Remarks to Software Forum Dinner Meeting

February 19, 1997

by Kenneth L. Hess

(c) Copyright 1997, Kenneth L. Hess

All Rights Reserved

Our Agenda

There are as many viable business strategies as there are grains of sand at the beach. My strategy just represents one of those grains. Most of what I say applies to productivity products. Some things would not apply to an entertainment product. And, I'll assume the founder wants to sell the company or go public. That being the case...

Company Background

I founded Banner Blue in my spare bedroom during September 1984, then sold it to Broderbund in May 1995. I left the company in November of 1996, having been responsible for over 200 product releases (including rolling releases).

Through 1996, Banner Blue has shipped over 2 million copies of software. FY 1996 sales were approximately $23 million.

Org Plus, introduced in 1985 to make corporate organization charts, was the company's first product. Today Banner Blue is focused on serving the market to help people find their ancestors then organize and present the information they uncover.

Primary products:

Prominent Awards:

My Bias: The Bootstrap

These comments will focus on a bootstrap, an organization funded by the founders. In other words, an organization with no outside investors. My comments also assume the founders aren't wealthy! Banner Blue was funded with about $20K of my money, not counting my time.

In some areas, the source and amount of funding makes no difference. In others the difference is quite significant.

Let me turn philosophical. Throughout history: railroads, automobiles, semiconductors, computers, even financial services -- all required substantial amounts of capital and large organizations. Even today's farm requires large amounts of capital. Not in software, not on the web.

To my mind this is a wonderful time, highly favorable to a bootstrapped startup in a variety of software and web-oriented markets. Our time is one in which pure thought (the entrepreneur's brain) working through an instrument requiring limited capital (a single computer) can create vast wealth as if from nothing at all. In this realm of the pure entrepreneur, size retards the creative process and homogenizes the end result. The world has been turned upside down. Today's world belongs to the entrepreneur.

Why a Bootstrap?

Not every product is appropriate for bootstrapping. But, the advantages of a bootstrap are so great you should seek out such business opportunities.

The math is compelling:

Founder's Equity Employee's EquityInvestor's Equity Company SalesMarket Value Founder's Net Worth
Bootstrap85%15% 0%$10 million$ 20 million $17 million
Investor funded15%15% 70%$10 million$ 20 million $ 3 million

Of course, venture investors don't want a $10 million dollar company. They want a $50 million dollar company:

Founder's Equity Employee's EquityInvestor's Equity Company SalesMarket Value Founder's Net Worth
Bootstrap85%15% 0%$10 million$ 20 million $17 million
Investor funded15%15% 70%$50 million$100 million $15 million

Now the investor-assisted founder is catching up. A key question: What are the odds of building a $50 million dollar company versus building a $10 million dollar company? -- The odds are much longer. It's another way of saying the founder's expected value is much lower in a venture-funded startup!

The truth: I didn't do this math until later. I bootstrapped because I didn't want investors meddling in my business! And, that's not a bad reason to bootstrap either.

What's Changed Since I Founded Banner Blue?

The technology has changed.

The markets have evolved; you would found a company to meet different customer needs.

But, the principles of founding a successful business are essentially the same. I think you'll see that's proven by Banner Blue's success on the Web.

Ken's Checklist for Building a Company

This checklist is about getting the odds in your favor. Fitting together all these pieces of the puzzle is what separates a good business plan from mere speculation.

1) Are you focused on creating the product?

2) Are you the world expert in your product niche?

3) Does your product meet viable new product criteria?

4) Do you have the force of will to make things happen regardless of the inevitable obstacles?

5) Do you need help?

6) Are you spending money wisely?

Then once you've shipped, continue to ask:

7) Will today's task contribute to or diminish the organization's focus?

8) How can I broaden the market?

9) Is the company's scale appropriate to the task?

10) Is it time to sell?

Are you focused on creating the product?

What can a startup do better than a larger organization? Create and build products. A startup can do this with more elegance and originality and with greater speed. The act of creation is what generates value.

(Note the things that aren't on this list: train employees, affect public policy, contribute to charity, build an industry trade group, save the world, get your name in print, make spiffy presentations, ...)

