Imagine if a CEO could turn an idea into a large company without hiring anyone else. That lonely but economically tantalizing idea remains utterly out of reach, yet some startups have gotten close. For example, Instagram had 13 employees when Facebook acquired it for $1 billion in April 2012, a few weeks before its initial public offering. Instagram built an app that attracted 30 million users and a private market valuation of $500 million. Instagram’s ability to create $77 million worth of value for each employee at the time of its acquisition—4.7 times more than Facebook’s $16.6 million for each of its 30,275 employees— highlights a question of great interest to startup investors and the people in whom they invest: What is the purpose of hiring people and how can a founder manage those people in a way that maximizes the value of the firm? In the case of Instagram, its 13-person staff zoomed from the first to the third stage of scaling by building an app that sold itself to 30 million people without extensive sales or marketing. Most companies, especially ones that sell to businesses, can’t skip directly from Stage 1 to Stage 3.
Why do most startups hire and how do they define jobs as they scale? Founders hire people because turning their idea into a large company means that work must be done and founders can’t do all the work themselves. So, founders define jobs—their own and the ones that they want to fill. As we’ll see in this chapter, the nature of those jobs changes as a startup advances through the four stages of scaling. In the first stage, a founder defines jobs more broadly, giving each employee the freedom within certain limits to do whatever they believe is needed to meet the goals set by the founder. For example, before a startup makes its first sale, a founder with outstanding product development skills may hire a sales cofounder who is charged with winning the first customers. To do that, the sales cofounder may do everything, such as helping the first customers get financing to buy the product, installing the product, and getting feedback on what is working well and what needs to be changed. However, as a startup enters scaling Stages 2 and 3, the CEO will split that sales cofounder’s job into smaller pieces: the jobs of speaking with the media, creating advertisements, ranking sales leads, and working with partners will be assigned to a Chief Marketing Officer, who will in turn hire Vice Presidents to lead each of these more specific functions. The CEO will divide up the sales parts of the sales cofounder’s job into parts (North American Sales, European Sales, Customer Success), each being done by Vice Presidents who report to a Chief Sales Officer.
Execution layer : interaction of four scaling levers
Holding people accountable : To build a scalable business model, CEOs must hold people accountable for keeping the cost of acquiring a customer well below the amount of revenue that customer generates during its relationship with the company (I will cover this topic in Chapter 7). Doing so means that companies must lower their sales, marketing, and other expenses as a percent of revenue as the company grows. It also means that the company must add new customers, make them enthusiastic about the company’s products and service so they will keep buying, and encourage them to buy more.
Redefining jobs : To meet these goals, the CEO must redefine jobs, specifically creating executive positions that will be responsible for key functions such as R&D, product management, sales, marketing, and service (addressed in this chapter). Reporting to each of these executives will be Vice Presidents or managers who run key parts of those functions. For example, the Chief Marketing Officer might oversee Vice Presidents for Public Relations, Sales Training, Event Management, and Distribution Partner Management. Defining more specialized roles facilitates greater efficiency.
Hiring, promoting, and letting people go : To fill these roles, CEOs must decide whether they should hire people who have already scaled these functions successfully or promote current employees into those roles (this topic is discussed in Chapter 6). Moreover, the CEO must decide whether to let go people who have been in those roles before to make way for more qualified individuals.
Coordinating processes : Finally, building a scalable business model depends on coordinating processes that enable specialized functions to work together as needed to achieve the goals the CEO sets (covered in Chapter 8). For example, to get new customers, marketing must work with sales to generate sales leads that help sales people to close deals. And to create loyal customers, sales and product management must listen to evolving customer needs to create new products and customer service must assure that customers perceive that they are benefiting significantly from using the ones that they’ve already purchased.
Identify the most basic jobs to be done. When a company is started, its CEO must consider whether to hire cofounders. Cofounders create an executive team to do the jobs that the founder believes must be done to win its first customers. While the most basic jobs vary by startup, in general the other members of the founding team should excel at important tasks which the CEO does not do well. For example, a CEO who is great at selling and managing people should bring in a technical cofounder who manages engineers and listens to customers as the company cycles through building prototypes and improving them based on customer feedback. Conversely, a technical CEO should bring in cofounders with great sales and possibly management skills (if the CEO lacks them).
Fill those basic jobs with the best people available. Having defined the key jobs needed to win the first customers, the CEO must find people to fill those roles. Ideally, a CEO should hire people who’ve excelled in those roles and worked well with the CEO in the past. First-time CEOs may have trouble hiring excellent people to do these jobs—and may have to bring in the best people willing to take them. At the first scaling stage, individuals may do many different jobs because the company lacks the resources to hire new people to do each of them. As the company scales, CEOs will need to weigh the tradeoffs between appointing proven performers who fit with the startup’s culture and hiring an outsider who has previously done the job well at the startup’s next scaling stage.
Assess how well the structure is working . As a company starts trying to win its first customers, the CEO must assess some basic questions: Is the product prototype getting built quickly and well? Is the company developing relationships with customers who can help develop the product? If not, how should the company reorganize its work to complete the first stage? Often the CEO must wait until after raising capital before hiring better people to do the company’s jobs, which should be easier to do once the company begins the second stage of scaling.
Redefine jobs that are not working well. In the second stage of scaling, the CEO must rethink roles so the company does everything more efficiently and effectively. Jobs that were previously done in an ad hoc manner must be split into smaller pieces and filled by people with specialized expertise. For example, a Chief Sales Officer would oversee teams of sales people responsible for meeting revenue growth targets in specific geographic regions. A Chief Marketing Officer would be measured by growth in the number of high quality sales leads generated, improvements in the startup’s net promoter score (NPS), and the strength of its brand. The CMO might supervise public relations, advertising, and partner relationships. The aim of the job redefinition is to make the startup’s business model more scalable so it is ready for the third stage of scaling.
Boost functional specialization and limit span of control . As a company sprints to liquidity, the CEO must monitor whether the organization is adding new customers, selling more to current customers, and boosting operating cash flow. If the organization is becoming less effective and/or efficient, the CEO must consider whether redefining specific jobs might solve the problem. For example, if a manager’s span of control is growing beyond six or seven direct reports, the CEO should shift some of that manager’s responsibilities to a new manager. Consider the case of a manager in charge of European sales whose country sales reps are responsible for meeting revenue targets in Spain, France, Italy, Germany, England, Norway, and Portugal. Were that European sales manager to fall short of his sales goals, the CEO might assign Germany, England, and Norway to a Northern Europe Sales Manager and create a Southern Europe Sales Manager position charged with meeting sales goals in Spain, Italy, and Portugal.
