a16z Podcast - a16z Podcast: The Basics of Growth 1 -- User Acquisition

Episode Date: August 9, 2018

with Andrew Chen (@andrewchen), Jeff Jordan (@jeff_jordan), and Sonal Chokshi (@smc90) Growth is one of the most top of mind questions for entrepreneurs building startups of all kinds (and especially consumer ones) -- but how does one go beyond a mindset of "growth hacking" to thinking about growth more systemically and holistically? What are the key metrics to know; why; and how? This episode of the a16z Podcast -- one of two in a series -- focuses on the user acquisition aspect of growth, followed by engagement and retention in the next episode. Featuring a16z general partners Andrew Chen and Jeff Jordan, in conversation with Sonal Chokshi, the discussion also covers the nuances of paid vs. organic marketing (and the perils of blended CAC); the role of network effects; where does customer lifetime value (LTV) come in; and much more. Because at the end of the day, businesses don't grow themselves... The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments and certain publicly traded cryptocurrencies/ digital assets for which the issuer has not provided permission for a16z to disclose publicly) is available at https://a16z.com/investments/. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see https://a16z.com/disclosures for additional important information.

The content here is for informational purposes only, should not be taken as legal business, tax, or investment advice, or be used to evaluate any investment or security and is not directed at any investors or potential investors in any A16Z fund. For more details, please see A16Z.com slash disclosures. Hi, everyone. Welcome to the A6 and Z podcast. I'm Sonal. Today's episode is all about growth, one of the most top-of-mind questions for entrepreneurs of all kinds of startups, and especially for kids. consumer ones. So joining us to have this conversation, we have A6 and C general partners Andrew Chen and Jeff Jordan, and we cover everything from the basics of growth and defining key metrics to know to the nuances of paid versus organic marketing and the role of network effects and more. Part one of this conversation focuses specifically on the aspect of user acquisition for growth, and then we cut off and go into the aspects of growth for user engagement and retention in the next episode. But first, we begin by going beyond the concept of growth hacks

and beginning with the fundamental premise that businesses do not grow themselves. So the topic we wanted to talk about today is growth, which is a big topic. What would you say are the biggest myths and misconceptions that entrepreneurs have about growth? You know, not only is there the misconception that happens magically. Then the next layer, I think, is that it's really just like, oh, a series of like tips and tricks and like growth hacks that kind of keep things going as opposed to like a really rigorous understanding of how to think about growth, not just as the top line thing, but actually that there's acquisition, that there's engagement, that there's retention and each one of those pieces is very different than the other.

And you have to like tackle them systematically. Done right. It is a scientific discipline because it requires you to understand your business and business dynamics at this incredibly micro level. I love that you said that because one of the complaints I've heard about growth hacking is that it's just marketing by a different name. And what I'm really hearing you guys say is that there's a systemic point of view. There's rigor to it. There's stages. There's a program you build out. If you're fortunate enough to achieve product market fit and your business starts to take off, when in the wonderful situations you get this hyper growth where growth year over year, you know, it's triple digits. It's just exploding. And then gradually the law of the large numbers start to kick in and maybe the 100% growth becomes 50% growth the next year. And then the law of large numbers continue to kick in and it's 25%. And then it's 12.5%. And so growth tends to decay over time, even in the best

businesses. And so the job... And you used to call it like gravity. It calls it gravity. It just comes down to earth. And then the job of the entrepreneur is to be looking years down the road and say, okay, at some point, growth in business A is going to stop. And so I want to keep it going as long as I can, and there's a whole bunch of taxes to do that. But then the other strategy is, okay, I need new layers on the cake of growth. At eBay, the original business was an auction business in the U.S. And so, you know, some of the things we layered on earlier, we layered on fixed price in the U.S. Not revolutionary, but it really did increment growth. Then we went international. And then we layered in payment integration. And each time we did that, the total

growth of the company would actually accelerate, which is very hard to do at scale. That's the whole point. Like, there's intentionality to it. It's not an It's not an accident. You guys introduce new businesses, new layers on the cake. Businesses don't grow themselves. The entrepreneur has to grow them. And, you know, occasionally you stumble into a business that seems to almost grow itself. But there just aren't many of those in the world. And that growth almost never persists for long periods of time unless the entrepreneur can figure out how to continue to drive. I remember a post you wrote actually a few years ago on the, oh, shit, moment when growth stops. Because people are a little blindside.

