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EP245 Lecture 5

Contents

Customer Relationships

Today, we're going to be talking about customer relationships. In other words, how do you get, keep and grow customers. So in the last lecture, you remember the business model canvas, all the 9 components of a startup. We talked about value proposition, we talked about customer segments, we talked about channels, but today we're going to focus on customer relationships. Customer relationships really is about how do you get customers, how do you keep customers, and how do you grow them. Here are two get, keep and grow funnels, and the one thing to note is just the one on the top represents a physical channel and the one on the bottom is web/mobile and the thing to just remember is at physical channel is we're going to see later of the details inside of how you get or acquire customers are different than how you would acquire customers in web/mobile. Just know that the physical representation of the customer's life cycle--get, keep and grow, is kind of this double-barreled funnel and that's why we draw this way. It just allows you to kind of understand how do customers get into our company, how do we get them, how do we keep them, and how do we grow them. And so let's look at both of these get, keep and grow for physical and web/mobile channels in a little more detail.

Three Components

To recap, what are the three parts of customer relationships? Is it channel, is it grow, is it segments, is it get, is it partners, or is it keep. Select the three that make up customer relationships.

Three Components Solution

The answers are get, keep, and grow--are the three parts of customer relationships. As we'll see, customer relationships start with get. Get is how you actually acquire customers and get them to purchase your product. Keep--just like it sounds. How do you keep customers for long period of time rather than losing the ones you've spent all the money acquiring? And then grow is a neat trick that smart companies do--is that they understand that it's a lot more expensive to get customers than to keep them and grow them. And so they figure out how to sell existing customers more products. Get, keep and grow--the three components of customer relationships.

Customer Archetypes

Now we keep using the words get, keep, and grow, but this get, keep, and grow actually refers to human beings not just random ideas. And one of the things we need to understand is what's the archetype
or the persona of our customers that we're actually wanting to get and so one of the things that's kind of hard for startups is to realize that getting customers isn't some abstract idea-- you really need to understand who your customers are and this is not just thinking about selling to consumers. Even in corporations, there are human beings with titles that you need to figure out almost the same things as you would in a consumer company. And so what you need to understand--what are the roles of these individuals you're trying to sell to. Who are they? If its in a company, what's their position? What's their title? What's their organization, and by the way not just on the org chart. How do they get influenced to? Who do they influence? And if there are actually buyers, how do they buy. I mean how do they hear of our products, how do they know about you, and as we'll see later one of the interesting things is there are some customers that are users like in Google-- There are people who use search, but there are people who are payers who are actually a whole different customer segment. You need to understand that these people--this archetype I'm trying to define are they users or the payers, are they regulators, or they're somewhere else in the buying process. And what you really are trying to understand, if you remember from the value proposition
and customer segment lectures, is you're trying to understand what pain is being solve for them
and what gain is your product creating for them, and if the core is you're trying to derive an archetype of who they are and so what we tend to do is suggest there are startups that you would literally start with a series of hypothesis and you get out of the building and in your customer discovery process, you're going to start refining archetypes.
It turns that most companies are selling to multiple archetypes. If you have two or three, don't worry--that's probably fine. If you have 20, it means you voted none of the above and you really need to refine it more, but then we suggest the company is actually pick a representative picture of who that persona is-- who the person would most represent that archetype. Put together a poster and post it on the wall of your engineering department
and say, "Here's who you're building the product for"--it's they. He might be a young urban professional, 21 to 30, lives in the large cities, buys x or y. Or it could be Sally, a Midwest mother of 45 to 55 in the MIdwest of the United States or someone in India or China--it doesn't matter. What you need to do is have an opinion based on some fact that gets refined. It helps you understand these are the people we're trying to acquire and don't angst about your first hypothesis, but understand the whole goal of customer discovery is to continually to refine-- these are the people we think are most likely to buy in the early stages of our company. 

