go bottom up, not belly up

What a TAM!  If you’re an entrepreneur who’s tried to raise funds, or you’ve even glanced at an article about market sizing, then you’ve probably been asked to think about the size of your total addressable market.  How much money each year (from now through 2017…) will be spent on products or services in your space?  There are many crucial follow-up questions: how fragmented is the market?  How geographically dispersed are the customers?  How important are the check-writers?  (There are many convenient tools that explain these concepts in further detail, many of them are described by convenient acronyms such as SAM and SOM.)  Ultimately, how much of the TAM can be yours?

Unfortunately, this top down approach to market sizing tackles the who, what, where, and maybe hints at when and why.  It neglects the how altogether.  If you believe there’s a $5B market opportunity and you can capture 10% of it in five years with proper positioning and an effective go-to-market strategy, that’s splendid.  But Gartner quadrants and pie charts won’t help you do this. Presuming you’re no P&G, Microsoft, or Wal-Mart, then you need to define, understand, and measure how your obscure product or service rolls out in your intended market over time.

To demonstrate how you grow and scale, construct a basic bottom up analysis.  Timeframe varies by industry, but an 18-36 month window is typically sufficient for a new, lean technology company.  How much revenue do you forecast each year / quarter / month?  Now work backwards: what are the transaction sizes and customer numbers that get you there?  How many “trial users” or “free users” are needed to net each customer?  How many people or companies have to hear about you for just one to engage with your brand in some basic way?  Be conservative with these estimates.

A simple Excel sheet (with assumptions built into the first tab) does the trick for a basic bottom up analysis:

– Play around with assumptions and discover key sensitivities in the business model.  Find not-so-obvious areas of risk but also upside to your growth.

– Compare with metrics from the top down approach to see that customer and revenue targets remain roughly in line.  Brainstorm reasons for any discrepancies.

– Ensure that M-over-M, Q-over-Q, and Y-over-Y increases in your analysis are feasible.  Be aware that sudden increases require additional resources and introduce risk.

– Do not introduce changes in growth rates without justifiable, clearly-articulated reasons.  (Unless you have fundamental changes to your business model, your purchase conversion rate won’t increase from 1% now to 10% next year simply because more people have heard of you.)

Perhaps the most useful benefit of all is that your bottoms up analysis becomes a living, breathing document.  You can collect feedback from trusted board members and advisors.  You can compare future results with past estimates to refine your growth trajectories.  And you can explain how capturing 10% of a $5B opportunity in five years is achievable.

pricing your product from scratch

Remember supply and demand curves from Economics 101? Toss them out the window. If your revolutionary new mobile video sharing service is unlike anything the world has ever seen, then how can your customers possibly assign value? If you’re magically bringing back family photos from the graveyard of broken hard drives, how can anyone possibly put a price on that? Conventional calculations based off costs and margins simply don’t work here. Particularly if you’re delivering products or services with nearly zero marginal cost.

Pricing your product – the likes of which the world has never seen before today – is more of an art than a science. But here are five guidelines to get you started:

Ask your target customers how they purchase a complimentary product or service. Do they typically buy online or do they require a bit of hand-holding? Are they accustomed to a la carte pricing or all-in-one pricing? What price ranges will they accept without outside approval (manager in B2B context, significant other in B2C). Listen and learn from their past experiences. Use this as a starting point.

Sign up for competitive products or services and attempt to purchase. Notice the messaging, website flows, and sales processes. For more expensive products and services, tap your brother-in-law who works at EMC or example.com and have him speak with a sales rep. Companies can’t patent their prices. There’s no shame in using your competitors as a starting point. Presumably they’ve learned something from their customers. There’s no need to make all of their past mistakes yourself.

Exploit introductory pricing. As a new entrant, you can slap the label “introductory pricing” on your first paid product. Some customers will expect to keep their Year 1 contract terms forever, so make it explicit up front that prices will change. It’s still difficult to raise prices, but at least you can save against some of the reputational hit while protecting future revenue streams.

Err on the high side. Pricing too high gives you wiggle room and has many advantages over pricing too low. You can always lower your prices permanently or temporarily (through discounts, deal sites, and product bundles). However, it’s nearly impossible to raise your prices – especially once they’re floating out there on the Internet. People get anchored to the lowest price they see and negotiate downwards from there. Another benefit is that higher prices imply higher quality in the minds of consumers. And finally, you don’t need to sell as much. One of my previous companies priced an iPhone app at $39.99 when the average price in the App Store was under $2. Some protested the first few days, but our target customers ultimately acknowledged the quality product we offered and bought anyway. Even without the download figures of Angry Birds, the software became a Top 20 grossing app.

Don’t publish your highest price tier. While publishing your pricing is always user-friendly and sometimes necessary (depending on your vertical), there’s no harm in requiring an offline discussion for those largest contracts. If you offer some all-encompassing license with “unlimited” usage or capacity, then your large customer will immediately latch onto it as a starting point and negotiate steeply downward form there. If there’s no delineation between high price tiers and low price tiers, then impose viable capacity or usage constraints and force the tiers. You can always remove them later.

what’s the deal with customer acquisition?

A man walks into a bar and sits tentatively at a stool in the corner. The barkeep notices the man’s SoLoMo.co shirt (something like that) so he offers to redesign the newcomer’s website. But the man kindly refuses the barkeep’s offer. Having noticed white scuffs on the man’s shiny black loafers, the barkeep offers him a shoeshine. “Only a couple dollars!” But the man tolerantly refuses this offer too. It seems like the man isn’t waiting for anyone, so for the next ten minutes, the two engage in a friendly conversation about the New England Patriots, the upcoming election, and the latest episode of Fringe. The barkeep offers to add the man on Facebook. This time, the man is visibly annoyed. “Please sir, a Bud Light!”

We try to guess what our customers are looking for. Even when we’re right and uncover something they want, we are unable to communicate the value proposition. Perhaps our message is unclear, our context is inappropriate, our timing is off. Other times, we merely project our own worldview onto others. We rarely ask the right question at the right time in the right place. We seldom hear the answers we anticipate (even when these seem obvious in hindsight).

For a tech startup, customer acquisition is as important as any other function. To be sure, technology and team building are critical too. However, a company with zero customers is doomed to fail. I paraphrase Andy Rachleff, founder of Benchmark capital, when I suggest that, “A company with no product-market fit can have a smart team, sharp CEO, and superb technology, but will go nowhere without customers. A company with strong product-market fit can screw nearly everything thing else up and still build a viable business.” Product-market fit is a necessary – if not sufficient – criteria for building and scaling a successful technology company.

Richmond Global is The Customer Acquisition Fund. In addition to some outside help, we have two full-time investors on staff. We can’t become subject matter experts in every vertical, nor can we claim to have the largest network out there. But we know we can add value by helping you validate your market fit and build out your go-to-market strategy. We admire Andreesson Horowitz’s ability to build out functional expertise in multiple disciplines, but we have to pick one, and we believe customer acquisition reigns supreme.

I’m an entrepreneur first and an investor second. I passed on an exhilarating actuarial career to join a fledgling startup-turned-IPO, LogMeIn, where I built out the marketing analytics, marketing operations and online marketing functions. My partner Peter Kellner co-founded Endeavor, a hub for the largest international network of top-notch entrepreneurs. Together, we’ll help you work through validating market fit, defining appropriate customer metrics, and increasing customer adoption, engagement, and monetization. We’ll advise and guide you on international expansion. We’ll encourage you to ask the right questions and we’ll constantly put the customer before the horse.