Month: February 2020

Why founders should never build the one-stop-shop

Are you okay? The founder was reacting to my painful facial expression. The pain I felt wasn’t physical, but it was real, nonetheless. The unpleasant sensation stemmed from a proclamation the founder had just made. One I have heard too many times before.

We are going to build a one-stop-shop platform! the founder had stated seconds earlier.

Right then, I knew I had a long and difficult conversation in front of me.

I began (again): Look. Many startups founders get the idea of building the one-stop-shop. The logic is obvious. Each individual element to a platform has value. If the platform has a lot of elements, it has a lot of value. And if the platform has ALL elements possible, then it has the most value. Thus, it will be superior to competing products.

The founder nodded.

Unfortunately, the logic is wrong, I said. The founder looked a bit confused.

I continued: Imagine we do a startup. We decide to build an online room planner for private homes. Millions of people need to design their home when moving or renovating, and we know the pain from having moved our self.

We launch, create some buzz, and a few hundred people start using it. However, the number of users is less than we have hoped for. And after a while, we realize that the hockey stick isn’t happening.

The scenario was exactly what the founder was currently experiencing. So, she was very attentive.

What do we do? I asked rhetorically.

Well, maybe there aren’t enough people who need a room planner for private homes, we might conclude. But if we add an office layout, then office managers could use it too. It is easy to add office furniture to the inventory library, so we do it.

What we hoped for happens. Offices are being designed on the platform. But it is still not a hockey stick. At the same time, we learn about multiple competitors that offer office planning. What to do? I asked again, rhetorically.

Well, we just learned that when we added the office elements, we broadened the scope of our product. This meant more people could use it. So, we decide to add more elements.

Factory planning! We add factory layouts and create 3D models of conveyor belts and machines. Now we have the only platform where users can plan homes, offices, and factories. We have no competition.

Still, the hockey stick eludes us. Worse still, we see a reduction in the number of private homes being planned. Maybe because we haven’t fixed all the bugs before we started focusing on the factory elements. Anyway, we have found a way to grow and escape competition, we think.

Next, we enable planning for yachts. Then restaurants. Then concert halls. With each element, we broaden the relevance of the product to even more people. Or so our logic goes.

Finally, we have built the ultimate room planner. The only place you can design any space regardless of function or size. We are the “standard”. The go-to-place. The one-stop-shop. Nobody else offers anything as complete as our software. And then God abandons us.

The founder looked a little confused. Maybe it was because I brought God into the picture. So, I elaborated:

What we would learn is what eBay learned when they added video conferencing (Skype) to its auction site. Or Burbn founders learned before they simplified their app and renamed it Instagram. Or Endomondo experienced when they added e-commerce and social networking to their running app. And these companies are among the surviving examples. The failed projects that have learned the same lesson are endless.

I looked directly at the founder and said: We would learn that the impressive breadth of use cases our software handles is utterly worthless to our customers. I continued:

The thing is that additional elements only provides value to the user if they are integral to the same problem. As an example, it’s valuable if a webshop also offers payment and delivery. The problem the user is trying to solve is to obtain a specific item. If users had to go to a third-party payment solution to transfer money. And to go to another service to arrange delivery, the friction would be unbearably high.

The question is: how integral must problems be to add value to the same platform? Well, more integral than you think, I said.

Take the running app Endomondo, I continued. Endomondo enables runners to track their runs. But runners also need running apparel. So, would Endomondo be a better product to runners if it also featured a shop with running apparel? I asked. The founder looked unsure. So, I continued: It turns out not. Endomono tried that, and it wasn’t a success. Why. Because tracking your run and buying apparel are very different problems. And no runners have these problems at the same time.

Our imagined room planner startup would suffer the same lesson. Nobody needs to design a home, an office and a factory at the same time. The section that supports office planning is worthless when you want to plan your bedroom. In fact, it’s confusing and adds clutter. The idea of the one-stop-shop is false.

Now, it was the founder who felt pain. And then came the inevitable question. But what about Amazon? The founder asked. I had expected it and said: Amazon is a perfect example. Amazon sold only books for a long time. In fact, they decisively refrained from selling anything else before they had nailed the book problem. Amazon did not become successful because they sold everything. They became successful, exactly because they did not sell everything. Later, they added another element one by one. And so, should you, I said.

The founder was quiet, but slowly her painful facial expression lifted. Then she said: I guess Uber did the same thing. They started out offering expensive limousines, and not until later added cheap taxis and food delivery. Because….well none needs the same thing at the time. She let it sink in.

Then I could see her facial expression change into a very familiar one. Determination. Thank you, she said. I know what I must do. She got up and left. I looked out the window and thought about how often I have had this conversation. And then, I started writing this blog post.

Advertisement

How to spot a scalable startup and why I got it wrong in the past

There is a lie that permeates the startup industry. And venture capital especially.

The lie is this: startups are binary outcomes. They either become big or die trying.

