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January 13, 2015

Scaling the Chasm

One of my favorite business books of all time is Crossing the Chasm by Geoffrey Moore. It is a classic. My boss and mentor from Open Market, Gary Eichhorn, made the entire management team read it in the 1990s to hammer home its important lessons as we stumbled through the chasm on our way to scaling from zero to nearly $100 million in revenue in a few years.

I have been thinking about the challenges of crossing the chasm - that is, taking a cutting-edge product and selling it successfully to the mainstream, not just early adopters who are more tolerant of less complete solutions - and the challenges of scaling in general as many of my portfolio companies are dealing with these issues.  A few years ago, I wrote a few case studies on how some big players achieved scale - like Akamai, TripAdvisor and athenahealth - to help crystalize my thinking on the topic, but I thought it might be appropriate to write a more general blog post on the challenges that companies face at different points in the scaling process.  

Scaling up is becoming a hot topic lately, from non-profit Endeavor and the World Economic Forum focusing attention on the importance of scaling up companies in the Global Scale Up Declaration to The Economist pointing out that Israel's miraculous start up economy is seeking to transition from "Start Up" to "Scale Up".  I coined 2014 as the Year of Results, where the lofty promises would finally translate into real, tangible outcomes (and it was for us).  2015 may be the year of the Scale Up.

Dealing with scale up challenges is particularly important to me because of our firm's investment strategy.  We pride ourselves on being lifecycle investors, which means we invest very early on (typically at the seed or Series A stage) and then stick with a company through exit.  Some VCs prefer investing at the earliest stages and then cycle off the board of directors.  Others prefer to come in at the later stages, post product-market fit, and not have to deal with the risk and roller coaster of the early stages.  Gluttons for punishment, we prefer to start early, take the risk and stick around through the end.  As a result, I get to work with companies both during the search for product market fit and after they hit product market fit, and race headlong into the chasm.

For quick context, I sit on the board of eleven Flybridge portfolio companies and am an observer on two.  Each of us typically makes one or two new investments per year (I made one new investment in 2014).  With that rhythm, if things are going according to plan, I should have a spread of companies across a wide range of scaling stages, as measured by annual revenue.

If I plot my portfolio companies across a few broad revenue buckets, looking at 2014 figures, below is a chart.  They spread fairly evenly, although slightly more in the earlier stages as few companies achieve the kind of success that $> 50m in revenue entails.

PortCo Revenue

At each stage, there are different problems.  Here are the patterns of issues I typically see at each stage - maybe you will recognize a few of them in your own companies:

$0-1 million

  • People:  founder-run and trying to recruit amazing technical talent (the product development team is a huge priority at this stage) and integrate a few senior managers to help prepare the company for scale - which leads to cultural clashes and communication challenges. Also, the founders' roles' start to evolve (see:  "The Other Founder") as functional areas and responsibilities become more precisely defined.
  • Product:  the product is buggy and incomplete - really more of a feature than a complete product - but it is past MVP.  Customers are using it and deriving value and now the challenge is how to complete it - fast, before running out of money. 
  • Business Model:  running a lot of experiments - pricing, packaging, value proposition. Always testing and trying to run fast tests to put up some strong metrics before running out of money (did I mention we're running out of money?).
  • Financing:  holy crap - we are running out of money in 6 months! Have we acheived enough value-creating milestones to raise an up round? who will lead it (insiders vs. outsiders) and on what terms?

$1-10 million

  • People:  things are going well - everyone gets excited when the cash register rings after a few big sales. The first version of the go to market team is hired (i.e., first sales person, first marketing professional).  The founders are getting restless because they have been diluted, have less responsibility and realize that the company isn't going to reach $1 billion in 3 years. Also, that first VP you hired was great from 0-1 and good from 1-10, but you're afraid she can't scale to the next level.
  • Product:  the product is better - A LOT better - but now we have technical debt thanks to our success. Anyone up for a rewrite? How much do we invest in a rearchitecture versus adding new features.
  • Business Model:  Time to get some channel and business partners on board, because adding revenue by adding sales and marketing dollars is going to be expensive - no matter what the early LTV vs. CAC data shows.  The focus now is building a repeatable, scalable sales machine
  • Financing:  The "hopes and dreams" financing stage is over. Nothing ruins a good story like numbers and now we have numbers so we better have them look good enough to support a strong expansion round. And why does it look so easy to raise $20m on $100m pre for companies at an earlier stage than I am every time I read TechCrunch, as my board reminds me every month (and can I stop having monthly board meetings already)? Do we take a little venture debt to get us to give us some cushion as we progress to the next valuation inflection point.

$10-50 million

  • People:  The functional management team is running out of steam - do we need to roll up a few things and perhaps hire a COO? The board has too many investors on it (how did that happen?!) - can we add an outside director of two?  Most critically, is the CEO scaling or is time to replace them as well (ideally not).
  • Product:  Now that we have a robust product and paid down our technical debt, we seem to have lost our ability to run experiments - how do we maintain that mission-critical quality for all these customers while remaining as nimble as we were when we were a startup? Also, customers are pushing us to provide a solution, not just a product, and so suddenly we need services and partners to round out our offering.
  • Business Model:  Now that we are at a reasonable scale, why are our gross margins so low and what can we do to fix it?  Is it time to be profitable or should we continue to prioritize growth and invest ahead of revenue?  Should we pursue adjacent M&A or tuck in acquisitions to expand our market footprint?
  • Financing:  Is our market big enough to support another round (which puts the exit bar even higher)? Is it time to consider an exit? Would an IPO be possible in the future if we can continue growing 50-100% per year?

$50-100 million

  • People:  Should we have a business unit structure or retain the functional structure?  Do we have an IPO management team in place? Is the CEO still a single point of failure or can she delegate effectively in the event of a road show? Board committees start to really matter.
  • Product:  With a robust product and complimentary solution in place, let's open this sucker up - let's build as many APIs as we can and evolve this thing into a platform. Time to enlist some 3rd party developers!
  • Business Model:  If we're not profitable at this point, we better be growing > 50%/year. How profitable should we be? Are we seeing erosion in our LTV vs. CAC math or is it continuing to scale nicely? Where should our first international office be and how much should we invest?
  • Financing:  Do we have the metrics to support a growth or mezzanine round?  Let's expand our debt capacity and put in place a working capital line and receivables facility.

>$100 million

  • People:  The A team is in place at the top and now we have to focus on solidifying the next level and providing them with great training, career paths, growth and additional stock options (in the form of refresh grants) as they are all getting approached by pesky recruiters.
  • Product:  We are in the midst of a feature war with competitors - how much do we invest in new product innovation versus continue to harden and prepare for scale. How can the product be changed to lower the cost of delivery for us and cost of ownership for our customers?
  • Business Model:  Services revenue and services partners become more important. Investing more heavily in international.
  • Financing:  Why haven't you filed the S-1 already?!

One of the things I've learned from my two decades in startup land is that it doesn't get any easier as you scale - the problems just evolve, but there are still problems.  And opportunities.  But I guess that is what makes the startup game so fun.

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