Why marketing is eating the world

I was born and raised in the San Francisco Bay Area and grew up during the dot com boom in the late 1990s. One of the most interesting things in looking back are the stark differences in what it took to be successful back then with a software company and what it takes to be successful in building a software startup today in the US.

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When I was a teenager, if you wanted to get into internet startups, you needed to find information on how to build websites. Although there were some no-code website builders, they were largely terrible. Building websites from scratch was the way to go. Moreover, developer knowledge was not really available online, because content on the internet was still being written. You had to hop over to your local Barnes & Noble bookstore to buy books on HTML, Javascript, Perl and whatnot. Lastly and most importantly, you needed access to servers. It was not uncommon for internet companies to spend boatloads of money setting up their infrastructure in a closet at their office. Back then, technical knowledge was a really valuable and a limited skill. If you could assemble the best technical teams and keep them happy, that was a really strong moat for you because you could prevent other would-be competitors from being able to build a competing offer.

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And as a result, for many years, there were not that many websites in the US market (or anywhere). If you had a website, it was relatively easy to capture attention and web traffic. One such website, Craigslist, a simple peer-to-peer marketplace site that we are all familiar with, was started in 1995 and continues to reign to this day despite so many upstarts trying to compete with it on better design and usability. Why? Craigslist gets the job done and more importantly, people know about its existence. Distribution is king.

Although it often took months to build out a website in the 90s, today you can often get a fairly straightforward site out the door even with no-code tools in less than a day. And if you do need to write code, you can search for code examples on just about every possible topic in a variety of discussion forums and on YouTube. Even more advanced computer science topics such as in machine learning now have so many open source resources and infrastructure. You can often use a variety of specialty libraries without having specialized knowledge. For the most part, in software, technical information has largely become commoditized. This isn’t to say that you can’t make good money being a software engineer — and in fact, if you are a top engineer, you can now make a boatload of money! But it’s to say that most “run-of-the-mill” software development is not a unique skillset and most software businesses developed today don’t require specialized software development skills.

This has led to a flurry of many applications being built online – often with multiple teams building the same thing. It is not uncommon to run into 50 different founding teams all trying to build a marketplace for gym trainers. Or 300 founding teams trying re-invent marketing automation.

According to Statista, the number of websites has ballooned to nearly 2B!

For most software businesses in the US, the problem isn’t technical knowledge anymore. The problem is getting a wedge into distribution — also known as marketing.

Furthermore, incumbents who generally do a good job, often manage to continue reigning. According to Brad Gerstner, CEO of Altimeter Capital, who recently did a podcast on Invest Like The Best, large tech companies have managed to take even more market share than 10 years ago. Some people may argue this is because the large tech companies have improved their products over time to stay ahead due to their increased collection of data and better algorithms that feed on that data over time. That may be true for some companies but not all. This also applies to other products that have not made significant strides in their technology — Craigslist, Salesforce CRM, Turbotax, Quickbooks to name a few. Even Google Search which arguably had a better product in the 1990s compared to its peers is about on par with alternative search engines today, but 90% of people worldwide still use Google. Old habits die hard, and distribution matters more than ever if you are just starting a business. It’s hard to topple incumbents who have strong distribution and already large audiences — even if you can build a much better product.

So where are the opportunities in software? Is it even possible to build a company that takes an entire market? I took to Twitter to find out.

A big warm thanks to everyone who participated. A number of people came up with some great suggestions of winner-take-all companies within a variety of developer tools / API markets, but in large part, this was an incredibly difficult challenge. No one could think of a company that has started in the last decade and has clearly dominated above all other competitors. On the flipside, we’ve already rattled off a number of older software companies that continue to dominate market share TO THIS DAY in a variety of areas: Google Search, Amazon Books, Turbotax, etc. This isn’t to say that you cannot build a big business if you don’t own a market, but it’s to say that the old way of thinking about market domination is just not applicable anymore.

Put another way, a lot of the “low hanging fruit” in the US software market is now gone. Software in the US generally works. And new opportunities get swept up with would-be competitors immediately. If the 90s was about thinking through your build, the 2020s is about thinking through marketing & distribution.

