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Why churn is a critical metric for investors to understand in startups

David Skok | Four-time founder, investor, and author of the blog For Entrepreneurs

  • | Acquisition | Customer Success | Growth | Metrics | Retention
  • July 2019
  • EP16

Startup Investing

Why churn is a critical metric to understand

Today on the show we have David Skok, a four-time founder, investor, and author of the blog For Entrepreneurs.

We chatted about how David evaluates startups to invest in, the definition of product market fit, and what he looks for after it.

We also discussed the importance of churn and retention in the investment evaluation process, the key characteristics that companies with great retention share, and the power of negative churn.

David also shared what a healthy LTV to CAC ratio should be, why the time to recover CAC is critical, and what attracted him to SaaS, to begin with.

I really enjoyed this conversation and I hope you do too!

If you have any feedback I would love to hear from you and you can email me directly on Andrew@churn.fm

Enjoy the episode!


Highlights

Time
How David evaluates startups to invest in 00:02:30
What David looks for after product market fit 00:05:30
The definition of product market fit 00:07:00
The importance of churn/retention in the investment evaluation process 00:09:00
Product value vs product usage 00:10:45
The key characteristics companies with great retention share 00:12:30
The power of Negative Churn 00:16:00
David’s top pick of public SaaS companies 00:18:00
Your internal champion’s impact on churn 00:19:45
Why Churn is a company problem to solve not a team problem 00:22:10
The methods of measuring churn and when to use them 00:25:00
Why your LTV to CAC ratio should be 3:1 or greater 00:27:30
Why months to recover CAC is critical 00:30:00
What attracted David to SaaS businesses 00:32:00
How HubSpot unlocked negative churn 00:34:30
Why David shifted to investing after a being a 5 time founder 00:37:50
Where David would start to help a portfolio company with churn 00:41:00

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David Skok

Four-time founder, investor, and author of the blog For Entrepreneurs

David’s recommended resources on churn

About the podcast

My name is Andrew Michael and I started CHURN.FM, as I was tired of hearing stories about some magical silver bullet that solved churn for company X.

In the real world tackling churn and increasing retention is one of the hardest problems a subscription business faces.

In this podcast, you will hear from founders and subscription economy pros who are taking a systematic approach to increase retention and engagement within their organizations.

Transcription

Andrew Michael
Hey, David, welcome to the show.

David Skok
Thank you, Andrew, great to be here.

Andrew Michael
It’s six. It’s really is an honor to have you on the show, as I mentioned, to like really big, big fan of your work. For the listeners who are not familiar with David, and his work. He’s a five-time entrepreneur. He’s the author of for entrepreneurs blog, it’s probably Eric is one of the sauce Bibles are recommended reads. He’s also a general partner at matrix partners. And he’s a board member on several different companies which HubSpot is one of those and be interesting to touch on some of that today. But thanks for joining. Good to have you. Yeah. Cool. So as mentioned, like one thing I wanted to touch on today, definitely is coming from your perspective as an investor. Now we’ll go back on to their entrepreneurial side a little bit later. But to start off our to just have a good understanding and your thought process when it comes to how you go about evaluating a startup when you think about investing it in? And what are some of the key metrics that you’re looking at Why?

David Skok
Got it? Okay, so one of the most important things for us, when we’re investing, is the founder. So we will spend a lot of time trying to understand whether we think this founder has a particular edge, particularly in service or they’ve been in this domain area that they’re working in for several years. And they have a particular understanding of that industry and how to disrupt it and whether they’re the right person to be doing that disruption. And do we believe that they have the kind of grit and intelligence and the ability to attract other key management players and be able to sell customers? So they need to be good at selling and evangelizing. So once you’ve got through that, we would then start to look at what is the nature of this product. And particularly important for us, if we’re investing at a stage where there’s a little bit of traction is to understand what kind of product market fit they have. And I think churn is really an incredibly good indicator of that. If they have high churn, then it’s really an indication that the product isn’t working. And that’s a bad sign, very bad sign. So we really care a lot, do they have product-market fit. So that can be one of the early ones. And sometimes we might go further than that, if it’s too early to really judge that, we might ask to see what’s happening with usage patterns of customers that they signed up by cohort. So we look through and we might even ask to see every single customer that and how they’re, you know, the revenue usage has trended over time to give us a sense of whether this product is actually working is really delivering the benefits, what they said that they would be delivering. So that’s, that’s where Chen comes in. And I think, for other things that we would care about, we really care about a large market. VCs, the way our model works is we need to create these really big winners, things that are fairly small, do not cover them, you know, the losses that you have in this high-risk business. So you have to have the bandwidth. So you can care about finding big markets, you look for things like defense ability, is there a way where this business model can actually have some significant defense ability, and you’re really ideally looking for things that are significant and big. So at this moment in time, for example, we still will see a lot of people who are looking for the nth degree of how they’re going to find you in sales enablement. It’s not really that interesting. What the idea that’s kind of a truly a big idea that’s going off to something unique. That’s not just an incremental twist of a tweak of something that’s already out in the marketplace out that

Andrew Michael
can change the way people work.

