribution margins of between $300 to $500 (roughly translating to monthly price of $400 to $700). For a local startup, either stay below the $300 price with a telesales team or move up to offering a product or service in the $700+ price (depending the marginal contribution could be much higher price) with a direct feet on the street sales force. With such a high sales fix cost, not getting caught the previously mentioned retention trap is incredibly important. If a startup cannot achieve roughly around 70% retention, it will not be able to continue to invest in the growth of its salesforce in the long run and must rely on outside capital to sustain itself. (for finance geeks, a negative EVA)
Monthly Point: $700 – $2,000+
Net Margin Contribution: $500 – $1600+
In many ways, local does not exhibit the typical dynamics you would expect for an Internet business such as network effects and high viral coefficients. Scale is linearly dependent on sales people and value is often constrained by one’s ability to reach the target audience. In local, everything is hand to hand combat – there is no shock and awe, no easy solution. In the end, making a business work in local is not significantly different from running an offline business. You need to keep your pulse on all your metrics, how they inter-relate, and where you need them to be in order to achieve scale & profitability. (cashflow statement is more important than your income statement) There are no easy short cuts; no random superbowl ads (almost), no spamming tricks, no viral social integration etc. (but if you find one, please let me know!) You win one sales person and one conversion event at a time. Time horizon in local is long too, be prepared for the long slog. Groupon is really an exception rather than the rule (and you do have to give them tons of credit for scaling out sales at an almost humanly impossible rate). Yelp, after close to 10 years in business did only around $60M in the first nine month of 2011. This is more typical of the lifecycle of startups in local not Groupon. . . . want to start an e-commerce business instead?
Appendix: Model, Analysis, and Examples
The following section is a bit of an overkill (thus called appendix) but its Sunday morning and I’ve had enough of Thanksgiving family time . . . so I decided to hack together a simple per sales person economic model to make it easy for someone to quickly evaluate their go to market strategy and momentum. You should really stop here if you are not actively running or looking to start a new venture targeting SMBs – the discussions below are a bit esoteric.
The model is mainly useful for answering a few questions about the direct sales strategy (not self service) of a local startup.
1. Is it even feasible to launch a direct sales force? (given the product I’m selling and the results of my current sales trials)
2. Does my existing pricing level and retention rate enable me to build a sustainable business in the long run and continue to scale my sales force?
3. Given the current constraints of my business what retention rate do I need to achieve in order for me to scale?
4. When will each of the sales person I hire become cash flow positive?
5. How much invested capital do I need initially to boot strap my sales force?
6. Can my sales force eventually throw off enough cash to re-invest in its growth? If so, when?
Before we get started here is the Google spreadsheet where you can enter in your own numbers: Local Sales Analysis.
I’m going to plug in the model with a couple sets of assumptions just to show how it can be used.
The first sheet in the model (pic above) is for entering some basic information about your existing or planned go-to-market sales strategy. It should be pretty self explanatory but I did make some assumptions to simplify the model – that sales efficiency & retention rate stays constant over time, and that the all in cost of sales is about 1.5X of base salary (think laptops, health insurance, T&E etc). If you are serious, you probably need to build a much more sophisticated model with a lot more flexibility in the assumptions. (add in things like sales management overhead, office expense etc) Plus, the assumptions I am using above are impossibly optimistic – they are close to best case scenario (except for issues around addressable market given how expensive this product is).
The second sheet of the model (pic above) shows some basic output around revenue, contribution, and sales cost on a monthly basis. More importantly, it shows how a single sales person can break even and build a big enough book of business; in this case, by the 7th month to be marginally profitable (not including fixed cost). In that 7 month of ramp, you would have invested cumulatively about $100K on the sales person (in the real world, you might want to add in training costs etc). As a result, if you want to scale your sales 20 people at a time, you would need to find capital for atleast $2M (20 *$100K) to boot strap the investment for the first class of the sales team. Even more importantly, depending on how aggressive you want to be, between the 13th to 16th month, a single sales person would be able to generate enough contribution margin (either cumulatively or per period) for the company to hire another incremental sales person. For a venture startup, sustainability is not just about achieving profitability – its about eventually achieving hyper growth organically – i.e. without outside investment capital. If the initial investment was $2M for 20 sales people, at the very least, on the 16th month, another class of 20 sales could be hired without selling equity or debt.
Let’s make more realistic assumptions which will quickly show how fast the local sales business model crumbles.
The assumptions above are how a typical local online SEM or lead gen business operates. I took sales / month down to a more reasonable level, annual retention to 55% (its actually even lower than that especially with the bad economy), and added in media cost (buying traffic on Google etc) to the COGS.
Evidently, both breakeven and payback period is not even in the first year. (Month 23 is where the breakeven happens.) The only way a business with this type of dynamics can scale is with a lot of venture capital and blind trust. It’s not a good business to run or invest in. (Yes, the local lead gen/sem business is in need of an overhaul.)
The sweet spot in this equation is to have a product/offering that produces about $100-$300/month in revenue and 75% gross margins. With a lower price point, going to market with an inside sales model is possible thus reducing sales cost as well as increasing sales velocity. Ideally with a differentiated product and burgeoning brand, the startup is able to achieve annual retention rates of about 85% (at the height of print yellowpages dominance, the industry was able to get to around 85% retention rate). The beauty of this model is that even without outside capital, the company can double sales staff every 7 month or so (20, 40, 80, 160, 320 etc). Ironically, with retention rate so high, the risk for investors is low, making raising money an (relatively) easy task as well. There are a few companies focused on the local space that has spent their last 5-10 years slowly growing and perfecting their models. They did it without much fanfare but certainly are better investment options than some of the more buzzworthy local startups. With their key metrics stable and go-to-market strategy proven, it will be really easy for a venture fund to determine if additional capital can really turbo charge an already profitable business model. My favorite company fitting this mold is a company called DemandForce (they do have a mix channel strategy by now though) which was founded in 2003 and only recently raised money from some very well known VC’s (but kept it quiet) to turbo charge its sales force & revenue. Patience and discipline is an undervalued virtue. The last caveat I have is that VC firms like to invest in companies that are the “exceptions” rather than the “rules” – there is always the chance that a product is so groundbreaking that it doesn’t fit this model at all – in that case, throw it all away – just sit back and wait for the money to roll in