Tuesday, January 17, 2017
I am in investor in the FireStarter Fund, and when I received my investor update from one of our...
I am in investor in the FireStarter Fund, and when I received my investor update from one of our portfolio companies, I nearly fell out of my chair. The company featured was Chicago-based Home Chef, and the company's revenue run rate had increased from $20MM in 2015 to over $200MM in 2016, a whopping 10x increase in one year. It took me about ten seconds to pick up the phone and call their founder and CEO, Pat Vihtelic, to ask him to share his story with all of our Red Rocket readers, which he was kind enough to do in this post.
ABOUT HOME CHEF
Founded in 2013, Home Chef is one of the leading players in the growing home meal delivery kit business. Consumers sign up for a weekly subscription of meal kits to be delivered to their home, and the buyers have all of the ingredients and recipes they need to prepare that meal at home, in less than 30 minutes. They basically have removed the time-consuming need to go shopping for ingredients, and have made it incredibly simple to prepare with pre-portioned ingredients and step-by-step directions. A great solution for time-started families that want a home-cooked meal, but may not otherwise have had the time to pull it all together.
Home Chef is one of many venture capital backed startups that are racing to dominate this space, including industry leading Blue Apron (estimated at over $1 billion dollars in sales) and Hello Fresh (a division of the publicly-traded Rocket Internet, estimated at over $400 million run rate at their U.S. operations). But, what Home Chef has had, from the very beginning, perhaps to a greater extent than their competitors, was a data-driven approach to building their business to ensure their business economics were sound and scalable, before they began to hit the gas with their growth. And, now they are reaping the benefits, as their competitors are still struggling to get their expensive marketing economics to pay back in a timely fashion.
THE CHALLENGES OF METEORIC GROWTH
My first question of Pat was, "how can you reasonably handle 10x revenues in one year, without the wheels of the business falling off?" And, he detailed three areas of his business, to better educate me on how he was able to grow this fast in the first place, and more importantly, how he avoided growing faster than the business could "digest" (pun intended). Those areas were: (i) marketing; (ii) fulfillment; and (iii) staff and culture, which I will detail in the paragraphs below.
MARKETING YOUR WAY TO 10X GROWTH
2013. The company's website launched in September 2013, bootstrap financed by Pat. So, with cash in short supply, it started by getting the product and customer experience right. Where competitors were focused on other gimmicks, like promoting fancy chefs' recipes, for Pat, it all started with what does the customer really want to eat and truly learning their behavior. With a lot of research and testing with his initial customers, he ironed out a winning customer solution to their day-to-day needs And, the research paid off; the company's business started to take off with zero paid marketing spend. In 2013 they were growing 30% month-over-month, driven simply by word-of-mouth referrals from their early adopters who really loved the product.
2014: With that all-important proof-of-concept behind the business, it didn't take long for the venture capitalists to take notice, and Home Chef completed its first rounds of seed capital, closing $500,000 in July 2014 and a $500,000 in November 2014. They used the proceeds from these rounds to prove out their paid marketing plan and economics, testing media buys in the search engines and in social media. It was here they learned their cost of customer acquisition, their best promotional offers (e.g., get $30 of meals for free, if you refer us a friend, who will also be given $30 of free meals), their customer retention rates which drive lifetime customer revenues, which media sites performed better than others and how fast they could grow without hurting their business economics (e.g., no more than 10% new customers a month, relying on 90% returned customers each month). And, they learned they would need to take the "long view" here, as three years of customer revenues would get them a 3x return on their marketing investment, which needed to be paid back in the first 6-9 months. The company ended the year with a $1MM revenue run rate.
2015: Marketing success in 2014 lead to more venture capital attention and monies coming in, raising $10MM in August 2015. This is where they began to pour the gasoline on their marketing fire, accelerating both their customer referral program and their paid marketing efforts, still focused on the search engines and social media (primarily Facebook). They learned social media was the key paid channel to focus on, as the industry was still new and people really weren't looking for "meal kit delivery" keywords yet in the search engines. But, lets not forget, the great product was still driving a ton of free word-of-mouth business, which comprised over 50% of their new customers acquired. The big increase in marketing spend, resulting in the business ending the year with a $20MM revenue run rate (up 20x in one year).
