Traversing the Traction Gap

by Bruce Cleveland

  As already noted, there is little data or advisory support available for teams entering the Traction Gap. Worse, we have discovered that while many startups typically apply rigor and discipline to the development of their products, they more often rely upon myth and lore when it comes to team building, marketing, and sales.

  Too many of these teams release a product and then squander valuable capital and time experimenting with a variety of marketing programs, positioning statements, user-acquisition strategies, pricing models, onboarding schemes, and sales tactics. Then, as the initial capital begins to dwindle, the team and its investors grow increasingly nervous as they realize that the company has failed to generate sufficient traction to secure interest from new—or even current—investors. At this point, the company faces a shutdown or is forced to sell its assets at a substantial loss.

  What is going on? Why is a process involving billions of dollars of investment and run by some of the smartest people in the business world operating at such a low level of success?

  In the chapters that follow, I am going to show you how to navigate the perils of the Traction Gap—using a new set of milestones, processes, and tactics—to emerge successfully on the other side.

  I end subsequent chapters by introducing the “Traction Gap Hack,” the anecdotal, how-to-do-it section you will find following the information in each subsequent chapter. Here is a commentary by the founder of a company that has adopted the Traction Gap model—and that wishes to share some of the techniques it learned along the way.

  Jamie Miller is the CEO of Amplero. Amplero positions itself as an “Artificial Intelligence Marketing (AIM) company that enables business-to-consumer (B2C) marketers at global brands to build lasting customer relationships at a scale not humanly possible. Amplero’s award-winning AIM technology experiments, learns, and optimizes each interaction as customer relationships evolve.”

  Here is how Jamie describes their use of the Traction Gap Framework:

  The management team was first introduced to Bill Ericson and Bruce Cleveland at Wildcat Venture Partners through a joint relationship at RocketFuel, where Bill Ericson sat on the board. When I joined the company as CEO, I was introduced to the Traction Gap Framework and its concepts. The approach immediately made sense to me.

  I was impressed with the simplicity of the model and its relevance, and have used it to align our objectives top to bottom throughout the company. In fact, we have organized our board meetings around the four Traction Gap Architecture Pillars—product, revenue, team, and systems—to explain to the board what we’ve done, where we are, where we need to go, and what we need to do to get there.

  For our board meetings, we make the board aware of several high-level accomplishments/issues. We typically do this with a slide called “Bottom 3/Top 3.” These include the three biggest challenges or downside developments in the business, such as product delays, deal slippage, customer issues, or even negative team dynamics, and three of the most positive accomplishments, such as new customers, product shipments, and staff members, that have affected Amplero since the last board meeting. We use this as a way to inform the board of our most pressing matters and focus conversation in the board meeting.

  The slide immediately after “Bottom 3/Top 3” is the “FY Goals” slide. We break this slide into four quadrants—Product Architecture and Revenue Architecture on the upper/bottom left of the slide. Team Architecture and Systems Architecture are on the upper/bottom right of the slide.

  In each quadrant, we list out the high-level FY goals/objectives we have set for ourselves for that particular Traction Gap architectural pillar. To the right of the text that identifies the goal/objective, we use a rectangle colored red, green, or yellow—based upon the executive team’s assessment of where we are against the goal.

  This approach allows us to quickly convey to our team and the board where we believe we are succeeding and where we are not, relative to our operating plan for the year. We spend little time on the green rectangles; we focus the board meeting on the yellow and red ones. This allows us to talk about key issues and get the board’s input efficiently and effectively. We use a similar approach in our weekly executive staff meetings.

  We have found the Traction Gap Framework taxonomy and principles to be an invaluable way to think about and manage Amplero. Companies of any size developing a new product and business to address an emerging market opportunity would be well served to use the Traction Gap Framework.

  2

  APPLYING THE TRACTION GAP FRAMEWORK

  Alas, time is not a luxury that startups have if they want or need to raise venture capital. Venture investors seek traction—increasing growth rates—over anything else. In general, profitability only becomes a factor for investors once a company has become a market leader and growth begins to taper off. Even then, profitability takes a back seat, as investors have learned that they are rewarded for growth over nearly any other business metric.

  As a result, traction is a powerful investment decision factor for venture investors. You must show increasing traction at each Traction Gap value inflection point.

  Your mission is to use early-stage venture capital to achieve product/market fit as rapidly as possible, and then raise additional venture capital at each successive value inflection point by demonstrating increased traction through metrics such as revenue, usage rates, downloads, etc.

  As I explained in the beginning of this book, if you are in search of venture capital, you need to build two products—one a business or consumer offering, and the other a financial offering for investors.