This seems so simple, but many companies put their primary focus on sales objectives or worse.

Technology investors (now we're talking about someone buying the company) buy sales growth. But, sales are a derivative of product creation. Sales objectives are for sales forces. Banner Blue didn't have a sales objective until it was about 7 years old because it didn't have a sales force until quite late.

Are you the world expert in your product niche?

To create something new, you have to know everything that already exists. Otherwise you won't know whether it's new or not.

To create something better, you have to know why things are done the way they are. And, how they could be done.

A world expert can effectively communicate the benefits of the new product to prospective customers. They can write the sales pitch. (Others may polish it...)

Being the world expert is vitally important to meeting the new product criteria I'll discuss in a moment. If you aren't the world expert, you're just kidding yourself about your chances for success.

New Product Criteria

The first two criteria help insure a low cost of sales.

1) Solves a single, known problem

Why a single problem? Swiss-army knives are hard to sell and prone to featuritis. Also, keep in mind that all the components of a Swiss-army knife were sold individually before their incorporation into the multi-purpose tool. Simplicity and elegance are the objective.

Why a known problem? People who know they have a problem are looking for a solution. And, it's VERY expensive to convince someone they have a problem when they aren't aware of it.

Let's look at some of the other words in this criterion:

"Solve" means 10X better than the alternative. An order of magnitude better. 1.2X better, 1.7X better, even 2X better -- that's the realm of the big, established company. That's the realm of a startup when it upgrades. Small incremental improvements are a matter of opinion. 10X improvements are undeniable. 10X improvements generate the kind of growth that proves the worth of a startup.

1.2X improvement doesn't even get your customer to raise his head from what he's doing. A 2-3X improvement may get them to look you in the eye. 10X improvements cause people to reach for their wallet.

Org Plus is easily 10X better than drawing by hand or drawing manually on a computer, especially when updating the chart. When I was at HP, there were customers who would pay $10K to get a standalone terminal and a plotter that allowed them to draw orgcharts manually. These people were looking for a solution and they gave Org Plus a very quick start.

Family Tree Maker produced 10X prettier output than any other computerized solution. But it really took off when we redefined the market and offered a solution for finding your ancestors that was 10X better.

Of all the business ideas I see, this criterion is most seldom met. Many people think a modest, incremental improvement sufficient. Others mistake an idea for a solution. Customers buy solutions, not ideas. You have to be the world expert to get it right.

Who is the ultimate judge?

The customer judges the solution. HP used to talk about the "next bench". Product ideas were tested on the engineer at the next bench. If he liked it, it was a good idea. If you try that with a consumer product, prepare to be humbled.

Banner Blue has replaced the "next bench" with canvassing in stores and written surveys to customers and prospective customers.

We also like to write an ad or an upgrade letter as we're finalizing a feature set. Will it sell?

An example: I was really excited about my initial forays on the web. I was about to visit home and I just knew the web would be what it took to get my Dad to use the computer more. So I checked out some neat sites related to his various hobbies. At home, I showed them to him one-by-one. "Does it have this?", he would ask. "Well, my weekly newsletter has that." And so on. Not a single site improved on his periodicals. None met what I call the "Dick Hess" test for web sites... 10X---they were 0.5X!

2) Has no significant competition

The cheap way to be the market leader, with disproportionally large market share and profits.

With no competition the first release doesn't have to be perfect--a tremendous advantage for a startup. In general, time to market supersedes perfection. But even without competition you'd better fix it fast. We did two upgrades within the first year for Org Plus. Family Tree Maker was similar.

If you listen, your customers reinforce your position as the world expert.

The next criteria is a good cross check on the first two.

3) Makes good use of the computer, web, as the case may be ...

For a computer, Chris Crawford called this "crunch per bit". Higher number crunching per bit of code being the figure of merit. For the web it's something else... This criterion is a good check that you're doing something useful.

The original Org Plus did about 1000 calculations per box in the org chart before printing it. These were things like centering text, positioning the box, positioning the lines, ...

