Target the Right Market

HBR’s fictionalized case studies present dilemmas faced by leaders in real companies and offer solutions from experts. This one is based on the HBS Case Study “HubSpot: Inbound Marketing and Web 2.0,” by Thomas Steenburgh, Jill Avery, and Naseem Dahod. The knock on Jane Tamsen’s office door startled her. Vikram, one of Jane’s sales directors, poked his head in. “You ready for us?” he asked. Jane waved him in. Andrew, another of her team members, followed. “Let’s hear it,” Jane said. “The data are showing what we’ve suspected all along,” Vikram started. “We’re playing in two major markets. The first is small businesses—they have owners who run their own companies, fewer than 20 employees if that. The other is medium-size businesses with 20 to about 100 employees; the purchaser at these places is a senior manager, not the owner.” “I think of them as ‘small Sams’ and ‘medium Marys,’” Andrew added. “Creative,” Jane said. Andrew had been one of her first hires at SparkPlace, a two-year-old provider of online-marketing software, and he’d continued to impress her. Founder and CEO Dirk Middleton liked him, too, especially after Andrew coined what would become the company slogan: Marketing is broken. Dirk, who had spent his career in sales, started the business for that very reason. He firmly believed that cold calling and spamming were destroying marketing. Rather than pestering prospective customers with pushy e-mails, companies should, he thought, use blogs and other social media to attract people who were already researching and shopping in the industry. Then those potential customers could give companies permission to market to them. That approach would be not only less annoying to consumers but also more profitable for the companies doing the selling. SparkPlace’s software, available for a monthly fee, was designed to let customers manage and measure the effectiveness of that approach. Jane had been Dirk’s third employee, and although they didn’t always see eye to eye, they agreed completely about the company’s mission. “Where does the analysis say we should focus?” Jane asked. Vikram explained that from a sales perspective the Sams were easier to bring on board: The sales costs were less than $1,000 for each one, and those businesses were eager for the service. Marys, in contrast, were more expensive to acquire—about $5,000—but ultimately more valuable as customers because they stayed longer and were willing to pay a higher monthly rate. “Still,” Andrew said, “the potential with the Sams is greater because we can do a bigger-volume business in that market. Sams outnumber Marys by three to one, and that ratio is growing because of the tough economy. More and more people are starting their own businesses. Plus, our salespeople can easily identify the decision maker and quickly close the deal. It’s the opposite with the Marys. When we show up at a sales call, our competitors are in the waiting room, or at least their business cards are on the Marys’ desks. Our people are sick of fighting for time with the Marys. And it’s clear no one is having as much success with the Sams as we are.” “They love us,” Vikram chimed in. “The feedback is unbelievable.” “OK. Nice work, both of you,” Jane said. “At our Friday meeting, let’s recommend to the larger group that we refocus efforts on the Sams.” Vikram and Andrew started to get up, but she stopped them. “We need to be sure the data back us up. Let’s double-check the analysis. Marketing isn’t going to like this.” “Will do,” Vikram said. “But don’t worry. The analysis is clear.” Profit vs. Potential Standing before her colleagues, Jane saw that everyone was rapt. The Sam/Mary narrative was clearly working. “You can see that our market sizing shows a lot more Sams that we can target as potential customers—1.3 million—compared with less than half a million Marys who have the right profile,” Jane said to the group. As she began to wrap up, she eyed Dirk sneaking in and taking a seat at the back. Lately he had been consumed with the company’s newest venture, an adjacent software product that helps businesses collaboratively create content. He was in constant meetings with the VCs who had put up the initial capital for SparkPlace. “In conclusion, that’s why we believe we need to focus our limited resources on the Sams of the world,” she said. Josh, the head of marketing, shifted in his seat. Jane had expected him to be the first with questions. “I’m not getting the same message you are from the data. The numbers show that the Marys are more profitable for us over their lifetime as customers. On average, each Mary generates $50K of profit; each Sam generates only $10K. It seems like a no-brainer to go after the more profitable market,” Josh said. Jane looked to Vikram. They had agreed he would field questions about the analysis. “Yes, that’s true. But that’s not the whole picture,” Vikram said. “The Sams produce a much higher return on investment. Each marketing dollar we spend to acquire a Sam gives us $5 of profit. It’s only $2 from the Marys.” “But that’s not the only question we’re asking,” Josh insisted. “You know as well as I do that we can’t make strategic decisions on marketing ROI alone—or any one metric for that matter. Maybe the Mary market is smaller, but they’re more committed. They stay longer and require much less hand-holding, which means more profit. Don’t we want those kinds of relationships?” “We see more potential in the Sams,” Jane interjected. “Yes, they’re not staying long now, but we believe we can bring down their churn rate by paying more attention to them. We can evolve the product to better meet their needs—or try using longer contract terms. We lock them in for only three months now, and many are leaving soon after that.” “Oh good, we’ll force them to stay longer,” Josh said, shaking his head. Jane tried another tack, thinking it might prompt Dirk to weigh in. “What about our mission? We want to change the way this business is done. The Marys are already savvy about permission-based marketing. The Sams know little about it, so when