Why Most Startups Fail at Acquiring New Customers (and how you can succeed!)

Why Most Startups FAIL at acquiring new customers (and how you can succeed) Saar Gur Stanford Graduate School of Business Startup Garage Presentation January 2014

Me Saar Gur saar@crv.com Twitter: @saarsaar Current: General Partner at CRV Past: VP of Customer Acquisition for one of the largest online advertisers in paid search, display, affiliate, email and SEO (Before “Growth Hacker” was coined) Very lucky to have learned from a lot of world-class people and companies: 50+ Million Users 200+ Million Users 150+ Million Users

Why Most Startups FAIL at Acquiring New Customers #1 Reason: BAD PRODUCT

#2 Reason: Don’t really understand who the customer is and their needs

#3 Reason: Clueless on the amount of effort it takes to acquire new customers Expectations Reality Example: A sophisticated marketer may run hundreds of A/B tests in a given year to optimize their banner ads. And will do the same for landing page sign-up flows, email subject lines, etc.

#4: Make Bad Spending Decisions

#5: Investing Time/Money in Sub-Optimal Channels

Topics for Today 1. 2. 3. 4. 5. 6. Developing a great product Understanding your customer Expectation setting Making good spending decisions Channel overview and selection Channel examples

How much can you spend to acquire a new customer?

Customer Lifetime Value (CLV or LTV) analysis helps set an upper bound on what you can spend to acquire new customers profitably.

Why does LTV set an upper bound on CA? IMPORTANT Drill This Into Your Head When the cost to acquire customers is greater than the company’s ability to monetize those customers, the business model FAILS. Common mistake: Entrepreneurs wildly underestimate how expensive it is to acquire customers, make wrong assumptions about LTV (e.g., see unexpected churn), or make bad assumptions about expected future improvements in their CAC and LTV.

Even startups with limited or no customer data should still think about LTV before making marketing and sales decisions

Lifetime Value of a Customer (LTV) = net present value of the profit stream of a customer Key things to think about: - Average profitability per customer ($) - Customer life (years) - Cash cycle

LTV is about profitability (not revenue!) per customer Advertising as a business model is hard without scale, & LTVs tend to be low, but gross margins at scale are great (70%+): (Estimated revenue per user per year) Google: $29.32 Yahoo: $8.00 Facebook: $4.12 Yelp: $1.26 TIP: Wrapping a low margin single sale item with a high margin add-on product will substantially help your LTV Ecommerce has bigger ARPU, but gross margin is usually much lower (20-40%): (Estimated revenue per user per year) Apple iOS User: $150.00 Amazon: $245.00 Zulily: $210.00 Enterprise software has rich customers, high margins, high LTVs : (Estimated revenue per customer per year) Salesforce: $15,000 Sybase: $1,000,000

Customer Life: Often much longer than expected Vendors at tourist attractions Dentist Average Job in US=4.6 Yrs Customer Life SHORT (1 Transaction) MEDIUM (0-36 Mos.) Long (Years) VERY LONG (10+ Years) How many years have you been using the same razor? Using Google? Drinking Coke?

Why does this matter? Every Penny Counts in LTV because: (1) If your LTV is “low” it is hard to invest in paid acquisition channels (2) Many media channels don’t scale linearly

Many Channels Don’t Scale Linearly This is the front page of Yahoo. 392 Million Visitors/Month. Note the banner.

Many Channels Don’t Scale Linearly Example: Y! front page 300X250 banner ad has a minimum commitment of $250,000/day at a CPM (cost per thousand impression) of $2.00*. If you are able to profitability acquire customers and pay $2.00 (LTV>CAC), than you get TONS of customers through this ad placement. If your CAC>LTV by even $0.01, your business model is upside down, and you can lose millions. Many media channels have this non-linear characteristic. Another example: If LTV>$2250 you can hire inside salespeople. If LTV<$1000 generally won’t ever be able to make it work. Makes a big deal if you think a $100/month subscription customer will have an average customer life of one year or 3 years. *Numbers are used for example purposes and not accurate