Once I understand who my archetypes or persona is, the next thing I want to figure out is how do I get them in to this funnel. Regardless of whether it's web or mobile, I need to somehow figure out how to get the interest of my customer archetypes--Dave in the major urban area or Sally in the Midwest or someone in China or India. How do I get them interested, and there are two types of ways to create demand. The first set of things are paid demand creation activities. Fancy word for saying--I'm going to pay somebody to get your interest. First people I might want to pay is the public relations agency. I might pay them a certain fee per month to help get stories about my products
and or my company in newspapers or in blogs or in tech journals, etc.
And so hiring a PR agency is a paid demand creation activities.
Another common paid activity is advertising. What kind of advertising? Well, it depends what my archetype reads. If they read a blog, I want somehow get either keywords or better ads or something in the blog. If they read newspapers, tech journals, or listen to radio or television, that is I want to match my demand creation activities to what I know about my archetype. I'm not just going to randomly do this. I'm actually going to try to match what I know to what I'm going to pay for. Next thing could be trade shows.  In some industries, people still physically go to trade shows. Have booths, walk the aisles, meet people. Maybe I should be in one and have a booth and maybe I'll find out my archetypes don't even care, and by the way, just as inside, you might also want to be worried about whether your partner show up.
Maybe they show up at trade shows. The other thing is that I might find out that such trade shows or webinars might be interesting or I just might want to be sending them e-mail or direct mail. US post office or post offices in other countries are still happy to carry your advertising. Though this become less and less effective the more and more people are on the web, and then finally search engine marketing, Google ads or Facebook ads, etc. are now just a standard way to pay for demand creation activities
regardless of whether it's a physical channel or a mobile channel. All of these activities are designed to feed the sales model. The demand creation funnel is going to fed by these things you do.

Earned Demand Creation

Unlike pain demand creation activities, earned demand creation activities is just another word for the types of demand creation activities we get for free. These might be publications in journals, they might be conferences--you get to speak up, speeches you give elsewhere, maybe blogs you put on your blog, or you might be invited to do guest blogs elsewhere, or guest articles, or most importantly, it might be social media. You might have a company Facebook page, you might twit, people in your company might twit-- anything you could for free will get you attention of the key customer archetypes and helps draw them into your acquisition activities.

Get Keep Grow

Let's just take a look again if there's activities. If you remember what we're trying to do is get, keep and grow customers, and so these things on the left with all these arrows going into the funnel, those represent all the demand creation activities you were doing either paid or free. And in the physical channel that we're getting you into the funnel on the top. And for web, mobile or cloud, we were getting you into the funnel on the bottom. Now remember, these are just visual representations of the process. The world doesn't actually look like this but when you get good enough ad, thus you tend to actually look at your process. What we are really looking is a funnel laying on its side and you tend to think about how do we efficiently get payers or users into the funnel and all the way through it.

Get Physical

Let's take a look at getting customers for physical channel. Now, what does that mean. Imagine you're JetBlue and you now have a new airline route going from LaGuardia in the United States in New York City down to Orlando, Florida and you really want to get people to know about this new airline route, well the first you're going to use is earned and paid media. You might run TV ads, you might run radio spots, newspapers, or your website, you might send out email and the first thing you're doing with this paid media is you're trying to get people aware that you even have a flight from New York to Orlando. This first step in a physical channel is generating awareness. People just need to know that this thing exist. Now the bad news is that your ad agencies or whatever could tell you how many people this ad will reach, but they can't quite tell you yet how many will purchase but you're interested in--okay, did they hear this. The next thing that you might want is to know are they interested. Nowadays, even in physical channels, we could see--did anybody hit the JetBlue website and did they push the button on fares from Orlando and New York to Orlando, is there some interest or do they call your 1-800 number but really we're finally gets engaging in a physical channel. Is there people actually asking for the schedules and are hitting the "How much does it cost" page. In fact, what you really want to be tracking is--are people calling reservations or if this was a car dealership--are they showing up in the dealer, taking the car out for a test drive-- that's consideration. In the physical channel, it's really interesting to measure the differences between how many people did my ads or free media reached versus how many did I get in to my physical channel to actually consider the product. How many showed up in the store, how many showed up on my website, how many called the 800 number, and it's this space between actually doing and this is what makes it so hard in physical channels. It's all the effort on paid and earned media. You really don't know where those customers are until they're physically inside you channel considering the purchase, and then of course, when they click "I'll buy it" or tell a dealer "I'll take the car," or in JetBlue's case actually say, "I'll but this fair" or "Book a seat," you'll finally understand whether you have the order or not and that's what acquisition looks like in a physical channel--awareness, consideration and purchase.