Subtract functions that no longer add value. Finally, the CEO should eliminate functions that were important in the past but now slow down decision-making without adding enough value to justify their existence.
Steps to redefine jobs
Takeaways for Stakeholders
- Winning the first customers
Envision the most essential capabilities the startup will need to win its first customers.
Identify the CEO’s greatest strengths and weaknesses.
List the most important skills for the startup’s success that the CEO can’t provide.
Hire skilled cofounders who can provide the missing skills.
Set goals and collaborate to achieve them.
If startup does not achieve goals, consider redefining jobs to strengthen the team.
- Building scalable business model
Identify key business functions, such as engineering, sales, marketing, and customer service, that must become more efficient.
Define specific job categories within each of the key functions.
Agree on corporate and functional goals for growth in the number of customers, revenue per customer, operating efficiency, NPS, and brand recognition.
Assess progress in meeting all goals as frequently as every week.
If goals are not being achieved, consider redefining jobs to boost performance.
- Sprinting to liquidity
Create general manager jobs responsible for adding revenue in new geographic markets, new product lines, and new channels of distribution.
Split general management jobs into smaller parts to boost entrepreneurial opportunities and limit span of control.
Assess performance relative to quarterly goals and adjust job functions to boost performance.
Tap into the experience of newly-hired vice presidents and C-level executives to improve the startup’s organization structure.
- Running the marathon
Add job functions responsible for growth through acquiring new companies, forming partnerships, and strengthening relationships with sales channels and original equipment manufacturers (OEMs).
Identify and eliminate job functions that cost more than the value they generate.
Assess performance relative to quarterly goals and adjust job functions to boost performance.
Redefining Job Functions Success and Failure Case Studies
In this section, I offer case studies of redefining job functions used by successful and less successful startups at each scaling stage, analyze the cases, and extract principles for helping founders to redefine job functions at each stage.
Stage I: Winning the First Customers
To win the first customers, a startup requires two basic functions: product development and sales. Like stem cells that become specialized, differentiating to become heart muscle cells, blood cells, or nerve cells, a startup’s organization becomes increasingly focused as it grows. Before a company has revenue or capital, a small number of cofounders must do many jobs that later become specialized as the need for more focused functions becomes more critical and the startup’s success attracts the capital needed to hire people to perform those functions. For instance, before a startup gets its initial customers, the cofounder in charge of sales will perform many jobs, such as identifying sales leads, closing sales, getting customer feedback on product prototypes, forming distribution partnerships, hiring, and raising capital, most of which are later assigned to individual executives and managers. And the product development cofounder will architect and build product prototypes as well as hire and direct engineers.
A CEO who is strong in sales should recruit a cofounder who excels at product development and vice versa. The CEO’s role in defining jobs is not as simple if the startup can raise capital before it gets off the ground. In that case, the CEO will have the capital needed to define new roles such as engineering, customer service, and marketing and hire people to fill them. Moreover, CEOs must decide how to evaluate tradeoffs when they allocate capital between hiring new people and marketing and promotion. First-time CEOs will likely need to learn how to define the right jobs at the right time and ought to seek advice from others, possibly board members or mentors who have done so successfully.
Success Case Study: Ethos Wins Customers and Boosts Staff to 20 Three Months After Launch
Introduction
San Francisco-based Ethos , a life insurance startup founded by a pair of former Stanford Business School (SBS) roommates, got off to a rapid start in turning an idea born of one of its cofounder’s unfortunate decisions into a company that raised a big round of seed capital and grew to 20 people within three months of its launch. Given SBS’s stringent admissions standards, the cofounders were skilled at doing what was required to raise capital and win Ethos’ first customers rapidly. Their initial success was due to a combination of factors: their abilities as leaders, their focus on a large market, their service that provided consumers with a far better experience, and how the company defined its jobs as it grew.
Lingke Wang’s unfortunate decision was to buy so-called permanent life insurance , which only paid a death benefit if a policyholder never missed a premium payment, as a 20-year-old college student. Such permanent policies generated huge agent commissions. But 85% of those policies lapsed or were surrendered because the insured stopped paying. In June 2018, Wang and his SBS roommate, CEO and co-founder Peter Colis, launched Ethos to solve Wang’s problem with the mission of “helping individuals and families feel safe and protected, not bought and sold by commissioned sales agents,” according to my August 2018 interview with Colis. Ethos took 10 minutes to provide consumers with life insurance policies, compared to 15 weeks for insurers like MetLife and New York Life, which sold through agents who were motivated to sell the most expensive policies to maximize their commissions, according to Colis. Ethos used predictive analytics to provide a life insurance policy without a medical exam or a lengthy approval process, it did not employ commissioned sales agents, and at the time was available in 49 states through partnerships with insurance companies Munich Re and Nebraska’s Assurity Life. Ethos raised an $11.5 million Series A investment from Sequoia through partner Roelof Botha, who was previously CFO of PayPal, two famous actors, and a basketball star (Robert Downey Jr., Will Smith, and Kevin Durant).
Case Scenario
Wang, who earned a degree from Brown in applied mathematics, did not define his role as strictly a coder. Indeed, he used a design thinking approach to product development and spent time hiring staff. In 2015, Wang and Colis first started a platform for cashing in life insurance policies. Ovid Life operated a platform to enable holders of permanent life insurance policies to sell them to institutional investors. At Ovid, Wang considered himself responsible for software development, growth, and hiring. He prioritized tasks based on how much they directly affected revenue, cash flow, product, or employees. To develop products, he used design thinking, encouraging Ovid’s team to generate many ideas that might seem “outlandish or impractical” while withholding “all judgement and cynicism.” When developing its product, Ovid spent a considerable amount of time focusing on customers, “figuring out their problems and building stuff to solve them.” Wang believed that without “a crystal-clear idea of what problem” it was solving, Ovid would fail. He also used Heap Analytics, which tracked behavioral metrics and pinpointed which parts of the product were not working, to measure the effectiveness of its product.
