Inaki Berenguer, MBA '09

Basic economics of consumer Internet startups: CAC vs. LTV

One of the last talks of this semester at MIT Sloan was given by Nick Beim, a general partner at Matrix Partners, who focuses primarily on Internet investments (his investments include TheLadders.com, Gilt, Conductor, or Care.com). Matrix Partners invested in the past in companies like Apple, Sandisk, Aruba or Veritas.

For an entrepreneur like me in the consumer Internet industry, it is always iluminating to listen to Nick. He makes you focus on the simple things that make the difference. This time he talked about the economics of consumer internet startups that make them attractive.

When you fund a startup, there are many things that matter: market size, the specific product/service, management team, business model, investment requirements, competitive landscape, barriers to entry, market readiness, exit strategy, etc. But in consumer Internet startups, there are 2 metrics that make the difference:

• Customer Acqusition Cost (CAC):  it is the cost associated with convincing a consumer to buy your product or service, including marketing, and advertising costs, and it is measured in $/user. An average ceiling cost can be easily estimated placing adds on Facebook and Google Adwords (or using other channels like lead generation, partnerships, revenue sharing, CAC, coupons, vouchers, offline mktg., etc) even before launching the product. Just use some simple arithmetics with CPMs/CPCs, Google Analytics, with simple landing pages and conversion rates (and our own site analytics). It can be estimated very early on and then optimize it over time using smarter marketing (trial & error, lots of analytics and fast iterations and adaptations). Smarter marketing includes better marketing with the right messages to the right demographics (e.g., age, gender, geography, etc.) using the right channels to attract customers to your site; and then have a compeling user experience to convert those visitors into customers (give the right user experience to the right user). Ideally, the CAC should drop thanks to word of mouth, branding, SEO, PR, and marketing optimization (trial and error).

    

• Lifetime Value (LTV) of a Customer: it is the future cash flows attributed to the customer relationship. An average floor value is easy to estime if you are selling a product like in our case at Pixable. Understanding repeat sales, word of mouth, and returning customers might be a little bit tricky during the first months of the life of a startup (you should wait until the whole customer cycle that might be years if repeat sales happen in subsequent years. It is also tricky to understand promotions to those customers. But you can always work with comparables and hypothesis and use values as "worse case" if the time span you are considering is shorter.

The goal is to have (in $$): 

LTV > CAC 

Clearly, the best businesses are those that are viral (although viral loops are difficult to observe early on) and have a lot of word of mouth, making CAC dropping to $0. And it would be even better if the product is sticky and customers go back to your site next time.

If you can prove early one that on average LTV > CAC (in $), then investors will not have any problem in adding more money to your business to acquire more customers and grow it faster (ideally, for every $1 invested in acquiring a customer, the LTV is much greater than $1, even if it happens in the mid/long term).

At Pixable, we have already empirically validated the average CAC and estimated the LTV. Now we are working and optimizing the messages, to the right demographics and using the right marketing channels (e.g., partnerships vs. Facebook adds vs. Google adwords); and understanding how people would like to have the site to increase the conversion rate (improve user experience). We do not want to work with averages but with complete lifecycle per marketing campaign.  It might happen that some marketing channels and demographics might have a higher CAC although then those customers do more repeat sales of top products. But until then, we work with the average values.

Power and Negotiation

One of the best classes I took at MIT Sloan was "Power and Negotiation", taught by Professor Jared Curhan. The main book in the class was "Getting to Yes", a highly recommended book.

I like the definition Prof. Curhan gave about POWER: "the perceived ability to bring about desired outcomes (it is relational!)". He differentiates about 6 types of power

1) Expert power

2) Reward power (if you have a lot of resources to compensate others for what they do for you)

3) Coercive power: ability to punish

4) Position/Legitimate power: e.g., age, police officer

5) Referent power (attract others and build loyalty)

6) Subsequently power: have a lot of connections or information

Finally, he said that the most powerful word in negotiation is "wha?????" (like "where does that come from?") and be silent after that.

