BeyondVC

Competing with the big boys

I was talking to a portfolio company CEO today about his sales pipeline and one of the key items of interest for me was understanding competitive dynamics.  Besides looking at the raw numbers, I like to understand whether or not we are seeing more or less competition, why we are winning, and why we are losing.  As I started to dig into this area over the last two quarters I have noticed that the big boys or incumbents have started to show up in more deals.  In my mind that is a good sign because incumbents don't enter a market unless they believe it is worth pursuing.  I also typically do not mind competing with the larger players as they are generally less agile and less innovative than startups. 

That being said, incumbents tend to add confusion in the marketplace and lengthen any startup's sales cycle.  Their typical tactics including saying they have the product when they don't, promising they will have the product in one to two quarters (maybe three or four or never is the real answer), or giving it away for free in a bundle of other things that the customer buys.  The last one is a tough one to counteract - I mean if the customer gets it for free, then it doesn't have to be as good as an innovative startup's product, does it?  So how do you compete against these tactics? 

First, as a startup you have to get away from a feature/function battle because you will always lose against a big boy.  If a customer has already bought a product from an incumbent, they are more often than not willing to stay with that incumbent if they can deliver the extra feature/function soon enough in a good enough way. What I like startups to do is win with the product roadmap and vision.  Show the prospect how you solve their needs today better than the incumbent but more importantly why you are different and how your approach will solve their future needs.  If you can differentiate on this level, it gives you a much better chance to win. 

One other piece of advice is that you must qualify the opportunity early in the sales process.  If the incumbent is esconced in the account, you may be better off walking away quickly in pursuit of greener pastures.  As I got off the phone with the portfolio company CEO today, what made me happiest was not hearing about all of the wins against the incumbents, but how we walked away quickly from those types of deals. Just today the CEO had a conversation with a particular prospect who said that our software was the best but the incumbent was willing to offer it for $30k instead of $150k.  We ended up walking away from this deal and told the prospect to return to us when the product didn't work.  Having been through this before, I can tell you that many of these prospects will come back to you.  Over the long run, if the market is big enough and you build enough market share and critical mass early it will always be easier for an incumbent to buy you rather than start from the scratch.  If not, you may want to figure out how you can partner with the incumbent or their competitors.  Either way, remember one of your key advantages is to keep innovating and staying a product generation ahead of your competition.

When competitors are acquired...

It is clear that we are moving towards a consolidation phase in the technology sector.  M&A activity has been heating up over the last 18 months as strategic acquirers are looking to bulk up and broaden their product offerings.  During the last few months, we have had a few board discussions on this very topic.  The conversations were not about us trying to shop any of our companies as I firmly believe that companies are bought and not sold (see an earlier post).  Rather, our discussions focused on what happens when one of our competitors are acquired.  Usually when a competitor is bought at a huge price the first reaction is why it wasn't me.  The second reaction usually becomes fear as you begin to worry about what your competitor's product will do in terms of market share with a huge sales force and partner channel, strong brand name, and global infrastructure to support the customer growth. 

Having been through this a number of times, this is the point at which you need to take a deep breath, stay the course, and look at the situation in a positive light.  First of all, the majority of acquisitions fail.  Secondly, your competitor will be inwardly focused and quite distracted for the first 6 months trying to integrate with the parent company.  Finally, depending on how the acquisition was completed, employees will begin to leave as soon as they get the bulk of their money off of the table.  When a competitor is acquired, rather than sulk and worry about why it wasn't you, try to aggressively exploit the situation and use it as an opportunity to grab market share and poach some experienced and talented personnel from your nemesis.  Last year, for example, one of my companies was able to build an incredible sales team overnight, saving us six months of hiring and giving us an opportunity to hit the market harder and faster.  So the next time this happens remember that you will more likely than not be in a better situation after your competitor is taken out of the market leaving you with plenty of opportunity to grow.

Cisco, a value play?

I was reading Barron's this morning and came across an article (sorry-need subscription for this) claiming Cisco's potential appeal as a value stock.  It is hard to believe that this high flying company which once was the largest market cap company at $600b is now potentially a great value play.  The hot growth sector these days is energy and now Exxon Mobil is the largest market cap company at $400b.  Anyway, this table from the article says it all.  The P/E ratios (range from 18.7 to 19.6)of the tech giants like Cisco, Microsoft, Intel and Oracle are equal to or less than non-tech large caps like J&J, Wal Mart, and Coca Cola (range from 19.4 to 21).  In fact, Cisco's 2005 P/E at 17 is less than that of the S&P 500's at 17.4.  When most people think tech, they think high growth but this chart and these P/E ratios should really bring us back to earth.  I don't disagree with Larry Ellison's assertion a couple of years ago that the technology markets are maturing.  That is one of the reasons we see all of these huge mergers happening as companies seek to expand their markets, their product lines, and revenue.  That being said, there are still large pockets of growth which will provide startups with plenty of opportunity to succeed.  Cisco, for example, is spending heavily in new markets like security, VOIP, storage, and wireless.  The great news is that in pursuit of growth many of these big players are not afraid to pay up for the right products (think of the $450mm Airespace acquisition in the wireless area as an example).

Know when to say "No"

I have said many times before that with respect to doing deals that saying No is as important as saying Yes.  Let me elaborate.  A portfolio company has recently been in trials with a potential strategic partner about a reseller relationship.  We got in first, set the criteria for success to leverage our technical and business advantages, and were selected as the winner.  We had the most customers, the best product, and best customer support.  There was one huge caveat-one of our competitors who came in second place was willing to do the deal at a 50% discount.  The strategic partner asked us to do the deal at that price if we wanted the win. 

Of course, there was much deliberation on our side and as we ran the numbers over and over again there was no way we could understand how this competitor could ever make money on the strategic partnership.  From our calculations, it would take a couple of years to breakeven off the deal under the very best circumstances.  Trying to make the deal work for both sides, we went back to the potential partner and asked them to give us an NRE (non-recoverable engineering expense) and to handle level I customer support.  At the very least, if the partner handled the first tier of customer support, we could be marginally profitable.  The potential partner said no, and we walked away from the deal.  Trust me, it was a tough decision, and we tried to rationalize why it made sense.  However, when the deal is not a win-win situation it is very hard to make it work successfully. 

From my perspective, one of the huge problems is that there is tons of VC money out there and lots of me-too deals as Brad Feld elaborated in a post recently.  A space gets hot, lots of venture money pours in, and only a few companies survive while the rest vaporize.  We do live in a competitive world and taking market share and killing your competition is part and parcel with being in a startup in a large market.  That being said, what killed many companies during the bubble was pursuing market share at all costs.  I feel like that mentality is coming back in the market.  In my mind, losing money on every new customer signed up is not a long-term winning strategy unless you think you can get financed to infinity (yes, many did during the bubble).  At some point in time, to be a real business you have to generate cash flow from internal operations.  Having done enough deals, I am of the opinion that if it is extremely one-sided and never makes economic sense, it is a recipe for disaster.  To that end, I wish my competitor the best of luck because I can see the train wreck around the corner.  We will stay close to the strategic partner and when the time comes reopen the dialogue.