2016: The huge lift in revenues had the venture capitalists frothy with excitement about Home Chef, and the company raised a whopping $40MM in August 2016. Now, the marketing spend was increased to millions of dollars each year and their marketing team grew to 10 people. The company tested new marketing channels to diversify their media mix and learned that customer acquisition costs per user rise by spending more in the same channels without diversifying the media mix, so they needed to turn the screws in terms of adding even more data-driven discipline to their efforts. And, it paid off, as the company ended the year with a $200MM revenue run rate with only a modest impact to their marketing economic efficiency.
SCALING YOUR BACK-END FULFILLMENT TO HANDLE 10X GROWTH
Marketing was only part of the success story here, because what good is bringing in millions of new customers, if your back-end cannot support the growth. The back-end for Home Chef primary means adding new kitchen and warehouse space to process the meal kits being ordered. What started out as a 2,000 square foot test kitchen in Chicago from inception through September 2014, turned into an 8,000 square foot food processing facility in October 2014 and further expanded to a 50,000 square foot facility in July 2015. Yes, that was two moves in just over a year, and all the distraction that comes with that.
The company considered adding new locations in the beginning of their growth, but again, to better control the business, they wanted to fine tune everything in one place first, to get their processes fine-tuned at scale. Then, once they were comfortable they had the right fulfillment model, they began to export that model to new locations, adding a 70,000 square foot facility in California in March 2016 and a 120,000 square foot facility in Georgia in September 2016 (which is currently being expanded to 180,000 square feet).
This growth presented tons of challenges. To preserve their desired process, they relocated key staff members from Chicago to get those new locations off the ground. They needed to convince large landlords that Home Chef was worth backing for the long run, a startup that wasn't going to ultimately flame out. And, in Pat's conservative approach, he would not open up new production facilities until he was 100% sure the sales volume was there to support it, so it had the old facilities running on overdrive, until the new facility could be opened to take the pressure off. Again, all of this expansion--growing to 300,000 square feet processing over 10 million meals a year across three locations--in only three years!!
MAKING SURE 10X GROWTH DOESN'T IMPACT YOUR CULTURE
If you thought growing your production capabilities was hard, imagine having to grow your workforce from zero to over 700 workers during this time, 150 of which in your headquarters. All, in a way that doesn't negatively impact your desired "scrappy startup, customer centric" company culture. Pat attributes his success here to a few things. It was critical to get your initial hires (and subsquent hires) right. Executives that weren't afraid to roll up their sleeves and lead by example. Secondly, deal with growing pains as quickly as you can, so they don't last long. And, thirdly, keep a relatively flat organization, without a lot of layers of middle-management.
It sort of takes your breath away, that you could build a business of this scale in just over three years. And, with the company planning to at least triple revenues in 2017, this train is still just getting started. A tip of my hat to Pat and the entire Home Chef team. Yet another rising star in Chicago's exploding digital tech ecosystem. So, now that we have the blueprint for scalable 10x growth that would have crippled most other businesses, let's do this thing for your businesses!! Thanks again, Pat, for sharing your incredible story. Deep respect for what you have accomplished here, as I truly understand how hard it was to pull off.
For future posts, please follow me on Twitter at: @georgedeeb.
Friday, January 6, 2017
I was recently in a client’s office, and they had an interesting collage of words and images hung...
I was recently in a client’s office, and they had an interesting collage of words and images hung on their wall, trying to summarize the culture they wanted to create for their employees. One section stood out to me. It said “Narrow your say-do gap” next to the word “Commitment.” I thought it was a great way for the client to manage their team’s expectations. And it must be working. The company has a love affair with their leadership team, evidenced by their employees long tenure with the company and the very high reviews of their CEO on Glassdoor. There are some juicy nuggets in here -- something we can all learn as we try to be good leaders with a narrow say-do gap.
Read the rest of this post in Entrepreneur, which I guest authored this week.
For future posts, please follow me on Twitter at: @georgedeeb.
Wednesday, January 4, 2017
When building a business or product offering, it is comparable to building a house. First you l...
When building a business or product offering, it is comparable to building a house. First you lay the foundation, then the rough carpentry, roofing, plumbing, electrical, HVAC, drywall, flooring and finishings, in that order. God forbid you try to install the plumbing after the drywall has gone up, otherwise you will have to rip it all down and start again, at double the cost. And, unless an architect has provided the builder with a clear blue print on what is being built, chaos will surely follow.
