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Category Archives: Go2Market – Sales & Monetization

self-service

The Enterprise Self Service Myth

self-serviceAs techies and nerds, we tend to believe in the utopians promise of technology enabling, at the very least, automation, and at the very best, intelligence. As consumers we have come to expect the “social contract” we have with the internet services we consume as arms-length “users” rather than as white-glove “customers.” As a result, as builders of magical web and tech products we come to view customers/users as an anonymous herd who must prefer to figure out what to buy and how much to pay on their own through endless screens of wizards, forms, and dropdowns instead talking to a human being. For consumer focused startups (e-commerce, social, gaming . . . etc) where lifetime monetization per users is at most in the hundreds of dollars, self-service transactions is an inescapable fact. But for entrepreneurs in enterprise markets, (saas, ad tech, b2b marketplace etc) we all too often believe self-service transaction and sales (usually in forms of some sort of purchase flow) is a development must-have rather than a feature to trade off. I’ve heard way too many entrepreneurs who believe the solution to building scalable sales channel is to not have one at all, but rely on potential customers to conduct the purchase with self-service via the website. More often than not, self-service transaction is a myth – a terrible joke and waste of time that many entrepreneurs and product managers come to realize only after spending months of engineering resources to find out no one cares.

Adoption. Self service is hard. More often that we think, customers or partners rather pick up the phone and have someone else to do the data entry for them. Take Google Adwords for example – after 15 years of being the only scaled source for quality traffic on the internet, less than 20% of its new customer revenues are from “self-service” – major brands and e-commerce/lead gen companies either uses agencies or have Google manage the campaigns for them. When startups that do not have the market leverage nor the history of value creation try to offer self-service, they must truly understand the transactional value of what they offer and the simplicity of the service they provide.

Price Discrimination and Value Pricing. Value pricing was one of the most important “innovations” of the late 90’s ERP boom. As it turns out (at least during that era), how much a customer is willing to pay for enterprise software is not how many engineers it took to develop it, nor the number of seats that the software is deployed to . . . but instead by the financial value/benefit the software can generate for the customer. Typically how this work is that a sales person will ask the potential customer a set of questions (product contribution margin, scale, sales process, cost structure, employee salary etc) and create an excel model to estimate the potential cost savings or even topline improvements the software can potentially bring if implemented. The sales person aims to charge between 10% to 50% of the value generated. The ironic artifact of this pricing scheme is that the sales process is more art and politics than it is science and math for a couple reasons. First, sales person is incented to go elephant hunting w/ the largest companies which typically have a much longer and convoluted sales process. Second, it is really hard to get customers to part with information that actually INCREASES the cost of their purchase – so it takes a really skilled and seasoned sales person. Using this technique, enterprise software companies can charge upwards of tens of millions of dollars per installation and generate tens of billions of dollars in revenue from simply targeting Global 5000 companies. It should be pretty much obvious by now that the process and outcome is pretty much impossible to replicate by building a bunch of web forms through self service.

Payment Method. A web self-service transactional funnel typically ends in a credit card based payment form. The other alternatives are not really optimized for self service – invoicing creates too much credit risk while ACH is not very secure for the enterprise applications. Given the typical limits on credit card transactions – the average transaction value is no more than $5000 and more likely in the hundreds of dollars range. Essentially a pricing ceiling is created when we forgo a sales person for a self service transactional funnel instead.

Sales Cycle. Enterprise sales cycles are measured in month – yet online web engagement is measured in minutes. Trying to force feed a “conversion funnel” into a month long decision making process is pretty much like threading a needle from a mile away. RFP type questions are hard to answer via a bunch of web pages – it is nearly impossible to credibly compare features, understanding pricing models, and understand technical limitations without a sales person hand holding the customer one step at a time via a series of meetings.

