When you are evaluating a business (to invest in or join), one simple heuristic is to understand how easy is it for the business to get new customers.
In B2B businesses, the metric that companies track is CAC (Customer Acquisition Cost). But this metric in itself isn’t that interesting and companies typically track LTV/CAC ratio where LTV is the LifeTime Value of customers. The problem with this ratio is that many companies are constantly focusing on the numerator rather than on the denominator.
The cost of acquiring the next marginal customer should be less than the cost of acquiring the last customer. And you should see this cost decline over time.
The CAC itself should decline each month. If it does, it means you likely have a great business. If it doesn’t, the business is a good business at best.
Of course, CACs should be declining for a specific cohort of customer. If your business was only focused on small businesses and now you are selling to enterprises, your CAC will increase dramatically. In this case, the key thing is to track the CACs for SMBs and enterprise customers separately (with is why so many firms use the LTV/CAC ration to simplify this step).
The best way CACs will decrease over time is if you haver some sort of network effect. LiveRamp (my last company) is a middleware company … which means it is essentially a marketplace of buyers and integration partners. It is a classic network effect business that makes it easier and easier to acquire new customers over time. Once we hit about $10 million, the CACs started dropping fast.
One other way to think about this when selling to enterprise is to track the quota for a full ramped sales rep. Is the quota for an average sales rep going up over time? If so, you have a great business. If not, the business still has some work to get to great.
All platforms follow this logic. Companies like Plaid, Segment, Marqeta, LiveRamp, and Carta are classic platforms where acquiring new customers gets cheaper over time (disclaimer: I’m either an investor or friends with the CEOs of all these companies). These types of companies can take the savings (from not having to invest as much in sales and marketing) and put them into the product. So the product can get better and better over time (which is the double-edge flywheel that all great companies have).
Other companies that have declining CACs are ones with great brands. Essentially every time a company buys their service (and raves about it), other companies are more likely to use it. Twilio and Stripe have declining CACs because they have become the default go-to companies in their space. There is a LOT of power in being the default.
Summation: Once a business gets over $10M ARR and it has declining CACs, it has the makings of a great business.
When venture capitalists tell you “your TAM is not big enough” what they are really saying is “I don’t think your team is smart enough to move to an adjacent market once you dominate your initial niche.”
They are not really saying your TAM is too small. Great VCs invest in companies with small TAMs all the time. They might believe that the founders’ think too small or that the founders just are not very good.
Many great companies started in markets where the TAM (Total Addressable Market) is small. In some cases, the companies under-estimated the TAM (the TAM got way bigger over time). In other cases, the team was smart enough to move to other adjacent markets.
Of course, it is really hard for a venture capitalist to tell a founder “we do not think you are talented.”
Even when a VC truly believes that, they can never actually say it. But founders want to know why a VC is passing and the VC wants to preserve some optionality to invest in the founder in the future (in case the VC’s assessment about the founder was wrong) or in the founder’s friends. So VCs come up with another reason not to invest. A good one is that the TAM is small — that usually satisfies the entrepreneur (who thinks the VC is just not smart enough to see the bigger picture) and satisfies the VC (who wants to preserve the relationship).
Investing in companies that are initially focused on a smaller niche is actually easier to do than investing in companies that are going after a giant market.
If the company is going after a giant market, then there is usually massive competition in the market and you really have to spend a great deal of time understanding the market (and each competitor) before investing.
For instance, if we were thinking of investing in Ford Motor Company (which competes in the giant market of automobile sales), we need to understand a ton of things:
What are the future of of cars? Will demand increase in the short term? What about the long-term?
How does the rise of places like China and India change the demand curve for autos? Even if it greatly increases the demand for cars, will Ford be able to capitalize on it? What about auto tariffs?
Ford makes much of its income on selling trucks (like the F150 — one of the most amazing vehicles). How does the demand curve for trucks change in the future?
What will happen to emissions policies? Is Ford investing in enough green vehicles to take advantage of potential policies?
While Ford is a big company, its market share in the auto industry is really low (because there is SO MUCH competition). So now we need to know about ALL the other car companies (and even potential car companies like Apple) to understand the future competitive dynnamics.
