Disciplined Entrepreneurship Workbook
Page 24
STEP 14
Amazon.com’s Beachhead Market was selling books. They have had a wide range of follow-on markets over time—toys and games, electronics, video games, clothing, household supplies, and many others—and many of these have proven to be more lucrative than bookselling, particularly as many used books have become available for as low as a penny plus shipping through Amazon’s affiliate sellers. Amazon.com has also interestingly expanded into Amazon Web Services (making its back-end systems available to others for a price) and now they are creating their own products (e.g., Echo) and content (e.g., movies and TV shows). All of this is a long way from books, but you can see the logical progression over time.
Do not go to market #2. If you have to develop a new product for a new target customer, you might as well throw away your primary market research from the 24 Steps and start over, and you simply don’t have the time or resources as a startup to do that.
STEP 15
Business models: HP printers use a “razor/razor blades” model where the initial product (the printer) is cheap, and the required consumables (ink cartridges) are relatively expensive compared to the printer’s purchase price.
Automotive companies primarily use a one-time charge (buying a car—using yearly model updates to encourage customers to sell their existing car and purchase a replacement), with additional revenue from out-of-warranty parts and services. New recurring revenue streams that these companies are trying include subscriptions to services like OnStar, updates to GPS systems, onboard Wi-Fi, and others. Look for these sorts of recurring revenue streams to increase in number. Tesla breaks the automotive mold by not updating their models every year, and I anticipate they will look more like a hardware company that charges a one-time cost for the hardware plus a recurring maintenance fee to update the software regularly, which will be a high-margin revenue stream.
Salesforce disrupted the software industry with a subscription/leasing model and some elements of a per usage cell phone-type plan, so that users did not need to make large up-front investments (buying server hardware and software).
LinkedIn has multiple streams of revenue—advertising, premium subscriptions, and reselling data to recruiters and companies looking to make new hires. Reselling of data has turned out to be the most lucrative, but the revenue streams are independent of each other so LinkedIn can keep pursuing all the revenue streams without fear that one revenue stream will interfere with the success of another.
iTunes started with a one-time charge model for buying individual songs. Spotify is a subscription service where a recurring monthly fee provides access to their whole catalog. When digital music first came out, customers preferred one-time charges because that was more consistent with their buying habits (CDs, tapes, vinyl records were all one-time charges). Over time, customer purchasing habits have evolved and now a subscription model has become more preferred, especially with younger buyers.
Lack of access to money favors one-time charges that allow for large up-front payments so the startup can fund its growth more effectively. Most other business models, such as subscription and consumables, are harder for a startup to implement, because you have to spend a lot up front with the promise of future revenue. Startups have found ways to work around these obstacles, such as encouraging prepayment of a full year subscription at a discount, like how a magazine subscription works.
STEP 16
Answer is C—Product management should set pricing because they have the full picture and are incentivized by both short-term and long-term success of the product. Sales is focused on short-term results; finance’s role is not to try and understand market dynamics; engineering has to focus on getting the technical side working. Everyone has valuable input—sales can tell you about customer reactions, finance can assess the financial viability of the pricing, and engineering can tell you the costs and what technology is feasible to build—but only product managers or similar roles (such as the CEO at a small-enough company) has the full picture. On that note, don’t give sales too much leeway in promising discounts, because sales has the incentive to “make the sale” even if it means steep discounts; too steep a discount is dangerous in the long term. Let the CEO handle strategies for discounts.
Behavioral economists find that consumers react favorably to products with prices that end in nines. One theory is that consumers focus on the first part of the number, so gas for $1.999/gallon seems like buying at $1/gallon, which would be much cheaper than gas at $2/gallon, whereas the jump from $2/gallon to $2.01/gallon is seen as less significant. Another theory, which MIT Sloan Professor Duncan Simester and Northwestern/Kellogg Professor Eric Anderson discuss in the Harvard Business Review, is that seeing a product ending in nine can make a consumer think that the price is discounted. See “Mind Your Pricing Cues,” Harvard Business Review, September 2003, https://hbr.org/2003/09/mind-your-pricing-cues.
In the book The 1% Windfall, Dr. Rafi Mohammed shows that a 1 percentage-point increase in price increases profits by an average of 11 percent. All of your fixed costs are already set, so increasing the price further is all profit. By contrast, adding more customers also results in revenue, but offset somewhat by customer acquisition and support costs. Pricing your product at what the market can bear is important precisely because underpricing means you are leaving money on the table.