Quote from Entrepreneurial Finance class

You can learn as much as you want about clauses in term sheets but in the end "Those that have the gold make the rules" (refering to VCs)

Lessons in entrepreneurship from consumer internet entrepreneurs

Lately, I have been reading or seeing interviews with consumer internet entrepreneurs to see what can be applied to Pixable. Here I collect some interesting lessons and random thoughts:

Reid Hoffman, founder of LinkedIn and investor in Facebook, Flickr, Digg or Firefox

• Two definitions of entrepreneurship:
  • "It is like scubadiving: you are deep in the ocean and you try to find the way to the surface and you analyzie what resources (air, etc.) you have before you reach it"b) "    
  • "It is like jumping off the cliff and assambling the plane before reaching the floor" 
• He thinks that the combination of consulting and MBA does not add to entrepreneurship (bummer). He thinks that portfolio diversification (low risk management) is the same as building a career with a JD, PhD, MBA and consulting (low risk=low average returns). 

• Raising money enables you to be successful, but that's it.  
• If you raise too much money, in the end the bar is too high.   
• WORK, ACT AND BEHAVE AS IF YOU WERE GOING TO SUCCEED
• Measure early on the things that you can survive and focus on them. Time matters because there is a market readiness.
• Control risk: a) if it is not risky you are diluting yourself; b) take the simple solution which is viable 
• Get users organically (virality). If you don't, your value is zero. 
• Solve your problems in order. Don't solve them all at once.
• Think about competition: set your territory (you are alone there), it is great to have stupid competition
• Your manager has to do with your happiness more than your spouse  
• Investing is like getting married with the company after two dinners
• As an investor, you have to believe that if you don't make a decision for them, the company will still be successful; if not, you are only investing in the idea
• In consumer internet you need a substantial part of free things
• Be excited explaining what you do
• In B2C, treat your customer first. If they start doing something, give it to them. 

Founding team of Cooliris

• Funded by Kleiner, 2 Stanford guys (one of them the youngest intern at Apple when he was 15). Their main product is a browser plugin that provides contextual navigation (when you mouse over a link you want to see the content of that destination, including videos). This is a TINY PAIN POINT who everyone in the world feels. 
• co-founded by my colleague Mayank Mehta, who worked with me at Microsoft during the summer  
• Time is an asset more important than capital.
• Focus on metrics. Cooliris is a data driven company. In their case, the 3 main metrics are:
  
  • active users 
  • engagement time 
  • revenue per user
     
• They raised funding as a trunch investment. A piece is give to you but you need to hit a metric. 
• In a data driven company, organize your company where everyone is accountable for a number. It is easy to measure success.

• As many other consumer internet entrepreneurs, they claim that "there is no substitute for going out there and watch users how they use your product". It is very iluminating for designing products. You get very BIG SURPRISES, e.g., how difficult is for people do things you think are easy. 
• They have 34 employees full time (they call them "more than full time") and 25 interns (party teammates)
• Try to hire A+ players. Although the A+ people usually have great opportunities. So get them excited. Try to hire connectors (tipping point). People respected in the engineering community (or any other community) and very social
• They see 3 main challenges in a startup: 
  • recruiting A+ people when they could go to Google with all the benefits; 
  • building the product 
  • execution: processes, organizational structure, metrics, prioritization of ideas you have, etc.

Greg Waldorf, CEO of eHarmony. 

• He is doing entrepreneurship in the business of love (that sounds cool). On an average day, 200 people get married who met in eHarmony.   
• "must have" in startups:  
  • Working with great people. It is difficult to predict the next Google but easier to find the people you like and interests you
  • Willing to take risk. Don't go the safe path (e.g., the prestigious job)
  • Willing to adapt
    
  • Love what you do (in his case, 100K babies were borned from people who met in eHarmony)
  • Take charge of your careers. The really good things don't come to you.
     
• A lot of people think it will be easier to go back to entrepreneurship. But NOW is the time, don't wait, IT DOES NOT GET EASIER. Get a job that shows you what makes people happy, the sooner the better. Fast forward your life 15 years and imagine how you would like to talk about yourself and the decisions you made. You want to be happy, fulfilled, satisfied and love going to work. 

• Some facts about eHarmony: In the US there are 80 million single people, 13 million visit dating sites and 4 million subscribe. 1% of marriages in the US are from eHarmony. There is a lot of word of mouth when you find out about that wedding. 

