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

Starting point is 00:00:00 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 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

Starting point is 00:00:45 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 aspect of the aspect of the aspect 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?

Starting point is 00:01:16 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 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.

Starting point is 00:01:53 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, you know, 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 and a half percent. 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

Starting point is 00:02:41 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.

Starting point is 00:03:08 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 accident. You guys introduce new businesses, new layers on the cake.

Starting point is 00:03:23 Businesses don't grow themselves. The entrepreneur has to grow them. And 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.

Starting point is 00:03:46 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 that 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?

Starting point is 00:04:04 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

Starting point is 00:04:24 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 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 number like total. monthly active users, right? Or you're looking at, yeah, MAUs, right? Or you're looking at, you know, the GMV, like adding up all the transactions in your marketplace, right? So gross

Starting point is 00:05:00 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

Starting point is 00:05:39 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

Starting point is 00:06:19 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. CAC is what it costs to acquire a user. Blended CAQ is what it costs to acquire a user on a paid basis. Plus then also what, quote unquote,

Starting point is 00:06:40 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 cack is a really dangerous number. Most of the best businesses in the internet age of technology haven't spent a ton on paid acquisition.

Starting point is 00:07:00 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 tended to grade over time, you know, as it grows. And you should try to scale it.

Starting point is 00:07:18 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-pay. When it quickly defined LTV, it's lifetime value of the customer, but what does that mean?

Starting point is 00:07:51 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 does the two of them in conjunction mean? Let's break them down. LTV's lifetime value.

Starting point is 00:08:15 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 typically there's costs associated to a user. What's the incremental contribution that user brought from that incremental... 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 to understand the leverage you have. between what I need to spend to acquire a customer and how much they're worth.

Starting point is 00:08:49 If your CAQ is higher than your LTV, you're sunk. Because it's costing you more to acquire a user than that users. Then you get out of the user. If it's the opposite, at least you're in the game. I get more profit out of the user than I get cost 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.

Starting point is 00:09:10 Because on the CAX side, you're acquiring the less interested users over time. So they cost more to acquire and they're worthless. And so that LTV to CAC 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 CAC, 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, 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

Starting point is 00:09:53 CAX-L-TV 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

Starting point is 00:10:33 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 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, OpenTable, when I was managing it, did not pay any money at all to acquire consumers.

Starting point is 00:11:10 You're like, how can you do that? We had millions of consumers. The restaurants would market open table on our behalf. You 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.

Starting point is 00:11:35 To be fair, and this is another definition we should tease apart really 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.

Starting point is 00:12:04 So there is a wicked network effect that came up. Like a flywheel effect, right? If you're not spending anything on paid acquisition of consumers, consumers, how do you start it? And the placements that Open Table got in the restaurant, both physically in the restaurant, but particularly on 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, getting around the bootstrapping or the chicken

Starting point is 00:12:33 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 of plays together. I bring two examples up. The pink lift mustache when they first got to San Francisco.

Starting point is 00:13:13 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. Lyme'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, you know, 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

Starting point is 00:13:54 collaborating. Yeah, like, for example, Slack is a great, you know, example of this. And so these 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?

Starting point is 00:14:21 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 for it 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?

Starting point is 00:15:13 It usually looks pretty good at the beginning of the play, but in the middle, it starts getting a little complex, and then 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, you know, marketing to kind of get it going. And so in a case like that, really paid marketing is a tactic to kind of kind of get a network effect jump started. Gotcha.

Starting point is 00:15:40 Right. 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

Starting point is 00:16:01 right way to think of it is 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 cac 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, you know, 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.

Starting point is 00:16:27 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

Starting point is 00:16:53 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, 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.

Starting point is 00:17:37 So you're like, man, look at these user economics. They're awesome. And then Facebook, you know, kind of got to equilibrium when supplying demand met and the cost went up multiples. And those businesses that looked so good early just, you know, 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 of on Facebook mobile or whatever the specific channel was there. But Andrew, you were also earlier talking. about just a cap on how much is possible. You both reference the fact that things

Starting point is 00:18:08 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 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

Starting point is 00:18:24 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 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

Starting point is 00:18:48 that's temporal? Because it seems like, 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, 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

Starting point is 00:19:24 themselves highly Instagramable. They're 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 scooters 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. because it reminds you that it's there and reminds you to talk to it.

Starting point is 00:20:03 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, 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

Starting point is 00:20:38 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 the time. Well, thank you guys for joining the A6NC podcast.

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

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