And many, many more things (like the financial profile of Ford, its labor contracts, its capitalization structure, and more).
It is much simpler to invest in smaller businesses that are tackling a smaller niche. We can get our head around the niche faster. We can assess the competition faster.
The essential questions we need to answer when investing in a niche business are just four:
Will this company be able to dominate the niche? Sometimes the company is already dominating the niche. Sometimes there is a network effect reason to dominate the niche.
Is this niche more important than other people realize? Maybe most people think the niche caps out at $50M/year in revenues but you believe it is five times bigger. Sometimes the niche gives the business a jumping off point to other niches because of its centrality. In general, niches that are more central (have more adjacent niches) are more valuable than niches that are less connected.
Is the team capable enough to move to adjacent niches once it dominates its first niche? Some teams find themselves in a good position but cannot take advantage of their position. This is actually why most VCs pass on companies. Of course, they cannot tell the founders that they passed because they do not think the founders are smart enough. So they make up another reason (the “market is not big enough”) which is just code for “we do not think you have an excellent team.”
Is the price of the investment reasonable? This one is hard to understand but if the first three are yes and only a few investors think they are all yeses, then the price is probably reasonable.
LiveRamp’s niche dynamics: dominating onboarding
One interesting example is LiveRamp (NYSE:RAMP). (note: I was the founder and CEO of LiveRamp for its first 9 years … so I am incredibly biased). LiveRamp launched its initial product at the end of 2010 going after the “onbooarding” niche. At the time, the market was less than $3 million worldwide! (Now that is a really small niche).
LiveRamp’s first year revenues from on boarding was $1 million and we ended the year with about 25% market share. But there were a few things that made the niche interesting:
We believed the niche was a total of $50M year. (Turned out we underestimate the niche by 4-6 times). So there was room to grow.
We thought there were network effects in the business — it made sense (for a bunch of reasons we will not go into now) for one company to be the winner — essentially it was a winner-take-most market. Ultimately we were proven correct as LiveRamp quickly got to over 70% market share.
We understand the capabilities of all the competitors and figured that they would not invest appropriately to dominate the onboarding market. Each competitor was already in many other markets and it did not make sense for them to continue their investment.
We believed that onboarding, while a small niche, had significant centrality to other markets in the marketing ecosystem. We assumed we could use our position to move into those other niches. This ultimately turned out to be true in some cases and more difficult than we hoped in our cases.
We had a lot of confidence in our team. Even today, almost nine years later, LiveRamp is known for having an extraodinarily talented team. Of course, most start-ups think they have a great team (and many overvalue their talent). But in 2010 our team was extremely young and inexperienced — so one could forgive an outside investor for undervaluing it.
Carta’s niche dynamics: dominating cap table management for start-ups
Carta, formerly known as eShares, is a great company. (another disclaimer: I am an investor in Carta and also a customer across many businesses).
Carta helps companies manage their capitalization table. If you have invested in a bunch of start-ups, you almost surely have gotten some of your stock certificates via Carta. In fact, of the 130+ start-ups I have invested in, Carta is the ONLY forward-facing cap table management system that I have ever interacted with (except for mergers and acquisitions where I have seen many different systems).
Carta, even from its early days, dominated the cap-table management for start-ups. And yes, it was a small niche (one that many VCs underestimated). But even today, most start-ups run their cap table on Excel — so there is still a lot of growth in the niche.
If you were an investor when Carta was starting, the first thing to understand was do you think Carta could dominate its niche. Surprisingly, many investors that passed on investing actually thought Carta WOULD dominate its niche. Given Carta’s huge current success, the investors either made one of two errors:
They underestimated the power of owning the niche of cap table management in start-ups.
They underestimated the talent of Carta’s team and its CEO (Henry Ward).
My belief is that any VC that passed for Error #1 should stop being a professional investor. That is not a good mistake to make.
