"An obvious requirement for a successful startup is that they are able to make more money from a customer than they spend for a customer, i.e. Lifetime value (LTV) should be greater than cost of customer acquisition (CAC) (see my prior blog post, Startup Killer: the Cost of Customer Acquisition)."

"Entrepreneurs must spend significant time thinking about the complexity of their sales process and the cost of customer acquisition, as these factors will strongly impact a company’s ability to make money and attract investors."

"In this model, some version of the product or service is given away, with the goal of up-selling or cross-selling over time."

"(Note that only some portion of the free customers will likely convert into paying customers.)"

"Here you drive traffic to the web site using SEM/Pay per Click ads, SEO, Inbound Marketing, Freemium, etc. Visitors convert to paying customers without any need for salespeople."

"In this model, you might provide some light level of human touch such as email exchange to answer questions and provide customer support."

"Here you still sell your product/service over the phone, but the amount of work in closing the deal requires several phone calls, sales engineers, and/or web-based demos."

"Now you require an on-site visit using a field sales organization. You might also need multiple on-site visits, selling to several decision-makers, use of SE’s (sales engineers), and perhaps on-site proof-of-concept installations that take considerable SE time."

"If you are like me, you would expect the Cost of Customer Acquisition (CAC) to rise as sales complexity increases."

"What we see above is something quite surprising: using the rough numbers that I had estimated for these different categories, CAC appears to increase exponentially as Sales Complexity increases."

"using my estimated numbers, the cost of customer acquisition (CAC) jumps by about 10x as you move between these different sales models."

"The numbers indicate that it is possible to reduce CAC by very significant amounts if you could change your sales model from: Inside Sales –> No Touch Direct Field Sales –> Inside Sales"

"Complex to understand and/or evaluate, install, configure"

"Requires multiple people to get a purchasing decision (frequently caused by a high price)"

"Expensive – high cost to the purchaser, and/or takes a long time to get an ROI"

"Requires the purchase of other elements, or integration/development work to make a complete solution"

"There are two other factors relating to your buyer that can make it harder to sell a product: Where there is low customer pain Where there is no sense of urgency"

"Customer Monetization (LTV) must exceed CAC"

"As Sales Complexity and CAC increase, this means that businesses need to find a way to charge their customers more money for their product/service to remain profitable."

"To get a customer to pay for a much higher priced product in today’s tough economic environment, I believe there are three driving forces that need to be in place: Value: the customer needs to perceive that they are getting good value for the money they are paying Pain: the customer needs to be experiencing some significant pain that they need to see resolved Urgency: there needs to be a sense of urgency to get the problem resolved"

"Startups that fall below the line are likely to be in the Unprofitable Zone where their buyers will not be willing to pay them enough money to cover just their sales and marketing costs. See diagram below:"

"Red Zone 1 (Field Sales)"

"As you might imagine, the color red signifies danger. Startups in Red Zone 1 usually have high priced sales people selling direct to the customer."

"The only way to cover the high CAC number is to close high priced deals."

"There is also another fundamental problem: buyers see high risk in purchasing from startups as there is a perceived high risk that those startups may not be around in the long term. This is the so-called “Safe Choice” problem, which adds to the sales complexity, and makes an already tough problem considerably harder."

"Lumpy deal flow that makes revenue forecasting difficult and unpredictable"

"Using Strategic Partners"

"There is one very good strategy that companies in Red Zone 1 can follow which will move them into Blue Zone 2, and that is to sign up strategic partners like IBM, HP, Oracle, etc. to resell their products for them."

"To play this game right, ideally the partner should sell a platform version of the product, leaving open the opportunity for the startup to go back to those customers and up-sell them additional modules, thereby establishing its own customer relationships."

"Channel Sales is complex category that is not easy to represent on this chart. It could span a range of complexity/CAC values depending on whether the channel management program is human intensive or not."

"I also chose to place this in the Red Zone, as it can be very hard to get a channel started and working well.  Entrepreneurs and startups tend to underestimate just how hard this can be, and how long it will take."

"It may also require field sales people working alongside the channel if there is no existing demand in the market, as channel partners are not good at creating new markets or evangelizing a major new concept."