  The Traction Gap Framework is designed to help you develop a well-grounded operating plan with strategies and tactics that enable you to build traction and scale. More importantly, the Traction Gap Framework will help you build a financial product, one specifically that venture investors will back.

  You may wonder why, if you can grow organically through your profits, you might consider taking venture capital. If you have no competition—and don’t expect to have any in the foreseeable future—then self-financing through your profits might be a perfectly viable strategy. But if a competitor emerges in your category, and that competitor is better capitalized than you, that entity may be able to grow more quickly, having the financial capacity to invest more than you can in engineering, sales, and marketing, and thereby diminish your ability to compete and survive.

  Additionally, depending upon the industry you are in and the products you are creating, many venture investors can help you; most have networks that you can tap into for hiring needs, customer introductions, and other key resources that you may require. These are some of several legitimate reasons to take venture capital even if you believe you can grow organically without it.

  Venture capital is the most expensive source of capital you will secure—you have to give up ownership in your company in exchange for it. Therefore, it is important to understand why you want it, when you want it, what you are going to use it for, who you want to take it from, and how you’ll spend it: as wisely and miserly as you can!

  Once you’ve made the decision that you want to raise venture capital, your objective from that point onward should be to maximize the probability of being able to raise that capital quickly, thereby minimizing the amount of dilution you will suffer in exchange for it.

  Some advice here. Raising venture capital is not a task the CEO can delegate. Many times, you are asking for millions in capital. This requires relationship building between the CEO and her investors—which takes time. Consequently, you must plan to invest a significant amount of time and effort against this task. All of this will take you away from building your business. Sorry about that, but it’s what you must do.

  This is where the velocity of your startup becomes a factor. The amount of time it takes for you to move from one Traction Gap value inflection point to the next will play a significant role in your ability to generate interest by venture firms, and at
what valuation.

  Until now, the metrics startups need to successfully raise capital have not been well publicized. In fact, if you meet with a venture firm, few will have written down some of the metrics I’m going to share with you here. But the best venture investors have some pretty good back-of-the-envelope metrics that constitute traction in their minds. They just have not been forthcoming about these matters.

  If you have a product in the market and meet with a venture firm with the hope of raising capital, and the firm concludes the meeting with something like “Wow. It looks like you’re making a lot of progress. Let’s circle back in six months to see how you’re doing,” then you don’t yet have traction. Well, at least not traction exciting enough for the firm to consider making an investment.

  While the Traction Gap value inflection points are valid for any startup, the specific metrics and timing between those value inflection points will vary, based upon the type of product you are building and the markets you serve.

  For example, the average amount of time between Ideation and Initial Product Release (IPR) varies significantly between a consumer mobile application company and a database company. The former can usually get to an IPR in months, the latter can take several years and will require a lot more capital to reach product/market fit.

  This is just one reason why consumer applications are so popular. They are relatively fast to build, don’t typically require much capital to see if they can achieve product/market fit, and, if successful, can generate significant returns more quickly than most business applications. This is what excites entrepreneurs and investors alike.

  That said, according to a recent blog post, each year more than 30,000 new consumer products are launched—and 80 percent of them fail. If you are building a consumer software product, the numbers are even higher: more than 90 percent fail.1 This is why defining your Minimum Viable Category, doing statistically valid market research, and preparing to go to market in the go-to-product phase are so critical to your success.

  Startups building products for businesses and consumers need to reach the same Traction Gap value inflection points, but the metrics and even the timing tend to be different.

  What I am about to share with you should help you better understand the metrics—the velocity of growth—you need to achieve in order to attract venture investors. The examples I show are primarily for B2B software startups, but the timing between value inflection points is surprisingly similar for startups with other offerings and business models.

  ■

  THE METRICS

  The following metrics come from examining the data from public software companies—the ones we are all familiar with, such as Marketo, Salesforce, and Workday—when they were small private companies.

  As I pointed out previously, most B2B software startups take about one year to one and a half years from Ideation to Initial Product Release (getting to MVC is part of “market-engineering”; this process should take place in parallel with creating your IPR), and another half a year (up to one year) to reach Minimum Viable Product. For more complex offerings—such as database or platform software—it can take two, three, or more years just to reach IPR. The amount of time to IPR and the capital required to build the product can and does vary greatly during this go-to-product phase.

  Traction Gap Timeline

  FIGURE 7

  These time frames can vary dependent upon the complexity of the product and market.

  Consumer software startups often can get to IPR with a few people and in a few months and with far less capital. B2B startups typically require much longer to get to IPR, as the products are more complex and they require people with significant computer science and domain expertise. That said, consumer products aren’t cheap downstream; once they reach product/market fit, they require significant amounts of capital to scale.