Colis, a philosophy graduate of the University of Colorado, Boulder whose grandfather was a successful life insurance salesman, liaised with investors, partners, and the media. He gave a 60-minute presentation to a large team from Downey Ventures and talent agency Creative Artist Agency. As Colis said, “We didn’t have enough chairs in the office for everyone. So I gave the 60-minute investment pitch while sitting on a hot radiator, while trying to act cool. One of our first uses of their investment capital was purchasing more chairs.” Sequoia’s Roelof Botha, who led the Series A funding round and joined the board, was confident that Ethos had room to grow. “This is a team that’s gotten a lot done with very little. That shows a creativity and resourcefulness that is attractive as an investor.” Colis was also optimistic about Ethos’s future. “We are going after a $20 trillion market, the legacy players are broken, the market is ripe for disruption, it’s an execution-heavy business, and our team really cares about solving the problem. We’re processing thousands of customers and growing rapidly with a team of 20 in engineering, design, and customer success. Our customers are coming from advertising on Facebook, partnerships, and word of mouth from customers. Ethos will be the next great life insurance company because our product is so good that it is bought, not sold,” concluded Colis.
Case Analysis
Ethos won its first customers quickly and raised a large Series A round early in its development. This funding enabled Ethos to hire people who could perform the activities that its CEO thought were most essential at this stage for assuring that its customers were happy with their experience: engineering, design, and customer success. Ethos hoped to create highly satisfied customers who would recommend the company to others in their networks, helping the company grow quickly without spending too much money.
Less Successful Case Study: After 12 Years and $484 Million, Fuze Lacks A Scalable Business Model
Introduction
Can a company that claims over $100 million in revenue and $484 million in capital be less than successful? Possibly, if it took 12 years to get there, it still lacked a scalable business model, and its most recent capital raising slashed 48% from its valuation. This is what happened to Fuze, a Boston-based office communications platform founded in 2006, which by August 2018 employed 700 people (about the same as at the end of 2015) and had raised a total of $484.4 million. Sadly for Fuze’s previous investors, the company’s valuation was slashed 48% from $765 million in February 2017 when Fuze raised $134 million to $400 million in May 2018 when investors provided it $150 million. In 2006, Fuze, cofounded by former CEO Steve Kokinos, was called Thinking Phones. The company initially focused on voice communications. ThinkingPhones later expanded to operate on mobile devices and to integrate with outside applications like Salesforce and LinkedIn. Between 2014 and 2017, ThinkingPhones acquired three companies: Whaleback Managed Services, a cloud-based communication service for medium-sized businesses; Contactive, a caller ID and data analytics company; and Fuze, which provided cloud-based video conferencing, voice calling, and document sharing services. In 2016, ThinkingPhones changed its name to Fuze and opened offices in Australia, Germany, Switzerland, and Spain and three new data centers in Hong Kong, Singapore, and Australia. These offices were added to Fuze’s operations in the U.K., the Netherlands, Denmark, Portugal, and France.
But Kokinos was moved out as CEO eight days after Fuze raised its $134 million. Why? As Colin Doherty (who took over as CEO from Kokinos in February 2017) said “We’d like to get more predictable revenue and execute as a public company. That’s a little bit about process, execution, market growth, being a little more predictable in terms of balance sheets and financial metrics.” Of his being deposed from the CEO role, Kokinos said that Fuze brought on Doherty because of the “operational horsepower” necessary to reach the company’s next stage of growth. In August 2018, Doherty told me, “Steve is a serial entrepreneur and I am a serial operator. Steve had the idea that people who were using iPhones in their personal lives wanted to do the same thing at work. He wanted to replace plastic phones with cords. And the product evolved from cloud-based telephony to include video, messaging, and collaboration. I was brought in to establish systems, processes, marketing, sales force, and growth.”
Case Scenario
Fuze was competing in what it deemed to be the $100 billion market for office communications. However, that market attracted significant competitors, including business messaging service Slack and videoconferencing service Zoom, which were doing far better than Fuze. After all, in August 2018, Slack announced a $427 million round valuing the company at more than $7.1 billion. With three million paying users, Slack had been able to generate “hundreds of millions of dollars in annual revenue.” And Zoom, which Doherty did not view as a competitor since it did not supply telephony and messaging, was valued at $1 billion in January 2017, when it raised $100 million. But Doherty was unflappably optimistic about Fuze’s prospects, he said, “There has always been speculation on private company valuations and we have never commented on any of them. Our revenue is over $100 million, and we are growing at 40% a year. There is a huge market opportunity and we win most times we compete with Microsoft’s Skype, Cisco’s WebEx, and Avaya.”
By August 2018, Fuze believed it was entering the second stage of scaling. As Doherty said, “We have 1,700 customers and we are modifying our go-to-market from a direct sales model to a blend of direct sales and partnering with the channel, which we think will welcome the opportunity to replace high cost hardware with a variable cost service. We are going after a more than $100 billion opportunity: 400 million knowledge workers who could potentially pay $35/seat/month. We are competing with products that cost companies $75 per seat per month and we combine six to 12 enterprise applications into one.” Trying to bring in revenue from the channel had the potential to help Fuze grow without spending as much on its sales force. Moreover, by adding a focus on the channel, Fuze hoped to improve its execution. Indeed in Gartner’s “2017 Magic Quadrant Unified Communications as a Service Report,” Fuze was among the leaders on Completeness of Vision but fell below the center line on Ability to Execute, according to industry analyst Michael Finneran who said, “To fuel their international aspirations, it looks like they’re stepping up to the plate with regard to bolstering their channel program, so the key now will be execution.” Chief Sales Officer Chris Doggett said in February 2018 that Fuze’s expanded program would enable value-added resellers, solution providers, and IT/communications solution consultants to offer Fuze’s products.
Doherty hired people who had considerable experience and who fit with Fuze’s culture . “I look for people with the ability to recognize patterns. When they see a familiar problem that can suggest the right solution. I emphasize EQ over IQ; it’s how you use your intelligence and how you collaborate. I want people with a fantastic attitude, high energy, the ability to collaborate to solve problems, and a will to win.” Fuze was organized by function. As Doherty explained, “I hired Doggett, who is doing an excellent job. He oversees sales, sales engineering, customer success, customer deployment, and account cultivation. Our Chief Marketing Officer directs media and public relations, lead generation, partnering, and market outreach. We also have heads of engineering and R&D, product management, and G&A functions like IT, finance, HR, and legal.” Fuze’s investors had placed a huge wager on Doherty’s ability to get them a return. He said, “We have done a lot of work and are looking at the possibility of an IPO in 18 months.”
