Post foda da Venture Beat.
I’ve been building venture-backed businesses for over 11 years now. In that time, I’ve seen a sea change in how businesses are put together. Engineering approaches, marketing approaches, pricing, service delivery … they’re all dramatically different than what they used to be.
But what I’ve come to appreciate is that, ultimately, businesses live and die on three simple dynamics: Distributions, network effects and sigmoid curves (s-curves). Almost all problems (and most opportunities) come from understanding how to take advantage of these functions – rather than fight against them.
Distributions – A distribution is a measure of how tightly grouped something in your business is. For instance, if you plot all of your customer deal sizes in a distribution, you’ll identify some interesting observations. You might see a tight packing around the mean (average), which indicates that most of your deals are about the same size.
You may also see a bifurcated distribution – which means you have two types of customers. (For discussion’s sake, let’s say one has a peak value of $1,000, while the other’s peak is at $100,000). If you find yourself in this scenario, you’re likely heading towards a problem.
With a bifurcated distribution you will have to sell differently. You can’t afford to have direct sales reps selling $1,000 deals and $100,000 with the same costs and compensation plans. A company spending $1,000 and a company spending $100,000 may each be spending the same percentage of their revenue on your product, but you can’t service them the same way because your earnings relative to their service costs is vastly different. Therefore, maybe it’s time to change your marketing (or selling) focus to one type of customer or another.
Another way to think about distributions is how to move the mean up – or, in other words, towards more value. If you can control where the mean falls by making some changes to your business (i.e. pricing, compensation plans and marketing targets), you can greatly increase the value in your business without increasing the cost.
Sigmoid Curves (S-Curves) – S-curves are everywhere in your business. They describe your ability to scale and where various approaches will break down. You can take almost any example and run it through a sigmoid test.
With paid search, if you plot conversion volume (your number of sales) versus conversion cost (the cost of each sale) – it will always result in a sigmoid curve. This simply means at some point the cost to get one more sale will go up dramatically using paid search; you won’t be able to get another cost effective sale simply because you’ve tapped into practically everyone that is looking for your product on Google each day.
S-curves can also describe the scalability of processes and the necessity for automation. For example, if you manually handle customer service issues, you should expect at some point that a customer service rep can’t handle any more customers without some form of automation or process change. This is bad for your business because it means you’ll have to linearly scale customer service reps with the number of customers you have. (We’ll come back to linearity in a second.
Network Effects – Network effects are a beautiful activity if you can find them because you create value exponentially in your business by increasing the value for each customer with the addition of each new customer.
The classic example is the telephone system: for each new phone added to the telephone network there is someone additional that any existing customer can call. A more contemporary example is dating sites. For each new person signed up to a dating site, an existing person might now have access to a soul mate match that wasn’t there before.
eBay provides a different example. Each new product added to the eBay market doesn’t necessarily add value to me as an eBay shopper directly (I may not want to buy antique tea cozies), but it creates a positive cycle of attracting more buyers (who do want tea cozies) and thus more sellers who might in the future sell something I want. The network effect is that each member of the market drives growth for both sides of the market.
The last business I built, an enterprise software company, had basically no network effect. That’s a tough slog. Your only hope is to build a large customer base and then mine them for new revenue streams by introducing new products.
The counterpoint to all of this is that linearity is the enemy in any business. You don’t want a sales model that is linear forever (each new sale takes as much effort as the last one) – and you don’t want a support model that is linear (I need a new customer support rep for every 10 customers).
While you can still find businesses that are highly profitable and very linear, it takes time and money to grow those businesses to scale. Professional service businesses are the epitome of the linear approach. If you want to double your revenue, you have to double your staff.