Max Revenue

CliffLooking
Let’s say you are a CEO of a rapidly growing startup (or a VC deciding whether to invest in a rapidly growing startup).  All the numbers look up and to the right. How do you know how big this company will get?

When looking at subscription-based companies (or any company that is based on Lifetime Value vs a one-time transaction) a few simple equations can help you predict your maximum engagement levels, maximum revenue or (in a future post) maximum EBITDA or profit.

In this post I’ll describe the equations first (sorry – have to go into a little math) and then discuss the repercussions.

The simplest equation is figuring out your peak or maximum engagement.  

Equation #1 – Maximum Sustainable Engagement =  1/CHURN x NEW GROWTH

To figure out the maximum sustainable engagement, take the reciprocal of your churn (i.e. 1/CHURN) and multiply it by your average new growth.  

For example: If you lose 25% of your customer base year over year and get 1000 new customers a year, your max customer size will be 1000 times 1/.25 or 4000.  At 4000 customers you will be losing 1000 (or 25%) each year due to churn which is exactly the same amount of new members you get.  

You can use a similar equation to determine your maximum revenue.

Equation #2 – Maximum Revenue = 1/(ARPU CHURN) x GROWTH x (INITIAL ARPU)

To determine your maximum revenue, instead of churn, use ARPU churn (Avg revenue per user) churn or the fraction of money you make per cohort in year 1 vs year 2.  For example, if you make $1000 from 100 customers in their first year and $800 from those same 100 customers in year 2 you have an ARPU churn of 20%.  ARPU churn accounts for not only churn in terms of inactive members but also churns in terms of less revenue per customer due to less engagement or declining purchases over time.  So if you are growing at 1000 new customers a year with a $10 ARPU (Average revenue per user)  in year one and  a 20% ARPU churn, without any other changes your company’s maximum possible annual revenue would be $50,000 or (1/.20 * 10 * 1000).

In both of these equations, the reciprocal of your churn (i.e. 1/churn) is your multiplier effect.  If you have a churn of 50% you maximum size is 2X your annual new membership. If your annual churn is 10%, your maximum size will be 10X your annual new membership.

So why do these equations matter?  First, by understanding your max sustainable revenue you can start to predict how big of a company you are actually building.  Second, if you play around with the model you will start seeing some key take-aways.  Specifically:

  1. Churn – not growth – is the key metric to building a long-lasting great business.  Increasing your growth or your revenue will linearly increase your market-size potential, but reducing your churn can grow it exponentially.  If 50% of your existing customers drop off each year, you have to make up for 50% of those customers each year before you can start growing.  On the flip side, if your customers stay 99% active a year later retention rate, you only need to make up for 1% of your existing base before you can grow your audience.   You can cover up the churn problem in the short term by growing quickly but eventually it will come back to haunt you.  (Note: this is one of the reasons I am so bullish on building fantastic long-term engagement.  Long-term engagement of existing customers is the key to long term profits – even more than new membership growth)
  2. Churn is the combination of both people who stop using the product AND a decrease in revenue.  Companies often think of churn as the % of customers they lose completely each year.  But real churn is the amount of % of revenue you lose each year from each customer.  This is particularly true for ecommerce-based and entertainment-based companies where customers may still be active but just buy less in year two than they did in year one.
  3. All else being equal, all companies that have churn in a steady state have a maximum size.  If you are losing customers (or revenue per customer) each subsequent year, you will have to make up for it.  Eventually the existing customer base will get so large that the company can only replace its churning revenue and basically be running to stand still

I find it interesting that a large number of investors, press and potential employees considering companies overlook these numbers and just look at the hockey-stick rate of growth.   In my mind they are missing a key component that may eventually come back to haunt them.

In future posts, I will delve into more of the details on how you can more accurately estimate churn, and growth rates and eventually start predicting the max sustainable EBITDA.

Notes:

  • The Max Revenue model is a simplified equation.  In particular, it assumes long term industry growth is similar to the discount on future revenue.

The Limits To Viral Marketing

wildernessculture-rei1440project-welltravelled-awesomeearthFor the last few years virality has been in vogue.  Talk to almost any consumer or small-business-based startup and they’ll tell you that their marketing plan is to figure out how to grow by word of mouth, become viral (so that each person who joins brings in at least one more person) and then sit back and watch their customer-base exponentially grow.

