Judah Taub is Managing Partner at Hetz Ventures, a VC of the highest early stage, based in Tel Aviv. He lectures on time management and creative thinking.
In his book Black Swanshows Nassim Taleb how building on the average or mean is essentially pointless in numerous industries.
He uses two scenarios to illustrate this point. In the first, imagine there are 100 people in a room and I tell you the average height is 6 feet. Now you pick one at random. What would you guess the height of the person? Knowing the average is certainly helpful here, and even if you happen to pick the tallest or shortest person, you’re unlikely to be far off the mark.
Now imagine in the second scenario I told you that 100 people provided the amount of their net worth, and the average is $100,000. But if Bill Gates is in this random assortment and you pick him, you’re about 1,000,000,000% off.
As Taleb explains, in too many cases—from the climate to the stock market—averages or means make no sense.
Averages when it comes to startups
But one scenario we see much more often than hidden billionaires is working with and investing in startups. I find that startup investors and founders all too often rely on averages. For example, we can ask ourselves questions like, “What does an average customer pay for a typical product like this?” “What will be the average lifetime value of a customer?” “What is the average discount in this industry?”
I find it funny that so many do this when we know that the venture power law suggests that a small number of startups can generate significant returns, benefiting all the other startups in a given fund; these startups continue to perform far from “average” on each of their metrics.
Simply put, if you pitch that your startup will perform anywhere in the range of the average, it’s probably doomed. It is the outlier startups that fall outside the norm and defy statistical expectations.
There are many examples of statistics and factors that fit this rule; here are three that stand out.
Customer Acquisition Cost (CAC) and Annual Contract Value (ACV)
Investors often hear grand pitches about how revolutionary a particular product could be. At the end of the pitch, they will often ask how much a customer will pay for this product. The answer is often something along the lines of, “Well, like most DevOps tools in this space, we should price it $10 each” or “Like most cybersecurity products, we think $30,000 is reasonable for a mid-sized organization.” it.”
But in fact, we see time and time again that the very best products inherently create greater willingness to pay and typically require less to acquire first customers.
How critical is your product
This is a follow up to the previous point, but it’s one that allows startups to test where they are on the priority scale. Today, most companies are cutting costs, special around third-party applications. I hear plans ranging from 10% to 50% of the tool budget.
Too often, startups interpret this as saying they need to lower their prices to keep their customers. While this may sound true since they are right on average, in practice they are usually wrong. Similar to managing your household expenses, when you need to cut back, it’s the “nice-to-have” expenses that are cut 80% to 100%, while the “must-have” expenses are unlikely to be affected . not at all.
On a side note, this is what I see happening today with most startups trying to cut costs. Instead of announcing a 20% company-wide salary cut, startups are letting go of the ones they can’t spare.
Startup growth trajectory
There is a classic table I often see how fast a startup has to grow to get into the top quartile, depending on what stage of growth it is in. These types of tables are popular because they are easy to produce and intuitive to digest. However, I believe they are flawed, for they take the average over and over again.
Look at the very best startups and you’ll see alternative phenomena like a network effect kicking in after reaching critical mass, negative churn because upsells outweigh customers leaving or economies of scale that actually make things easier as you get bigger instead of of more difficult.
Another way to see this? Think differently about starting investing. When selecting stocks, it is sometimes more important to get the broader sector on track (such as investing in airlines) than a particular stock (such as British Airways). If you get the big picture right, the rest should fall into place.
I find that the opposite is true for startup investing. It is infinitely more important to choose the winning startup. Unfortunately, averages in our ecosystem don’t count that much.