1/31: The biggest question coming out of my recent tweet thread about the evaluation of startups is: “How important is the startup’s distribution strategy in your diligence work?” The answer is: “Damn important because the business needs customers to exist!” Unpacked:
2/31: This may sound backwards to some investors but my diligence process around a company’s marketing strategy starts with the unit economics of their product/offering. The greater the contribution margin (in absolute dollars) the more options a company has to scale.
3/31: If a product can only throw off a few dollars of contribution margin a year then the channels the company should be testing will be very different than if the product can throw off a few hundred or a few thousand dollars of contribution margin.
4/31: Even if the contribution margin isn’t understood with precision, it’s not difficult to estimate the “zip code” of the economics and back into what the acquisition costs would have to be for a new customer to pay back the marketing spend in a reasonable amount of time.
5/31: If the contribution margin is $5 a year and the required payback on marketing is 12 months then the marketing costs have to be less than $60. If the contribution margin is $250 a year, the marketing costs can be $3,000 to have a similar payback period.
6/31: To state the obvious, the channels that can produce customers for $60 are different than those that have $3,000 to work with.
7/31: The first major fork in the road is: “Can the product afford people in the process?”. Products that need to be explained by people better produce enough contribution margin to make the math work.
8/31: Sales costs are a major tax on a business because people cost between $0.50 and $1.00 a minute and sales calls can range in length from 10 minutes to 30 minutes. The success rate on sales is usually in the single digits so the tax is critical to understand.
9/31: Possible disconnect: If the product requires people in the sales process but the contribution margin is thin then the business is unlikely to find a scalable marketing channel that has a reasonable payback period. Result = High odds of failure.
10/31: The next important question to ask is: “Which of the two major forms of demand generation does the company plan on testing --- interception of signal or building of awareness?”
11/31: If a company’s target audience has a distinct problem and the audience is actively searching for solutions to that problem then it’s possible to find channels that can intercept this signal.
12/31: Pre-internet, the highest signal channel was the Yellow Pages. Today, high signal channels include Google and product specific comparison sites like Confused.com.
13/31: Intercepting signal isn’t always a smart strategy. The contribution margin and funnel efficiencies of a company relative to those of other companies competing to intercept signal in a channel determine how viable the channel is.
14/31: The advantage to incepting signal is that if a company has a truly better solution to a problem that a customer is looking to solve then the “inception of signal to sale” ratio can be amazing. But this is well understood so intercepting signal can be really expensive.
15/31: Possible disconnect: Thin economics or an inefficient funnel relative to a company’s competitors destroy a company’s ability to scale in channels predicated on bidding to intercept signal.
16/31: This disconnect materializes frequently in the evaluation of startups because many startups want to compete on price but also want to scale by intercepting signal in channels occupied by competitors with better economics. Result = High odds of failure.
17/31: Other marketing channels are designed to build awareness (Facebook, TV, Billboards, etc.). In these channels, customers aren’t directly seeking out solutions to problems. Instead, the channels present a company’s value proposition to prospects to pique their curiosity.
18/31: Building awareness can be expensive if there aren’t enough target customers in the engaged audience and if the target customers aren’t highly receptive to a company’s offering.
19/31: Cracking channels that build awareness can be tricky because it’s easy to generate low-signal top of funnel interest but difficult to generate high-signal top of funnel interest that converts to customers.
20/31: Building awareness isn’t always a smart strategy. Top of funnel demand generation can appear cheap but the funnel inefficiencies routinely crush the economics. And it’s impossible to avoid paying to build awareness with customers who have no interest in your product.
21/31: The advantage to building awareness is that if a company has a low friction sign-up process, a large target market and a compelling value proposition it’s possible to put loads of marketing dollars to work given how deep these channels are.
22/31: Possible disconnect: Awareness oriented marketing channels typically only work when a product or service is well understood by the target customer, the pitch is extremely compelling, or the product is cheap enough to generate impulse purchasing behavior.
23/31: This disconnect materializes frequently in the evaluation of startups because many startups want to test deep and flexible channels like Facebook but overestimate their ability to convert low-signal leads into customers that stick around. Result = High odds of failure.
24/31: So where do Partnerships fit in this framework? Borrowing brand and distribution through Partner channels is another form of building awareness and can be very efficient if the Partner has highly engaged customers who trust their endorsement.
25/31: Possible disconnect: Most Partnerships fail because the Partner is typically much larger than the company trying to access the Partner’s customers and this imbalance is difficult to navigate in terms of incentives and urgency.
26/31: This disconnect materializes frequently in the evaluation of startups because most startups that sign a Partner overestimate their ability to generate substantive results even when the Partner has a huge user base. Result = High odds of failure.
27/31: So where does content marketing fit in this framework? Intercepting signal with high quality content can work but it’s an investment that takes time to prove and requires unseating existing content owners.
28/31: Possible disconnect: Content marketing takes a team and constant attention to index on the first page of search results for high traffic keywords. The activity and sophistication of existing content owners has to be evaluated to understand the probability of success.
29/31: This disconnect materializes frequently in the evaluation of startups because most startups that embark on a content marketing strategy have at least one team member who managed content strategies in a less competitive era. It’s really hard to do well today.
30/31: The “so what” of this entire thread is that it’s possible to assess in advance what the odds are of a company cracking a given channel, especially if the odds are low. Eliminating channels is critical because you have to believe in the probability of cracking what’s left.
31/31: And always remember this gem: “The best place to hide a dead body is the second page of Google search.” Thoughts welcome and remember that retweeting keeps the conversation alive!
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