The next three criteria represent what your product can do to keep you in business.

4) Development cycle of less than a year (3-6 months for the Web)

In my experience, if you go over one calendar year, your market assumptions no longer have validity. For the web, it's probably 3-6 months!

Look at General Magic! They still haven't learned. They just announced a new strategy (web-based no less) calling for products to ship in 18 months. Good luck. That's what happens when you're spending someone else's money.

I was involved in one project at HP that kept taking two years to code. Well at about two years your platform tends to change on you. Ooops! Restart. So after this happened several times the product finally shipped--seven years after initiation. Needless to say, the product was unsuccessful.

Long projects also bleed money.

5) Makes the required profit

If you bootstrap your company, you have to make a profit. It's a matter of definition. Obviously, the estimated revenue potential of the product has to cover your estimated costs and investment needs.

Must provide customer support, but the cost must be reasonable.

6) Has built-in barriers to competition

MS story...

Do You Have the Willpower To Overcome Obstacles?

Force of will is perhaps the most undiscussed requirement for success. And it's a tricky beast, more than worthy of study.

People don't do things just because you tell them to. There are many steps to get the result you want:

Objectives are the first step. No matter how much time and energy you devote to it, you can't ever understand what's going on inside someone's head. That's why MBO and results are so important to a manager. Results are the only objective truth.

The objectives must be realistic and they must be necessary. Otherwise people will treat them as what they are-- silly. Dilbert's boss is a master of the unrealistic and unnecessary.

We also tried to have incentives for meeting objectives or making the extra effort. Those help a lot.

But people are people and they're going to wiggle. An objective in the world you the entrepreneur has created is going to conflict with an objective in an employee's world. Or, there will be circumstances unaccounted for, requiring extraordinary effort to compensate. Probably both, probably several times. It's inevitable.

You need to know when YOU can wiggle and when you can't. When I believe that something MUST be done, there is no force on Earth that can divert me from the task. When others are involved you MUST be able to impose your will on them. It's your responsibility.

You have to say what's necessary, why it's necessary, and ultimately you need to be correct most of the time.

It helps if you have an external enemy. A competitor is a good foil. Make them the bad guy.

Do You Need Help?

A startup doesn't need to be a one-man show. Most have a small core of key people. And, a weakness in one person can be made up in another. Previous experience working together is ideal (although not a guarantee of a good future working relationship under the strains of entrepreneurship).

There is no precise metric, but for a good number of things, you should be more capable than anyone you can hire. If you have lots of holes or holes in vital areas you may need help. Consultants can fill small holes, but you may need to add a member to the team, or even abandon the effort if the holes are large. Your destiny may not be as an entrepreneur OR you may find another opportunity is better suited to your talents.

Personally, I investigated a number of businesses before taking the leap. On one, I invested a substantial amount of time. It gave me more confidence when I started Banner Blue and one of the people involved in my investigation played a key role in Banner Blue.

The job of building a company gets harder as the company grows, not easier. You want to start with a strong team, because you may not recover from a weak team.

On balance, the entrepreneurial team needs enough knowledge to do the job, but not so much knowledge that fear takes over!

Spend Money Wisely

Profit. A bootstrap must have a positive cash flow (by definition), even though this is much less important to someone purchasing the company than sales growth.

"Just say NO" to things that aren't profitable -- and be happy

Hire people AFTER you can pay for them. Don't hire them because you wish you needed them. How many times have you seen that happen?

Develop products that will be profitable. A give away, market share strategy is inappropriate for a bootstrap.

Do marketing that is profitable. Don't do a promotion just because a distributor says you have to! Let some other sucker pad their bottom line. Just say NO.

Play on being small, "We don't have a budget for that..."

Measure everything so you don't repeat mistakes

The 80/20 rule applies to money you spend. Many people inside and outside the company want to spend YOUR money because of what it does for THEM. You must ask what spending the money does for YOU.

Focus

Focus, focus, focus. I hypothesize that an industry has a narrow window of time during which it is advantageous to construct a company with a broad portfolio of products. It's MUCH harder to do than to build a single product company. It's like fighting more than one war at the same time.