  The most difficult question startups must answer during the go-to-product phase is whether they can develop tangible proof that if they successfully build a product—even if their initial market feedback is positive—will consumers or businesses actually purchase and use it?

  Angel and venture investors who invest in startups during the go-to-product phase must rely mainly upon their intuition rather than copious evidence of a market or actual business metrics. I like to call early-stage investors “slideshow investors,” because for the most part that’s all there typically is to go on when making an investment decision! In contrast, I call the mid- to later-stage investors “spreadsheet investors,” because they have the advantage of being able to look at spreadsheets and evaluate actual business performance. Early-stage investors tend to be informed (well . . . sometimes not that informed) speculators who believe that a potentially large addressable market exists for a particular product and that the product team they are investing in are rock stars.

  Many of the best-known venture firms employ growth-sniffers (people who track websites, social media, and other sources of digital data to identify startups that are gaining traction) and analysts who meet with entrepreneurs to track startups early, but hold off from investing until they see that the startup is close to MVR or MVT.

  They can wait because they have “brand power” that enables them to get into and win competitive investment opportunities. Lesser-known venture firms many times must invest in startups at an earlier stage—with more assumed risk—or lose out to firms with more significant brands.

  This is just one of the several reasons the better-known venture firms can generate better returns than other venture firms; their reputation (brand) affords them the opportunity to see more startups when they are working—that is, generating traction. Even if they have to invest at higher valuations, by investing in the best of the startups, they benefit from correspondingly lower failure rates.

  This doesn’t mean that the best-known venture firms won’t invest in the early go-to-product phase, even at Ideation. They absolutely will—and often do—if they have a deep conviction about a certain market opportunity and the founders have great credentials.

  ■

  TICK TOCK

  In general, the Traction Gap clock—the amount of time it takes to get from Initial Product Release to Minimum Viable Traction—doesn’t begin to run in earnest until a startup reaches Minimum Viable Product. And the good news is that the startup is in control over when it decides to declare MVP.

  The bad news is that public software companies have generated a fairly well-known revenue growth curve from Ideation that private startups need to match or beat if they want venture investors to get excited about them.

  Most real revenue growth doesn’t begin until a startup reaches MVP, so that is where I will begin.

  From when they declared MVP, the most successful public software companies using a subscription model (SaaS) on average were able to generate $1M annual recurring revenue (ARR) by the end of their first year in market. By the end of the second year, they were able to generate at least $3M in ARR. At the end of year 3, these companies were generating at least $10M in ARR.

  It looks like this:

  ■ ARR Per Year After Reaching MVP ■

  So if you want to be on an equal or better revenue growth path than these successful predecessors, this is the model upon which you need to build your operating plan.

  Let’s assume you believe your average Annual Contract Value (ACV) for each customer will be $30K. To match the better SaaS companies’ revenue growth model, you need to reach $1M ARR by the end of Y1 from MVP with a total of 33 paying customers.

  ARR GOAL: Desired ARR / ACV = # of needed accounts

  For most SaaS companies, the value inflection point of MVR is about $2M ARR and, to be on model, you should reach this critical value inflection point within one and a half years from MVP. Assuming that a typical deal generates an average of $30K in Annual Contract Value, this means you will have approximately 66 paying customers.

  By this time, you should have delive
red several releases of your product, hired multiple people for various business functions, and begun to have a sense of your sales cycle. The metrics of your business should now emerge so you understand what type of pipeline coverage you need to generate monthly new customer targets, revenues, and what your customer acquisition costs average.

  Just prior to reaching MVR is the time when you should expect to invest in developing full-scale marketing and sales functions. As I noted previously, scaling before reaching MVR is ill advised. The cost of building a growth engine is expensive; and if you don’t have well-honed value propositions, and absolute product/market fit, you can rapidly deplete cash reserves with little revenue to show for it.

  Prior to MVR, the entire management team should be actively involved in selling activities and focused on learning which value propositions, demonstrations, features, et al. are persuasive with potential buyers/users. Knowing this enables the product marketing, marketing, and sales teams to build marketing and sales enablement content and tools that everyone can have some confidence will work in preparation for scaling.

  By the end of the second year after MVP, to be on a similar growth model to the best public software companies when they were at your stage, you should be at $3M ARR; and by end of the third year from MVP, assuming your average ACV per customer remains at $30K, you will need at least 333 customers to be generating $10M ARR. You can easily close 33 customers without a growth engine in place, but once you double this and reach MVR, you will need to have a well-functioning growth team in place if you want to reach MVT ($6M ARR) on your way to $10M ARR by the end of your third year in market.

  If you can reach MVT ($6M ARR) within two and a half years from the time you declare MVP, the best known—and for sure the unknown—venture firms will take notice of your company. They will have heard about you and will reach out. Guaranteed.