Decision Making. Enterprise decision making is not linear nor singular – but a website does make that assumption. That the user that is going through the self service transactional flow is the only decision maker and has the authority to pull the trigger on the purchase. This leaves a important part of the decision making process and their stakeholders up to chance where as a sales person can actually nurture and build consensus.

It is not to say that “self service” transaction will not work in all circumstances. In very very large horizontal markets where the actual number of potential customers is HUGE (in the tens of millions), forgoing the extraction of all the value of the product in exchange for sales and operational efficiency CAN work. Web analytics, web infrastructure, web site building, domain registration etc are all very large markets where there are just so many customers that a self service funnel actually CAN actually be a strategic advantage vis-à-vis a traditional go to market sales strategy. BUT only in very narrow set of B2B markets can billion dollar businesses be built on top of such low average transaction price. So chose your market carefully when trying to abandon the sales function for a self-service funnel.

Mobile, The Great Destroyer of Companies

350px-Kilroy_Was_Here_-_Washington_DC_WWII_MemorialMobile is broken. Mobile commerce is broken. Mobile advertising is broken. Mobile lead gen is broken. Mobile app discovery is broken. Mobile app pricing is broken. Mobile subscription is broken.

There is no doubt that mobile is going to be more than 50% of internet usage within the next 18 month. The problem is that consumer adoption has gotten way ahead of the industry’s ability to innovate and capture value . . . and the worst part is that the gap continues to grow. I’ve bitched about this problem a while back but I never expected the problem to get worse. Seems like not a day goes by that a web giant gets their market cap cut off at the knees because of the shift of their userbase to mobile (Google, Facebook, Zynga, Pandora etc). Let me count the ways. . .

Mobile commerce has largely been a mirage. Only the very few and the very large e-commerce companies has been able to actually make their mobile users “buy” on a mobile device. This is because despite of Apple’s protests, mobile has largely been a content consumption device – the very act of getting users to input credit card number and data to buy something has become a near impossible task. (try typing 16 consecutive numbers on the iphone without out screwing up – especially when predictive auto-correct is useless.) Only the very largest sites can leverage their existing user base (from online) to get them to login (a comparably easier task) and use existing credit card information they’ve stored to skip the credit card step. As a result, the long tail of mobile commerce has yet to appear – small e-tailers are not moving to mobile, and innovation around mobile commerce has slowed to a crawl. (side note, where is Apple & Paypal when you need them?)

Mobile advertising is also broken because neither direct response advertising nor branded advertising have truly scaled. When the internet world collapsed in 2001, the internet economy got back on its feet because; as it turns out, the web is a great place to advertise when you have something to sell. It all started with GoTo and scaled with Google. Despite the economic down turn, e-commerce companies and lead gen companies went head long into search and even display advertising to help create a “pricing” floor for most web based advertising inventory. Mobile, because of the difficulties of entering contact information and credit card information, simply haven’t attracted a significant number of direct response advertisers that are looking for direct ROI on their advertising spend. Because of the lack of a pricing floor, most remnant and network driven mobile inventory CPM’s has cratered in the last 18 month (plus the explosion of mobile usage also created a glut of inventory.)

On the top end of the advertising market where brand advertisers spend their $15 to $35 CPM’s, mobile is struggling as well. The original thesis around brand advertising was around addressability, engagement, and targeting. Turns out, brand advertisers want non-standard ad creatives and integrated marketing campaigns on mobile, just like that did online (hmm… should have guessed that one) – the addressability stuff is cool but not as interesting as whole screen take over, exploding, dripping, spinning ad units. The problem is that mobile screens are so small that it is really really hard to create the type of branded campaigns that advertisers (and users) love.  With Apple taking away UDID – the addressability / targeting value proposition is eroding as well. And thus the premium mobile inventory pricing continue to drop.

Everyone had thought that local mobile advertising would be the great savior of mobile advertising too. The thesis around geo and context based targeting has lot of promise. But to-date, no one had figured out the tactical portion of how to effectively sell to local advertisers and get the advertiser coverage and inventory density needed to actually run a campaign.

