Customer Retention Matters
Customer acquisition was always top of mind at my startup. I’m not marketing-minded and I wasn’t smart enough to hire someone strong in this area, so we struggled. Eventually I figured out a decent strategy. When we acquired customers, we did so in a profitable manner. Over time, I realized that retention (which in our business model meant having customers who bought repeatedly) was key to our growth.
We spent tons of time, energy, and money trying to find new customers. Once we had them, it was easier to convince them to stay (purchase again) than it was to find new customers. If I had to continually replace old customers with new ones, fast growth would be extremely difficult. When I figured this out, we started to focus on the things that mattered most to our customers AND the type of customers most likely to be loyal. This, with other adjustments, allowed us to grow quickly to over $10 million in annual revenue.
Getting customers is important, but founders should also think about how to keep them. If your customers stick around, you’re on to something!
Large Landlords Acquiring Tenants on Airbnb
A friend shared an article with me today. It’s about an institutional investor, ReAlpha, planning to spend $1.5 billion to buy 5,000 homes to rent out. I’ve followed institutional buyers of single-family homes for the last decade. Atlanta is one of the biggest markets for companies like Invitation Homes and American Homes 4 rent, both of which are publicly traded and own tens of thousands of single-family homes across the country that they rent out on a long-term basis. The strategy has worked well as home prices and rental rates have steadily increased since the financial crisis.
The article discussed a slightly different strategy: purchasing thousands of homes to rent out short-term on Airbnb. The idea isn’t new, but it hasn’t been pursued at scale by institutional investors. The customer acquisition strategy is intriguing. Instead of acquiring customers (i.e., renters) through traditional sales and marketing efforts, they plan to acquire them on Airbnb, which is a marketplace.
Marketplaces are places where buyers and sellers connect. Using a marketplace to acquire customers is an attractive and capital-efficient strategy for sellers. The fee (or take rate) is usually a fixed percentage of the revenue a buyer pays. That leads to a highly predictable customer acquisition cost. Sellers pay X cents for every dollar in revenue from buyers. Sellers don’t have to worry about paying to attract potential buyers who never pan out; they pay only to acquire revenue-producing customers. Sellers don’t even need to take on sales or marketing—they need only have the ability to service customers.
This approach has downsides, and the customer relationship is a big one. The marketplace owns the customer relationship. Buyers aren’t loyal to the seller they transact with; they’re loyal to the marketplace. Concentration is also a big risk. If you get all your customers from a single source that you don’t control, changes can significantly affect your revenue. Lots of stories circulate about businesses being crushed when a marketplace they rely on changes how listings are displayed or suspends their account.
If ReAlpha moves forward with these plans, it will be a huge growth opportunity for Airbnb. I’d imagine ReAlpha will seek discounts on Airbnb’s fees, but even so this could unlock a new product offering with the potential for massive scale in Airbnb’s platform.
I’ll be watching to see how this evolves.
Being Everything to Everyone Is Tough
This week I caught up with an entrepreneur working on an interesting problem. When we first met months ago, he had just launched his MVP and was targeting both corporations and consumers. This immediately stood out to me. He was trying to serve multiple masters.
Corporations and consumers are totally different types of customers. Their needs are different and the sales processes used with them are different (if the solution isn’t self-serve). It’s certainly possible to have both as customers—if a company has adequate resources. Early founders should use limited resources wisely and efficiently.
This founder shared his 2021 plans with me. His team developed annual goals and strategized on how to achieve them. The data told them that targeting a specific consumer profile would likely be their best path. The founder also got feedback from his team that to provide an ideal experience to a broader customer base, they would need more resources. The founder listened. He narrowly defined the company’s target customer for 2021. His team rejoiced!
It’s hard for companies to be everything to everyone, especially in their early days. If you’re an early founder, consider focusing on one type of customer and one solution first. You don’t hear about many companies failing because they solved their customer’s problems too well or exceeded their expectations.
How Should I Price This Thing?
When I meet with entrepreneurs, sometimes I’m asked for feedback on their pricing strategy. Pricing is always challenging, especially at the idea or MVP stage. I typically share the following considerations:
- What’s the problem? – Can you articulate it clearly?
- How painful is the problem? – How does the customer view this problem? Is it slightly annoying or immensely painful? The more painful the problem, the more valuable the solution.
- How effective is your solution? – Is it a nice to have but they can get by without it? Or is it a painkiller they can’t live without? The more pain relieved, the more valuable the solution.
- Is there competition? – Are there competitors? How does their solution rank against yours? How do they price their solution? Understanding the market and where you rank in it is important.
- What does the solution cost? – How much does it cost you to provide this solution? You can’t charge less than your costs.
Deciding how to price your solution isn’t as simple as picking a number. There’s no one-size-fits-all answer. There are lots of variables to consider. The reality is that the pricing process is iterative. Perfecting pricing takes years for some companies.
In the end, the goal is to quantify how much value your solution is providing to customers and capture as much of that value as possible in your pricing.
