Startups: How To Build A Barrier To Entry With Inbound Marketing

By Dharmesh Shah on October 20, 2009

I’ve been doing a fair amount of speaking lately.  It’s partly driven by my recently released book, Inbound Marketing: Get Found Using Google, Social Media and Blogs (which is doing exceptionally well -- more below on this). The topics I usually speak on are startups (surprise) and marketing (surprise, surprise).  And, when I’m really on a roll and feeling adventurous, I talk about startup marketing. inbound marketing book

First off, a quick confession.  I’m not really a marketer, and I don’t play one on TV.  I’ve never had the word marketing in my job title, ever.  The closest I’ve come to any formal academic training in marketing are two marketing classes I took in grad school.  Neither of them were really about marketing a startup (they were about pricing and branding and other high falutin’ stuff).  So, much of what I’ve learned about startup marketing has been through (gasp!) actually doing it

Now, I want to lead with the fundamental premise of this article: 

Exceptional marketing can be a formidable barrier to entry. 

For those of you that are new to the investor game (which is usually where the phrase turns up), “barrier to entry” is loosely defined as that thing which makes it hard for competitors to enter your market and reduce your profits.  In most cases, when VCs ask a startup about barriers to entry, the response usually falls into one of two categories:onstartups barrier

Type 1:  We’re doing something that is so hard to do that few others can do it.  This is usually manifests in the form of some intellectual property (IP) like source code.

Type 2:  We’ve got exclusive/proprietary access to some important resource that others can’t get to.  This could be in the form of some product integration partnership (like bit.ly has with Twitter).

Of course, there are other types of barriers to entry, but the above two types capture most of what you’re likely to hear — and software entrepreneurs are often focused on the first one (i.e. "lets build a kick-ass product that’s really hard and others can’t replicate because we’re just so freakin’ awesome").  Nothing wrong with that.  I’m a big fan of doing really hard things that you’ve got a rare talent for and others can’t easily emulate.  However, it’s entirely possible that late at night, when you’re talking to yourself, you might say “Self, I know my application is cool and all, but honestly, I don’t think it’s that hard to build.”  Be comforted in the knowledge that most software being built is not particularly hard to recreate.  So, the question is, if it’s not the software that’s going to be your barrier to entry, and you’re not fortunate enough to have a lock on some proprietary resource, what do you do?  My advice:  Get phenomenally good at acquiring customers efficiently.  The emphasis is on the word “efficiently”.

So, here are some thoughts and insights on how I think you can build a barrier to entry with marketing:

How To Build A Barrier To Entry With Inbound Marketing

1. Getting good at spending money doesn’t count.  Your strategy shouldn’t be “go raise a bunch of money, then use that money to go buy your way to some customers. Then, make it up in volume.”  Though that can certainly work, that’s not a defensible barrier to entry.  Just about anyone can spend money (some smarter than others).  You need to focus on creativity, not cash.  More on this later.

2. PPC (Pay-Per-Click) can be effective, but will not protect you.  One of the popular forms of marketing today is pay-per-click advertising through programs like Google AdWords.  I’ve seen entrepreneurs get really, really good at figuring out just the right bidding strategy and figuring out precisely how much they can afford to spend on a given word based on their conversion rate and lifetime value of the customer.  This is all fine and good, except for one thing.  PPC programs like AdWords run as a real-time auction.  She who pays gets the clicks.  It’s easier to describe why this is a problem with an example:  Let’s say that you’re building a web-based app for home theatre installers (random example that I just made up).  Let’s also say that over time, and with some maniacal focus and PPC bidding ninja skills, you figure out that you can afford to pay up to about $2.76 a click based on the traffic that these clicks generate, how many clicks lead to purchases, and the value of each purchase.  Life is good.  For every $1 you put in to the PPC machine, something > $1 comes out.  This goes on for weeks/months.  Then, all of a sudden, you wake up one morning, check your analytics and discover that for some reason, the price for your most important keyword went up.  Way up.  Enough that your morning coffee comes shooting out your nose.  After some poking around on the Interwebs, you find out that some lame startup on the other coast just raised $5 million from some lame VC.  They just emerged from the shower freshly sprinkled with a new round of funding, hired a VP of Marketing who then went out and started buying AdWords.  Your AdWords.  The real tragedy with this story is that this competitor is not all that bright.  They don’t know that they can’t really afford to pay that much for a click and make profits (they’re not thinking about profits — they just raised a bunch of money).  Your problem is not that they’re super-smart, it’s that they’re super-ignorant.  And that’s the thing with PPC.  You’re basically at the mercy of the stupidest market entrant.  Call me simple-minded, but that doesn’t sound like a particularly effective barrier to entry when someone can just come along and drive your cost of customer acquisition (COCA) up.  And, it doesn’t happen overnight — it happens immediately