Virality is a great cause (and often difficult to achieve) but it is almost always fleeting.  You can be viral to start off your membership base but you will almost never remain viral for long.

Here’s why: When you first start becoming viral, your users can reach out to a pool of 100% of potential new users.   As more people sign up via viral channels, the number of potential new users decreases since more people become existing members.  As a result, whereas someone might have originally been able to introduce 10 new people to your service, they might only now be able to introduce 9, 8 or 7 (since the rest already know about it and have signed up).   

A company that starts off with a K-coefficient of 1.1 (i.e. 1.1 new people sign up for every initial signup) will stop being viral once less than 10% of its target audience becomes members. Since the available pool of new members decreases by 10%, you will end up with a K-coefficient of less than 1 and your growth will soon start to decelerate.  A company with a K-coefficient of 1.05 will stop being viral after only 5% of its target audience becomes members.

In fact the only companies that continue to grow by word of mouth in the long run are those that both have absurdly high virality coefficients – think messaging companies like WhatsApp and Facebook –  and are in huge markets (think global population).

Reaching viral growth is a noble goal and definitely can help kickstart your company.  But keep in mind that it will only get you the first set of customers of your total audience.  

Creating vs. Disrupting

The word “disrupt” is everywhere these days. In Silicon Valley today you can’t spend more than 5 minutes in a coffee shop without hearing someone describe how their company is going to “disrupt industry <fill in the blank>.”  Entrepreneurs and business school students are repeatedly taught case studies of companies who ended up “disrupting” markets.  It’s even the name of TechCrunch’s popular startup conference.

Disrupting a market to improve it is definitely a difficult and noble cause.  But Silicon Valley’s obsession with focusing on disruption is leading people in the wrong direction.  You don’t build the biggest companies purely by focusing on disrupting an existing market.  You have to come at it from a different angle.

Here’s why:  Thinking purely in terms of “disruption” psychologically limits your direction and potential. If you are just thinking about disrupting an existing industry, you will tend to narrow your market size to just the current market’s customers and their needs.  And product-wise you are led to think of big improvements to current products (i.e. “How can I make a faster horse & carriage for people who currently use it” or “how can I build a better flashlight”?) vs thinking of something completely different.   For example, ten years ago, if you were trying to disrupt the personal flashlight industry would you have thought of developing an iPhone?

Most of the most successful Internet companies today did not find wild success by just taking over old industries — they found it instead by first focusing on creating a new market where nothing previously existed.  They targeted the customers who were not currently served and found a better way of serving them.  And in the act of creating that new market they ended up disrupting many existing markets along the way.

Much has been said about how Uber, Lyft and other ride-sharing services – today’s poster children for “disruption” –  have “disrupted”  the taxi industry.  Yes, people are now definitely taking Uber and Lyft instead of taxis. But they are also using those services in ways in which they never would have used a taxi.  Commuters are taking Uber and Lyft instead of driving to work and paying hefty city parking fees.  People are now choosing Uber over walking, taking the bus, or just not going somewhere.  And the designated driver is getting replaced by the Uber driver.  Uber/Lyft have not just replaced the Taxi service, they have made personal transportation so convenient and inexpensive that they serve a market need an order of magnitude larger than just the one served by yellow cabs.

Other highly successful companies have similarly disrupted an existing industry by creating a new one. Apple’s iPhone is used for so much more than a phone, AirBNB is addressing a much larger market than just hotels, Pinterest is used for much more than pinning images, and Facebook was used for much more than the original college picture directory or “Facebook”.

My advice to executives, product managers and entrepreneurs:  When you are thinking about building out your new enterprise, don’t limit yourself to “disrupting” an existing market and the people who are already served.  Instead, focus on creating a new industry.   Look at who is not being served and go after them instead.  You far more likely to come up with a much larger idea and business .

Takeaway:

  • Disrupting an existing industry is too narrow of an approach.  Think about creating a new industry serving people who could not originally be served.  You’ll end up with a bigger total market, a more creative solution and a willing audience eager for a new indispensable product.

Do You Believe in Magic?


sparkles

 

I have been helping a few startups try to reach product-market-fit and have encountered a common theme: everyone is too tactical.  Discussions quickly digress into incremental benefits and features.  Attend any company’s product meeting and you’ll often hear debates about adding Feature X vs Feature Y based on criteria like development time and which one the customer would prefer.

Want to build a truly great customer experience? Stop talking about features – or even benefits – and start talking about creating an overall “magical experience.”