But, that only talks about the initial construction. Unlike building a house, a good business or product offering is fluid in its design, and is constantly trying to improve to keep up with its competitors and customers’ needs. Think of it like evolving from version 1.0 to version 2.0 over time, under the mantra: continue to innovate or die a slow death. But, the worst thing you can do, is try to build features of version 2.0 on top of flaws embedded in version 1.0. That is the equivalent of building a house of cards, where the whole thing can topple over with one wrong move.
You wouldn’t continue construction of an addition to your house, if your kitchen was on fire, would you? Of course not. First you would extinguish the fire, repair your kitchen and then get back to building your addition. The same holds true for your business or product line. But, more often than not, I see businesses keep plowing money into new features and functionalities of their product offering, without paying any attention to whether or not the core product is stable and meeting the needs of its stakeholders. Below are a couple case studies I have seen with my clients that help better illustrate this.
Case Study #1: Version 1.0 Keeps Breaking
Nothing will upset a customer or an employee more than a product that doesn’t work as advertised. Especially, if you don’t own up to your mistakes and have a clear plan on how you are going to get it fixed, and fast!! If you are promising to solve painpoints for your users, but the system keeps breaking, all you are doing is upsetting them. Which most likely means, there goes your repeat sale or your frustrated employee right out the door. If your house is on fire, put it out!! The new addition will just have to be delayed. Or, risk the whole house burning to the ground.
Case Study #2: Version 1.0 Not Selling or Meeting Needs
A house on fire can also mean the product works fine, but the users just don’t like it. Maybe it is simply not selling or competitive in the market, or a complicated user interface, or a mismanaged expectation of how the product would actually work compared to what a customer was communicated during the sales process, or a lack of depth in the features or reports that are most important to the users’ needs. Again, time to stop the presses!! You need constant feedback from your internal and external users that everything is meeting their expectations, otherwise you need to fix it first, with a tight partnership between your product developers and your sales team. You can try to put lipstick on a pig, but at the end of the day, it is still a pig destined for the slaughter house.
Case Study #3: Version 1.0 is Breaking the Bank
The last scenario is the technology is working fine and users are happy with it, but it is costing the company of a lot of time or money to operate. Maybe it is small gross profit at the current selling price, or a long onboarding process to educate users how to use the product, or the infrastructure was built on legacy systems that are no longer supported or preferred in the market? If the economics just don’t make sense, it is back to the drawing board to find a better way.
So, the point here is: don’t invest good money on top of a bad base platform. If you have a broken business or product, something is not going right and you need to fix the core first, before trying to pretty it up with additional features and functionality. Yes, that may upset your sales team trying to impress clients with the next “bell and whistle” of a competitive product offering. But, if you don’t fix your foundation first, you risk the whole house falling down. Or, at a minimum, the cost of your addition may double, if you have to build it a second time on a more stable foundation.
For future posts, please follow me on Twitter at: @georgedeeb.
Monday, December 19, 2016
Red Rocket gets introduced to hundreds of startups each year, in the normal course of doing busin...
Red Rocket gets introduced to hundreds of startups each year, in the normal course of doing business, or via our involvement with FireStarter Fund, TechStars, Techweek, Founder Institute or other startup groups or events. We wanted to honor the best of these startups that we met in 2016, in Red Rocket's 5th Annual "Best Startups of the Year". This list is not intended to be an all-encompassing best startups list, as there are many additional great startups that we are not personally exposed to each year. And, this list is not intended to be only for businesses that launched in 2016, it is open to startups of any age, that they or their advisors had some personal interaction with us in the last 12 months. The business simply needed to have a good idea, good team or good traction, that caught our attention. Congrats to you all!!