As such, while many VCs are still fixated on finding unique technology in software and chasing companies that will ultimately be the sole winner, I’d contend that these two strategies — while successful in the 90s and early 00s — largely no longer work. There are certainly exceptions but if we are talking strictly about software, (not hardware, not drug discovery, not synthetic bio, etc) you’d be hard pressed to find a company where winning does not require a solid marketing and/or sales game. This is very different from the 1990s. Having a marketing skillset and mindset is what you need to win in 2020 in the US software market.

Although the low hanging fruit opportunities in the US are gone, it’s not to say that you can’t build a Salesforce competitor or a Craigslist competitor and be successful. The software market in the US has gotten so big — you can still build a billion dollar business if you are the 15th email service provider. We are seeing more and more unicorns ($1b valuation businesses) and many in the same market. However, we are also seeing many more startups than in the 1990s being built. This means that while there are more unicorns as an aggregate number, there are also many more companies that will not become unicorns. And with increased competition, even if there are more winners, the cost of customer acquisition becomes more expensive for all.

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In fact, there are economic schools of thought around where we are in the tech-economic landscape. As economist Carlotta Perez describes, we are now in the Deployment Phase of the internet in the US — meaning, we are in-process of exhausting all use cases for internet technologies in the US. What has traditionally happened at the end of a technology phase is oversaturation of investment dollars chasing smaller returns. Valuations go up, returns go down, and investors lose their money. (Sound familiar?) On a company level, what this means is, if not careful, a lot of companies will end up wasting marketing dollars in this type of landscape. Companies in the 2020s, unlike in the 1990s, need to really be performance-marketing driven in order to compete. The end of last year certainly showed us many examples of well-funded companies that could not make the unit economics work. The software industry has become a marketing game.

Even if you aren’t running a strictly software business but use software platforms to operate a business, marketing is still key. If you run your company off Yelp, Shopify, Patreon, Stripe, Recurly, ConvertKit, Substack, or any of the others, you need to stand out, and that’s marketing. And the people who do the best at marketing make a LOT of money, and those who don’t, just can’t catch a break, even if they are good at their craft. Marketing is necessary.

There are, of course, exceptions to this — there are still emerging markets (both in the geographical sense and technology sense) where marketing doesn’t matter as much.

In developing geographical markets, it’s largely greenfield. We have a portfolio company in Indonesia that was able to get 250k signups almost immediately from brick and mortar small businesses and no budget. In the US, without a large marketing budget, this would be challenging to do now. Why? Because every Square and Opentable is knocking on their door and has been for years. There’s just so much noise small businesses tend to ignore. But in Indonesia, that isn’t the case…yet. The software landscape there is similar to the 1990s in the US. It’s harder to piggyback off of existing software infrastructure — whether it’s payments or platforms — but there’s also a lot of obvious opportunity in software that no one is going after. The same could be said about investing elsewhere in Southeast Asia or in LatAm or Africa. There are fewer startups to compete with for attention, and it’s less of a marketing game than building a software company in the US.

In addition, for companies pursuing developing technologies — such as in hardware or drug discovery, we’ve barely just scratched the surface of these technologies. There is so much opportunity left to be explored outside of software, and I suspect many US software investors will eventually have to rejigger their skillset to migrate away from strictly software into other technologies to find opportunities that don’t require playing as much of a marketing game. But eventually, marketing will become the name of the game for both global software markets and these other technologies.

In conclusion, the US software industry, for the most part, is no longer about technology. If you are highly technical, and you want to win on product and tech, your best bet is likely in building a business that is not strictly software in the US OR in building a software business for an international market. But if you want to win in the US software market, ironically, the best thing you can for your company is to really ramp up your performance marketing knowledge. Marketing is eating the world.

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Marketing funnels in simple terms

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In my last post, I talked about the ideal marketing machine you’re trying to build and how to think about it. I talked about lifetime value (LTV), customer acquisition costs (CAC), and payback period as the key terms you need to monitor.

Today, I talk about marketing funnels. I think most entrepreneurs have a general sense of what a marketing funnel is. But, what are the key components to look at? What should go into your funnel?