• If you go to a top university you have incredible safety below you and it is easier to take "smart risk". Don't worry about falling behind your peers. 

• You can't be a doctor without going to medical school. But you can be an entrepreneur without going to business school. 

• Speak to everyone about your company. Word of mouth is the best PR you can get. 

Overall, some key messages: Urgency, adaptation, work with great people, in startups time is an asset more important than capital, don't wait, smart risk, "work, act and behave as if you were going to succeed", "there is no substitute for going out there and watch users how they use your product"   

"When you have a problem, ask everybody", Eric Von Hippel

This semester I took the class "innovation in the Internet age", taught by the innovation guru Professor Eric Von Hippel.  He is famous for coining the terms "democratizing innovation" (e.g., Threadless business model, where users that innovate can develop or choose exactly what they want, rather than relying on manufacturers to act as their often very imperfect agents) and "user innovation" (e.g., when an ordinary user, frustrated or even desperate, solves a problem through innovation). 

With the Internet he recommends "when you have a problem, ask everybody". Even IBM asks people for ideas.  And as the CTO of P&G says "For every scientist we have, there are 200 other scientists in the world as good as him". Surprisingly, in Spain, entrepreneurs are super super secretive about their ideas and problems.

Everyday I belive more and more in the wisdom of crowds, and we have used it in many ways at Pixable. I recommend again the book "The wisdom of crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations", one of the best non fiction books I have ever read.

Pixable has a logo!

At Pixable, our startup that enables people to print their Facebook photos and content, we have finally chosen a logo. Believe it or not, I have counted over 300 logo proposals until we have made the final decision.

Everyone told us that what matters is the company name, not the logo. For that reason, in January, we used "the wisdom of crowds" to select the company name and we sent a survey to +100 friends to vote for the names we proposed in a survey. But as this is a consumer facing product, we felt that the logo design is a very important part of our identity.

Since January we have been exploring various options and about a month ago we decided to use Crowdspring, a crowd sourcing website dedicated to graphic design. Crowdspring is a pretty recent service although there are similar competitors. The interesting thing about Crowdspring is that you decide how much money you want to award to the winning designer and you can also iterate with the graphic designers, asking for modifications.

Given that we are in the personalized and on-demand printing industry, we wanted a logo that could print in high quality independently on the printer's quality, could print in different backgrounds, could print in black and white and we could also easily modify the colors. We also provided some guidelines in Crowdspring about the message the logo should convey in relation to our value propostion: "Pixable turns your Facebook photos into printed memorabilia in under 5 minutes".This is: Speed to create the albums in less than 5 minutes, simplicity, user friendly online service with no download required, creative design and low price. We also mentioned our target demographics (age, gender, social and online behavior, or native language), types of fonts/logos we like, and the things we did not want to see in our design. We also needed to have something characteristic in the logo that could be used as our icon (the "p") and we also wanted to maximize the "real estate" of the logo, i.e., a compact design without much vertical or horizontal space.

We received over 140 logo proposals and we could iterate with the designers in a daily basis (all of them very responsive). Our whole team was aligned with ~5 logos and we finally chose the one below, which we love. We use the "p", which looks like an elegant, stylish, chic and simple camera, as our icon.

I highly recommend Crowdspring for everyone starting a company and willing to have more options to choose their logo from. In Crowdspring you can start from nothing; or you can even start with mocks or very specific guidelines and let the designers on Crowdspring iterate over them.

Disclaimer: I do not know anyone at Crowdspring.

Discussion with Bain Capital Ventures

Today I joined a discussion about entrepreneurship with Scott Friend (cofounder of ProfitLogic, acquired by Oracle), Jeff Glass (founder of mQube, acquired by Verisign for $250M) and Ajay Agarwal (Trilogy), the three of them partners at Bain Capital Ventures.  The event was organized by Bain Capital Ventures and HBS Entrepreneurship Club and it was followed by some drinks and appetizers with the 3 partners.

Bain Capital Ventures has ~$1B under management and has invested in companies such as LinkedIn, Tokbox, Doubleclick, Skyhook, Staples or Vonage.