David Skok
Yeah, yeah. And you and you go to believe that this company is well positioned to be the winner in the marketplace and that you’re not seeing a company that’s well positioned to be made. Maybe number two, or number three, because that’s really not whether when it’s typically going to.

Andrew Michael
Yes, sir. Sorry.

David Skok
And so I gave you the earliest, earliest stage company, yeah, there is also another phase of a company that we evaluate, which is a little bit further down the line where they’ve got a bit of growth happening. And in that particular case, I really care about, you know, once I’ve established that they have product-market fit, my next question is How far are they in the journey to getting a repeatable, scalable, and profitable growth process. And those three words are incredibly carefully chosen words, they know, if you have something that you can repeat, and that you can scale up. And that’s also profitable, you should be hitting the gas and investing like crazy in that because it’s going to create profit for you. Even if it might take a little bit of time you invested on it might take three years before you get the $4 back out of the thing. Yeah. And those three words tend to be very easy to say, but really hard to achieve as a startup founder. So I typically will find that somebody halfway through getting to predictability have shown a little bit of ability to scale and is really maybe got some early indications that they can be profitable. And we can invest in that because it’s maybe enough indicators there that if we, you know, we think we can see it past the solving all the rest of it. But if they’re really well through that journey, then they’re going to get a higher valuation. And there’s less risk associated with the business and just much easier for us to get behind it,

Andrew Michael
and direct your investments as well. And you touched on product market fit as well, twice. Now, and I think it’s definitely a topic that’s probably most often misunderstood and be interesting to share sort of, from your perspective, like, what is product market fit?

David Skok
Okay, so product-market fit to me is when you are able to demonstrate that you have a decent number of customers that are in a single sector with a single use case that are all successfully using the product and getting the business benefits from it that you promised that they would get many business benefits, not just usage, they’re not just using the product. And if you decided to take it away from them, they would scream like crazy and say no, we, you know, we need this thing, this is absolutely essential for us. And you’re not seeing churn in people using the product or China people paying you for the product. And they should be paying you for the products as well. Because if they’re not paying you then it’s evidence. important enough. Yeah. And as for how many customers that means it would be a minimum of two. But if you’re a very low priced product, it’s probably going to be a much higher number than that sounding like a 50 to 100 customers that you’d want to see, to have evidence of that. And I do want to be clear here, that early product market fit even a company as large as HubSpot still is constantly adjusting to get better product market fit. So you never finished with that journey. But that’s sort of evidence that you’re in in the early enough stage to be interesting to a VC to, to invest in.

Andrew Michael
And so what you’re saying, is your product market fit, then it’s not a binary yes or no, you either have it or you don’t it’s levels of degree. And the further you get into company, just the further along that scale. You go and you get

David Skok
exactly right. Yeah, you got it. So

Andrew Michael
how important then, like his return or attention in your evaluation of a company you mentioned, it’s one of the things you look at, but how important is it that the different phases of growth of those companies, so you talked about earlier stage company, and then you talked about a later stage company?

David Skok
Yeah, so if you’re doing a seed stage investment, where it’s really just a concept, and you don’t have very much done at all, then it would be lower in importance. And far higher would be the quality of the entrepreneur and how much you liked this idea. As they start getting traction, I think it’s really one of the absolute top metrics, because it’s it’s the best indicator we have of product market fit. And product market fit is essential. You can’t build a repeatable, scalable and profitable growth process. If you don’t have product-market fit, you’re wasting your time to even start to try. So I think it’s you know, it’s probably one of the most powerful metrics that we have available to us. And the only other one that I would say is as powerful as that would be a measure of what kind of business benefit your customers are getting. And whether you’re actually delivering that or not. And do the customers agree that that’s an extremely important business metric for them to to really care about?

Andrew Michael
So basically, how far up on your customers budget lyst, you lie? Are you at the top? We’re at the bottom?

