The Four Rules of Setting Expectations
May 22, 2014
by Scott Johnson
When you see a public stock being crushed, or a public company CEO being fired, it is nearly always due to a failure to meet expectations. This is the main reason companies stay private — they don’t want to have to apologize to sell-side analysts for missing earnings by a penny, or explain to wall street why they will need to scale back their earnings forecast for a time while they invest in the next big growth opportunity. But is expectation setting just as important in private companies? It sure is.
Every company, public and private, is ripe with opportunity to screw up expectation setting. When will the mobile app be submitted to the app store? What will customer acquisition cost be in 6 months? How many customers will be acquired by year-end? How many free customers will convert to paid next year? What will the customer churn rate be? How much can each salesperson sell on average per month? And the grand-daddy of them all: What will revenue be next month, next quarter, this year? This leads me to my first rule of expectation setting:
Rule #1: Always set expectations at the 90% likelihood level. If you are 90% sure you can do $5 million in revenue next year, then that is the number you commit to delivering.
In any relationship, setting expectations so they will in all likelihood be met or exceeded leads to great feelings all around. If I say I will be at a meeting at 10:00, and I get there at 10:15, then I am unprofessional, disrespectful, and kinda loathsome. If I say I will be there at 10:30, and I get there at 10:15, I am professional, respectful of other’s time, and a pleasure to do business with. Exact same performance, wildly different result. But in the face of great uncertainty, as we always have in startups, how can you ever be 90% sure of anything? This leads me to my second rule:
Rule #2: Call everything below that 90% threshold “upside to the plan.”
If you have some big contracts with long lead times, leave them out of your plan entirely. Only include the things you have reasonable comfort with in your expectation setting. Then if something on the “upside” list comes in, you exceed plan, and you are adored. Putting those large, uncertain things into your plan, and having none of them show up, makes you a goat, often imperils your job and can imperil your company. Spending happens according to a revenue plan, and not delivering the revenue means your spending was too high, you will run out of cash sooner, seriously bad stuff. Seems obvious, but I know of very few entrepreneurs who can resist making this mistake! They argue that leaving these big opportunities out of the forecast and lowering spending because of that paints a lame growth story nobody will get excited about depresses valuation. But you can have your cake and eat it to, if you use my third rule:
Rule #3: Set expectations with a range, not a single number.
Investors in startups are, by necessity, optimists. As such, they will focus on the most optimistic number. So if you give a range for your product delivery of “May-20 to July 20, and delivery is July 10, then you missed the May number by a whopping 50 days. And your investors will be disappointed, but know it is their fault for being overly optimistic. Particularly if you follow my fourth rule:
Rule #4: Communicate early, and not in email, when you see things going awry
I still get bad news at board meetings — news that has been festering in companies for weeks. This should never happen. Or sometimes, instead of a phone call, a smelly fish lands in my email inbox stating “looks like May will be $200K, not the $500K we forecast”. Bad news happens all the time in startups and in life. The credibility you gain by being upfront, and discussing solutions with your stakeholders is always the best policy.
Part of the reason expectations are so incendiary is that they have far reaching impact up the chain. For example, we venture investors have limited partners who provide most of the capital for our investments. When our companies set expectations, and we pass those along to our LPs, and things go off the rails, it erodes our credibility as stewards of their capital. We generally don’t want to work with people who cause that to happen. It is the same for the sales VP who doesn’t deliver the number he promised to his CEO. Or the Engineer who doesn’t deliver on time and delays the product a month, which delays revenue, and shortens runway. Because of this chain reaction, no matter where you are in the chain, treat expectations setting as if your job depended on it. Because it does.
Originally published at navfund.com.