If you cannot make money by selling advertising space on your mobile app or website, maybe, just maybe you can sell your app on either one time or subscription basis? Well, the mobile app economy is pretty dysfunctional too. It’s pretty common for a developer/publisher to charge $30+ for a desktop application or game (go visit Fry’s or Gamestop) – but in the android and apple app store, if anyone tries to charge anything above $5, people screams highway robbery. The lack of true breakthrough revenue opportunity for developing mobile apps has given publisher very little incentive to advertise and build “franchises” that can charge a premium price . . . it’s a self-fulfilling prophecy. Even worse, Apple’s insistence on taking a huge cut of both onetime as well as recurring revenue from publishers effectively created a new virtual socialist state where 30% sales tax is levied on all transactions. Talk about killing innovation and jobs. . .

Now, here is the good news . . . the best and bravest entrepreneurs and VC’s look at structural problems in an industry as opportunities to innovate and exploit. Mobile is only in the 1st inning of reaching its full monetization potential. The first generation of mobile entrepreneurs focused on building companies that played within the rules inherited from the online world. The second generation mobile entrepreneurs will create new rules and platforms indigenous to the mobile world. A mobile ad network that converts. A new kind of mobile only ad unit. A distributed mobile commerce payment network. An alternative application discovery platform. An truly open mobile operating system. Fixing broken platforms = big ass opportunities.

Segmentegery – The Art of Segmentation

find-your-waldoPatrick Vlaskovits (Go Falcons!) was over at MuckerLab the other day talking to our companies about customer development which reminded me of the most important (only?) skill I took away in business school – segmentation. While “strategy” is the most over used word in business, “segmentation” is probably the most underutilized. It’s certainly not as sexy as “strategy” but it is the foundation from which any business is built. In a world of limited resources – a laser like focus on a few worthy target customers will help create efficiencies and purpose across the entire company from marketing, advertising, product management, engineering, – and yes, strategy.

The below are just some thoughts from Patrick’s presentation and my own experiences.

Choosing Segmentation Attributes

Its very easy to start the segmentation exercise thinking in terms of demographic information (my target customer is an Asian American male, 24-35, earning $50K a year etc ). Segmenting using these attributes is at best, lazy; and at worst, useless.

  • Does the difference in these attributes (male vs. female) explain the varying needs or pain points of each of the segments? E.g. I want widget X cause its cheaper vs. I want widget X cause it makes me look cool? If not, don’t use them.
  • Can my customers self identify through these attributes? Self discoverable attributes allows you (the startup) to qualify a customer/user through a simple questionnaire at the beginning of the engagement/funnel before investing too much resources in attempting to acquire that customer (or user).
  •  Are the attributes unique to the market you are targeting? If your market is the offset printing industry – talking about demographic information of the owner might not be an useful exercise.

The Anti-Segment

It is really hard to get started in any segmentation exercise – often the best way to build some momentum is to understand who are NOT your customers. In most cases, at the end of the exercise you should have significantly more “anti-segments” than “target segments” – otherwise you haven’t really made the hard choice of selecting your customers and truly understanding who your best users/customers might be.

The McKinsey “MECE” Test

Make sure your segmentation scheme (Anti Segments + Target Segments) is “Mutually Exclusive and Collectively Exhaustive.” Its really bad to “miss” a segment because 1) that might be the segment you should be targeting 2) if you or someone at your company come across an user in that segment but put them in the wrong bucket (cause nothing fits) it will actually give you false readings for your hypothesis driven market tests.

Iteration & Segmentation

I like teams that are able to iterate at a high velocity. However; all too often, I see companies endlessly pivoting from market to market without really understanding WHY their initial product didn’t achieve market fit in the first place. One of the area to dig into as part of the iteration exercise is to “re-do” your segmentation scheme. If the user feedback on why they did not adopt the product is inconsistent WITHIN a segment, its highly likely you’ve screwed up the segmentation in the first place. As a result, instead of revamping product drastically, or pivoting to a whole new market – try re-segmenting the target customer base, rebuild your value hypothesis for a new segment, and make it another go.