CAC Payback: Not All LTVs are Equal Example: Two customers generating $150 in revenues YEAR: Customer A Customer B Margin assumption: Customer A Customer B 1 2 3 4 5 $ 110.00 $ 10.00 $ 10.00 $ 10.00 $ 10.00 $ 10.00 $ 20.00 $ 30.00 $ 40.00 $ 50.00 Total Revenues $ 150.00 $ 150.00 50% $ 55.00 $ 5.00 $ 5.00 $ 5.00 $ 5.00 $ 5.00 $ 10.00 $ 15.00 $ 20.00 $ 25.00 $150.00 Customer A $100.00 Customer B $50.00 Gross Profits $ 75.00 $ 75.00 $- 1 2 3 4 5 Assume CAC = $50. Customer A makes $55 in profits Year 1 and can reinvest those profits in acquiring more customers in Year 2. Customer B won’t generate $50 in profits until the end of year 4. Company B has to borrow money or raise more equity if it wants to spend money on acquiring customers in years 2, 3 or 4. The time to recover CAC is a capital efficiency indicator for your company and an important metric for startups where capital is tight and expensive. Tip: Charging upfront installation/setup fees or asking for some pre-payment upfront (with a cancellation fee) can have a large impact on your cash.

Last Thoughts on LTV - LTV is about Gross Profit per customer, not Revenue per customer: Many websites out there are wrong! Your COGS cannot be ignored when determining LTV. - Overhead costs such as administrative expenses and R&D are not included in LTV calculations. Operating at a higher LTV>CAC ratio roughly takes this into account. - “Attractive” investor metrics are: (a) LTV>3x CAC and (b) less than 12 months to recover CAC - As a startup, don’t worry initially about the LTV>3x CAC ratio as it will take money to test and optimize new channels. But be very mindful of your LTV and CAC so that your business model is not upside down (LTV>CAC).

Setting a Sales/Marketing Strategy (pre-channel work) Need some understanding of: • The Customer Profile – – • The Decision Criteria – – • Where can you find them online or offline? Location, Age, Gender, Marital Status, Children, Income, Interests, Device (e.g., iPad? Internet Explorer?), Magazines they read, Conferences they attend, etc. Do they know that they need this product already? What factors matter most to them in the purchase decision? (e.g., price? Look or taste? ROI? speed? convenience? Brand name? Not getting fired?) The Purchase Process – – – – How is the purchase decision made? Is there one decision maker or multiple approvals required? Is there an existing budget or does one need to be created? Where is this purchase taking money away from (share of wallet)? RFP process? Impulse purchase or a considered purchase? Does the buyer need to talk to a person before committing? Can this be sold online without a person? Can it be sold over the phone? What influences the decision maker? E.g., Their peers, research sites, manufacturer/company websites? How long does the buying process take? Immediate or months? Helps filter high level decisions such as: - Do you need to touch the customer in multiple channels or will one channel work? - Do you need to hire salespeople to close the sale? And it drives your messaging as you develop sales and marketing collateral.

A Single CA Channel Can Work! Easier when: - Low price point. - Consumer has intent. - Brand is not important. - An impulse decision and easy to purchase. (Minimal effort required) - Limited time from purchase to delivery (less likely to cancel or change their mind)

Considered Purchases Example: Buying the search term “best electric car” on Google won’t work to sell a new startup vehicle for $40,000 to consumers. Need to market in multiple channels to convert car intenders to buyers. Example: The Car Buying Process = 6 Months Months 5-6 Upper Funnel (Demand Generation) Months 2-4 Middle Funnel (Maintain Consideration) 1 Month-2 Weeks Lower Funnel (ROI) TV ads, magazine ads, manufacturer websites, friend/relative/colleag ue Consumer review sites, magazine ads, television ads Local newspaper ads, local dealer sites, friends/relatives

Overview of Channels • Every customer acquisition channel has positive and negative attributes. • Most channels eventually “run out” of customers and don’t scale effectively beyond a certain point • Early adopters can be “extra cheap” and so CAC tends to go up significantly as you cross the chasm • Existing channels tend to be expensive (fully priced). New channels are created all the time and may or may not work for your product. There are generally HUGE first mover advantages for testing new distribution channels and platforms as their media is not efficiently priced – especially when those channels become huge (e.g., Google in early 2000s, Facebook, iPhone App Store). Over time prices can go up 5-50x as a marketing channel matures and other advertisers start spending. – Example from Groupon: “Between the first quarter of 2010 and the first quarter of 2011, the customer acquisition cost rose 485% to more than $30 per email address.”