Case Analysis
Fuze took a very long time to win its first customers and its founder, who did succeed in raising an unusually large amount of capital in the 11 years he led the company, was unable to create a scalable business model. Interestingly, Kokinos raised another $150 million in capital a bit over a week before he was replaced by Doherty. It appears to me that Kokinos was given a face-saving exit; he was seen as having raised $134 million and choosing his successor. However, it would not surprise me if investors gave as a condition of providing the capital that Kokinos would need to step aside for Doherty. To be fair, Doherty seemed to have put in place a functional organization and culture that appeared logical. Yet roughly 15 months later, Fuze raised another $150 million but at a 48% lower valuation. If Fuze had more than $100 million in revenue and was growing at 40% a year, as Doherty said, it should have been able to go public, even if it was unprofitable. Doherty’s August 2018 statement that Fuze had not built a scalable business model signaled that its operations needed to become more efficient. But it did not disclose the sources of the problem; perhaps its direct sales model was too expensive .
Principles
- Do
Hire the best cofounders possible to perform most critical jobs needed to win first customers, such as product development and sales.
Make listening to customers and building prototypes key parts of the cofounders’ jobs.
- Don’t
Add new job functions without considering cash flow or profitability.
Assume that investors will keep funding organizational expansion without a path to profitability.
Stage 2: Building a Scalable Business Model
Most startups do not follow Instagram’s easy path of going from finding its first customers with 13 employees to being acquired. Instead, once they succeed in the first stage of scaling, they try to replicate that success while adding far more customers. While startups can achieve rapid revenue growth by targeting new growth vectors, as we explored in Chapter 2, many startups choose to do so without regard to profitability, deferring Stage 2 and skipping directly to Stage 3. The reason is that these startups believe that investors want startups to reach at least $100 million in revenues, regardless of profitability, while growing over 40% a year so they can go public sooner. But that is a risky strategy for a CEO who wants to build a large company that will change the world. That’s because investors can change their attitudes abruptly. It happened in 2015 when a handful of venture-backed IPOs did not do well as public companies and spooked investors, who told portfolio companies they would not invest until they became profitable. That change of heart caused big trouble for money-losing companies that were rapidly burning through their dwindling pile of cash. Simply put, while few companies build scalable business models before they take on huge capital investments to grow quickly, all of them should. And a key scaling lever for accomplishing that is how the CEO redefines jobs.
Success Case Study: Growing at 300% a Year, Hired Raises $132 Million with a Quick Path to Profitability
Introduction
How does the startup get people to try its product if they know the startup has a good chance of running out of money?
If the startup gets initial customers, will it be able to raise enough capital to keep going?
If it gets big enough to go public, will its CEO be able to keep beating investor expectations each quarter so its stock rises?
This comes to mind in considering the battle for a piece of the market for talent recruiting. For example, LinkedIn was a huge player—in 2018, LinkedIn was doing well: Microsoft (which bought the company in 2016 for $26.2 billion) reported that LinkedIn revenue grew 37% to almost $1.1 billion. San Francisco-based Hired, founded in 2012, was a LinkedIn challenger that raised $132.7 million and was growing at 300%, most likely from a much smaller base. Hired flipped the traditional model of online recruiting on its side. Instead of wasting candidates’ time sending out applications and never hearing back, Hired put technology talent in the driver’s seat. As CEO (since 2013) Mehul Patel explained in a July 2018 interview, “We allow companies to apply to tech talent. Through Hired, job candidates and companies have transparency into salary offers, competing opportunities, and job details. On June 20, we announced a subscription service that enables companies to meet more predictably their employment requirements with higher quality people.” Hired reduced the pain of talent recruiting for candidates and employers. As Patel, previously a marketing and business development executive with a law degree from University of Virginia, said, “We remove the painful job application process for candidates who can spend more time interviewing instead of sending out resumes and employers [can cut the time they spend screening candidates who don’t fit], reducing time to hire by 33%.”
Case Scenario
By August 2018, Hired was adding employees and customers at a rapid clip, but close to profitability . “In 2017, we saw 300% growth in bookings. We have grown from five employees in 2013 to over 200 employees across the globe, with 140 of those employees sitting in our San Francisco headquarters. We have over 10,000 companies using our platform to hire including Dropbox, Zuora, WeWork, Nordstrom, and Booking.com,” said Patel. Hired believed it was targeting a large market opportunity. “The total addressable market for hiring knowledge workers is $400 billion and our segment of that—paying agencies to hire engineers, project managers, and data scientists—is $80 billion to $100 billion,” he explained. And Hired was working on building a scalable business model, expecting to reach profitability by the end of 2018 and then sprinting to liquidity.
Hired’s culture was set up to keep it from falling into the many pitfalls that can cause startups to fail. “I was in venture capital for a while where’s it’s all about pattern recognition. Most startups fail. Why? The market is not big enough, there is no product/market fit, they can’t raise money, they can’t scale their people and culture. I believe it’s crucial to get culture right,” Patel said. Culture is the operating systems that keeps Hired’s level of bureaucracy low. “I talk about values every week and interview people for values. Since the company is now too big for me to look at everyone, I am relying on everyone having the same understanding to make decisions consistently that benefit the customer. We revisit this every six months because I want constructive conflict, for example, if we go to a new category, but after the debate everyone commits to the joint decision,” he said.
Hired’s organization became more specialized as it grew. According to Patel, “Early on we hired generalists before we had product/market fit. As we grew up, we added functions and looked for specialists and the generalists left. When our [contracts] got to six or seven figures, we added an enterprise sales team. Our departments include engineering; marketing (to candidates and companies along with brand and PR), and sales (to get new clients, to help grow the client relationship, and to solve problems for existing clients).”
Case Analysis
Hired’s rapid growth and ability to raise capital resulted from its creative business strategy. By focusing on scarce high-tech workers and the companies that seek to employ them, Hired diminished the pain of its platform participants; high tech workers were able to reduce the time they wasted pursuing opportunities that did not fit, and employers were able to plan for and fill positions more efficiently. In short, Hired followed one of the most basic principles for startup success: find customer pain left unrelieved by rivals and provide a product that sharply reduces that pain. Hired defined and filled the jobs needed to bring in new customers, keep them buying over time, and expanding revenues for each customer. In addition, Hired had a clear path to profitability, suggesting that Patel was redefining jobs to make its business model more scalable.