David Skok
And are you actually here impacting the, you know, the business process that they bought you for? So if they bought you to get more leads? Are you actually delivering more leads? Or do they want you to improve the conversion rates of that age? Are you actually improving the conversion rate of their funnel? For if you want them to make your salespeople more productive? Can they see in real productivity results that that salespeople are actually now more productive than they were before they started using your tool? And others metrics that we just discussed in Portland, all those three are very important to any business, but some of them, some of them are less important.

Andrew Michael
Absolutely. And I think that those while you’re definitely see a strong retention rates, if you send you’re delivering value, because ultimately, when you’re not delivering value, that’s when customers start churning.

David Skok
Yes, yes, sir. There is an interesting thing in here, if you don’t mind me taking two seconds? Because I definitely believe it’s worth I’m just thinking of a graph and imagine the graph is having value on the vertical axis and usage on the horizontal axis. The worst question is one way you’ve got high usage and low value. So you’re doing a lot of work, but you’re not getting a lot of value out of that product. The very best product is one where you drop it in and you don’t do any work. And it automatically works away in the background, and you get high value out of it. So that would be on the high left hand side of the graph. The most products for probably more in the you’ve got to do a fair amount of usage to get the value out. But certainly I mean, I give you an example of this. At HubSpot, one of the things that we struggled with in the early days was inside inbound marketing was a brilliant, powerful concept. And no question about it would deliver you more leads. But there was one huge issue with it, you had to host regular content, but you also had to do good content. So not only did it require a lot of work to deliver that business benefit, but it also required talent to deliver that business benefit. And that’s not a great thing. So the the if you The more you can find a product with is no rip dependence on your customers have talent, and less work required by them more business value delivered, that gets you into better and better in a segment of what kind of products will really work well.

Andrew Michael
And also, then what you’re saying as well, turns out from the speed is another aspect to that. So then the example of the blog, and the content is typically something that you see big returns, but the returns take longer to get to them as well. And

David Skok
exactly right. Yeah.

Andrew Michael
So we started touching on like a few characteristics, then be interesting to hear. From your perspective. What have you seen some of the most successful companies do when it comes to churn and retention? What are some of the key characteristics of these companies share that has this helps them be too strong retention?

David Skok
Yes, so one clear thing is they have built a great product. And so to me, I think one of the ways that that happens is at least one of the founders is a product person, and is intimately familiar with the customer and the customers problem, and really has just a natural ability to translate what the customer wants into an actual working version of the product. So that’s probably the most important starting point of the whole lot. Their second characteristic is you really have to be great at onboarding the customers. So once you’ve sold it to them, make sure that they actually know how to get up and running and get using it and get usage out of it. And the more you can make the product do that automatically without them needing to have people doing that process, the better. So again, it comes back to great product design is super helpful there because it can really make the product just intuitive and obvious to us without needing a long training session before you can actually get results out of it. Then another key characteristic for me of this is they have some metrics in place to understand what’s happening here. So one metric that I’d like to see is the measuring the onboarding process, did the customer success, come out of the onboarding, able to use the product and telling you that they are able to use it and scoring you highly on what they were able to achieve that. So that that one of the reasons why I bring that up is that we found out that churn is most highly correlated with two things. Number one, did you onboard them successfully? And number two, did you lose your champion in the business, those two things are the highest indicators. You think about the onboarding thing, a lot of people think they can stop churn by having a sales force that runs around trying to close everybody on the 11th month before the contract expires. But go back to your own experiences here. If you bought a product, the moment you’ve bought it, you’re actually kind of excited about it, and you’re willing to put in time and effort to make it work. If it doesn’t work for you, you get really disillusioned. And if somebody comes back to you 11 months later and says, Hey, I want you to give this thing another try. It’s a hell of a hard sell to get them to retry this thing. So you’ve got to get them at them when they are excited and make it work, then that’d be one. And then you know, going back to the metrics here, I do think the companies of the great at this also have a way of measuring the effectiveness of the product. And so in the simplest case, you could measure usage of the product. But I did love that, as I mentioned before, you could be using something heavily and not getting a lot of business value from it. So I’m far prefer the idea of measuring business value. And finding a way to say is my product actually delivering on increasing the number of leads or increasing the conversion of leads in the funnel or increasing the productivity of my salespeople, whatever your business thing that you’re trying to impact. And because if you can measure that, then you’ve got a fantastic report that you can send to your champion every quarter, that gives them a good reason to remember Oh, yeah, we’re paying for this thing. But we’re getting more out of it than we were paying for it. So this is a good thing to keep you out. If they get lost, you still got easy justification to the CFO whitelists money well spent. So that’s my series, I think that I think one of the other parts of this is they have negative churn. And, you know, let’s, let’s explain negative churn for those that don’t know what negative churn means that you’re always going to lose some customers every year. So let’s say you lose 10% of your customers every year, to have negative churn, the remaining 90% need to expand how much that paying you so that the filling up more than that 10% that you lost. And if you look at businesses like zoom, zoom has 130% revenue retention, which means that every year, every customer that they had spends 30%, on average, every customer they have spent 30% more next year than they did last year. And the year after that, they’ll spend another 30% more, and the companies that have that business model. To them, this got 122% or something like that negative retention rate. And there are others out there that I’ve heard of that have even 140%, negative revenue, retention rate or negative. those businesses are unbelievably successful. And they get me very, very excited as a investor out there. Because even if you stop all the sales and marketing, they will still keep.

