Start digging your moat

Warren Buffett coined the phrase economic moat to describe those aspects of a business that provide competitive advantage. What is often stated within definitions of Buffett’s economic moat is the requirement for the advantage to be ‘sustainable’; as a value investor, Buffett does not want to buy into a company that wins today but loses tomorrow. His objective is long term performance.

I work with technology companies – the vast majority using a significant element of software within their overall offer. How does Buffett’s concept apply, when software is by its nature replicable – often by cheaper resources in other countries? You make the mistakes, others imitate with a much lower cost of establishment. Have a look at the Samwer brothers in Germany for the textbook case study.

So what to do? The obvious answer is legal instruments – patents and the like – but do all companies have the time / energy / finances to both create and protect intellectual property in this manner? I would argue (in a highly successful manner) not. There are enough things to do in the early stages, many of which will be the start of digging your moat, without recourse to lawyers.

Consider the component elements of a company selling software. These can be broken down into two categories:

  1. Revenue generation and retention capability
  2. Technology capability

When defining and refining your business, think about each category and ask yourself ‘what can I do here to develop my economic moat?’. Some examples might include:

  1. Revenue generation and retention
    1. Dominate a specific market – either a vertical (e.g. supermarkets); a horizontal (e.g. human resources); or geographical (e.g. Italy)
    2. Ruthlessly pursue customer retention strategies – a business that does not lose customers grows
    3. Create revenue momentum – a series of wins shows the market you will dominate it
  2. Technology
    1. Create network effects – leverage your users to dominate areas through networks (e.g. Facebook – there can be only one personal social network at any one time)
    2. Develop technology which will naturally expand its footprint within the customer, e.g. SAP – it reaches out across the enterprise
    3. Ensure accessibility – if technology is easy to acquire and use, it will stick
    4. Get multilingual quickly – think of the Samwer Brothers

You’ll note as you read through these points that there is significant overlap. Often the technology enables the revenue generation and retention objectives, and conversely the revenue and retention objectives will dictate (to an extent) what technology development must take place. Get out a sheet of paper and write these down for your business. Are they compelling? Do they link back to the objectives you set out?

Reflect on this exercise, and bring the thought processes into your day to day work – an economic moat creates sustainable long term advantage, enabling valuable businesses to be built.

Market focus is directly proportional to deal value

I wouldn’t pay me anything to consult on Java development, if I were you.  Why?  Because, to be frank, I don’t know very much about it.  You are, almost certainly, wasting money.

So why would you separate yourself from a lot of capital, to buy services from someone who didn’t know a lot about your industry?   Again, you probably wouldn’t.

The lesson here for entrepreneurs, particularly those in the business to business space, should be clear: if you do not understand the industry you are selling into, you are unlikely to achieve significant revenues from it.  Is this always a bad thing? No.  Salesforce.com does not need to understand the markets it sells into in particularly great detail – why?  Because it’s a highly disruptive offering, primarily because of its low ticket price, which means the customer cannot reasonably expect to have an industry-specific product.

Salesforce.com is disrupting an existing market – not all entrepreneurs start in such a fortunate place.  If you have a generic product, with a limited market, and are resource constrained – you need to be doing big ticket deals in order to survive.

My argument for the non-Saleforce.com entrepreneurs is this: you need to create market focus to drive up deal values.  What does market focus do you for?  Several things:

  1. Focusses the mind – no more ‘we can sell to anybody / we aren’t selling to anyone’ nonsense
  2. It directs resource – you need to learn quickly, so learn French quickly – don’t decide to become a specialist in European languages tomorrow
  3. It creates credibility – I really understand your industry, and because I understand it you are going to trust me to provide good advice on how to drive business performance
  4. It informs the proposition – a well-researched and targeted proposition unlocks all the stores of value, and increases the likelihood of conversion

So ask yourself this: do I have market focus?  How focussed am I on that market – some entrepreneurs achieve a zen-like state where they will happily refuse business from those that are outside their target group, anticipating that in the long term this will result in a superior return.

One to consider…

To VC or not to VC

My colleague Aaron came in this morning having attended a TechHub event last night.

Wow, and I thought some of my ideas were bad.  Aaron gave us a long description of a series of ‘companies’ he’d met (I put that in inverted commas because I’d call most of them ‘ideas’) – and some of them were truly depressing, and only one did not evoke the question “but…why would you want to do that?”

Most depressing of all is that the majority of these people are looking for venture capital (VC) investment.  Now, I’ve looked through a lot of VC portfolios and worked with a number of the businesses of which they comprise, and I am always shocked by the quality of some of the investments – and it leaves me asking the question “how?”

In reality the answer is all too obvious: many ‘ideas’ chasing too much cheap capital, brought about by low central bank interest rates.  The sad fact is: most of these companies will fail.  Why?  Because a) they should never been offered investment in the first place, and b) the ‘entrepreneur’s’ motivation for taking investment is misguided.