Overview of Channels • LTV and CAC will differ by channel and often within a channel. – Example: Buyers for “Diamond Ring” on Google will have different LTV metrics than sales from the search term “Dimond Ring” – Example: One salesperson on a team may close sales like crazy but have high customer churn (selling them a bag of goods), while another may have lower sales but high LTV customers. • In some channels you are competing with direct competitors on LTV, and in other media channels you are competing against everyone. – Example: In Google PPC – Zappos and Cheapshoes.com compete for clicks on the keyword “Nike shoes” but in online display Zappos competes with Netflix, Bank of America, and others. • Huge reductions in CAC or improvements in LTV can be achieved by optimizing conversion funnels by each customer acquisition channel – Not covered today, but worth mentioning that the focus of many growth hackers is on onboarding and retention by optimizing sign-up flows and making sure customers stick

Channel Attributes Attribute Example Ability to Target (Intent? Females over 30? U.S. only?) Are you spear fishing or casting a broad net? Minimum Test Budget (How much capital is at risk on a given campaign? How much capital is at risk to fully test a channel?) Example: Minimum buy may be $10k and need to commit to 5 tests to adequately test the channel Creative Requirement (Custom creative needed? Images?) Making a commercial requires money, time and creativity Time to traffic (get impressions) Adwords=Immediate, A magazine ad could take 3 months Degree of management and coordination required One person can often manage SEM, SEO requires code changes, Telemarketing requires management of a sales team

Channel Attributes Continued Attribute Example Measurability (tracking) TV, Radio, Print are hard to measure Scalability of the Channel There are only a certain number of searches and intenders on Google on any day. Predictability of the channel Consistent performance of the acquired users, no fraud/spam Control of the channel / Platform risk Being featured in Apple’s App Store, Google changing its search results Degree of integration and schedule/pace of the partner Ecommerce sites freeze code in October

A Few Channels to Acquire Customers • • • • • • • • • • • • • • • • Radio • Television • Print • Billboards and Out-Of-Home • Direct Mail/Catalog, Door hangers Online Display • (Banner/Video/Mobile/Retargeting) • Paid Search • Social Media / WOM Viral (user contacts for invites: email/facebook) • Incentivized word-of-mouth (tell-a-friend) • Search Engine Optimization Affiliate – CPA, rev. share, coupons, bundles • • Pay Per Install/Download • Incentivized actions/downloads • Email Co-Registration & 3rd party/outsourced lead gen Platform promotion (e.g., App Store) PR Paid content marketing (e.g., Infographics, white papers) Third party endorsements (e.g. Forrester) Educational programs Webinars Offline events, tradeshows, conferences Contests Freemium/Free trial Telesales / Inside Sales Field sales Field sales with SEs BD and Channel sales

Some Channels Won’t Work. Period. Social/Viral: - People don’t want to talk about or share certain things with friends (e.g., being in debt) Search: - Can’t buy keywords if there is no intent (e.g., selling a new service that has no existing demand and does not fit a category) But you can market to them in plenty of other channels Target a Demographic Directly in Print Use Infomercials for Demand Generation

Channel Example: Google PPC

Channel Example: Google PPC Merits: • Highly targeted: Great LTV performance since you are finding intenders (know they have a problem, looking for a solution) • Easy to create a text ad, no images required • Easy user interface, fast setup • Able to traffic immediately • Can test with a small budget (<$1000) • Consistent performance (limited fraud), regular search patterns Considerations: • Expensive channel, mature with existing advertisers • Requires regular bid management and creative optimization • Volume is limited even if you broaden the search terms

Pay Per Install

Pay Per Install Merits: • If your product is a mobile app, this can be a fantastic and highly scalable channel • Great targeting on Facebook (targeting in mobile used to be hard!) Considerations: • Expensive. Need high LTV to compete with other spenders. • In most cases, building a mobile app is a bigger development effort than putting up a website. • Consumers have limited attention for apps. Just because you got a download does not mean that your app will remain relevant in the sea of apps on the user’s phone. • Doesn’t work for many companies where a mobile app is not the primary customer experience. (Example: Quickbooks) • Platform risk if 90%+ of your spend is on Facebook for installs

Channel Example: Social Media

Channel Example: Social Media Merits: • Low cost, high impact when it works • Potential to go non-linear and become a phenomenon (e.g., Gangnam) Considerations: • Very difficult to execute well. • Hard to create an authentic message that consumers authentically want to share and talk about. Won’t work for many companies. • Requires specialization: Needs to be tailored specifically for the channel (A Pinterest campaign will be totally different than a Twitter campaign. There can be 10+ channels within Facebook!) • Often hard to repeat even from the most creative teams. (e.g.., DollarShaveClub – one trick pony?) • Hard to forecast and control