"Amber Zone 1 (Freemium): this zone is for companies that have used a free product to acquire non-paying customers, e.g. Open Source. The challenge for these companies is to figure out how to monetize their customer base without damaging the growth of the free product."

"CAC is low enough here, that the challenge of figuring out how to increase value to move to the Green Zone is not as hard as it is for companies with higher CAC numbers."

"Companies in the Amber Zone are likely to have the ability to leverage the transformational effects of the Internet on sales and marketing."

"Green Zone 1 (Freemium) can work well where the free version of the product is highly attractive to customers and drives considerable numbers of people, and when the conversion rate to paying customers is high."

"Green Zone 2 (No Touch Self-Service): One of the most powerful B2B business models. These companies in this zone have found a way to create very clear value propositions for their products/services that can be easily understood just by visiting their web sites."

"Having a touchless conversion from website visitor to buying customer means that all your focus should be on maximizing visitor traffic to your web site, provided you can do that and keep CAC at a reasonable level below your LTV (the lifetime value of your customer)."

"Green Zone 3: (Inside Sales): An attractive business model provided that you are able to appropriately monetize the value that you are providing to your customers."

"By moving from a an on-premise, enterprise software product to a SaaS model, a company changes the following elements that contribute to Sales Complexity:"

"Freemium offerings can aim to reduce sales complexity by doing the following:"

"Making it easy for the customer to try to the product Eliminating risk for buyers, as they don’t pay for other services or upgrades until they have seen some results from the free version"

"The best Freemium offerings are like DropBox. They provide the full functionality of the product for free, but find a measurement that the customer will likely exceed that draws them into paying."

"In a similar way, free trials reduce sales complexity by: Providing a very powerful way for your customers to ensure that your product will solve their problem Greatly reduce the risk for the customer when purchasing."

"Open Source software has a similar transformative effect on Sales Complexity. By making your software free and Open Source, you change the following:"

"Make it easy for the customer to try the product"

"The wide new range of tools available including SEO, SEM, the Social Web, Inbound Marketing, viral techniques, etc. all combine to provide a savvy marketer with great ways to generate low cost web traffic. Then once you have those visitors, other web tools allow the use of rich interactive media, videos, free trials, etc. to answer buyers’ key questions, and handle their objections."

"Leverage Engineering to solve Sales and Marketing problems"

"Leverage Channel Partners to do more of the Human Touch"

"One of the more interesting developments in the software industry is the emergence of a new breed of companies that have leveraged the revolutionary effects of the Internet together with either a touchless sale or inside sales model."

"Pioneers in this area include JBoss, SolarWinds, Acronis, and HubSpot. These companies have developed new techniques and scientific approaches to lead generation, marketing automation, and inside sales, and used those advances to sell software in high volumes at low prices."

"The Low Cost Sales Model has the power to disrupt the industry as companies using the Low Cost Sales Model can disrupt players using the older enterprise sales model."

"Sales and marketing costs are now low enough that it is finally possible to profitably sell sophisticated software to the SMB market."

"The most fascinating new insight that I discovered while writing this post, was how CAC grew at a roughly exponential rate as sales complexity forced higher levels of human touch into the sales process."

"Given this, I recommend that B2B Entrepreneurs gain a clear understanding of the sales complexity of their proposed new business, and carefully contrast this with the associated customer value / pain / urgency levels. This comparison should help them understand if they have what it takes to make a viable business model."

"The data also shows that it is extremely important to consider ways to redesign your product/service and resultant go-to-market models to minimize the amount of human touch involved in the sales process."

"Do you have a clear documented picture of the issues in your buyers’ mind in each step of the sales cycle that have to be resolved before they can make a purchasing decision?"

"What attributes of your product/service are causing it to require a complex sales cycle? Can these be changed?"

"Are you using all the latest techniques for leveraging the web including Inbound Marketing, lead scoring and lead nurturing, marketing automation, SEO, SEM, social media, web video, etc."

"Does your Web site answer all the questions and issues that arise in your buyers’ minds during their purchasing process?"

"Can you use a free product to help acquire customers that you can later up-sell or cross-sell?"

"There is nothing wrong with having high sales complexity provided you are able to get large enough orders, in a reasonable time period, to cover your cost of sales. That is a very viable business model."

