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Phil Carrai is Managing Director of Ventures for the Morino Group and Special Advisor for General Atlantic Partners, one of the world’s most respected technology investment firms. He has a long history in the technology business, including stints as President and CEO of McCabe & Associates, a provider of applications development products, and President & CEO of S&R Systems, a software integration company. Before that, he was Vice President and General Manager at Legent Corporation, responsible for the future of some 100 products, large and small, in the company’s $200 million systems management business unit. In addition, he sits on the boards of several technology companies and teaches business courses at George Washington University.

Talking Product Strategy with 
Phil Carrai

In August of 2001, Phil Carrai appeared as a guest expert on product strategy in Netpreneur’s Talk-the-Talk discussion group, an email list where technology entrepreneurs exchange ideas, questions and answers about growing their businesses. Questions ranged over a variety of topics, from pricing to international licensing to marketing to college professors. Selected postings are recapped here, edited for focus, length and clarity.

Netpreneur: We’ve heard people say that among the “lessons” of the bubble was that many companies got funded that really didn’t have products you could build a future on. Is that true?

Phil Carrai (PC): There’s no question that many companies were simply playing the momentum of a market that was craving anything “,” regardless of the underlying economics of the idea. While I’m not sure it’s relevant to revisit the Internet bubble companies, it is important to understand the real technical and economic issues of any company so management and investors don’t repeat the past. For instance, one core question that many do not ask is whether the idea or product is tactical or strategic.

Netpreneur: What’s the difference?

PC: By a strategic product I mean a broader solution, something that touches many people within a customer’s organization, often across departments. Strategic products frequently cause the customer to change their organizational processes; for example an eCommerce application that may lead a company to change the way they do pricing. That’s good because once you get the sale, it erects high barriers to change and can help pull you into deals you might not otherwise have been a part of. Strategic products are almost always higher-priced solutions, and they often have add-on potential, either with associated products or services. On the down side, the cost of sales for a strategic product is almost always higher, with longer, more complex sales cycles and more people involved in the decision-making.

Tactical products, on the other hand, have a much more specific and clearly-defined objective, such as disk compression or managing your bookmarks. They have quicker and more demonstrable return on investment (ROI), require little or no process changes, and affect fewer people in an organization. Tactical products have lower prices (regardless of their inherent value), are easier to replace, and the sale usually occurs lower in the organization. Sales cycles are shorter, and you usually have more channel options available. In this sense, consumer products are always tactical products, regardless of how critical the solution is to the individual.

Netpreneur: Which ones are investors more interested in, strategic or tactical?

PC: Well, the answer is both, although individual VCs may have their own preferences.

Almost all investors are interested in truly strategic solutions. If you’re selling a tactical product, the issues will be whether or not there is the potential for future growth, either in related products for the same marketplace, add-ons, similar niches in adjacent markets, etc. How big is the idea? How leverageable is it? How big is the market? These are not just questions for investors, you have to answer them for yourself if you expect to have any success bringing your idea to market and growing into a sustainable company (assuming that’s your goal, of course).

While it may not matter to investors whether yours is a strategic or tactical product (assuming they like the idea) they do care very, very much about whether you understand the difference, whether you understand the market, and whether you’ve constructed (or thought about) the infrastructure required to execute. Do you really have a sense of who buys it, why, and how to reach them, or have you simply collected a bunch of numbers from analyst reports? If you say that you’re selling into a vertical market, like telcos for example, do you know how much they really spend on similar solutions? Is it an available or an addressable market? Are you really just a piece of a larger solution, and how do you fit into the overall value chain? The next big interest area, of course, is: What’s your competitive advantage?  

Netpreneur: What are some of the most common questions you see people failing to answer about their product strategies, either from the development or the marketing side?

PC: Ironically, it’s often the most basic ones, like: Is the offering vertical or horizontal?

Applications tend to be vertical within an industry or department; infrastructure tends to be horizontal, running across departments or industries. Will the customer view the solution as driving revenue or avoiding cost? How much does the customer process need to change to derive value from your product? How long will it take them to recognize the value, and how many people will be affected? The answers to questions like these will affect everything from your product features to future release schedule, from pricing to channel selection.

Take channel selection for a B2B product, for example. How many departments are involved in the decision? Does purchasing occur as part of another decision, or is it tied to a specific offering? Is there actually money in the budget, or will it have to be approved separately? These may seem like highly tactical questions, but they are all factors that determine how much you can rely upon direct versus non-direct channels. Options that seem promising on the surface, like telesales, VARs, resellers or the Web, may not really be effective for your marketplace.

