A single metric for business: Profit per x?

I’ve been profoundly affected by a book: Good to Great by Jim Collins which has studied hundreds of companies to understand what made some of those good and others great. The findings are just incredible and the way the book is written allows any business person to reflect on its own attitude and approach and try to pursue the path of greatness in business.

I won’t go into every points addressed in the book, although I wanted to call out one of the thing Collins noted: great companies have a very clear metric they were following relentlessly. It’s the denominator of the formula: Profit per x. Each of the great company had a clear profit per x. For example, profit per visit for Walgreen, profit per employee for Abbott, profit per region for Circuit city, etc.. It seems very simplistic but it drove billion dollars businesses’ strategy and became the heart of their culture. The shift of revenue metric from one denominator to another was often time the starting point of fantastic results.

As I was reading this I asked myself what could be the right denominator of a profit per x of a very small business, and how could this drive the strategy of the company. I was fortunate enough to run such a small business, Iniflux, in the past and I was trying to think what it should have been.

The first step is to determine what metrics we have and that is probably the biggest issue most small businesses are facing. When you are small, you often live day by day, each deal is important, be it outside of your realm of skills, focus is not a virtue, and because management is so close to the field there is no time to think too broadly about culture, strategy, hiring and investment. Accounting is outsourced to a CPA which role is mostly to help filling taxes and make sure the company pays the right taxes to the state and the visibility of the cost structure is very weak.

Building those metrics takes time initially but they are crucial to growing the business. You need to ask the right questions:

– What are my costs? How much does every employee cost really? What’s my total overhead cost (attributing overhead correctly is also very important)? What is my cost per profile of employee? per employee? per deal? What is my sale cycle length? by type of deal, by size of deal, by sales person? How much hours of each profile have been put in on each deal? How much do I spend in marketing? where? for what return? what is my support cost? How much is debt costing me? etc..

– What are my revenue? What margin do I make by type of product, by deal size, by sales guy? How much revenue by practice if you have several? by region? compared to last year? and the year before? etc..

The idea is to have a perfect picture of your cost and revenue structure. The goal of this exercise is not to just do it once but also to be able to track those metrics over time and see trends appear. Once this is in place, the company has to compare itself to the market, and comparable companies in particular if this data is available. For example, what’s a good revenue per Sales in the first year? the second year? Hopefully you will realize that you are good in certain areas and weak in others but overall, you will know, from now on, how to plan for the future. By understanding your core metrics, planning becomes much easier. Later you can always compare your plans with your metrics to see if you are on track. Another to know more is to talk! talk to other small business owners, go to networking events, ask questions, talk.. IT is in fact incredible to realize how much first hand conversation can bring, and often times how people are open to talk about their company and experience. Who does not ask gets nothing. Talk.

So, as you are planning, what should be your denominator? The x of profit per x. Force yourself to think about a single one. What should it be?

I will take a few example to illustrate the impact that such an approach could have on your business.

As a service company, the denominator could be: Customer. Profit per customer. If you are set on this what does it mean: The number of customer is not that important, what you want is increase the profit for each of them. That might drive you to go see your current customers more. It might drive you to drop customers with which the type of deals you have are not in line with your strategy (service versus pure software/hardware sales for example). It might drive you to expand partnerships with a single partner. It might drive you to diversify your offer into a more complete or global offering. You will try to find ways to cross-sell or up-sell products with existing customers. At the same time you will try to reduce the cost allocated to each customer which means you might want to have someone dedicated to each customer that knows them in and out and can be efficient, spending less time on each new deal. You may want to incentivize your sales team on this metrics as well.

Now as the same service company, the denominator could be: Practice. profit per practice. Let’s imagine you have a security practice and a database practice and you want to maximize the revenue per practice. To achieve that goal you will have to develop certain expertise that justify higher sales costs, maybe find product in those practices that have bigger revenue and margin, your training costs will be distributed differently to maximize for this denominator. You may even want to drop one of the practices all together. Overall your strategy will be quiet different that is your denominator is “customer”.