Think of it from your customer’s perspective.  Ask customers to describe their favorite products and they will almost never list out features.  Instead they describe an experience that is so amazing and so over-delivers on expectations that they can’t help but feel like something magical just happened.

Some examples:

Uber:  Need a ride somewhere? You used to have to wait for a cab and hassle with cash payments.  Now just push a button.  A personal driver *magically* appears and takes you wherever you want to go.  When you arrive you just get out.  The rest is all taken care of.

Sprig/Munchery:   Need dinner? Don’t think about cooking or calling for delivery. Choose a picture of a beautiful meal prepared by a professional chef.  Push a button and it *magically* appears at your house in 30 minutes.

Amazon Prime:  Need to buy something?  Don’t deal with the hassle of driving to a store and parking.  Tell this website what type of item you are looking for.  Then push a button and in 48 hours it *magically* appears on your doorstep.

At their core, almost all of the most used Internet services today are defined not by their features but by an experience so impossibly simple it just seems magical.

So what makes an experience magical?  Three key elements:

  1. It’s absurdly simple. Something as simple as “Push a button” or  “type in a word” or “wave a magic wand”.   Any work required by the user and the magic goes away.
  2. It’s doing a task that is normally hard. The harder the task feels to begin with, the more magical it will feel to make it simple.
  3. It’s helping solve an important need.  If the task you solve is not important you’ll get a nice “wow” but it just won’t have the same emotional appeal as fixing something that matters.

Before you create incremental features, take the time to flesh out the ideal “magical experience” for your customer.  What very difficult, important task are you going to make impossibly easy?  Ask your customer “If you could push a button or wave a wand, what would you like to have happen?” It’s a much easier way to figure out their most pressing problems and their ideal solution.   Then back into what exact product changes – feature additions, changes AND removals –  you need to make that happen.

Takeaway:

  • When building your roadmap, rather than focusing on features, focus on creating an experience your customer would describe as “magical” – then back out the minimum amount of features or changes to make it happen and remove everything else.

 

Smart Tips for better customer feedback

My latest post, 6 Smart Tips for Better Customer feedback, is now on the Inc.com website!

Three of the tips are:

1. Keep customer support in-house and staffed by smart people.

2. Initiate customer conversations yourself.

3. Test constantly.

To read more about them, check out the article.

 

First Impressions

At Shop It To Me, we are constantly experimenting.  It’s one of our core values.  In fact, as of this morning, we have 24 different A/B experiments running on different parts of our site.    Each week we probably add anywhere from 1-5 new experiments to our testing pool (and take out 1-5 old ones).  We experiment not only with small features but big ones too.  At any given time have 1-2 completely new products that we are testing with a subset of our users.

But unlike a lot of companies who announce any new feature or product, we don’t announce even our biggest products when we first put them into the wild.   Even though we have press asking for new things and we could get a great “usage spike”  we actually tell our PR team not to talk about them until the time is right.

The problem is, until you have nailed the product, a press “spike” is just a spike.

Now don’t get me wrong, I’m not a big fan of the “stealth company” technique — companies that promote that they are doing something amazing but won’t tell you what they are doing.  I think these companies actually set such high expectations it is really hard for the user to beat them.

But I am a fan of not announcing a new product until we are pretty sure it is a hit.  Why?  I am a big believer in the disproportionate power of first impressions.  Humans are hard-wired as a species to take a tiny bit of data and extrapolate big decisions/impressions from it.    It’s leftover from when our ancestors had to quickly decide if a creature is predator or prey, and it is still in almost all of our decision making.

We make significant long-term, big decisions based on only on a first impression all the time.  Have a terrible first date and there’s a pretty high chance you will give up before going on a second one (even though even your “soul mate” and you are likely going to have bad days together).  Try out a new restaurant and have a bad service experience and you likely won’t ever return — even if they later get great service reviews.   And in business, start off a presentation poorly and much of your audience likely stopped listening  (and will rate it poorly) even if remaining 80% is amazing.

Remember that before spending loads of money announcing your next product. If someone tries your product and just likes it (or thinks it is mediocre), you have likely given them the permanent impression that your product is just OK.  They won’t return.  On the other hand, get a user to have an “I LOVE THIS!” first impression, they often will still have positive impression years later.  We’ve seen this time and again —  our best users are the ones who found something they wanted to buy in their first emails.

