3 Crucial Features of High-Growth Startups

Originally published on http://www.appsterhq.com

Countless startups are created every year, with ambitious founders hoping to create the next Instagram, Uber, or Facebook.

But the fact remains that only a very small percentage of startups ever achieve the growth needed to become billion-dollar companies.

So how do they do it?

In this article, I’ll discuss 3 crucial features high-growth startups share in common.

Many hugely successful startups created over the past two decades are neither founded upon truly revolutionary ideas nor the results of getting into the market before anybody else.

As I recently noted:

“Myspace and Friendster were established, and had many active users, before Facebook was ever created; there were a variety of group buying websites operating a decade before Groupon emerged; and electric cars were available on American roads before Tesla rose to dominance.”

Likewise, Google emerged after Altavista and Yahoo were already online and operational, and Dropbox was founded at a time when cloud storage startups were arguably becoming cliché.

Luckily, execution is no more a new term to many people in the tech field.

Rather than coming up with utterly groundbreaking ideas or launching far before existing markets had reached “saturation”, the Dropboxes, Facebooks, Googles, Groupons, and Teslas of the startup world are distinguished from the other 90% of all new companies that ultimately fail by their commitment to execution.

Angel investor, Martin Zwilling, describes the meaning and significance of execution in the following way:

“Every startup begins with an idea, but from that point forward, it’s all about execution. Founders soon learn that customers only spend real money for solutions rather than ideas. Investors have also learned not to invest in ideas but only in entrepreneurs and teams who can deliver solutions. Success requires moving your passion quickly from the idea to the business implementation. A good execution requires a plan and the right people, combined to create operational excellence and exceptional customer value. Companies that do this best become market leaders.

High-growth startups are new companies that quickly and effectively scale and expand their operations.

The “classic” examples are ventures like Facebook, Google, Twitter, and Uber, with recent examples that include Slack, Cloudfare, or Intercom.

Crucially, most high-growth startups know how to execute in 3 ultra important ways:

  1. They master customer retention capabilities;
  2. They focus on viral marketing; and
  3. They understand exactly to whom they should market the first iterations of their products (i.e., they know when to “cross the chasm”).

Let’s consider each of these 3 elements in greater detail.

1. High-Growth Startups Master Customer Retention Capabilities

Technology startups operate in highly competitive environments.

As an example, consider mobile apps.

Research on smartphone use suggests that:

These basic figures persist despite the fact that there are currently 2.8 million and 2.2 million apps available for download on Google’s Play Store and Apple’s App Store, respectively.

What separates the relatively small number of “go-to” apps (such as Facebook, Twitter, and Instagram) from the huge number of “download and install and delete and forget” apps?

It’s no surprise:

Ultra successful startups create products that eventually become the focus of new habits.

If you think about all the various products that have been adopted en masse in modern society — from credit cards, toothbrushes, and televisions to automobiles, computers, and MP3 players — then you’ll realize that they actually aren’t commonly perceived as products.

Instead, they’re simply part of our everyday routines and regular behaviours.

And creating products that customers simple can’t live without is one of the fundamental components of high growth startups’ abilities to retain their customers over long periods of time.

Let’s briefly discuss the essentials of how habits work before then looking at some key examples of hugely successful companies whose growth can be attributed to their habit-forming products.

Author of The Power of Habit, Charles Duhigg, argues that “a simple neurological loop resides at the core of every habit, a loop that consists of three parts: a cue, a routine and a reward”.

(image source)

Here’s how Duhigg describes these 3 key aspects:

“There’s a cue, which is like a trigger for the behavior to start unfolding. A routine, which is the habit itself, i.e., the behavior, the automatic doing of what you do when you do a habit. And then at the end, there’s a reward. And the reward is how our neurology learns to encode this pattern for the future.”

In order for a habit to take hold, all 3 elements must be present.

Hazel Gale expands on Duhigg’s description, noting the following:

“The cue is the thing that triggers the habitual behaviour. It could be a negative emotion like loneliness, boredom or stress. Or, it could be a certain situation, a group of friends, the time of the day, etc.
The routine is the habit itself: the biting of nails, smoking of cigarettes, or walking over to the fridge and eating a massive lump of cheese…
The reward could be anything pleasurable. It might be as obvious as the physical stimulation of nicotine or sugar… It could be connected to a feeling of acceptance, belonging or achievement; or it could simply be an excuse to get away from your desk.”

