Monday, February 3, 2014

From consulting to syndication

Consulting businesses are like dental practices - if you're not drilling teeth, you're not making money.  Syndicated information businesses, on the other hand, deliver cash flow while you sleep.

So it's not surprising that consulting firms are anxious to shift their business model - nor is it surprising that how to do so is one of the most common questions I get.

The quick answer: though it looks simple, converting most consulting-heavy business models into great information businesses is hard work.  Really hard.

Why?  Because although it seems like a hop, skip, and a jump, it's actually a tremendous voyage between the two.  Though they both have insight at their core, they're actually very different businesses.

Have I scared you off?  I'm not saying it's an impossible transition - just that making the leap isn't for the faint of heart, or those short on patience.

On the other hand, it's a journey that can radically improve the economics, predictability, and value of a consulting business.  For the right business, it's worth the time invested.

Here's the typical path:


Let's walk through it.  Bespoke consulting is where many (most?) information services businesses begin.  When you've got expertise, consulting is the easiest way to monetize it - and provide direct value to customers.

But the very thing that makes consulting valuable - the custom delivery of insight - is what makes it poisonous to a syndicated business model.  

I've worked in both kinds of businesses and one fact is very clear: it's the rare person who can succeed at both.  Successful consultants like to consult - they like to be the smartest person in the room and love to win over a client.  

They don't, on the other hand, like to create standardized offerings - especially those that put their livelihood at risk!

Standardized Consulting.  Standardized offerings, however, are the only way to move the business to a new model.  Think scorecards, maturity models, benchmarks, and the like - tools which allow a consulting engagement to take on a standardized workplan and standardized set of deliverables.

As an example, think about web customer experience consulting.  A bespoke project might involve an expert examining the web site, testing the experience, and offering a wide variety of perspectives on how to improve it.

A standardized project, on the other hand, might involve assessing the site against a few dozen "best practice" characteristics and presenting a report card about how the site fared.  

While the former is more specific (and perhaps useful to the client), it also will be expensive. The latter, on the other hand, can be delivered quickly - and often cheaply - by using less expensive talent.  Thus, the client can get much of the value for a fraction of the price.

That being said, however, it still requires the time and effort of an expert to deliver the engagement.  

Automated Deliverables.  But what if you could automate the assessment?  Perhaps the client could do much of the legwork - for example, filling out a worksheet to assess the maturity of their shift to cloud computing.  Or sending in their data for a salary benchmark.

Then, algorithms can do much of the work of the expert.  Rather than drafting a deliverable from scratch (as in bespoke consulting) or working from a template (as in standardized consulting), deliverables can be automated. 

For example, a web service can take in salary data and spit back out benchmarks against other firms, industries, geographies...or anything else the client desires.  No human contact necessary.

Syndicated Information.  We're almost there - but not quite.  We still need to make the transition from one-off consulting sales to subscription-based relationships.  

You see, it's relatively easy to sell a one-off consulting engagement to someone with a particular need.  It's another to sell an ongoing stream of data or insight - and get the client to keep paying year after year.

The secret?  Developing an offering that's embedded in a business process.  Follow the link for the real details, but here's the quick summary: great information businesses are embedded into their clients' workflow.  They are consumed by the client in a way that they power a required step in the completion of a business process...such that removing them would make the process cease to function effectively.

So that's the path from consulting to syndicated business.  It's a long - but often worthwhile - journey. 

Have you taken your information business from consulting to syndicated?  Tell us the story in the comments below!  And let me know if I can help with your business as well.

Monday, December 16, 2013

Spending Money in the Right Places

Sweet - a blog post about corporate resource allocation!  What could be more fun?  A sharp stick in the eye?

Stick with me (hah!) - it actually won't be that painful.

Here's the punchline: Great information businesses spend a minority of their resources on creating content and the majority on distributing that content.

Alas, many info businesses get that backwards.

In an earlier post, we took a deeper dive into the common problems in information businesses.   We talked about how many info businesses are subscale - and allocate resources inappropriately.  Turns out, those two characteristics are closely linked.

First, some definitions: when I say content creation, I mean all the time, money, and effort spent to collect, process, analyze, and package content for customers.

In the TV ratings business, for example, that would include all the data collection on who's watching what, calculating viewership share, creating analytics, etc.  In the consumer credit reporting business, that would include collecting data on who's paying their bills (and who isn't), creating scoring algorithms to segment consumers, reporting tools to allow buyers to access the data, etc.