So before we turn on the PR machine for a new release and send it to all of our users, we make sure that almost anyone who sees the product is going to have a great first impression — such a good impression that they want to keep using it (and hopefully tell their friends).   How?  We spend months usability testing the heck out of it —  constantly tweaking it with user-testers and thousands of random users and friends and family-members and even random people we recruit off the street (yes we’ve done that).  And we learn from them and make the changes that gets their reactions from “Meh” to “Like” to “Love” (a subject of a future post).

So while we may lose some “brand-awareness” and short term traffic from multiple product releases, we more than make up for it by having a product that for most people feels “pretty awesome” right from the start.

 

Blue Oceans

In my previous post I talked about how having a focus is super important to a product’s success.  The question comes, what to focus on?

Here’s one angle.

I have been a big fan of Kim & Mauborgne’s Blue Ocean Strategy since I first read it in 2008.  If you haven’t read it yet, I encourage you to get it.  The basic premise is well known.  Instead of competing on the same attributes for the same customers as everyone else (i.e. red ocean), go after the customer who is not served and focus on the attributes most important to them.     For example, take Southwest, who carved out a great business for themselves by competing not with other airlines, but for the customers who normally take buses and trains.  And there are dozens of other examples of companies who got their first foothold going after markets that did not really exist beforehand (Honda and racing motorcycles, AirBNB and the home-owner willing to rent on a nightly basis, Salesforce and small sales teams without IT resources).

When I started working on Shop It To Me in 2004, buying apparel online impulsively was a blue-ocean.  Online shopping at the time was optimized for planned purchases — electronics, books and DVDs. Comparison shopping sites ruled the day and few people (women included) thought of it as a place to buy clothing and certainly not impulsively.  I believe a 2004 survey showed that 75% of women would never buy clothing online because of fit issues.  Sites like Gilt Groupe did not exist; apparel retailers were still looking at the Internet as an experiment, and designer brands often did not even have a website let alone a store.   Investors looked at our service — a free personal shopper that would get people to buy items they didn’t plan on buying that day — as a novelty.  Who would buy clothing on impulse without being able to try it on?  47 of the 50 investors I pitched turned me down — mostly because they did not think impulse apparel purchases was a big enough market.

Today the impulse shopping space is a complete red-ocean. Hundreds of companies are trying to be in the “discovery” or “sample sale” space.   The fact Shop It To Me launched and built out our site before these sites existed gave us a huge advantage.  We were different and were able to build out our brand identity before the space got crowded.  It allowed us to grow our user base and leverage that base to make our future products even better.   Had we started now, we likely might not have separated from the noise.

When you think about the market you are in, instead of blindly going after the same customers everyone else is going after with the same features and attributes,  step back and think — who is NOT using the product?  Who is underserved?  Who do all of the competitors overlook because they are just not profitable enough?   What do those people value the most and what product would best suit them?    If you see an opportunity, sacrifice the “good users” and go headstrong into this new market instead.   Focus on just the attributes that will help those people and get them to pay up.  Keep building and take that market away.    The entrenched players won’t be able to compete and you may end up the leader of a new market bigger than the one that currently exists.

Focus: What is your product going to be awesome at?

One of the most important things to do when you are building a product of any size is to focus.   Pick the few things you are going to be amazing at and the many things you will not be.  It’s hard, but it’s the only way to succeed.

Try to be great at everything and you’ll end up with a mediocre product.  Focus on one thing to be great at and you have a chance to dominate your competition.  Why?  You can align your entire company (sales, marketing, product, dev) on just one goal and therefore do it so well nobody can compete.

Take Google Search.  Since their launch their focus has always been one thing:  Get you an answer to your question as fast as possible.  Their home page doesn’t have ads or news or anything but one big search field.  Most of the features they add have traditionally been about making that better.  Or take Walgreens. They don’t have the best selection or the lowest prices.  But they succeed because they are the most convenient with stores on pretty much every corner.  They’ll pay up to be on every street corner so that at the moment you need something you first come to them.

When we are thinking of building out a new product, I generally ask three questions: Where do we want to Win? Where are we just going to Play (and be just good enough)? And where are we purposely going to Lose (and let someone else win)?  A great product will have all three.

