Celebrating SaaStr: The essence of software and zero marginal cost

My partners and I will make our first pilgrimage to SaaStr this week. The tweet at bottom from my colleague Jackie should give you a sense of how SaaStr feels for a SaaS focused VC. It’s like a StarTrek Convention for a Spock impersonator. SaaStr and – twice in one week – being asked “what does AI mean for SaaS?” got me thinking about the “essence” of software.

There is only one other technology in human history that has had the impact of software – the printing press, of course. (okay, maybe electricity too) However the growth of literacy rates that printed books spurred pales in comparison to software adoption, using internet as a proxy:

Essence.jpg

Source: Ourworldindata, OECD, UNESCO, Scribblrs

Why is this? The marginal cost (and often price) of software is truly approaching zero, putting it within reach of even the poorest of the poor. The marginal cost of a printed book has never been that close to zero, so the price and effort required to learn letters has long been insurmountable for poorer tiers of society. The good news is software itself has now too made the marginal cost of a book zero, which in turn will help drive literacy rates on their final climb towards 100%.

Okay, so software is “eating the world” rapidly, but what does this mean at its core? In short, software is a digital means to drive marginal costs of transactions of any kind – human-to-human, human-to-machine, business-to-human, and so on – to zero. This definition is pretty broad, but purposely so. From punch cards replacing the human “computers” of Hidden Figures to a bot managing customer service interactions for a banking app, it is all part of the same trend. Software can help humans do stuff faster, cheaper and more accurately, and each new wave of technology (eg, now AI) brings software that much closer to surmounting costs of existing transaction methods… and displacing them.

Nerdy, true, but I am using this specific economic framework purposely to lay groundwork for the AI question. I am not excited about AI itself; it is just another tool in the expanding toolkit of technology infrastructure that underlies software. What I am excited about is the specific situations in which it can make software work cheaper, faster and more accurately such that non-software processes can be replaced.

We’ve invested in two examples of this, both in Ann Arbor, MI. Why there? Surprise, surprise not every developer knows how to do AI just because they are a developer (a word of caution to the AI snakeskin salespeople out there… we’re on to you). There is real AI coming out of The University of Michigan. Notion uses AI to help me communicate with my colleagues more efficiently by knowing what and who is important. I use it instead of gmail. Clinc lets banks offer personalized chat interaction with consumers, foregoing frustrating phone trees, waiting and customer service reps’ own shortcomings.

But AI is only the most recent in a long line of infrastructure innovations that drove (and continue to drive) the adoption of software to the zero marginal cost singularity:

Silicon transistor (and Moore’s Law) –> Workstation/mainframe –> PC –> Internet –> SaaS (cloud) –> Mobile –> IoT –> AI

There are also UI innovations I’ve discussed that have a similar effect:

Punchcard –> Keyboard –> Mouse –> Touchscreen –> Voice –> VR

As with AI, when any infrastructure or UI innovation emerges, there is always buzz of exponential promise. However, entrepreneurs and investors need to see through the hype to specific use cases where transaction costs are actually diminished by the new innovation, and therefore adoption is warranted. We believe, for example, we are doing this with our investments in Notion and Clinc. A cool infrastructure or UI shouldn’t be used just because it can be and is not a customer benefit in itself. for this reason, I cringe when I hear startup one-liners like “AI for XX” or “ML for YY”. In many cases, the best innovation implementations will barley be noticed at first as with Google’s use of AI for image recognition, now a powerful consumer benefit in Google Photo that enticed me to switch from Dropbox. Google doesn’t call it AI; the new feature is simply an obvious enabler of search that makes search faster and more accurate.

So at SaaS this year, let’s not get caught up in the hype of technology but see the long arch of software for what it is, an unfinished journey of removing transaction costs in business and all facets of life.