Acquisition Channel & Segmentation – The “Usefulness” Test

Often, the created segmentation scheme looks good on paper but ends up pretty useless in practice. When there are no efficient, obvious, and cheap acquisition channels to reach a particular segment – its better to start over than to over compensate with impractical or expensive acquisition campaigns. Large companies have the marketing budget to only reach 25% or less of their intended segment with a mass market campaigns – startups don’t have that luxury and need to hit at least 75% efficiency on its acquisition spend. In terms of velocity and iteration testing – it will be next to impossible to get the right sample size, speed, and feedback loop if the acquisition channels do not match nicely with your segmentation scheme. This is why I typically stay away from using psychographic profiles as part of a segmentation model – there is just no simple or efficient marketing channels to reach, as an example, “upwardly mobile jet setting urban gen X’ers.”

The LOCAL Innovator’s Solution

 

Hand-To-Hand-Combat-300x198I 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.

Business Model:

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.

Channel Strategy:

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.

Product: “Basics”
Monthly Price: <$100
Monthly Net Margin Contribution (Gross Revenue – COGS – Sales Cost – all other variable cost): $20 – $80
Retention: >40%

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
Retention: >60%

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+
Retention: >70%

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.

Example-1-Assumptions

 

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).

Example-1-Output-1024x147

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.

Ex-2-Assump

 

 

 

 

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.

Ex-2-Output-1024x186

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.)

Sweet Spot:

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 :)

 

Sweetspot-1024x332

 

 

 

The LOCAL Innovator’s Dilemma

By my count, around 100 startups focused on local were launched between Q2 and Q3 of 2011. there are mobile apps, deals/offers companies, social relationship management dashboards, ad networks, merchant acquiring/ processing solutions and more. (Although the slow down in the last 30-60 days has been seriously alarming). By 2013, I doubt no more than 10 of them will still be in business (and potentially none, if the Euro collapses – but in that case we are all in trouble anyway). Most would have gone out of business because they failed to solve the “Local Innovator’s Dilemma” – how the heck do you profitably acquire hundreds of thousands of SMBs when hundreds of companies large and small failed to do so in the past 20 years.

Many local startups founded in the last year or so since “So-Lo-Mo” got hot, have hit inevitable the wall. The valley is starting to wake up to how hard this problem is to solve.  Peter Thiel understands this problem.   He said, “High paid sales people can get big companies, mass marketing can get consumers, but it’s difficult to get small businesses.”

Dave McClure echos the same sentiment, saying.“We’re pretty bullish on Groupon and LivingSocial as being future platforms for local. Everyone thinks of them as buying platforms. We think of them more as small business platforms. If you think about it, in the U.S., there are millions of small businesses. These people have historically not been that easy to get to, so it’s been hard to have a business focused around small businesses.”

There are limited options to reach the SMB market, and all of them require significant acrobatics to work profitably:

  • “I’ll build it and they will come!” a.k.a self service – Self service for local rarely works – but entrepreneurs and companies, like Ponce de Leon – keeps on trying. Online merchants are able to focus on customer acquisition and marketing while the operations of their businesses are automated by the website. Offline merchants, on the other hand, have exactly the opposite problem –they must spend 9am-7pm everyday serving their customers or manning the register – as a result, marketing or infrastructure investments become their after hours activity. In such a context, the online solutions they are buying must be so simple and so obvious that “checking out online” is a no brainer (such as domain registration, email list management).  Even Google Adwords (targeting mostly online businesses, after more than 10 years of education) has less than 20 percent of their revenue from their self service operations – local compounds that problem by a magnitude. Even Groupon tried its hands in self service, before retrenching again. The reality is that local startups should be conservative and thus expect online self-service conversion rates to be less than one percent based on the industry average. And they must be creative in how they acquire that traffic (i.e., SEM is usually not the answer).
  • “Forget selling to an advertiser, I’ll outsource that problem to an (local) ad network” – This strategy is only viable for consumer application startups – if the startup is selling a service or applications to SMBs, they obviously need a sales force.  Here is some crazy math – it’s somewhat facetious but it does explain the scope of the problem.   Assuming an average of $2 CPM to generate $100M in annual revenue, an application would have to roughly generate 4B impressions a month or roughly 200M to 400M monthly unique visitors.  The only local mobile application close to achieving that scale would be Google Maps – for most local apps – it’s pure dreaming. Ad Networks are great to bootstrap your business and to augment your revenue stream – but it could never be the final answer in local.
  • “I’ve got $10M from a tier one VC, I’ll build my own sales force” – Oh boy, where do I start.  First of all, it’s a huge operational task. Second of all, even if you know how to build a sales team, can you make the sales rep commissions and ROI math work in the long run?  Again, some rough math: a sales person needs to make about $100K a year to feed a family and send his or her kid to college. Assuming sales commissions of 20 percent (generous), that means the sales person needs to sell $500,000 worth of products a year to make his number. Sales cycles in local are not necessarily shorter than selling to Fortune 500 enterprises.  A $10K outlay a year for a $1M business is just as big of a decision as a $1M expenditure for a $100M business. So assuming your sales person can close one sale a week (can they?), he or she would have to sell around $10K a year worth of “stuff” to an SMB for about $800 a month.  There are a couple of problems with this math. First, only about the top one percent of the SMBs can afford to spend $800 a month. Second, does your offering really provide at least $800 of value a month to the SMB?  The math gets even more complicated when you factor in churn rate – which will create significant leverage on both the negative and positive side.
  • “I’m good friends with the CEO, I’ll strike a reseller partnership with X company” (insert a newspaper, radio, or Yellowpages company with a local sales force) – Due to consolidation and attrition, only a few of these companies are left; as a result, there a lot less chairs than startups in this game of musical chairs. Furthermore, these so called “dead tree” companies are getting smart and smarter – the forward thinking ones have their own web/mobile development capabilities and management teams capable of dreaming up these ideas too.  The longer-term problem is that these sales forces are declining rapidly at a rate of 20 percent or more a year (because high margin “dead tree” products are dying), creating a huge vacuum in the overall marketplace for a uniform channel to reach the SMBs. There will be survivors and even winners, but I believe five years from now this channel will be less than 80 percent of the size of what it is today, and the start-up is either back to square one or has completely lost its leverage. In short, it’s a lottery ticket with an expiration date.

Building compelling local product is only half of the equation. Selling locally is even harder and is really how winners and losers will be determined. The best product will not win in local – it’s a critical part of the equation, but not the only part. If it was easy, it would not have taken almost 15 years since the dot-com era for Groupon and Living Social to “crack the nut” – and even now, their long term sustainability is still in doubt. At least in the short term, Groupon and Living Social have discovered a product that generates enough revenue on a per sale basis, with short enough sales cycle, to support a direct sales strategy at scale.

It’s easy to think that there is a pot of gold at the end of that rainbow given, let’s say, Groupon’s rapid growth – the reality is that the merchant acquisition conundrum is harder to solve than most entrepreneurs wants to believe. I’ve spend most of the post bitching about local as a homage to Clayton Christensen.  I still believe in “local” as an investment thesis and the opportunity for a startup to disrupt existing infrastructure and make a ton of money in the process.  It is not impossible to crack the nut (and I’ve came across a few companies in the last month or so that are almost there). My next post (maybe I’ll get around to it next week), naturally pre-titled The Local Innovator’s Solution (original book here) will focus on how to navigate the treacherous waters of how to go to market in local.  (and just like the original, you’ll be forewarned that the sequel will be a lot less satisfying).