And that's a flip side of it. You know, early on you get this great growth yet to keep it going. When it stops, your strategic options have been constrained dramatically. A lot of times when you're looking at what seemingly is an exponential growth curve, in fact, it's really something like, oh, you're opening in a bunch of new markets, right? So there's sort of a linear line there, but then you're also introducing products at the same time. And you're also reducing friction in, you know, sign-ups or retention or whatever. And so the whole combination of those things is really kind of like a whole series of accelerating pieces that looks like it's, you know, this amazing viral growth curve,

but it's actually like so much work underneath, you know, that makes that happen. I've also heard you talk about being able to distinguish what is specifically driving that growth so you don't have this exponential looking curve without knowing what that lever that you're pulling to make that happen or knowing what's happening, even if it's kind of happening naturally or organically. Can we break down some of the key metrics that are often used in these discussions, including just what the definitions are and then maybe just talk through how to think about them? Yeah. When you look at a large aggregate, like total monthly active users, right?

Or you're looking at like, yeah, MAUs, right? Or you're looking at, you know, the GMV, like adding up all the transactions in your marketplace, right? So gross merchandise value. Yep. And so when you look at something like that, and if it's going up or down, you kind of don't have the levers at that level to really understand what's really going on. You want to go a couple levels even deeper. How many new customers are you adding? As you're growing more and more new customers, right, a bunch of things happen.

if you're using paid advertising channels, things tend to get more expensive over time because your initial kind of like super, super excited core demographic of customers, they're going to convert the best. And as you start reaching into, you know, different geographies, different kinds of demos, all of a sudden, they're not going to convert as well, right? Just to pause on that for a quick moment. You're basically arguing that growth itself halts growth in that context. Right. So the law of large numbers being that there's only a fixed number of humans on the planet. There's only a fixed number of people that are in your core demographic, right? Once you surpass a certain point, it's not like it falls off a cliff. It's just more gradual that the customer

behavior really changes. How do you determine what's what when you don't have product market fit? Sometimes aren't these metrics ways to figure that out? Or is this all when you have product market fit? Like, is there a pre and a post difference between this? Very concretely. Like, you want to understand how much of the acquisition is coming from, you know, purely organic, people discovering it, people talking to each other as opposed to, you know, oftentimes you'll run into companies that have over 50% of their acquisition coming from paid marketing. And like, that tells you something that you're, you know, needing to spend that much money to get people in the door. So CAQ, customer acquisition costs. That's what you're talking about when you talk about

acquisition. KAC is what it costs to acquire a user. Blended KAC is what it costs to acquire a user on a paid basis plus then also what, quote unquote, free users you acquired. So if you're acquiring half your users through paid market and you're paying. $100 to acquire a user, but half your users come in at zero, paid cacks 100, Blended Cacks, 50. I view Blended Cac is a really dangerous number. Most of the best businesses in the internet age of technology haven't spent a ton on paid acquisition. And so one is, you know, you've got the first cut with this, okay, the truly magical businesses, you know, a lot of them aren't buying tons of users. Amazon's key marketing right now is free shipping. And then the economics of paid acquisition

tend to degrade over time, you know, as it grows, and you should try to scale it. And, you know, largely you're cherry-picking the best users, and then you're trying to also scale the number you get to grow. You know, I need twice as many new users this year as last year. And you typically pay more. So that magical LTV to KAC ratio, which early on says, oh, we're three to one, you know, in two years, it'll probably be one and a half to one if you're lucky or something like that. So we typically do try to look for these other sources.

of acquisition, be it viral, be it some other form of non-paid. When I quickly define LTV, it's lifetime value of the customer, but what does that mean? When you're shown an LTV to KAC ratio, you have no idea what you're seeing, essentially, given all the potential variations of the number. So we will almost always go for clarity. LTV lifetime value should be the profits, the contribution from that user after all direct costs. How do we define the LTV to KAC ratio? What do the two of them in conjunction mean?