I talk about this in these next three videos:

What is a marketing funnel?

How to dissect and debug a marketing funnel by customer acquisition channel?

Where to spend your time debugging a marketing funnel?

Note: in these videos, I talk about 2 important dimensions to consider in looking at your marketing. Segment by 1) Customer acquisition channel and 2) Time

In these videos, we don’t talk about how to slide and dice your marketing data by time.

BUT, attend my online event on June 23, 2020 to learn how to slice and dice your marketing data by time using cohort analyses. Sign up today!

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Three marketing terms you should know explained in simple terms

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Marketing is a really confusing profession. When I was a senior in college, I was so excited to get a job offer and I told me friend about it. His questions to me were, “What is a marketer? What are you going to do? Is it like advertising or something?” Truthfully, I had no idea. I was just happy to even get a job — this was in 2004 when the job market wasn’t so hot.

But even after I took the job and even years later yet after going to business school and working in marketing at Google, I still didn’t really understand what marketing was. It seemed like a series of activities. Like running ads. Or putting on events. Or writing copy.

In fact, what marketing is didn’t click for me until many years later when I was running my own startup and could start to see the big picture of what I was trying to achieve with marketing. In addition, it would be years after that before I really understood what were the most important things to consider in marketing and what could generally be ignored? There are so many terms in marketing. There are so many things you can track in your funnel. It’s all overwhelming.

So, over the last few days, I’ve put together a handful of videos on marketing 101 for startups. Just 3 terms will get you 90% of the way there. And things you need to consider as a business owner w/ regard to those 3 terms as well are covered in these videos.

What is marketing?

Three simple terms in marketing:

What is a payback period?

What is the cost to acquire a customer (CAC)?

What is lifetime value of a customer (LTV)?

Why cohorts are important in looking at your lifetime value?

Wrapping up the three key terms in marketing

Today I just wanted to get the basics of marketing out of the way. But now that we have three terms that we can use, subsequent marketing posts can get a lot more interesting.

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On Power Constructs

The last week has been rather disturbing on a number of levels. I’ve been able to reflect a little bit more methodically on what is actually happening here in the United States in the last 24 hours or so.

But before I dig into that, I wanted to share with you something that we shared with our portfolio companies this weekend to give you a sense of how at Hustle Fund are thinking about things. We write a weekly newsletter to our founders in our portfolio, and this is what my partners and I sent:

Not only are we still dealing with the surge of cases of the coronavirus, which we know is affecting so many of your businesses, but in addition, you may have seen in the news a lot of racially charged incidents that also happened this week. This spans from a police officer murdering weaponless George Floyd to a woman threatening to call the police on a Black man who was birdwatching and rightfully trying to tell her to put a leash on her dog. These are not one-off cases, but just the latest in a series of incidents where Black Americans are the subjects of casual police brutality. For those of you who are not based in the United States, a lot of this may sound completely senseless. I, too, couldn’t explain any of this to my kindergartener. It just doesn’t make any sense.

We’ve heard from our Black friends that they feel afraid and fatigued. It’s a fear and anxiety that comes back every time injustice directed towards the Black community happens. The events of this week are reminders that you can be innocently minding your own business — not even near a crime — and can be a target for violence simply because of your skin color. If you are afraid, I want to give you a big social distancing hug. 

From Aeon’s How to See Race

Race is ultimately a power relationship; racial categories are not about interesting cultural or physical differences, but about putting other people into groups in order to dominate, exploit and attack them.

In the United States race as a form of power has existed since the very beginning.

The US Constitution divided people into White, Black or Indian, which were meant to stand in for power categories: those eligible for citizenship, those subjected to brutal enslavement, and those targeted for genocide. In the first census, each resident counted as one person, each slave as three-fifths a person, and each “Indian” was not counted at all. But racialisation is often more insidious. It means that we see things that don’t exist, and fail to recognise things that do. The most powerful racial category is often invisible: Whiteness. The benefit of being in power is that Whites can imagine that they are the norm and that only other people have race. An early US census instructed people to leave the race section blank if they were White, and indicate only if someone were something else (‘B’ for Black, ‘M’ for Mulatto). Whiteness was literally unmarked.”

