This post is part of a series of posts from the 2010 Business of Software conference (BoS2010). For a summary of the conference, and an index to the other presentations, click here.
Dharmesh’s 2010 Business of Software presentation: “Building A Great Software Business: Notes From The Field”
I’m a big fan of Dharmesh. I’ve been following him for sometime now, so I was really looking forward to his presentation.
Before heading out to Boston, I watched Dharmesh’s 2009 and 2008 BoS presentations (to see the videos go to the end of this post). It was nice to see some recurring topics in his presentations, because that indicated to me that these were important enough ideas for him to repeat.
Dharmesh’s 2010 talk was packed full of insights – customer acquisition, customer retention, customer data, transparency, and venture capital. Dharmesh provided us with lots of useful equations and data throughout his presentation.
How to Measure Customer Happiness
To have a successful software business, you need happy customers. It’s simply not enough to just acquire lots of customers – you need to retain them. And to retain your customers, you need to make them happy.
Let’s look at customer acquisition first, and then customer retention.
The total Cost Of Customer Acquisition (COCA) is determined by dividing the number of dollars spent on Smarketing by the total number of customers. Smarketing, as defined by Dharmesh, is the total cost of sales and marketing.
The Lifetime Value (LTV) of a customer is the value, in terms of dollars, that you get from a customer for the expected length of time he’s your customer. For example, if you have a customer that pays $10/month, and you expect him to be a paying customer for 4 years, then the Lifetime Value of that customer is $480.
LTV = annual revenue from customer * expected length as customer
A customer’s LTV should be greater than your COCA. If it’s not, that means it’s costing you more money to acquire a customer than you’re making from that customer. That’s a bad business model…and sure to fail! If the LTV is much greater than the COCA, then it’s time to start pumping more money into the business to start acquiring more customers.
These may seem like obvious points, the problem is that very few of us actually take the time to do these calculations. Keeping an eye on these numbers will help you make better business decisions.
It takes a fair amount of capital to obtain a customer. Therefore, once you acquire a customer, it’s important to retain him as a customer for as long as possible. Customer churn, or customer turnover, is the rate at which your leaving customers are replaced by incoming customers.
Customer churn can be measured in several ways. The simplest way is to look at what percentage of customers are actually staying onboard versus leaving. Another way to measure customer churn is to look at what percentage of leaving customers are high paying customers versus customers on your lower priced plans.
When looking at customer churn, the higher the number of customers staying on compared to the number of customers leaving, the better. However, the above methods of looking at customer churn can lead to deceiving numbers. A better way to measure customer churn is to measure the discretionary churn.
Discretionary churn measures how many users actually have the option of canceling your service. For example, a customer tied into a 6 month subscription plan, may not be happy with your service, however, he won’t have the option to cancel for another 6 months. So, discretionary churn is a much better way of measuring customer churn than the above methods.
Customer churn can be a good measure of a customer’s happiness with your product or service. However, it is imperfect, because the absence of churn doesn’t necessarily indicate customer happiness. And this takes us to HubSpot’s Customer Happiness Index (CHI).
What Is the Customer Happiness Index
The guys at HubSpot created the Customer Happiness Index (CHI). CHI is a number from 0 to 100 that measures the probability any given customer will cancel, given the option to cancel. CHI is determined by three factors:
- Frequency of product use: By looking at the frequency of use, you can assume that the more a customer uses your product, the happier they are with it, and the less likely they are to cancel.
- Breadth of product use: By looking at the breadth of use, you can assume that the customers who use more features, are happier with your product, and again are less likely to cancel.
- Sticky product features: This one is important, and probably not so obvious. Sticky features are features that provide a lot of value to your customers, especially when compared to your competition. Those customers that use sticky features are likely to be happier, and thus less likely to cancel. HubSpot has found that this factor is more important than frequency of use and breadth of use – irregular users that use sticky features tend to stick around longer than those that use frequently and use lots of features.
By religiously following the CHI scores of customers, HubSpot can identify early on which customers are unhappy. They can then take a proactive step towards fixing the problem by calling up the customer before they cancel. This action has helped HubSpot keep about 33% of their previously unhappy customers.
Dharmesh did warn against taking their success rate too much to heart. Although they may have prevented a customer from canceling this month, if the customer’s happiness level isn’t brought up significantly, odds are that customer may still cancel the following month.
The cool thing about CHI is that it can be used to measure other aspects of your business, not just which customers are likely to cancel. You can also use CHI to:
- Measure the quality of the leads generated by your marketing efforts
- Make decisions on which product features to keep, remove, add, enhance, etc
- Make decisions on how much to compensate your sales folks.
How to Improve the Customer Happiness Index
“Invest in the experience, not the product, and everyone wins.”
Dharmesh used a quote from Kathy Sierra’s 2009 BoS presentation to set the mood:
Don’t make ___(fill in the blank)____ software. Make ___(fill in the blank)____ superstars. For example, don’t make marketing software. Make marketing superstars.
