The Magic Quadrants of Startup Efficiency

Rocketships and Challengers: The Magic Quadrants of Startup Efficiency and how to use Burn Multiple and Revenue Growth to inform product strategy and execution.

In the lengthening Year of Efficiency, what does it mean to be “efficient”? What does “Efficient Growth” actually mean for a startup? As we read the articles and press releases from the past year plus, it would be easy to think it’s just about layoffs. A 10% reduction in force would do the economic trick. But what about growth? How can you grow while cutting costs?

To know where to go you need to first know where you are. How efficient is your growth and how do you measure it?

This article provides a framework through which to view your organization, business, and product strategy in terms of efficient growth. We start with a definition of efficiency and use that to characterize the “Magic Quadrants of Startup Efficiency” in which all startups sit:

1. Rocketship: Low-Cost High-Growth

2. Challenger: High-Cost High-Growth

3. Concorde: High-Cost Low-Growth

4. Cirrus: Low-Cost Low-Growth

Lastly, I provide some product strategy direction and actions for what you must focus on to move your business into the Rocketship Magic Quadrant of Low-Cost High Growth. Where we all want to be.

Calculating Growth and Efficiency

We don’t just want growth, we want efficient growth. Central to the efficiency concept is the ratio of energy in vs power out. In the context of a company, it is the relationship between the cost of capital to acquire new revenues and the rate of growth of that revenue. Let’s start with calculating the Revenue Growth Rate and then the Burn Multiple.

Rate of Revenue Growth

The economic power of a software business is the subscription-based business model that drives predictable recurring revenues. If you’re ad-supported, then it is the balance between engagement and the quality of the ad network you’re leveraging. The Annual Recurring Revenue (ARR) of a startup. We need to calculate the Year-on-Year (YoY) ARR Growth of the company.

According to data gathered across the Iconiq portfolio and released in their Growth & Efficiency report for 2023, at a company with ARR less than $25M the median Year-on-Year ARR Growth is 270%. This decreases over time as ARR increases. However, we can see how even with a decreasing growth rate, ARR growth compounds to create the hockey stick investors are looking for. So they can invest with a higher probability that they will recoup outsized returns from a new product and freshly constituted team.

Burn Multiple

As we learned when the era of zero interest rates drew to a close, growth at all costs is not sustainable. We need to correlate growth with the capital needed to drive that growth to understand where the company is and where it is heading. How do you do this?

Partner with your CFO and get a solid understanding of the company’s key financial flows (see below).

• Expansion ARR: Increase in ARR from existing customers

• New ARR: ARR from new customers.

• Churned ARR: ARR that is lost due to customer churn

• OpEx: Operational expenses

Each of these metrics is impacted by the product and the R&D organization that builds it. But how good is good?

To understand how efficiently the company is using capital to generate revenue, we use the Burn Multiple. The startup efficiency metric devised and popularized by David Sacks of Craft Ventures in 2020. The Burn Multiple distills all the financial flows of a business down to a simple ratio of how much additional revenue was generated by every additional dollar of capital that was spent. Net New ARR versus Net Burn.

Your company’s Burn Multiple tells you, the rest of the executive team, and the board how efficiently your company is operating and how your product is performing in the market. A Burn Multiple of less than two indicates a healthy degree of company efficiency. A Burn Multiple of less than one is an amazing level of efficiency. But as we shall see, this alone does not make a company an attractive investment for VCs. That depends on which Efficiency Magic Quadrant your company is in.

Growth Efficiency Magic Quadrants

When we map a company’s year-on-year growth rate against its Burn Multiple, we see there are four types of startup companies. Each with a clear level of attraction for potential investors and associated probability of reaching a positive exit - acquisition or IPO.

Rocketship: Low-Cost High-Growth Quadrant

This is the company we all want to build and be a part of. It takes a lot of teamwork, experience, and market timing to bring the right product to market at the right time to solve a problem a very large market needs.

We have a valuable, sustainably differentiated product with a relatively low cost of goods sold (COGS). The cost of acquiring a new customer (CAC) is low relative to the price that can be charged. And the entire organization is operating at a high degree of operational excellence. Smooth running. I’ve been lucky enough to experience this at multiple times in my career. It’s awesome. It’s where we all want to be. In a high-flying company at escape velocity on a trajectory to a strong exit.

Challenger: High-Cost High-Growth Quadrant

Many of the companies that shot to unicorn status during the zero-interest rate era were in this quadrant. In this situation, we have a company that has built a product that people want, but the question is “How much?”. The product may not be differentiated enough or solve a pain large enough to warrant a price that effectively covers customer acquisition costs. Alternatively, the distribution of the product may be too expensive relative to the price charged. Demand is mostly ad-generated and costly with little Product-Led Growth (PLG) or word-of-mouth (WOM) marketing opportunities to bring down costs. Or the sales process is too long and involves too many people relative to the average contract value (ACV) for the sales organization to effectively recoup their costs. Lastly, there could be systemic operational efficiency issues within the company. All the pieces are there, but the company needs to get out of its own way before it breaks up and comes crashing to earth.

Concorde: High-Cost Low-Growth Quadrant

These can be solutions in search of a problem. The product is technically differentiated, but the size of the pain solved is not large enough to generate adequate demand or a large enough price point in a large enough market. Sales cycles are long, expensive, and don’t often close. Growth marketing pours cash into ad campaigns that don’t generate enough demand that converts. The gap between the promise and product truth is too high, and so customers quickly churn. Lastly, the product could be inadequately differentiated and is in the middle of a deep Red Ocean filled with competitors. There’s a great deal of promise and potential in the team and the technology, but the business just cannot get off the ground.

