The last decade has seen many companies focused on growth without reference to making sure there is sound underlying business logic (or in other words, ultimately, more profit than loss). The argument usually points to examples of companies that focused on growth at the expense of profit early on, and only later reached profitability, i.e. Facebook and even more notably, Amazon.
Amazon spent years in the red and essentially subsidized delivery to gain incredible market share that has in turn yielded profitable returns (many, many years down the line).118 The very idea of using outsized relative funding to create a moat, or a considerable competitive advantage, was taken to even greater heights (but in many cases with less commercial success) by companies funded by SoftBank’s Vision Fund.119
In the Zell Program, for better or worse (and I would argue for the better), the idea of raising enough capital to be able to ignore the imminent economics of the business is usually not an option. As first-time or young entrepreneurs in a market far removed from Silicon Valley, they are expected by the local Israeli investor ecosystem to have the economics figured out sooner rather than later.120
At Zell, we push teams to think about the ‘business end’ of their venture from day one, though this is not an easy mindset to instill. This chapter covers the business end of the business in Back-of-the-Napkin, and continues with the basics of unit economics, including the importance of understanding customer acquisition cost risk and the way in which we employ the concepts at Zell in the Economics of One. The chapter proceeds with examples of customer acquisition cost (CAC) solutions in CAC Hacks, and explores additional ways to use distribution hacks to minimize customer acquisition spend and economic risk in Hacking the Downside.
In the Zell Program, once students form teams and start the process of ideation, they tend to be pulled rapidly toward a solution, and then often proceed down a rabbit hole of adding more and more features to that solution. It makes sense that thinking about the concept is more appealing than assessing how much it will cost to make and sell, whether people will pay for it, and if so, for how much.
We try to gear them toward a deep understanding of the problem first, and in particular, the economics underlying that problem. As discussed above in Chapter 3 on ideation, focusing on the problem helps capitalize on learnings and focus. The emphasis on economics helps ascertain if the problem is the right one to be spending time trying to solve.
To address our students’ propensity to ignore the ‘business end,’ we have instituted economic thinking into the process from the preliminary validation stage at the start of the semester.
Our process includes following Why-Who-Which-What and How steps, which all converge in the Zell Journey Validation Questions, and a consideration of the ‘business end’ of the business, from which we glean the unit economics and the business model.
At every step in this journey, there are economic variables to consider (as can be seen in the last row of the table, namely market size, pricing and business model, demand and willingness to pay, and the counterbalance of the cost of building the product and its distribution).
Assessment of the above helps gain an understanding of how a business model would work for the business, and at a high-level if this business makes sense or ‘cents.’
We call this high-level assessment the ‘back-of-the-napkin math,121 or the assessment per unit of product or service provided to a customer in terms of the price a customer is willing to pay, and the cost of producing/procuring that product or service and getting it into a customer’s hands. That, multiplied by the number of customers the company can reach and sell to, gives a high level indication of the viability of the business.
The underlying math of the back-of-the-napkin assessment is based on the idea of unit economics.
One of our longtime advisory board members and the founder of OutBrain,122 Yaron Galai, has spent considerable time with student teams over the years on his visits to Israel and mostly on our study trip visits to NYC. Whenever he meets the teams, he spends most of his time expounding the virtues of unit economics.
The term ‘Unit Economics’123 refers to a profit/loss calculation per customer (or unit). This is a unit-based (one product, one service) indicator for assessing whether there is viability in building out the business at scale. It is especially relevant for technology businesses in that it does not take into account the R&D and underlying technology but rather the cost of acquiring customers (or customer acquisition cost, which is referred to as CAC). The idea is, if you can make sure that the cost of acquiring users (even if not initially, but sooner rather than later) is less than the lifetime value (LTV), then you may have a good business opportunity over time.
Another way to think of unit economics is the direct revenues and costs attributed to a particular business model on a per unit basis.
As in the example of YesChef, how much marketing spend is required to onboard a lifetime subscriber for the YesChef app? Generally, the more you spend, the more customers you can get, but that is not necessarily sustainable and investors see it as a risk for needing more and more funding (and for them, increased dilution). In order to break that spending axiom, hacks to reduce customer acquisition costs are necessary.
Some companies find hacks to user acquisition cost. Good Pharm, for example, deliberately decided to focus on some local PR and allocate no budget to traditional marketing. [See the Good Pharm Case Study] This was possible because it was in a localized market, where proactive journalism knocked on Good Pharm’s door.
The week before the opening, Adam Friedler (Zell 10 – 2011) was contacted by a prominent news channel in Israel, Channel 13, to feature Good Pharm as a more economical drugstore alternative. They aired the 20-minute feature during prime time the night before Adam launched. To his astonishment, this brought herds of shoppers on opening day who cleaned out the shelves.
“If I show you the business plan with the numbers we thought would be accurate for the first store, we were 10 times this number,” Adam said. “We did, in one day, what we thought we were going to be able to do in a week or more.” But their decision not to spend on marketing was largely supported by the small market dynamics inherent to a localized physical presence.