As startup founders, we understand power and power structures as it pertains to incumbents and their grip on the markets we are attacking; and yet we try. We are optimists who believe we have the power to change things, otherwise we wouldn’t start companies

We want you to know that at Hustle Fund, we condemn violence, discrimination, racial profiling, etc. Whether it is now or down the road, if you ever feel like you are an outsider or that you are being discriminated against because of your race, gender, nationality, age, or anything else for that matter, I want everyone in this Hustle Fund family to know you can come to us. If we even just take the smaller startup community in the broader world, I know that the startup community, too, is fraught with problems. There is a lot of discrimination and bad behavior within the startup ecosystem, especially as it pertains to raising money from investors.

Part of the reason we decided to start a VC fund is so that we can start to right the world a little bit. It will take a long time. We are not the biggest VCs. And we are not the most powerful VCs. But we have a bit of a voice. Let’s use it for good. Let’s use it to effect the change we want to see in the world — even if it starts small. We may all be different but you will always be Hustle Fund Family. 

Let’s break this down further though. Also, as a reminder, these next thoughts are mine and do not necessarily reflect the thoughts of the partnership.

I am disturbed by what happened to George Floyd, a Black man, who was murdered by a White police officer named Derek Chauvin last week. I am also equally disturbed by the video that I saw of the conflict in New York between Amy Cooper, a White woman with a dog and Christian Cooper (unrelated Coopers), a Black birdwatcher. Although both cases are very different in their outcomes, the latter was also just as disturbing because it showed the sinister power dynamics in that situation. 

Amy was in the wrong – she did not have a leash on her dog — but she played the power card of calling the cops to potentially wrongfully arrest or hurt Christian (even though SHE was in the wrong!). What this actually illustrates is that she KNEW very well the “power construct” of the situation. She KNEW that even though she was in the wrong, she could bring about trouble for Christian because of the power dynamics. 

And that is incredibly evil. 

I don’t care if that woman doesn’t normally act like that – it could have been just a bad day for her. But what it does show in that one example is what everyone deep down knows and dismisses — that there are “power constructs” based on race in this country that are so extreme such that you can call the cops because of someone’s skin color. She KNEW that something bad would happen to him simply because of the color of his skin. In fact, studies show that police brutality is a leading cause of death amongst Black men. The root of this stems from slavery, and we have not overcome this. 

Let’s rewind a bit on something separate and then I’ll come back.

In the “old days” — many centuries ago — around the world, most governments were monarchies or dictatorships of some sort. Under these governments, it was very clear who had power. There was no pretense of life being fair or just. Or that you could work your way up. If you were not royalty, you just lived with it and hoped to make your life as best as possible. 

And if things got really bad — like the dictator was crazy or really unjust — then you’d see revolts and governments overthrown. Usually this was instigated by a mad family member who wanted the throne, but things would have to be bad enough for a mad family member to generate support from other people. This type of government was rinsed and repeated for many centuries. 

Ok fast forward. In the US, we’ve never had our government overthrown. This is because our social contract in the US is that if you generally work hard and generally follow the rules, you can work your way up. This is what is promised to us as Americans. And, in large part, for many years, if you were White and male, this is/was true. Afterall, we have a currency that hasn’t had hyperinflation, there’s food to eat, clean water, and we have rule of law that generally works. These are the basics of a developed nation. You don’t see complete anarchy unlike in other countries.

But our system isn’t perfect and is especially far from perfect for many other people. It’s been good enough such that we haven’t had revolt but under the surface, there are major systemic problems. There’s a premise and social contract that things in the US “should be fair”. I.e. if you do a, b, and c things you can get ahead. But beneath the surface, there are power constructs encoded in our laws that don’t allow for this and reinforce power in the hands of a concentrated group of people. And so things on the surface “seem fair”, but then they actually are not. Even if there are no longer physical shackles of slavery, there are legal ones that loom and are often hidden. 