"The opposite situation is also worth stating: any business that has low sales complexity but inadequate value provided to a customer is very unlikely to be successful."

"Channel sales can be used to create extremely successful business models. The channel gives powerful leverage to an organization, adding additional sales resources, and taking advantage of existing customer relationships that the channel partners bring to the table."

"You should recognize that you will need to figure out the sales model yourselves before you are ready to start to teach channel partners how to replicate that model."

"Channel sales usually take a long time to get off the ground. The reason for this is that a reseller has a different set of priorities to yours."

"They are usually focused on other products and deals that are paying the bills, and will usually need a lot of work to convince them that they will get a return on time invested in your product."

"Resellers often are lazy, and don’t want to do the work to create demand for a new product. They usually prefer to sell products where the demand already exists."

"Resellers need education on how to sell, handle objections, differentiate your product from the competition, etc."

"Resellers are notoriously bad at marketing."

"So in addition to your own demand creation marketing efforts, you are likely to want your  channel marketing staff to create materials and programs that can be used by the channel to market to their own customers."

"Check to make sure there is a channel that sells similar products to a similar buyer."

"If you decide to use a channel sales model, be prepared to commit to it entirely, and not take orders directly (unless there are some very clear rules)."

"Don’t expect sales execs that are used to direct sales to transition easily to channel sales. There is a different mindset involved in committing to the long term effort of building a channel."

"Sales people used to direct sales prefer more control, and the faster results that come from doing things directly with the customer."

"Channel sales people know that with patience they can get greater leverage than doing things themselves."

"Given the right channel, the right people, good product/market fit, and a lot of patience, the channel sales model can be one of the most profitable business models."

"In the startup world, there is a significant misperception that if you find Product/Market Fit, you are now ready to hit the accelerator and scale the business."

"While this may be true for many consumer focused businesses, this does not work for B2B startups. B2B founders who try turning up the spend on sales and marketing are surprised to find that they are not getting the results that they expected, and are burning through a lot of cash."

"There is a key missing step, and that is the search to find a sales motion that is repeatable and scalable. This stage often turns out to be just as hard as finding product/market fit, and is unpredictable in how long it will take. Many startups fail at this key stage because entrepreneurs and investors like to skip this step, and try scaling sales before there is a clearly repeatable sales motion."

"You cannot skip steps, and any attempt to do so will lead to a lot of wasted time and cash"

"Standard sales people require a playbook for a repeatable sales process and are not good at defining that playbook. Hiring them before that playbook exists will not work, and will defocus the company and burn cash."

"Finding a repeatable growth process is a job that should be tackled by the founders, possibly assisted by a Pathfinder/Trailblazer sales rep that is specialized type of sales person who can help figure out a repeatable sales process"

"Building product before meeting enough buyers to validate the hypothesis"

"Hiring salespeople before founders have proven they can sell the product"

"Scaling sales before growth process is repeatable"

"Hitting the accelerator pedal before solving churn problem"

"Scaling sales when SaaS profitability is not there."

"Reason 1: Market Problems"

"A major reason why companies fail, is that they run into the problem of their being little or no market for the product that they have built."

"The market timing is wrong."

"The market size of people that have pain, and have funds is simply not large enough"

"Reason 2: Failure to find Product/Market Fit"

"In the best cases, it will take a few revisions to get the product/market fit right."

"Our experience indicates that it takes about 50 conversations with customers that are not friends to find out if the product concept is really going to sell"

"Reason 3: Failure to find a Repeatable and Scalable Sales Motion"

"Reason 4: Failure to find a profitable Growth Model"

"That may happen with the first few customers, but after that, it rapidly becomes an expensive task to attract and win customers, and in many cases the cost of acquiring the customer (CAC) is actually higher than the lifetime value of that customer (LTV)."

"To compute CAC, you should take the entire cost of your sales and marketing functions, (including salaries, marketing programs, lead generation, travel, etc.) and divide it by the number of customers that you closed during that period of time."

"Because most businesses have a series of other functions such as G&A, and Product Development that are additional expenses beyond sales and marketing, and delivering the product, for a profitable business, you will want CAC to be less than LTV by some significant multiple."

"For SaaS businesses, it seems that to break even, that multiple is around three, and that to be really profitable and generate the cash needed to grow, the number may need to be closer to five."