However, my guess is that the vast majority of VCs made Error #2. That error is much easier to make as it is extremely difficult to evaluate people (especially after just spending a few hours with someone). Henry Ward has turned out to be an excellent CEO. But everyone has vastly underestimated people before. And everyone has vastly overestimated people before.
What you should do when a venture capitalist tells you that your TAM isn’t big enough
Obviously you should spend time evaluating the TAM. But you should also take solace that many, many great businesses (from AirBNB to Zoom) were passed by talented VCs who underestimated the team.
Summation: When VCs tell you “your TAM is not big enough” what they are really saying is “I don’t think your team is smart enough to move to an adjacent market once you dominate your initial niche.”
Also, the tax rates can change substantially between regions and cities. The top income tax rate in California is 13.3%. The top income tax rate in the State of Washington is zero (the seven states with zero income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming). So even though Seattle is getting really expensive, you can save a lot of money by taking a job there instead of San Francisco.
So what would happen in there was a law that stated that all salaries need to be quoted in post-tax PPP-adjusted dollars?
Imagine that there was a law that forced every employer to quote both the absolute salary (like $120,000 in SF) and the after-tax PPP-adjusted salary (would transform to probably $50,000 in SF).
What would happen?
First thing that would happen is that many fewer people would want to work in places like San Francisco and New York City. While everyone intuitive knows that these places are high-tax and high-price, seeing the stark different on the job offer would make a significant number of people pause before taking a job.
The second think thing that would happen is that many employers would need to react to this. One way to react is to increase salaries. But the salaries in places like San Francisco are already much higher than most places and would likely need to go up another 50%+ to compensate. The more likely reaction is for employers to hire more people outside high-tax and high-PPP areas.
Long term, more people are going to start thinking about their income in “real” dollars — which means the dollars they have left over after living their life.
Old lessons die hard.Everyone of a certain age has heard the VHS verses betamax tale.
VHS was an inferior technology to betamax but it won out due to marketing, etc. After hearing enough of these tales, one starts to wonder how important a better product actually is. Is it all about marketing? That was the moral of the VHS story.
Turns out a better product … even a slightly better product … is REALLY important.
One interesting case study is Zoom — the videoconferencing solution. Now let me put my cards out there: I use Zoom at least once a day. SafeGraph uses Zoom (and Zoom rooms). I like Zoom and would recommend Zoom. And we pay for Zoom (it isn’t free).
Why does one pay for Zoom?
Well, you might say that you need a videoconferencing solution, you evaluated the market, and choose Zoom. Maybe Zoom is more expensive than its competitors but it is the best so it is worth paying for.
The problem with that logic is that one of Zoom’s most feature-filled competitors is Google Hangouts. And Google Hangouts is “free” if you are already a Google Apps customer (which 99% of technology start-ups are).
So there is a choice to be made. Google Hangouts which is a very good product and is effectively free. or Zoom which is a better product (but not massively better) and is also pretty expensive.
Tons of companies need to make this choice. A lot of them have chosen to go with Zoom (as evidenced that Zoom is one of the fastest growing B2B companies). Why is this?
Of course, from a customer’s perspective, free is much preferred than paid. My company chose to use Google Drive rather than Box or Dropbox because we thought Google Drive was pretty good and did not think Dropbox or Box was enough of an improvement to justify their very high enterprise cost.
So for video conferencing, why don’t people choose Google Hangouts over Zoom?
First off, to state the obvious, Zoom is actually better than Google Hangouts on almost every dimension (the one dimension that Hangouts is superior is that it has a better integration with Google apps: no surprise there).
So if you are choosing to go with Google Hangouts verses Skype or verses GoToMeeting or verses Webex or verses one of the other dozen video conferencing systems, choosing Hangouts (because it is free and it is very good) is a no-brainer decision.
But Zoom is just better enough that people are happy to pay for it. Well, they might not bee “happy to pay” exactly. No one loves spending money. But companies are certainly willing to pay for Zoom. Zoom Rooms is an amazing product and they have really focused on a great user experience. The Zoom video quality is really strong. The mobile experience isn’t wonderful but seems to work better than most of the competition.