Cirrus: Low-Cost Low-Growth Quadrant

For a startup, this is a company that has evolved into a lifestyle business. It’s not a bad place to be. It’s just not a company investors are interested in as they don’t see the potential for outsized gains. The business is well understood and the company has honed its processes through good hiring and automation to reduce waste. The customer base is not very large and unlikely to grow as the Total Addressable Market (TAM) is relatively small. The product is differentiated enough and there is strong customer loyalty to ensure retention is high so customer acquisition costs are manageable relative to the price of the product. There are few competitors to erode pricing but enough that keeps margins down.

How to Build a Rocketship

Now we know where we stand as a company, what do we do to get into the Rocketship Magic Quadrant? Each of these sections will get a deep-dive treatment in separate posts, but here is a summary.

Turning a Challenger into a Rocketship

The main issues with a Challenger company are that operational costs are too high to make sales and sustain growth; too many hard-earned customers leave and so need to be re-sold. Companies raised a ton of cash while interest rates were zero, they hired like crazy and forced a difficult market into existence. They’re on the right track but they’re not capital efficient. They need to right-size themselves to hit escape velocity towards exit.

Resources hired to scale the product can be more effectively utilized through ruthless prioritization and a customer and business orientation. We can also deploy resources to make the sales and marketing organization more efficient. Here’s a brief list of how.

Reduce ARR Churn

Keep the customers you already have.

• Fill the gaps between the product promise and product truth.

• Increase customer loyalty and engagement through design. Eliminate cognitive load and create user delight.

• Eliminate product quality issues to increase the perception of value, increase engineering velocity, and lower Customer Support and Success costs.

Reduce CAC to Lower OpEx

Move to a PLG or Product-Led Sales (PLS) go-to-market model. (Look here for a deeper dive on PLG implementation.)

• In a sales-led growth company, enable a partner distribution model through integrations or platform development.

• Augment a sales-led motion with PLG strategies to shorten sales cycles and increase the rate of penetration into an account.

• Dig deep into your Demand Generation strategies and build PLG motions to reduce the dependency on ad spend.

• Release a freemium product to shorten sales cycles.

Lower OpEx

Become a better PDE organization.

• Identify low-value functionality and either deprecate it or outsource its maintenance to focus finite resources on your core value proposition.

• Increase overall R&D velocity and productivity through ruthless prioritization and by streamlining product development processes.

Getting a Concord Airborne

This is the hardest Magic Quadrant to be, as a very large number of changes are needed to get off the ground and accelerate growth efficiently. Often you have a solution in search of a problem to solve. Depending on many factors, not least of which is runway, you can steer the company through the Challenger Quadrant en route to building a Rocketship. Alternatively, finding a direct route to the Rocketship Quadrant is the quickest, but likely the most painful and risky to the business.

In addition to addressing the Operational Expenses and ARR Churn issues discussed in the Challenger Quadrant above, you need to orient resources to find new sources of revenue at a higher rate.

Increase Market Opportunity

Pause your spending on ads, as that’s not getting you where you want to be quick enough. Find ways in the market to expand your addressable market and then map that set of needs against the capability of your product and your team.

• Get out of the office and talk to customers and prospects. Re-orient your perspective, strategy, and messaging away from what you’ve built and towards the customers you’re serving.

• Get clarity and expand your user personas and their Jobs to be Done to ensure you’re solving high-value problems they care about and will pay for.

• Work with Product Marketing (PMM) to uncover opportunities in adjacent segments you can easily serve.

• Work with PMM and Customer Success to uncover opportunities across the ecosystem of products your customers use. Form partnerships or selectively compete as you create a more complete and compelling solution.

Use Existing Customers and Capabilities

Expansion ARR is defined as revenue generated by cross-selling and up-selling additional products to the customers you already have. For businesses with a subscription-based business model, this includes increasing the number of users of your product. This translates into more seat licenses and a higher ACV and customer Life Time Value (LTV).

• Work with PMM and sales to develop a pricing and packaging strategy to create upsell and cross-sell opportunities with the functionality you already have.

• Ruthlessly prioritize the execution of sustainably differentiated high-value functionality to increase the price of your highest SKU (Stock Keeping Unit → feature-set and price combination).

• Improve product usability to free Customer Success resources to focus on upsell and cross-sell opportunities.

• Aggressively implement PLG strategies to drive opportunities into the top-of-funnel and accelerate adoption within customers and segments.

Take a Cirrus to Space

The challenge in this situation is to demonstrate traction in a new market or segment with a high and growing TAM. Alternatively, to find new revenue streams within the market you’re currently serving and show outsized traction in this new adjacency.

Increase TAM and Build New Revenue Streams

Similar to the Concorde Quadrant, you’re looking for adjacencies. However, you’re in much better shape to execute against them as you don’t have the existential threat of getting to the end of your runway. Alternatively, you’ve got a good product that is hampered by a distribution model that is too conservative.

• Work with PMM to identify adjacent market segments, redefine the customer set you serve, and fill product gaps you uncover during the analysis.

• Work with your CFO to identify acquisition targets to quickly establish new customers and complementary revenue streams. Support them and the CEO as they leverage your healthy balance to make the acquisition.

• Another option would be to a Private Equity firm building a rollup holding company and look to join that as the first step in a two-step path to a larger exit.

• As with the Concorde and the Challenger Quadrants, look for ways to accelerate efficient distribution. That can be done via partnerships or through the creation of a Freemium business model - give a little to gain a lot.

Conclusion

As a CPO, start today and map out which Growth Efficiency Magic Quadrant your company sits in. Look at your Product Strategy and your immediate product roadmap and ask yourself what you need to change to better support the company to meet its financial and business goals. Remember, it’s a team sport. You’re part of the team and it’s not just about the features you’re shipping.

Go Beyond the Build! 🚀