Entrepreneur’s Journey

Disposable Starups & Organic Cash Cows

Musing:
I’ve been reading a lot about how it is currently a great time to be an entrepreneur.  Joe Kraus has an interesting post about how this is the right time.  Basically he argues that the cost of getting something off the ground is so dirt cheap that it is almost imperative to start a company.  Jeff Clavier’s post “The era of the disposable startup” makes one think about whether or not this type of Disposable Execution is really possible and some of the barriers.

In working through all this, the Disposable Startup doesn’t seems like a workable model, however a close second cousin: the Organic Cash Cow, might just be worth pursuing.

Problem:
The issues I’ve seen regarding launching a startup are two fold:

1. How do I get quality equity supported labor?
2. Do I really need to be acquired for many $MM?

These seem to be the two pressing problems at hand.  With infrastructure, hardware, and software costs being driven down to $0, what does it take to create a successful startup from the entrepreneur’s perspective: People and exit are certainly the two top issues.

Solution:
There does seem to be an alternative to the Disposable Startup and I would call that the Organic Cash Cow (OCC).  The goal with the Organic Cash Cow is to get a project off the ground with as little outside free labor as possible while creating a cash flow plan that doesn’t require Google to acquire you for $100MM to make it worth your while.

How do I get quality equity supported labor?

Getting people to work for equity (and I mean quality people who probably already have jobs, families, mortgages, etc) is much more difficult than it seems.  Startups at the will-work-for-equity stage are very similar to a garage band: lots of passion and enthusiasm, but everyone doesn’t always show up for practice (i.e. poor execution).  The amount of time you spend organizing the free-for-now labor and extracting actual value from their work hours can easily rival their contribution (you know: can’t work tonight, the kids are sick/the project is late/my brain hurts, etc).

In order to counteract this, get good at delivering alpha or beta version products, services, web sites with a minimal amount of outside labor as possible.  This means a core group of engineers (2-4 at most) or develop the prototype yourself.  Stop looking for venture capital, angel capital, 10 engineers, etc.  Just get the first version on its feet.  That means doing exactly what Guy Kawasaki says in his “Rules for Revolutionaries” book: “Don’t Worry Be Crappy.”  This doesn’t mean you can put out buggy software, web sites that don’t work, and concepts that will lose customers their data … because you’ll lose your reputation.

What it does mean is fall OUT of love with your idea and strip it to its bear essential functionality and get that functionality out the door … quickly, solid, in beta form, but get it out the door with you and a couple of guys at most.

You can think about outsourcing strategies in India/China/wherever after you have launched your first beta version.  The seed execution and differentiation is your ability to find passionate people (even if that is only you), fall out of love with technology for technology's sake, and deliver to customers a necessary product that will fulfill a need.

That last paragraph is quite a mouthful, because there are too many entrepreneurs out there who have no idea of what problem they are solving for the customer and are simply doing something cool … especially software and high tech entrepreneurs.

Do I really need to be acquired for many $MM?

The second question of the Disposable Startup vs. the Organic Cash Cow is an exit strategy.  Yes, if you are getting investors, and have a bunch of employee stock options, equity supported engineers, and require a staff of 50 just to get dollar 1 in the door, you will need a big acquisition/exit to support the initial investment.  And this is the thesis of the VCs/Angels and it is what they are looking for in the Disposable Startup.  But it doesn’t have to be what you are looking for as an entrepreneur.

The Organic Cash Cow is exactly the type of problem you are trying to solve.  Build an idea into a cash generating machine that can grow organically.  Then you don’t have to worry about short-term or even intermediate-term exits you can worry about adding those customer satisfying features you left out in beta.

So the question is how can you build the cash generating machine.  You need to leave the technology on the back porch and focus on the business model.  And this is tough for most of the technology guys / CTOs out there trying to start a business.  You need to focus (and I mean hyper-focus) on the following:

1. Customer acquisition cost
2. Short-term life-time value of the customer
3. Revenue model
4. Cash-flow breakeven

None of these concepts are technology based.  They are all business issues that need to be worked out in detail before you start your Organic Cash Cow or Disposable Startup.

1.  Customer acquisition cost – Don’t assume you know what it will cost to get your customers.  Become a virtual customer yourself and figure it out to the penny.  Go to Google, look at the costs of keywords, figure out the number of clicks and the conversion rate and then get your customer acquisition costs down.  Or do whatever research it takes to figure out how much it will cost to acquire your customer … to the penny.

I guarantee it will be more than you expected and your research will be off significantly (I tend to double the number I get from research).

2.  Short-term life-time value of the customer – The customer will provide a certain amount of cash flow (not profit but cash … cash is king) over their lifetime, but that is only important to a company with lots of cash to wait for the customer’s purchases.  As an Organic Cow, you need to look at how much cash the customer will bring in now … in the first 30 days of their experience with you.  That is the important number.  That is the number that will help you grow without the need for investors, and that is the number that you can use to build the other technology features.