One of the things that Zoom proves is that you can be extremely successful even when you have a crowded category, lots of great competition, and when even your strongest competitor is giving away the service for free.
Twenty years ago no one would think that a company like Zoom would thrive.
One of the biggest trends that is driving Zoom’s success is that companies are forgoing the full stack and buying the best-of-breed. The number of vendors the average company is buying from has increased almost 10x in the last 12 years. Companies are happy to buy from many different places … they are even happy to buy from new start-ups.
In fact, it has never been easier to sell to large companies. Large companies are open for business. They want to be sold to. They are sick of having a third-rate solution. They want to use the best product. If you can show them your product is superior, they are excited to buy.
The best product is actually starting to win. Sales and marketing and partnerships are really important (as is brand), but it is so much easier to market a great product than one that is fifth-best. Even amazing companies like Google, Microsoft, Oracle, SAP, Salesforce, etc. are struggling to get their clients to use products or features if they are deemed sub-par by the customer (even when they bundle it in for “free”).
That wasn’t true 20 years ago. In the 1990s, it was really hard to sell software to a big company for less than $3 million. You had to hire Anderson Consulting (now Accenture) to integrate the software. So big companies spent most of their money buying from a very small number of big trusted vendors. And they mostly had a fourth-best solution across their stack.
Today it is much easier to buy. The SaaS revolution has changed everything. Big companies can dip their toe in the water and start for $10,000 per yer in many cases. So even if it doesn’t work out, no one gets fired. It is a low cost option to try out the later and greatest technology.
Even the most crowded markets and even those markets dominated by amazing companies are open to new ideas, new products, and new companies.
Having the right vendors is as crucial to one’s success as having the right employees … and in the case of large companies potentially even more crucial (because it might be impossible for a large boring company to hire the best people in the world but it is still possible to get the best vendors … because a software vendor will sell to everyone).
In fact, one of the best ways to evaluate a company is looking at what vendors it has. You should have a really good idea about the sophistication of the talent, the ability to move quickly, and how fast the company can respond just by knowing which vendors it uses.
Before I invest in a large public company I personally like to review what vendors it employs (you can get the data for free on a site like Siftery). The list of vendors is essentially like a DNA snapshot — no two companies are alike … and like DNA, there are some genes that are just better than others and some genes that work with each other better.
Summation: we need to take new learnings from the old lesson that superior products lose to superior marketing. While both are important, the quality of the product ultimately trumps the quality of the marketing.
Data companies fall in four quadrants: Truth verses Religion and Data verses Application
If you are thinking of starting a data company, you have to make a very important choice: what kind of company will you be? There are four basic types of data companies and all can be very successful … but the biggest mistake data companies make is that they try to do more than one at a time.
First let’s define the x and y axis…
Truth verses Religion
Truth companies are backward looking. They tell you what happened or when something happened or something about a person, product, or thing. The main objective of these companies is to have true data. Good examples of truth companies are a credit bureau (like Experian, Equifax, and Transunion), middleware (like LiveRamp, Segment, Improvado, and mParticle), and financial services data (like large parts of Bloomberg). These companies are usually very long on data engineers.
Religion companies predict the future. They tell you what will happen based on a set of data. The main objective of these companies is to accurately predict the future. Good examples of religion companies are credit scores (like FICO), fraud prevention (like ThreatMetrix), and measurement (like Nielsen, Market Track). These companies are usually long data scientists (and sometimes machine learning engineers).
Religion companies often purchase data from truth companies. For instance, FICO uses the data from the credit agencies as the core ingredient for its credit score.
Data verses Application
Once you have a valuable set of proprietary data, you have to choose if you will be a pure data company or if you will build an application on top of your data.
Data companies just sell data. The best way to know if you are a data company is if you have no UI or a very limited UI. Data companies sometimes sell direct to end buyers but often also sell to applications (which is why it is so important they do not become applications as you do not want to compete with your customers). Good examples of data companies are in financial services (like Yodlee, Vantiv), a pure data co-op (like Clearbit), location (like SafeGraph), wealth predictions (like Windfall Data), and others.
