If your enterprise software brings revenue it is worth a lot more than if it just cuts costs – the revenue model shift from Subscriptions to Transactions June 4, 2014Posted by Bernard Lunn in Corporate Strategy, Enterprise Sales, SAAS, start-ups, Strategy Workshop.
Tags: b2b2c, crossing the chasm, revenue sharing partnerships
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Historically, the objective of enterprise software was to make employees more efficient by automating tasks. The software industry moved from cutting G&A costs to making people at the front line more efficient through software such as CRM, Marketing Automation, Business Process Management and Collaboration.
In all cases, the business model was licensing. The licensing model moved from perpetual to periodic (monthly or annual). Seen in this context, SAAS is just an evolution of the old licensing model (plus bundling the hardware into the price). Consumerization of software is a natural response to the risk/reward shift of periodic pricing in SAAS. When vendors got all the money upfront, they could afford an expensive sales process. SAAS shifted the risk to the vendor who got investors to fund the cash flow gap. Investors were happy funding that cash flow gap because periodic SAAS revenue is more predictable and therefore more valuable. To reduce the cost of sale and therefore minimize dilution, entrepreneurs created consumerized services and Freemium.
That about brings us up to date.
So, what’s next?
What’s next is usually an evolution when it comes to enterprise. There may be a disruptive 10x technology shift driving the change, but big companies tend not to make big disruptive shifts. There are exceptions of course, the most famous being Intel’s shift into semiconductors under Andy Grove. That is such a compelling story (told in Only The Paranoid Survive) and so many enterprise executives reference it in glowing terms that we can easily believe that it is the norm. It is not the norm; it is “more honored in the breach then the observance”. Enterprises have built-in inertia, because senior managers are incentivized to optimize short-term profits.
The next iteration will continue the risk/reward shift that was started by SAAS. This will change the revenue model from licensing to % of transaction/revenue (in any shift we see hybrids of old and new so many ventures will mix subscriptions with transaction revenue). I am observing a few innovators who are combining digital consumer marketing techniques with selling a partnership model to enterprise. This is where the puck is going. These ventures get their revenue from a % of the transaction/revenue. This is obviously highly scalable. These ventures take on more risk and have to generate more value before they get paid, but if they can get there they have great scalability and moat.
The idea is simple. You create a consumer service and get enough users that you prove the proposition. Then you scale by partnering with enterprises. One way to look at this is as a technique for crossing the chasm. You can easily find early adopters online. (I say easily, it is of course not easy, but the techniques for doing so are well understood and documented). However, scaling beyond that is hard. Only a tiny % of ventures, blessed with great virality and addictiveness, cross the consumer chasm. As always exceptions (such as Facebook) prove the rule while blinding us to the rule with their brilliance. Many other ventures will cross the chasm by partnering with enterprises. One reason that enterprises are so big is that mainstream consumers trust these large enterprises.
If you prove the proposition directly with consumers you have created a lot of value. You can exit at that point. You can sell to a company that can cross the chasm to the mainstream consumer. Or you can partner with the enterprises that have access to those mainstream consumers in a shared revenue model and scale to become a large enterprise. You will typically be making one or more of these propositions:
- Get more revenue from their existing customers. You are accessing their customer base and they are using your service to get extra revenue from those customers.
- Bring them new customers. This is where the big $$$ prize lies. If these new customers represent the early adopters, the enterprise will be worried that eventually their mainstream customers will “see the light” and want to switch to your model. If they see that they will buy you for a big premium or partner on terms that are more advantageous to you; in this situation you have real clout.
You can create these partnerships on a white label or co-branding basis. Obviously you get higher margins if you get co-branding. There is a spectrum of co-branding. The more traction you have with consumers, the more clout you will have in those co-branding negotiations. Once again, Intel was the thought-leader, with their Intel inside campaign. These negotiations are fundamentally about “how big is my logo vs your logo?” Screen real estate is precious, so this matters. If you have 1 million consumers and the enterprise has 1 billion consumers you have reasonable clout if your 1 million represent early adopters and they can see their 1 billion moving to your model at some point. If you have only 1 thousand consumers, you will be limited to offering a white label service.
Back in the days of the Dot Com Boom/Bust era we saw the concept of B2B2C. Like many concepts from that era, it is easy to ridicule this one, because it did not happen then. That may simply be related to the % of people online. Now that more than 50% of the global population have mobile phones, the concept of tiny ventures getting millions of consumers directly is no longer a pipedream. However it is not wise to ignore the power of the incumbent enterprises. Rather one should get enough traction with consumers to have some clout when negotiating revenue sharing partnerships with those enterprises.