THE BEST STARTUPS OF 2016 (in alphabetical order):
AirMule (CEO Sean Yang) - B2C P2P express shipping via travelers
Bright (CEO Jeff Judge) - B2B revenue analytics platform for SaaS companies
Brightwork (CEO Josh Carter) - B2B backend development as a service
Bucketfeet (CEO Raaja Nemani) - B2C custom canvas shoes
CarLease.com (CEO Tim Sperling) - B2C online car leasing service
ClassicCars.com (CEO Roger Falcione) - B2C classic car buying marketplace
Cloud Craze (CEO Chris Dalton) - B2B cloud-based ecommerce platform
Collbox (CEO Chad Shuford) - B2B bad debts collection platform for SMBs
CompleteSet (CEO Gary Darna) - B2C marketplace for collectibles
Crowdfind (CEO Jay Sebben) - B2B lost and found platform for venues
Dough/Tasty Trade (CEO Kristi Ross) - B2C investing platform for do-it-yourselfers
Dorm It Up (CEO Shanil Wazirali) - B2C ecommerce for college students
Drivin (CEO Kayne Grau) - B2B used car marketplace for auto dealers
EatPakd (CEO Rebecca Sholiton) - B2C healthy meal delivery for kids school lunches
FitReserve (CEO Megan Smyth) - B2C central boutique fitness reservations
Gesture (CEO Jim Alvarez) - B2B mobile bidding app for fund raisers
Jiobit (CEO John Renaldi)- B2C location tracking wearable for your kids
Keeper (CEO Darren Guccione) - B2B and B2C secure password manager for mobile
OppLoans (CEO Jared Kaplan) - B2C sub-prime consumer lending
Opternative (CEO Aaron Dallek) - B2C online vision testing
ParqEx (CEO Vivek Mehra) - B2C P2P parking spot reservations
PenPal Schools (CEO Joe Troyen) - B2C online global education across borders
PeopleGrove (CEO Adam Saven) - B2B corporate mentoring social network
PhysIQ (CEO Gary Conkright) - B2B human body analytics
PrintWithMe (CEO Jon Treble) - B2C printing stations in public places
Q-BBQ (CEO Michael LaPidus) - B2C fast casual BBQ restaurant chain
Reverb (CEO David Kalt) - B2C online marketplace for musicians
Rewards 21 (CEO Cary Chessick) - B2B employee and customer rewards platform
Rithmio (CEO Adam Tilton) - B2B motion recognition technology for consumer products
Roost (CEO Jon Gillon) - B2C rent storage space from locals
Routific (CEO Marc Kuo) - B2B route delivery optimization platform
Savo (CEO Jason Liu) - B2B sales enablement platform
SkyMedicus (CEO Amy Holcomb) - B2C medical tourism booking
Socedo (CEO Aseem Badshah) - B2B business demand generation from social media
Tempus (CEO Eric Lefkofsky) - B2B data-driven cancer treatment
TenantBase (CEO Bennett Washabaugh) - B2B small office space online brokerage
TurboAppeal (CEO Badal Shah) - B2B and B2C online tax appeal platform
Uchange (CEO Avi Kugel) - B2C P2P currency exchange between travelers
Urban Leash (CEO Lina Pakrosnyte) - B2C dog walking reservation platform
Virsera (CEO John Diefendorf) - B2B gamifying business objectives
Xensr (CEO David Troup) - B2C 3D analytics for sports
ZooKKs (CEO Kishore Kotapati) - B2C ride sharing platform for commuters
And, don't forget to check out the 2012 winners, 2013 winners, 2014 winners and 2015 winners, many of whom continue to be doing great things.
Congratulations to you all!! Keep up the good work.
For future posts, please follow us at: @RedRocketVC
Monday, December 12, 2016
For all you entrepreneurs trying to attract investment capital, this post will be the most impor...
For all you entrepreneurs trying to attract investment capital, this post will be the most important one you read. If you cannot answer the following customer acquisition related questions for your target investors, your fund raising process is over, before it even started. Below will walk you through the inputs required to calculate the most important marketing metric for investors: your return on marketing investment ("ROMI").
AVERAGE TRANSACTION SIZE
Your average transaction size will significantly vary based on your product and target consumer. An ecommerce company selling arts and crafts supplies may have a $50 average order size, and an enterprise software company may have a $250,000 average order size. For purposes of this post, I am going to focus on the consumer facing businesses. Average order size is calculated by taking your total revenues in the period, and dividing it by the number of transactions in the period. So, if you did $1,000,000 in revenues with 10,000 orders last year, your average transaction size is $100.