For companies in the online world, it's harder to make the necessary noise to convert their PR into customers, and usually far more expensive. 24me however, was lucky. Though they had planned an under the radar soft launch, they had been noticed by Apple, and a week after they launched, they were featured on the App Store as an Essential Productivity App.124 This actually went against Liat Mordechay Hertanu’s launch strategy, which was to start quietly and continue to fix some of their code and app functionality on the go. Nevertheless, it drove user traffic and a great response from both users and Apple developers alike.
“We got a phone call from Apple from one of their senior staff members at the App Store, and he told Gilad that they really love what 24me is doing, they love the design and product offering, and to please keep in touch. It was surprising because we always thought we would need a lot of money to acquire users. With next to zero dollars in our bank account, this was a big deal that again generated a lot of organic traffic for us,” said Liat.
As 24me advanced, so did the company’s revenue opportunities. Most of their user traffic started and continues to be organic. But connecting with other apps and service providers created a ‘hack’ to distribution in that now other parties were cross-promoting the 24me app.
Clearly, public relations is a great way to promote business, especially if you can get that PR without paying for it. For Nim Bar-Levin (Zell 4 – 2005) of OnO Apps, the hack worked a little differently. In order to get customers, OnO Apps needed to gain experience building apps to be able to showcase. In a classic chicken and egg dynamic, without apps, it would be hard to get customers, but without customers, there would be no apps. Nim decided to break that cycle by offering NGOs in Israel ‘pro-bOnO’ apps.
They strategically created a program where they would create one such app every six months. At this point, OnO was only a few months old, but the team knew that if they could build an app that people would use, and help the community in Israel at the same time, it would be well worth their while. As expected, the first app was successful and popular, but as an unintended consequence, the NGO project and OnO Apps were cited all over Israeli newspapers for months.
Beyond these examples, marketing usually doesn’t come cheap. In fact, SMBs commonly spend upwards of 8 percent of their gross revenue on marketing initiatives.125 Yoni Elbaz (Zell 11 – 2012) of Loox wasn’t keen on spending marketing dollars he didn’t have, and instead, he came up with his own hacks and rules to live by when it came to marketing. He did this with an understanding that distribution was the lifeline, but that it would not come cheap by conventional methods and required a creative solution. “Really for us, what was key for early growth was being able to reach customers without having to spend any money on marketing,” said Yoni.
But how can a company acquire customers without paying? Loox, a bootstrapped Zell Venture, [See more in the Loox Case Study] hacked customer acquisition costs by skirting them all together.
The methods were as follows:
Between their marketing tricks and their implementation of a subscription-based business model, Loox found the route to profitability.
For Bizzabo, hacking the CAC (and the rest of their metrics) also meant instituting a subscription model (one of their many pivots. [see the Bizzabo Case Study] Previously, Bizzabo had relied on the industry standard of price per ticket. Bizzabo would give out heavy discounts to organizers based on large expected ticket sales, but the actual attendance of these events would often come up short. Subscriptions, however, meant the same service for the event organizers, but allowed Bizzabo to be agnostic of event size and turnout.
They were able to pre-package utility based on expected event size and included modularity for growth and additional features. Over time, this model helped Bizzabo stabilize, and it eventually led to high growth in LTV and annual contract value (ACV). Additionally, the more targeted segmentation that focused on larger organizations led to lower CAC. Because Bizzabo didn’t have one simple way of cracking such benchmarks, they continuously worked on tweaking and fine-tuning all of their features and aspects of the business.
“We literally fought for every 1% of business improvement,” Boaz said. And then came COVID-19 and a different kind of pivot.
Keeping customer acquisition costs low and lifetime value high are the key to strong unit economics, however, they are not the only component of business risk, and certainly not the only cost function that impacts the bottom line.
Cost of goods sold is also an important component. The hack for Good Pharm was choosing products that were best sellers rather than a full product offering.127 In that way, they capitalized on “sure” bets and optimized their shelf space to accommodate those products that yielded the most revenue.
Distribution platforms and partnership platforms (such as those used by Loox) also protect from downside risk. For partnership programs, the fact that you only pay when you yourself are paid is critical to downside protection and cost mitigation. Distribution platforms achieve scale at lower costs and also spread risk among partners.
Overwolf learned that lesson the hard way. After many years and rounds of funding, Uri Marchand (Zell 8 – 2009), Overwolf’s founder and CEO, realized that instead of Overwolf building all of the functionalities for games in a closed shop, it would be better to build an open platform where third-party developers could share in the gains and the execution risk.
The app store model seemed to be the holy grail of distribution for Overwolf, and a good story for fundraising to boot. “The lesson here is that what we should have done as an open framework for creators is think about commercialism from day one,” Uri concedes. For Overwolf, hacking distribution meant developing a viable business model and achieving profitability. [See the Overwolf Case Study]
For Rewire, an online banking platform for remittance payments, this meant not wanting to be reliant on one source of deposit offering and to solve for this through partnerships. Their competition all had physical locations for taking in deposits. Between 2016 and 2019, Rewire grew to three different deposit partnerships in Israel:
Through these partnerships, Rewire offers over 1,000 deposit points, which is more than any single network. Not having to operate the deposit points themselves helped Rewire scale at a lower cost, which they passed on to their customers. That savings, the relatively low CAC of $25 dollars, achieved with word of mouth and community advocates, and the LTV of $750 dollars, makes the Rewire story financially compelling.