3. Get spectacularly good at search engine optimization (SEO).  Instead of becoming really, really good at PPC, invest in the time and energy to become an SEO-ninja instead.  The first reason for this is that SEO is cheaper.  Not free (generally), but free on a marginal basis.  Here’s why:  In PPC, each additional click costs you money (based on the cost-per-click).  Want 1,000 more clicks?  You pay for all of them.  For SEO, once you’re ranking well and getting traffic, the clicks don’t cost you anything.  It’s going to take some time/energy to rank in the first place, but once you do, life is good.  Further, unlike PPC, SEO does not reward the stupidest market entrant.  Someone that’s new to the game can’t just walk right in and snatch your #1 ranking.  Granted, they can spend some money and eventually get there, but it’s not going to be immediate and you’ll probably see it coming.  (All you have to do is watch the search engine results for your favorite keywords and see who’s creeping up on you).  So, unlike PPC, the presence and skills you build in SEO-land are much more sustainble and defensible.  In fact, if you’re out raising money, being able to demonstrate that you’ve got strong rankings for traffic-generating keywords is a major, major plus. 

4. Create content that kicks butt.  It’s really simple.  If you produce things that are useful/interesting to your target customers — you win.  You win by drawing people in to your business not because you had the largest marketing budget, but because you created something of value.  The kind of stuff that people tweet about, link to in their blogs and and share with their friends.  That’s magical.  The type of content can be varied.  At my startup HubSpot, we’ve tried lots of different things: “normal” blog articles, music videos, parody videos, songs, cartoons — and of course, free marketing tools.  For most startups, if you took every dollar you would have spent on advertising to try and beat your prospects over the head in the hopes that they’ll buy from you and instead spent that dollar on actually producing useful content, you’d win.  Seriously win.  This worked so well for us that almost all of our increase in marketing spend is allocated towards hiring people that can produce content.  They make videos, write blogs, create research reports and develop software tools.  The beauty of this content is that long after you’ve invested in creating it, it’ll continue to generate traffic and leads.  To this day, some of the early articles I wrote for our marketing blog drive consistent cash into our bank account.  We don’t have to spend a penny for those leads.  I’ll summarize again in four words:  Create content.  It works. 

So, I want you to imagine this:  Imagine that you’ve got a business that is exceptionally good at pulling customers in by the truck-load.  Not by spending money on outbound marketng (like advertising, spam, telemarketing and direct mail), but organically because they think the stuff you have to say is just so freakin’ awesome.  People are shouting from the virtual twitter rooftops about how great you are.  They’re so mind-bogglingly happy that they’re writing entire blog articles talking about your company and your product.  And you don’t have to pay them a penny.  Now imagine that some competitor emerges, raises money from Sequoia and comes after you.  Do you think it’ll be easy for them to reproduce that magic that you’ve built?  Nope.  It’s hard.  And that, my friends, is what I call a bonafide barrier to entry.

On a closing note, I’m going to ask you a favor.  It has been less than 36 hours since my book, Inbound Marketing has been available in bookstores nationwide.  Today was the big “release” day.  Already, it’s in the Amazon Top 100 business books list, and the #6 book on marketing (if you helped make that happen, thanks!)  The entire book is about pulling customers in.  I wrote it not to make money (it’s near impossible to make money writing a book), but to try and convince more people — especially startup founders, that inbound marketing is a better way to go.  So, you should buy the book. To make it easier for you, I’ll give you my personal, one-question asked, money-back guarantee.  If you buy the book and don’t find it useful, just tweet me @dharmesh and I’ll send you $25 via PayPal.  (The only question I’ll ask you is “what should I do to make it useful so people that read the next edition don’t waste their time?”).