Viral Loop

Now, in a world where basically that's all you do is you create demand on the left side of the funnel and somebody purchases on the right, you could kind of like measure how much it cost to do that and then we'll talk about customer acquisition cost a little later, but there's a little magic accelerator on the bottom of this funnel, and that's called the viral loop. A viral loop could be something as simple as somebody bought one of your products in the store and could not wait to tell their friends--wow, this was the greatest thing ever, you can't wait to get them boom. You now have kind of a magnifying effect, a viral effect, about selling your product based on users loving it. Well, this happened for a hundreds of years, but now we could sometimes engineer this viral loop by saying--is there anything that we can do, any incentives, any ways to kind of get rebates, is there a way to turn our customers into sales people to kind of accelerate this purchase to help us get new customers. And Smart Startups think about this loop all the time, so viral loops are something that startups want to see if it's possible to create. Now, just don't feel bad if in your company it's really not possible to do viral-- for example, in dating sites. Not everybody wants to announce to their friends that they are actually visiting a dating site. So in some cases it might not be possible, but in other you should always keep your eye out-- is it possible to make this funnel more efficient.

Get Alternatives

Just as a note, one of the interesting things about getting customers is-- I happen to draw the funnel that says awareness, interest, consideration, and purchase, but here's just a heads up. In your funnel, in your physical channel, you might decide the steps are slightly different. Now you feel locked in to calling them awareness, interest, consideration and purchase, just realize that you need to modify these to what your real cycle is and you will only kind of learn that as you watch customers get from being aware of your product to purchase. Use this as a template but don't think that there's anything magic about this. It's just a proxy.

Keep Physical

We've just been talking about getting customers in a physical channel, but what's really interesting is most startups kind of forget that it's much more expensive to get a customer than it is to keep one. Yet, we seem to go from order to order or user to user forgetting about thinking about all the time is how can we extract more dollars or usage or whatever is important to us from our existing customers. How we do that is the first thing we need to do is make sure our existing customers we've just gotten don't go away, and so if you're in business long enough, you'll start thinking about how to keep customers. Some examples, well the airlines are the perfect examples of keeping customers. They run something called the loyalty programs. They give you points, they give you rewards, etc. for staying with their airline. Credit card companies--boy, they love to keep you using their credit card because you know what it's just a piece of plastic and they're loaning you money--anybody can do that, but they want your business full-time, so they'll make up programs and things that make you think about--oh, it will be terrible to leave this credit card with this airline because I loose all the points. That's a great example of a loyalty program. Or product updates, here's a way to keep me loyal is instead of just this one-time purchase, I'm getting these updates or newsletters or something useful through the lifetime of the product and Smart Companies not only do loyalty and product updates, sometimes they send me newsletters and here's what's going on and here's whatever and how can we help you, etc. Even though on day 1 you're not thinking about keeping customers because you're desperately worried about getting them, just understand the next thing you're going to be doing is worrying about how to keep your most valuable customer.