Applications make data sing. To really get benefit out of data, you need an application. These companies will have nice UI and more front-end engineers. Good examples are query-layers (like SecondMeasure), refined datas co-op (like Verisk and Abacus), integration layers (like Vantiv, Plaid), B2B product usage (like G2Crowd) and others.
Winners and lowers and winner-take-most markets
For a “truth” company to dominate its field, it has to be clearly better than everyone else. And “better” means its data needs to be the most true AND the market needs to believe it is the most true. In addition to truth, breadth and price are very important to dominate.
For “religion” companies, the most important factor is brand. When predicting the future, ideally you want to believe that the Nostradamus within the religion company is making accurate predictions. And while some people may dive into the Bayesian logic, most will trust the market perception. That’s why there are so many poor predictive analytics companies, because one can buy brand with money.
Series beats parallel
The biggest mistake data companies make is that they attack more than one quadrant at once. For the first $100 million in revenue, you should be focused on just one type of business.
Summation: Older people (over 50) are getting more advantages from computers than younger ones. We should expect to see a huge renaissance the productivity of older business people in the future.
In business, there are advantages of being younger and advantages at being older. And historically there has been tensions between the two.
Many advantages of Being Younger
Fearlessness: Youngers people have less fear of older ones. They have less to lose, less social status, no mortgage. If they fail, they will not be lower on the status ring. The best soldiers are usually those in their 20s.
Older people have much more to lose and that means they are often quite poor at calculating risks.
More time: The older you are, the more time commitments you gather. You eventually get married and have kids. You volunteer at a non-profit. You get involved in your church. You pick up golf as a hobby. You go to the Sundance Film Festival and Burning Man every year.
When you’re younger, you have not yet accumulated the debt of these commitments. That allows you to spend more time working. Of course, not every young person spends a great deal of time working (many spend an equal amount of time socializing) … but those that do concentrate on work have a massive advantage because working hours compound. Almost all super-successful people worked insane hours in their 20s. In fact, people who do not work insane hours in their 20s are at a massive disadvantage for the rest of their lives.
More raw brainpower: Younger people have better working memory, they have more stamina, and they have more calculations per second. They have a much faster CPU. It seems unlikely that we will have a 55 year old chess champion. And most Physics Nobel prizes went to work that was done by people in their 20s or early 30s.
More ignorance of “what works”: Older people are more likely to get stuck in their ways. They have a hard time seeing that the Emperor really has no clothes. So they are more likely to do things the way they have been done before. The old saying “science advances one funeral at a time” applies to business innovation as well.
But there are also many advantages of Being Older
Money: Older people are a lot richer than younger ones. Many older people gain leverage by hiring younger people and telling them what to do. They are often able to rent the time, fearlessness, and brainpower of younger people.
Cunning: Cunning is the ability to work with people and also work against people. It is something one gets better at over time. It is not something people are just born with. A 55-year-old can often play two 25-year-olds against each other.
Wisdom: While young people benefit from ignorance, older people benefit from wisdom (which is the opposite side of the coin). Older people have had more time to read, learn, and compound knowledge.
Connections: While “What-You-Know” is now more important than “Who-You-Know”, who-you-know is still important. Older people have had more time to develop meaningful connections. And many of those connections will be other very successful people. I did not know any major CEOs, U.S. Senators, world-renowned authors, etc. when I was 22 (but many of the people I met when I was 22 turned into these people).
Stature: Older people have a history and a brand. And while that history can work against them (like a voting record for a member of Congress), it gives comfort for others to work with them. People with a brand have an advantage in recruiting talent, raising money, etc. If an entrepreneur sold their last company for $300 million, it will be a lot easier for her to recruit people to her next company than a first-time entrepreneur.
Less competition: Weirdly, older entrepreneurs have a lot less competition than younger entrepreneurs. At least in Silicon Valley, it seems there are 100 times more entrepreneurs in their 20s than entrepreneurs in their 50s. Most successful people in their 50s have no desire to go through the rigor of starting a company again. They usually opt for less stressful lives (like deciding to be a venture capitalist or running a winery). That means that those 50+ people that do decide to start companies have a pretty big advantage because there are a not a lot of wise, well-connected, monied people who they are competing with.