they see the results they get from our software, they’ll become immediate converts.” “And then they cancel their contracts because all the easy wins are won,” Josh said. Now Dirk did pipe up. “You all know how I feel about the mission. Marketing is broken. But our board isn’t going to allow us to leave money on the table. They want growth. Why can’t we go after the Sams and the Marys? Make inroads into both markets.” “That’s what we’ve been doing,” Jane said. “It feels like we’re hedging our bets rather than placing one.” “But isn’t it possible to serve both markets well?” Dirk asked. “Dirk, with all due respect, you know that the strategy experts say we can’t be all things to all people,” Josh said. “Our go-to-market strategy will be very different depending on which of these groups we’re trying to target.” Jane nodded. The company had to pick a strategic direction. It would affect a whole host of decisions over the coming months: what features to add to the software, what adjacent products they might offer, how to price all the services, and so on. “Well, what does Serge say about all this?” Dirk asked. Serge was their lead developer. Jane shot a look at Andrew and Vikram. Why hadn’t she—or they—thought to get him on board first? “Um, he’s waiting on direction from us, waiting to see where we net out on this issue,” Jane said. She could see Josh smirking. “Why isn’t he here?” Dirk pointed to Josh and Jane. “You two need to talk to him, find out where he stands, and then come back to me with a recommendation you’ve both agreed on. I need you two to help me with this, given everything else that’s going on.” Tiebreaker Josh and Jane sat across from Serge as he finished writing an e-mail displayed on one of five computer screens on his desk. He pressed send and asked, “So I’m the tiebreaker?” “We wish it was that easy,” Josh said. “At this point, we just need your honest input, because we’re at a crossroads,” Jane said. “Is that what you’re calling your disagreements these days? Crossroads?” Serge teased them. “Our disagreements are a good thing. They’re productive,” Jane said. And she was being sincere. The pushback she got from Josh—and gave to him—wasn’t always comfortable, but it often led to better decisions. “Isn’t this your job to figure out?” Serge asked. “Come on. Just give us the software development perspective,” she said. “That’s easy: Marys all the way. They’re more experienced, so they really dig into the software. They use all the features and see more potential in what we do. It’s a far more interesting challenge to design for the Marys,” Serge said. “You know that we can’t make strategic decisions on marketing ROI alone—or any one metric for that matter.” Josh raised his fists in the air, jokingly claiming victory. “Not so fast,” Serge said. “Yes, the Marys make my team’s work more fun, but this isn’t really about that, is it? It’s about what this company is meant to do. Part of the SparkPlace model is to give people simple solutions, right?” “Right,” Josh agreed. “We make their job easier.” A key component of SparkPlace’s software was to help companies coordinate all of their disparate marketing activities, and Serge’s main challenge in developing the product was to reduce complexity for customers. “And that’s what the Sams are asking for,” Serge said. Now it was Jane’s turn to gloat: “Exactly. It’s what Dirk set out to do. We’re not transforming the industry by giving the Marys access to fancy reports.” Josh rolled his eyes. “This shouldn’t be about any of those things. It’s about growing the business, about how much of the market we can capture. And the Marys are more profitable,” he said. “But there are many more Sams than Marys to make a profit from,” Jane quickly added. Serge leaned back in his chair: “Still at that crossroads, I see.” “You were supposed to help us,” Josh said. “I tried. But this is up to you two. I’m just a programmer.” This was Serge’s common refrain when he didn’t want to get involved in a business discussion. He turned back to one of his screens. “Let Dirk make the call,” Serge yelled after them as they walked out the door. “Maybe we should,” Josh said to Jane, making their way toward her office. “We can’t do that. Dirk asked us to hash it out, and he’s overwhelmed,” Jane replied. “If we go back to him without a recommendation, he’ll send us away, saying that’s what he pays us for.” “OK then,” Josh said. “Let’s go get a drink.” Should SparkPlace go after small Sams, medium Marys, or both? What Would You Do? Some advice from the HBR.org community It’s always easier to sell to a satisfied, profitable customer rather than a new one. SparkPlace should package its product to eventually move the Marys to a higher-priced offering with additional capabilities. This will grow the individual-customer revenue stream and lower selling costs. Tom Sadtler, founding partner, Maastary Before diversifying its focus, SparkPlace should consolidate and grow its position in the Sams segment, which is three times larger than the Marys segment. Product-development costs will be higher for the Marys, given their demand for features. And the Sams already love the product. Juby Jose, product manager, Accenture I would avoid the temptation of the Sams. Their lack of loyalty and smaller margins will have SparkPlace sprinting in a hamster wheel. The medium Marys understand the value of the product, have the resources to support a longer-term relationship, and can yield better profit margins. Matthew Jay, business development director, Growll.com The company’s salesforce can surely capture both market segments. They have common requirements, and the software can meet each of their needs. Some small Sams will become medium Marys, and SparkPlace can grow with them while serving its cash cows—the current Marys. Thami Luke Mabaso, executive director and founder, Khalulu Marketing The Experts Respond Roger Martin is the dean of the University of Toronto’s Rotman School of Management. SparkPlace should pursue both the Sams and the Marys. Strategy is not about following a recipe but exercising judgment. Josh’s