Deals, like unrelated product lines, are another way to lose focus. Most prospective deals never even come to fruition--the proverbial goose chase. Best to screen them out early. Most deals to make a little money on the side, don't. They just serve as time-consuming distractions. Yet some deals are important. Which ones?

Abstractly, I have described a business method that one could call create and control. We create our own products and our own environment and we have a strong desire to control their every aspect. People or things that disturb the ability to create or control incur my wrath. That method has many implications for deal-making.

Banner Blue's great deals, Automated Archives and Genealogical Publishing Corporation, served a strategic purpose and preserved our ability to create and control.

Banner Blue's worst deals, with Heath Printers and one I've been asked not to mention, served a strategic purpose and did not preserve our ability to create and control.

This is a different tune than I sang five years ago when I spoke about our desire to have a diversified portfolio of products. We introduced several other products in unrelated areas. There was a cost to losing our focus as shown in the table below. We returned to focus and got higher growth... Should have had two companies... Sell Org Plus early, then new company for Family Tree Maker.

YearGrowth Rate High-level Strategy
1986853%Focus
1987105%Focus
198813%Focus (subset marketing)
198935%Diversify (Family Tree Maker)
199023%Diversify
199136%Diversify (Mercury, Movie Guide)
199222%Diversify (Brochure Maker)
199326%Diversify
199455%Focus (superset marketing)
199557%Focus (superset marketing)
199640% est.Focus (superset marketing)

Note: Subset and superset marketing are discussed below.

Much precious management time was consumed searching for attractive, new product niches during the period of 1989-1993. Development resources were devoted primarily to new products. The results speak for themselves.

Broaden Your Market

It's important to give your existing customers what they want, but sometimes it's better to give them what they need. To grow, you must broaden your appeal, giving your prospective customers what they want . And, that may be quite different than what your existing customers desire. You must broaden the market.

Geof Moore (a Software Forum speaker last year) has written a wonderful book that discusses these issues, Crossing the Chasm.

We did a poor job of broadening with Org Plus and an excellent job with Family Tree Maker.

Upgrade ProcessOrg Plus Family Tree Maker
SurveysExisting customers Existing customers & prospective customers
Target of new featuresSubset of existing market Superset of existing market
Rate of upgradeExcellent Excellent
ResultGrowth stopped Growth accelerated

Let me address a couple technical issues that relate to market broadening: the product architecture and the rate of product enhancement.

When I look back over the 200 product releases I managed, the product architecture takes on a unique significance. The data structure and algorithms of a program, it's underlying architecture constrain the degrees of freedom as you enhance the program.

A good architecture preserves the freedoms you ultimately need. A bad one doesn't. You have to throw out the program and start over. We had enhancements we wanted to make that were impossible because of the product architecture.

Org (DOS) story... [printer drivers, formatter, ...]

OPW story... [addressed DOS deficiencies, but with spaghetti code]

FTM (DOS)... [capacity desired was a surprise...]

Architectural strategies: plan carefully and leave as much freedom as you can imagine (the more closely you come to being a world expert, the better you'll do) OR throw away the first version when the program is still relatively small (not a bad strategy on the Web) instead of waiting until it can't be fixed any more.

Obviously, if the marketing function and development function are in one person or like Siamese twins, the odds of a good architecture are improved.

Now, let me describe Hess's Law. You've all heard of Moore's Law (as in Gordon not Geof Moore). It describes the rate of decline in semiconductor prices per electronic function. Hess's Law is analogous.

Hess's Law states that software functionality will increase at approximately 30% every year, or prices will fall. (I reserve the right to adjust the percentage upon further study.)

Software is a lot like hardware. People expect to get about 30% more every year (give or take) for the same price (more functionality for a productivity product, more "realism" or content for an entertainment product). When you add 30% more stuff, you can maintain your prices, maybe even raise them. You'll also stay abreast or even ahead of your competitors, because it seems no one can add much more than 30% without burning out everyone who works for them. Add less than 30% more stuff and you start falling behind.

If neither you nor your competitors are adding 30% more stuff, you're really in trouble because there will be a glut of undifferentiated product.

