Dharmesh Shah – Valuation, Competition, Porter’s Five Forces and Culture

This is a summary of Dharmesh Shah‘s Business of Software 2012 presentation.

Your Company

Your company should be coming from a place of love. Zynga’s motto is “do evil.” It is one of the most evil places from a culture perspective, and in its business approach. Before you gamify your product, you should decrapify it.

Go big great or go home. Attention is finite, problems are infinite. Build companies that solve problems. Work on a problem you care enough about that you’d be happy even if someone else solved it.

Valuation

Valuation vs. Value

• Value: What it’s actually worth.
• Valuation: What someone is willing to pay for the company at a given time.

The valuation equation -> Valuation = Revenue x Multiplier

Valuation is based on revenue?! Not profits?! Yup. This isn’t Dharmesh’s rule. He’s just telling you how things are done.

The multiplier for SaaS companies is around 5.0. Historically the multiplier is around 3 for software companies.

So how do I get my multiplier to that? Growth is hugely important. The faster your revenues are growing, the higher the multiple goes. Profitability is negatively correlated with the multiplier for companies about to go public. The market rewards growth. They are investing in growth, they don’t want dividends.

Factors affecting the revenue multiplier:

• Growth
• Predictability
• Sustainable competitive advantage
• Scale

How to increase revenue:

• Get more customers
• Increase price
• Increase retention

At this point Dharmesh used a car metaphor to highlight a few important points.

• A better engine lets you go faster.
• Visibility: The further out you can see, the faster you can go. (Achieve more visibility into the business wherever possible. For example, what impact is this changing economy going to have on my business? VCs like to see things that can give you more visibility.)
• Brakes: The better your breaks, the faster you can go. (For example, don’t sign a five year lease for a space that’s too big.)
  

  Image credit: @mdclement

Culture

How important is culture?

• Your early culture sets your future destiny.
• Build the kind of company you want to work in.

How do I scale my team without losing my culture?

• Raw transparency.
• People overvalue transparency.
• Take the mask off.
• It makes it hard to do stupid things out in the open.

Strive not just to build a great startup. Strive to build great entrepreneurs.

Your Competition

Barrier to Entry

Warren Buffet quote: “Build a moat around your castle.” The idea is that you want to make it hard to attack your castle (i.e. create a barrier to entry).

Determining your revenue multiplier is determining your risk. Mitigate your risk, because your success will attract competitors.

You don’t just want customers. You want crazy, loyal fans, because this discourages competition. The most attractive thing to your competitors is when you suck as far as your customers are concerned.

Technical switching costs should be low, and emotional switching costs should be high. This makes an awesome barrier to entry.

Porter’s Five Forces Framework

Porter’s five forces is a framework for industry analysis and business strategy development. The five forces determine the competitive intensity and attractiveness of a market. Attractiveness refers to the overall industry profitability. An “unattractive” industry is one in which the combination of these five forces acts to drive down overall profitability.

Pick markets where the barrier to exit is low. If your competitors can get out easily, they won’t fight to stay in.

Really, I can build my business on your platform? Platform partnerships are awesome…until they’re not. It’s easy to fall into this trap. When you get awesome (i.e. big enough), they will either buy you or kill you. Unless you’re so big the costs will outweigh the benefits.

[I'd like to thank Bill Horvath, founder of DoX Systems, for sharing his notes with me.]