reminder that the company “can’t be all things to all people” is correct. However, two segments do not constitute “all people.” Within a narrowly defined business—software that manages and measures the effectiveness of permission-based marketing campaigns for social media—SparkPlace is considering only companies that are miniscule (fewer than 20 employees) and those that are tiny (20 to 100 employees) as potential targets. Firms with more than 100 workers make up about 65% of U.S. business employment, so SparkPlace is already excluding most potential customers. The Sams and the Marys both seem to be attractive customer segments. The Sams market has fewer competitors and an easier, less costly selling process. The Marys use SparkPlace’s software intensively, so they usually stick with the product and, as a consequence, generate greater lifetime profitability. So it’s hard to make the argument that one segment is a strikingly better target than the other. Josh and Jane both believe that the two segments are distinct. Josh says, “Our go-to-market strategy will be very different depending on which of these groups we’re trying to target.” Jane thinks that the choice “would affect a whole host of decisions” about product features, related software, price, and so on. But both of them are overlooking the most important question: How hard would it be for a provider who successfully serves the Sams to tackle the Marys as well, and vice versa? If the answer is “very difficult,” I’d agree with Josh and Jane that the segments are truly distinct and that one must be chosen over the other. But I don’t buy that answer at all. The right strategic choice is to figure out how to penetrate both markets: the Sams and the Marys. Imagine that SparkPlace focuses only on the Sams. Then a competitor will tackle the Marys. That other player will build the software, perhaps with features that the Sams don’t need because their requirements aren’t as sophisticated. But guess what? The Marys already paid for the development. The competitor just has to adjust the price for the Sams and then get to work selling. I would worry a bit less if SparkPlace chose the Marys and let someone else dominate the Sams, because I suspect that migrating upward in sophistication is somewhat harder than shifting downward. But I wouldn’t be altogether unconcerned. The adjacency is just too close for comfort. The winner with the Sams segment will be in the Marys segment soon enough, with its software development paid for on the backs of the Sams. The software business is tricky, as it’s a highly fixed cost game. After the software is built, the cost of an incremental unit is close to zero. The fixed cost per unit drops, and profit rises as volume increases. So it’s a smart strategy to try to sell the software in adjacent markets. If SparkPlace wants to win long term in this business, now is the time to figure out how to penetrate both markets: the Sams and the Marys. That is the right strategic choice. Mike Volpe is the chief marketing officer at HubSpot, the marketing software company on which this case study is based. Jane’s team has done well at identifying the traits of the two distinct customer segments. That will help SparkPlace make smarter decisions about its overall strategy. But Josh and Jane are nevertheless at a crossroads because they have a bunch of numbers that don’t cohere. Without better data and deeper analysis, it will be nearly impossible to determine which market is a better fit. For each segment, they must consider the likely cancellation rate, the upgrade numbers, the referral rate, and a customer-satisfaction measure such as a net promoter score—not to mention the budget for marketing software that businesses in each segment are likely to have. Given what we know, I would advise SparkPlace to focus on the Marys. In the software business, three things underpin most of a customer’s lifetime value: the price paid, the cancellation rate, and the upgrade rate. If 5% of customers cancel their subscriptions but a greater percentage upgrade, you more than make up for the losses. The Marys already have lower cancellation rates and pay higher prices than the Sams. They are also much more likely to buy additional services because they have larger budgets to spend on software. With the right product, the potential to increase lifetime value is huge with the Marys but limited with the Sams. Josh is correct that SparkPlace can’t satisfy everyone, at least not yet. Limited resources compel start-ups to choose a core strategy. Josh and Jane should pinpoint which resources are scarcest—marketing, sales, or product development—and focus those on just one market. For example, develop the product for the Marys and then use the more-abundant sales and marketing resources to sell the existing product to other segments. SparkPlace should align its thinnest resources with its most profitable segment: the Marys. HubSpot was at a similar crossroads three years ago. For us, it was far easier to expand sales and marketing than to hire more software engineers. So we focused on software to delight the Marys. We added features and acquired a firm that had the product-development talent and technologies we needed. Then we challenged our sales and marketing people to sell that same product to the Sams. And it worked! Since 2009 we have increased our prices, reduced the cancellation rate, grown upgrade revenue, and tripled customer lifetime value, which has more than tripled the profitability per customer. We have also found new ways to sell to the Sams, primarily through indirect channels such as marketing agencies, and have more than doubled the Sams’ profitability to us. SparkPlace should use data about each customer segment to structure its business. That will help it align its thinnest resources (probably in product development) with its most profitable customer segment (the Marys). Then it could always come up with innovative ways to sell and market the existing product to other segments.

Target the Right Market

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