S6 E9 Advice from business’s best thought leaders made easy to understand and practical to implement - Jeremy Gray

Season 6 Show 9
Advice from business’s best thought leaders made easy to understand and practical to implement
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Today we  look at another case study and explore the theme, Why Startups Fail?

Then we will look at advice from a co-founder from Skype on the key actions startups need to take to scale up effectively.

In the last two weeks we have looked at businesses that had initial success but had to close within the first five years of business. This week our case study will consider the challenges of scaling up a successful business.  As you will learn, some of the factors that led to the closure of today’s business are not too dissimilar to the problems of the early start up businesses we covered in shows 7 and 8.

Today’s business was called Dot & Bo and was launched in 2013. The founder was Antony Soohoo, a serial entrepreneur with a solid track record. Even before he had finalized his plans for his latest venture he had raised $4.5 Million for a pre money valuation of $9 million.

Dot & Bo was going to focus on home furnishings, a market not well served by brick-and-mortar stores, which often had a poor selection of goods, aggressive but poorly trained salespeople and long delivery times.

Dot & Bo’s unique selling feature was that it focused on carefully selected collections of décor and furniture. Each piece was presented as part of cohesive room design. Each collection was presented as an episode in an imaginary television show, with the products as characters. When Dot & Bo were selling a chair, unlike their competitors who would focus 99% of their effort on selling the chair, Dot & Bo would focus 50% of the attention on the chair and 50% on everything else in the room. They would pull everything together and sell the concept. Similar to how a great interior designer would sell a design.

The price point made the products affordable, about 10% premium over IKEA with better quality and designs. This was appreciated by shoppers who were seeking great design and guidance. Sales in February 2013 of $10,000 grew to $750,000 by December 2013. Dot & Bo’s promotional emails were opened at nearly 3 times the industry average. It was a very strong launch for an online retailer. To maintain this rapid growth Soohoo decided to raise further funding. Such was the initial success that he received two term sheets within two weeks plus an unsolicited offer to buy the business of $40 million. Sensing the potential for the business the purchase offer was declined and a further $15 million was raised, giving the business a pre money valuation of $50 million.

2014 saw the business continuing to find success. Revenue grew to $15 Million, the company was able to maintain its product market fit. Repeat purchases remained strong. The lifetime value of the customers was estimated to be $200, with an average cost of acquisition of $40. This five to one ratio was much higher than their leading rivals.

However this rapid growth came at a cost. With margins of 25% Dot & Bo was spending over 40% of revenue on marketing. The business with sales of $15 million made an operating loss of $8 million. Growth was also putting a strain on the company’s supply chain. Dot & Bo sourced using a variety of ways, some products were shipped to their warehouse, either in advance of orders, or in small batches after orders had been received, others dropped shipped directly to customers. This complexity led to highly variable and often unreliable lead times. As a result Dot & Bo’s net promoter score pre delivery was 41, post delivery it was a disappointing -17.

It was clear that a seasoned manager was needed to run the warehouse and shipping functions. Soohoo hired a VP of Operations who had been a GM of divisions within two large high tech companies and had been a CEO of two startups. But he has never been responsible for e-commerce operations.

It was clear that the company systems were not up to the job and they needed an enterprise resource planning (ERP) system to manage procurement, inventory, orders etc. Unfortunately due to the team's lack of industry experience they made a poor choice for their ERP system. It could not handle the complex mix of sourcing methods that Dot & Bo were using. As a result goods that were available were listed as out of stock and vice versa. Sales were lost and many orders were delayed for months. The delays resulted in an increase in customer enquiries, unable to hire and train enough customer service staff email response times could be up to 11 days. Shipping costs ate further into margins as orders incurred rush delivery fees. The poor choice of ERP system meant that the company could not answer simple customer questions such as “where is my stuff?” Let alone calculate shipping costs, plan demand and facilitate communications with vendors. Implementing an ERP system is a demanding task and changing an ERP system is even more difficult.

To regain control Soohoo reduced marketing costs to slow down growth, and recruited a new VP operations with an extensive knowledge of logistics. Using his knowledge he managed to reduce the percentage of delayed order from 40% to 15%. Dot & Bo’s net promoter scores both pre and post delivery improved considerably.
May 2015, with revenues for the year projected to reach $40 million it was time for the next round of funding. Soohoo hoped to raise $30 million with a pre money valuation of $200 Million. However market conditions were less favorable than in the past. Investors had become nervous of e-commerce companies as valuations were falling by an average of 40 percent. Not being able to raise funds, the decision was made to sell the company. An offer of $50 million was received but negotiations dragged on. Cash reserves were getting low so headcount was reduced to reduce spending.  Then came the announcement that a rival that had raised $225 million in funding had been sold for less than $30 million. That ended any hope of selling the company. The bank called in their loan in September 2016. The only course of action was to shut down the business.