Grow Physical

The next step in this funnel is remember we just talked about getting customers and let's talk about keeping customers. This is what I called the you-should-be-so-lucky-to-have-this-problem part of the funnel, and that's how you grow the customers you have. When you're thinking about growing customers, nothing magic. You've now sold these customers way back here under purchased, and you've kept them around with relative programs and product updates, but really what you'd like to do, understanding now that it's a lot cheaper to sell existing customers more stuff than it is to get new customers, is let's go try to sell them some stuff, and how can we do that. Well, the first thing you might want to think about is, can I un-bundle some of the stuff in my startup that I tried to package all at once. What are the mistakes that early stage ventures make that this new company is thinking that you have to stick every possible feature in the product and sell it for the one price. It might be possible once you understand more and more about your customers to know that, you know what, most people just kind of want the base product or you might have a freemium strategy which just says I'll give them the base product for free but really understanding that what they're going to want some percentage is these other things. Un-bundling is just a fancy word for saying--can I somehow decompose the product into separate pieces, giving some for free or if you're lucky, charging for everyone of them. I used to do this all the time to actually increase the average selling price by un-bundling the product. And next thing to think about is can I up-sell the product. A retailer in the United States called Sears had a line of tools that they sold to people who made things and their product line always had three types of products--good, better, and best. And what they would try to get you to do is get you into the store looking at the price of the good product but then when you got there, you said-- well, I deserve better and then someday I could aspire to the best. And so that was kind of up-selling in the same product line and in fact in the United States from the 1920s to the 1960s, the master of up-selling was General Motors. When they had separate brands, each had a fixed price point. You started buying a car with a Chevrolet then you moved up to a Buick, then a Pontiac, then an Oldsmobile, then eventually you could aspire to a Cadillac. And these were all kind of up-selling based on aspirations and the quality and features of the product increase as well. You might want to think about creating an up-sell strategy. Cross-sell, well that's also kind of simple. Gee, if you're buying one product, are there any accessories or companion products that you ought to just figure out to make sure that you customers are aware of or on the pricing page or on a price list say-- Gee, when you buy this product, we'll give you a 20% discount off of this other one, which most consumers would realize, ooh I'd like to have that too, and so thinking about what adjacent products, what products next to the one you're already selling customers can buy is a cross-selling strategy. Finally, the last piece is referrals and that's another grow strategy. And referrals basically generates this outer viral loop. Remember what we were trying to do in the initial purchase or get your new customers to start telling their friends about your products, you want to do the same thing after you've had those customers for a while. Maybe now you want to give them discounts on future purchases. You want to say thank you for doing this, by the way, a $100 off or $5 off to the next purchase. When you bring in the next new customers, banks now think that's a popular strategy, and this referral program just helps your customers, hopefully, who are satisfied sell more of your product for you. And so that's get, keep, and now grow customers. By the way, this grow funnel just like in get customers, there's nothing magic about cross-sell, up-sell, and un-bundling, there might be other strategies that your company and your startup might want to stick in to this funnel as well. We put this up as kind of a canonical model because most companies tend to use these types of techniques but it really depends on what you're industry and product line is.

Get Web

Let's take a look at now the web/mobile funnel. Now, what's really interesting is in the web/mobile funnel--the getting customers part of the funnel is actually quite simple, at least on first glance. We still have earned and paid media driving customers into the funnel. If you remember, we understood who the customer archetype was with running search engine marketing or search engine optimization, but in the web, we just really have to do two things-- First one is we got to acquire customers and then we activate them. Well, what's acquire mean--acquire on the web is how we want to get them to my site or to my mobile app or to my cloud app. How do I do that--as we said, earned and paid media will drive customers somehow to be looking at a place that you're at, but the next step is much harder. After I acquire them, I want them to do something--I just don't them to look and go away. I want them to either pay for the product or sign up for something and become a user. What is the word activate means. I want you to engage with my website or my app and do something I have planned for you to do. Now in a simple world is what I would plan for you to do is open your wallet and give me all your money. In a non-perfect world, you might just be a user and I'm going to monetize you by getting pairs to pay for the fact that I have lots of users, but acquisition-- that is acquire, and activation is a 2-parts strategy. In theory, understanding acquisition and activation seems pretty simple. I get it, I understand who my customers are, and then I figure out what earned and paid media I want to use and on the web, I might be paying Google forever. I'm going to acquire them and then activate them. How hard could this be. Well, hopefully it gets kind of fun because the real metric--the way we kind of measure things, the language we use on the web is customer acquisition cost. And what we want to do is figure out how much is it really going to cost us to get an activated customer out here on the right hand of the get funnel. Let's do an exercise and see what it feels like and how does it work to get an activated customer and how much it cost.

