This week on the startup to scaleup journey:
1. Insights of the week
Competitive positioning; the USP and the moat
Early stage investors will sometimes tell founders not to get too distracted by competition. Instead, they want you to focus on developing the product, engaging with customers, and building out the vision. The words that one major startup accelerator - YC - uses are unequivocal: “Ignore your competitors, you will more likely die of suicide than murder.” Whilst the sentiment is understood, it should only apply if you have done your competitive research first. If you can't convince yourself that you are building a business that can become a leader in its space, you have no right to try and convince others. You have to assume that there are going to be other companies trying to do the same thing as you, either at the same time, or at some later point once they see it’s successful. Competitive leadership will therefore require clear differentiation on two fronts: First, a clear USP that will open up the market to drive early growth, and second, the creation of a long-term defensible position - a 'moat'.
The USP can be a key product capability or feature that gives you a calling card to make the early sale. In tech businesses this is often some form of IP that may even be patented. Sooner or later though, if the market is big enough, someone else will find another way of doing it. Over the long haul, it's becomes harder to gain leverage from what was a 'unique' capability at the start. A moat provides this long-term protection, but its creation is far more nuanced and is often a combination of factors. Examples are brand, embedding, and network effects. Brand creation is considered by some to wield less power in the online world and can also take considerable time and money to establish. Embedding works when you integrate your product into a customer’s operations so they can’t easily rip you out and replace you with a competitor (think Stripe for payments processing). A network effect is when another user makes the product or service more valuable for every other user, as we discussed in our earlier article.
So when Investors say you should not get distracted by competition, keep this in perspective. It may be useful guidance at inception but with each stage of investment, competitive positioning becomes increasingly important. It's usually a hot investor topic by Series A, as the market is often starting to wake up by then. The irony is that investors will see competition as a form of market validation, as long as they are confident that you have a strong USP and have plans to develop a deep moat. Putting competitive risk to bed quickly and confidently in the investor's mind is key. You can then focus on discussing operational execution, where the ultimate risk of failure is much higher. This is where the ingredients - the team, the product, the chosen point of market entry, etc. - are much more under your control. And as you execute these plans, you will then gradually and intentionally build the deepest moat, squeezing out the longer-term threats as the power of the initial USP inevitably fades.
The key to enterprise sales is understanding the enterprise
Startups building enterprise solutions must quickly become adept at B2B sales. And in big ticket deals, the target customers will almost certainly be major corporations. The payoffs here can be huge, not just in terms of early revenues but the kudos that comes from having marquee customer logos as references. If you find product-market fit for Tier 1 customers and their problems, everyone else downstream should be much easier to convert. But the Tier 1's are going to be the most demanding - and the most pedestrian. Figuring out who to target, how to qualify, how to design and execute an engagement, and then finally get paid, can be a daunting and time-consuming challenge. The process can sometimes be so painful and frustrating that startup founders are forced - out of short term financial necessity - to lower their sights to SME targets. Whilst there is something to be said for cutting your teeth with less demanding customers first, you may never accrue the understanding necessary to address the complexities of doing business with the big players. If you are aiming to build a high-growth global business, investors will want to see this capability from a very early stage.
Savvy founders that don't have direct experience of enterprise sales will look to hire a business development (BD) specialist. These are not sales people. Sales people sell what you have. BD people sell what you don't (yet) have - a full solution. Making the right hire - and early enough - can be make or break for a startup addressing B2B markets. The best BD practitioners are experts at 'value selling', borne out of years of training and application. They unearth the value propositions for both the customer and the executive sponsor - the individual who will drive the deal to completion. These internal champions steer the project through the tricky corporate minefield, driven by strong personal motivation. This is usually linked to becoming the company 'saviour' for the problem at hand. The unique attributes of the product (the MVP in the very early stages) will unlock the door, but an understanding of the internal politics of the customer will be essential to keep the door open. Hidden forces will try to shut it at every turn. The champion becomes a vital collaborator and experienced BD operators know how to manage them and the associated sales process.