Four Gates That Multi-$billion Ventures Pass Through. September 28, 2012Posted by Bernard Lunn in capital markets, Enterprise Sales, IPO, SAAS, start-ups, Strategy Workshop.
Tags: software ventures
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I also think about these Four Gates in the form of a funnel, with lots at the top and very few at the bottom (just like a sales funnel):
Gate #1: Conceptual Clarity.
Gate #2: Prove the Concept.
Gate #3: Scale within Niche.
Gate #4: Expand and Dominate.
It takes totally different skills to go through each of these four gates. Few founders have all the four different skills needed, which is why so many ventures fail as they attempt to pass through these gates. Even harder is the fact that the skills, techniques and attitudes that make you successful going through one gate are exactly the opposite of the skills, techniques and attitudes that make you successful going through the next gate. Each gate requires a wrenching pivot.
Gate #1: Conceptual Clarity.
This is the “fit to the future” phase. This is where you have a vision of “a world where….”. From this you have a mission for the venture along the lines of “in this future world, we will…”. Finally, you have a strategy, as in “we will do this by….”
There has been a lot of fruitless debate about whether concept or execution is more important. This debate is silly, because you must have both. A bad concept that is brilliantly executed will be nothing more than a tough uphill slog with relatively little reward at the top if you get there. On the other hand, a brilliant concept with weak execution is nothing more than “woulda, coulda, shoulda”.
In consumer web ventures, the investment in this phase is coding an early version of the site; these ventures are usually founded by developers who can invest their moonlit coding time, knowing that the best way to articulate the concept is to show something. In enterprise software, the investment in this phase is talking to lots and lots of potential customers to really understand their pain points both now and the likely pain points in the future world that you envisage. The founder is often a sales executive in an established company who keeps hearing the same request from customers that his/her current employer has no interest in fulfilling. They start with a crystal clear understanding of the pain, but only when they team up with a great developer do they create a solution to that pain. The established vendors are not being totally blind, nor are they only inhibited by the innovator’s dilemma from cannibalising their core business. Usually a technological breakthrough is needed as well. Thanks to Moore’s Law the world is awash in technological breakthroughs but most of them are solutions looking for a problem. What differentiates the great ventures is a crystal clear understanding of the problem, because they have heard the pain described by so many customers and prospects.
I look for conceptual clarity in 4 dimensions:
- Large enough market. A niche might make for a great venture that can be bootstrapped or flipped, but these are criteria for ventures that can “go the distance” through the four gates into multi-$ billion in value.
- Massive disruption hitting that market. This is the kind of disruption that creates an existential threat to the major players in the market – think of Skype vs telephone companies or Google vs traditional advertising. If it is not disruption of that scale, the existing vendors will add the features they need to stay competitive (“adding that feature” may mean acquiring your venture, so this is fine for ventures that will be acquired before they go through all these gates).
- You have a 10x proposition. You have to be 10x better or faster or cheaper than the incumbents. That seems like a high bar, but it needs to be this big to overcome the start-up risk that you are asking customers to take. Tactically you may start by offering say 3X knowing that as the technology rolls onwards you have much more in reserve, but you must see where that 10x is coming from.
- You really, really want to do this more than anything else in the world and deep down you believe that you are the best person to pull this off. You are saying “damn the torpedoes, full steam ahead”. If you want people to take that risk with you, you had better believe it yourself deep down in your heart and gut. You also must be ready to commit to at least 10 years with 60 hour weeks, forget about a balanced life for a while.
Here are the two things you do NOT need to have at this stage:
- A strategy that seems viable to most people. Most great ventures look totally ridiculous to most sensible people in their founding days. You do need a couple of smart people to believe in the strategy, whether they be co-founders or investors. But get comfortable with the fact that most people think you are crazy (unless you actually are crazy, there will be times when you doubt yourself and when you think most people are right).
- Any proof that any of the four things on that checklist are true. Anybody who asks for proof at this stage does not know how this works and does not deserve to be your partner.