The first problem I cannot solve – if investors make obviously poor investments, and have access to the money with which to do so, then it will continue to happen.  However, I’d rather that entrepreneurs’ energies were put towards creating useful outputs.

The first mistake is for an entrepreneur to take an idea then go out looking for VC investment in the misguided belief that it is the end-state they want to achieve.  It doesn’t exist to boost egos – it’s there to support company growth.  It is no more than the enabler.  Your idea may not even need VC investment – and let’s face it, it may not need the strings that a lot of modern VCs attach to their investments in order to de-risk them (although you could question why they’d need to do this if they, as an industry, hadn’t had their fingers burned making stupid investments in the past).

VC investments in London these days often constrict the very companies they are supposed to be helping through capital.  They use debt instruments and clauses to take over companies and make the entrepreneur do what the VC thinks is right.  Do entrepreneurs really need / want that?  The only time you should be taking VC investment is when you do not need it.  I was taught that lesson by a very impressive US entrepreneur called Tim Wallace.  You don’t need the money, but it will enable you to do things faster than without it.  At the end of the day, if you need something – you are going to get screwed.

A properly planned business will take account of the trials and tribulations it may face – ‘courses of action’ and ‘actions on’ – it will consider all possible options before piling around the local VC community boring the good investors to death with rubbish, or convincing the incompetent investors to part with (what is often) someone else’s cash.

Adopt the ABA Revenue Model

Are you in the process of establishing or growing an early stage web business?  If so, I thoroughly recommend the ABA revenue model.

What is it, I hear you asking?  It’s the “Anything But Advertising” approach.

Over the last twenty-four months we have detected a shift in the type of technology start-up being established in London.  For whatever reason (and I suspect a $100bn initial public offering may have something to do with it), the proportion of B2B versus B2C businesses seems to have changed markedly.  A number of commentators have already noted the number of “Global Vice Presidents of Sales” floating around the Old Street roundabout – usually residing in start-ups with two other employees (one a President and the other an Executive Vice President).

I read a nice set of statistics recently on LinkedIn’s blog that demonstrates the dangers of assuming eyes plus hours equals cash – an assumption that I fear underpins a lot of these start up businesses:

  • LinkedIn users spend an average of 18 minutes a month on the site. Facebook users spend 6.4 hours a month.
  • LinkedIn gets $1.30 in revenue for every hour those users spend on site. Facebook: 6.2 cents.

Surprising, aren’t they?

How to monetize website based business is something we’ve debating at Rapid Innovation Group recently – and I was pleased to find earlier that we are not alone in this debate, with this Wharton professor expressing a similar ABA preference.  However, other than Professor Clemons no one seems to be addressing this issue.

So why wouldn’t you depend on advertising revenue as your main source of funds, other than on the basis that Facebook cannot make substantial amounts of money from it?  Firstly (and sadly), when things go bad in the economy advertising revenues tend to get hammered – and secondly, how many other businesses (starting with Google) are trying to make money from the same source?  Yes, the answer is lots.

I do not have a definitive answer for you, but what I will say is this: if you are creating or seeking to grow a business, you need to be looking for sustainable revenue streams.  If you are providing a product or service that is to be used day in, day out, you do not want to be dependent on the vagaries of wider economic performance for your end of quarter sales figures.  Identify another way of extracting value from your customers early on, have a rational reason for setting your pricing point, and then stick to your guns.

Examples you should be considering:

  • Do people go to your service on a regular basis?  Then use a subscription model
  • Do your customers want different amounts of something each time they visit?  Then use a transactional model
  • Do your customers need to understand your service before they can see value?  Then use a no-charge-but-I-need-your-credit-card-details-in-advance trial model

Whatever value your service or product provides, please do not kick off into the market on the basis that your customers might be interested in a General Motors Chevy Cruze or a package holiday to Spain as a result (unless you are selling cars or Spanish package holidays)!

Pricing models and points are difficult issues for early stage businesses to address – but they set the tone for the business over the coming decade, and demark your limits of growth to an extent – so make sure you get them right!

Insights from a complex negotiation

Most readers of this blog will be interested in getting to the point that a current client finds themselves in, so I thought I’d record the process we are working through to resolve it.

Picture this: you’ve found an enthusiastic sponsor, got them to buy into your proposition ….. you then find they have opened an opportunity bigger than you could have dreamed of (or given them credit for!).  The opportunity is business changing …. it smashes that sales target ….. the world is about to take a serious change for the better!

You’ve dealt with the sponsor and business user all the way through the sales process, everything makes sense …. then you hit (corporate) reality – an unhappy procurement function.  Why are they unhappy?  Your sponsor decided (almost certainly correctly) that if they were involved early on they’d kill the whole thing stone dead – and the business needs your software so they didn’t want it killed off early.

The call is set up, the agenda point is ominous – “commercial discussion”.  That’s where we find ourselves today.  Time for some scenario planning.

Position-based negotiation – a brief segue 

Just like in position-based warfare, you either win or die in your trench.   Positioned-based negotiation is the same – and thus to be avoided unless you have nowhere to run!