Andrew Michael
This was actually one of the questions I had for you for later. But if I were to look at sort of public companies currently, which is your favourite sauce company, I had on my list like zoom was going to be one of those analysts thinking you would be mentioning that

David Skok
Yeah, I am super excited about.

Yeah, so I bought into that in a big way when it did its IPO. And it’s already up to about 50%, actually, which is amazing. It’s drastically of a price right now for where its revenue is. But yeah, I like the fact that it has viral marketing. So you know, if you invite me to a zoom, and I see how well and easy it was to set up, I’m going to think about using that the next time around. Yeah. And I also like the fact that has a bottoms up entry models, so an individual can start using it for free. And then you get a lot of usage, and then you this episode of land and expand and expand business model. I love that. And then I love the fact that it’s really entering a huge marketplace. And the product really works. We throughout our $750,000 Sysco video conferencing system replaced it with the Zoom Room, several zoom rooms, and it’s worked so well. And I see every one of my conversations with entrepreneurs is done on zoom just like this one must be prompting you to do it on Supercell. I love them. I also happen to love by the way Atlassian because they have a very low sales model. And wherever you are able to do that, you have something super powerful that takes place, which is all the money that if you look at Salesforce com sales and marketing line, it’s a very high line, I don’t remember the exact amount but it’s it’ll be something like in the 40 to 50% of their revenue will be spent on sales and marketing last year this way down below that. So they were able to take all the money that they would have been spending on sending the customer care about which is sales and marketing doesn’t benefit the customer. But all of that into r&d, which does directly benefit the customer. So that creates a sort of a beneficial loop where you’re giving the customer more of what they care about, which is great product. And that’s a much better investment.

Andrew Michael
Yeah, we actually had someone from Atlassian Sean Coutts, the previous link is a previous VP of growth on the show. And he definitely spoke a lot to that as well. I’m not being a sales side of things. But then also, like you said, land and expand model where anybody can just get started within the team with JIRA. And then eventually, these different units start popping up within our organisation and somebody in the company comes along and says, Hey, wait a minute, like we need to get a company account. Let’s bring this in. Another thing you said as well, which was interesting. The first time that it’s come up is the concept of sort of having a champion within the company. And you lead to there was two things. So one is the psychology and like really onboarding, and we’ve talked about that on the load of the shows, like probably the biggest area you can improve retention is focusing on those things first, on today’s, but the thing that hasn’t come up, and it’s interesting up here, to your perspective, is how this came about how you figured it out in terms of having that champion within the organisation that drives and figuring out who that champion is. Yep,

David Skok
yeah, your champion is typically the person who helped you get the sale because they were willing to take a risk. And they generally are a change agent of some kind that has got a little bit of grit to face up to taking risk in their company and bringing in something new. And when that person leaves, if there’s nobody else there who’s a big supporter and fan of yours, and you come up for a new, you run a huge risk that at that moment in time, it just drops away and the new person coming in to replace that person’s got their own agenda, different tools that they’re loyal to. And they really often want to prove that the previous guy wasn’t actually that good. And they’re better than that. So they’re going to change stuff up just to prove that. So we saw this happening time and again, and companies that we’re seeing high churn is that this was a big factor behind why they were losing deals. So we thought that, you know, if this is important, you should have a regular call into that customer, at least quarterly to figure out is your champion still there. And if there isn’t, if they aren’t still there, recognise that you’ve got a completely new sale to do, even though you’re not going to get any revenue from that sale. Now you’re going to save the renewal, if you do manage to sell the replacement. But even better still is to anticipate what kinds of things you could do to do well, even if you do lose your champion. And I mentioned, for example, being able to produce ROI reports that gets seen by a broader set of executives inside of that company. Yeah, really clever thing is to find out, can you produce the report that gets seen either at the board level or the management, you know, regular Monday meeting that shows the status of your particular part of the department, because that way, you start getting built into the fabric of everybody who’s a key decision maker that they know what you do, and they know why you’re useful.