"Two metrics help you understand this: Sales Efficiency, and Months to recover CAC (cost of acquiring your customers)."

"Sales Efficiency measures how much Net New ARR is generated by $1 of sales and marketing spend."

"A very efficient SaaS company will have a Sales Efficiency of 1"

"The other metric, Months to Recover CAC is very similar to Sales Efficiency, but it differs slightly different because it looks at Gross Margin of the Net New ARR that is created by spending one dollar in sales and marketing."

"imagine that we have 100% Gross Margin, in that case an efficient business will spend one dollar on sales and marketing, and generate $1 in Net New ARR, which means that it will recover CAC in 12 months (and have a Sales Efficiency of 1)."

"Reason 5: Poor Management Team"

"Reason 6: Running out of Cash"

"A key job of the CEO is to understand how much cash is left and whether that will carry the company to a milestone that can lead to a successful financing, or to cash flow positive."

"Progress from Seed round valuation: goal is to remove some major element of risk. That could be hiring a key team member, proving that some technical obstacle can be overcome, or building a prototype and getting some customer reaction."

"Product is shipping, and some early customers have paid for it, and are using it in production, and reporting positive feedback."

"Product/Market fit issues that are normal with a first release (some features are missing that prove to be required in most sales situations, etc.) have been mostly eliminated. There are early indications of the business starting to ramp."

"Business model is proven. It is now known how to acquire customers, and it has been proven that this process can be scaled. The cost of acquiring customers is acceptably low, and it is clear that the business can be profitable, as monetization from each customer exceeds this cost."

"Business has scaled well, but needs additional funding to further accelerate expansion. This capital might be to expand internationally, or to accelerate expansion in a land grab market situation, or could be to fund working capital needs as the business grows."

"What frequently goes wrong, and leads to a company running out of cash, and unable to raise more, is that management failed to achieve the next milestone before cash ran out."

"One of a CEO’s most important jobs is knowing how to regulate the accelerator pedal. In the early stages of a business, while the product is being developed, and the sales motion is still being developed to make it repeatable and scalable, the pedal needs to be set very lightly to conserve cash."

"There is no point hiring lots of sales and marketing people if the company is still in the process of finishing the product to the point where it really meets the market need, or if the sales motion is not repeatable."

"However, on the flip side of this coin, there comes a time when it finally becomes apparent that the sales & marketing motion (Growth Model) has been proven, and is profitable. That is the time when the accelerator pedal should be pressed down hard. As hard as the capital resources available to the company permit."

"1.  Identify your buyers"

"Start with an intense study of the Customer"

"However most of the time when I work with people to diagnose what is not working as well as they hoped, the problems arise because they have not found a good way to motivate their customer to move forward through a particular step."

"A good way to make sure you are building a sales process that will work for your customers, is to diagram out their buying process."

"I recommend starting by identifying the different job functions that are involved in purchasing your product or service."

"2.  Diagram: customer’s buying processes"

"3.  Diagram: add the steps to address the buying process"

"4.  Diagram Actions to move prospects through the funnel"

"5.    Examine Linkages between Actions"

"The next step is check that there are clearly defined linkages between every action on the diagram, and the following step."

"One of the most common problems I see is marketing activities that have no clear call-to-action; or no clear step to process the leads after the action is completed"

"Another common problem is marketing activities that have no connection to this process."

"In my view, no startup can afford to do any kind of marketing activities that don’t directly contribute to the process of moving a prospect through to a closed deal."

"6.    Defining Qualification criteria"

"Another common problem is no integration between sales and marketing. Sales complains that marketing doesn’t provide them with enough leads, and marketing complains because they gave sales a ton of leads, and sales won’t call them."

"This happens because there wasn’t a discussion between sales and marketing where they mutually agreed on a clear definition of what represents a Qualified Lead that is acceptable to sales. Getting the lead to that level of qualification (often referred to as a Marketing Qualified Lead or MQL) is the responsibility of the marketing department."

"7.    Examine the customer motivations for each Action"

"The most common reason that a sales process isn’t working well is because your customer is not adequately motivated to do a particular thing that you want them to do."