Oh, and for whatever reason, if you owe me a favor (or $25), this is a great karmic-loop way to pay me back. For some reason, even though the money made is miniscule, I get some emotional gratification from seeing the book do well.  And, $25 is a small price to pay for my emotional betterment, don’t you think?  OK, that’s enough guilt for one blog article.  Go buy the book on Amazon.  Then, copy-and paste this message into twitter — “I let @dharmesh talk me into buying his book (http://InboundMarketingBook.com). You should too". 

Or, just click here to tweet it.

Thanks a bunch for your support and apologies for the shameless promotion this time (I don't do it that often).  I promise to get back to my regular shameful promotion next week, once the newness of being a first-time author has worn off.

Oh, and what do you think about exceptional marketing being a barrier to entry?  Agree or disagree that this could work?

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Holy Crap! HubSpot Has Now Raised A Total Of $33 Million

By Dharmesh Shah on October 19, 2009

It has been a little over a year since I announced the news that my marketing software startup closed it’s Series B round of funding.  The article, “Insanity? Why A Bootstrap Entrepreneur Raised $17 Million in Venture Funding”, was a candid glimpse into the rationale for raising what seemed like a huge amount of money to me at the time (it seemed huge, because it was — at least to me).

Today, we’ve released news that HubSpot has just closed on another $16 million funding round (our Series C) bringing our total capital raised to a whopping $33 million. 

As I write this, I’m a bit worried that this article is going to come off as arrogant and/or self-indulgent.  I promise that’s not my intent.  I’m just going to let you “inside my brain” in the hopes that some of you will find the excursion interesting, amusing or useful.  Although not all of you are out raising money (thank goodness!), I thought you might want an insider’s view on why an otherwise rational and pragmatic entrepreneur would make this kind of leap.  I promise, the decision to raise this kind of money wasn’t as crazy as you might think.

The Story Of How I Ended Up Raising $33 Million In Funding

1. Did we need the cash?  No, we didn’t need the cash.  We had over $6 million in the bank.  But, if I’ve learned one thing about VC fund-raising it’s that not needing to raise money helps a lot. 

2. Why raise money at all?  As the company has evolved, we’ve learned a lot about the mechanics of our business.  We have gotten pretty good not just at predicting our growth path — but actually solving for it.  There’s no better way to illustrate this than with the graph below:

HubSpot Growth Chart

This graph shows the number of customers (people that pay us money) over time.  Note that our revenue curve is  even better than this (because the average revenue per customer has steadily gone up over the same period).  In short, things have been going pretty well.  As we’ve gotten more visibility into the business, we’ve gotten good metrics around the drivers in the business.  The two most important are:  COCA (cost of customer acquisition) and LTV (lifetime value).  We’ve worked hard to ensure that COCA < LTV.  And, this margin is getting better over time.  Given that we’ve got a decent handle on things, it made sense to further invest in the business so that we can continue to scale it.  Once we found a model that works, we figured it would be a good idea to iterate, execute and scale it.  As I’ve noted here in the past, we’re swinging for the fences with HubSpot and have not backed off of that position one iota. 

3. Should we raise now or wait?  OK, fine that we decided to raise money, but why now?  Given the state of the economy over the past year, some thought we were raising too early.  The business has been growing exceptionally well.  The question was:  “Why not wait until the economy improves, the business is even further along, and raise at better terms?”  That was a good question.  Our primary argument was that we didn’t want to wait too long, because the longer we waited, the less leverage we would have (see #1 above).  It was not a particularly easy decision.  We’ve been fortunate to have great investors in the company (General Catalyst and Matrix Partners) who have been exceptionally supportive.  We were reasonably confident that had we waited until next year, we would likely have had no issue raising funds.  But, even during our best times, we’re cautiously optimistic at HubSpot.  A few factors we were pondering:  1) Would the economy really improve?  If so how, when, how much, and for how long?  2) Even if the economy improved, what would the VC industry look like next year?  (We had already witnessed a fair amount of shake-out and expected more).  3) Even if things did get better, how much better would the deal be then vs. now?  How much should we discount back for risk?  4) How would a “wait until later” approach impact our decision-making in the business right now?  Would we take appropriate levels of risk or as time passed, would we start to act with increasingly more conservatism? 