This week illustrated just how sneaky some of this is. For example, from all the videos that we saw, I was appalled by the police brutality on peaceful protesters and journalists who want to share the truth. In this country, freedom of speech is a fundamental right. 

But it was very clear to me from these past few days that freedom of speech is a social contract that isn’t being fulfilled. The police shouldn’t be allowed to shoot rubber bullets at you for videotaping them. They shouldn’t be allowed to tear gas protesters who are chanting unarmed. 

What is amazing is that even though there is all this video footage of all these things, it doesn’t even matter! The police don’t care that they are videotaped for this. Why? Because nothing bad will happen to them. As I’ve learned more recently, there are no checks and balances on the police. In many cities around the country, leadership positions within the police may be voted on directly or indirectly, but citizens have no ability to effect change within the ranks. And (thank you to my VC friend Kanyi Maqubela for this) unions and qualified immunity prevent really anything bad from happening to any cop — regardless of whether they uphold American laws or break them. This is frustrating. The people who are supposed to protect you can do literally whatever they want. And while I do believe that most people are fundamentally good people, power constructs have led to a culture to enable rampant wrongdoings and complicity in police forces in America. Ultimately, power is consolidated in the hands of a few, and this isn’t what most of America signed up for. 

I know that many of you don’t read my newsletter to read about societal issues. But this a good lead in to other power structural issues that directly pertain to you. Also just to be clear, this next part is in no way meant to suggest that these next issues are as bad as police brutality or racism. It’s just another example of power constructs meant to consolidate power that directly pertains to entrepreneurs:

A power construct that should worry you, as an entrepreneur, that most people don’t know about: VC funds are only allowed to have 99 investors. There are a couple of exceptions. (ie. if you want to have a small VC fund, you can have up to 250 investors or if all of your investors are worth over $5m, you can have an unlimited number of investors). But, for the most part, most VC funds can only have 99 investors. 

Let’s do the math on that. If you want to raise a $100m fund, that means that your average check size from an investor in your fund needs to be over $1 million. This means that you cannot crowdsource small investments here and there from 5000 people.  If I had my way, I would just market the sh*t out of things and raise a fund from 10k individuals, and a good marketer could easily do this. But, that’s not allowed per SEC rules. 

What this really means is that if you are raising a VC fund, you can only raise money from very wealthy organizations or people. The number of people or groups who can easily write a $1m+ investment check is very few. Power in the investing world is concentrated in the hands of just a few people and that money generally continues to support existing funds and the founders they support who are typically White, Male, graduated from an Ivy League or MIT/Stanford, and worked at a top notch tech company liked Facebook or Google. This is why you don’t see new money or new ideas go into investing. Literally, change is prevented by the laws that are in place. 

Now let’s follow the money. If you are an overlooked founder – and by this it can mean a lot of things. It can mean race. It can mean geography. It can mean schools or workplaces that you went to or didn’t go to. It can mean age. If you are overlooked, you are likely not going to find a large fund to fund you — at least not in the beginning when you have not built out much. 

If you find anyone to fund you, it will most likely be a startup fund (such as from Hustle Fund and others) that is small and cannot for many years raise a large fund because the money is so concentrated with power constructs to keep it this way. This means that it’s harder for you as an overlooked founder — there isn’t truly a free market here. Laws like this are subtle but have big impacts on society. 

Again, in bringing up the fundraising issues that founders or funds have are in no way meant to be considered on the same plane as police brutality or racism. Just generally speaking, if we really want to effect change in this country, we need to change the way “hidden” power constructs like these are set up in our legal system. Specifically in the areas that consolidate power and have no checks and balances. Just like how we don’t approve of power monopolies in companies in the US and have antitrust laws (that are sometimes enforced), we shouldn’t accept power concentration in other facets of our lives. These are currently encoded in our laws in ways that the American public is largely unaware of but have huge impacts on our society. 

