With billions of dollars of venture capital residing down the street on Sand Hill Road, two Stanford professors are attempting to answer a fundamental question “why does it always take longer and cost more to build a hi-tech company than anyone ever expects?” For all the intellect, experience and graduate degrees in the venture capital industry, the sad truth is that 80% of venture capital investments do not pan out. While the reasons for this high attrition rate are too numerous to list here, a simple fact defines every successful investment – the company figures out how to bring in more money than it spends. The secret to solving this fundamental equation these two professors believe lies in the Sales Learning Curve.
Mark Leslie, an entrepreneur turned Stanford lecturer who took a startup company, Veritas, from nascent stages to over $1B in revenues and a recent $13.5B merger with Symantec, and Charles Holloway, the Kleiner Perkins Caufield & Byers Professor of Management at the Stanford Graduate School of Business have developed a framework, that goes a long way toward answering the question “why it always takes longer and costs more?” Leslie and Holloway call this framework the Sales Learning Curve (SLC) and believe that it will prove as powerful a construct in the high tech sector as the Manufacturing Learning Curve (MLC) was to the manufacturing sector in the early (date?). Today, manufacturers wouldn’t think of running their operation without tracking the MLC because of the dramatic improvements in productivity that it offers. Similarly, Leslie and Holloway believe the SLC holds the potential to fundamentally change how high tech companies are managed and will lead to more high tech companies reaching the promised land of “positive free cashflow.” Increasing the number of cashflow positive companies should lead to greater venture capital returns, more capital being allocated to the sector by LPS, more early stage company formation, more innovation, more jobs, and increased productivity.
So what is the Sales Learning Curve?
[Note to Editor — there are 2 graphics that were stripped out when I pasted in the article into this form]
As illustrated above, the Sales Learning Curve tracks the contribution margin per sales rep (Sales Yield) against the number of customer transactions. The shape of the curve will be different for every company and every sector but the central tenant of the SLC remains constant – the “go-to-market” phase is when companies should “Go Slow to Go Fast” (which is some advice from a Nordic skiing expert that I recently received when I asked for some tips on improving my performance prior to an upcoming race – Google the phrase and you will find that triathletes, grade school teachers, executive coaches, swimmers, and karate instructors are all well aware of the Go Slow to Go Fast benefits).
Leslie and Holloway believe the “organizational learning” that occurs as sales reps interact with customers to close initial sales is crucial to the ultimate success of the organization. The classic “go-to-market” strategy involves hiring a VP of sales once the beta product is complete and then hiring as many reps as the balance sheet will allow in order to “drive revenue and get to breakeven.” According to Leslie and Holloway, this strategy is doomed to failure because the company has failed to take the time to understand the shape of the SLC for its product in its market. Some reports generated over the last two years by Fenwick and West, a prominent Silicon Valley law firm, bear out their assertion. There is a consistent pattern of inflated B round valuations; the percentage of down rounds for C and later rounds is always greater than B rounds. As Leslie and Holloway state, “One inference from this is that both entrepreneurs and VC’s underestimate the cost and time required to move up the SLC after completion of the Beta product. VCs and entrepreneurs often assume that the company is ready to gain market traction at this stage when in fact the company is only ready to begin the SLC learning process, which like product development stages has a somewhat indeterminate duration.”
When moving from beta release to first release, Leslie and Holloway argue that only a few technically versant sales reps should be hired. These sales reps should serve as a conduit between the initial customers and the engineering team and compensated not on revenue targets but on the “organizational learnings” that are achieved. Only after enough of these “learnings” have been incorporated into subsequent releases of the product and the organization knows how to sell the product (defined as the point at which each sales rep’s contribution margin is twice their fully burdened cost) does it make sense to aggressively hire additional sales reps. Leslie and Holloway posit that the SLC is immutable and can point to numerous theoretical models and concrete examples that indicate that until you have reached this pivotal point on the SLC, the capital invested in hiring additional sales reps is simply wasted.