If you are a SaaS software vendor, you denominator could be “visitor”, “paying customer”, “server”, “marketing campaign”, etc.. and each of them will call for a different focus, culture and strategy.

Finding your denominator is going to be very hard and will certainly be the source of many debate internally. Be honest with yourself, face the hard reality of your situation. Don’t just come with a denominator, try to figure out what is going to be the strategy to increase it (using the great tracking you have put in place earlier). You might realize that this focus will be what takes your company to the rank of great company.

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Running a Flat organization.. Really??

I stumble upon this article today: http://www.inc.com/magazine/20110401/jason-fried-why-i-run-a-flat-company.html from Jason Fried the founder of 37Signals. I thought I would get some really good insights on how to run a startup and all this, and then I realized how I could not disagree more with him. I am starting to understand why, despite the claim of double digit growth, 37Signals has not grown to be the major player it could have become.

For the history, 37Signals with Basecamphq was in my line of sight when I was creating effecteev (www.effecteev.com). We are trying to solve the same problem of team collaboration. When I found basecamphq I really felt that they had solved it.. The product had plenty of really good features and was claiming over a million customers (although many free). I thought they were not making that much money and not growing very fast because their pricing model was stupid (way to cheap for the value it provides), and their software is a bit clunky with a security scheme that I would call “poor”. Now I see more clearly. Jason Fried seems to be very short sighted and is not the leader that company needs and that really doesn’t help growing a business with a long term vision.

Let’s consider the flat organization he is describing:

– At 37Signals it’s all collaborative, no managers. That is a structure that can never ever scale! Who makes decisions? Who handles conflicts? Who takes risks? Having this structures builds a world of compromise where the outcome of a decision is simply the average of all opinions. That makes the outcome average, and average is not enough to beat the competition. Also, underlying this structure, mister Jason Fried then becomes the King of the castle. In the end, he decides, he solves conflicts, he takes the risk. That’s fine, but please, don’t come saying how great it is for your employees to leave in this world when you are just at the opposite of the spectrum!

–  At 37Signals they don’t promote people, they take people who love what they do and want to get better at what they are doing.. Man.. I’m sure employees at 37Signals are really really good at what they do after 11 years of service doing the same stuff.. Can you really get that good?? Is there an unlimited growth potential in what you love to do? I’m sure you can always get better, but the growth curve must become pretty flat pretty rapidly!They are lucky in the sense that the Web is constantly evolving and new technologies appear all the time so they can certainly evolve their skills that way but I don’t really buy it.. it’s a bit of the same over and over. The biggest problem I see is the fact that Jason Fried doesn’t think about his employees. What about their career? Do you think they will spend 40 years working at 37Signals (where titles don’t matter) and enjoy what they are doing for 40 years? Do you believe, really, that it’s making them a favor to not promote them? to not teach them managerial skills? to not force them to think strategically more?  What happens when they decide it’s time for them to move on somewhere else? Do you have a notion of how recruiting is done in most companies? If you are an Software Engineer, have never managed anyone, even for 10 years, and you are really good, you will end up as maybe a senior Software engineer with a bunch of 23 year old all around you and a salary that fits that profile. 37Sginals needs to help people grow their skills so they can have a successful career after 37Signals. Nobody likes turnover, but that’s a fact of life for a business. Embracing the fact that some turnover happens, and making sure your former employees like you is key to succeed in business. Those former employee will pass the good word around, about how good it is to work in your company, they will want to work with you in the future as partner, or customers, they will help your business!

If your employee don’t want to evolve and develop new skills, fine, let them, but make them think “long term”, and they will quickly realize that this is not sustainable. They will pay this Flat Organization the day they leave.

Now Jason, I’m sure your employees all own some equities in your business, or at least I hope they do, and I hope they have enough of them so when you make it in a few years, they will sit on a pile of cash big enough so they don’t have to worry about their career anymore. If you think that is not the case.. then I say, you are screwing them and their future.

