What is the number one mistake technical founders make? Why is pricing so important? Should entrepreneurs avoid at all costs having a service component to their business? What is fundamentally new and different in go to market strategies for modern enterprise software startups?
A self-avowed “failed physicist”, Martin Casado is a General Partner at Andreessen Horowitz, and previously was the co-founder and CTO of Nicira, a pioneer in software-defined networking and network virtualization that was acquired by VMware for $1.26 billion.
I have had the pleasure of getting to know Martin through the board of ActionIQ, a great NYC startup in which we are both investors.
Martin joined us for a fireside chat at the most recent edition of Data Driven NYC. The conversation centered largely around one of Martin’s favorite topics, go to market strategies for enterprise startups. There’s plenty of interesting thoughts and directly applicable advice for entrepreneurs in there, as Martin spoke as much from his previous founder experience as he did as a VC.
Here’s the video, and my notes from the chat are below the fold.
Why Go to Market (GTM) matters:
- The Number One mistake technical founders make is to think that whatever they have created has intrinsic value [and not pay enough attention to distribution]
On category creation:
- A market category is when a) people know what you’re selling, it’s part of their everyday thought process, there’s a buyer and hopefully a budget for it; and b) they’ve assigned a value to it
- When the category does not exist, the entrepreneur has two jobs: you need to a) “create the object in their head”, so that they start thinking about what you have built, which is a fundamentally hard thing to do, and b) attach a value (or price) to it
- Traditionally, this was a direct sales-driven exercise, you had to show up and walk people through the thought process and product, but this is changing (see below)
- Especially for enterprise startups, there’s no single decision that you make that is more important or more directly tied to your value than pricing (Ben Horowitz)
- Over time, almost all of variable costs are related to GTM, and you don’t control your CAC (how much you pay your sales people is dictated by the market)
- But you can control how much you price your product, and therefore your margin
- Entrepreneurs tend to think about pricing in terms of how much value is created (bottoms up) but they should also think in terms of margin for their business, or ensuring their business can be solvent (top down)
- Initial contract size matters but net dollar retention (meaning, expansion after the first deal) matters even more
- Some simple math: if a great sales person can do 6 deals a year (in a category creation context) and they’re paid $400k a year OTE, to have reasonable margins, you need their quota to be 3x OTE, so that’s $1.2M… so that basically means you need to have $200k ACV (for those 6 deals to get to quota)
- The traditional way of thinking of services (most VCs) is that they are non-scalable and low margin
- The reality is that for every one dollar a customer spends on software, they spend $2 to $3 on services (contract engineering, integration, etc), it’s a large TAM
- The traditional services providers (e.g. Cap Gemini) not only get more dollars, but they also become strategic advisors to the customer, deciding which product are being used, especially in a context where there’s more and more products being released every day
- At Nicira, we realized that if we used services in a disciplined manner (to become strategic advisors to the customer, push for a higher sale, push for expansion), we built those very sticky relationships with our customers
- So my view has changed… If you sell core, hard tech with lots of integrations, it’s great to have a services business, and in fact it’s a differentiator
- But it is dangerous and you can get addicted to revenues… you should keep the services P&L separate (early on), and eventually the service providers should take it over… this can start happening when you have about $30M in revenues
On bottom’s up sales in the enterprise:
- In consumer, it’s all about whether people like the product, which is very hard to predict, so as investor, you observe the trends and the graph of adoption… it’s also all marketing led distribution, with organic and bottom’s up adoption models… so you just wait to see if it’s getting adopted
- In enterprise, you have a pretty rational buyer, so you can just ask them… so traditionally as an investor, you’d focus on the team (can they make it) and the market (can they sell it)
- The big disruption is that the enterprise, across the board, is now adopting in a bottom’s up way… for the fastest growing enterprise companies today (Atlassian, Slack, Dropbox, etc.), early growth came through marketing, they only did sales afterwards
- Incumbents have no idea how to defend against this… they’re good at a lot of things, except making “cool” products that will sell themselves
- Except for a couple of examples like Atlassian and Dropbox, however, all successful enterprise startups at some point overlay a sales team on top of organic growth (see Slack, Github, etc.)
- Having those two sales motions (bottom’s up and sales team) makes things way more complicated than building a consumer company… for example, you can have a user you acquired through an organic sales motion, but they’re not the buyer for your product and they don’t have budget for it… or you made your product too good in order to generate the organic growth, and now you’ve cannibalized your own ability to make money later [because you’re giving away too much of the product for free]
On open source:
- Open source can be a way of building that organic sales motion… but at this stage it has been superseded by any company doing software as a service… Github is very proprietary, AWS is very proprietary, even if they use a lot of open source… and you may have things that are open source, but the way to deploy them in product at scale is not… once something is delivered as a service, whether it’s open source matters less (it’s a different story for on prem software)
- A common angst is that, once your software is open sourced, the big cloud providers can take it and host it themselves… there’s some truth to that for very mature products that have been around for a long time… but if you’re sub $100M in revenues and you’re the innovator, it’s very difficult for those large cloud providers to compete with you (they can’t build the sales force, they can’t keep up with the versions, etc.)
- This bottom’s up trend helps do more with less money
- The flipside is that we’re no longer in the days where you can show up with a deck and get funding, because now, as investors, we can’t tell what the enterprise is going to like [until we see the organic adoption]… [it’s not about the complexity of the product,] some products like Slack are relatively simple but get enormous traction
- So entrepreneurs should focus on building that bottom’s up traction – users, engagement…
- Metrics: curve needs to be up and to the right… but to understand what VCs will consider traction, understand what kind of traction your peer set has (across metrics like Github stars, etc.) and show you’re doing better than them
- Regarding valuations and round sizes: I don’t care about the state of the VC market, I care about the market… all those companies are much bigger than we ever thought they would be! So worrying about $10M or $20M of valuation is myopic.