I’m grateful for all the entrepreneurs who have spent time teaching me how to build their companies. Over these past few days, I have been reading the book Antifragile written by Nassim Taleb. In the book, he writes about many provocative things, but the one that sticks out with me this holiday is about innovation, and it harkens back to the original title of this blog that I started to write nearly 7 years ago: ex post facto.
In the eleventh episode of Masters of Scale, Reid Hoffman interviews Peter Thiel. The episode revolves around the idea that to truly succeed, a startup must not beat the competition, but break free of competition entirely. The episode has many great points, but the one that stood out most to me is the idea of false competition.
You could say that Coke and Pepsi compete very intensely, on the other hand you could say that there’s somehow quite differentiated from a brand so that in practice different people prefer Coke or prefer Pepsi and they’re actually is a much smaller set of people who view them as interchangeable products. And so, I think measuring how much actual competition is happening is not always a straightforward thing to do. transcript
Disagree and commit. I first read about this idea in the 2016 Amazon Shareholders letter. But the idea can be traced back to Andy Grove at Intel. Grove wrote about this topic in High Output Management. Disagree and commit is a management technique for handling conflict. There are two parts to it. First, expecting and demanding teammates to voice their disgreement. Second, no matter their point of view, once a decision has been made, everyone commits to its success.
Founders often describe their unit economics in terms of their LTV/CAC ratio - the ratio of the Lifetime Value (LTV) of a customer to the Cost of Customer Acquisition (CAC). The LTV/CAC metric can be a powerful metric to unpack the health of the go-to-market team of a company, as Netsuite has shown. But this figure is often meaningless for early stage startups.
Why? Because a company one or two or even three years into sales can’t yet accurately forecast customer lifetimes. If a business suffers from a very high churn rate, then, yes, it’s possible to calculate LTV in just a few years.
The startup acquisition market is off by roughly 35% year-over-year. Why the decline? One consistent response from potential acquirers is that they are waiting for tax reform to happen. If it does happen, and when acquirers do decide to pursue acquisitions, I suspect we will enter a very acquisitive environment for three reasons.
First, the cash available to finance acquisitions on the balance sheets of public companies has grown by 20 X over the last 10 years and now totals more than $8.5 billion.
Initial Coin Offerings, a fundraising mechanism for companies using cryptocurrencies as a mechanism to buy their service, seem to be upending the world of venture capital. Filecoin raised $250M through an ICO. Tezos raised $232M. Bancor raised $153M. These are massive amounts of money. Recently, I’ve been wondering how prevalent ICOs are and whether they could potentially be a substitute for venture capital.
One of the major trends facing SaaS companies today is the rising cost of customer acquisition. Data on this trend has been difficult to find. Fortunately, Patrick at ProfitWell sent me his survey results across about 800 companies. The chart above shows the increasing cost of customer acquisition on a per company basis. Those surveyed have observed a ~65% increase in cost of customer acquisition over the last five years.
In 2015, I wrote about the trade-off facing vertical SaaS companies. Vertical SaaS companies focus their efforts on a particular group of customers. Procore targets construction with their software and Veeva targets pharmaceuticals with their CRM. This concentration limits the market size, but improves product market fit. Both of those businesses are now worth more than $3B. There is a new twist in SaaS with a parallel dynamic.
I’ve started to call them AI Agencies. AI Agencies use machine learning to disrupt a market dominated by agencies. Often, these startups begin as software companies selling machine learning software into agencies.
Starting in January, public software companies will report their financials using ASC 606. Normally, accounting changes are not that interesting, but ASC 606 will change several of the key attributes and benchmarks SaaS startups use. The two most important changes are changes to revenue and profitability.
Today, all software revenue is recognized ratably over the contract period. If a business finds a 12 month contract for $12,000, the company record $1000 of revenue for each month. Under ASC 606, hosted revenue recognition doesn’t change.
Last week, I participated in two discussions about the changes in the SaaS world. I believe they are fundamental. The most important force shaping the industry today is competition. The level of competition in many core SaaS segments is intense.
Why? The SaaS era is about 20 years old. Salesforce was founded in 1999. Since then, many major categories of software have been saasified. Venture capitalists have financed many of those businesses. Over that 20 year period, annual SaaS investment has increased 20x, peaking in 2014 at $7B.