Bonus 1: Internet adoption inflection point with mobile

In looking more closely at the internet adoption curve, it is amazing to see the inflection point to a higher adoption rate in the late 2000s. What caused this? The first major trend of linear growth happened from 1998 to 2007 with the PC boom while the second major trend of linear growth – at a higher rate – happened from 2007 through today with the mobile boom. This is driven by India, China and South America where mobile leapfrogged gaps in electricity, phone and other infrastructure in poor and/or rural society. No doubt access to mobile internet will help drive the final journey of global literacy rates in these places as well.

essence-3 Source: Scribblr

Bonus 2: VC excited for SaaStr!

 

Five cities, five days, unbounded opportunity

I spent last week meeting hundreds of top talent student and faculty members at Purdue University, University of Chicago, Notre Dame, University of Illinois and the MKE Water Council. My mission: find great talent for our companies and find the next great company to invest in. Thanks to the many folks at each campus who hosted us; I’m excited about the companies and people we’re now engaged with after the trip.

There were a few common themes I observed on campuses:

Entrepreneurship is finally an established career option: Even only 18 years ago when I was an engineering student, no one talked about “entrepreneurship” career options. 20 years ago at top MBA programs, “entrepreneurship” was a dirty word. Today, entrepreneurship is the top concentration at U of C’s Booth School of Business, and Purdue now counts 1900 students in their entrepreneurship certificate program, with 400 new students joining per semester. Wow. Yes, entrepreneurship is risky and volatile, but it can be taught, or at least coached.

Starting young is low risk: Of course, the entrepreneurial spirit cannot be taught. It emerges in macro and micro cultures – on campuses, in countries, in families – over decades and generations of attempts, successes and failures. Our modern cultural heroes of Zuckerberg, Levie and Jobs help as well. The beauty for students is that starting a company or working for a startup young is a great time to do it. Students and recent grads have little “expertise or experience” – and so may not be at the point in their lives to maximize chances of success – but cost of failure is very low. Students and recent grads without families and responsibilities can live cheap, and if they fail, they can hit the “reset button” of grad school or joining a big company. Moreover, students at top schools have not yet experienced failure – they are at a unique point in there lives where everything seems possible. Make it happen.

The only regret I have from the trip is that I couldn’t visit more places in one week, so I’m planning some follow-up trips. So far on the list:

  • Monday, February 20th  – UW Madison
  • Tuesday, February 21st – Marquette University
  • Rose-Hulman and Northwestern are also in the works

If you couldn’t make one of the stops, here are some resources for you:

Slideshare startup/VC primer: To learn more about startup internships, careers or raising capital, check out the Slideshare below of my deck from the tour. You can also check out my recorded presentation from Purdue’s Anvil at this YouTube link.

Find jobs: Our team at Hyde Park Venture Partners recently launched a talent portal to match top talent within our 50+ portfolio companies across the Midwest, Atlanta, and Toronto – please share your resume with us, so we can find a few opportunities for you: Hyde Park Venture Partners Talent Portal. Please also checkout TransparentCareer, the best place to find salary and comp stats for early career roles (shameless portfolio plug!). 

Career decision making: At many of my stops, I referenced this framework about how to think about career decisions: Career advice: don’t listen to it, but if you must…

Enjoy and see you on the road for the Midwest Startup Tour Round 2!

Midwest startup tour: Little cities, no little plans

On Jan 23, I kickoff a five day tour of some of the Midwest’s most innovative cities and campuses. It seems fit to frame this with the oft quoted “Make no little plans” from our favorite son, planner and architect Daniel Burnham. He turned the railroaded cow town of Chicago into a model of urban innovation.

Silicon Valley is unequivocally this same model for startups and tech innovation globally. Its concentration of talent, risk taking mantra, capital and history make it one of a kind. Unfortunately, the Valley’s bending gravity leaves most investors blind to the forming critical mass of these same ingredients throughout the college towns and small cities in the Midwest – many of these places are becoming mini tech hubs. Why here?

Positive selection of people: 20% of the top 50 computer science programs, 26% of the top 50 med schools and nearly 30% of the top 50 b-schools are in the Midwest (US News). Startups are built on people, and like Silicon Valley, these programs draw the best of the best people from around the world. These are smart, driven people, willing to take risk.