REPEAT CUSTOMER MIX
It is hard enough to acquire new customers, so it is important you don't lose your old customers. You always need to be figuring out what percent of your current year transactions came from prior year customers (and improving that metric over time). So, if you did 10,000 orders in total in the period, and 5,000 came from customer acquired in prior years, you have approximately a 50% repeat customer mix (where some customers may have made their second transaction with you, and others may have made their fifth transaction with you). You can calculate this based on unique customer identifiers, like client numbers or email addresses in your system. Anything north of 33% is acceptable, and if anything less, you may have a customer retention problem on your hands (which may spook investors).
LIFETIME VALUE OF REVENUES
If your average transaction size is $100, and your average repeat customer rate is 50%, on average, one customer will drive $100 in year one, $50 in year two, $25 in year three, $12.50 in year four and $6.25 in year five. So, that is a lifetime value of revenues (often abbreviated LTV) of around $194. Understanding, the one customer that made five orders in five years, most likely spent $500, but they are the minority, and made up for the majority of the customers that only spent $100 for one order in five years.
COST OF CUSTOMER ACQUISITION
Your cost of customer acquisition (often abbreviated CAC), is the total marketing investment required to bring in one customer. Let's say you spend around 10% of your $1,000,000 in revenues on advertising; so, you spent $100,000 to generate 5,000 new customers in this example. So, your CAC is $20 per new customer acquired. Notice, I did not divide the marketing cost by total customers in the year, I only divided it by NEW customers in the year, as I wanted to get a clean look at my acquisition costs without it being benefited by free customers generated from repeat sales or word of mouth. Those items are the gravy, if they end up happening.
RETURN ON MARKETING INVESTMENT
And, now, what you have all been waiting for, the key metric that matters most to investors: your ROMI. This is calculated by taking your LTV of $194 and dividing it by your $20 CAC, in this example. So, your ROMI is almost 10x in this case study. If you are doing 10x that is pretty terrific. Most average companies are doing around 5x. And, companies that can't exceed 3x typically lose money, after subtracting their cost of sales and operating expenses. If you want to edit this calculation, don't use revenues, use gross profit as your numerator and shoot for a 5x return, understanding most companies will be around 2.5x with a 50% gross margin.
WHAT THIS MEANS FOR YOU
If your marketing investment does not drive a healthy return (5-10x on a revenues basis, or 2.5-5x on a gross profit basis), and does not have a quick payback period for investors (from the first transaction, in this example), you are going to have a really hard time of attracting investors. And, know going in, consumer marketing for brand new companies, is going to be expensive and less efficient than established companies (e.g., one-third as effective, on average). So, the sooner you start testing and optimizing your marketing efforts, to start illustrating healthy marketing returns, the sooner investors will start flocking to your business.
Don't forgot, as I have said many times in the past, your proof of concept is more important than your product when talking to investors. And, having a solid ROMI is one of the key metrics they are going to be focusing on, in determining if you have passed your proof-of-concept threshold. This will make or break your fundraising efforts, so don't reach out to investors until you have identified, tested and optimized scalable marketing techniques which can be accelerated with the use of proceeds from your raise. Investors prefer to pour gasoline on an established fire; they don't like to start the fire.
For future posts, please follow me on Twitter at: @georgedeeb.
Monday, December 5, 2016
As many of you know, Red Rocket has been looking for an ecommerce business to buy over the last ...
As many of you know, Red Rocket has been looking for an ecommerce business to buy over the last few months. We have been doing due diligence on over 50 ecommerce companies during this time, and what an eye opening experience it has been. My overall conclusion is: U.S. based ecommerce companies are going to see a lot of headwind in the coming years, and you better figure out how to defend yourself before the looming overseas guillotine falls. Here are the details of what I have learned.
PHASE 1: A QUICK HISTORY, ONLINE RETAILERS KILL OFFLINE RETAILERS
To put this topic into perspective, first a quick history on ecommerce. After the first wave of ecommerce companies hit the market in the late 1990's, it was clearly only a matter of time before the offline brick and mortar retailers would succomb to death's grip. Gone go Blockbuster, Borders, Circuit City, CompUSA, Linens N Things and Sports Authority, just to name a few. Unless the retailers made quick pivots to the ecommerce channel, there was no way they could effectively compete with their huge investments in real estate, inventory and payroll, like a noose around their neck.
