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14 / Avoiding the startup graveyard

February 5, 2023
Stable Diffusion's “Startup Graveyard.”
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Welcome to Issue #14!

I’ve been thinking about what separates small companies (almost universally beloved) and big companies (loathed). I think I’ve figured it out, and it all comes down to The Great Value Swap. Small companies focus on creating customer value, which accidentally creates shareholder value, and big companies focus on creating shareholder value, which accidentally destroys customer value. I think a grand unified theory would unify customer value, shareholder value,and employee value. But for now, think of it as food for thought.

A Question

What is the price threshold at which your company could no longer afford to field a sales team?

A Quote

“The single most important decision in evaluating a business is pricing power.”

—Warren Buffett

Big idea #14: The Startup Graveyard

Two ingredients, a low price and a high-touch sales process, when mixed together create a poultice equal in its ability to seduce and kill founders and their companies.

Theory

Why it Matters: On the path to $1B in revenue, every company needs to figure out how they will get there. Will it be selling something for a lot of money to a small list of customers or selling something at a low price to an extensive list of customers? Depending on the answer to that question, a company has to decide how it will get customers to pay, and there are three choices, and choosing the wrong one can kill your company.

  1. Enterprise: A high touch-sales process means multiple meetings, often over months or even years. These sales are expensive, meaning the company needs an expensive product to cover the costs of the sale.
  2. Transactional: Some products can be sold in a 30-minute meeting or maybe two. The salespeople use a straightforward script and don’t require a lot of expensive training. As long as the company’s sales yield is >2, the company can afford to field a sales team. Refresher: sales yield is the fully loaded cost per rep divided by the revenue they bring in.
  3. Self-Service: A company can’t afford a sales team below a specific price threshold. For example, if your product costs $1K / year, even with “cheap” salespeople, they’d have to close hundreds of deals per month to get sales yield >2 (assuming fully-loaded cost = $150K, $1K / year means 150 deals per month for sales yield to equal 2). In this situation, a company needs a website that clearly explains the value so that customers can decide whether to buy on their own or with minimal interaction with a person, also known as “self-serving.”

If that’s the case, how do some companies end up in the graveyard? Who would try to field an expensive sales team for a low-priced product?

  • Before startups close their first sale, they’re in “discovery mode,” talking with potential customers to learn about the market, and customers’ problems, getting feedback on ideas and prototypes, and there’s a lot of pressure for founders to close their first deal.
  • The discovery process is almost identical to sales. Both involve talking to customers, figuring out pain points, assessing how the company could create value, and getting customer commitments on how much they’d be willing to pay for a solution.
  • The output of a good discovery process should be information on what the company can successfully charge customers. If that price is low, the founders must prioritize proving customers can buy it on a self-serve model. If the price is high, they need to determine whether it requires a simple (transactional) or complicated (enterprise) sale.
  • But what often happens in the low-ish price scenario is that the founders only pay attention to the fact that they can sell the product, even if they don’t cover their costs with the money that comes in, especially if they have a war chest of venture capital. For months, revenue goes up until the company goes out to raise again, only to realize that their CAC is unsustainable, they can’t raise money, and they don’t have enough cash in the bank to pivot to self-serve.

Practice

Within months of founding Mattermark, we sold subscriptions to our product for $500 / mo. or $4,799 / year. Our fully-loaded cost per rep was probably between $200 - 300K. At the lower range, that means we’d need to close ~3.5 deals per rep per month, and at the higher end, that means 5.2 deals per month to reach break-even, but we’d have to hit double that to hit traction. Our CEO closed between $500K - $1M in the first year, and I closed another $500K in under a year, putting us well above a sales yield of two, leading us to believe we were ready to scale a team of salespeople. But once we hired salespeople, it was a rare month that our reps could close more than five deals a month.

What happened was that the complexity of our sale in the early days, when we were selling to early adopters, was low, but as we crossed the chasm in our market, complexity went up, which caused our sales yield to drop. And when our sales yield fell, we blamed it on poor sales performance instead of recognizing it as a red alert. We either needed to simplify our sale, build a self-service path, increase our prices, or create more value via new features. The company tried all of those things, but it was too late.

I hope this serves as a cautionary tale, both the theory and practice, for founders to avoid the graveyard at all costs. Please print out this 2x2, post it at the top of your Notion, look at it every day, and figure out which of the non-graveyard quadrants you’re going to occupy and use to win your market.

Reads & Resources

Articles

In my last issue, I wrote about The Sales Learning Curve, a concept and paper that Mark Leslie co-authored. This piece, Leslie’s Compass, is a fantastic complement to this week’s big idea. The compass is all about the relationship between sales and marketing intensity, and the piece is full of great questions to ask yourself about your product and your go-to-market strategy.

From Twitter

Late last year, Gokul Rajaram (whose experience goes from Google Adsense to Facebook to Caviar to Doordash and more) shared that he’d been hearing Chief Product Officer (”CPO”) candidates that series B and C companies hadn’t yet found product-market fit (”PMF”). It seems CEOs are hoping a CPO hire will solve that. The tweet itself is good food for thought, as are many comments. My favorite? “Any CPO capable of finding PMF for a series C company is better off starting their own company.”

Audio

Since the theme of this issue is pricing and value, this brand-new episode on the history of the NFL is perfect. In their end-of-episode wrap-up, Ben and David conclude that The NFL may be one of a very small number of organizations that manages to capture all of, if not more, value than it creates.

Books

Naming is a pain in the ass. Thankfully, Eli Altman, founder of A Hundred Monkeys (a firm you can pay to come up with a name), created a workbook anyone can use to guide the naming process. I’ve used it myself, but trust their portfolio of names: Dolby Atmos, Standard Deviant Brewing (a favorite of mine), and more. The book combines theory on naming with exercises to help you think different about what to call your new thing.

Dice Roll

This is a bit of a deviation from management content, but I’m a big believer in managing ourselves first (as in: managing our health!). Hat tip to Brian Wang for introducing me to this app. It’s the easiest app I’ve ever used for tracking my macros (protein, fat, carbs). It’s beautifully designed and has been a helpful feedback mechanism as I’m trying to cut body fat and get healthier overall.

That’s all for this week. I’m looking forward to what’s next!
Andy.