I know that entrepreneurship can create wealth and change lives. Although money isn’t power, they are directly related, and by helping overlooked founders create wealth, we can start to — in small ways — right some of these power constructs. At Hustle Fund, 18% of our North American portfolio companies were started by underrepresented founders (Black & LatinX). This is a start but we know there is so much more work to do including: 

  • Welcoming and continue to welcome cold pitches. 15% of our portfolio companies came from cold inbound pitches. We didn’t know them. They didn’t have a referral. Great companies come from everywhere including outside one’s network. We don’t want to miss out. 
  • Building and continuing to build informal deal flow relationships with others who reach different sets of networks. This includes working with our Venture Associate Intern Jasmin Johnson who works with Score 3. Or Lolita Taub in her investor-matching program. Or relationships with a large variety of co-working and entrepreneurship organizations around the country.
  • Meeting founders remotely. Even pre COVID-19, almost all of our investments have been done via phone calls and video conferencing. Contrary to what many other investors think, I think meeting with founders in person doesn’t actually show you a person’s true colors – it’s just a show. People dress up and they put on a pitch show. And in-person pitches also introduce unconscious biases — everything from ability to pay for travel to how a person looks / dresses to how good a person is in pitching. I just want to know the raw nuts and bolts of a company and, to the extent possible, minimize unconscious biases across pitches. 
  • Post investment, helping our founders by:
    • Getting to know and introducing our founders to other microfunds and angels who share similar ethos in funding entrepreneurs based on execution rather than based on network or ability to pitch. 
    • Building a following online to help amplify our founders’ stories — one of our founders raised $80k+ from angels through our tweets
    • Running growth camps (4-6 weeks) to help our founders increase their revenue right away so that they don’t need to rely on more investor money
  • Scouting new team members. It’s no secret our team is almost entirely Asian and we are not racially, nor by background, a diverse team! Furthermore, in the GP-ship, we all went to Stanford and have been friends for 20+ years. We are exactly guilty of what my VC friend Rich Kerby writes about here! At the same time, we also have no management fees as a small fund to bring onboard new paid hires (and actually rely on grants and sponsorships to make our current budget work). We have been slowly getting to know & “courting” a couple of talented operators whom we would love to work with so that we can add more talent to our team in the coming 2-3 years. To be clear, the way that I think about things from a North American investing perspective is who do I want to eventually replace me? Who do I want to replace Eric? (hah sorry Eric) How will the demographics and needs of the United States change in the next 2 decades? What and who are underserved groups of people within the US as consumers and businesses? This isn’t some quota thing — I aspire to have a diverse partnership because I think it’s an asset in being able to identify opportunities and underserved markets, and being able to connect with different groups of people within the US. At Hustle Fund, I aspire to be a 100+ year franchise, and in order to get there, we will need a team that is different from what we have today. Always be scouting and building relationships early.

Credits: Special thanks to Jasmin Johnson, Dr. Billie J. Moore, Shiyan Koh, and Eric Bahn for all their incredibly helpful thoughts & feedback on this post

Why VCs are obsessed with Unicorn companies? (HINT: let’s do the math together)

I’ve written a bit about startup investing portfolio theory before:

But I find some of the nuances of portfolio construction hard to grasp in writing. So, today, I thought I’d try something different. I made a super raw video that walks through the rough math of startup investing. I did this with 1 take and no editing – so bear with me.

This video is geared towards both founders and investors. I think going back to first principles of portfolio construction helps in understanding a lot of the psychology of what investors are looking to achieve. It may change how you pitch your company. Or heck, it may even help you decide that raising VC money is not for you, and that’s ok.

And for budding investors, this will help you understand what you’ll need to think through. I’ve met so many new microfund managers and angel investors who haven’t run through various scenarios of portfolio construction. And that’s surprising to me!

As if you didn’t have enough to subscribe to, subscribe to our Hustle Fund YouTube channel for more walkthroughs and interviews on a variety of startup topics.

Here’s why understanding switching costs is crucial to good product strategy

I recently spoke with my business partner Eric Bahn about the importance of selling products that fit into customers’ existing workflows.

That conversation got me thinking how important switching costs can be to the success of products — often in ways that don’t seem obvious at first.

So I’ve written about the relationship between switching costs and product strategy below. I hope you’ll find them helpful:

First, it’s not enough to just have a good product

Of course, it doesn’t hurt to have a good product.