At Shop It To Me, we want to win on personalization — understanding you, the consumer, like nobody else  and then showing you the most personally relevant items on sale.  And almost everything we do reflects that.  We launched first in a category (clothing) where personalization is super-important.  We require all of our users to tell us all of their individual preferences before they can sign up.  We have invested in sophisticated technology to figure out which sizes a retailer has available each morning and which are sold out so that your email only has items in your size.

When it comes to personalization — we purposely do the hard stuff.  Our system knows which items you have seen before so you don’t get duplicates and even tries to guess items and sales you might like based on not only your behavior but the preferences of others like you. We send millions of emails every day and each one is different —  individually personalized for its recipient.  It’s the reason why my mom, my wife and my teenage cousin can each feel like the Shop It To Me emails they receive are “just for them”.

To keep this focus, we are willing to give up on winning other things: We don’t have a celebrity promoting us; our site is pleasing but there are many that are prettier; we don’t include fashion advice or content in our emails;  our item pictures are good but definitely not the best.

And for many things that are critical to most shopping sites,  we are willing to lose completely:  we don’t play SEM arbitrage and our SEO is terrible.  Why?  None of these matter for a personalized product.  In fact, they hurt it.  Instead of optimizing for a transaction, we want to build a long-standing relationship with our users — and that requires a different type of interaction and focus.

In fact, I believe it is our unending focus on a personalized shopping experience that lets us succeed and thrive in a crowded marketplace.    While some companies have made personalization a feature (and are trying to shortcut it by guessing based on what you clicked or optionally asking you) — we have made it our core which means when it comes to building a product “just for you”, we can beat them every time.

So my question for you product managers out there:  What do you want to be awesome at?

How we celebrate the little things

Running a startup is definitely an emotional roller-coaster ride.  You are going to have really good days (like when you are featured on The Today Show) and a bunch of down days as well.

Your product development will always be much slower than you want;  you’ll put your heart into product changes you think are great but the customer balks at (or even worse, doesn’t notice).   You’ll put in an experiment “destined to win” until it meets the real world where it promptly loses by a large margin.  And as you go through the meandering customer development process of  learning what exactly the customer wants, it will feel like your  company is going nowhere.   Add that all up and if you are only waiting for the end goal it will feel  like it will never come.

So how do you stay optimistic and keep moving forward?

At Shop It To Me, instead of only celebrating the final goal, we make an effort to celebrate the little things.   We release new functionality weekly, and with every weekly release comes a mini-celebration (“Beer-Thirty”) — reveling in what was accomplished that week, the hard work that was put in, and the fact the product is (almost always) better than the week before.  We celebrate that we put the experiments in and found out the results even if they weren’t the results we actually wanted.

And we’ve been experimenting with another way of celebrating too — the “mini-milestone”.   Each product team comes up with a set of small milestones that are achievable in about a month’s time.  The milestones are not guaranteed to happen, but likely if everyone works hard (   examples include a set of features or experiments included or a metric goal that shows we are making some progress.) Each time we achieve a milestone. the team is given a small allotment ($250 or $500) to spend on the company and celebrate that milestone — they get to pick how.    The celebrations are usually not that big —  examples include a fancy brunch for the company or a Nespresso machine  — but so far the result has been super positive.  The team gets recognized for the work they have done, the entire company sees that progress is being made towards reaching our bigger goals, and after each celebration the teams are more motivated than ever to be hosting the next one.

How To Find Early Adopters For Your Internet Startup

I recently  came across a Brookings institute article on global happiness level.  The premise is simple (and well-documented from other books on the subject) — the human psyche towards happiness is incredibly adaptable.  People even in the poorest, most war-ravaged parts of the world have happiness levels as in the US because they have adapted to their environment.

The same is true with users of any software.   People have a fantastic coping mechanism to be “complacent”.  People “like” their existing email provider even though it might put 30-50 spam emails in their inbox each day because they have grown used to it.  They can’t imagine anything different.

But every once in awhile you’ll find someone pissed off with the status-quo.  They’ll either be doing something on their own to make it better, or just vocally complaining about it.  THESE are the people who are your early adopters — the unhappy people.    When you first put a new product, it’s not going to be perfect.  There are going to be major parts you’ll need to either add or change .  Don’t test it against the mainstream user as they don’t know there is a problem.  Ask your friends and check discussion boards and Twitter for the people who are not happy with the status quo and test your product with them first.  You’ll learn a lot more about the unserved problem and ways to fix it.

Then once you have nailed the solution, go after the mainstream “complacent” user and show them just how much  they are missing.