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)

Startup Analysis: Gliider, can a Browser Plugin have a successful Business Model? – part 1

I recently saw a pitch for a startup called Gliider and was impressed with the product. To make it simple, it’s a Firefox plugin that allows you to store travel information that you find on the web (Hotels, points of interest, Flights, whatever) by a simple drag and drop to the Gliider box. Once you are done, you can print or share you saved stuff.. Usually people will bookmark, print, copy and paste into a word document (at least that’s what I do) which is pretty bad.. Honestly, I really like Gliider.

At the presentation, one of the question after the pitch was: “Do you think this can have a sustainable business model?”. This is what we are going to find out now. I took the liberty to make a few hypothesis of course but I hope to give you an idea of a process that should be applied by every entrepreneurs who wishes to start a business.

First question: How do they make money? They have a “deals tab” in the widget that will send you travel deals (hotels, etc..) according to the saved search. That’s interesting as you can imagine those deals as well targeted.

Second Question: how much do they make per deal sold? That’s an unknown, but they do have a partnership with Expedia (source: Techcrunch) and looking at expedia’s affiliate program, you can easily find that they would make $4 per Flight transaction (which Gliider doesn’t seem to offer yet), and 5.5% to 6% of the transaction on Hotels. That seems pretty high so I’m wondering if it’s the full booking transaction or the gross margin made by expedia (which would be a lot smaller..). Anyway, we’ll stay in wonderland and imagine that it’s the full booking.

A hotel booking can go from something like $60 to an easy $250 (I’m excluding master suits!), for 1 to 5 or 6 nights in general. That ranges the potential gain per room from 5.5% x 1night x $60 = $3.3, to $250 x 6 nights x 6% = $90 commission. Pretty big range and we’ll deal with it. Most probably the transaction commission will fall in the $12 to $20 dollars on average.

Third question: how much do they have to make to be sustainable? That’s along question but I’ll keep it short by just keeping it simple. Gliider is a startup, they are small, probably somewhere around 4 or 5 people, low cost infrastructure, average salary around $90K, a professional web hosting, distribution through Firefox plug-in platform, some benefits (healthcare) and a  little bit of marketing + PR.. Let’s keep it low and say $700K for the year (ok that’s low…). At $700K they can sustain the initial team and maybe improve the business a bit.

Fourth question: For users who have the plugin installed, how many will use the deal section? This is a bit like a CTR (Click Through Rate).. You might play with it after you install it, but then you’ll forget about it until you actually search for your next travel, and out of those they would need to click the Deal tab and see what’s available. I would venture a guess that this number stays in the low %.. Let’s take from 0.5% up to 5% (which would be incredible).

Fifth question: For the users who click on a deal, what would be the conversion rate (user who actually buy after clicking)? This is a classic and I would guess it in the same 0.5% to 6.5% (if the targeting is really great).

Last question: How many Active Users do they need on a monthly basis to make the necessary $700K to be sustainable?

Let’s recap:

  • target revenue: $700K
  • Revenue per transaction: between $12 and $20
  • Users clicking a deal: between 0.5% and 5%
  • Users booking a deal after clicking on it: between 0.5% and 6.5%

We are ready to plug this into Excel and play with the sensitivity parameters:

Those table tell us how many Users of the widget per month they need to have to reach their sustainability:

Ouch… in the best of the best scenario, they would still need to have about 900K users monthly.. and in the worst, 194 million.. That’s a tough call and it brings us to conclude that this model is NOT sustainable (and definitely not interesting for a VC investment). You could do the model yourself and play with different options but honestly, I didn’t find any that would be great…

So the bonus question is: How can they become sustainable? because as entrepreneurs we want to find solutions not just stare at the problem.

I think the post has been long enough for now, but in the next one we’ll talk about ways for Gliider (and probably a lot of other plugins) to reach their goal and succeed.

Any comments are welcome! and by the way: install it and try it, it’s really a good product..

-Antony Passemard

Global Entrepeneurship Monitor 2008

I skimmed through the GEM report for 2008 and found out a few good stuff that are relevant to this blog:

The first one is the age distribution of early stage founders:

Despite the fact that the biggest segment in every type of economies is always 25-34, you can notice that a large majority of entrepeneurs are actually over 34 year old. This is reassuring ;-). This is also confirmed by a report from the Kauffman Foundation (May 2008) that presented the data in an other fashion:

Honestly I found this amazing.. What about all those stories of Undergrad student starting the best ideas out of their dorm room or their garage? Well, Yahoo was started by college student, same for DELL and for Facebook is probably the most impressive with its CEO.. But those are the flashy ones! How many companies are very successful but were started out of strong fundamentals, based on experience, skills and well thought business model and great technology? To wannabe Entrepreneurs: don’t be fooled by the few companies like Facebook or Twitter.. they are so rare that they shouldnt be taken as example for your next venture..

In the GEM report you could find the main reasons (auto reported) why Entrepreneurs stopped their business:

Around a third of the startups stop because they are not profitable (I hope those guys had at least a business model that was supposed to be making money – which is not always the case unfortunately) .. Around 20% for personal reasons (you can imagine what it could be: Arguing with your partners, spending too much time on the business and your partners wants to leave, loss of passion, etc..). What I find interesting is that only a few percent have the opportunity to Sell!..

Conclusion: It’s never too late to start a business (average is 39), and if you can make sure that at least the business is profitable (if not big) you can increase significantly your chances of success.. Seems obvious? Well.. wait a little and you’ll see that it’s not for a lot of entrepreneurs..

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.

Startup and entrepreneurship

What’s entrepreneurship? A commonly used definition at Berkeley is “the pursuit of opportunity beyond the resources you currently control”. That means that entrepreneurship is not limited to startups, but can also happen inside an enterprise (Intrapreneurship). For the purpose of this blog, I would like to focus on entrepreneurship involved in starting a venture that has the willingness and potential to reach a certain scale. The vast majority of startup are Mom & Pa types of startups that turn into a life long business (about 60% of firms in 2005 had less than 10 employees in the US. Source: US census). Some of them are good business, even excellent businesses: An ice-cream stand, a gift store, a service company are all interesting ventures and deserve that their founders do their homework before starting but they are not the ones I’m going to focus on.

My background being strongly skewed toward IT, and the web, I think I will be able to talk more about IT ventures and especially if they are Web-based.

I will also try to focus on Startups that could be suitable and/or seeking Angel or VC funding as those are the types of venture I’ve been mostly working on in the last 2 years. Basics are the same for all those ventures, but the way to reach the end result is very different.