Many great entrepreneurs have conceptual clarity but are weak at articulating it, or too busy executing on the next phase. At this stage nobody cares about your concept. Only after you have passed the next gate does anybody care. Enterprise software ventures tend to be bootstrapped from customer revenues, not from VC, so the founders learn to focus their pitch on the immediate needs of customers who are ready to make a commitment now, leaving out all the futuristic, big picture stuff which would only scare potential customers. However, somewhere in the back of their mind, the great entrepreneurs carry a conceptual vision that is a lot bigger than the immediate solution that they offer to get through Gate # 2.
Gate #2: Prove the Concept.
This is the “fit to today’s market” phase. This is also what VC call “traction”. Many entrepreneurs stumble at this point because they are not consciously making the transition from thinking about the future to executing on the present. The future that you envisage may or may not come to pass. If it does, you may strike gold. However that won’t help you get traction with customers today. All they are concerned about is problems they have today. Your customers maybe happy to “shoot the breeze” about the future, but they will only spend their money on problems that they have right now.
That almost certainly means you get traction in a niche that is tiny compared to the big vision in your concept. This process of digging deep into a niche and focussing 100% on the present day needs is a vital step in turning dreams into reality. It is also 100% opposite to what you do to get through Gate #1.
In enterprise software, getting through Gate #2 means getting the first three paying reference customers. This is a tough job because most customers prefer to wait until you have these three references before committing; one way to drive enterprise software founders crazy is to ask them about this chicken and egg problem. These need to be real enterprise-wide deployments with customers paying 6 figures. A few logos of customers deploying the software in one small area and paying a few thousand dollars won’t make the grade. Lots of enterprise software ventures reach this stage and become cash flow positive without raising any VC, but then stumble at the next Gate.
In consumer ventures, getting through Gate #2 means proving fit to market in a niche. So the service has to work and deliver what those consumers want. In the lean startup model, this is when all that pivoting takes place. However great entrepreneurs don’t pivot at a conceptual/strategic level, they got through Gate #1 with conceptual clarity, but it may take multiple tactical pivots to get traction in a specific niche.
Gate #3: Scale within niche.
This is the “make it work as a business” phase. This is when you throw out the lean startup guide book and start working like a real business with serious amount of capital and real management bench strength. Blowing it at this stage for lack of resources – human or financial – is dumb.
During the last decade, most enterprise software vendors that made it past Gate # 2 got acquired. VCs mostly shunned enterprise software during this time and it takes huge amount of self-sacrifice by the whole team to make it past Gate # 3 without VC. At this stage – you have the 3 reference customers, you have proved the concept – the acquirer will not consider your revenues to be meaningful, so you will be acquired for your R&D value with a bit of credit for the quality of your customer relationships. If you are lucky, you hit a market just at the point where two behemoth vendors who compete like crazy absolutely must, must, must have this technology….. If you raised VC, the acquisition value at this stage will usually be a disappointment to investors. As VCs usually get liquidation preference, this will be an even bigger disappointment to founders and management. If you bootstrapped past Gate # 2, the value you will get from the trade sale will still be life-changing as you don’t have to share the spoils with VC. However the big money, the fame and fortune, is reserved for those who make it to Gate # 3. One way to look at this is, don’t raise VC unless you are determined to make it past Gate # 3.
Entrepreneurs who want to build enterprise software ventures that make it through this gate need to make the tough transition from founder-led sales to a scalable, professional sales team. This is harder than it sounds for reasons that I describe in this post.
For consumer web ventures, the big obstacle at this Gate is proving a scalable and profitable revenue model. There are now trade offs and conflicts to be managed between the needs of free users and the different needs of paying customers (i.e advertisers) and that is often hard for the entrepreneur who won in the last Gate through their self-proclaimed single focus on user experience. This is when we see the free users (“if the service is free, you are the product”) start to get annoyed as the company starts to monetize them more aggressively (think of Facebook or any other social media venture), but a great entrepreneur and management team can navigate their way through this challenge.
Businesses that make it through this phase are “in the catbird seat”. You have a profitable, scalable model that you can grow with internal resources as long as you like. You will be fending off acquisition offers all the time, both from financial buyers (private equity funds) as well as strategic buyers. You get to choose when and who you sell to. Or you may choose to go all the way to Gate # 4.
Gate #4: Expand and Dominate.
This is the post IPO sustainable public company phase. This is where ventures grow into their original conceptual potential, moving beyond the niche orientation that you need in order to get through Gates 2 and 3.
For consumer technology ventures, consider the difference between Apple and Google and all the batch of 2011 IPOs. Apple and Google look good on all financial metrics, they built a superb monetization engine, not just superb products.