What went wrong?

Professor Eisenmann has identified a test to find if a startup is in a position to scale up successfully. It is the RAWI tests.  RAWI stands for Ready, Able, Willing and Impelled.

Ready – is the business model proven, is the market large enough to keep growing. As it scales up, is the profit margin high enough to cover higher costs if new customers become harder to attract?
Able – can the startup access human and capital resources to expand rapidly? Training new workers is often a challenge.

Willing – are the founders keen to grow? There are risks to the founders, they are likely to have a lower total stake in the company as financiers increase their investment. There is the risk of being fired as investors take control of the board. And of course there are the long hours that will be required

Before embarking on a rapid scale up the answer to these questions should be yes.

But for the fourth question I or impelled the better answer is no. If you must expand rapidly, it is because you believe if you do not, a competitor will gain an advantage over you. This could be due to a network effect where the number of customers or subscribers is key to your service, such as we see in the case of Facebook or WhatsApp.

It could be because you need to be the leader in your field. Google had to become the leading search engine before it could begin to monetize its service. Something it has done to incredible success.  Or it could be that there are high switching costs, a customer once established with the competition faces considerable barriers to moving to a new supplier. Apple have done this very effectively. Because my iPhone, iPad and to some extent even my windows based computer are so effectively synchronized it is highly unlikely I would switch to an Android device, just too much hassle to change.

And this is even more true today than it was a few years ago. New phone releases are more focused on things like better cameras rather than business related functions. The pressure to upgrade is not as strong these days. In fact, I use my wife’s cast-off phones which maybe a few years old but still deliver the functionality I need,
But if you are not impelled to grow, you can still do so if the answers to Ready Willing and Able are yes. It would be your and your backer’s choice.

Clearly if the answer to all four questions is yes then you have no choice, you have to grow or be left behind by your competitors.
But what if the answer to the impelled question is yes, but the answer to one or more of the ready willing and able questions is no. Then the entrepreneur must address the constraints to growth as effectively as possible and try to grow as rapidly as she can.

How does RAWI apply to Dot & Bo’s situation? They stumbled on the Able portion. Remember the Able question is can the startup access the capital and human resources they need to achieve the growth required.  Dot & Bo suffered because it could not or did not hire the right specialists and it could not raise capital because their e-commerce business had fallen out of favor with the investment community. Dot & Bo failed due to mistakes in hiring and misfortune,  the loss of faith in e-commerce.

The risk of not being able to raise additional funds is an issue all start ups face. Recall an earlier show and the pet care provider Baroo. One of the reasons they went out of business was because they were unable to find additional backers for their venture. The problem is even more acute for late stage ventures. A startup may be able to stay afloat with a relatively small bridging loan that gives them time to reset and to hope that market conditions improve. As ventures become larger the funds needed become greater and backers begin to question are they throwing good money after bad?

What, as an entrepreneur, can you do to minimize the financing risk?
Firstly be aware of the boom bust cycles of investment. There have been many, biotechnology was hot in the early 1990s, clean tech in the 2000s and of course,for my listeners who are old enough to remember, the dot.com boom of the late 90’s that led to irrational exuberance as described by the Alan Greenspan, the Fed Chairman at the time.

So if you are launching late into a hot sector be on the lookout for the market losing its luster among investors. If you believe this may happen you can consider raising more funds than you think you will need. This will provide you with a cushion. Famously Amazon raised $2 billion in debt shortly after it completed its IPO. This enabled it to survive despite considerable losses when capital markets were depressed after the dot com bust.

Of course, there is a tradeoff. If you borrow more money you will dilute your equity stake in the business. And if the business grows as predicted and capital remains available then you will have given away more of your business than you needed to. Also keep in mind that later fund injections are usually at higher valuations further reducing how much of your stake you need to give up. But if growth is slower or capital becomes more expensive, or impossible to obtain, those extra funds you put aside as a cushion might be what enables your business to survive. It depends on your own risk profile, and as an entrepreneur your risk profile is higher than most. So think carefully.

Choose your backer. If possible raise capital from investors who are more likely to be able and willing to provide bridge financing should it be needed. If successful, VCs raise funds every three to five years. Once a fund is closed, i.e. all the allocated capital is invested, the VC will start a new fund and this new fund is unlikely to put money into businesses that an earlier fund had backed. To do so could create a conflict of interest with the partners in the new and old funds. So understand where the VC is in the investment cycle. Are they just starting out? Or are they about to wrap up this round?

The third way to minimize the funding risk is to be able to cut costs should the need arise. Keep your options flexible, avoid long term commitments in preference to short term options that can be terminated if needed. For example, use a co-working space for your staff rather than a long term lease.