Less Successful Case Study: Growing at 300% with $56 Million in Capital, Pendo Trades Off Profitability for Growth
Introduction
A startup that competes with large companies in a newly developing market faces significant challenges. For example, if those large rivals are established, respected companies for which the startup’s sole focus is a small product line, potential customers may wonder why they should risk buying from a startup that might not be around in six months. Moreover, even if that startup is growing rapidly because it offers a superior product, investors may hesitate to provide capital because that newly developing market does not feature any publicly-traded companies that focus solely on the startup’s product line. In short, investors in such a company must believe that the emerging product category will become a large market and that the startup in question will be a successful pioneering IPO. This comes to mind in considering the emerging market for product engagement software which helps companies learn whether customers are using a product after the purchase and, if so, which parts of the product get the most use and which do not. Such software is valuable because if the product is not used, customers won’t buy more, and if a company knows this early, it can improve the product. Product engagement software is a new $20 billion in revenue category, according to one the startups. Raleigh, NC-based Pendo , populated by startups and products from large companies like Google Analytics and Adobe Analytics.
Pendo , which was founded in 2013, was growing fast. It enjoyed a 170% increase in bookings in the second quarter ending July 2018 (adding 90 new customers). The new customers included “Instacart, Digital River, Inc., RingCentral, ADP, Lithium Technologies, Mimecast, First American Financial, and MetLife.” As cofounder and CEO Todd Olson said in an August 2018 interview, “Pendo has raised $56 million in venture capital from Bay Area investors like Battery Ventures. As of July 1, 2018, we’ve landed more than 600 customers and employ 200 people across offices in Raleigh, San Francisco, New York, and Yakum, Israel. Annual recurring revenue has grown between 300% and 400% each year since our inception in late 2013.” Olson’s background prepared him for Pendo. He was previously CEO of 6th Sense Analytics, which he ran for four years before selling it to Rally Software in 2009. Rally went public in 2013; in 2015, CA Technologies acquired the company for $480 million. His Rally experience inspired Pendo. As he said, “I came up with the idea for Pendo when I was leading the product team at Rally. Each week I’d receive dozens of requests for new features, but I had no product usage data to help me decide which were worth the investment of time and capital. When I started Pendo, I wanted to solve this problem for product managers.”
Case Scenario
Since it provided a channel through which companies could receive and respond to feedback from their customers, Pendo’s product helped its customers grow faster and more profitably. And in so doing Pendo’s customers could boost the likelihood that customers would recommend their product to others through a higher net promoter score (NPS) . Indeed, some early customers, like Cisco Cloud, saw a 20% increase in their NPS after installing Pendo’s platform. With data, Pendo was able to help companies determine the best ways to engage with users to get feedback.
Pendo was not profitable but it believed it could become less unprofitable if it spent less on sales and marketing, but that would apply the brakes to its growth rate. As Olson said, “We are not cash flow breakeven. But I can invest $1 in sales and marketing to get $3 to $5 in revenue. I can control my cash burn, but I grow faster by spending. We can keep growing between 100% and 200% without killing the company.” Pendo started off without a formal culture but in 2014 Olson started writing down the company’s values. As he said, “We have a maniacal focus on the customer, which fuels many aspects of our business and we are transparent, sharing almost everything. We believe that if we eliminate the information asymmetry between executives and individual contributors, they will make better decisions. We use culture to decide whether to hire and promote people.” As it grew from a few people to 200, Pendo formalized its organization in response to problems. “We started out with people who were jacks of all trades. Later we carved things out based on pain. Sales was a problem and we hired a head of sales. Our head of customer success lacked enough experience; we needed a new marketing head. We bring in people ahead of the need. We don’t want to wait until it breaks. I have 5 or 6 direct reports; 10 to 15 is too many.”
Case Analysis
Pendo was growing rapidly, had raised considerable capital, and its product could improve its customers’ NPS. Moreover, Olson had a clear idea of how changing Pendo’s organization would affect key goals such as bringing in new customers, boosting the odds that customers would renew, and selling more to each customer. He also redefined jobs to make them more effective and hired people to fill those new jobs who would be able to keep up with evolving demands. Yet a nagging problem with Pendo was its inability to build a scalable business model, which would become a significant problem were Pendo to lose access to new capital. This left open questions about its business model and how its organization might change to accommodate growth. Could Pendo grow without adding so many expensive sales people? If not, could Pendo pay for these sales people by raising its price? Was there another way for Pendo to grow and become profitable?
Principles
- Do
Redefine jobs to make the business profitable based on specific customer metrics such as renewal rates, revenue per customer, and cost of acquiring customers.
Add new jobs that boost the company’s performance on these metrics.
- Don’t
Assume that it is better to trade off profitability for growth.
Keep adding new job functions—for example, to manage operations in new geographies—without regard to their effect on profitability.
Assume that investors will keep financing losses if revenue keeps growing.
Stage 3: Sprinting to Liquidity
As mentioned earlier, it’s risky for startups to sprint to liquidity without a scalable business model. After all, if investors decide to stop funding the losses of such a company, it will almost certainly lose its independence unless it can quickly become profitable or survive a few years until investors change their minds and decide that being unprofitable is fine if the company is growing fast enough. However, it’s much better for a startup’s long-term prospects if its business model is scalable before it takes on significant capital to sprint to liquidity. A startup will be far better off if its CEO designs the organization to add new customers efficiently and keep them happy so they renew and buy more. Such as scalable business model puts a startup in a better negotiating position with investors, whether it is raising capital in Stage 3 or seeking to boost its share price in Stage 4.
Success Case Study: Growing at 60% a Year, Redis Sprints Towards a 2021 IPO
Introduction
A startup boosts its odds of success if it targets a very large market, for example, larger than $10 billion or $20 billion. That’s because investors expect a company to have at least $100 million in revenue before it goes public and consider it unlikely that a startup will be able to get more than 10% market share. Sadly for founders, such large markets are often dominated by a handful of large competitors who have locked customers into long-term contracts. For a startup to grow quickly, it must offer a product that solves a customer’s problem far more effectively and at a much lower price; otherwise, the cost of switching from the incumbent is so high that it’s not worth the trouble. Hurdling that challenge will not gain the startup enough market share unless it can grow its organization in ways that boost its customer count. And to build a scalable business model, that growth must come at low enough cost to make the company profitable as it sprints towards liquidity.