The key is to think about your customers. Think about what they want out of your software, what they want to accomplish. Make them awesome at what they do. Case in point, meet Molly:
The stuffed teddy bear in the picture is Molly. Molly is the customer’s stand in, and is required for quorum at all of HubSpot’s management meetings. Most meetings don’t happen without someone saying, “What would Molly say?”. It’s a good way to remember that your software is really about your customers, and making them great at what they do.
However, Dharmesh did point out that although customers are very good at finding problems, they are not so good at finding solutions for those problems. So remember that it is your job to find solutions to their problems. (Side note: This reminds me of the old project management cartoon about project requirements 🙂 )
Increasing Customer Happiness Through Services
Another way to increase a customer’s CHI score is by providing consulting services. HubSpot decided to not only offer consulting services to their customers, but to also charge for those services. Why charge? If a customer pays several hundred dollars for a few hours of consulting they will:
- See more value in it, than if it were a free service. Something that costs $500 is definitely better than something that costs $0, right?
- Get more out of their consulting session. If the customer is paying $500 for consulting you better believe that they are going to get their money’s worth out of the session. The customer will ask questions, and make sure they understand everything, just because they paid for the service.
A customer that knows how to get the most out of your product will be a happy customer (assuming you have a good product), which will increase their use of your product, as well as their LTV. Therefore, you should work towards making that happen – whether you charge for it or not.
HubSpot’s profit margins on consulting are actually very low. However, they continue to offer these services because it increases their customers’ CHI scores, which in the long run means greater overall profits for the business.
How to Gain (and Keep) Customers With Branding
Your brand is an important part of your business – and of acquiring and retaining customers. The most important thing your business can do (aside from creating a brilliant product) is to not screw with your customers. Dharmesh strongly advises against the Salesforce philosophy – don’t trick people into buying your product. To put it in Dharmesh’s words, “Brand is what people say about you after you have left the room.”
Dharmesh shared some HubSpot philosophies, including how much company information they share, and why they decided to accept venture capital.
Transparency Trumps Secrecy
Except for salary information, all of HubSpot’s data is available to all employees. All data! This includes financial information. (Side note: This seems to work for HubSpot. I recently saw the below tweets from HubSpot employees.)
Although HubSpot makes all of their data available to its employees, the data is off limits to the public. The reason is that they don’t see any real benefit to doing so.
The Evilness of Venture Capital
HubSpot is not Dharmesh’s first startup, but it is his first venture backed startup. Most of us think of pure evil when we think of Venture Capitalists, but VCs can play an important role in some businesses. Most software startups don’t need venture capital, and are actually doing themselves a disservice by pursuing it. But there are a few select startups that can benefit from venture capital.
If you are aiming for quick, high growth (like Facebook), or are starting a business that requires a lot of upfront capital (like a hardware business), then it might make sense to obtain venture capital. At HubSpot, they made a decision early on that they:
- Wanted to become the dominant player in the industry.
- Were looking for rapid growth.
Because you need a lot of money to accomplish both of these goals, they chose to look for venture capital. A key part of HubSpot’s strategy was to acquire these funds before they actually needed the money. The reason being that:
- It is easier to obtain venture capital before you need it, than it is if you are already in need of it.
- You get better terms early on because since you aren’t desperate for the money you can always back out.
Do note that once you take VC funds, you move from solving your customers’ problems to solving your investors’ problems. And the two rarely align with each other.
Key Takeaways From Dharmesh’s BoS2010 Presentation
These are the main points I got out of Dharmesh’s BoS2010 talk:
- Log as much data as you have, even if you can’t use it now. You may be able to use it in the future.
- Measure your customers’ happiness. Come up with your own metrics if you have to, but look at those numbers closely. Determine what makes happy customers, and what doesn’t, and adjust your business model accordingly.
- Dream big, and execute small. If someone offers to buy your company, seriously consider it, even if it’s not what you dreamed of. Selling gives you cash, which allows you to move on to your next dream 🙂
Some memorable quotes from Dharmesh’s BoS2010 presentation:
- “Don’t make customers happy. Make happy customers.”
- “Brand is what people say about you after you’ve left the room.”
- “Venture capital isneither necessary nor evil.”
- “Services are low margin…except when they’re not.”
- “Invest in the experience, not the product, and everyone wins.”
- “Customers are very good at finding problems, not at finding solutions for those problems.”
- “Transparency trumps secrecy.”
- “Dream Big. Execute Small.”
More on Dharmesh Shah
Dharmesh Shah is the founder and CTO of HubSpot, a venture-backed software company offering a hosted software service for inbound marketing. Prior to HubSpot, Dharmesh was the founder and CEO of Pyramid Digital Solutions. Pyramid was a three time recipient of the Inc. 500 award and was acquired by SunGard Data Systems in 2005. Dharmesh is also the author of OnStartups.com, a top-ranking startup blog with over 20,000 subscribers and 100,000 members in its online community. Dharmesh is the co-author of Inbound Marketing: Get Found Using Google, Social Media and Blogs.
You can find Dharmesh’s startup blog here.
Follow Dharmesh on Twitter here.
What are your thoughts on Dharmesh’s presentation? If you attended BoS2010, did I miss an important point? What was your favorite part of Dharmesh’s presentation? What was your key takeaway from his talk?