Ideas are championed – nothing is impossible: The academic spirit aflame around these top academic institutions engenders both ideas and respect for ideas. This is a key ingredient as every startup begins with a founder’s idea and a few other people saying “wow, that’s a good one”.

Midwest values:  However, without Midwest practicality, ideas would die on the academic vine. The Midwest values of sensibility and action-over-words drive practical application and progress. They ask of any idea “So what? Show me”.

Abundant talent: The institutions of the Midwest yield a wide and deep talent pipe – a few of whom become founders – but many more who can join an already seeded startups. While the job market here is healthy, it is not nearly as tight or as expensive as Silicon Valley. Talent is more affordable in the Midwest and yet itself can afford a better quality of life. This yields a more loyal talent base with less turnover.

It is true that for rapid scaling a startup will need to expand beyond a single college town or maybe even the boundaries of the Midwest. In any given Midwest city, the talent pool may be high quality, but is also usually small in absolute size, presenting denominator challenges as a startup gets large. There are also fewer people here who have built large tech companies – the startup DNA is thinner, though deepening by the year – and capital remains relatively scarce. When these considerations are balanced well with the upsides, however, big wins happen.

Most know about Grubhub, Groupon, Braintree in Chicago, but think also of ExactTarget in Indy, Workiva in Ames, Duo in Ann Arbor, Toa in Cleveland, just to name a few examples. There are many more to come. We are already thrilled to be part of FourKites and G2Crowd in Chicago and Farmlogs in Ann Arbor, a truly a unique startup hub.

There will be more big successes, and we are on the road to find them. For founders founding and others looking to join a startup, below is my schedule so far. Email me if you want to meet:

UPDATED 1/15

Mon, Jan 23: @ Purdue in West Lafayette, IN

Tue, Jan 24: @ The Water Council in Milwaukee, WI

Wed, Jan 25: AM TBD, PM @ University of Chicago

Thu, Jan 26: AM @ Notre Dame in South Bend, IN; PM at U of I in Champaign, IL

Fri, Jan 27: AM @ U of I TEC Center in Champaign, IL

Next year already happened, were you ready?

Fred Wilson’s blog last week on end-of-year planning was a good reminder to get everything in order (strategy, plan, people) to hit the ground running in 2017. If you have anything of a hiring or sales cycle, however, most of 2017 is already baked.

End of year planning can work well for consumer businesses, where (once a product is developed) the turnaround time from spend to revenue and margin is very short. You can move the levers of marketing spend to drive more site traffic to conversions to transactions quickly to impact revenue – almost in real time. But even in these businesses, there persists a bottleneck on hiring people. The national average time to fill a job is about a month, though weighted heavily to hourly positions that are much faster to fill than professional roles. Startup hiring cycles are often longer. Then you need to add ramp time. Sales person ramp time, for example, is combination of training, experiential learning and the normal sales cycle baked together.

Here are rough guidelines on how long it takes new hires of different types to reach 100% contribution in a startup:

  • Executive: 6 months (many would say longer)
  • Developer: 6 months
  • Inside sales: 3-6 months (for the ~50% that make it)
  • Outside sales: 6-12 months (for the ~50% that make it)
  • Marketer: 2-4 months

So, in a consumer startup you might still have hiring cycle + ramp time = 1 month + 3 months = 4 months lag if you are relying on new marketing hires to scale the business. That means trajectory through Q1 to early Q2 is pretty baked in the worst case.

B2B businesses are much worse with lag time = hiring cycle + ramp time for sales people.

  • In SMB = 1 month + 3 to 6 months = 4 – 7 months
  • In Enterprise = 2 months + 6 to 12 months = 8 to 14 months

Based on this, if you are a B2B enterprise startup, your 2017 is pretty well baked already. Note that this math doesn’t include any capital raising needs which can add another 3-6 months if you need the capital to make the hires. Yikes! Given such a lag in cause and effect, end-of-year planning is not a very practical time for fast growing startups to set the plan for next year.