After having logged my first decade as a VC, I know it’s not true. On the contrary, most startups become small businesses. They simply fail to scale.

This is an important fact. Because studying these non-scaling companies offers valuable lessons about the true nature of scalability.

What scalability is not

Economists teach us that scalability is about low marginal costs. Meaning it is cheap to serve an additional customer. In this view, services are never scalable because the cost of servicing one more customer isn’t falling.

In contrast, production can be scalable because a machine can produce one more widget cheaply. And SaaS is very scalable because letting one more customer access the software costs next to nothing.

The theory of low marginal costs makes investors love SaaS companies. And for good reason. There is just one problem. Most SaaS companies never scale.

Clearly, low marginal costs do not define scalability.

What Scalability is

After a decade of investing, I have come to understand scalability somewhat differently.

In venture capital, scalability is defined by a time constraint. Funds must exit the companies with 7-9 years. This means scalability is more about the speed of growth than marginal costs. Put differently, a scalable company is one that can grow fast. To this end, marginal costs matter very little because marginal costs define profitability, and not speed.

Growth can come from two sources. Beta and Alpha. Beta defines the growth rate of the market. Alpha defines how fast the company can grow (relative to its competitors) in the market.

The strength of Beta and Alpha can vary. As an example, the SUV market has long enjoyed moderate Beta. The SUV market grows more than other car categories. But it is a far cry from the strong Beta the electric car market enjoys.

Extreme Beta also exists. It happens when a market is “unlocked” and all the new actors rush to the marketplace at once. Like it happened for Airbnb when they “unlocked” a global latent market of private hotels. Or Uber did with ridesharing.

Strong Alpha occurs when the product enjoys a reinforcing value loop, and the loop spins faster than the competitor’s loop. A reinforcing value loop is one where the product becomes more valuable when the company wins more customers, which in turn makes the product more valuable, which will attract more customers, and so on. This self-reinforcing nature of such a dynamic means that the company will quickly become dominant in its market.

A company like Templafy (Accelerace alumni 2014) enjoys such s value loop. Each new customer creates new templates than can be added to the product for the next customer. This means Templafy has strong Alpha.

A perhaps even stronger example of Alpha is a company like Trustpilot (Accelerace alumni 2009). For Trustpilot, new users create reviews, that make the site more valuable to other users, who will create even more reviews that in turn increases the value of their product offering to the businesses who are reviewed. The businesses start using Trustpilot ratings in their marketing, which makes new users aware of Trustpilot, who then create more reviews. And so, the reinforcing value loop accelerates.

And as you will see, these forces greatly influence scalability.

What Scalability looks like

In our first fund (vintage 2011) with 49 investments, I have witnessed cohorts of very similar companies start around the same time. But over the ensuing years, they experienced unbelievable different trajectories.

A few have become bigger than even the founders imagined. And many never scaled, but still lives. For years the reason for this difference eluded me. Because it wasn’t marginal costs, market size, team, IP nor competition. In fact, one company is by far the strongest in all these parameters. But it still failed to scale.

In 2012 we invested in a SaaS company in a vertical with very little competition. We will call it WorkWeek (not the real name). The founders have industry insight. The product is great. The customers love it. The market is worth billions. The CLV is very high because customers never churn. The board is among the strongest I have seen.

We did the seed round, and the company projected to reach 10M ARR within three years. Today, eight years later they are at 3M ARR.

The problem is that WorkWeek enjoys no Beta. The market is stagnant. There are hundreds of thousands of customers in their vertical. But if the market is not growing, no new customers are appearing without a solution to their problems. Consequently, their Beta is zero.

In addition, WorkWeek enjoys no Alpha. There is no reinforcing value loop within their business. The product does not become more valuable to the next customers, regardless of how many customers they have.

The founder team estimated they would have “conquered” Germany within two years. It would take them five years to get the first German customer.

The problem was that the customers in Denmark didn’t make the product any better for the German prospects. On the contrary, each new sale gets harder because all the “low hanging fruits” have been sold to. What remains are customers who are hard to convince to change their ways.

WorkWeek is what you get when both Beta and Alpha are absent, but everything else is great. The company grows 50% per year and have done so since inception. Such growth rate means that if a company has 50.000 EUR in revenue year one, they will have less than 1 million EUR in year seven.

In contrast, Trustpilot and Templafy are what you get when strong Beta and strong Alpha are present simultaneously. Trustpilot rose during rapid growth in e-commerce which gave them strong Beta. And their Alpha is simply unique. Templafy enjoys strong Beta from the seismic shift to cloud-based office programs, and the user-generated templates create strong Alpha.

Today, I understand that to be truly “scalable”, companies must enjoy both Beta and Alpha simultaneously.

If both factors are in place, the growth from each source will compound, creating the famed hockey stick as a result. Witnessing a hockey stick unfold in real-time is quite remarkable. But low marginal costs and big markets are not enough if you want to see it for yourself.