Let's break them down. LTV's lifetime value. What you're striving to there is the incremental profit contribution for a user over the projected life of that user. So not revenue per CAQ because that, you know, typically there's costs associated to user. What's the incremental contribution that user brought from that. And that you mean the user brought to your company's value. So it's a value of your customer to the bottom line. It's the value of each customer to the bottom line. And then you compare that to the CAQ or cost of acquired customer. customer to understand the leverage you have between what I need to spend to acquire a customer and how much they're worth. If your CAQ is higher than your LTV, you're sunk. Because it's costing you more to acquire a user than that user than the value get out of it. Now I get it. If it's the opposite, at least you're in the game. I get more profit out of the user than I get costs to acquire that user. And then there's these dynamics on how does it scale over time. CAC tends to go up. LTV tends to go down. Because on the KAC side, you're acquiring the less interested users over time.

So they cost more to acquire and they're worth less. And so that LTV to KAC ratio in our experience almost always degrades over time with scale. And so, you know, when you're in that conversation, you're in a very specific conversation of, okay, how much room do you have? How is it going to scale? You know, what's going to impact your KAC, like competitive thing? So there has to be a lot, you know, it has to be like 10 to kind of get.

you over that concern that, oh my goodness, those two are so close that you have no margin for error. Right. This also goes back to the big picture of the layers on the cake, because if you have other layers, you don't have to only worry about one layers of LTV ratio. It really does affect the calculation. If it's, I'm in a new business and I have a whole different KAC versus LTV ratio, then that's a different conversation as well. And the big picture there is that if you don't know the difference of what's doing what, when, you might get very mistaken signals, mixed signals about your business. And so you guys don't want blended cack because you want to know what's driving the growth. I think what blended cat gives you is it gives you a sense for at this

particular moment in time, you know, what's happening. The challenge is that when it comes to paid marketing in particular, it's easy to just add way more budget and to scale that than it is to scale organic or to sale SEO. Blended cack is giving you a snapshot. But then as you're trying to scale the business, you're trying to increase everything by 100% over the next. You're trying to double everything, then all of a sudden, you know, your blended cack starts to approach whatever your dominant channel actually looks like. And so if you're spending a bunch of money, then it'll just approach whatever is your, you know, paid marketing cack. What entrepreneurs should think about is what is the unique, organic, new thing that's going to get it in front

of people without spending a bunch of money, right? A lot of the best businesses have this very interesting, I'll call it a growth hack. I mean, open table when I was managing it did not pay any money at all to acquire consumers. You know, like, how can you do that? You know, we had millions of consumers. The restaurants would market open table on our behalf. You'd go to the slanted door website, back when they were an open table customer, and you'd see, you know, you're looking, you go there to try to get the phone number

to make a reservation. You say, oh, make an online reservation. And we then got paid to acquire that user. But that hack was a wonderful thing that scaled with the business and got us tons of free users. To be fair, and this is another definition we should tease apart, quickly before we move on to more metrics that also had the quality of network effects, which we've talked a lot about, in terms of these things growing more valuable, the more people that use it. Is that growth? What's the difference there? Well, the business grew into the

network effect. The key tactic to build the network effect was that free acquisition of consumers that the more restaurants we had, the more attractive it was to consumers. The more consumers who came, the more attractive it was to restaurants. So there is a wicked network effect Like a flywheel effect, right? If you're not spending anything on paid acquisition of consumers, how do you start it? And the placements that OpenTable got in the restaurant, both physically in the restaurant, but particularly in the restaurant's website, was the key engine that got the network effect started. You had to manually sell some restaurants, come for the tools, stay for the network. But then once the consumers got enough of a selection and started to use it, it was game over.

