A deeper dive into how operational leaders can make changes in their processes and functions to improve capital efficiency.
In Part 1 of my thoughts on capital efficiency published earlier this week, I explained how the pendulum slowly shifts from growth at all costs to growth balanced with efficiency. And I went through the different ways in which the private investment community has measured effectiveness. I recommended measuring efficiency based on the ratio of accumulated cash consumed to annual gross profit, using the data published by Shin Kim as the basis for my recommendation.
However, this high-level measure (the ratio of cumulative cash invested compared to annual gross profit) does not help operators to identify the elements to modify in their daily processes to improve efficiency. So in part 2 of my article, I’m going to dig a little deeper.
My favorite efficiency measures:
- CAC reimbursement (customer acquisition cost): I am a big fan of this metric. I focus on the number of months of gross profit required to repay the ACC. When the repayment of the CAC is fast, it allows you to reinvest these cash inflows in the acquisition of new customers without having to mobilize as much external capital. For companies that target multiple user segments, the CAC Payback analysis must be performed by segment. Tom Tunguz has a good recent post on this metric. The overlap with the most efficient companies in terms of total capital raised at ARR is striking.
- Net dollar retention: Ideally measured by cohort (ie all customers acquired by specific period, often in three-month increments.) This analysis applies to B2B and B2C companies. I’m looking to see how cohort retention measures evolve over time – do they improve or not?
- Customer draw: It helps me understand how much potential customers want / need your product. And when customers proactively seek you out and buy your product, efficiency will be high. Measures related to customer attraction are the percentage of incoming prospects (ideally, the form fills in the requests for a call with a seller in B2B) or the growth rate at rest (for consumer start-ups when they stop paid marketing). I like this article by Kent Bennett and Connor Watumull on consumer businesses where episode 5 focuses on the growth rate at rest and describes its importance.
Build capital-saving businesses
“Efficiency means getting it right; efficiency is doing the right things.
– Peter Drucker
As business owners and operators, we always want to create capital-saving businesses. And that is not easy. Here are some thoughts I would offer to business leaders on the specific tactics to consider. Obviously, as leaders, you know your businesses and your challenges, so you need to both add to and prioritize from this list the elements that would have the most impact on future profitable growth and growth. customer satisfaction. In striving to improve efficiency, we must always focus on the most important things first.
(i) Design for product-oriented growth, if possible. Have an offer with freemium or a limited free trial that promotes virality.
(ii) Ensure that the product proactively reminds users / customers of its value through automated messages and updates that stimulate engagement.
- Sales and Marketing:
(i) Marketing: Pay attention to how you use paid marketing – it is rarely defensible and an addictive drug (hard to deactivate when you fear that growth will slow without paid expenses). This is not to say that paid marketing is not necessary, but focus first and foremost on your owned and earned marketing channels.
(ii) Sales: focus on optimizing the conversion further down the sales funnel (small improvements will mean much less need for more raw leads at the top of the funnel); and use product marketing content to improve conversation in the middle and bottom of the sales funnel.
(iii) Understanding the components of your gross margin amortization in months: break down your amortization from the total gross margin by month in each part of the sales cycle. For a B2B business which could include the following components: (i) costs of the marketing team; (ii) all marketing expenses on all channels; (iii) all costs associated with free trials; (iv) the cost of the DTS team; (vi) costs of the sales team; (vii) general sales costs (management, sales operations, etc.) This understanding will allow you to focus on the areas for improvement that are important for the months of overall recovery of the CACs.
- Customer success and account management:
(i) Focus on retention early in the life of the business. Solving the leaking bucket problem from the start will save a lot of money.
(ii) Facilitate integration – a long integration with a recovery period really harms the customer experience. If the integration is necessarily complex (as will be the case with certain offers focused on the company), integrate another functionality into your offer which can be consulted relatively immediately (see my article on “the value of the community” as an example of such a possibility). feature).
(iii) Invest in the customer success function; ensure they make regular calls to customers and provide feedback to the product team on actual customer experiences.
- Invoicing: frequency and methods of payment
(i) Optimizing the frequency and terms of payment: each customer gain is a mini fundraising event.
(a) If you have a commercial subscription model, make your default payment frequency an annual payment in advance; second, offer payment plans that allow quarterly or monthly payments but at a higher price to reflect your cost of funds.
(b) Insist on credit card payments for lower value subscribers (especially small monthly payments) to compensate for the time and hassle of billing, even if it will cost 2 to 3% of the amount billed.
(ii) ensure that the payment terms do not exceed 30 days net; the sooner you collect the money, the sooner you can invest in additional growth efforts.
- Other operating expenses:
(i) Hire slowly; know the roles required to reach important milestones to enable a next successful funding cycle.
(ii) Slowly change the organization of revenues: it is preferable to see most or all of the sellers exceed the quota and be paid their accelerators while potentially leaving certain transactions open. The alternative, hiring additional reps too quickly, which leads to low sales efficiency (even if total sales are slightly higher), consumes much more money.
(iii) Save space on desks: place people until it is obvious that you need more space. More often than not, you will increase the workforce more slowly than expected. Sign short-term leases, taking advantage of the change WeWork has made to office leases.
- Pricing and compensation plans: simplify the terrain and develop
(i) Link the price to something: (a) directly related to the user experience of value; (b) easy to measure; and, © which leads to upselling. Products that generate value for all users allow seat models that lend themselves to improvement over time. The same goes for products that are directly linked to income or income groups. People understand that paying more when more users access a product or paying more when revenues increase.
(ii) Make sure the compensation plans allow the sellers to pay something for the land and grow over time so that they are incentivized to close small deals in the short term and collaborate with the success of the client and account management to support a business with your product and help with future sales incentives.
- Keep the business model simple
(i) At the start, keep the business model and product offering as simple as possible.
(ii) Over time, a growing company will create several different products (fundamentally different offers and not just price editions) and sell to several different customers. However, delay this urge for additional complexity for as long as you can. In the short term, the complexity of the business seems attractive. But in the medium term, the additional complexity will concentrate the cloud, slow down execution and increase costs.
Capital efficiency won’t put you in the trade press as often as there will be fewer fundraising campaigns to brag about. However, capital efficiency will increase the likelihood that all shareholders – employees and investors – will be well rewarded on exit.