And, these trends still continue today. Don't think for one minute the big chains like Wal-Mart aren't also worried about their long term future. Why else would Wal-Mart make such a large $3.3 billion acquisition of Jet.com after only one year of launch? To get them more formidably repositioned as a leading "ecommerce-first" company. Especially since Jet.com was able to generate over $1BN in revenue run rate after only one year of being in business, with a lowest-price messaging, a title most covetedly held by Wal-Mart over the years.
PHASE 2: AMAZON REDEFINES ECOMMERCE MERCHANDISING
Amazon quickly learned that there was a lot more product for sale than could possible be designed and managed by one company. At the end of the day, they realized their core strength was marketing to a huge base of consumers and doing warehousing and distribution in mass. So, what better to do that open up their website platform to millions of product sellers, both large and small, to basically become a "one-stop shop" for anything and everything on the web. And, what a move that turned out to be; today, it is estimated that 40-50% of all consumer product searches on the internet now begin at Amazon.com, not Google.com.
PHASE 3: U.S. BRANDS START TO KILL U.S. ONLINE RETAILERS
With that level of marketing and fulfillment power on Amazon.com, millions of "Amazon Only Sellers" were born in the last few years. Now, an ecommerce startup no longer needs expensive investments in people, systems, warehouses or marketing; they simply need to design a product (typically manufactured by an overseas partner), get the product over to an Amazon warehouse, let Amazon do their magic, and sit back and collect checks for doing hardly any work. Literally, two kids in a garage figure out best selling products on Amazon to knock off, from freely available Amazon sales data sources, and they generate $2-$4MM in revenues ($500K-$1MM in profits) in a year or two after launching.
And, that doesn't even talk about about the big national brands selling through national retailers and ecommerce sites today. Amazon and other big online shopping platforms have embolded them into thinking they can sell products themselves, disintermediating the wholesalers and retailers they have typically relied on for sales. And, as the product company, now they can undercut the retail price, make materially higher margins than they were before and really turn the screws on the online retailers, who are now starting to see their sales decline with this sales channel shift.
PHASE 4: OVERSEAS MANUFACTURERS START TO KILL U.S. BRANDS
When I read this article at Internet Retailer (click through all four pages), it pretty much scared the crap out of anyone looking at investing in the ecommerce space. What it basically said is: with a "customer first mindset" (translated: a desire to get consumers the lowest prices possible), Amazon is romancing Chinese manufacturers to start directly selling on Amazon.com in the U.S.
Why does that matter? Remember all those U.S. brands and "Amazon Only Sellers"? Where do you think they are sourcing manufacturers for all their products? Most of them from China!! So, what does that mean? If the Chinese manufacturers start selling direct on Amazon, at the same wholesale prices they are selling to their typical U.S. brand customers, they are going to force the U.S. brands to compete with them at basically a zero percent profit margin!! Said another way: that was the sound of the U.S. brands' necks snapping with the fall of the guillotine.
WHAT THIS MEANS FOR YOU
For all of you ecommerce lovers, like me, sorry to sound like the grim reaper here. But, you better get ahead of this trend, and fast!! How do you defend yourselves here? They are many ways:
- Create more "brand cache" (e.g., pants from Gucci and Levi's cost the same to make)
- Don't sell commodity products, where price is the only differentiator
- Focus more on consumer services or consumer entertainment, as harder to replicate
- Add value-added upsells (e.g, make your money on the popcorn, not the movie)
- Acquire some of your vendors or manufacturers, to vertically integrate with
- Joint venture with international manufacturers as their exclusive U.S. marketing partner
So, before investing heavily in the ecommerce space, do your homework! Make sure the business you are in, or are considering to be in, is not a sitting duck, already starting to feel the stranglehold of your vendors starting to sell direct (e.g., see if they are already selling against you on their own websites or on Amazon). And, if you decide to move forward, do so with a long term defense plan in place, like the ones listed above.
Each generation of selling products, tries to do it better and more cost effectively than the generation before it. Unfortunately, for most low-price-driven U.S. consumers, that means disintermediating the U.S. middlemen in what has become a global ecosystem. Be careful what you ask for (e.g., low prices). It may just put the entire U.S. retail, ecommerce and brand businesses, out of business for good, with a huge impact to the U.S. economy and the resulting jobs lost. All, but for Amazon, of course . . . the last-standing fox in the hen house.
For future posts, please follow me on Twitter at: @georgedeeb.