The discussion was about their perspective on fundraising and company-building from both the investor and entrepreneur point of view. Some interesting points covered:

• Personal risk is usually overstated in entrepreneurship
• In startups you control your destiny
• A startup is a series of chicken and egg problems: you do not have customers if you do not have a product, but you do not have a product if you do not have employees, but you do not have employees if you do not have money, but you do not have money if you do not have customers, ... 
• Startups are about young people trying amazing things and figuring out along the way
• At the beginning you need very talented and passionate young people. Athletes that can iterate rapidly. The common reaction of older and experienced people about trying new things is "this is why it won't work" instead of trying 
• The three of them agreed that in every startup, no matter how successful it becomes, there are always very low moments in which you are about to give up. In startups, both ups and downs are taken to the extremes. 

Breakfast with Chris Hughes, founder of Facebook and New Media Strategist of Obama's campaign

Today, together with a small group of MIT and Harvard students, I had breakfast with Chris Hughes, cofounder of Facebook. Chris joined General Catalyst Partners (GCP) as an entrepreneur in residence 2 weeks ago. The breakfast was held in a small room at the offices of GCP. Joel Cutler and Hemant Taneja, Managing Directors of GCP, were also at the breakfast. It was a very interesting 90 minute discussion in which I also had the chance to talk about Pixable. The founder of The Ladders (from Harvard) was also in the breakfast.

I like General Catalyst because it is one of the only firms in the East Coast with a very ambitious mentality even if it requires taking high risks. As Joel Cutler mentioned today, "different VCs do things differently. If you focus on breakeven too soon, it will limit the growth."

Chris Hughes(born in 1983, only 25 years old) co-founded Facebook, with Harvard roommates Mark Zuckerberg and Dustin Moskovitz. He worked at Facebook for 3 years and most recently served as New Media Strategist for Obama's presidential campaign and pioneered the use of online campaigning through the political social networking site My.BarackObama.com. Chris was featured as the cover story of April 2009's Fast Company under the headline "The Kid Who Made Obama President; How Facebook Cofounder Chris Hughes Unleaded Barack's Base- and Changed Politics and Marketing Forever". He holds a bachelors degree in history and literature from Harvard, where he graduated magna cum laude.

The conversation was more about what we were doing and how we wanted to do it, than on his experience (although in the end, everyone was asking him about his experiences). Some good insights of the conversation:

• About Chris's experience at Facebook:
  • At Facebook, Chris focused on user experience and product design
  • Before Facebook, sharing personal info on the web was about dating sites. Now it is a different paradigm.
  • I asked about the challenges of managing older people with more experience and expertise. He said that you need to be surrounded by good advisors but you also have to trust your instinct. As an example, he pointed out that when they had the $1B offer to be acquired by Yahoo, older people just wanted to take it because they had lived the Internet bubble and burst; but the young ones wanted to make it bigger and thought that it was possible.
  • He left Facebook when there were 200 employees (now there are 900).
• In the process of starting a company:
• • Identify inefficiencies in human interactions. E.g., recommendations of restaurants in the neighborhood, search of grad housing, etc.
  • Design a web product that can make the interaction easier
  • Think about how to make money out of it
• Use your own experiences and pain points to identify an opportunity. And BE ARROGANT THINKING YOU CAN DO IT BETTER THAN OTHERS (he stressed this many times)
• Look for opportunities in which the product demand already exists. Never create a demand that does not exist (e.g., never say "People may want more of this"). With Facebook, they saw that people were interested in "what are my friends doing?" but it was very inefficient to find out.
• Again, focus on a product that solves your pain point. And make sure that there are a lot of people with the same problem.
• Although you do not need barriers to entry at the beginning, think about them for the long term. For example, Kayak could have been copied in the beginning but they just focused on the product and now is when they have barriers to entry
• About the board of advisors for your startup: look for genuine advising that complement your skills. They should be people that were helping even before becoming part of the board.
• VCs make two types of investments: a) ambitious about the impact (and then they will figure out the final way to monetize it); and b) investments to make money.
• There are a lot of opportunities to make money in other countries adapting successful ideas in the US. They gave the example of European Founders
• He recommended us: Find a good idea and just do it; building a websites is easy and you can see what customers think. And later, write a business plan. You learn much more doing it this way than talking to VCs or experts (except when there is a big ecosystem or you are in a mature industry)
• Go where change is happening in the world and learn from it
• During the first year, focus on product product product. Everyone will tell you that what you are doing is wrong 
• As a founder/CEO, most time is spent hiring people (the most difficult part) and raising capital. Be always welcoming potential candidates.
• Expertise is not important. You just need to suffer a pain point as a customer and have a vision and ambition.
• There are 3 things that take a lot of time: hiring, product and monetization. As an early stage startup, you should focus on hiring and product development.
• As an entrepreneur, you need to spend a lot of time with the startup but you should learn to prioritize how you spend your time.
• About LISTENING TO CUSTOMERS: "PEOPLE ARE NOT GOOD AT EXPRESSING THEIR FRUSTRATION". Listening to the customer is not about feedback emails or questions you ask your users. The best way to listen to the customer is THROUGH METRICS: heat maps, who comes back, who they are, etc.

