How to understand your business economics: David Weiden of Khosla Ventures

When calculating Customer Acquisition Cost (CAC), don't rely on blended metrics

David Weiden is a founding partner and managing director at Khosla Ventures (he invested in Okta, RingCentral and Upstart). He recently gave a talk at Khosla venture’s conf and while it is a must watch, I am sharing notes from the talk (for the busy you).

"Without data, you're just another person with an opinion."

David Weiden’s talk focuses on understanding that the difference between success and failure often lies in the ability to make data-driven decisions (and not just intuition).

He shares how founders can leverage quantitative frameworks to target the right markets, understand their true business economics, and effectively raise funds.

Unlike most startup talks, this is all about numbers and how to revisit your business economics - a must read/watch imo.

Topics discussed:

• Targeting the Right Markets

• Understanding Your True Business Economics

• How to really calculate CAC

• Effective Fundraising Through Financial Transparency

• 3 Actionable TODOs for you

PS: From now, expect more activity on this newsletter around curation and notes (I read/watch a lot - so will be sharing more notes going forward).

Targeting the Right Markets

Intuition alone isn't enough. Successful founders overlay quantitative analysis on their intuition to make better decisions.

A quantitative framework simplifies your business down to atomic units, helping you make explicit decisions about which markets to target. This not only improves decision-making but also aligns the entire company behind the strategy.

For instance, when targeting the financial services market, one company used a framework with five criteria, including buying cycle and network compatibility. This allowed them to focus on the most promising segments, resulting in a significant increase in Annual Recurring Revenue (ARR) and profitability.

The real power lies not in the specific criteria, but in using a framework that forces you to think critically about your target market.

You may have an intuition about where to focus, but quantifying it can reveal surprising insights. For example, the largest companies in a sector may not always represent the biggest revenue opportunity for your specific product.

Understanding Your True Business Economics

Real business economics go beyond simple revenue figures. As a CEO, you should always know your revenue, cash flow, and cash position. But that's just the starting point.

Don't confuse activity with accomplishment.

Contribution margin is crucial. It tells you how much money you actually make when you sell something, before considering the cost of sales. This metric is often more revealing than gross margin alone.

When calculating Customer Acquisition Cost (CAC), don't rely on blended metrics. Instead, focus on:

1. Fully-loaded CAC: The cost when an average salesperson makes a sale, including recruitment, training, and support costs.

2. Marginal CAC: The cost of acquiring your last customer, which is often higher than your average CAC.

3. CAC at scale: Projected costs when you're spending much more on marketing or hiring many more salespeople.

CAC payback period should be calculated using contribution margin and marginal CAC, not revenue or blended CAC. This gives you a more accurate picture of your business economics.

A company tracking these metrics, even if they're not perfect, has a much higher chance of success. For example, a portfolio company showed improving CAC payback over time, demonstrating their focus on this crucial metric.

Effective Fundraising Through Financial Transparency

When fundraising, don't shy away from presenting financials, even if they're not perfect. Investors, especially at later stages, care about numbers.

Present your financials clearly and concisely. Use millions to one decimal point, show revenue (not just ARR), and highlight cash flow. Don't overload with explanations or non-financial metrics.

Be proactive about addressing potential issues in your financials. If you have a 'hockey stick' projection, be prepared to substantiate it. Show how you've already booked revenue for the current year and identified credible sources for the next.

If you're projecting margin improvements, break down the steps and show your track record of achieving such improvements.

Remember, it's not just about the numbers themselves, but about demonstrating that you understand and can explain the underlying dynamics of your business.

The Power of Quantitative Thinking

While visionary thinking is crucial for starting a company, quantitative frameworks are essential for sustainable growth. As Warren Buffett said, "Accounting is the language of business." Embracing this mindset can be the difference between being the next WeWork or the next Apple.

Focus on understanding revenue and cash flow to stay close to the source of truth.

• Being aware of revenue and cash flow helps in making informed decisions.

• Understanding customer economics and building a business set up for scaling is more important than just chasing revenue.

Bill Campbell, a renowned Silicon Valley executive coach, emphasized the importance of quantitative marketing. Even visionaries like Steve Jobs became truly great CEOs when they learned to surround themselves with and listen to people who understood the numbers.

Key Takeaways:

1. Develop a quantitative framework for targeting markets. This helps focus your efforts and aligns your team.

2. Understand your true business economics. Look beyond revenue to metrics like contribution margin and marginal CAC.

3. Be transparent about your financials when fundraising. Address potential issues proactively and substantiate your projections.

"Accounting is the language of business." - Warren Buffett

TODOs for you:

1. Create a simple quantitative framework for evaluating your target market or customers. Use it in your next team meeting to guide discussion and decision-making.

2. Calculate your true Customer Acquisition Cost (CAC) and CAC payback period using contribution margin and marginal CAC. Set up a system to track these metrics monthly.

3. Prepare a clear, concise one-page financial summary for your business, focusing on revenue, cash flow, and key operational metrics. Use this to guide your strategic decisions and to practice explaining your business economics succinctly.