In my opinion, starting with a deep understanding of your customer’s problem is key. You’ll be more likely to create a pain-killing solution that customers will eagerly pay a premium price for!
Digital Deep Dive: Social Media Strategy
Today I had the pleasure of being taken on a digital deep dive by a mentor. The content—social media marketing strategy—was prepared by VaynerMedia, so its quality was extremely high. Here are some of my takeaways:
- Platforms – Each should be viewed as serving a different purpose and targeting a different audience (usually). Knowing how to use the features of each platform is critical.
- Amazon – Marketers now see Amazon as a marketing platform. I hadn’t thought of it in that light.
- Strategy – Without a defined strategy, your efforts probably won’t be effective. It should be tied to the organization’s larger objective. Having a strategic leader with social media experience is important.
- Team – Proper staffing and budgeting is a requirement. Treat digital marketing on social media like any other critical function.
- Outsourcing –It’s difficult for agencies to know what resonates with your customer. In-house is more effective—hire an internal team.
- GaryVee – There’s a serious machine behind his personal brand. It’s well thought-out and well funded. What the public sees is the result of a ton of behind-the-scenes effort.
- Perception – It’s everything, even if it isn’t reality.
Full disclosure: I’m awful at marketing. I’m just not wired to think that way.
I was extremely impressed by the thoroughness of the content. The way the strategy component was explained connected the dots for me. It’s like a light bulb clicked on. I now look at social media differently and have immense respect for its marketing value. Social media and marketing are rapidly changing and I’ll be excited to see how technical evolution affects their trajectories.
Low Margins? Grow or Die
Today I was chatting with an entrepreneur whose company is in ecommerce; it sells other company’s brands to consumers. He does seven figures in revenue. He’s been affected—not too badly—by the pandemic. He’s concerned and trying to plan for different scenarios.
As I asked more questions about the business, I realized it’s a low-margin business that depends on volume. Product pricing is determined by the brand owner (i.e., it’s the MSRP or MAP), competitors offer the exact same products, there are low barriers to entry, discounting to maintain volume is common, and front-line workers are paid little.
For this kind of business, it’s grow or die. The customer wants to pay less (competitors offer the same product) while costs—shipping, wages, rent, etc.—creep up every year. So, of course, margin percentages gradually go down. Most entrepreneurs compensate by growing revenue.
Let’s look at an example.
- Year 1 – Margins are 10% and the company does $1M in revenue. That’s $100,000 in margin dollars.
- Year 2 – Margins decrease to 9.5% and the company does the same $1M in revenue. That’s only $95,000 in margin dollars.
If the owner wants $100,000 in margin dollars in year 2, he needs to grow revenue 11% to $1.11M in year 2. In other words, he essentially needs to do 11% more work to make the same margin dollars. As the years pass, it begins to get really tough. If margins drop to, say, 5% (that’s an extreme drop), he must do $2M in revenue to make the same $100,000 in gross margin dollars. He’s forced to grow the business or die a slow death because he won’t have enough margin dollars to afford the things he needs to run the company. (Of course, the example is purposely simplistic to make a point. It doesn’t differentiate between gross margin and net margin and it features a massive 50% drop in gross margin percentage.)
This kind of business is in a tough spot when the economy shifts from growth to contraction. I pointed all these things out to this entrepreneur and he agreed. We discussed ways to transition his business to healthier margins (for instance, value-added services, his own branded products) and making the best of this difficult period by renegotiating some of his fixed costs.
Are you an entrepreneur just starting out? Are you building a low-margin business? If so, do you understand the long-term implications of that decision?
Why Price Is Not a Competitive Advantage
Today I met with an entrepreneur who’s preparing to solicit investors. As we walked through his pitch deck, he detailed his advantages over competitors. One of them jumped out at me: lower price.
To be fair, there’s nothing wrong with providing a service or product that adds substantially more value than a competitor’s at a lower price. Companies that can do that are usually employing superior technology. But if your product or service is similar to your competitors’ and you’re differentiating yourself on price, you’re on a slippery slope.
Why? Customer loyalty. If the deciding factor for a customer is low cost, that probably won’t change. If a competitor undercuts your price, you will lose that customer. Bargain hunters don’t tend to be loyal to a brand. OK, you might ask, why not just find a new customer? Well, the number of customers is finite, so you want to keep the ones you have. Then there are customer acquisition costs. Marketing to snag a customer is expensive. The cost is justified when the customer will keep coming back over the long term (Amazon and Walmart are extreme examples) or when a one-time transaction has an extremely high profit margin. But when you spend a lot to acquire a customer who buys only once and your margins are low, you lost money on that relationship.
At CCAW, I learned early the importance of charging a fair price. We redid our pricing strategy in 2011. I was betting that consumers were moving away from a recession mindset and were open to paying full value. As predicted, we lost some customers. However, a foundation of healthier margins allowed us to bootstrap our growth from then on.
Venture capitalists can be reluctant to invest in a company where price is the competitive advantage. I encourage new entrepreneurs to be mindful of what kinds of customers are likely to be loyal.
What lessons have you learned about low prices?