Web Customer Acquisition Cost

Let's assume I'm using Google AdWords and I'm paying $0.50 per pay-per-click. Now, let's assume my campaign at $0.50 each gets me 10,000 people to come look at my website. Well, $0.5010,000, that cost me $5,000, but the goal isn't to just have people visit, the goal is to get them to the end of the funnel and at the end of the funnel, I want them to actually have paid for and/or used the product, so the goal is to activate them.. Now, what's interesting is assume I'm offering a trial and assume that maybe just 5% of the people who I've acquired actually now take the trial. And so I now have 500 people using my freemium product but the goal is not to just have them use the freemium product--. the goal is to actually have them pay for it and what's interesting is, assume 10% of those now actually paid. I'd start with 10,000 people who came to my site and I spent $5000 for them, So while 10,000 people upgrade for 5 grand because it only cost me $0.50 per person. If we now do the math, we can now see it cost me $100 to acquire one paying customer. That $100 equals my customer acquisition cost. I used this example for a web/mobile channel but it's similar for physical channel. You might not be doing pay per click, you might be doing direct math, or you might be doing television or radio math, but the math works the same. How much did it cost to acquire a customer? How much did the campaign cost? How much did it cost to get them to consider your product? How much did it cost them to take a test drive of your car or fly your airline? And what in the end was your customer acquisition cost? That's a key number for any founder thinking about a startup.

CAC

Now we're going to do a quiz and what we're going do is try to calculate how much it cost to actually get an active customer and let's start with the pay-per-click. Let's assume we're doing a web company and we spent 75 cents on Google AdWords for every click that comes to our website here. Now assume we actually have figured out that it require 4,025 customers at 75 cents in this campaign. Next, we just don't want to get them to our website, we actually want them to sign up for our product. Assume 3.7% of these 4,025 customers actually converted from acquired customers to activated customers, so the question for this quiz is calculate what was the customer acquisition cost per customer.

CAC

Let's see how we came up with our answer. Number 1, our pay-per-click number was 75 cents for each customer that we go to our side and we know we got 4,025 customers, and so if we multiply that out, we know we've spent $3,018. And on the next number that's important is that not all 4,025 actually activated and in fact, if we look at this number, our conversion number, only 3.7% converted. If we multiply that out, we'll discover that equals about 149 activated customers, and now if we divide the $3,018 by these 149 activated customers, we find out that the customer acquisition cost, the CAC, equals about $20, more precisely about $20.27.

Keep Web

Let's take a look at keeping customers for the web/mobile channel. Web/mobile works almost exactly like physical channels--keeping customers. It's exactly the same idea--we might want to offer loyalty programs, contests and events, blogs, RSS and email, or social media--all designed to engage customers. Why do you want to think about keeping customers is that customers are a lot more expensive to acquire over here than they are to keep. And the key thing that you want to worry about is churn or sometimes called customer attrition. And here is why--so imagine if you are losing 5% of your customers a month, well in 3 years you'll only have about 16% of them left, but imagine if you can reduce churn to 1%, so that every month only 1% of these customers left. After 36 months with 1% attrition, you'd have 70% of your customers left. Just think about it, with 5% attrition, your average customers sticks around for about 20 months, but with 1% attrition, they stick around for 100 months. You get 5 times more revenue from the same customers by just working on keeping these customers around. Now, by the way in reality, financial people discount the cash flows from customers later in this life cycle. The actual value you get is somewhat less--how much less depends on your industry and cost of capital, but we'll leave that for the accounting to set in a more detailed price