Overall, a very interesting breakfast at GCP.

Presentation of "The Facebook Era"

Last monday I attended Clara Shih's presentation of her new book, "The Facebook Era". Clara is director of enterprise social networking alliances and products at salesforce.com. Independently, Clara developed Faceconnector (formerly Faceforce), the first business application on Facebook. Previously, she worked at Google and Microsoft and is a Stanford and Oxford alumni. She blogs at www.thefacebookera.com. After the talk, I bought the book and I had the chance to talk with her about Pixable.com and some issues related to Facebook.

The talk was about how social networks are changing human relationships and what that means for sales and marketing. An excerpt of the talk:

Last decade was about the World Wide Web of information and the power of linking content pages. Today, it's about the World Wide Web of people and the power of the social graph. Social networks are rewriting the rules for our personal and professional lives and the ways we transact and interact in a radically new era: The Facebook Era. We are undergoing a radical transformation as traditional one-sided CRM gives way to bidirectional visibility and access, and an unprecedented degree of trusted online identity and access to people are forever changing human relationships. Facebook, Twitter, and LinkedIn are changing everything we thought we knew about sales, marketing, and product development - and empowering companies with new tools, insights, and ability to transform customers into true partners and your most effective sales force yet.

Some interesting notes of the talk:

• As a marketer, you need to be where people spend time. People spend 3 billion minutes on Facebook each day
• Facebook is a template for online identity
• Personal recommendation are much more powerful than any other marketing approach. Facebook is good for social validation: how many books we have read or movies we have seen cause someone else recommended them to us?
• Facebook is CRM for personal life. It is bidirectional. It is a channel.
• She talked about Bonobos, a company that sells awesome fitting trousers, started by 2 guys at Stanford. In two years, they have $2M in revenues and they only used Facebook marketing.

Visit to Battery Ventures in India

Last week, while I was in India visiting our SW developers of Babalah and Pixable, I had the chance to visit the offices of Battery Ventures in Mumbai with a team of MIT Sloan students. There we met with Gautam Patel, the Managing Director of the Indian office.

Battery was started by Howard Anderson, my professor at MIT (I blogged about his talks several times in the past). Over time, Battery has raised $3 Billion and in 2008 raised a new $750 million fund. Some of the successful startup investments include Akamai, Fore or Infoseek.

Some of the insights Gautam shared with us:

• "Any model that works in the USA can be somehow taken to a new country"
• In the US you would look for an enabling technology with global outreach. In the rest of the world, you should look for a company that provides cheaper and more scalable services in that local market.
• The 3 things he looks in an investment are:
  • Market adoption
  • Management depth
  • Market need through customer research
• In order to back a management team in India, you need a lot of trust. In India, it takes a while to trust people, and then you can do business (the first thing you think about a person when you meet him is that you cannot trust him).
• Entrepreneurs need to be close to the consumer market.
• You should go back to your country (in my case Spain, and in his case India) if there is a financing community and not because there is a market opportunity. 
• Some interesting sectors in India:
  • Financial service infrastructres: he thinks that 25% of the world financial service infrastructure will be from India
  • Mobile: ~60% mobile penetration in cities and 40% in India
  • Media
  • Education
• When you make a decision, think that in 10 years people will ask you why you made that decision.
• Battery has currently invested in about ~5 startups in India, including travelguru.com, which is the hotels.com for India.