Mr. Villanueva: I'd appreciate your insights on establishing pricing in an early adopter market. Our challenge is to establish pricing that encourages early adoption and limits excessive discounting, while at the same time generating profitable revenues. Pricing in an early-adopter market, particularly in the mobile market is difficult to arrive at through research since comparables are not always available and the first-to-market companies will, at best, only help you determine what hasn't worked.

PC: Pricing is often the most difficult component of the "go to market" package, especially in early adopter markets. That’s because, while you can generally test positioning, packaging, distribution, etc. in some limited fashion through alpha or beta stages, pricing can be incredibly elusive.

You must first define your solution and market exactly, ranging from large, Fortune 500 customers who use it as infrastructure for other applications, all the way down to a consumer-oriented product purchased through a telecom company (such as ringtones or even tickets). Next, define what will constitute success for you. In the enterprise space, 50 large customers over six months would be a grand slam; in the consumer world, it might be 500,000 users and 5,000,000 transactions.

Next, you must define what adoption really means for you. Is it purchase? Usage? Usage at a certain rate? Usage within a certain segment, demographic, or application? Expansion within a given customer? And so on. Then detail what will be the biggest inhibitor, such as hardware/handset technology, ease of use, degree of difficulty on installation, etc. Note that it probably won't be price outright, but price might be a way to lessen the inhibitor.

As an intermediary step, check to see if your success definition matches the basic market parameters. It’s amazing how many times I see business plans that will look at available market (that is, the total potential spending) instead of accessible market (the actual spending on a solution or similar solution). As a result, they need a huge percentage of accessible market to meet expectations.  

Finally, I believe strongly in analogy. That is, most consumers and business users will seek to equate a new product in a new space with a known product that is positioned similarly to yours. You can use this to your advantage, especially in the consumer end. I'd take a look at identifying the most successful programs within related early adopter spaces and see if there's a similar play to your offering. An example from the telco area is that while people will spend lots of time on overall plans, coverages, etc., they will not hesitate to spend 75˘ to $1.50 on a directory assistance call, call waiting, or call forwarding.

Most importantly (and my bias), perhaps the one thing the bubble taught us, is that the answer for rapid adoption with a resultant sustainable business is NOT to give it away. People do not value free items, since there's not the normal personal/psychological commitment that takes place during a purchase.

Mr. Kling: In the consumer market, the pattern usually is to charge early adopters a lot, because they are the least price sensitive. If you market to small businesses, on the other hand, such as dentist offices or restaurants, you probably have to offer a free trial period. These folks hate to see their costs go up until they have proven that they can get value from it.

If you market to large organizations, charge as much as you can as early as you can. Your cost of sale will be tremendous. What they most value is research. They will spend a lot of time evaluating your product. Try to charge them for that, rather than getting sucked into endless presentations and meetings. Come up with a consulting concept related to the product and charge for the "readiness assessment" or "feasibility study."

Finally, Phil's point about positioning your product relative to a known product is worth repeating. You almost never want to say that your product is "innovative" or "has no competitors." Position it as competing with something they already buy or as something they wish they could buy but cannot afford. For example, one netpreneur I know positions his product as "a poor man's SAP." Businesses that cannot afford SAP but want some of the functionality get that message immediately. (Arnold Kling is the author of Under the Radar: Starting Your Net Business Without Venture Capital.)

PC: Arnold's point on large enterprise/corporate sales is right on. In many respects, pricing for the enterprise space inverts for the early adopters. That is, the ones to jump first generally will pay more as they have the biggest demand, the most sophisticated infrastructure and technical staff, and receive the highest value (assuming the product/solution is on target, of course). Correspondingly, your cost to win and maintain the relationship will be significant, and something you must consider when constructing your business model and channel structure.

As you move along the adoption curve, customers tend to become more price sensitive. That’s driven not only by budget, but, also, and perhaps more importantly, by their lack of infrastructure and scale. That’s because, to them, it translates into a higher overall cost (to supply the infrastructure) and a decrease in value (scale). The tricky part is that, at some point, incremental demand flattens, leaving the high-middle to middle-market for other players with different value propositions (such as “poor man's SAP”) which address the issue of required infrastructure, customization, and scale. At the high-end it seems to be around 700-1500 customers for very successful products  

For those in the high-end, Fortune 2000, enterprise market, here's something to ponder. Pick a successful company and consider their installed base of unique customers by product. You'll likely be surprised at the limited reach of products focused at the high end, which means you'd better drive a tremendous amount of value for each customer.

