Friday, July 13, 2007

Startup to IPO: Choosing your sales channel strategy

For young software companies one of the highest impact and most expensive decisions you can make is what type of sales channel to use. Impactful because if you get it right you can grow revenue and customers quickly but if you get it wrong it does not matter how good your product is, the market won’t be able to adopt it. Expensive a) because of the above (which is one of the most critical issues as you get the company off the ground) and b) because you’ll spend money developing any of the alternatives and you’ll spend more money if you decide the right strategy is to go direct.

In this posting I’m talking about software companies that are in a B2B business model – selling to a professional user. In my current case, FirstRain, the user is in the buy-side of financial services or a corporate user, typically in marketing, sales or finance; in my last company the user was a semiconductor design engineer but the issues are the same in both cases.

There are three basic approaches to consider:

VAR or OEM: In this case the VAR (or OEM) designs your product into their platform. Sometimes it will be fully buried and not visible, sometimes visible but well integrated so the user is getting an advantage from your integration into their platform of choice. If it’s not integrated then you are really dealing with distribution in the guise of a VAR so beware (see below).

VAR relationships are great if the whole is greater than the sum of the parts. If you have designed a product that is good on it’s own but great when integrated into another system then this can be the most efficient way to go to market and grow. The VARs become part of your customer set and you serve them accordingly. You’ll often still need to talk to end customers to figure out what’s needed next and how to improve your product but the VARs needs can become just as important because they are your oxygen – your access to the market.

In our case this would be integration and distribution through a financial platform like Thomson or CaptialIQ. If we had a service that leveraged their data and platform in a unique way to create a customized service for select end markets it would make sense. However, we don’t do this today (see direct below).

It can definitely be less expensive to go the VAR route. It requires investment into business development and support resources but not a full sales force. The risk is whether you pick good VARs and whether you can get more then one. To have all your revenue coming from one customer is like selling your company without selling your company. You’re owned but without the financial benefits of being owned. So, for the strategy to be successful it’s important to identify and sign up multiple VARs, each with a unique integration of your product, to ensure you have some direct customer access for product design and to make sure they are focusing enough to get you growth in your end markets.
(VAR: Value Added Reseller. OEM: Original Equipment Manufacturer)

Distribution: Probably my least favorite for a software startup although it can be good for hardware. In a distribution relationship a rep or company agrees to resell your product as is. Sometimes it’s a soft reference sale – introductions, helping you through the front end of the sales cycle only – and sometimes it’s full distribution – taking your product through the full sales cycle including evaluation and close. For the former you pay less to the distributor and your sales costs can come close to direct, see below.

The advantage of distribution is clearly cost. You’ll typically pay a percentage of the sales price to the distributor and you train one team once and then they run with your product, taking advantage of their existing relationships and infrastructure to develop and make the sale. But the risk lies in two stumbling blocks: First, can the distributor truly represent your product? Do they have the knowledge to do it and can they focus enough? After all, making sales is life or death to your young company and not to them. But even if that hurdle is overcome the second issue is the higher risk to a new product and often overlooked. Can you get the information you need with an intermediary between you and the customer? If you have designed the product to ultimately be standalone (so you haven’t chosen the VAR or OEM route for that reason) it is critical to be in an intimate, give and take discussion with your customer so you can tune your product to perfectly match their needs – essential to creating a great product. Very tough to do unless you are in a direct relationship and I’m not a big fan of distribution for young B2B software products.

Direct: Definitely the most expensive but also the most rewarding if you have a rapidly evolving technology.

Setting up a direct channel is expensive because you need to lay in significant costs ahead of revenue if you want to scale. You need to
a) hire a great sales manager (yes, many entrepreneurs and CEOs think they can do this themselves, moi included, but having worked with great sales managers I swallow my ego and bring one on),
b) hire a (small) sales team – and plan for turnover because some of them won’t make it
c) hire a customer support team (although R&D can do this early on) and
d) develop a sales process, often through trial and error, until you have a model that scales. “Scales” means you can add 10 sales people and get 10X the sales you get from 1 sales person today. A lot harder than it sounds. Often sales people take 6 months to become truly productive so you are paying their salaries (and IT and office costs) 6+ months before they produce.

But the advantages can be spectacular: A direct relationship with early adopter users who will give you feedback and guide you to make your product great, not just good; the ability to try out ideas quickly and to rapidly respond as you see customer usage patterns; the ability to try out difference markets and messaging – it’s not unusual for young companies to try several markets before they find the one that is explosive for them and – when you work out the sales process – the ability to double or triple sales headcount and so double and triple revenues. I’ll write about the metrics that tell you when you’re ready to scale in a later post. And finally, the ability to focus and have 100% of a sales person attention on your fledgling product instead of competing for attention with more mature products.

In our case we’ve decided to go direct for FirstRain. The reasons were the advantages of the direct sales model. When you have a powerful technology that is revolutionary but needs to be integrated into a customer’s existing process I believe focus and frequent conversations directly with the end user are absolutely essential.


Jason said...

Very nice post about sales strategy. Well, it's 2 am and I am working on sales strategy for my startup.

One thing that you did not mention in the post is that a lot of SaaS companies, like, allow you to sign-up and pay directly from the web. What do you think of this approach?

It is still a direct channel. However I think that showing your price in clear sight will just automatically engage yourself into a price war with all the other competitors out there. Surely you can charge more if the brand is already built up, like SalesForce. Young companies will usually offer cheap price, hence "free", to attract new customers with no clear sign of how to make a profit. Plus people (or companies) tend to compare price and ignore the other factors when they see the price tags early on.

Penny Herscher said...

Jason - the critical metric is transaction size. If you can achieve a large enough transaction size then a direct channel works, if not it becomes too expensive. Likewise too large a single user price - which would be the online transaction size - won't work either because people don't like to use credit cards for large transactions.

Jason said...

To reply me so quickly, that is great. To reply me at 6 am, that is just awesome!!! Thank you for teaching us and the world on how to be a hard working CEO.

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