Right. That was one way of going around the bootstrapping or the chicken egg problem and seeding a network. Network effects have, there's a lot of really positive things about them, and one of the big pieces is that virality is a form of something that you get with a network. You know, the larger your network is, the more surface area, the more opportunities you have in order to encounter it, right? And so, you know, in the case of, you know, Uber, where I was recently, you know, by seeing all the cars with, you know, the Uber logo, those are all opportunities to be like, oh, what is this app? I should try it out. And so it's mutually reinforcing. Then you get more riders and then you get more drivers that are into it. And so, you know, I think all of that kind

plays together. I bring two examples up. The pink lift mustache when they first got to San Francisco, you could see it once in a car and you'd go, huh, that's pretty weird. You see it twice in the car and you say something's going on here that I don't know about and I have to understand what it is. It's the same kind of thing. They're bright green and they glow essentially. So when someone sees one in the wild, someone bolts by them in a glowing green electric scooter and you're just like, okay, what is that? And Lyme hasn't spent a penny on consumer acquisition. Right. Because their model is such that that physical cue in the real world leads to it. The other one I'll throw in as well is within workplaces, you know, enterprise products, there's a lot of kind of bottoms up

variety that comes out of people, you know, kind of sharing and collaborating. Yeah, like for example, Slack is a great, you know, example of this. And so these are, you know, are all kind of really unique ways that you can get acquisition for free. And so then your KAC is, you know, quote unquote, zero as a result. You guys have talked a lot about organic. It makes it sound to me as a layperson that you don't want paid marketing. What's your views on this? Like, is it a bad thing? Is it a good thing? I don't mean to moralize it, but help me unpack more where it's helpful and where it's not. Are there any rules of thumb to use there? I mean, there have been a lot of great businesses that have leveraged paid marketing. I mean,

the OTA sites, the online travel agency, price line and Expedia. just spends, you know, they spend the GDP of many large countries in the acquisition. And then it's often a tactic in some good businesses. But if it's your primary engine, a couple things happen. One is the acquisition economics tended to grade over time for the reason we're saying. And it leaves you wide open to competition. If you need to buy users, I mean, if you're selling, you know, the new breed of mattress and you need to buy users and early on, you're the only person competing for that word,

Flash forward a year or two, they're like six new age manufacturing manufacturers with virtually identical products competing for the same consumer. The economics are not going to persist over time. And so, you know, one of the key questions in businesses driven by heavy user acquisition is kind of how does the play end?

You know, it usually looks pretty good at the beginning of the play, but in the middle it starts getting a little complex and there's tragedies at the end. And I think if it is something that you're using in conjunction with a bunch of other channels and you're kind of accelerating things, that can be great. For example, when Facebook in the past is broken into new markets,

they'll start with paid marketing to kind of get it going. And so in a case like that, really paid marketing is a tactic to kind of get a network effect jump started. And then you can kind of like pull off from that if you'd like. But if you're super, super dependent on it and you don't have a plan for a world that all the channels are going to degrade, then you're going to be in a tough spot within a couple years. Do you have a sort of heuristic for when to stop the paid?

Is there like a tipping point to know this is when you move? I think in terms of how much page you do do as part of your portfolio, I think that's the right way to think of it, is it's one out of a bunch of different channels, right? And so I would argue the following. So first is you really have to measure the KAC and the LTV and be super disciplined about not spending ahead of where you want it to be and not to do it on some blended number that doesn't make any sense.