STEP 17
The Lifetime Value (LTV) for the Pet Rock could go no higher than $3.95 since there were no recurring revenue streams (as the Pet Rock required no maintenance) and little customer repurchase (once you have one rock, you’re pretty much set, and there was no thought about getting customers to purchase additional types of products). The actual LTV was probably $2 since the manufacturer sold to retail stores at wholesale prices. Be wary of “one and done” products and fads, especially when the LTV is this low.
Order of magnitude estimates for each: Google: Tens of dollars
Bicycle shop: Hundreds of dollars (initial sale of bike + accessories, service)
Used car dealership: Thousands of dollars (one-time sale; little opportunity for repeat business since they are usually not in the servicing business)
New Lamborghini sales and service dealership: Hundreds of thousands of dollars (initial purchase is $200K–400K plus high-margin services and upselling)
STEP 18
LinkedIn almost never uses humans in the sales process to end users. Preference engines, algorithms leveraging big data, and automated e-mail follow-up with new customers take care of sales for almost all cases. Only recruiters with high LTVs are able to speak to an actual salesperson.
Purchasing a private jet is a classic high-touch sales process. Field sales will be heavily involved in the process because there is a large LTV, potentially with support from other channels. The representative will customize the sales process and product to your specific needs. They know that anyone who buys a jet has a lot of money, so there is a lot of opportunity for follow-on sales.
STEP 19
LinkedIn has a strong Core—networking effects—and value proposition, allowing its Cost of Customer Acquisition (COCA) to decrease among both users and recruiters who find the site more and more useful over time. Groupon does not have a strong Core or value proposition, since their consumers are loyal not to the website, but to the deep discounts they provide, allowing other “daily deals” websites to copy Groupon and gain market share, and the loyalty to deals means that businesses who advertise with Groupon do not get the expected volume of customers who become repeat customers, as these customers are driven by price and not other considerations. As a result, Groupon’s COCA has gone up over time as they have to actively persuade more users, especially on the business side, to use their product, whereas LinkedIn has been able to reduce their COCA by relying almost entirely on automated Internet sales to keep getting new users.
As of the writing of this book, Dropbox was moving to business-to-business (B2B) due to a more attractive LTV, compared to the consumer market�
��s expectation that the product is a freemium offering. Their COCA will also go up dramatically, since the Internet sales technique used for consumer sales will not be enough to gain, as customers, enterprises used to a more high-touch sales and support process. Dropbox will need inside sales, and probably some field sales, significantly increasing COCA. The sales process for selling to a business is much different than the process for selling to a consumer, and very few companies have succeeded in having two parallel sales processes. Microsoft is one exception, with success due to vastly superior resources and a core monopoly on its consumer side. I hope Dropbox succeeds, but it is a daunting challenge!
Amazon.com is on the leading edge of Internet sales—preference engines, algorithms on big data sets, targeted and personalized e-mail offers, etc., and no humans in the sales loop.
Gillette spends heavily on advertising and setting up a dominant distribution strategy through retail stores, to the point where their Core is their distribution channels. They achieved massive economies of scale and used their market power to raise prices and increase functionality, resulting in rapid product obsolescence that kept customers buying and kept the LTV growing. Dollar Shave Club realized that the retail store strategy was not the only way in a world where customers were increasingly comfortable with buying household products online, and through innovations like leveraging social media (see Step 19 in Disciplined Entrepreneurship for how their initial video, “Our Blades are F***ing Great,” disrupted the market), they were able to enter the market at a low COCA and build their brand. No wonder Unilever bought them for $1 billion within five years! In fact, it’s possible that Dollar Shave Club missed an even bigger opportunity by not developing a stronger Core and being more disciplined about their market growth.
STEP 20
Segway… where to begin? They built a product in secret and launched it to great fanfare without considering a wide range of questions. How does the product fit into the customer’s existing routine—or does it? Can a Segway be used on a sidewalk or on a road without regulators clamping down over concerns that sidewalk use is unsafe to other pedestrians, and road use is unsafe to both cars and Segway operators? Is the price too high? Perhaps most important, will anyone want to be seen on a Segway, or will users be viewed as “dorky” by others? Paul Graham wrote on his website, “They had focus groups aplenty, I’m sure, but they didn’t have the people yelling insults out of cars.”
STEP 24
One example is the Web browser Netscape, which was the first widely used browser that showed the world how exciting the Internet could be. They were eventually copied by others, most prominently Microsoft. Another example is VisiCalc, the original spreadsheet program from Software Arts, which revolutionized how people used computers—until the lack of a defensible Core prompted Lotus to develop a competing product that reaped the lion’s share of the market—which Microsoft then subsequently dominated with Excel. That is why some people call it “first mover disadvantage” instead of “first mover advantage,” because it is easy to be first in a market but not be ready to dominate that market long term.