This comes to mind in considering Mountain View, California-based Redis Labs , which said in August 2018 that it was on its way to disrupting Oracle in the $60 billion market for databases. Redis had 8,300 customers of its Redis Cloud service, which it introduced in 2013, and 250 customers for the same functionality as downloadable software, which it launched in 2015. As CEO Ofer Bengal told me in August 2018, “Our customers include six of the Fortune 10, 40% of the Fortune 100, three of the top five communications companies, three of the top four credit card companies, and three of the top five health care companies.”
Redis , which was founded in 2011, raised $86 million in capital, employed 225 people, and had a technology edge. It was based on an open source database developed by Sicily native Salvatore Sanfilippo (Antirez), who went to work for Redis. Redis believed that its so-called NoSQL technology was much faster and cheaper to own and operate than Oracle’s SQL database. “Companies were demanding much faster response time to operate their wireless apps on much larger databases. Traditional database response times were too slow. Specifically, customers wanted response times of under one millisecond to process 10 million transactions per second. We are the fastest database in the world: 100 times faster than Oracle and much cheaper to own and operate,” Bengal said.
Case Scenario
Redis believed that part of its success was the choice of which segment of the database market to target. As Bengal said, “10% of the market is for new applications and that segment is growing much faster than the overall market. Our revenues are in the tens of millions, we are growing at 60% a year and can maintain that rate for the next several years.” Customers explained why they liked Redis’s product. Gartner verified 68 favorable customer reviews of Redis, a total of 4.7 out of five stars. One manufacturing customer said, “Redislabs has been the most stable, secure, and highest performing vendor we have ever worked with. We have thrown increasingly ridiculous workloads at our cluster and it has never faltered.” Identity verification service Whitepages said, “Our Identity Graph product handles [a huge amount of data which makes] our applications extremely latency-sensitive. Redis Enterprise provided the single-digit latency we required.”
Redis, which operated R&D in Tel Aviv, was adapting its organization to keep up with the growth in demand. “When we first started, everyone did everything. Before you have a product it’s hard to attract top talent in Tel Aviv and Silicon Valley, so you take what you can get. Today it’s easy to attract talent. We have 110 people in sales, which is run by Jason Forget, the former Chief Operating Officer of Imperva; Manish Gupta, our CMO, was CMO at many Silicon Valley companies; our cofounder, Yiftach Shoolman, is Chief Technology Officer,” explained Bengal. Redis had several Vice Presidents within its major functional departments. As he said, “Under our Chief Operating Officer we have VPs of Sales for North America, EMEA, and Customer Success (who runs our database as a service), and Solutions Architecture (who provides proofs of concept for potential customers). Under marketing we have Vice Presidents of Product Marketing, Demand Generation, and User Community. And our CTO oversees Vice Presidents of R&D and the CTO team that develops cutting edge services like Redis Search.”
Case Analysis
While Redis appeared to be years away from reaching the scale needed to go public, it seemed to have overcome the hurdle of building a scalable business model, as suggested by its low customer churn and ability to double revenues per customers within 18 months of closing its first deal with each one. The way Redis designed its jobs suggested that it had experimented extensively with how best to break down key business functions to achieve its goals. Moreover, Bengal’s success in attracting and motivating executives with previous experience managing these functions in public companies reinforced the likelihood that Redis was sprinting towards liquidity.
Less Successful Case Study: After 21 Years Will Click Software Be Acquired Again?
Introduction
It’s unusual for a tech startup to go public, get acquired by a private equity firm, and then aspire to go public again. It’s particularly difficult to pull this off when the company competes in a relatively small market and faces rivals with far more capital behind them. The one advantage that this private-equity owned company might have is that its sole focus is on that one industry which could give it a competitive advantage over rivals that participate in many different industries.
This comes to mind in considering the market for software that helps companies to schedule customer service visits; consider Comcast dispatching vans to newly signed up customers’ homes and offices to install service. This global field service management industry is not particularly large; it reached $2 billion in 2017 and was expected to grow at a 16.5% compound annual rate to $4.45 billion by 2022. Despite its small size, the industry featured many large rivals. For example, GE, which Gartner dubbed a leader in this industry, owned ServiceMax, which raised $200 million in capital before GE bought it in November 2016 for $915 million (in December 2018, GE announced plans to sell a majority stake in ServiceMax).1 Oracle acquired another player, TOA Software, for $550 million in 2014 after it raised $120 million and employed 500 people. Microsoft bought FieldOne in 2015 and in June 2018 SAP acquired Coresystems, which uses AI to help companies find available field service technicians.
The biggest standalone player in this industry was ClickSoftware Technologies , based in Petach Tikva, Israel and Burlington, Massachusetts. The company was founded by an Israeli professor, Moshe BenBassat, in 1997, went public in January 2000, and in July 2015 was acquired for $438 million in cash by Francisco Partners. Prior to the deal, ClickSoftware expected to report a loss for the quarter ending March 31, 2015 and revenue in the range of $26 million to $27 million. ClickSoftware’s CEO, Mark Cattini, joined in February 2018. He had a track record of taking over companies that stalled and selling them. Before ClickSoftware, he was CEO of Autotask, maker of a business management platform for IT service providers, which Vista Equity Partners acquired in June 2014, and publicly-traded MapInfo, which Pitney Bowes acquired in 2007 for $480 million. As Cattini said in a July 2018 interview, “We have 700 employees and when I joined I benefited because my predecessor had done good things. We see a much bigger opportunity to expand beyond field service to customer service more broadly, offering solutions to empower our customers to retain and create better experiences for their customers. Thanks to Francisco, we can expand organically or by acquisition.”