Ms. Hopp: My company is developing an online educational software product targeting initial users in a very specific niche. One way for us to gain credibility for this product will be to have it used in a meaningful way by university professors, then enlist their support through testimonials, papers, etc. What are the most effective strategies for a small company like us to get these kinds of early users?

PC: I'll make a couple assumptions: that the product is used by professors as either a teaching aide or for eLearning, and that it requires content or courseware developed by the professor.

Given those assumptions, my take is that the product will be viewed more strategically by your customers than perhaps you realize. Specifically, you're asking the professor to take existing content, probably to add or change components, encode the content into your offering, then change the way a course or component of a course is taught. Remember, while you might look at your product as an interesting productivity tool that you're offering for "free" to beta users, but a professor will look at how the product fits within his or her workflow process. Unless you help them solve that problem, you'll get lots of interest, but little use.

My recommendation would be to outline the entire process which your product would be a part of, define exactly how your product would be/should be used, determine the amount of work/rework required by the professor, then create a plan to both minimize the process and work/rework impact. Focus far more on what's required by them (hopefully minimal) than on the benefits of the product (hopefully obvious, and probably not the stumbling block).

In all of this, remember that the more you require a change in teaching process, it will be proportionally more difficult to get early users and the more one-on-one, direct selling and support you'll need to do.

Mr. Freidman: I have two questions. First, in your experience, do successful companies tend to stick to the blueprints they defined in their early days characterizing their idea of sustainable competitive advantages? Second, in the past, many competitive choke points, such as control of a patent or customer access, were premised on information asymmetries that, in a manufacturing-era economy, could give a firm competitive advantage for decades. Today, in an economy suffused with information, those asymmetries and related choke points still arise, but may last for just a few years, perhaps only months. What do you look for in new technology or service that translates to sustainable competitive advantage?

PC: I'll start my answer to both questions with my take on competitive advantages, which is that, in the long term (whatever long term is), no initial advantage is sustaining. What a unique, differentiating position might provide is a platform upon which you can build the next unique, differentiated position.

That said, generally I've found that the earlier the stage the greater the delta between what you thought was going to be the path and what the path actually is. What's more interesting to me in early stage efforts is the thought and detail that goes into the blueprint, because I believe that one can change course during execution far easier when you know why and where you've deviated from plan.  

To your second question, the simple answer is that something that solves a significant problem in a unique way generally provides advantage for some period of time. More specifically, I do believe that if the solution required a significant amount of intellectual capital, a "breakthrough" in thinking on a problem, a significant amount of work by a number of smart people, or development by an individual(s) who have spent years in a space thinking about a problem area, you will generally have something that can't be easily replicated. Conversely, if it took two people three months to code, well . . .

In terms of how sustainable (perhaps a better word is “sticky”) the solution is within organizations, I've generally found that products that have longer implementation cycles, touch more people within the organization, and require more customization (or coding), are generally viewed as strategic, and generally stick around an organization for years.

Mr. Hasler: My company provides custom solutions for global research and knowledge management needs. We were established at the suggestion of a key executive of a top European management consulting firm, and have received a lot of guidance in the form of insight into their information needs and those of their top-tier customers. We've established an international network of correspondents to perform customized business research and passed a test to determine that we can provide quality results, however, our client is very busy, and decisions are very slow. While we don't want to upset our client we're considering testing the waters in the DC area to see if other major organizations with international interests would be interested in our services. Do you have any suggestions as to how we can best go forward?

PC: In this environment, I'd absolutely look for another 3-5 companies that have similar needs and requirements, with the hope that at least a couple could become "anchor tenants" for your service. In terms of zeroing in on clients, I'd do both an inside-out and outside-in analysis to better define who to approach.

From an inside-out perspective, I'd look internally at identifying the base need which drove the formation of the company -- what specifically you have in terms of delivery, knowledge network, process, expertise, etc. Then, outline why (again specifically) your initial client is happy with what you've done to date. Finally, define who within the client (by functional area, level, etc.) would use, recommend, and/or buy it.

From an outside-in perspective, I'd then map the marketplace for companies that have a similar texture as your lead client and approach those you think are the best fit. Focusing in a geographic region is very good.