3.  Revenue model – Figure out exactly what your cash revenue model will be.  How much can you charge customers for your product.  You will probably have to give away many features before a customer will be willing to pay.  You need to get as many users as possible as quickly as possible to generate the viral marketing needed to grow.  So come up with a revenue model that maximizes your customer base.  Look at Skype … free for most everything except the most professional features (the premium revenue model).  Or look at SalesForce.com (the per drink model), let users signup for something themselves at a very low cost.  Whatever your model, don’t guess, and make sure it provides quick revenue with high customer trial.  And understand your conversion rates (50% of everyone who tries your product will not become a paying customer … be realistic).

4.  Cash-flow breakeven – Notice I did not say traditional breakeven (profit and loss), I said cash-flow breakeven.  How much did it cost you this month to stay in business … actual cash … and how much did you make.  No accruing of fees, allocating yearly costs across 12 months, etc.  Cash-on-cash breakeven.

Once you know your cash-on-cash breakeven number, your customer acquisition costs, your revenue conversion model and your value of the customer, you can get a good picture as to how long it will take to get to a point where your Organic Cash Cow is generating monthly income.

And that is the goal of the startup.  Not to dispose of it if it doesn’t hit a home run, but rather to create as many cash generating businesses as possible.

For most entrepreneurs a business that is generating $5K-$10K per month consistently is a win.  And if it gets bought for $2-5MM, well that is a win as well.  Especially for the founder who is looking for his first win.  Don’t dispose of it, create ideas that can quickly turn profitable and then expand on their own.

Good luck in creating Organic Cash Cows.

See you on the wire

Steven Cardinale

I Can’t Believe It’s Not Advertising

Musing:

I was reading an article about Google and the writer was fawning over how wonderful the Google business model is and how fantastic the whole advertising supported world is and how great the Google boys look … and I almost threw up.

The problem with the Internet is that people still expect things for free (see the open source software, advertising supported games, etc, movements for examples of this), and the problem with this notion is that you can’t support innovation in a capitalistic society by giving away things for free.

This post deals with the advertising sponsored world and movement toward advertising based solutions as a whole while providing some insight into individual business models.

Now there is nothing wrong with expecting things for free, and in fact to get a viral customer adoption curve, setting your price point at $0 is often a very attractive offer to counteract initial customer inertia.  Look at the initial foray into mass adopted television.  You and I both know that TV isn’t free: it’s paid for by the increased product costs cause by advertising expenditures.  However, free and advertising supported is exactly how the first networks got their foothold and customer base.

However, after a while, the folks who consume entertainment started getting tired of all the advertising and started moving to the subscriber cable networks where part of the draw was the lack of advertising.  Just look at the Tivo phenomenon.  Viewers are skipping commercials as quickly as they can press the fast forward button.  In fact, I personally won’t watch anything not recorded on Tivo because I’ve become so accustomed to cutting out the commercials.

Problem:

With the above musing as a foundation, it is apparent that the problem is that advertising is an externality: a decision made by one group imposed upon another.  And if you think about it, advertising really should not exist.  Basically advertising is a transfer payment made by the consumer through the producer (in terms of higher product costs) to the marketing and aggregation/distribution channel for access to paying customers, supported by non-paying customers (people who don't buy the product).

If advertising is truly an externality and something that very, very few people want, then how can a company like Google make so much profit by being the delivery point for ads?  Can advertising supported services (software, search, content) survive for long in the hyperactive world of the internet?  Or will the natural progression towards value-added services quickly swallow this free-tv model?  Can-we / should-we get rid of advertising?

Solution:

I believe the solution is to look beyond advertising supported models and create business models that charge fees for the value they add and not because they can impose an advertising externality.

This means that if you are building a business based on advertising, your core model is based on a rocky foundation.  It doesn’t mean it won’t work, but it does mean that:

1.)    Someone / anyone can take away your revenue stream quickly (look at the advertising revenue from TV that is being sucked away by Google and the internet).

2.)    Your economic denominator / economic engine (as described in the book Good to Great) will be driven by forcing additional externalities on your customers and not on building better products (i.e. get more eyeballs at all costs vs. build a better product at all costs).

3.)    Your competitive landscape will not be driven by capabilities, it will be driven by attention acquisition: Meaning you’ll be trying to outwit competitors who are in the entertainment/media space (competitors who may be much better suited at grabbing attention than you).

Although Google has been incredible successful using the advertising model, they are one of the exceptions and it remains to be seen how long they can hold out until someone comes up with a “just as good” search engine with no advertising (this gives you a clue as to one of the projects on my plate).  And the founders of Google didn’t have the advertising model at the beginning, they decided upon it once they started needing revenue.

The solution to the advertising as an externality is to create a business using something similar to the Skype model.  This could be the Trial/Purchase model (aka Schick razor … give away the low end handle – and charge for the additional necessary piece - the blade), or the Skype premium model (give away the basic model and charge for additional services).

Take Away:

*  Stop trying to be Google and create an advertising based business, it probably won’t work.

*  Create a business model that will provide plenty of revenue when only 5-10% of your customer base opt for the premium version of your product (i.e. Skype)

*  Use a $0 entry price point to get as many people into your system as possible (the Trial/Purchase model)

*  If you can create a model where you eliminate the externality of advertising, while your competitors require advertising to live you can outpace them quickly

Although this has been somewhat of a general post rather than an a specific entrepreneurial problem post, I hope it has been interesting.

See you on the wire.

Steven Cardinale