– 37Signals has 26 employees. This is after 11 years and over a million subscribers! Honestly, with that big of a user base you should already be Public! 11 years, 26 employees, I’m not calling that success, I’m calling that stale. and I now understand that you are that way, not because the pricing is too low, not because your product is a bit clunky to use, not because your security layer is full of holes, but because you build a Flat Organization that can go nowhere.

My advise: Structure your company for growth, put layers in place, promote people, hire people that can manage for excellence (not average), and help your employees build their career at 37Signals, but also after 37Signals. You will do everyone a favor by offering a better product, a better equity value to your employees (that might eventually be able to retire and do what they love all their life if they want), and will open future doors for the employees that want to be good at what they do but like everyone on this planet, can get bored doing the same thing over and over..

 

Low CEO salary pay determinant success factor for Startups?

Once again a realy good article from my friend at iterativepath: http://iterativepath.wordpress.com/2010/02/03/one-question-to-determine-a-startups-success/

I cannot agree more with him, judging the CEO salary as one of the most important to look at to determine success factor just doesn’t make sense.

What are we talking about here? A lot of startups actually start by moonlighting, in a garage (or student dorm) or somewhere where structural cost are near 0.. CEO salary = 0. So what CEO are we talking about? the CEO and founder of the company (which I bet will have a low salary anyway because there is a good chance that the startup doesn’t generate much money anyway), or the CEO that will be hired by the VC when they fund the business (which I bet will have a high salary because he/she will be a seasoned entrepreneur, buddy of the VC, and coming from a previously high paid environment too)..

That said, if a startup generate very low revenue, and the CEO is taking a huge salary then, the person probably doesn’t understand much to the business:

  • The money he/she takes could have a much bigger return if reinvested in the company
  • Taking out all the cashflow gives very little flexibility to the company to grow
  • The guy is short term minded.. not good in a startup environment where the expected return is between 5 to 10 years.

good idea to replace him or her anyway in that case…

To Peter Thiel’s defense, it’s probably true that a VC will not finance those very early stage Startup where CEO take no salary.. VC tend to look at fast growing startup that already generate revenue (positive even better), and therefore, the CEO will have a salary, and looking at the amount can tell you about the personality of that leader as well as his or her understanding of the business logic behind a startup.

Debate around how much should a CEO be paid (peter says somewhere around $100K-$125K) will also very much depend on where you live.. The Silicon Valley is one crazy expensive place to live in 😉

Is the fact that the CEO has young kids a determining factor in the future success of a startup? some might say yes.. Well, read this: http://entrepreneur.venturebeat.com/2009/09/07/launching-a-start-up-and-having-a-family-life-it’s-possible/

(by the way: Steve Blank is no small entrepreneur.. and is also a professor at the Haas School of Business in Berkeley)

Did Apple made a basic mistake with the iPad?

There are so many blogs and comments about the iPad that I feel I shouldn’t add my drop in the bucket, but honestly I cannot resist. This is a blog about entrepreneurship so let’s try to take that angle. What does an entrepreneur do before launching a product? A market research to validate and quantify the need (among many other things of course). So, what about the iPad? I’m trying to figure what need did Apple identify to launch that product.

What is the iPad really? A big iPod touch (without video camera) or a small computer? a bit of both it seems. But what was missing between the iPhone/iPod Touch and my MacBook? When I’m on the go, I can check my email, find my way around. look at some websites, read my attachments (at least skim them), view my photos and listen to my music, etc.. All this in my pocket! Amazing!

Now if I’m not on the Go, I’m working on a few documents, editing videos, sorting my photos, blogging ;-), I can take my laptop on my Lap and watch TV at the same time. Do I need to have a smaller computer for that? Not really..