"To fix this problem, you will need to get inside your customers head and understand their concerns and motivations, and brainstorm a way to provide additional incentive to motivate them to complete the step."

"8.   Define the organizational resources responsible for each step"

"9.   Define the underlying technology and software"

"Interesting areas for marketing products are Inbound Marketing; Social Network monitoring and management; Lead Nurturing and Scoring; eMail marketing; and Web analytics."

"Direct sales using a field salesforce is one of the most expensive ways to pursue customer acquisition, and as a result only works for larger deal sizes."

"Field sales people are very expensive, typically running around $230k to $250k on target. They often need a sales engineer in the field with them, which can add significantly to the cost. They also have office costs, and travel costs."

"Because of long sales cycles, typically there is a long ramp time, of around six to nine months before a new salesperson becomes productive."

"The large deals that are typically worked on by a field sales force often only close in the last week of the quarter, making for lumpy bookings and nail biting revenue management."

"One of the most powerful techniques available for customer acquisition is giving away a free product or service"

"The trick to doing Free or Freemium business models right is to ensure that the product/service that you are giving away free is of very high value to the customer, which should result in both high customer satisfaction and a likelihood that they will tell others about your product/service, leading to viral effects."

"The usual temptation is to stop short of this, and take out the valuable features that would make the product interesting and valuable."

"The entrepreneurs and executives that I work with fall into one of two camps: those that get this, and those that don’t."

"The smart crowd that do understand this, realize that in a typical business the single biggest expense is sales and marketing, and recognize that offering a free product/service is an extremely smart way to acquire customers at a low cost that can then be monetized in a different way."

"Another less well known example of this would be the recent high priced aquisition of SpringSource by VMWare. In that situation VMWare far over-paid for SpringSource if one looked purely at revenue multiples."

"Another powerful effect of using the free strategy is that it usually results in a far larger customer base using the free products, who become proponents for your company."

"But the real value of SpringSource lay in their large base of developers inside of enterprises that were strongly committed to the Spring free Open Source framework."

"Another way of looking at the importance of footprint or marketshare is to recognize the importance of market leadership."

"Even if you have gained market leadership by giving away a product/service for free, the financial markets and acquirers realize that market leadership is worth a significant premium over niche players that may have more revenue."

"The entrepreneurs and executives that fall into the “wrong” camp, are so focused on trying to extract the maximum dollar out of every customer, that they fail to realize that this only leads to very slow (and usually expensive) customer acquisition, and consequently a small footprint or marketshare."

"In the Free strategy, the company is going to shift the expense of customer acquisition to the product development group."

"It provides its results in the form of a score out of 100. Human beings are very competitive, and when they don’t get a good score, they want to find out how to improve their score. That leads them to wanting to find out more about HubSpot which can help them improve their score."

"It allows them to compare themselves to their competitors. All businesses care about how they are doing relative to their competition."

"The effect of viral marketing is that a company can acquire their customers without spending any marketing dollars."

"Examples of successful viral marketing companies are Google, Facebook, YouTube, Twitter, Gilt, and Polyvore. In all these cases, the businesses grew very rapidly because of viral marketing. They also spent little money on marketing and sales, as their customers did that work for them."

"The perfect businesses: Virality plus Monetization"

"The best businesses are those that have figured out how to combine viral customer acquisition with a good scheme to monetize those customers."

"Perhaps the worst business model amongst these is YouTube, where the business has very high costs associated with the bandwidth of uploading and viewing videos, as well as storage costs."

"However if you do a few simple calculations on the level of traffic needed to drive $100m in revenue through CPM ads, you quickly realize that only sites that are in the top levels of traffic are big enough to make that form of advertising an interesting business."

"In the early days of Google, there was no strategy to monetize the traffic, but fortunately Adwords was discovered, and provided the solution."

"In many situations a business model breakthrough will have been created by one company and applied to a single area, and there will still exist considerable opportunity for that same business model innovation to be applied to other areas."

"After my exposure to literally several hundreds of startups, I have begun to realize that one of the most common causes of failure in the startup world is that entrepreneurs are too optimistic about how easy it will be to acquire customers."