My firm’s principals have served as executives, investors, board members, and consultants to nearly 50 early stage companies in the technology sector – some successful (Microsoft) – some not. We have found consistently the go-to-market stage (more so than product development or market expansion) is where there is the highest degree of uncertainty and the greatest potential to burn through finite cash resources typically through a misallocation of sales & marketing resources. Needless to say, once we were exposed to the SLC, we immediately began working to develop the tools and constructs needed to apply the theory behind the SLC to the day-to-day operating reality of rapidly growing companies.
The last thing most CEOs and venture investors want to hear is “Go Slow” when they have a product that is out of beta testing. Having become intimately involved with the SLC and Leslie and Holloway’s thinking, we are firmly convinced that is precisely what companies must do whether they are a start up launching a brand new product or an established company starting a new line of business.
When companies are pushing a product out of beta, it is not unusual for a startup to have a relatively poor handle on questions such as the following:
• What is the true Customer ROI?
• Does the company have a clear segmentation and customer focus strategy?
• Has the Sales Model been clearly defined?
Most management teams feel like they have a strong grip on these topics based on a few “high touch” initial sales, the feeling that it is time to put the “pedal to the metal.” Typically, when “v1” is shipped, it is a time of rising excitement, enthusiasm and confidence within the organization. There is also an expectation from investors that with rising expenses that management is going to push to get to breakeven in the shortest time period possible. Since revenue is only generated from sales activity which is directly related to the number of sales people in the field, there is a tremendous amount of pressure to hire and deploy reps ASAP.
Unfortunately, these sales reps are frequently deployed before the product is grounded in market reality and an effective sales and marketing process has been developed. Consequently, these sales reps are unproductive, “sales activity” never turns into revenue, and precious cash is wasted at an alarming rate.
What is the alternative? Our experience, which is echoed by the SLC, has shown that taking a much different approach to sales when introducing a new product into the market can result in far more favorable out comes. At this stage, management should focus on capturing market and customer feedback rather than strictly on generating near-term revenue. The rate at which this customer feedback is acquired and assimilated into the product is critical to a company’s ability to move up the SLC. Defining sales success in terms of the “amount of feedback collected from customers” influences the type of sales people hired at this stage as well as how they are compensated.
How does a company know the shape of its SLC and how to gauge its progress along it? A number of primary drivers of the SLC exist: readiness of the product, sales and marketing, product type, market structure and macro-economic conditions.
In tandem with the Venture Dynamics Group, we have developed a dynamic simulation model that estimates the SLC under different scenarios. The model helps entrepreneurs and investors model the shape of the SLC given a certain set of assumptions and then see the resulting impact on cash flow.
There are several actions an early stage business should take to apply the SLC framework that my firm, as well as Leslie and Holloway, are espousing. The following are some highlights:
• Identify and prioritize product, sales and marketing factors impacting the SLC
• Shore up gaps as well as exploit your strengths based on findings from broad customer contact and market experience.
• Engage in a regular process of analyzing how learning can be accelerated.
• Mobilize entire organization to engage with customers (engineering, product marketing, sales and finance)
• Staff and operate at the appropriate levels based on where you are on SLC.
The management team can then mobilize their entire organization towards learning and accelerate their path up the SLC. While some of the management team may believe that this process will slow the rate of revenue growth, it is important to remind them that this process is intended to accelerate the process by which companies reach the ultimate corporate goal, cash flow positive.
Though it can seem counterintuitive to slow down the go-go energy upon initial product delivery, a well-grounded approach that keeps the SLC principles in mind will end up being the fastest path to rapid market penetration and sales growth. This will ensure you avoid the old saying, “haste makes waste” while giving your team and investors the kind of financial return you desire.
If you would like to see a complete SLC presentation given by Mark Leslie at a recent event, go to [http://altusalliance.com/ceoInfo.html].
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