Thinking about these dynamics from the standpoint of mobile apps, we can see that:

  • “Likes”, “re-tweets”, “hearts”, comments, and all others forms of public endorsement (i.e., social indications of appreciation) function as rewards that lead our brains to recognize the positive outcomes associated with engaging in certain actions.
  • The more times we notice a connection forming between doing something specific (e.g., sharing a status update on Facebook) and receiving a particular reward (e.g., having that status re-shared with positive comments), the more we start to anticipate, i.e., crave, that reward.
  • External events — like email newsletters and social media notifications — and internal dynamics — like feeling lonely after seeing friends post status updates about their fun weekend activities on Facebook — function as triggers (i.e., cues) that encourage our brains to jump into “autopilot” mode and react.
  • Hearing a noise from your smartphone indicating that you’ve received a DM on Instagram “automatically” leads you to grab your phone and read the message. Why? Because your brain is anticipating the feel-good reward (the “dopamine drip”) that will come after you satisfy your craving to know who messaged you and why.

The following chart highlights several of today’s most successful high growth startups to show they do indeed rely on creating habit-forming products in order to retain their customers:

One of the advantages that start-ups with habit-forming products enjoy is a sort of self-generating growth loop in which the more their customers use their products, the less likely such customers are to permanently abandon their products.

This phenomenon is known as the “sunk costs trap”, whereby we become more liable to stick with (or finish) some system, task, or behaviour the more resources we sink into it.

The sunk costs trap usually has a negative connotation associated with it.

For instance, it explains why a company might continue pouring money into what are clearly poorly performing investments: “We’ve already invested $3.5 million at this point! It wouldn’t make any sense to abandon the project! We can fix it!”.

When it comes to high growth startups and successful customer retention, it’s typically more about the time and other resources that users invest into using specific products than it is about feeling “forced” to keep doing something even though it’s deeply unsatisfying:

  • You’re far less likely to abandon Instagram and join a rival mobile photography app if you’ve spent, let’s say, two years building up your Instagram profile and followers.
  • You’re far more liable to abandon Dropbox in order to join a competing online file storage service if you’ve used Dropbox for only a few days as compared to, for instance, the past 10 months. It’d simply be too much of a hassle to move, re-organize, and re-share across all your devices all the files you’ve been storing on Dropbox for nearly a year in order to make the switch.
  • The more friends you accumulate on Facebook, the less likely you are to de-activate your profile. No matter how “annoying” Facebook might become, building a social network over many months or years is likely a strong investment to keep you using the website.

The following graph, which compares 90-day retention rates with frequency of use per week for a variety of app categories gives some insight into how it’s possible for massive high growth startups like Facebook to receive a $200 billion valuation.

Let’s now see the second crucial feature of high-growth startups:

2. High-Growth Startups Focus on Viral Marketing to Grow Their Customers

A concept crucial to understanding how businesses strategize their efforts to recruit customers is the customer acquisition cost (CAC).

Chase Hughes, over at the Kissmetrics Blog, provides a straightforward explanation of this concept:

“CAC is the cost of convincing a potential customer to buy a product or service. Your CAC can be calculated by simply dividing all the costs spent on acquiring more customers (marketing expenses) by the number of customers acquired in the period the money was spent. For example, if your company spent $100 on marketing in a year and acquired 100 customers in the same year, your CAC is $1.00.”

When it comes to startups, a high CAC is often deadly.

The average online company, such as an e-commerce store, might have to pay upwards of $200 or even $300 in order to acquire one new customer via traditional marketing and advertising.

To put that into perspective, try and imagine Dropbox and Instagram each paying anywhere from $40 billion to $60 billion in order to accumulate their user bases of 200 million people.

Here’s something that sounds shocking but is true: some of the fastest growing technology, web, and mobile startups spend very little money on direct marketing and advertising efforts aimed at acquiring new customers.

How can this be so?

How can companies with tens, if not hundreds, of millions of users acquire such a massive customer base without having to pay hundreds of millions of dollars to recruit them?

It all comes down to the fact that high-growth startups use viral marketing strategies to expand their user bases.

One way to think about viral growth is to contrast it against the traditional “marketing funnel”.

The conventional marketing funnel portrays companies as paying lots of money in order to drive traffic toward their products in an effort to convert a small fraction of that traffic to active, paying customers.

A viral funnel is the inverse of the traditional funnel: rather than a huge number of potential customers producing a small number of actual customers, a small number of actual customers help bring in exponentially more customers.

In other words, each new user brings in one or more new users, who then bring in one or more new users themselves, and so on:

Viral marketing is based on the use of a product (e.g., a new Instagram user naturally recommending that his friends give the app a try) and sometimes also on the implementation of a referral system (e.g., a Lyft user circulating a referral code that allows her and the person who applies the code to each cash-in a free ride).

