When Growing Your Software Startup, Don’t Fall for Outdated Advice

by on February 24, 2014

Often, I get a call from an entrepreneur in my network that goes something like this:

“My consulting business is going great; we found ourselves solving the same problem for multiple client, so we’ve developed this amazing software to solve it. Today it just works for this specific industry, but we could expand. I want to grow this product business, how should I do that?”

Like many tech startups, this entrepreneur (we’ll call her Jane) has established some “lighthouse” customers and established valuable market insight. She needs to find the right balance between expanding geographically, horizontally and vertically. Before we contrast these three approaches, let’s look at a couple prerequisite points.

First, I always make sure Jane has a real beachhead of business in a narrow definition of all three dimensions. This ensures capital efficiency and allows Jane to be agile in applying lessons learned from early customers. I also want to be sure a real pain that customers are willing to spend money to solve has truly been identified. Sometimes business is won on the charisma of the founder and/or excellence of services rather than the product. That’s fine to start but hard to scale. Startups often employ a shotgun approach in order to identify an attractive market opportunity, but once that’s accomplished it’s critical to focus resources on delighting customers with that common problem. This is the source of scalability.

Expansion considerations are for the business that has validated a strong value-proposition across a reasonable set of customers, not one still searching for product-market fit. It’s also universally true, in my experience, that it is useful to think about tackling one expansion route at a time rather than splitting resources across two or more. I have, however, found it helpful to consider both organic (internal growth) and partnering or acquisition alternatives at each step along the way.

Now let’s consider Jane’s alternatives:

1. Expand geographically. Being from Alberta, Jane’s business sells to energy service companies, although the considerations are largely the same for any B2B tech startup. Consider how different regulations are different in other locations, and how much weight customer references will carry from afar. In the energy sector, having customers that love you in Alberta often doesn’t mean much to a Texan.

If in-person relationship building is necessary during the sales process, then this can make geographic expansion expensive. Although it’s usually an entrepreneur’s first instinct, I’ll argue that this way of framing the question is self-limiting. Customer goodwill has always and will always be a valuable asset of any company, so if you’re doing a great job then your customer referrals will pull you to other geographies rather than you having to push. Don’t push.

As a rule of thumb, geographic expansion provides only linear growth, and the cost of that growth is usually higher than the alternatives. My advice is to think about the sources of friction that result in far-flung customers not already using your product – can you design your product to reduce that friction across the North American market, or, like Jane, are you inherently siloed in regional markets?

2. Expand horizontally to adjacent market segments. Most industries have a plurality of specialized sectors that are largely common but each unique. It’s been an historically successful strategy for software companies to “tweak” their code to work for adjacent sectors.

But the reasons why it worked in the past are no longer true—software was hard to write, and problems were easy to identify. Now the opposite is true; the obvious “IT” opportunities have been addressed in most industries, and the existence of sophisticated web and mobile platforms makes it much easier to develop software today.

Horizontal scaling made sense when reliable, solid software was a scarce resource; the scarce resource today is excellence in domain understanding. Excellent user experience wins today, which comes from products that reflect a deep understanding of specific use-cases. Trying to generalize solutions to work for different groups of customers makes this super-hard or even impossible. I now contend horizontal expansion is an outdated and dangerous strategy for startups—you need to either be a solution or a platform; aiming for the middle will ensure your demise.

3. Expand vertically by adding products and services that can be sold to the same customers. This approach historically made sense only for large, integrated vendors but I argue it is now the best route for even the smallest startups. Let’s explore why.

A domain expert is as uncommon today as ever and companies that deeply understand how customers use their product are rare. Customers are drawn to thought-leadership in their areas of interest, so developing valuable content around your product is a great way to position your business as the best in the world in the narrow niche you claim. Develop a personality your customers trust. Your most valuable asset is customer goodwill, all the more-so if your customer base is narrowly defined. Have a clear plan to become the go-to person in the world on your chosen topic of expertise. Make case studies personal, and tell those stories using video on your web site. Write blog posts on a range of related topics and set goals for distribution. As one of my favourite portfolio company CMOs explains of his content strategy, “We aim to first provoke, then attract, and finally nurture.”

These strategies will lead to customers inviting you to solve related problems within their business—problems adjacent to your core product. This “vertical expansion” increases your share-of-wallet with those customers and optimally leverages the goodwill you’ve built. It’s also the most profitable way to increase revenue. Developing, partnering or acquiring new technology is generally (in 2014) less expensive than acquiring new customer. This said, a vertical-first approach will strengthen word of mouth (WOM) marketing, reducing your cost to acquire customer (CAC).

Given my own background, I enjoy talking through the process with other entrepreneurs; the interesting challenge is to figure out how to grow the business without requiring significant capital. It’s a sign of the times that the decisions we make on how to grow the business today are frequently the exact opposite of conclusions I might have reached a decade ago!

This piece was originally posted on TechVibes.