The sky is falling in Silicon Valley. Haven’t you heard? There has been a steady stream of opinions diagnosing a tech downturn and too many prescriptions for how to survive it. Old-timers – a relative term that roughly translates to anyone who remembers hearing “You’ve got mail!” – are now warning young whippersnappers, who can’t imagine life before Gmail, about harder times.
Suddenly, many are starting to struggle with an existential question: Why do some companies survive while others fail?
Sure, you can say the product itself isn’t any good. But let’s be honest, out of the gate, few products are. So what is it that makes some startups survive long enough to figure it out? And are there metrics we’re missing that predict survival?”
Things feel like they’re tightening
I only got into tech in 2011, working for a small ecommerce shop in Tampa, and I joined the Silicon Valley bubble in 2013. I can’t say I’ve felt the pain of the lean days. My short tenure has been mostly sunshine and lollipops. I’ve heard so much talk about unicorns that this ridiculous term almost seems normal.
It’s not that companies haven’t been failing; it’s just that it hasn’t felt all that bad when they did. Tech famously rewards failure. You learn, you grow, and you pick yourself off the ground and try again. And, of course, as the industry continued to expand, the opportunities were plentiful.
This appears to be changing. Or at least that’s the fear. “Winter is coming” the gray beards bellow, citing a litany of signs: the lack of VC-backed IPOs this year, the layoffs, the threats of down-rounds. Things feel like they’re tightening.
Don’t worry, I’m not going to opine on if or why this is actually happening. “Is it happening?” and “Why?” are bigger questions that many people smarter and more informed than myself have attempted to answer. I’ll save my own decidedly non-expert opinion for those off-hour rants with friends when we’re all at least a beer deep.
I’m interested in a more practical question: if things are indeed tightening or if they do in the future, what is it that a developer or product person can do to help their company survive?
Everyone at a company should care about survival metrics
From a venture capitalist and an entrepreneurial perspective, enough people have written about surviving the tech downturn that CB Insights put together a brilliant “thought leadership in a box” template for writing that post, rife with bits like:
Make hard decisions – tell founders that they may have to make hard decisions about their team and laying off folks. Say things like “you may have to cut some muscle as well as fat” to show that you mean business.
But what these posts fail to acknowledge is that, despite how it might seem from the last launch party you attended in San Francisco, the tech industry is more than just VCs and founders. There are developers, designers, product managers, customer success managers, and about a hundred other job titles that someone has unfortunately appended “ninja” to, and we are all coming together to build tech products. And if we’ve bought into the startup mentality of everyone has ownership of the company, aren’t we just as responsible for our company’s survival as any founder or VC?
“The closer you get to leadership, the more you see how different metrics tie into the bottom line,” Phillip Alexander, Chief Research Officer at Reactor Core, tells me.
A few years ago Phillip was a software engineer and lead instructor at Hack Reactor, a coding bootcamp. As he rose in the company, first to lead curriculum engineer and then to dean, Phillip saw the metrics through a different lens.
“Total applicants for Hack Reactor’ isn’t the metric that we’d want to grow as our sole focus,” Phillip says. “We use an admissions challenge to qualify our applicants. Being less stringent with the challenge would mean that prospective students might not be ready for the course which would negatively affect their experience and would be a poor use of limited resources.”
As an individual contributor or a small team, it’s easy to focus on driving just the metric that you are evaluated on, like leads or applicants. But when you take a step back from a single metric, you can see how it relates to others and how, eventually, it all impacts the bottom line.
Burn, burn, burn
We know why tech companies fail: burn.
“The thing that happens when you’re able to raise an ungodly amount of money, it’s easy to spend a lot of it,” Suhail Doshi, our CEO here at Mixpanel, told Business Insider this past February.
Burn is the amount of money a company loses as it works to establish itself and develop a profitable business model. If a company makes $40k a month in revenue, but spends $60k on salaries, office space, marketing, ect., their “burn rate” is $20k per month.
How long can you survive when you’re burning cash? Take the amount of money you have in the bank, divide by your monthly burn, and you’ve got your “runway”, or how long you have to make something happen or raise more money.
What we might not always appreciate is what goes into burn, and how increasing revenue doesn’t necessarily mean that your burn rate decreases. Burn isn’t just made up of Hint waters and catered lunches, right?
In a “What happened when we failed” medium post, CEO Maren Kate explains Zirtual’s burn:
Burn is that tricky thing that isn’t discussed much in the Silicon Valley community because access to capital, in good times, seems so easy …
Zirtual was not flush with capital — for as many people as we had, we were extremely lean. In total we raised almost $5 million over the past three years, but when we moved from independent contractors (ICs) to employees, our costs skyrocketed. (Simple math is add 20–30% on to whatever you pay an IC to know what it will cost to have them as an employee).
And at the end of the day… “burn” is what happened to Zirtual.
It’s hard for a new company of any variety, from the cupcake shop in Moreno Valley to the messenger app in Mountain View, to make money in the first few years. Getting a company going is expensive, and tech startups are often the most expensive of all. Most tech startups are burning through the money they raised pretty quickly, hoping they’ll hit profitability or earn another round of funding before they hit rock bottom.
This, I understand, is a vast oversimplification, since if burn is so dangerous, why are startups ignoring it?