Raj Khera: We've been talking to a firm that has ties to some large companies overseas to represent our technology for licensing. We were introduced to this firm from a pretty good source and my understanding is that they have a solid track record. They do not take any upfront fees to represent us, instead, they take a cut of any deals we form with the companies they introduced to us. They also want warrants for our company equal to some amount of the money we would get from such deals, and exclusivity for the countries they have connections in for 18 months. Since they don't take any upfront fees, they're obviously very picky about who they represent. The companies they would sign up for us would localize the technology's English parts to their own language, at no fee to us. What is a typical percentage given to these types of "agent" companies for such deals and are there any things we should watch out for?

PC: My experience with licensing has been limited to the enterprise space, so please take these comments within that context.

Many organizations provide distribution capabilities outside the country of origin for a commission ranging between 40-60% of the license fee. Included for the fee is marketing within the country, some small amount of localization (usually very small), first line phone support, etc. Generally, there's exclusivity within a particular region or country, but, along with the exclusivity, there is a commitment to revenue levels (12 month targets) that, if missed, will result either in a loss of exclusivity or a termination of the agreement. With such agreements, there's usually a ramp provision built into the first year of revenue levels, as well as a cure provision which allows the distributor to continue exclusivity if certain criteria are met. As an aside, I've never negotiated warrants on distribution agreements, but I know that many do.  

In judging your potential channel, I'd investigate the following:

  • Do they represent other technology/software products?
  • Do they know your marketplace?
  • How many sales representatives do they have?
  • How many technical sales representatives do they have and will any be dedicated to your product?
  • What is the quota of those sales representatives and what percentage of that quota will be your technology?
  • What is their planned marketing spend for your product, by country?
  • How will they handle first level support? Second level support?
  • If consulting is required for implementation, who will do it?
  • What revenue levels are they willing to commit to, by country?
  • How will they expect to work with you?

What's important to remember is that any distribution partner/organization must be viewed and managed like a sales organization, only they don't report to you. If you want a successful relationship you'll have to put energy toward training and supporting your partner.

Think long and hard before you take the leap. I've had great, terrible, and mediocre distribution partners, and the common thread throughout the terrible ones was that I thought they had a couple great contacts that I could secure for zero cost.

Mr. Bowers: Ours is a young company, with a new technology product, two full time employees and several customer prospects. We also have the impending need to grow our engineering team, more aggressively pursue new customers, and, in general, take the company to the next level. We are interviewing operational/managerial professionals as potential COOs, but my question is whether  this the right time to take on a high cost employee? How do we take steps to ensure we are not hiring too early?

PC: I've always relied on the old school thinking that categorizes the stage in a company’s life as:

  • startup, little or no revenue
  • early stage, $2-$8 million in revenue
  • expansion, $5-$20 million in revenue
  • growth or IPO, $20 million plus in revenue

We then look to the types of people who would best lead the company through each stage to the next with the hope of deferring the senior positions until you're either late in the early stage or beginning expansion. There are many reasons for this, but the biggest is the that person you want to expand organizational capacity (distribution, service, marketing, etc.) is not necessarily the person you want to help slog it out through the early stages where you're driving to meetings instead of flying and staying three people to a hotel room to save money. At your stage, I'd really challenge your need for a COO -- or any senior operations or management talent -- -at least until you've got paying customers. Instead, hire folks to help in the trenches. If you truly believe you need a stronger operations background, instead of a COO, think about someone who either can run the technical side (development and services) or the sales/marketing side, depending on your area of greatest need.

Mr. Bowers: What are your feelings regarding young companies that take on debt? We are looking into taking on a line of credit that, if all goes well, will allow us to deliver a whole product to enough customers and revenue to roughly break even. If we would like to take in outside capital later to accelerate expansion, would the presence of debt be a hindrance in the process?

PC: If the debt is small, say under $1 million for a software company, and line-of-credit-oriented, it’s generally not a problem. Before you take on a line of credit, however, think carefully about a couple of questions. What are you securing the debt with, receivables or personal assets? Also, what are the call provisions? It’s generally a demand note, meaning the bank can call at any time.

Remember, banks are not VCs. They do not take substantial risk, and, as one banking friend told me, would be more than willing to lend you money when you don't need it. The real answer is that the bank needs to secure against an asset that has terminal value, and software that can't be sold has little terminal value. If you can secure debt and have a known financing situation, such as receivables or contracts requiring payment, and you just need the money earlier, banks are great ways to help manage. If, however, you're looking for help to finish a product without known cash flow to pay the debt, proceed with extreme caution.

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