Grow Web

This last step is growing customers for the web/mobile channels. Now if you remember we started here on the left. We didn't earn and paid media. We got customers, acquired them, and activated them. We've kept them trying to keep the churn to a minimum. And now we're going to grow customers with the series of activities just like in the physical channel. Can we up-sell, can we next-sell, can we cross-sell, and can get referrals that will get us a viral loop. One of the most important metrics to think about now that we have an end-to-end funnel is something called lifetime value and a lifetime value LTV is not your lifetime but your customer's lifetime. How much will they spend with you and your company from the beginning to the very end. And this is kind of an interesting idea because most startups and most founders are focused on how do I get them to activate here? But for you to be a successful company and actually thinking about how much you could spend on them over here, you need to understand-- can I get them to spend more and more over time and how to keep them longer and longer by reducing churn. So one of the interesting equations for every startup is that lifetime value needs to be greater than customer acquisition cost. Seems intuitively obvious but what you want to make sure is the amount of money you're collecting over here is bigger than the customer acquisition cost to remember the amount of money you're spending from here to here. That was the customer acquisition cost, CAC, here. So lifetime value needs to be greater than customer acquisition cost. And as you get more familiar with your company and start talking to investors, the real interesting thing is what is this ratio? For example, in SAS software, some investors think that number should be 3>1. In Telecom, it might be something else but the key idea is you are now not just focused on the initial purchase but you're focused on the lifetime value. If you have world's most perfect business model, investors would love to see this number much bigger than this number and so what you want to look for is a well-balanced model that takes into account how much you need to acquire customers but how much ultimately you'll extract from them over the lifetime. What's the lifetime? That really is up to you and your investors on how many years you calculate lifetime value. Some use 3 years, some use 5--that's a question that you and your investors will discuss. This acquisition cost versus lifetime value discussion really is a balancing act. So what are some of the balancing acts? Well, in the customer acquisition cost, if all of a sudden, you could get a viral loop going, well, that decreases your cost of acquisition. If in fact, your conversion rate between acquisition activation could be increased. Again, it decreases your customer acquisition cost. If you could do in physical channels, telesales or inside sales versus having a direct sales force, Again, your CAC declines. The idea is what can you do to make this very efficient? And therefore, also, on lifetime value, how do you reduce churn and attrition in keeping customers? Do you have scalable pricing? Are you cross-selling and up-selling a lot? Can you expand your product line? And again, are you getting a viral loop and referral loop from happy and satisfied customers telling others word of mouth and so this is a balancing game, and for first time entrepreneurs who are focused here, it's really important to think about customer acquisition cost and a lifetime value.

Lifetime Value

The question is, what is lifetime value? Is it the sum of all get activities, reducing churn, all of the grow revenue, or is it the total customer revenue through get, keep, grow?

Lifetime Value Solution

Customer lifetime value is exactly what is says. What's the sum of all the revenue from day 1 purchase, so you're keeping them through all the grow activities you're undertaking. Lifetime value is the customer lifetime value from beginning to end, and just as a note, remember customer acquisition costs acquired over here, needs to be less than customer lifetime value. That's how you stay in business and become a valuable company.

Optional Reading

Now that we just covered the customer relationship to lecture--get, keep and grow, the optional reading for next week in the Startup Owner's Manual pages 180-188, 260-269 and 438-456. Now, there's a nice video we ought to watch which Mark Pincus of Zynga-- did called Quick and Frequent Product Testing and Assessment, just click on the link for access to the video. Now, for next week, we really want you to get out of the building and actually try to build a budget yourself and a forecast for customer acquisition, which is the first thing you need to do whether it's a physical channel or web/mobile except in web/mobile we were actually going to do it in the next couple of weeks. And create an objective pass/fail matrix for each of the customer acquisition get test because we are going to be using Google AdWords, what are the right metrics, what are the right test, and what's nice is--is all you have to do is guess because your experiments are going to be cheap--you could actually find out ??? $5 a day with keywords. In the physical channels, it's a little harder. You need to be talking to customers and trying to understand how do they get information and how to find out about products. Is it radio, is it still the web, is it other trade shows, etc., so sometimes both physical and web channels use the same vehicles. Other times how you get, keep and grow customers are distinctly different. You want to understand specifically--what is your customer acquisition cost, what are the customer lifetime values. There is no way you can actually know for certain in the first week of getting out of the building, but now you're asking these questions and these questions you're going to be asking for the next couple of years in your company, so here's a good place to start. If you want some examples, the link below will take you to some of these gate-keeping grow examples, optionally use a LaunchPad Central software and push your customer discovery narratives.