The funding problems encountered by Dot &Bo can be considered as back luck. The errors in hiring were mistakes. And we have seen the same mistakes made by other businesses we have looked at in earlier programs. The failure to hire people with the skills needed urgently to fix the problems. Hiring managers from large corporations without the flair, skills and attitudes to work in a startup environment.

Cost can be a factor. In Dot & Bo’s case, a COO with experience in the furniture shipping industry was passed over because his salary expectations were twice the budget for the role. I do not know if it was proposed but maybe the candidate would have been willing to work for the budgeted salary with options as an upside when the business achieved success. If she or he would have been agreeable to this arrangement it would have demonstrated the right attitude to work within a startup. Personally, I am always willing to consider sweat equity as payment for my services as a fractional CFO. Another option would have been a short term contract of say 6 months.

The final nail in the coffin for Dot & Bo was the poor choice for an ERP system. As businesses grow, effective decisions rely more and more on effective systems. In the early days communications are simple among a few folks who need to make the decisions. But in the later stages more structure is needed. A system failure was one of the reasons Baroo got into trouble, the off the shelf scheduling app they used was unable to keep up. Investing in systems is seen as an unnecessary expense in the early days of a business, and often that is the case. But when the time comes to make that investment, if you lack the expertise to choose and implement the needed software, hire an expert.

As Professor Eisenmann puts it Dot & Bo failed because they did not have the right help. Help in the form of backers who could provide funding when it was needed. Help in the form of employees with the skill sets to enable a startup to scale up.

We have looked at one company that was not able to scale up and identified some of the reasons. Now let’s look at the advice from a successful serial digital entrepreneur on what startups need to scale and succeed. The entrepreneur is James Bilefield. Among other achievements he helped scale up Skype, or Skypee as my Chinese colleagues would say, into a global business. He is now an advisor to McKinsey and in 2020 he shared his thoughts on how a start up can succeed.

His first insight is that successful startups prioritize results and customer satisfaction. He talks about Skype whose mission he describes as allowing the world to talk for free and change the face of global communication.  They hired a diverse team who shared this vision, excitement, and energy. As the business grew the founders strove to ensure that this unique culture and values remained strong. They had a clear focus on outcomes and were obsessive on delivering for their customers.

You need a lot of confidence. Mr Bilefield says that Skype had a simple goal to become a verb, like Hoover, Xerox or Google. To deliver on such a goal you need a lot of diverse talent, the founders need to find the time to attract, develop and retain the very best talent. As part of this the startup leaders must set an example of expected behaviors, and a true passion for the company’s mission. In my experience employees are very quick to identify when leaders are faking it. If you lose your passion for your business venture it is time to either remind yourself why you started the business in the first place and regain that passion or move on and let someone else build your vision.

Successful scale ups listen carefully to what customers, staff, partners and other stakeholders are telling them. Take this on board and adjust their model accordingly.

Maintain your culture as you expand around the world. Mr. Bilefield describes Skype’s culture as global in mind set, revolutionary in ambition, distrustful of hierarchy and customer obsessed.   But a startup must also recognize what works and does not work in different geographies. What works in Shanghai may not work in New Orleans. In my program on succeeding in China, show 6 of this season, we learned that Indian base InMobi recognized that Chinese customers valued speed of innovation, whereas the rest of the world valued reliability more highly. As a result, they set up a separate product development function in China to meet the needs of their Chinese customers.

Having taken a company into Vietnam, and been in at the early days of starting up in China, getting the balance right, of keeping the essential core elements of your business's reasons for being and adapting to meet local needs is extremely challenging. I think I got it about right in Vietnam, not so sure about China. Mr Bilefield is correct, hiring the right staff who share your values is critical. Our staff in Vietnam were enthusiastic about working for an American company and were willing to speak up if they thought we were pointing them in the right direction. They wanted us to succeed. Looking back on it, the team I inherited in China was a little more enthusiastic on looking after themselves.

James Bilefield’s one piece of advice is you need to think like a startup about the market and how best to serve customers, free of legacy and other constraints. The question: what would Google, Amazon or Alibaba do? Can also be a guide.

Solid advice, businesses that put their customers first are often highly successful. To do that you need to understand your customers' true needs. And that is not always easy to establish. Avoid scaling up until you have found your true market fit. In Singapore, and I believe there is a similar pattern around the world, the bicycle ride sharing industry rose and collapsed in a couple of years from 2017 to 2019. Sadly, for the companies in this market, it was customer behavior that drove their demise. Reckless riders, bikes being abandoned in places that created hazards to the public invited government regulation. And regulation greatly reduced the original convenience offered by the service. The ride sharing companies should have been able to anticipate that not all their customers would behave responsibly and put in place their own controls. That would have managed customer expectations and maybe the business would have survived.
 
Useful Links

• https://www.netpromotersystem.com/about/measuring-your-net-promoter-score/
• https://www.investopedia.com/ask/answers/difference-between-premoney-and-postmoney/​

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