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When acquiring big customers ruins your business

Posted by Chad O'Connor  August 13, 2013 11:00 AM

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We’ll land that big enterprise deal any day now…

Let’s say you’re a start-up technology company with a great product searching for its first enterprise customers. The pressure is on to find the first few customers who will validate your business, right?

If you’re trying to raise money from venture capitalists, you need customers so the VCs can make reference calls. If you’re bootstrapping the business, you need the cash that a first customer can bring.

You may have been working a long time to get the customer to sign on the bottom line, and you don’t want this time to be wasted. There are probably some customizations that will be necessary in order to launch your product or service, which isn’t so bad – an hourly consulting fee can help cover the costs of some of your engineers. So, if the deal is big enough, you can use it as a launching point for your entire business, right?

Many start-up businesses feel the gravitational pull of these big enterprise deals at their most formative moments, and I’m going to tell you to run the opposite direction … if you dare.

What it all boils down to is customer acquisition cost, or CAC, for short. And, in this case, you don’t want a big CAC.

CAC is the incremental cost of sales, marketing and technical support that it takes to find a customer, win a customer and launch a customer in order to get money to start to flow from a customer. CAC doesn’t include other operational costs, like engineering and G&A expenses.

A long sales cycle that involves direct sales people traveling all over the place to meet with customers is expensive. It requires a marketing effort to keep the top of the pipeline full, and this usually involves inside sales people who cold call prospects and try to identify opportunities for the direct sales team. Complex integration or customization efforts certainly add to expenses, and these efforts might involve your best engineers (which has the compounding negative impact of slowing down your development roadmap). All of this adds up to a high CAC.

If your revenue from the customer is less than your CAC, then this is unsustainable and you must price your product higher, which can further slow down your sales process. If you have a recurring revenue model and it takes years for the revenue to pay for the CAC, then you are probably in trouble. You can keep things going, but you probably don’t have a very good business.

Education & content vs. sales guys & expense reports
So, what’s the alternative? If you are staring at the possibility of building a high CAC business, think about what your sales guys and pre-sales engineers really do.

A huge part of what they do is to educate your customers about their problem, explaining why your product represents the best solution and proving the return on investment (ROI). What if you could educate the majority of your customers with content prepared in advance, which they could consume easily and anytime, instead of trying to interact with them in real-time?

If customers need to learn, give them content in the form of blogs, white papers, research and ROI calculators that will educate them about your product. Make the content useful and interesting (maybe even fun) and use your marketing dollars to make it as broadly available as possible.

In an ideal world, you can turn your inside sales guys into closers. I often say that this is at least a little bit analogous to waiters in restaurants. Marketing educates the customer and motivates them to come to the restaurant. When the customer sits down at the table, the waiter (salesperson) knows the customer wants to eat. A good waiter first works on the basic sale, followed closely by the cross-sell and ultimately the up sell in order to maximize the revenue associated with that customer.

Easy download vs. complex integration
What’s the best way to educate a customer about the value of your product? Let them try it out! If they can’t live without it, they’ll probably buy it.

The problem: It’s really expensive to provide a free trial if there’s complex integration required in order to enable the trial. It’s really, really tempting to try to preserve all of your options for possible integrations; however, your CAC will be lower if you can make the product super-easy to download and try out for free.

This means you probably won’t be able to enable all possible integrations right away, but if you make the right choices on your product-market match, you can cover a lot of the market with a product that’s easy to download and try.

Eliminating some features in favor of a simpler installation might require difficult decisions in the absence of perfect information about the market. This is why it’s important to take an iterative approach. Eventually, you’ll get there. If your product is easy to download and try, then it’s also going to be less expensive for your customers to download and install when it’s time to buy.

Why it’s easier said than done
Another plus: A low CAC can be very profitable with a lower average selling price (ASP). It’s easier, therefore, to get customers to sign off on smaller ticket items than huge deals.

However, the problem is that you need a lot of small deals in order to really pay the bills. For many entrepreneurs, this means a commitment to tightening the belt and living off very little for as long as it takes to get the business to the point where the cash flow from the business starts to exceed the engineering and operational expenses.

Not everyone can afford this approach, which leads us to look to VCs and other sources of funding for support. Historically, venture capitalists focusing on enterprise information technology have looked for large, big-ticket customer wins to help validate their investment theses, but more and more (maybe most?) VCs now recognize the value of a low CAC business over the long term.

In fact, a low CAC business with a recurring business model has become an elusive fantasy for many investors. If you can fund things yourself as you get started – great – but you’ll also find a much more receptive audience of investors today than ever in the past. If you can resist the high CAC deals, and stay true to your low CAC approach, and you have a great product with a killer product-market match, then everyone associated with your business is going to win big in the end.

Alex Laats is the President and COO of ZeroTurnaround. He brings 20 years of experience as a high-tech entrepreneur, business operator and team builder to ZT.

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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