Andrew Michael
And making your champion look good as well and basically doing the job for them. Exactly. So in that as well. What do you see some of the common challenges that people may can come some of the mistakes that you’ve seen companies do when they’re trying to tackle churn.

David Skok
So here’s a big one. I think there’s a lot of companies out there that think if they hire a great VP of customer success, that should solve that problem. And really, the important thing to understand about churn is that it is actually a company problem and not a departmental problem. So if you think about product, anybody who’s doing r&d, who does high-quality engineering and develops without bugs, they can have a very big impact on not having challenges through a high-quality product, the Product Management Group doing a great job of defining the product well and building great UI, they have a big impact, a much bigger impact probably in the customer success department can have, yeah, if the documentation people are writing documentation Help system have done a great job of writing that that can also have a big impact on it, the sales people can make a huge impact. Because if they oversell the product, or if they sell it to the wrong kind of customers, where it’s not really a good fit, which they will often do if they’re compensated wrongly, they will damage your churn rate. You have all sorts of other you know, areas, obviously, the support group and the onboarding group have a very high impact in the thing. Even billing, they can annoy people with the people who are doing pricing and packaging have a big impact on you know, whether you whether you get the chat, right. So I think the starting point here is to recognise this is a company wide problem. Yes, it makes sense to have a single individual perhaps tasked with trying to bring everybody together to focus on that problem. But the CEO should be working with that person hand in hand to help them align all of these other groups. Everybody in the company should be thinking about shell and realising that they can play a role in reducing churn.

Andrew Michael
This is actually one of the biggest reasons why I decided to start this podcast because also I was quite tired of hearing these different storeys of this magic number that magically solve churn or like a silver bullets that somebody came up with. And really, when you start to technology, see like how much of an impact everybody in the company can make. And it’s important that the company is aligned to be solving. It’s like it’s not the responsibility of an individual or single team. It’s really like, let’s see what we can do as a company as an org to align ourselves to make sure that we focused.

David Skok
Yes, yeah, absolutely. Nailed it. So you talked as well about

Andrew Michael
churn itself. And I think like when we look at it as well, there’s different ways to measure churn. And typically, we can either look at customer churn or we can look at meta mirage. And you mentioned in the case of tennis, maybe you want to talk us through the different types of ways of measuring churn and which wine is useful in which cases. Great. Okay, so

David Skok
let’s start with customer churn, which would be simply the number of customers that you’ve lost as a percentage of the total customer base. And that’s clearly a very valuable metric to have. But imagine the situation we’ve got only two customers and one’s paying you $100 a month and the others paying $1,000 a month. Obviously, if you lost the hundred dollar customer, it’s a lesser deal than if you lost the thousand dollar customer. So you want to measure dollar churn and gross dollar churn would say, if we lost the hundred dollar customer, where we lost 100 out of 1100 dollars, so that percentage, would you say like 8% or so it will last the thousand dollar customer, we would have something like a 92% of gross revenue churn. So customer churn would be 50%, in both cases, if we lost either one of them. So that’s why you want both of those metrics. Now, the, it’s still useful to know how many customers you’ve lost. Because if you’re losing a lot of customers, you it’ll probably tell you something interesting about the fact that you may be selling to a set of customers that you probably don’t want to be selling to and or you maybe do want to be selling to them, but you don’t have a good product-market fit with them, your pricing might be too high or your product features might not be right for them. So you want to segment your customer base and look at churn by segment and it can be super powerful to actually break your customer base down and look at maybe enterprise customers different SMB customers and understand your churn rates them. So then you get to the net dollar. And that means if there was expansion in one of those customers, let’s say for example, let’s go back to that storey where we had only two customers, one at 101, or 2000. And we lost the hundred dollar customer. But the thousand dollar customer ended up expanding from 1000 to say 1300 dollars, well, bigger, we got negative churn then and that’s a marvellous thing. So you really they want to measure that as well. There’s three metrics there for churn, you want your customer churn, your gross revenue churn, and your net revenue churn. And they’re all very powerful indicators of how well your businesses

Andrew Michael
continue looking to different aspects. Yeah, in terms of like powerful indicators for Well, your businesses doing I think it’s something you talk about a lot. And that’s when it comes to like the LTV calculation, and what makes a healthy business. So looking at the lifetime value to the ratio of the customer acquisition costs. So I think it’s three to one you typically talk about quite a bit, but maybe you want to tell us like, how did you come about this metric? Like what sort of gave you the first insight to say, Okay, this is what a good indicator of a healthy business,