Content distribution, on the other hand, includes the time, money, and effort spent to market, sell and deliver the content to customers.

In most information businesses, that would include the cost of the salesforce, marketing organization, channel sales costs, and the like.

Here's the key insight: the secret to a scalable information business is to sell the same information over and over again - with little to no marginal product cost.

I know - obvious, right?  Maybe in theory, but not so much in practice.

For example, I looked at a publicly-traded information business in the IT space recently - it's a sizable company with about $200m in annual revenues.  Problem is, it's a break-even business that spends 59% of revenues on content creation.  Tack on another 32% for content distribution costs and add in overhead and...bingo!  A lousy equation for investors.

(As an aside - that same company has less than $10m of deferred revenue on the balance sheet.  Remember this earlier post about metrics that matter?)

Contrast those metrics with another publicly-traded information business I'm doing a deep dive on right now.  That business is also break-even, making it a questionable investment.  But they're doing some important things right: content creation costs are only about 16% of revenue, while distribution is about 65% of revenue.  As the business scales, it's not unreasonable to think that great leverage could result from the low content creation costs...

Here's my rule of thumb: a mature information services business should spend 20% or less of revenue on content creation, and at least double that on content distribution.  

What's your experience?  Please share in the comments below!

Monday, December 9, 2013

Shifting from inside-out to outside-in

Brutal truth time: the product development process inside most information businesses is fundamentally broken.  

Most leaders of information businesses with whom I speak intuitively know this to be true.  But few are able to put their finger on exactly why things are so broken.

Here's the answer: information business product development processes almost always proceed from the inside-out.  They start with the data, analytics, or insight that the firm has - and proceed almost immediately to questions about how to take it to market.  



The result?  An information product or service that meets the company's needs more than the needs of its customers.

It's easy to understand why.  Product development teams are pressed to do more with the assets the company already has.  They have a time crunch to get things done quickly.  And they're often measured on the short-term returns on those products.

But that thinking is completely spɹɐʍʞɔɐq.  Sorry, backwards.  

Remember our discussion on what makes a great information business?  In a nutshell: great information businesses are built on proprietary data, embedded in a business process, and delivered through software.  

Therefore, a great product development process must focus on these same elements.  In particular, effective product development efforts in the info biz usually start with the second element - the customer's business process.

Here's what an outside-in product development process looks like.



Note that these questions take the discussion in an entirely new direction.  Rather than focusing on what we have, we focus on what the customer needs.  And, equally importantly, we zero in on the value delivered - which is key to effective pricing in the info biz.

Moreover, this line of thinking allows us to assess the "embeddedness", or stickiness, of the offering.  If we determine it won't be embedded enough, we can change course quickly - or move onto a different product offering long before we waste time bringing it to market.

So, in a sentence: Product development in information businesses must start with the customer's business process and work backwards to the product offering.  

How do you know which process to target?  Stay tuned - we'll cover that in an upcoming post.  

How have you developed products in the information services business?  Any tips for your peers?

Wednesday, December 4, 2013

Outside director compensation in VC/PE-backed businesses

This post is a little off-topic from where we've been (information services business analysis) - but I think it may be useful to many readers.

As I poke around the information services space looking for my next great gig, I'm increasingly receiving invitations to join the boards of both VC- and PE-backed businesses.  In evaluating these offers, I've tried to stay very selective - time is a limited commodity, and as I've said previously, many information businesses are actually quite lousy.

But I've recently joined the boards of two great companies - CallMiner and Buyers Lab, with a couple more waiting in the wings.  The former is a hot VC-backed company doing some amazing things in the call analytics space.  The latter is an example of a great information business.  Check 'em out.

When I contemplated joining these boards, I was a bit adrift in terms of nailing down market compensation for the role.  Given my background, I did what came naturally: I conducted some market research to find out the answer. 

I received over 40 data points from helpful folks in my network, including some recent (2011) benchmark data. All were from well-respected and experienced VCs, PE investors, startup CFOs, and the like.

While all the data points help understand the appropriate compensation range, it’s worth noting that many participants emphasized the specificity of individual situations. For example, outside directors brought in to offer specific expertise (access to their network, advice on operations, help in selling the company, etc) often received one-off compensation packages which fell outside these ranges.


Equity compensation. Not surprisingly, equity comp is the most prevalent (cited in 100% of individual responses and 93% of benchmark data). All those who used equity comp for outside directors employed up- front grants, while a substantial majority (84% in benchmark data) also offered some form of ongoing, annual grant.