In the enterprise software space, only one company has broken through into the big league during the last decade and that is SalesForce.com. There have been plenty of SaaS IPOs, but only a few of them have escaped the “small cap hell” by getting a valuation over $2 billion. It remains to be seen if this decade will produce more big winners, but that is the subject of another post.
The “expand and dominate” Gate #4 is about getting back to that original founding conceptual clarity, of realising the big picture potential. All the long years of the earlier Gates are simply laying the groundwork to make this possible. This is another wrenching pivot. The skills, techniques and attitudes that got you up to Gate # 4 are all about focussing on a niche, constraining ambitions for the future while concentrating on the immediate opportunities. If you have done a good job in the transition through Gate # 3, you will be able to leave the quarter by quarter growth to a highly competent team. That frees the founder CEO to focus on expanding into adjacent markets and dominating their market. Dominate may sound harsh to some ears but it is what public market investors expect, that is what the high valuations given to fast growth tech companies are based on.
Entrepreneurs that make it through Gate # 2 get the opportunity to exit and that can be a good result if they have bootstrapped to that point. Entrepreneurs that make it through Gate # 3 get the opportunity to exit and that is a good result for founders, management (this is when those stock options become life-changing) as well as any investors who are fortunate enough to be along for the ride. The Silicon Valley VC orthodoxy for a long time was that no founder has the right profile to make it through all the 4 Gates. Therefore VCs have usually tried to either sell the business at each of these Gates or find professional management to replace the founder CEO. (I refer to the Founder CEO as the key, even though there are often co-founders it is one of them who emerges as the leader). That conventional wisdom is being seriously questioned today as we witness the failure of “professional managers” from big companies to drive the growth of start-ups. When you look at the really great success stories, you tend to see one highly charged entrepreneur who takes it all the way through these 4 Gates – think of Gates, Ellison, Page, Zuckerberg, Bezos, Jobs, Benioff. Their ability to pivot and personally change at each of these Gates is the story of their success. It would be crazy to see these entrepreneurs in their founding days and envisage them as the CEO of a multi-billion $ publicly traded company, yet some of them actually do that. The current VC fund structure, with its need for exits to return money to the Limited Partners, is not conducive to backing entrepreneurs all the way through these four Gates. So we are likely to see some innovation in this area as the rewards for backing entrepreneurs through all four gates is very big.
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Yahoo does not get a lot of respect these days in the tech blogosphere, at least if you assume that the blogosphere is represented by Mike Arrington. It is possible that conventional wisdom is wrong. It is possible that we are seeing the early, messy signs of a turnaround. If so, it is a lot like the epic turnaround of IBM in the early 1990s by Lou Gerstner as told in his bestseller – Who Says Elephants Can’t Dance?
IBM had even less respect in 1993 when Gerstner took over – totally blew the PC opportunity, slow-moving bureaucrats etc. So Gerstner got a lot of flak when he dissed the idea that IBM needed a vision saying something like “vision is the last thing IBM needs”. In his own words “fixing IBM was all about execution”. Specifically that meant fixing the culture to a) get more urgency and b) get totally focused on client needs.
Yahoo clearly needed a lot of old-fashioned management discipline. It is hard to tell from the outside, but based on Carol Bartz’s track record and a few news reports, it looks like that is happening. Two years ago it was obvious that this was needed and that Jerry Yang would have to go (as I wrote here on RWW).
Gerstner was not saying that a vision or defining mission was unnecessary, just that it was not top priority. The same is true for Yahoo. They need a defining strategy. I am going to copy what I wrote on RWW two years ago, as I think that is still correct:
“The second part (disrupting current leaders with a new proposition for developers) should not be unveiled until there is something substantive. Yahoo has an opportunity to take a leaf out of Amazon’s AWS book, but go a lot further. Yahoo can open up all their search, content, communication and community services to developers via well-defined interfaces. If they do this really radically, Yahoo could lead the next wave of the “programmable web” or the “web operating system”. This has to be radical. More “too little, too late” won’t work. Radical means:
1 Simple pricing. This is where Amazon did well. A start-up can understand how to build their costs into a plan.
2 Cost plus pricing. This is again where Amazon did it right. They look at it like a retail “I buy infrastructure at $x and sell it at $x plus y%”. Nothing wrong with that model at scale.
3 Loosely coupled. You can use just the services you want. But you end up using lots of services as it is simply easier to integrate than something else and the price is right.