David Skok
right, so this is, this is fun, because it goes right back to about 2007 2008 timeframe, right at the very early days of SAS. And it, I kind of recognised that, to my mind, people needed to understand that in a recurring revenue business, it was crucial to recognise you had a fundamental cash flow problem, or at least p&l problem, which was, we were going to spend a tonne of money on acquiring the customer. And there was a good chance, you wouldn’t necessarily make it back in the first year even. And if that was the case, you would have a very bad set of financials using normal accounting principles like gap accounting, which is the standard way that an investor would look at a business. And you would have to find a different way to look at that business to judge if it was going to be good or not good. And the right way to do that would be to understand, Well listen, if I got this customer, and even though I haven’t really made profit out of them in the first year, but if I can keep them for another eight years or six years, and they’re going to continue to pay me money, I got to have a great business here. So the best way that I could think of that we could represent that to investors and board members and management to understand if their business was working was to look at lifetime value of that customer compare it to the cost to acquire that customer. So hence, I felt that that ratio, LTV to CAC was a really important ratio. And I guessed it the three to one number. And the reason why I guess it would be more than say two to one or whatever was you have to have product expenses covered GMA expenses, rent, all those sorts of things have to be covered as well as your selling expenses. So if you will just want to warn you, Amelia, covering the sales expenses, that wasn’t going to be any good. But in order to cover that must have some room to create some cash to go after signing up new customers. And in reality, I would say all the good businesses I’ve been involved with, they’re actually above, say four and a half and three is really on the low side. But if you’re not a three, forget it, don’t even think about hitting any kind of accelerator pedal to grow your business, go back and fix that number. And if you know if you if you only be about four and a half, then you should start to feel good about yourselves and really think like, Okay, now we’re in the kind of, and plus leading companies, I think I’m not mistaken zoom might be as high as nine or 10. Among. So there are some great time to put the Yeah, and I see it is extremely high on that list as well, because their CAC is so low in their nature. And there was another crucial metric that I introduced at the same time, which was months to recover Kak. And the reason why this was so crucial is it turns out, if you don’t recover your CAC, in in a short period of time, you will burn through a boatload of capital, trying to grow your business. So this is about capital efficiency. And it turns out, again, I’ve done I’ve looked at many businesses here, I originally said you should try to go in for less than 12 months, to be honest, that was at a time when raising capital was much harder than it is now. And there was period all these days that you can get away with like 18 to 20 months of time to recover Kak. But remember that if you are that high, you will be better learning a fair amount more capital and somebody is able to do it in 12 months or less. Yeah.

Andrew Michael
And I think as well like one of the big drivers in this is retention really helps accelerate that payback period. And so when you’ve got a good retention model, it also helps you to build back your competitive muscle when it comes to acquisition channels as well. If you have a really strong acquisition, retention, then it really helps you drive those that

David Skok
kick down as well, monster, I couldn’t have said it better. Because you know, if you think about, most people think about it driving only the LTV side of the house. But if you’re losing customers, you’re going to have some unhappy references out there that are eventually going to start growing big enough that along the line when you start trying to acquire new customers, the words cannot be out there. Now we tried that thing. And it didn’t work for you to sell your product. And if you bought really happy customers directing us references, it created viral retention between

Andrew Michael
Yeah, and more customers you’re attending every month, that’s more money being paid back to every month payback period just really, really decreases with it. Yes. So I’m really intrigued as well, like you mentioned in here that you the 2000 17,000 metres when you first started talking about these metrics and the early days sauce. So I’m intrigued that what really attracted you to sauce in the beginning and like what really got you excited about this business model

Andrew Michael
was that there were two things here. First of all, I was very early into open source with an investment in j boss in 2003. And if you think about what we were doing at j plus, we were giving software away free, we had 5 million free users of Jay loss, and we were monetizing them later on. We were monetizing them with a recurring revenue model. So we understood the incredible power of recurring revenue as a phenomenally potent business model. And I’ll talk about that in just a second. And it was essentially one of those, you know, product led businesses that had this recurring revenue thing. So let’s get back to what what I learned out of that, well, if I haven’t taken a company public that had non recurring revenue, you realise that you had the scary thing, every single quarter at the end of the quarter, you felt great for one day, and then half a day later, you were sitting in nervous and worried because now you had to completely climb the entire revenue ramp all over again, from scratch, recurring revenue model, everything that was there, last quarter was going to be there again, this quarter. And anything you added was simply increase the amount of revenue had so a person who’s run a business and he’s tried to do it with your licence model will tell you that that’s a nerve racking business model. And this is a fabulous business model. And then I also realised that if you talk to people who are investors in public companies, probably one of the things that they value, the greatest is predictability of the business. Knowing that you’re not going to get a surprise, you’re not going to get a shock. And having that pretty stability for many years ahead. gives them a reason why they will value that company far higher than they will do with something that is just not could fall off a cliff tomorrow.