  • Equity vehicles were heavily weighted towards options, with only about 15% offering restricted shares. Some experienced directors in the sample said they are trying to change this mix more towards restricted shares.
  • Size of initial grants ranged from 8 to 100 basis points of fully diluted company ownership. Three factors appear to govern where in this range the grant is likely to fall: size/stage of company, day-to-day involvement in the company, and committee assignments.
  • Across the board, the earlier stage the company, the greater the size of the grant. Median responses seem to cluster around 50 basis points, but that may be related to the nature of the sample.
  • Outside directors who commit to spending specific time with the company (e.g. a day a week) tended to fall on the higher end of the range as well.
  • Committee chairmanships among outside directors in the sample were few, but generally seem to merit an increase of 10-20 basis points.
  • Vesting schedules were weighted towards four-year vesting, with most vesting on a monthly basis (note that a substantial minority had a cliff vest at year one, with monthly vesting thereafter).
  • Vesting triggers were also relatively common – including full vesting upon change of control in nearly all cases. Experienced directors also noted that they seek – and often get – relatively long post-service exercise terms of a year or more.

Cash compensation. Here there were substantial differences between PE-backed and venture-backed firms. Very few early-stage venture- backed firms offered any cash compensation; in contrast, some later- stage PE-backed firms offered meaningful cash compensation. 
  • Overall, approximately 4 in 10 firms in the sample offered cash compensation. About half of those firms which offered cash compensation used an annual retainer alone; the remainder mostly some combination of annual retainer and meeting fees.

  • Annual retainers (when employed) ranged from about $15k to about $30k for VC-backed companies, and from about $25k to about $90k for PE- backed. Outside chairs of key committees – primarily Audit and Compensation – are likely to also have additional fees paid, though they seem to range widely.

  • Meeting fees (when employed) ranged from $500 to about $3k for in- person meetings, and about half that for telephonic meetings. Nearly all reimbursed direct meeting travel expenses for non-local board members. 
Other compensation. There was no clear pattern around other compensation categories. Some firms offered health insurance to directors, for example, while others offered more humdrum compensation like meals at board meetings. 

Other factors. Experienced directors and attorneys in the sample noted that outside directors certainly require firms to provide high-quality D&O insurance. In addition, some suggested the importance of specific indemnification arrangements for directors, separate and apart from those arising under corporate bylaws. 
Does your experience match the data above?  Please share!

Wednesday, November 20, 2013

The misleading economic cycle

The macroeconomic cycle has a very predictable impact on most businesses.  Revenue growth slows (or reverses).  Net income drops.  And, of course, valuations move in the same direction.  Not exactly rocket science.

But a curious thing happens in subscription-based information businesses.  While sales may move in the wrong direction, net income often soars.  Wait, what?

One of the great virtues of subscription-based information businesses is the revenue visibility afforded to management and investors.  Said more simply, everything in a subscription business (remember our discussion about SaaS?) happens in slow-motion.

Let's look at an example.  Take a look at the chart below, which plots net income for my former company, Forrester Research.



Explore more FORR Data at Wikinvest

See anything that looks out of place?  Like, say, a big jump in net income at the bottom of the economic cycle in 2008?

Here's the explanation: when the economy hits a bump, bookings may slow very quickly, but revenue (from prior contracts) keeps flowing strongly for a while.  A savvy operator, therefore, cuts expenses immediately to reflect lower bookings.  Ta-da!  Instant profit bubble.

But investors should beware - there's nothing sustainable about such a bubble.  And that makes a downturn a risky time to value an information business.

On the flip side, a rising economic tide has the opposite effect.  While bookings (and their associated expenses!) may grow quickly, revenue will trail behind.  That will artificially depress net income in the short run, leading some investors and managers to under-value the business.

So, what's the lesson in all this?  Simply this: deferred revenue is what really matters.

Make sense to you?  Please share your thoughts in the comments!

Friday, November 1, 2013

Metrics that matter (or why great info businesses are essentially SaaS businesses)

In a previous post, we talked about what makes a great information business.  In a sentence: great information businesses (1) have proprietary data or insight, (2) embedded within a business process, and (3) delivered through software.  The combination of those three factors tends to yield defensible, profitable, scalable businesses.

But how do those factors translate into the financial statements and metrics that we use to operate and value information businesses?

First, a bit of a primer on accounting in subscription-based businesses.  After all, who doesn't love an accounting lesson?