Case Scenario
ClickSoftware did not reveal its revenues but claimed to have many customers. “We have 400 enterprise customers, including some of the largest utilities and telecommunications service providers in the world. We also have 9,000 SMB customers, and nearly a million field service professionals are scheduled every day by our software. We have very healthy growth on the bottom and top lines,” said Cattini. Companies bought from ClickSoftware because the money it saved them exceeded the price they paid for the product. As Cattini said, “We demonstrate ROI. If a company has 200 to 500 technicians, we can cut 15 miles per technician for 250 working days from their routes. An energy company in Australia told us we saved them tens of millions of dollars. We charge from $200,000 to $3 million per year.” ClickSoftware’s culture and organization contributed to its growth. “Our culture is the most important thing. We value people who are team-oriented and passionate about customer satisfaction. We also want people to act with a sense of urgency and accountability. We’re organized functionally, with sales and marketing, product development, and customer service. Because of our great software and excellent customer service, we have a strong recurring revenue base.”
Case Analysis
ClickSoftware had a long and somewhat rocky interaction with capital markets. It went public during the dot-com boom but was not profitable and was taken private. Its CEO had a track record of fixing up less-than-stellar companies and selling them to private equity or corporate buyers. Indeed, Cattini seemed to think that ClickSoftware’s growth might come through acquisition thanks to capital from its private equity owner. To be sure, ClickSoftware’s product created measurable value to customers and it was able to raise its revenue per customer over time. Moreover, its culture and organization seemed to support these outcomes. Nevertheless, by August 2018, it was unclear whether ClickSoftware was growing rapidly enough to have hopes for an IPO, whether it was profitable or could become so, and exactly how Francisco Partners intended to generate a return on its then three-year-old $438 million investment.
Principles
- Do
Include executive roles to run key departments such as marketing and sales, and fill them with people who have performed these roles in companies that went public.
Define vice president jobs to run key functions within the departments.
Evaluate effectiveness of organizational roles by assessing how well each contributes to the company’s growth and profitability.
- Don’t
Depend too heavily on acquisitions to expand the scope of the organization.
Design the organization and run it without monitoring its effectiveness.
Delay making changes to the organization if it is not functioning well .
Stage 4: Running the Marathon
Geographic expansion: If the company decides to expand into new countries, it may hire general managers and put them in charge of achieving revenue and profit goals there.
Developing new products internally: If the company develops a new product, it may assign a very entrepreneurial team to explore the market opportunity, and then create a more formal organization structure should it be successful.
Growth through acquisition: If it acquires a company, the target’s CEO may stay on and be charged with meeting ambitious growth goals or the acquirer may assign an internal executive to that task.
As we’ll discuss more in Chapter 6, public companies more frequently replace the people who perform existing organizational roles. For public companies, the spotlight puts additional pressure on the board to use these scaling levers in ways that can withstand scrutiny as they run the marathon.
Success Case Study: Netflix Disrupts Itself with Help from Chief Content Officer Ted Sarandos
Introduction
Founded in 1997, Netflix invented the business of DVD-by-mail, which contributed to the demise of video rental store chain Blockbuster. Then Netflix created online streaming, which founder and CEO Reed Hastings knew would cannibalize its DVD-by-mail business so he focused most of his effort on building the online streaming business and planned for the decline of its DVD-by-mail business and in so doing created a new role called Chief Content Officer (CCO) , which Netflix filled by hiring college dropout and video store operator Ted Sarandos. The CCO role was particularly important to Netflix’s online streaming business because the studios that create movies and TV programs had no financial incentive to let Netflix stream their content on its platform, or at least would not do so without charging Netflix a prohibitively high price. Creating a CCO was also a new idea for Netflix since its DVD-by-mail business did not require it to create content; it simply bought DVDs in bulk from wholesalers. To keep content costs under control, Hastings realized that Netflix would need to backward integrate by making its own content.
Case Scenario
The CCO role changed dramatically during Sarandos’s tenure. Although Netflix did not launch its online streaming service until 2007, Sarandos first met Hastings in 1999 and became the company’s CCO in 2000. At their first meeting, Hastings described his vision for the company as providing streaming video delivered to subscribers via the Internet. Hastings’s vision impressed Sarandos even though there was no content to be created at the time because all of Netflix’s revenues came from DVD-by-mail , which contributed $53 million to company profits in the second quarter of 2018 from its three million subscribers. Sarandos was thinking about how to create online programs for Netflix while Hastings waited to launch until broadband speeds and streaming technology in consumer devices were strong enough to support instant online streaming. As Hastings said, it would be time to launch online streaming when the cost of mailing DVDs exceeded the cost of streaming video, which happened in January 2007. The service, dubbed Watch Now, started out small with around 1,000 titles—about 1% of Netflix’s 70,000-video physical library.
After launching online streaming via licensed movies and a few TV shows, Netflix’s CCO role began to evolve as Sarandos tried to anticipate the kind of content that Netflix subscribers would want to watch online. As consumers subscribed to online streaming, Sarandos tracked how they watched TV and discovered two important insights: first, consumers liked to binge watch shows and second, algorithm-driven recommendations could keep subscribers engaged for hours at a time. The CCO role ultimately became what it is today: a supplier of original content for Netflix subscribers. That began with the February 2013 launch of House of Cards. Sarandos ended up paying $100 million to license this UK series because his analysis revealed a significant market opportunity for people who rented House of Cards DVDs, watched political dramas, and preferred David Fincher and Kevin Spacey films. Sarandos concluded that the network effects of publicity for the show would boost viewing figures and enable Netflix to earn a return on its investment. This sort of data-driven insight into customer preferences helped Netflix to lower the risk of its in-house content gambles by setting appropriate budget limits for such projects.
Sarandos’s role evolved into a recruiter of programming talent. Unlike ratings-obsessed TV networks, Netflix was more eager to give talented people a chance to experiment. Netflix’s culture appealed to well-known show-runners who had succeeded on network TV. Examples include Netflix’s deals with Ryan Murphy, who produced American Crime Story, American Horror Story, and Nip/Tuck, and Shonda Rhimes, who created Grey’s Anatomy and Scandal. One of the most appealing things about Netflix for such creative executives was that it gave them the freedom to explore a wide range of different projects, regardless of ratings, according to Sarandos.
Case Analysis
Netflix founder and CEO maintained a clear vision for the company since he cofounded it. He understood that evolving technological, industry, and consumer trends created new opportunities and threats for the company after it went public. By reinventing Netflix’s strategy, organization structure, and top executives, Hastings created opportunities for the company’s highly talented team to change their job definitions to keep up with changing market opportunities.