Andrew Michael
Yeah, so predictability differently, I think that’s at least for me, is one of the most interesting aspects because I definitely see like that stress levels every quarter trying to make yourselves cut. But knowing that you have this Predictable Revenue coming in, definitely puts you in a much better position as an entrepreneur as well.

David Skok
And I will say that, you know that it took me a little bit longer to practice probably around about 2009 2010, when I finally figured out the negative churn thing, that was one of the most important unlocks in this business model. And it was really fascinating because at HubSpot, we had what we thought was really cool, which was a single product at a single price point. But you cannot get negative churn with one product and one price. But in order to get it you have to have the ability to upsell cross sell different products or expand within the product. And so we came up with this importance. And we’ve actually done the same thing at j boss many years earlier, which is figured out we had we had five pricing axes that Jay boss would use. So we could get $10,000 from a small customer, but a million dollars for exactly the same product from a large customer. And we had to have ways to justify why we were going to charge them a million dollars for exactly the same thing. Yeah, so hence the five axes that denoted different ways that they would get more value from the product.

Andrew Michael
I think as well like this is something we’ve again, we’ve talked about quite a bit, but in terms of expansion, revenue, and coming down to pricing, and packaging is definitely one of those biggest leavers that you can pull as well when it comes. Interesting as well. Like, I think I watched as well. A video where you talked about the HubSpot case and looking at sort of what the value metrics were that you decided to pick. How did you figure that out in the early days, and as well, and maybe a j bus? What sort of led you to the insights, pick those Park different axes and understand or it HubSpot, where it was sales? I think you have leads is one of those metrics is a few other different metrics.

David Skok
Yeah, in HubSpot case, it’s the number of leads that are inside of your database with them. Yeah. And to fix it made that a particularly useful metric. One of them was that if you were using HubSpot, it was going to generate more leads for you. That was its first, you know, primary business driver as to why you would buy it. Yeah. So it’s great in the sense of if they were successful for the customer, it would automatically great growth, number of leads, and therefore the amount of revenue that we get. But secondly, I think this is maybe more important, is if you’re the customer, it’s really important that when you pay us to pay more money for something, you feel good about it. And if you’re getting more leads, generally, you’re going to feel very good about something after the fact that you’re getting value from this product. So it aligns well with the customers perception of value. And that’s kind of what you’re trying to do when you come up with these axes is figure out, how does the customer perceive value, and how I align my pricing with that so that when I just give them a high price point, they didn’t think of it as high they think of it as being one that’s a great deal, because the value that I’m getting from that thing is much greater than the amount of money they want to charge me for them.

Andrew Michael
Absolutely. I think this is something as well commonly, like people default to cost-based pricing. But when you start to realise the value in value-based pricing, it sort of unlocks a whole new potential for your business. And I think in SAS business specifically at the early stage, like passings, everyone things you just guess it’s like, what you recharge and you just go around the market, take a look at a few different pages. Okay. 5999 sounds good. Whatever it is, and when you start to realise the importance of it, you really start to see the potential that it does have a really good solid pricing strategy. Yeah. Yeah, I agree. Cool. Last question. I have a that is why investing sort of you’re a five times founder, you’ve been fed all of this building startups correct me from but you had two or three companies go public as well. Like, why? What made you decide to sort of step back and say, Okay, I want to start investing now.

David Skok
Yeah, it was less a decision to do investing and more have to do five startups, they’re very gruelling, they’re a grind. I mean, there’s no question. You know, even when they go extremely well, you’re putting your entire life into it, you have no time for anything else at all. And frankly, after doing five that I felt like, well, I’m just going to live the same movie over and over again, and what I’m what I really enjoy doing, I love helping other people. I like teaching I like, you know, I love there’s nothing more that I enjoy sitting down, talking to a founder about what’s going on in their business and seeing if I can help them. And so I knew that I wanted to do that. And I knew that if I if I was going to do that, I would need to have a way to make money to support myself. And it turns out that actually being a VC is a particularly good alignment of those two things, because particularly the model of how we invest, which is very deep customer engagement with our portfolio companies spending time with them really trying to help them out. You put in a lot of that work. And it’s a bit different to being the entrepreneur, I often liken it to being the grandparent you get there at the exciting moments where you’re formulating the strategy of the company, and then for the next three months to come Yes, to go and execute on that’s kind of dull and boring, because nothing really new happening there. So even check in with them again, you know, maybe a month later, and you’re at the high level strategic part, which is the most fun part of it. And you’re doing it with several businesses, I really enjoyed that. And investing centre to be a very, very rewarding and fun path for me.