One example is the Apple Macintosh, which after stumbling into its “accidental beachhead” of the desktop publishing market, was able to leverage the high word of mouth in the creative professional community to deliver additional valuable and unique products to this market, cementing the association of Apple computers with high-quality products for creative professionals. The features of the Macintosh, such as pixel-addressable computing instead of the more efficient text-only operating systems, would not have made sense in existing markets, so by developing this Beachhead Market in desktop publishing, they were able to dominate a new market. Even after Microsoft gained a giant share of the desktop computing market in the 1990s, Apple’s follow-on products were consistently viewed as essential to creative professionals. Another example is the Honda Motor Company. When I first saw Honda products, they were making small mopeds and weed whackers with small motors. After success in this small market, they moved up to larger automobiles, and today they are well known as a luxury automobile manufacturer and are moving into airplanes and sophisticated robots.
INDEX
A
A/B testing: primary market research using
set pricing and use of. See also Test Key Assumptions step
Acquisition. See Customer acquisition
Advertising business model
Agreement on the Beachhead Market Selection Worksheet
Airbnb
Alba, Jessica
Amazon: Beachhead Market of
Jeff Bezos’s use of empty chair customer representation at
low COCA maintained by
Windows of Opportunity and Triggers application by
Amie Street
Apple: Beachhead Market of
competitive positioning by
Ardrey, Jillian
Ariely, Dan
Assumptions: Identify Key Assumptions step
Test Key Assumptions step
Automobile companies: identify business model of
paying customers acquisition by
Axis to Measure Value Proposition Worksheet
B
B2B Process to Acquire a Paying Customer
Bain & Company
Beachhead Markets: brainstorming to identify
building End User Profile for the
description of a
estimating TAM (Total Addressable Market) for the
narrowing your potential
primary market research and Market Segmentation Matrix Version 1.0 on
Product Plan development for
Profile the Persona for the
selecting a
Top Target Markets to Consider for My Startup form
World War II example of
Beehive student project: Identify Key Assumptions step on the
Test Key Assumptions step on the
Bezos, Jeff
Bias: confirmation
selection
social acceptability
Blank, Steve
Blogs
Bottom-Up TAM analysis: Bottom-Up TAM Analysis Worksheet
description of
Brainstorming: Idea/Technology
key points related to effective
Market Segmentation
Brainstorming forms: Brainstorming What My Startup Will Do
Idea/Technology Brainstorming Notes
BuildLine platform: description of project for building
Profile the Persona for the Beachhead Market illustration for
three Persona Profiles for multisided end user market for
Business models: designing your
different types of the most commonly used
four questions to ask when assessing your
how it extracts value for your company
Identify Key Assumptions to verify your
identifying for different companies
impact of effect assets on
C
Cell-phone plan business model
Cell phones. See Mobile phones
Chart Your Competitive Position step: Disciplined Entrepreneurship corresponding pages on
General Exercise to Understand Concept
process guide for
understanding importance of
worksheet on. See also Competitive positioning
Checklists: Checklist after TAM Analysis of Beachhead Market
Passion Checklist. See also Worksheets
Chen, Elaine
Christensen, Clayton
Competition: Chart Your Competitive Position consideration of
Design Business Model consideration of
Set Your Pricing Framework consideration of
Competitive positioning: plotting your
target customer priorities and. See also Chart Your Competitive Position step
“Concierging” MVBP strategy
Confirmation bias
Consideration (sales funnel lead)
Constable, Giff
Consumables business model
Continuum Innovation
Core: description of “special sauce” of your
Disciplined Entrepreneurship examples of
Set Your Pricing Framework on your
setting pricing consideration of strength of
unique, important, and grows elements of. See also Define Your Core step
Cost of Customer Acquisition (COCA): description and importance of estimating
estimating the
mitigation plan for adjustments of
overall interpretation of LTV and
sales process as input to estimating the
Show That “The Dogs Will Eat the Dog Food” role of
worksheets on
Cost-plus business model
Costs: Cost of Customer Acquisition (COCA)
gross margin difference between sales and product
marketing expenses
sales expenses and COCA. See also Financials issue
Pricing
Revenue
Culture and Team issue
“Culture Eats Strategy for Breakfast” (Aulet)
Customer acquisition: Estimate Cost of Customer Acquisition (COCA)
Estimate the Lifetime Value (LTV)
Map Sales Process to Acquire a Customer step
Mapping Process to Acquire a Paying Customer
mapping sales process for