Less Successful Case Study: Okta Grows Rapidly, Goes Public, Yet Remains Far From Profitable
Introduction
A company that goes public, grows quickly, enjoys a rise in its stock price, and has no track record of profitability or a path to becoming profitable raises a simple question: What happens if investors decide that they won’t buy the stock unless it makes a profit? That’s what comes to mind in considering San Francisco-based Okta, a 1,300-employee provider of a cloud-based service that verified the identities of people (employees, customers, and partners) who sought to access a company’s IT systems. Okta, founded in 2009, charged subscription, support, and professional services fees to the 4,700 companies that used its product.
Okta’s 2018 revenue of $259 million had increased at a four-year compound annual growth rate of 58.7%. In 2018, Okta posted a net loss of $114 million and negative free cash flow of $37 million. By August 30, 2018, its stock had risen 153% in the previous 12 months, valuing its shares at $6.6 billion. Okta’s cofounder and CEO Todd McKinnon previously held executive positions at Salesforce and Peoplesoft.
Case Scenario
Okta believed it had a large market opportunity and pursued a multi-pronged strategy to grow rapidly within the market. Based on its average calculated billings, share of each customer’s budget, and the number of worldwide business and educational institutions, Okta estimated that its total addressable market was $18 billion. To gain a bigger share of that opportunity, Okta pursued a multi-pronged growth strategy: adding new customers, boosting its share of existing customers’ budgets, expanding internationally (it opened offices in the United Kingdom, the Netherlands, Canada, and Australia), expanding relationships with systems integrators, adding new services, and providing analytics.
Okta’s growth was straining its organization, including functions such as management, customer operations, research and development, marketing and sales, administration, and finance. To keep up with demand, Okta expanded its functional departments. Its sales organization was structured to meet the specific needs of its various customer groups and was divided by geography, customer size, use case, and industry. Its direct sales force was supported by sales engineers, security team, cloud architects, and professional services staff. Its marketing function generated and communicated customer success stories from the Chief Information Officers of its client. Its marketing function also ran Oktane, a conference with over 1,000 registrants that included customer success stories and new product announcements. Okta’s R&D department designed, architected, created, and maintained the quality of Okta’s Identity Cloud. Its customer support and professional services organization helped maintain customer service and satisfaction.
Sadly, Okta did not have a scalable business model and as it added to its organization to meet growing demand from customers, it continued to lose money with limited hope for becoming profitable. Okta expected “to continue to incur net losses for the foreseeable future.” Moreover, the company expected its operating expenses to significantly increase “over the next several years” as it hired more people in sales and marketing to “expand and improve the effectiveness of [its] distribution channels, expand [its] operations and infrastructure, both domestically and internationally, and continue to develop [its] platform. Okta also expected a rise in legal and accounting expenses. Moreover, Okta was uncertain whether revenues would increase enough to cover future operating expenses.
Case Analysis
Okta enjoyed rapid revenue growth and a successful IPO. Its culture focused on getting new customers, serving them well so they renewed their subscriptions and added to their product line. Yet Okta faced considerable competition from established companies and upstarts which sustained a high level of price competition. As Okta grew, it hired more people to keep up with the needs of its customers and the imperative to sustain high levels of revenue growth. Okta’s expenses continued to rise above the level of the revenue it generated from these efforts and despite a well-designed functional organization, Okta had yet to enhance its efficiency enough to have confidence in its ability to generate a profit or positive cash flow.
Principles
- Do
Create new organizational roles to lead changing elements of strategy.
Empower talented people to determine how to implement new strategies.
Monitor the effectiveness of the strategy and adapt key roles to sustain growth.
- Don’t
Get locked into a high cost organization that only grows by raising costs above revenues.
Maintain the current organization structure despite changes in strategy.
Redefining Job Functions Success and Failure Principles
Summary of the principles of redefining job functions
Scaling Stage | Dos | Don’ts |
|---|---|---|
1:Winning the first customer | Hire the best cofounders possible to perform most critical jobs needed to win first customers, such as product development and sales. Make listening to customers and building prototypes key parts of the cofounders’ jobs. | Add new job functions without considering cash flow or profitability. Assume that investors will keep funding organizational expansion without a path to profitability. |
2: Scaling the business model | Redefine jobs to make the business profitable based on specific customer metrics such as renewal rates, revenue per customer, and cost of acquiring customers. Add new jobs that boost the company’s performance on these metrics. | Assume that it is better to trade off profitability for growth. Keep adding new job functions—for example, to manage operations in new geographies—without regard of their effect on profitability. Assume that investors will keep financing losses as long as revenue keeps growing. |
3: Sprinting to liquidity | Include executive roles to run key departments such as marketing and sales, and fill them with people who have performed these roles in companies that went public. Define vice president jobs to run key functions within the departments. Evaluate effectiveness of organizational roles by assessing how well each contributes to the company’s growth and profitability. | Depend too heavily on acquisitions to expand the scope of the organization. Design the organization and run it without monitoring its effectiveness. Delay making changes to the organization if it is not functioning well. |
4. Running the marathon | Create new organizational roles to lead changing elements of strategy. Empower talented people to determine how to implement new strategies. Monitor the effectiveness of the strategy and adapt key roles to sustain growth. | Get locked into a high cost organization that only grows by raising costs above revenues. Maintain the current organization structure despite changes in strategy. |
Are You Doing Enough to Redefine Job Functions?
Are you adapting your organizational structure to your evolving business strategy?
Are you splitting organizational responsibilities to limit managers’ span of control to six or seven direct reports?
Are you holding key executives accountable for results and giving them freedom to redefine their roles as the company grows?
Are you eliminating roles that cost more than the value they create?
Conclusion
Redefining jobs is an element in a cluster of scaling levers that enable a company to implement its growth strategy for turning an idea into a large company. Underlying the process of redefining jobs is the notion that once a company wins its first customers, it must go from hiring entrepreneurial leaders, setting a goal, and letting them improvise solutions to increased specialization and formal process. Such formalization is essential to achieving growth without spending too much money. As a company sprints to liquidity and runs the marathon, the CEO must create new roles that will be held accountable for capturing new growth opportunities. And once the new roles have been designed, the CEO must decide whether to promote current employees into the new roles or part ways with them and fill the position from outside the company. Such decisions are a test of the CEO’s ability to hire, promote, and let people go, which we examine in Chapter 6.