PR Twitter co-founder's startup: Accept credit cards with your iPhone By Rachel Metz Associated Press POSTED: 01/01/2010SAN FRANCISCO — Jack Dorsey revolutionized online socializing by co-founding Twitter in 2006. Now he wants to transform the way people exchange money. Uber Breaks Hearts With Short Supply Of Kittens On Cat Day The Huffington Post | By Lydia O'Connor Posted: 10/29/2013 7:49 pm EDT | Updated: 10/30/20138:12

PR Merits: • Can get very targeted and/or very broad exposure for zero or little cost. Considerations: • Stories often don’t lead directly to sales. • Hard to scale. Reporters often want to talk directly to the CEO or senior executives. • Constantly coming up with a story is hard unless your product is topical with a broader world issue. As a result, many teams can’t build a sustainable PR channel and don’t invest in PR. – Example: Mint.com after the financial crisis when everyone was talking about saving TIPS: • Remember: Reporters and bloggers write stories. They are not trying to sell your product. – – • • Need a story arc – is your product topical? controversy? A hero? David vs. Goliath? Unique data or statistics you can share? Is there a headline or message that can easily be shared? Stories about the product and its features/benefits are much better than stories about the founder, hiring events or financing events. (May help in raising money though, or in creating the echo chamber for considered trials/purchases.) Reporters are on their own deadlines. Be easy to work with an focus on long-term relationships with them.

Channel Example: Incentivized WOM

Channel Example: Incentivized WOM Merits: • Trusted referrals from friends have extraordinarily high conversion rates • Best when the service actually improves when your friends joins (e.g., Facebook) Considerations: • Unless the incentive is very strong and customers feel that they are offering something valuable to their friends, this channel usually does not scale significantly (a) not everyone will participate (either they don’t have many friends or they don’t feel the offer is valuable enough to send to their friends) (b) you generally need a large existing customer base to start the campaign • Requires tracking referrals and has the potential to create problems with existing customers • Hard to A/B test and offer different incentives to different customers (E.g., Tough to offer one user $5 and another $500 for a referral) • People will always look for ways to game the system. Need to look out for fraud.

Channel Example: Sales Can you afford to hire salespeople? Inside Sales LTV>$2,250 Assumptions: - Sales person will cost $75k/year in OTE (On target earnings = base + bonus at full quota) - Want LTV>3x CAC -> need to generate $225k in LTV - Average inside sales teams will close 10 sales per month - LTV per contract is $2,250 ($225k/10) - Reminder: LTV is not the same as Revenues (the invoice amount to the customer may or may not be close to LTV depending on the COGS and gross margin Direct Sales LTV>$150,000 Assumptions: - Sales person will cost $300k/year in OTE and additional marketing support will cost additional $100k = $400k - Want LTV>3x CAC -> need to generate $1.2m in LTV - Close 8 deals a year - LTV per contract is than $150,000

Channel Example: Sales Merits: • Very effective IF your unit economics support it Considerations: • Many consumer product businesses can’t reach these LTV requirements • Salespeople take time to get to quota and many don’t perform. • Managing an army of salespeople requires management.  • Active cash management and sales performance monitoring are critical. There is usually a funding gap between salespeople getting productive and the cash needs on the business. • Because you are hiring bodies and talking to customers, it is hard to reach the same scale as many online customer acquisition models. • Key sales departures or hiring gaps can impact revenues dramatically.

For another day…  • • • • • • • • • • • • • • • • Radio • Television • Print • Billboards and Out-Of-Home • Direct Mail/Catalog, Door hangers Online Display • (Banner/Video/Mobile/Retargeting) • Paid Search • Social Media / WOM Viral (user contacts for invites: email/facebook) • Incentivized word-of-mouth (tell-a-friend) • Search Engine Optimization Affiliate – CPA, rev. share, coupons, bundles • • Pay Per Install/Download • Incentivized actions/downloads • Email Co-Registration & 3rd party/outsourced lead gen Platform promotion (e.g., App Store) PR Paid content marketing (e.g., Infographics, white papers) Third party endorsements (e.g. Forrester) Educational programs Webinars Offline events, tradeshows, conferences Contests Freemium/Free trial Telesales / Inside Sales Field sales Field sales with SEs Business Development and Channel sales