January 8, 2019 – When entrepreneurs approach me to discuss issues related to their product develop or sales & marketing strategies, I generally tend to have one of two discussions with them- Are you creating a vitamin or a painkiller and Are you developing a feature, a product, or a company? Both of these topics came up during recent ITEN Office Hours so I felt the need to dedicate a blog post to walking entrepreneurs through these discussions.
Feature, Product, or Company
The vitamin/painkiller discussion is an attempt for investors to uncover product market fit insight, and the feature/product/company discussion is an attempt for investors to determine whether or not your idea can support a commercially viable business model. Unlike product market fit, this is a more complex issue to assess since there are multiple factors that can determine the long-term success of your overall business model. Including but not limited to: a strong product market fit, scalable sales & market strategy, good margins, large enough opportunity, etc. Evaluating any one situation to determine where it falls can involve a high number of variables, but I will try to offer some insight that can be applicable to most.
Features & Products
It’s tough to distinguish between features and products but both are missing key components that will allow them to grow into stand-alone businesses. Unfortunately, it’s something that becomes easier the more business models you have been exposed to- investors refer to this as “pattern recognition”. Here are some examples:
A New Instagram Filter (Feature)
While your filter may be very cool and people love to use it, it will be challenging to commercialize the product because; it’s difficult to market, you can’t charge a lot since it’s not a “need to have product”, and outside of an established social media platform—most of which supply free filters—the filter has minimal utility. Thus, it would be very difficult to build a successful business based on a single smart phone filter.
Widget for a Larger Enterprise Level Software Solution (Feature/Product)
I routinely see companies pitching investors that are developing an add-on product for larger more established infrastructure technology such as a CRM like Salesforce, an Electronic Medical/Health Records like Cerner or Epic, or email server like Gmail and Outlook. Unfortunately, even if these “companies” have a strong product market fit their high dependence on another technology combined with the difficulty of building a scalable sales & marketing team limits/restricts the opportunity to grow beyond a feature or a product and into a stand-alone business. Sometimes these products are able to be effectively commercialized through a network of distributors. But unless you have high margins the distributor fees can make it challenging to scale efficiently, thus limiting the overall growth potential of the company.
SaaS product for Enterprise Clients (Product)
Not all enterprise SaaS solutions can grow into standalone companies like SalesForce or Epic. Most enterprise level SaaS solutions I run across entrepreneur’s pitching have a weak product market fit and thus won’t be able to gain a large enough market share to be a stand-alone company, are targeting a problem that represents a limited market opportunity, or have additional challenges related to scaling the sales & marketing efforts efficiently. These types of products generally require being sold as one product in a portfolio of similar products.
Drug Discovery & Medical Devices (Product)
Developing a new drug or medical device can create products with an extreme high product market fit but due to the highly regulated approval and sales process commercializing these products can be too cost for a small company. Due to the economic challenges associated with commercialization most companies will need to partner with a larger pharmaceutical or medical device company that have the internal resources and capital in place to bring the products to market or will be forced to use a distributor that already has an established sales force and a portfolio of similar products. Alternatively, these companies can sell their assets/intellectual property to a larger company better suited to commercal the assets.
What’s wrong with developing a feature or product?
The short answer is nothing, but you need to approach product development, sales & marketing and fundraising with full knowledge of your limitations. Too often I see entrepreneurs developing features with full blown financials projections that “justify” their ability to be a stand-alone company in 2-3 years. Reality is that these financial models are built on bad assumptions that grossly overestimate the market penetration potential, ability to scale the sales & marketing efforts, and underestimate the churn rate. The same thing happens with products. Where entrepreneurs try to convince investors that they can be a stand-alone company when the reality is that the only way to economically scale the sales & marketing efforts will be through distributors. Which will significantly decrease the gross margins thus making it difficult to see the year over year growth that their investors are expecting.
The Investor Perspective
Investors write checks to entrepreneurs with the expectation there will be a financial ‘return’ on their investment. Unfortunately, most of the investments early-stage investors make don’t deliver a financial return. Thus, seasoned investors are looking for investment opportunities that offer them the potential for an outsized return since they need to recover their investments into failed companies. Subsequently investors have minimal interest in features and some products.
When features are acquired by a larger company, the acquisition price is generally low and investors don’t see much of a return on their investment. This is because the acquisition is either an “acqui-hire”- where the team is acquired to build new features for the acquiring company, or the company is acquired for their raw intellectual property. In both of these situations, the acquiring company is acquiring raw assets which will take awhile to be commercialized and generate revenue.
Products can make great investment opportunities for early-stage investors assuming the deal is structured properly and the management team is focused on achieving the milestones required to make them an attractive early acquisition target. Classic examples of early acquisitions of companies developing products are the acquisition of new medical devices following FDA approval and strong early clinical usage data, new drugs that either have demonstrated stong preclinical data or positive early clinical data, widgets being acquired by the larger enterprise technologies they are integrated to expand the native functionality of the larger product, or SaaS solutions being acquired to develop a strong portfolio of SaaS solutions that can be bundled into a larger technology offering.
Investors are attracted to investment opportunities from stand-alone companies since they offer multiple options to generate returns, ranging from dividends, merger/acquisition, to an IPO, many of which are not realistic for features or products.
It is important to note that these designations are not necessarily static, they can be dynamic. Your idea can start as a feature, develop into a product as you add more features, and then transition to a stand-alone company as you begin targeting new market opportunities or bundle it with other products. However, this will require the management team to create a plan that outlines what developmental and sales & marketing needs to be achieved at each stage and how the company’s focus will adjust as the technology and team transition between the three phases—feature to product to stand-alone company.
Keep in mind that most investors use sales as an easy proxy to test product market fit, ability to commercialize your idea, and develop a scalable successful business. Strong early sales will suggest to investors that you have a solid product market fit- you are a pain killer not a vitamin, and that you have identified an economically viable path to commercialization that can hopefully be scaled into a successful standalone business. Therefore companies that are meeting resistance from early-stage investors should look to strengthen their early sales efforts and if your early sales efforts are sluggish entrepreneurs need to revisit their product market fit- are you developing a vitamin or a pain killer, and determine whether or not they can actually develop a viable business for their idea.