So what is it in the middle? What’s the iPad? how does it fill a painful need I had? I cannot find the answer.. It’s too big to be a real mobile device that I can carry around all the time (like my iPhone) and it’s too small to really do the stuff that I do on my home laptop. It’s cool, I can grant that, but it doesn’t solve a pain and this is why I strongly believe that the iPad is not going to be successful. Some people will buy it, for the hype, for the fun, because it’s not too expensive, but it’s not going to be a blockbuster like the iPhone.

I hear some people say “and the BOOKS!”. Sure. the Kindle is amazingly ugly but at least with eInk you can really read like on paper for days on a single charge. The Que from plastic logic is even more amazing to me (still very slow though), and those really come as a replacement for paper. No way the iPad can do that.

No. Really. I think Apple has been looking at building an incredible machine but forgot to look at the market opportunity, too product centric. Well, who said Apple listened to there customers when building products? Entrepreneur 101..

So, what’s next? This is where I think the iPad could be a first step to an amazing break through: The first step toward a keyboard less laptop. As an entrepreneur I am very excited about this. I’ve been thinking about it since they launched the iPhone. Imagine that now: Open your MacBook, but instead of a keyboard, you have a touch screen, the size of the iPad. It displays a Keyboard, plus your dock with all the application. You type an application with your finger and it launches on the main screen. That application happens to be iMovie, the great movie editing software from Apple. The keyboard disappears  from your touch screen to give way to a whole bunch of editing tools. going bakc and forth in the movie in a swipe. Cutting with your fingers, slowing down or accelerating with your fingers, etc. etc.. The application could feel like you have a Pro system at your fingertips.

Once  you are done, you drag the dock with your finger from  the top of the touch screen with your finger and launch a game. The keyboard become a Game controller with shortcuts and controls under your fingertips.

This would be the revolution in gaming, and Laptop usage in general. A revolution to that old input system eeryone has been using for dozens of years.. This is the kind of revolution I would love to see Apple doing. And this is the kind of revolution I bet they are aiming for with the iPad.. the iPad is a trial, believe me, once Apple gets enough usage data, the next Gen of laptop will be there and destroy anything you have seen so far.

now I’m excited.

What about the Team?

As I was reading my previous post about how good the picture needs to be for an entrepreneur, I realized that I totally overlooked the team. This was not intentional as the Team is definitely very important but I have a certain view about that.. My feeling is that VC would love to have a business with a great team: Knowledgeable people, outstanding track record of success, etc.. But what you realize is that when you start working with a VC it’s for years (hopefully), and the VCs will try to have either people that are the cream of the crop for the job, OR former buddies they worked with in the past and who have been successful in the post. You should not under-estimate the fact that Affinity will play a enormous role in the choice of the team (for you and the VC). I’m not blaming them for that, would you not rather work with people you have already worked with and who have been successful rather than having to bet on a  new team?

The only advice I could have is certainly to find a someone who already had a successful startup at a key role in your team.. or be ready to hire a CEO (from the list provided by the VC ;-)) Additionally, make sure you REALLY get along with your teammates and open up issues as fast as possible. It’s easy to change things at the beginning of a company, but as time passes, things get harder..

A few myths about VC funding

I met an entrepreneur who filed a patent for a pretty interesting technology and he was willing to get some funding for his business. He came to me as I was participating in panel for the launch of the UC Berkeley Business plan competition 2010. He was very convincing about his technology and really felt that his idea could get funded quickly.

After his first presentation to a VC firm that turned him down we had a long conversation about the most probable reasons why he had been turned down. This is when I realized that some people (probably more that I think) actually have a misperception of VC funding. The influence of the Bubble era pre-2001 are still deeply rooted in many people’s mind,making them think they can get funding with “just an idea”, but the scares of the burst after 2001, are also deeply rooted in the VC’s mind.

