May 28, 2017 John Tough 0Comment

There are many lessons you learn early in a VC career. You learn how to identify product-market fit, size a market, evaluate a team, review the business model and determine scalability within the market position. The list could go on for days.

And yet, one of the items that I only slightly recognized in my ongoing venture experience – but ABSOLUTELY recognize in my operations experience is the importance of establishing a very lean (or non-existent) marketing budget for the early stages of a company. There are two main reasons why:

1) Organic / “free” customers that are naturally drawn to your product for the service you offer are VERY different customers than customers acquired through paid channels. The cohort analysis on an organic customer will (almost) always show significantly improved economics versus a paid customer. Solving for your core user base and improving the product-market fit by not being distracted by more secondary, paid channel customers is key. Quite simply, paid customers could hide the real solution you want to solve for with your early adopters. Optimize for those early customers before expanding.

2) Venture capital firms expect a 30-50% annual return on their capital. It is pretty dam hard to get a 30-50% return on marketing dollars. There are many high flying adtech firms out there promising returns of +1-2% more than usual channels – and those companies are still questionable in their success. And even more scary is that if there is an easy way to get a 50% return on marketing dollars, the returns will quickly be competed away by competitors. Just look at the food delivery market. Competition will drive down returns to marginal cost. Combine that with sunk cost bias and you can see why VCs and high flying unicorns are raising hundreds of millions of dollars for what can quickly become a commodity product.

Jim Goetz at Sequoia Capital made a great comment in a recent HBR article that I believe demonstrates the danger of excess capital, usually spent in marketing.

“In our portfolio there is a correlation between cash required and long-term market cap—but it’s negative. The more you raise, the less value you create. Google, Cisco, and Oracle were incredibly efficient with their cash, as were ServiceNow and Palo Alto Networks. Those companies all had market caps north of $10 billion within a couple of years of going public. One curse of raising lots of cash is you lose that discipline. We discourage our teams from raising too much capital.”

Yes, you are reading that right. More cash = less success.

In summary, when you raise money as a young company, focus on nothing but customer-driven product development. Focus on listening to your early customers to create an amazing product that will serve them so well that the customer not only WON’T go anywhere else, but actually CAN’T go anywhere else to meet their needs. Save that money to hire better engineers and do more customer inquiries. In fact, I challenge you: give yourself a $0 marketing budget for the first 12 months and see how scrappy you can become. You will thank yourself later – because when you are ready to let yourself enter the paid customer acquisition channels, your barrier to entry and competitive advantage will be significant.