"They assume that because they will build an interesting web site, product, or service, that customers will beat a path to their door. That may happen with the first few customers, but after that, it rapidly becomes an expensive task to attract and win customers, and in many cases the cost of acquiring the customer (CAC) is actually higher than the lifetime value of that customer (LTV)."

"The observation that you have to be able to acquire your customers for less money than they will generate in value of the lifetime of your relationship with them is stunningly obvious."

"they often begin to realize that their business model may not work because CAC will be greater than LTV."

"Also if you would like to have a capital efficient business, I believe you will find that it is important to recover the cost of acquiring your customers in under 12 months."

"Can you find a scalable way to acquire customers"

"Can you then monetize those customers at a significantly higher level than your cost of acquisition"

"In the hybrid viral model, you make up for the shortfall in customers by acquiring those through some other means such as paid search, or SEO."

"is the value proposition of your product really that compelling that your customers will want to share it with others?"

"Every time I have looked at other blog articles or formula for Viral Growth, they appear to have gotten this part of the calculation wrong."

"A short study of this web site reveals that a hugely important factor for success in startup companies is finding ways to acquire customers at a low cost."

"The first thing that we need to calculate is the number of new customers that each existing customer is able to successfully convert. This turns out to be an extremely important variable, and is known as the Viral Coefficient."

"K Viral Coefficient K = i * conv%"

"The Viral Coefficient must be greater than 1 to have viral growth."

"In YouTube’s case the Viral Cycle Time was extremely short: a user would come to the site, see a funny video, and immediately send the link on to their friends."

"Unless you have a Viral Coefficient that is greater than 1, you will not have true viral growth."

"The most important factor to increasing growth is not the Viral Coefficient, but the Viral Cycle Time (ct) which should be made as short as possible. This will have a dramatic effect on growth."

"The second most important area to focus is the Viral Coefficient (K). Anything that you can do to increase the number of invitations sent out, and the conversion rate, will have a significant effect on growth."

"Virality is not a marketing strategy that can be executed by the marketing department. It has to be built into your product right from the beginning. This is a function that needs to be thought through by the product designers and developed by the engineers."

"The most viral products are those that only work if they are shared."

"To make the Viral Cycle Time as short as possible, we can apply the same thought process that we use in Building a Sales and Marketing Machine, where we look at what are the customers motivations and negative reactions as they flow through the viral cycle."

"Consider leveraging viral platforms such as Facebook, which have built in social features to let friends know what apps you are using."

"Use A/B testing to figure out which approaches and creative presentations are getting you the highest conversion rates."

"To give you a preview of this post, what you will learn is that there are two key parameters that drive how viral growth happens, the Viral Coefficient, and the Viral Cycle Time."

"The first thing that we need to calculate is the number of new customers that each existing customer is able to successfully convert."

"To fully understand the model, it’s useful to look at the second, and subsequent, cycles of growth."

"The Second Important Variable: Viral Cycle Time"

"Tabblo, on the other hand, had a much longer cycle time. A customer would post some photos on the site and invite their friends. The friends might see the photos on Tabblo, and like the experience and decide that they would use the site the next time they took photos they wanted to share."

"A quick look at the table that shows the effect of varying the Viral Cycle Time shows that customer growth is dramatically affected by a shorter cycle time."

"For example, after 20 days with a cycle time of two days, you will have 20,470 users, but if you halved that cycle time to one day, you would have over 20 million users!"

"The Viral Coefficient K is raised to the power of t/ct, so reducing ct has a far more powerful effect than increasing K."

"Another great way to increase virality is to incent customers with a reward for every customer they successfully convert."

"Since this can result in an individual feeling guilty that they are making money off their friends, the best way to do this is to also provide the friend that is receiving the invitation with an equal incentive. Now your customer will feel like they are doing their friends a favor."

"If you are successful in creating a viral model with very short cycle times, watch out for what can happen."

"Rather than giving up, it is worth considering a hybrid viral model. In the hybrid viral model, you make up for the shortfall in customers by acquiring those through some other means such as paid search, or SEO."

"This has happened to several Facebook app developers. They experience very rapid growth, and then suddenly the growth dies."

"What happens if you have attrition in your customer base over time. An easy way to extend the model to take this into consideration would be to add a variable to model Attrition Rate as a percentage of the entire installed base at each cycle, and simply subract this from the total population at each cycle"