To dig more into this , I turned to Alex Wilhelm, currently the editor of the Mattermark blog and formerly a longtime journalist on the Silicon Valley beat at TechCrunch. Mattermark organizes massive amounts of information to help companies research and answer business questions. Alex is in the business of explaining the stuff that appears in board decks to the average techie who wants to know how it all works.
“I’m an observer,” he emails me back, attempting to create separation from the tech scene before admitting, “but I suppose everyone who lives in SF is tech now.”
I’m curious, I tell him. What’s actually happening? How is this different from the dot-com bubble, when seemingly everything crashed?
“You can see the historical echoes that have come back in the past year or two,” Alex writes me. “Growth was again fetishized, but in a slightly different way.”
The dot-com bubble, he explains, was about getting visitors and pageviews. Everyone assumed they would be able to monetize web traffic at some point, but no one focused on it. There would be time for that later. The web was new, and it was going to be huge, so startups didn’t think twice about burning capital to grow traffic.
“You wanted to buy market and mindshare – clicks and eyeballs – while it was still greenfield,” Alex says. “Of course, that all went to hell when the expected economics failed to materialize.”
It turned out that pageviews were not a great survival metric. And so pageviews, like many of the companies that garnered them in 2000, are dead. We’ve learned from our mistakes.
“We moved one rung down the value chart closer to profit,” Alex explains. “If an attracted eyeball is potential revenue – in the potential energy sort of sense – then in the first dot-com boom, we were at the top of the profit funnel. This time around we put a different god on top: revenue growth.”
All this sounds pretty good to me. I can see where things could go awry with overvaluing traffic, but more revenue has to be good, right? It turns out, though, that growing revenue can be quite expensive.
“Lots of the revenue that startups are buying – cash burn in the short-run on sales is revenue acquired via spend – may not actually make money in the end,” Alex says.
“Revenue has proven to be either more expensive to acquire, or more elusive than expected. Therefore, before things get really rough as they might, companies are battening the hatches, raising, cutting spend, and generally trying not to die.
“Recurring top line revenue is lovely. But the math is harder than everyone thought. They invested, they spent, and now they are shitting themselves over a modestly correcting market.”
What Alex is saying, in so many words, is that, when revenue costs more to acquire than it’s worth, the faster it grows, the more cash you burn.
The cost of revenue
Two important metrics for tracking the relationship between revenue and burn are Customer Acquisition Costs (CAC) and Customer Lifetime Value (LTV).
CAC is a simple calculation of how much a company is spending to create new customer (sales, marketing, Cost per Install ads, swag, ect.) divided by how many new customers it brings in. So if you spend $100 to find and onboard 20 new customers, your CAC would be $5.
And LTV is the average revenue that a user will bring in over their lifetime as a customer. Let’s say your company makes $3 a month on its users, and retains users for an average of 5 months. Your customer LTV would be $15.
So the ratio of CAC to LTV would be $5 to $15, or 3. So for every dollar you spend acquiring a customer, you make $3.
But when your CAC is higher than your LTV, you have a CAC:LTV ratio that is less than one. With a ratio under 1 as your company grows, your burn rate grows, and the shorter your runway gets. You’re adding customers and revenue, but it’s more than offset by the expensive cost of acquisition.
A case study in Lean Analytics by Alistair Croll & Benjamin Yoskovitz outlined how Backupify paid nearly $250 to acquire a new user, but only charged $39 a year. This meant that Backupify wouldn’t break even on a customer for more than six years. Not surprisingly, they rethought their model, and pivoted from consumer- to business-facing.
But too high probably isn’t ideal either. If your lifetime value is many times what it costs for you to acquire a user, arguably you should be optimizing profits by paying more per user to grow faster. If you’re only spending $3 to get $30 worth of revenue, it would probably be beneficial to spend a bit more per user and grow faster.
This isn’t anything advanced or novel. It’s basic math. It’s just not something many non-founders think about, or at least talk about. And if you’re helping to build a great product that you hope will return some fiscal value at some point (or at least make your stock options worth something), you probably should.
Know your role in survival metrics
But for a product person, a developer, what does that mean? It’s not hard to see the things that they care about. Look at the metrics that product and engineering meticulously measure: onboarding conversion, active users, retention. Crucial metrics, but those growth numbers don’t exclusively reflect the health of a product.
A designer might be more used to thinking in the terms of the conversion rate of a flow. But, when you’re looking at how much it costs to acquire a user, if spend is consistent and new customers grow because of a better performing onboarding flow, CAC will go down.
Similarly, a product manager already cares deeply about customer retention, and it only takes going another step further to see how that metric affects LTV. The longer a user is retained, the more she accumulates value for the company.
For years tech has forced finance to think about tech products from its perspective, valuing user growth above all else. Perhaps to be prepared for a fluctuating market, we should all appreciate our products more from a financial perspective. Maybe marketing teams haven’t completely ignored metrics like Customer Acquisition Cost and Lifetime Value, but they certainly haven’t been the in-vogue numbers for growth hackers, product managers, and designers. And we certainly haven’t focused on how our individual efforts contribute to the overall burn rate.
But these survival metrics aren’t just the responsibility of someone in finance. To survive we all should understand the numbers behind how our products perform. All these metrics are all intertwined. Designers, developers, and product people all play a role in helping their company survive and, hopefully, thrive.
— Mixpanel (@mixpanel) June 23, 2016