Andrew Michael
I can imagine when you get to spend a lot of time in with some really talented founders and be always on the pulse of what’s new and what’s happened in different media,

David Skok
you know that yeah, that’s, that’s, that’s a huge attraction. I’m such an early adopter, if there is even half a day, the newest Apple product is haven’t got it. I’ve been cursing for some storeys, and I have to everything that comes out. And I love trying. I’m a sucker for new things, definitely. So it’s super exciting hearing, you know how people are thinking about that we have a very cool startup that takes the neuro signals that your brain sends down to your hands to figure out what your muscles should do. And by putting a cuff on your arm, they’re able to interpret all of those signals. So one of the demos that they do that’s absolutely genius is they give you a keyboard, and you wear these cuffs and you type for about five minutes, and they then take the keyboard away. And you were able to continue typing in fresh air and they will put the letters up there. So you’ve typed on real people, based on the signals that they’re reading off its surface of your skin. So you kind of see ideas like that, that right at the cutting edge.

Andrew Michael
Yeah, and that excites me just listening to it as well being able to have access to this constantly. So yes, I did last question next year. But I think maybe one last thing I’d like to leave the audience with as well is that imagine you getting started now look at a company now that you’re going to be working with portfolio. You see the company’s really like the retention levels are very low churn is high. What is one of the first things you would do to try and help this company turn things around? Like what would be your advice? What would you advise them to God and start looking at?

David Skok
Right? So I the one of the immediate things I would do is get them to stop spending money, and recognise that they don’t have product-market fit. And it’s not clear how long it’s going to take them to fix this problem. And keep that burn as low as possible. And then have the founders who’ve got the greatest product DNA, get out there with the customers and understand what’s going wrong. So first thing you want is an analysis of exactly why is churn happening is churn happening because they were on boarded badly is turn happening because the product doesn’t work in some crucial capacity is turn happening because you sold incorrectly and they oversold this thing. So understand the reason behind the charm. And then obviously, you can fix that reason. But almost invariably, the reason is going to come back to the product. And the fact that is the product is either not delivering the goods that you thought it would deliver. And in some startups, if you’re very early stage startup, this may be a time to actually really recognise your business may not be viable. And one of the smartest things, you could just shut this thing down and stop wasting your time on it. Yeah, but let’s, you know, let’s face facts, you gotta get the balance here, right, because the best entrepreneurs have grit to go through tough moments like that and figure out how to solve that problem. But you don’t want to overdo that to the point where you’re wasting three, four years of the best years of your life on something that fundamentally was never a good problem to be tackling in the first place. And you my top advice to people here is, I see, entrepreneur after entrepreneur after entrepreneur does not do enough customer development before they build the product. So they built something because they convinced the thing that how the customers what the customers are going to like. And then they find you start showing it to customers, they discovered it. Well, it’s sort of interesting to them, they’ll have meetings with them, but people aren’t buying the damn thing or whether or not it’s not see. So my top advice to entrepreneurs these days is look, you should do 50 to 60 phone calls, with customers potential customers, before you’ve gone further than building just some kind of a prototype, even if it’s just a PowerPoint deck that shows what the screens are going to do for them, and validate that they really care about that, that that’s actually a high priority thing that they really need and that they’ll pay money for the few that work in, you’ll save yourself so much expense and hassle later on. If you built the wrong product, you’re not going to modify that product to make it right. That’s that’s incredible wasted energy competitive. You’ve got it right before we start building.

Andrew Michael
It’s painful listening to this because I’ve made all of these mistakes.

David Skok
sorry to hear that I made a mould myself, which is what I’m saying fighting about them. I just try to help people stop making the mistakes that I made as well.

Andrew Michael
Yeah. Well, David, thanks very, very much been a pleasure having you today. I’m sure the listeners are going to pull out a lot of valuable insights from this episode. And thanks for joining.

David Skok
Yeah, my pleasure. great talking to you. Thank you.