Wait - come back!  I promise, it won't take but a moment.  

Let's say you've got an information business which sells a subscription-based product.  When a customer signs a non-cancelable contract for, say, 12 months of service for $120k, no revenue is generated up-front.  Instead, the revenue is equally recognized over the life of the contract - in this case, $10k per month.

Until recognized, the revenue remains on the balance sheet as deferred revenue.  Remember that metric - it's the single most important thing to look at in an info business.

Now, let's presume that the customer pays up-front - which is typical in info businesses.  The cash balance of the business, therefore, is enriched immediately - allowing the further re-investment of that cash into the business.

OK - enough accounting.  Let's back back to the metrics that matter.

If you were able to look at only three metrics to assess an information business, what would they be?  Here are mine, in priority order:

1. Deferred revenue.  Did you skip over the accounting section above?  If so, go back and read it.  For those still with us, deferred revenue growth is the best forward-looking indicator of revenue performance.  Want to know whether an info business is trending upwards or downwards?  Don't make the mistake of looking at past revenue performance - deferred revenue is all that matters.

2. Operating cash flow.   Great info businesses shouldn't need ongoing injections of capital. Instead, customers fund the growth of the business with up-front payments.  Therefore, operating cash flow should be growing in lockstep with the growth of the business overall.  

3. Renewal rates.  A growing deferred revenue balance is terrific - it means customers are continuing to invest more and more in their relationship with you.  But which customers?  Renewal rates - on a dollar basis, in particular - are the best indicator of client satisfaction with the offering.  And satisfaction = stickiness = goodness.

On to my final point.  If you've spent time looking at SaaS businesses, some of these metrics might look familiar.  In fact, very familiar.  

To put a fine point on it: great info businesses look, act, smell, and taste just like great SaaS businesses.  The physics are the same, the business dynamics are the same, the cash generation abilities are the same...etc etc etc.

So that's it.  Of course, there are hundreds (thousands?) of other metrics we could consider - especially when we start talking about valuing information businesses.  But for my money, deferred revenue growth, operating cash flow, and renewal rates are the right place to start.

What do you think?

Common problems in information businesses

As I've mentioned in previous posts, there are so many information businesses that have the potential to be great...but just aren't.

In fact, most of the information services deal flow I see these days falls into this category.  Often small-ish ($10-25m), often run by their founding management team, often undercapitalized, and often lacking clear/coherent strategy, these firms have wasted a great opportunity.  

Sometimes they can be fixed.  But they're mostly not worth the time it would require to do so.

Some of the most common problems I see:
  • Faulty pricing (often hard to fix).  When executed properly, pricing in information services businesses is a very sophisticated undertaking, rooted primarily in a clear assessment of the value delivered to the buyer.  But all too often, mediocre information businesses have set their pricing far below the real value to the customer.  And when that disparity is too large, it's very hard to fix.
For example, I looked last year at a potentially interesting healthcare informatics business.  It ticked all the boxes for me - proprietary data, embedded in a business process, and delivered through software.  By my calculus, the value - in terms of revenue generation and cost avoidance - was measured in thousands of dollars of month.  But the firm had priced their offering at hundreds of dollars a month - and I could see no way to make a 10x price increase stick.
  • Wrong allocation of resources (quite fixable).  Great information businesses are zero marginal cost businesses - once the product is produced, there should be little to no cost involved in delivery.  That, in turn, implies an appropriate allocation of resources - specifically, relatively small expenditures in creation of the product and relatively large expenditures in distribution.  Note that I didn't say that it must be inexpensive to produce the product - rather, that the cost to do so should be a fraction of the money spent on distributing it.
For example, I recently looked at an information business that spends approximately 55% of revenue on producing their information product - and less than 20% of revenue on sales/marketing.  By my estimation, that ratio is backwards.  The fix?  An injection of capital and a rapid expansion of the salesforce.
  • Lack of embeddedness (nearly impossible to fix).  Lots of information products are really nice-to-have.  But nice-to-have doesn't cut it when the economy takes a downturn - and it conveys little or no pricing power to the business.  In other words, it's a product that will produce only modest, cyclical returns.  Again, not worth the time invested.
For example, I once was part of an information business that was intensely nice-to-have.  But it wasn't need-to-have, because it wasn't embedded within a customer's business process.  The result?  A 40% drop in revenue during the next recession.

There are many more problems of course - but these are the most common ones I see.  How do these observations compare with your own?