Yahoo has lots more to offer than Amazon. Nor do Yahoo need to worry about cannibalizing their core e-commerce business (which does constrain what Amazon is willing to offer).
This developer offering has some risks. Theoretically, any start-up can compete with Yahoo’s existing cash cows, using Yahoo’s own assets. In practice a) start-ups will tend to focus on new markets and b) start-ups can compete with Yahoo anyway, with or without their help.
Yahoo can score four ways with a really open suite of services for developers:
1. They make money immediately from fees for the services.
2. They empower start-ups to compete with Google and Facebook.
3. They become exciting again, getting talent back on board.
4. They get a steady flow of acquisitions with zero integration cost.
Yahoo has occasionally done things that excite developers, such as Delicious, Pipes and SearchMonkey. They need to take that to a much higher level and offer everything they have via interfaces and promote that like crazy. That is how Microsoft won the PC era. With the right leader, Yahoo could still do this in the Web era.”
Tags: information bus, marketing, messaging, mindshare, teknekron, tibco
Note: I wrote this 10 years ago and remembered it when facing a similar issue today.
Software market leadership starts with mindshare. Winning the mindshare battle requires intense clarity about your message. If you can distill your message into a single word or phrase that defines your market, you have a big competitive advantage.
Of course it is not that easy. Thousands of marketing professionals get paid millions of dollars every day to come up with cringe-inducing phrases and tag lines that last as long as snowballs in hell. What makes it so hard is that messaging clarity has to be based on a very deep understanding of the dynamics of your industry and the position of your company within that industry. If your message does not seem real, it does not stand a chance. In fact it has to seem so real and obvious that when people hear it they assume they have heard it before.
History Lesson – Information Bus
However that final touch of clarity that is enshrined in a single phrase or word, can make all the difference. I learnt this the hard way in the early days of the market for real-time application integration middleware. In case you are thinking 2001, let me set your clock back about a decade to 1991. This was when technology such as Publish & Subscribe, real time messaging bus and Enterprise Application Integration was being adopted on a large scale in the first vertical niche market – financial trading rooms on Wall Street.
My company, Aregon, was an early innovator with solutions dating back to 1984 that were the first implementations in the industry. We were the technical pioneers. However when customers started to ask us whether we had an “Information Bus”, a term invented by a rival company, things started to go wrong.
How To Respond When A Rival Has Mindshare?
None of our responses was very effective.
For example, “no, that is not what we call our technology, let me explain” left people cold. Customers saw the Information Bus concept and automatically “got it”. They did not want to waste time understanding some new concept. Coming up with an alternative message is doomed unless you catch things very early and you are very, very good coming up with an alternative.
Replying that “yes, we have an Information Bus and ours is better for the following reasons” will get you sales but will automatically relegate you to the position of follower. You can build a good business as the number two or three vendor in the market and, if you time it right, you can sell out at the right time for a reasonable valuation. That is what happened to Aregon. However that is a far cry from being the market leader in a large market, which was what happened to Teknekron, which was later renamed TIBCO (as in the The Information Bus Company) and became the leader in the booming enterprise integration market.
Why Was Information Bus Messaging So Powerful?
The payoff from getting it right is huge. However there are very, very few examples of great successes. Why was Information Bus so powerful as a message?
- It was simple and easy to understand for the target audience. This does not mean “dumbing down” for everybody. This was a smart, sophisticated audience and they could count on a certain level of base knowledge.
- It was based on a genuine “aha moment”. As related by Vivek Ranadive, TIBCO’s founder, the moment came when he asked a software expert to describe why so many software projects failed. As a hardware engineer Vivek, could not understand why well-tested components could not simply plug into the system Bus. Why not do the same with software?
- TIBCO created a clear and simple diagram of the Information Bus that anybody could draw on a napkin and understand in a heartbeat.
- The company made sure that everybody stayed on message. Execution consistency is critical to success. The phrase enabled a dialogue that went into increasing levels of details as the company engaged in customer dialogues. Yet at every level they could come back to the simple Information Bus concept and diagram.
Think SAVE – Simple, Aha, Visual, Execution.
Don’t Force It
Hiring external consultants to create your messaging is usually a mistake. At best external consultants can act as facilitators, drawing out what is already known but hidden. Great messages cannot be forced out; they have to emerge. You cannot set a firm deadline and it is better to have no message than a bad one.