After all was said and done, we decided that there was a price (or more accurately a “set of terms”) at which we’d be willing to do a deal now, instead of waiting until later.  We were able to beat that “minimum bar” (by a relatively large margin), so it made sense to do something now.  Of course, in these situations, it’s never “knowable” as to whether we made the right decision or not.  But, we’re relatively comfortable that we at least made a pretty thoughtful decision. 

4.  Did you really need to raise that much?  Not really.  Our model and plan called for significantly less than this.  But, the other important thing I’ve learned about venture fund-raising is that you should always raise more than you think you need to get to the next milestone.  We had a model and plan in place that would make this the last venture round we’d need.  But, given the terms on the table, it made sense to leave ourselves some wiggle room and buffer.  This increased the probability that we’d be able to get to where we wanted — even if things didn’t quite go precisely as planned (which they rarely do).  And, it’s painful to go through the fund-raising process, so if you can condense things into fewer rounds, it saves a lot of pain and agony.  We had the opportunity to raise more than we needed, with pretty “entrepreneur friendly” terms — so we took it.

5.  What are you going to do with all that money?  Well, we’ve always been pretty capital efficient.  One quick calculation I’ve been doing in my head since the early days of starting the company is this:  Figure out your run-rate annual recurring revenue.  Multiply this by some conservative industry multiple (somewhere around 3X).  Then, make sure that the total money you’ve “consumed” is less than this number.  When it is, you’re basically operating on an “accretive” basis (i.e. the actual enterprise value built — even if sold to a conservative financial buyer — is greater than the amount of money used to build that value).  In our case, we’ve been accretive from the early, early days.  And, despite our torrid growth, we’re still accretive now (revenues and associated “enterprise value” is growing faster than our rate of capital consumption).  So, back to what we’re planning to do with the money:  #1 product.  #2 product.  #3 customer acquisition.  We have a backlog of ideas that’s both uplifting and depressing at the same time.  There are so many great ideas for how we can deliver more value to our customers.  We plan to pick the best of these and execute on them maniacally. 

We are out to build the next-generation marketing platform.  

6.  So what’s next?  We’re also on to what we think is a massive opportunity that helps organizations capitalize on the major tectonic shift in the marketing industry.  It’s a really, really big deal.  But, with radical change comes the need for radical education.  And that kind of education takes committment — and capital.  We’ve got a burning passion to help people figure out how to better reach their potential customers by pulling them in.  This is what caused me to devote most of the Summer to write Inbound Marketing (a book that captures a lot of what I’ve learned about marketing by helping startups and small companies figure out how to “get found”).  But, enough about me.  Let’s talk abut you.  You’re likely in the startup game because you perceive something fundamentally wrong with the world that you know you can make better.  I know how you feel.  My advice is to dig in, understand the problem as well as you can — and go fix it

OK, so reading back through the article, it came off as more self-indulgent than I had planned.  But, it’s 2:00 a.m. here in Boston and I’m not sure investing more time is going to make the article much better.  Such is life sometimes.  I trust you’ll forgive me for this lapse.  It’s a big day for me and my team at HubSpot.  We’ve now got even higher expectations for ourselves than we had before.  Like you, we’ll be working hard to live up to those expectations.  I’ll close (once again) with my definition of success:

Success = Making those that believed in you look brilliant.

What do you think?  Did I do the right thing in raising all this funding or am I just rationalizing my behavior decision?  What would you have done?

Oh, and if you're a blogger/journalist/media type and are curious about details or want to write a story, feel free to email me at dshah {@} onstartups.com.  Would be happy to chat.

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