Instead, startups should maintain an 18 month forward plan at all times to avoid the hiring and ramping bottlenecks discussed above. This is equivalent to driving a dark road at night where your headlights illuminate a continuously rolling path ahead. This plan is a weekly referenced operating plan for startup management and something the Board should review and adjust formally 2-3 times a year. At the operating level, it changes all the time. With this plan continually in hand, end-of-year planning is more about how you will measure success and reward performance in the next calendar year; you already know “the 2017 plan” and are likely thinking ahead to 2018.

 

Bend the curve with Average Contract Value (ACV)

SaaS entrepreneurs know how hard it is to scale their companies from zero to their first few $M in revenue. I’ve posted before about misconceptions about scaling SaaS businesses – namely that adding more sales pods will lead to exponential growth. While pod additions are part of it, the single most powerful lever in driving exponential growth of a SaaS business is increasing Average Contract Value (ACV). I’ll assume for this article that ACV also equals annual contract value.

The other day our team was reviewing portfolio performance, and I nearly fell off my chair when I saw the power of ACV in the chart below (scale, years and a few data points adjusted to protect the innocent):

SaaS startup example revenue and customer growth

pic-1

While after Q2 2013, monthly customer growth of this company stays relatively constant on average (meaning customer count grows linearly), revenue is a hockey stick. Why? Incredible gains in ACV of new customers.

The chart below distills this in more detail. In fact, below, monthly customer additions do increase but go up only a bit more than 2x from a relatively steady average of ~7 in 2013 to ~16 in 2014. However, new ACV grows from $5K in the early days to nearly $25K in the most recent months shown, a 5x increase. WOW!

New customers and ACV per monthpic 2.png

For those of you who like calculus, the 2x and 5x represent multipliers in a sort of second derivative of the ARR revenue level – the change in the change that bends the curve. In other words, over a period of a few years, the company is adding 2x * 5x = 10x per month more in ARR than it did early on. Yet it is doing this while only adding twice the number of customers per month than it used to. Assuming sales people remain as efficient from a # of customers per month perspective, the company is doing all this with only a 2x the size sales force. In fact, this company added more sales people than that because higher ACV also comes with somewhat longer sales cycles and higher levels of support. However, even if sales person deal efficiency is half of what it was, overall ARR efficiency of the sales force is still up 5x * 50% = 2.5x. I would invest in that all day and night.

So how did they do this? (you can do it too)

Mature your product (fast): A SaaS MVP usually lacks integrations, enterprise functionality and other controls and features – just enough for small to medium size businesses to find value in. To increase ACV, you need to give something to get something.

Who are the key adjacent software players in your ecosystem? More importantly, with which ones have your early customers expressed a desire for integration? Then there are the common MB and enterprise asks: single sign on, administrative controls, reporting, etc. Once you integrate a few key adjacent platforms and basic enterprise functionality, you suddenly have a means other than number of seats/users to drive price. Want Salesforce integration with SSO? Sure, that’s our “pro” version for 2x the price.

You don’t get what you don’t ask for: Early on, the startup game is about getting a few customers, any customers. You don’t really care what your early customers pay. Often they are friendlies and have agreed to iterate with you on product and feedback, so you’re fine with giving them a deal. Unfortunately, this can anchor you and your sales team to bargain pricing. While being conscious of competitor and comp pricing in your space, take off the gloves and ask for more. You need to prove that you can do this for yourself and your sales team. If your ACV is $10K when you hire your 4th, 5th and 6th sales rep, it’s likely to stay that way until you prove to them it can be higher. The only way to break the habit is to land some higher ACV sales yourself – as a company leader – and set a new precedent. You will both show your sales team that it can be done and get mad props.

Puff up your fur with killer marketing: Animals puff their fur in a fight to make themselves look bigger. Smart startups do this too. Our best SaaS companies are spending surprisingly large parts of their budgets on sponsoring key industry conferences. It’s how you look bigger than you are, help customers overcome startup aversion and grease the sales skid with name recognition.