Young vs Old: Who Wins?
To summarize the post thus far:
Ability to buy brainpower and time
The advantages of being young seems to equal the advantages of being old … at least when it comes to starting companies.
Historically young people have a way higher failure rate … but they also have a much higher rate of creating an iconic company (Google, Facebook, Microsoft, Apple, etc.).
In the past there was a tension between young and old. The young having big advantages in some societies and the old having big advantages in others. If I had to pull a number out of my butt, I would say that the best age to start a company has been 34 (not exactly “young” but definitely not old).
The best age to start a company will get much higher as computers are becoming a bigger part of our lives …
How the age advantages shift with computers: advantage to the older
Computers significantly change the advantage calculation.
Computers give younger people more access to wisdom through easy access to knowledge. The compounding advantage that older people have had in the past is going to be less important in the future. Computers also make it easier to find people and get in touch with them — so the Who-You-Knows are going to be less valuable in the future — and younger people, while still having less access to connections, are at less of a disadvantage here.
But computers help older people IMMENSELY.
Computers are the world’s best way to get access to raw brainpower. And as more brainpower tasks are getting taken over by computers, people with money (older people) will have a significant advantage over those that don’t (younger folks).
The proliferation of tech services also advantage older people. You can get access to the best APIs and services with dollars. Of course, most people (especially older people) will have trouble selecting and managing vendors. Most people (especially old people) are going to be trapped in the 20th century paradigm (one that rewards hiring and growing people). The most important business skill in the 21st century is the ability to select and manage vendors. But the older people that can successful navigate the new world will have an advantage.
As computers get stronger, it gets easier and easier to buy time and brainpower. We already have compute-on-demand (AWS) and people-on-demand (UpWork).
The biggest disadvantage that remains for older people is being trapped in an old way of thinking. If science really advances one funeral at a time, innovation could be significantly slowed as older people have more advantages (and are living longer).
One of the advantages that older people have that seems to be not going away is lack of competition. It used to be that very few 24 year olds ever thought about starting a company (especially those that had lots of opportunities). Even when I started an Internet company in college in the 1990s, it was really strange to have a student entrepreneur. Today it is becoming easier and easier to for 24 year olds to start companies — easier to get training, knowledge, and seed capital. YCombinator and other institutions have significantly promoted entrepreneurism among the young. My guess is that the number of amazing twenty-somethings starting companies has gone up at least 5 times in the last decade … and that trend is happening all over the world.
But people over 50 are still not starting companies in large numbers. It never was big, and I see no anecdotal evidence that it is growing. People that have been successful in the 30s and 40s are rarely opting to get back “in it” in their 50s. Instead, they are opting for easier and less stressful lives. So the few 50-somethings that do start companies could have increasing advantages. Especially those that still put in the long hours. (Even Bill Gates, one of the best entrepreneurs ever, hung up his business cleats before he turned 50).
More people in their 50s SHOULD start companies. It is actually a great time to start a company. Many people in their 50s are empty nesters (or at least no longer have super young kids). They can actually travel more and work harder than those in their 40s because they have fewer family obligations. They are usually more financially secure (maybe have paid off their mortgage already) and potentially more willing to take some sort of financial risk. And people in their 50s have so much more energy today than in years past — people live healthier, are more active, etc.
What are the societal implications of computers giving older people advantages?
The most obvious implication is wealth inequality. If older people get more advantages as they age, their wealth will compound faster. Coupled with living longer (and being active longer) means more wealth inequality.
Since the person in their 50s is more likely to build a one-to-N business than a zero-to-one business … it could mean less innovation for society and more incrementalism.
But it also could give hope to millions of people who are over the age of 50 and still have big dreams and ambitions. Ambition shouldn’t end at 45. Computers can keep ambition going way longer than in the past.
This also means that MORE 50-year-olds should start companies. However, I don’t think they will. So the few 50-year-olds that do should see very big advantages.
Summation: They advantage of getting older is growing. Computers are getting better at doing what young people do.