Here are a few myths about VC funding that I think should be well understood by wannabe entrepreneurs:
A good technology is enough for a VC: Technology is good but not sufficient. A VC firm is here to invest and make fast returns on their investments. A company at the technology stage has a lot of work to go by to prove the market opportunity, define a business model and acquire customers. A VC would rather invest a bit later in a proven business than earlier in a technology.
VC have so much money they’ll finance everything: It is true that VC do have a lot of money and they do need to invest it. But make no mistakes, VC bet on big wins for most of their investments. A big bet is a Google, a VMWare or similar company for which the return is astronomical. Out of 10 companies in which a VC invest, One will be a big win, 2 or 3 will make money and the rest might barely make it or lose money. (BACKUP WITH NUMBERS) If you think about the fact that all of those were thought to be potential big wins, imagine how much a VC can be wrong.. Just a little less wrong that others (hopefully).
Asking for a low amount is equivalent to low risk for a VC: I have seen a incredible amount of entrepreneurs taking that stand: asking for $100K, or $250K to make the VC feel it’s so low that they are not taking much risk. This attitude clearly shows that the entrepreneur doesn’t understand how  a VC works. There is two component when looking at how a VC works in terms of investment decision. To make it brief:
If a VC has several millions to invest and a very limited number of partners to take care of their portfolio. if a $300M fund invest in $250K deals they will need to find and finance 1200 deals.. knowing that most of the time those VCs have 2 to 10 general partners, is their something wrong in the equation? VC are willing to invest from $5M to $30M or more in one venture if the return is good enough. A few deals a year is perfect for each General Partner and their is no time for very small deals.
if your venture requires only a few hundred thousands dollars to start and explode to the level a VC is interested in, it certainly means that their is a very low barrier to entry and competition will be very quick to come by and hinder the growth. Some competitive edge must be present to explain how you can produce so much value with such a little amount of cash to start with. I’m not saying it is impossible, but it’s doubtful.
Any VC will do for my Venture: This is a very common mistakes made by Entrepreneurs as they pitch to VCs. A VC is here not only for the money they invest, but for the network they provide, their experience, and their capacity to execute a good exit. The Track record of previous funds and of the general partners as well as the composition of the VC’s portfolio are very important in choosing the VC you want to work with. I might be naive, but I feel that a VC-Venture deal has to be a match for both sides otherwise it is doomed to fail. Pick your VC carefully because if it makes sense for you to work with them, the reciprocal might very well be true.

I’m digging up some numbers and will post them very shortly..

What drives the entrepreneur?

As I promised I’ll talk a little bit about what drives an entrepreneur. How many times did you hear about “serial entrepreneurs” (that sometimes failed many times but keep on starting again) or about the fact that entrepreneurs have a special mindset? Nobody would rely deny that entrepreneurs usually have a way to look at opportunity and business in a different way. But what is it?

I consider myself an entrepreneur at heart but it’s not because I’m risk seeking or because I have faith in every possible opportunity I encounter. I truly believe that it’s almost a need. A need for creation, a need for innovation, a need for curiosity, understanding, improvement. It’s a need to challenge the Status Quo and come up with new ideas.

I have heard many times (from non entrepreneurs) that entrepreneurs don’t like authority and want to be their own boss. I for one do not believe in this argument, but I do believe that entrepreneurs require some freedom to create.

Some people are more artistic than other and enjoy more the art of creation in and all itself, and I believe that those people are more of the entrepreneur’s type than others.

I think that entrepreneurs start businesses not only because of the business opportunity but also because they need to work in an environment where they can create, change, and improve everyday. This is the key element of a startup, ideas are generated all the time, the product varies and adapt in an agile way, nothing is set in stone and everything becomes possible. The opportunity of a big exit with multimillion dollars awards is very tempting but on the day to day hassle of entrepreneurship it takes more than a big check at the end to make you hold for years in a very demanding startup environment.

That said, I do not want to generalize and also do not want to convey the idea the non-entrepreneurs are not creative or don’t have the mind set for innovation but I an convinced that a vast majority of entrepreneurs (successful or not) do share those common traits.