Back to the point

What will come up?  In reality there are actually very few things that procurement can say / do.  They either need to tick a due diligence box to say they checked it all out and understand it – or they are going to try and beat you down on price.

As I see it, there are only really three start points you should prepare for:

  1. The price is too much
  2. They don’t like the pricing structure
  3. Justify the whole piece

The price is too much

So let’s start with the first point – the price is too much.  The price is too much?  How is that possible, we spent all that time with the business users who hold the budget working through it and making it the right fit.  How can it suddenly be too much?

In my experience it can be too much because: a) procurement has a corporate target for reducing initially quoted prices e.g. everything down by 10%; b) the budget that the sponsor and business users identified got spent and they weren’t aware of it; or c) procurement isn’t particularly evolved in this corporate and is spectacularly unimaginative when it comes to negotiation!

So how to respond?  Remembering to avoid a position based approach (“it’s the best we can do”), ask a question: “why is it too much?  We have spent time with X and Y, who confirmed the budget was available, so you need to explain this to us”.  It’s a killer – now the procurement person has to explain their rationale for their statement – if they aren’t coming clean, try a couple of other questions: “do you have a corporate target? Has the budget been spent elsewhere?”  This puts you in the driving seat as you are now asking the questions.

We don’t like the pricing structure

This for me is a classic.  I have a tendency to specialise in subscription-based businesses – I like the model, as it lowers the cost for users to adopt and provides the business with on-going revenue to pay its employees and further develop the software.

However, subscription-based software isn’t old hat to everyone – in fact, some people still think that all software is sold on a license / maintenance basis.  This is not good, because you might have to explain the whole rationale of subscription based software to them, and then break the news that they won’t even own it – and some procurement departments hate not having something they can take away (even though in the long term they are totally powerless to develop it in house!)

There are several ways to address this:

  1. That’s our business model – take it or leave it (bad position-based start!)
  2. The pricing structure is like this because it reflects how we deliver the software – a lot of our costs are in on-going development for your benefit, as well as server space to deliver it across all those different geographies
  3. Give them a quick calculation of the license / maintenance cost – hey, if they want to buy it like that then why not!  So your £50k per annum software is now £127k (£115k+£12k) year one and then £12k for the following two years.  Obviously that’s good for my cash flow and bad for yours, Mr Procurement, plus we won’t be able to deliver you with any of the development benefits over the three years because we are going to have to create a separate instance of the software for you on another service, and once that’s in place we won’t be able to tinker with it in case something goes wrong and affects your business
  4. Ask them why they don’t like it – then knock off all the responses with the standard SaaS arguments – it won’t make them look good, so hopefully they will stop making stupid points fairly quickly!

Justify it…..all of it

This has to be the worst one …. not because you can’t do it, but because it takes so long to do.  You have confidence in your pricing, otherwise you would not have put it in front of them, and you’ve probably already been through this with the sponsors and business users – so it’s just tedious.

Do get some practice in beforehand though – time spent in preparation is time well spent.  In all likelihood the question that keeps coming up as you go through will be “why is that like that?  And why is that like that?”   As I said before, you have confidence in your pricing …… you are just going to have to spend a long time explaining it.  And there’s always the risk that either “that’s too much” or “I don’t like that” is going to come up – if so, I reference you back up to the previous two sections.

Final Thought

Generally you don’t get to a negotiation unless the customer wants to work with you.  Keep that in mind….and you’ll have a successful outcome – and lastly, the only business worth winning is profitable business!

Radian6 Acquisition

So Radian6, the Canadian backed social media monitoring and engagement platform provider, has been bought by Salesforce.com.

Having looked at the deal, I have two observations:

  1. The revenue multiple was just short of 10
  2. Salesforce.com paid A LOT of cash.

There must have been an intense amount of competition in the space. Both of these points are interesting for differing reasons. A multiple of ten shows these type of exit deals can still happen for VCs – the buyer clearly saw massive opportunity value in the technology platform (they estimated a three year build cycle if they attempted it in hour), rather than just the current revenues. Salesforce.com must be scared by the social space to pay this kind of money, and this leads onto my second observation – they paid A LOT of cash.

I realise that a lot of the large tech companies are cash-rich at the moment but this deal implies that there was a lot of perceived competition for Radian6 – Salesforce.com wanted it badly, and knew that if they didn’t get it then someone else would (who maybe wouldn’t give them access to the capability). I don’t know whether a single line in Vocus’ recent quarterly report (Q1 2011), detailing $1.2m fees spent on a failed cross-border acquisition, has anything to do with it.

I also reflected on my own experience in that marketplace in the UK. That a Canadian company had the sales and growth trajectory to get picked up by Salesforce.com shows how far behind the UK is. I cannot think of many companies, with the exception of Glide Technologies, that provide a similar level of social media engagement service in Europe. Equally, I haven’t heard of many corporates this side of the pond that have engaged with the space to the extent that a best practice technology platform provider has been able to emerge.