Politics can be a huge thing inside big corporates. These are the hidden motivations that influence key decisions and protect the status quo. They are part of the DNA and can't easily be removed, so startups must understand how they can be leveraged. Experienced BD execs are not just skilled at qualifying the business opportunity but qualifying the sponsor's informal power in the political 'system'. The more senior the sponsor the more likely a startup will be aligned with the right political forces. Junior sponsors are also more likely to be reallocated at short notice - often leaving your project rudderless. Successful BD operators use all these insights to ruthlessly manage the opportunity pipeline for the startup. This is the revenue dashboard that communicates deal status, key dependencies and critical actions required. Realism over how this pipeline will then convert into wins and ultimately generate revenue (and cash) becomes a cornerstone of trust with the board and investors. Startups must quickly grasp that successful enterprise sales requires not just a killer product but a BD capability that can apply a value selling approach at both the company and sponsor level.
A proper financial model is a funding power tool
Just about all VCs will say they take financial forecasts with a pinch of salt. Founders misinterpret this as meaning that financial forecasts don't really matter. As a result, many startups don't put the effort into creating a proper financial model, or if they do, it's done as box-ticking exercise rather than a serious piece of investment preparation. The consequences can be severe. At Series A, not having a proper model will almost certainly be a showstopper. Even at Seed, you will likely get heavily marked down. So, what's going on here? Why are investors so keen on evaluating your model if they don't think your forecasts will ever materialise? In short, the financial model is hugely insightful to investors as it reveals how the founders think.
Creating a financial model requires the founders to translate their business model into numbers. That means all the key assumptions around revenues, costs and cash must be quantified. The important relationships and sensitivities between the P&L, balance sheet and cash flow forecast then become clear. This reveals key insights that investors will care deeply about. These are typically macro-level issues to start, such as: Capital intensity; How much cash is needed before the businesses is self-sustaining? Economies of scale; Do margins increase healthily over time? Capital efficiency; Do revenues cost less to generate as the business grows? Cash burn; How quickly will the business run out of cash if we miss the revenue forecast by x%, y%, z%? And most tellingly, what has to happen for this business to reach $100M in revenues? In other words, can this potentially be a $1B valuation business in say 5-7 years? Easy scenario planning like this is a must.
The act of gathering all these financial assumptions in a proper financial model also says a great deal about the rigour with which the founders approach the business - the attention to detail and the operational discipline that imbues investor confidence. This is not about being held to a specific number but about having a vision for a business that is economically viable and has real scaling potential. It also shows you are not trying to hide the past. Any good model will have at least 2 years of history so trends can be easily identified. The investment in time to create the model then pays dividends right through the funding process and beyond. Most importantly it can be used tactically by founders in the early stages of the funding campaign: It's a tool to re-engage after the first meeting, providing another opportunity to tell your story about where the business is heading.
2. Other pieces really worth reading this week:
The VC Guide to Mergers and Acquisitions
From Notion Capital, a new report on the ins and outs of M&A. "A number of our portfolio companies have made acquisitions and in all cases they have had a positive impact on underlying performance. We think more high-growth startups should be thinking seriously about acquisitions as a business strategy. At the very least, it should become part of the entrepreneur’s everyday role to evaluate the opportunities in the market and consciously decide not to make an acquisition, as opposed to inaction being the norm."
VCs: Competing To Win Deals
From legendary VC Fred Wilson, some powerful insights into VC behaviour: "...So I clicked on the link to my 'Competing To Win Deals' post, which I wrote in 2010, and read it. I often read things I wrote a decade or more ago and cringe at how out of date they have become. Not this one. It is as relevant today as when I wrote it almost twelve years ago. So I am reposting it below." See this timeless post here.
Transitioning to Usage Based Pricing
From the OpenView blog a case study in shifting to a usage based pricing model: How Algolia Built Their Most Customer Friendly Pricing Model Ever. "Remember that PLG (product led growth) is a long-term game. When you move to a usage-based model, it will take time for new customers to ramp up their expenditure. If you are coming from an SLG (sales led growth) business, revenue per customer might appear small compared to what you were doing before in terms of landing big customers. Be patient. It will pay off."
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