I think the key here is simple. The need to offer 30% more every year never goes away. If one has a strategy that doesn't address the 30% rule, one doesn't have a strategy.

In both our major product lines, Banner Blue was adding enough functionality. But as you have seen, it was the wrong functionality in the case of Org Plus.

The Appropriate Scale

There is an appropriate size for everything including your company. There are some wonderful, one-person businesses right here in the Software Forum. Unfortunately there are many one-person businesses that an ill-guided founder tries to make a ten-person business. That is a strategy of failure.

Once you create your product and market it effectively, the environment determines the appropriate size of your company. Many elements of success are outside one's control. Alma (my second in command) and I would often ask, "When is one of our products going to take off?" We saw smashing success happen to others we judged to be our equals or less. Ultimately, we reaped a reward for building a solid foundation, not trying to build a monument until market demand arrived. Banner Blue had the appropriate scale at all times. We positioned ourselves for success with tremendous investments in new ideas, but disciplined ourselves with a requirement for ongoing profit. Consequently, our objectives emphasized product development and profit. Growth targets (when we had them) were seen as a necessary discipline for the sales organization and not the primary focus of the organization. Finally, our time came. It might not have. Be humble.

Is It Time to Sell?

Sell the company before it's single product limits growth. Asked about when to sell, another wise entrepreneur once told me, "Trees don't grow to the sky." That's all he said.

You sell a company when things don't look like they can get any better. They won't.

Ken's Checklist for Building a Company: A Review

1) Are you focused on creating the product?

2) Are you the world expert in your product niche?

3) Does your product meet viable new product criteria?

4) Do you have the force of will to make things happen regardless of the inevitable obstacles?

5) Do you need help?

6) Are you spending money wisely?

Then once you've shipped, continue to ask:

7) Will today's task contribute to or diminish the organization's focus?

8) How can I broaden the market?

9) Is the company's scale appropriate to the task?

10) Is it time to sell?

Mistakes/What Would I Do Differently the Second Time?

Here's a summary of what I would change (with a couple new ones we haven't discussed thrown in for good measure):

But We Avoided the Common Failure Modes

So, mistakes were made, but our success was great. Nothing is ever perfect. We did a good job of avoiding the common ways companies fail:

For small companies:

For large companies:

For all companies:

The Web

Family Tree Maker Online is a profitable, award-winning web site (www.familytreemaker.com). It also represents a current example of a business unit founded on the principles I have discussed.

Focused on creating the product?Yes, dedicated, small business unit
World expert in product niche?Yes
Meets viable new product criteria?Yes, as follows below
-- Solves, a single known problemFinding ancestors 10X better (things you can't do with the PC software and things you can't do with available print media)
-- Has no significant competitionHas none
-- Makes good use of the web--Many-to-many communication

--Extremely low cost to distribute information

--Searching capability

-- Development cycle <1 year--Major upgrades every 3-6 months

--Content changes real-time

-- Meets profit objectivesWe said it had to make money by EOY and it has
-- Built-in barriers to competition--Installed base of 800,000 users

--Our database of ancestors

Force of will to make things happen?Yes
Need help?Yes, hired a UNIX guru
Are you spending money wisely?Always
Focus? The team works only on the web project
Broadening the market?A major objective
Scale appropriate to the task?Yes, a very small team
Is it time to sell? Nope!

But, How Do You Make Money on the Web?

Banner Blue is pursuing many alternatives:

1) Premium features available only to owners of the current shelf product. Revenue comes from incremental upgrade sales. This is working very well.

2) Online sales of physical goods. In this case, our Family Archive data CDs. This is working very well.

3) Sales of data online. Success TBD.

4) Sales of services online. Classified ads doing surprisingly well.

5) Sales of advertising. In due time.

6) Sales of subscriptions. Doesn't apply in current model.

What About Building Traffic?

Site traffic has been building steadily. The site obtains an extremely high number of page hits per user visit. People use the site intensively.

We did some simple things:

Banner Blue also has results on a number of experiments:

SEF_spch.html

2/19/97