But even if your amazing product solves a dire need better than any other product out there, you’ll never sell anything if customers have to pull out their hair to switch to your product from the product they’re already using.

So before you start selling your amazing product, you need to understand how switching costs impact adoption and retention of your product, because that will determine how — and more importantly, when — you should sell your product.

Switching costs are a two-way street

When it comes to switching, it’s important for entrepreneurs to think in both directions.

This may sound obvious, but it’s really important: When a customer switches products, they switch to one product and they switch away from another product.

  • The cost of switching to a product determines adoption.
  • The cost of switching away from a product determines retention.

The key is to make switching costs work for you, not against you: Ideally, entrepreneurs want low costs of switching to their product and high costs of switching away from their product.

Photo by Snapwire on Pexels.com

So, what does that look like for actual businesses?

I’ll start by digging into a few examples that are close to home:

Example 1

At my prior startup, we sold ads. The initial sales process was fast and easy. Why? because marketers were willing to try many different ads. So since the cost of switching to my product was low, my rate of adoption was high

But on the flip side, many of my customers would move on quickly to the next ad product.

Example 2

My partner Eric ran a GMAT test preparation startup that offered GMAT coaching on discussion forums. His initial sales process was also easy, because it was easy for students to post questions on numerous forums. Again, the cost of switching to his product was low, so adoption was high

But his users were more likely to stick with his platform because they got faster and more thorough answers to questions on his platform, and therefore had little reason to leave.

Of course, these are simplified snapshots of just a few businesses. 

But switching costs impact all kinds of businesses 

Switching costs shape buying decisions for everything from T-shirts to tax software. They can take several different forms: 

  • Financial costs, such as “exit fees” or lost reward points.
  • Psychological costs, such as the perceived loss of status or comfort associated with a known brand or product.
  • Procedural costs, such as the time and effort it takes to set up or learn how to use a new product.

Products are “stickiest” among consumers (retention is highest) when they are associated with several different switching costs. 

Let’s zoom in on marketing automation software as an example 

Marketing automation software is software that helps companies send emails to prospective users, publish content, among other marketing activities. These platforms, like Hubspot or Marketo, are usually tightly integrated across an organization’s entire operation. Potential customers can’t just “try out” a new product without investing a huge amount of time and energy — it’s a product that has enormously high switching costs in both directions.

So marketing automation software companies have 2 main options when it comes to selling their products:

Option 1: Win over existing customers by competing directly against similar products.

This strategy is challenging because: 

  • It involves long sales cycles and constant follow-up to get the timing right — when a potential customer is ready to switch and has the time and energy to switch
  • It requires offering a product that’s not just as good as, but often 10x better than competitors’ products to convince customers to switch
  • It still involves a gamble of getting customers to overcome the inertia and risk of switching 

Option 2: Find new customers by selling an adjacent product and then expanding.

This strategy is generally preferred to Option 1 because:

  • It doesn’t require customers to rip out software
  • It doesn’t require such precise timing in the sales cycle

HubSpot, who is now a leader in marketing automation, successfully used this second strategy to battle incumbents. 

Unlike other marketing automation companies, HubSpot targeted smaller companies who didn’t already have any form of marketing software and then grew with them. They started by offering free products such as “website grading tools” that were small little widgets with fast adoption cycles. And, once clients started signing up, over time they grew their software product offering to eventually go head-to-head with marketing automation behemoths.

Now, HubSpot is a large and diversified software company that sells a variety of sales and marketing software products.

So, how can entrepreneurs use switching costs to their advantage?

HubSpot calls its strategy of up-selling customers products with higher switching costs a “flywheel” approach. 

The model works by using products with low switching costs to get customers in the door, and then using other products with higher switching costs to shut that door behind them. 

The same principle is applicable to ANY product: 

  • If your primary product has a low switching cost, focus on retention by increasing the value (and therefore the switching cost) of your product or by offering other higher-value products.
  • If your primary product has a high switching cost, focus on adoption by reducing the friction it takes for customers to try your product or by offering other products with lower barriers to entry.

Special thanks to Conor Grant on this post!