And then I think the other part is you really want it to be a small enough minority of your channels such that if you were to, get to a point where it turns out to be capped, that you're okay, that you can live with that. Your business will survive and continue to grow and be healthy. You can still get the growth rates you want and you can still, you have such strong product market that you're able to maintain that. Take a couple sector examples. You know, e-commerce, a lot of companies struggle with, okay, how do I get organic e-commerce traffic? So most e-commerce companies rely heavily on paid user acquisition. You know, typically one of the interesting things is they degrade over

time and they're all competing for the same user. It's hard for e-commerce companies in most segments to be profitable. And you look at the same kind of dynamic in meal kits, in, you know, restaurant delivery. If you can't differentiate yourself and you're highly relying on paid marketing, the movie typically doesn't end really great. And so we look for segments where there's a balance or they've come up with that really unique growth hack and they're not then relying on page channels. And then, by the way, paid channels can degrade too. I mean, when I made a couple investment mistakes where the paid acquisition looked really good, and actually what they were doing or they were arbitraging something like Facebook's early mobile attempts, where the people who

participate in Facebook mobile ads early got real deals. They were nowhere near kind of the price they should have been trading at. So you're like, man, look at these user economics. They're awesome. And then Facebook, you know, kind of got to equilibrium when supply and demand met and the cost went up multiples and those businesses that look so good early just got incredibly stressed because they had no alternative to that inflation. That's a case of platform risk where you're dependent on the channel on Facebook mobile or whatever the specific channel was there. But Andrew, you were also earlier talking about just a cap on how much as possible. You both reference the fact that things can become very competitive, that your competitors can also buy the same channels

and then it gets very crowded or very expensive. So there's multiple layers of the The risk of the paid is what I'm hearing, but you have to be aware of that. Yeah, so I think on the acquisition side today, there's a couple really interesting opportunities that might be, you know, temporal, right? And it may go away, right? But for example, I think that if you have a product that is very highly visual, and I think this is, you know, one of the reasons why e-sports has gotten, you know, so huge, is because you have a product that naturally generates a ton of video in an age which all the platforms

are trying to rush to video, right? And so, you know, maybe this. will be less of an opportunity coming up, but like, you know, that's, why would you say that's temporal? Because the competition will do the same thing. Yeah, we'll do the same thing, right? Like, I think we're now going to move to a thing where, like, all of these different kind of software experiences all are incredibly shareable. Like, there's no point these days in building a new game that doesn't have built-in recording and publishing to Twitch and built-in tournament systems and all the community features and all that stuff that you need. And, you know, I think

it used to be that you would think of a game as just the actual IP, but in fact, fact, it's sort of these layers and layers of social interaction and content around it. And I think that's both true as well as all of these different brick and mortar experiences that are making themselves highly Instagramable, that are adding areas where you actually stand there and pose. Oh my God. My favorite story about this is the restaurant's trend of making square plates and layouts so it really fit beautifully with Instagram.

That's one of my favorite things in the world is when the physical world adapts to the digital. And then you can go the other way too, right, which is physical products like scoot. that remind you to engage digitally. The other, you know, what fun example I always like is everyone's had the experience now where they're just like in a room talking and then their, you know, Amazon Echo just turns on and is trying to go. And I'm like, you know, they have no incentive to fix that.

Yeah. Because like it reminds you that it's there and reminds you to talk to it. I think the big takeaway here is that you have to really be creative and really be on the edge of what everyone's doing, right? And so if it turns out that everyone's really into video and they're really into Instagram right now, Now, you have to think about, like, how does my product actually fit into that trend? And if you can find it, then you can get an amazing killer way to get jump started. And if the trend lasts, then great, accelerate it with paid marketing, accelerate it with PR, do all that stuff to kind of keep it going.

I want to make the distinction that we're mostly talking about growth and acquisition. Yes. And that is what startups mostly care about in the early days because you don't really have any active users, right? But the other part of this is that you see all the users who show up and how active they are starts to change over time. Well, thank you guys for joining the A6NC podcast.