Here are some famous examples:

  • The group buying website Groupon offered huge savings on attractive deals right in the middle of an economic crisis: because such deals were activated only if a certain number of buyers joined. Existing users invited their friends to join the website and Groupon’s user base thereby expanded.
  • Back when the file storage and sharing website Dropbox first launched, it offered free storage space to all referred users. The incentive was so strong that the company acquired 1 million users in the first 7 months of its operations.
  • Facebook was one of the first web-based startups to leverage email invites, allowing new users to easily and quickly invite all their email contacts to join the site.
  • Airbnb achieved massive expansion of its user base by “hacking” Craigslist via use of a bot that allowed new Airbnb users to share their listings with many others, thereby creating a network effect that drew in other people.
  • Instagram implemented a cross-posting feature that allows users to automatically share their photos with their Facebook and Twitter friends; this feature encourages people from other social networking sites to sign up for Instagram.
  • Uber’s dual-side referral code system is so successful that approximately 50% of new Uber customers arrive via referral.

The key metric to follow here is the viral coefficient.

The viral coefficient represents the number of new users that each existing user brings over to the company.

For example, a viral coefficient of 1.5 means that, on average:

  • 100 users refer an additional 150 users,
  • those 150 users then bring over 225 more users, and so on.

Importantly, if your startup can maintain a viral coefficient above 1.0 then you don’t need any sort of substantial marketing budget to keep growing.

3. High-Growth Startups Know Exactly Who Their Early Adopters Are

Airbnb co-founder, Brian Chesky, once told an audience at Y Combinator:

“It’s better to have 100 people who love you than to find a million who just sort of like you. Build your business one person at a time. Just focus on 100 people. If they love you, they will market the product for you and tell everyone else. Go to your users. Do one scalable thing, one person at a time. It’s actually that simple.”

Chesky’s remarks point toward a crucial fact:

All successful startups share the demonstrated ability to determine the exact kinds of people to whom they should market the early iterations of their products.

As we’ve discussed over at Appster in the past, one of the essential stages involved in building a successful product that achieves a solid product-market fit is the creation of a minimum viable product (MVP).

Part of effectively developing, testing, and refining your MVP involves understanding two crucial things about how people embrace new technologies:

  1. Everett Rogers’ theory of disruptive technologies, which states that different types of people adopt revolutionary technologies to different degrees and at different speeds; and
  2. Geoffrey Moore’s theory, outlined in Crossing the Chasm, that contemporary startups must concentrate on effectively dominating the early adopter market — repairing bugs, responding to customer issues, winning the hearts of users, and gradually building a brand reputation — before trying to “cross the chasm” by seeking out success in mainstream markets.

The chasm is the key space splitting the innovator and early adopter sectors from the mainstream customers:

In a recent article, I spoke rather extensively about the need for startups to take into consideration the key differences between different sectors of the market when launching their products:

“Successful startups tend not to market to mainstream consumers because these consumers typically don’t trust new technologies: they’re looking for safety, security, and brand reputation whereas most startups are buggy, unknown, and relatively unproven at least during their earliest days.
Customers in the mainstream care about two things, i.e., established brands and security.
They generally don’t buy new things unless other people are clearly already using (and recommending) them.
Early adopters, on the other hand, don’t care if your company/brand is unheard of, yet-to-be-proven, or straddled with the risks associated with pushing a new product.
They’re actually drawn to your venture by these very kinds of novel and radical qualities that characterize it”.

If you look at the top startups from the past two decades then you’ll notice that all of them began by first dominating small segments of their markets before then trying to takeover the mainstream:

  • Facebook dominated Ivy League universities before moving beyond the educational field in order to target the wider society.
  • eBay customers were the first to use PayPal, with PayPal dominating that market entirely before moving onto other areas.
  • Upon returning to Apple, Steve Jobs put an end to many of the company’s products and chose to focus exclusively on creating computers that creative types would love (musicians, designers, photographers, tech geeks etc.).
  • Snapchat began by going after and dominating the teenager market.
  • Instagram zeroed in on hipsters, foodies, and other unique, artistic types before becoming steering toward the mainstream.

What these companies (and many other high growth start-ups like them) did is successfully execute on when to cross the chasm from the early adopter segment to the mainstream population.

To become truly disruptive, new products must dominate early adopter markets first. Early adopters are both open to novelty and relatively forgiving if product bugs arise.

Once a product succeeds amongst early adopters, the company behind it can leverage this much-needed validation by successfully targeting mainstream users.

Mainstream customers are likely to be much more receptive of a product when they know that they aren’t the “guinea pigs” on whom some potentially unreliable gadget is being thrust.

Dominate the early adopter market first, fix your bugs without fatally damaging your reputation, and establish your brand name — these are the key steps to convincing mainstream customers to give your product a try.

Originally published at http://www.appsterhq.com/
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