Scaling the Magic Metric

In November 2013, Aileen Lee, a venture capitalist, wrote an article in TechCrunch about the growth of billion-dollar start-ups. She dubbed these spectacular successes as ‘unicorns’ because of their truly rarefied status. 

The name stuck. 

Back in 2013 she was able to identify 39 ‘unicorns’ across the globe, which included Airbnb, Facebook, LinkedIn and YouTube. Household names now, that nine years ago were still ‘startups’ stealthy building the future. 

Recently Hubert Palan, the CEO of Productboard, signed on to Zoom from his home in Oakland, California to address his 400 or so employees. He had big news. The company had raised substantial new funding at a valuation of $1.7bn. 

A newly minted unicorn. 

More remarkable was the fact that Productboard had become the 1,000th global unicorn. As Brian Lee who oversees research at CB Insights commented: “When you have 1,000 unicorns, that’s almost an oxymoron”. 

In 2022 thus far unicorns have appeared at a rate of 1 per day, and in that time there have been 4 new ‘decacorns’ – private companies with a valuation in excess of $10bn. 

Software continues to “eat the world” as Marc Andreessen put it, and despite recent fallbacks in listed technology company valuations, all industries will continue to go through massive digital shifts. In this digital shift, we are still closer to the start than the end, benchmarked by the fact that over 80% of US companies have yet to make a substantial switch to cloud computing. 

As more of the world’s services become digital, software companies become more valuable and infrastructure such as Amazon Web Services makes it easier than ever to start a tech business. With reduced barriers to entry, one specific battle becomes that much more fundamental in the race to build market dominance. 

Specifically this a marketing battle. Venture Capitalists even have an equation that defines this marketing battle. It is called the Magic Metric.  

To simplify the start-up ‘phases’ - there are broadly 3. It used to be very hard to get to phase 2, when capital and resources were expensive. Now there are literally millions of start-ups around the world in phase 1 & 2. And if you want to understand why there are now way more ‘unicorns’ it’s because there are way more start-ups. However, the transition from phase 2 to phase 3 remains rare, and it where most of the value lies, and it is fundamentally a marketing battle. 

Phase 1: Product Market ‘Fit’: Is there a gap in a market and a clear solution to that gap? Whatever capital the start-up has is generally spent on building and testing the product & hypothesis. Very little is spent on marketing. Broadly investors call this the ‘Seed’ stage, with venture investment less than $5m.

Phase 2: Unit Economics/ Go-to-Market: You have a solution that customers want, but can you sell it to them profitably (‘unit economics’)? Small budgets spent on marketing typically using Facebook/ Adwords and other direct response channels. This is typically known as Series A stage by investors, with capital raised typically ranging from $2-20m. 

Phase 3: Scale Up: Once you have a product and unit economics that work, the game is substantially all about how fast you can acquire customers (Customer Acquisition Cost/CAC) and keep them (Lifetime Value/LTV). This ratio is the Magic Metric, and if your ratio is 1/3 or better and going in the right direction, then the Venture Capital community will line up to write investment cheques, and you are well on your way towards unicorn status. Capital raising at this stage can be $50-500m. 

Winning the marketing game at phase 2 is all about proving the magic metric using direct response advertising, with the ratio easily definable. But what happens when many start-ups are given a big pot of cash to go ‘mass market’ is that they find that there are diminishing returns to this ‘bottom of the funnel’ approach. Magic Metric ratios go in the wrong direction and valuations hit the buffers. 

Research by Binet and Field is well known to marketers, but less so to Venture Capitalists. They have shown that a 60/40 split between brand awareness and direct response has a much better return on capital than the typical phase 2 start up approach of 100% direct response. In fact, they show that for unheard of start-ups the ratio should be even greater at 70% for longer term success. 

To give an example. I recently engaged with the CMO an innovative pensions company. Great business, in a massive market. The company was well passed phase 1 and 2 of their journey and were looking forward to an IPO. The ‘unit economics’ for this company were stellar – they generate fees of c.1% per year on transferred pensions pots, and their average transferred pension pot was running at around $100,000. They had 100,000 customers and had been growing at 100% per year. Typically, a pension pot is very ‘sticky’; once transferred it can stay with the company for 20 years+. A back of the envelope calculation of LTV therefore is £1000 per year for 20 years; which has a rough value of £15,000 in present value terms. The CMO told me that their average CAC was running at about $250, but that he had placed a cap on this at $500. I asked why he had that cap when the LTV was so high, and the response was ‘we are growing fast enough’. 

I understand a little bit about valuation, so I know that the key metric that investors were looking at for this business to decide its valuation at IPO was its customer growth rate. They had proven phase 1 and 2 – and LTV was in no doubt, and the size of the market is enormous. The arbitrary cap on CAC if it had been doubled or trebled in the run up to the IPO meant that the company was literally leaving hundreds of millions of £s ‘on the table’. 

There are 2 things at play here: firstly getting marketers to understand how important their work is to company valuations, and secondly as businesses scale – how do brand channels get their due share of the investment?

At Mediabridge we are working on both, and some recent case studies with scale ups are testament to that. We are getting closer to our own ‘golden ticket’ - translating the measurability of Outdoor into the language of the Magic Metric.