I’ve not yet decided whether to take the site down entirely or retain it as an About.me style profile page with a handful of my favorite essays. Either way, it will cease to exist as a blog.

Why, might you wonder, did I decide to do this?

• Lack of time. I’m a big believer in doing something well or not at all.  I’d prefer to shut the blog down over having it die a lingering death due to lack of posts.

• The impetus disappeared. Recall that for most of its life, Kellblog was called the “MarkLogic CEO blog.” I started the blog because we sold heavily to the media vertical and I wanted to generate expertise in user-generated content.

• Generation of discomfort.  Having a mixed role as operating guy plus blogger often made people uncomfortable. I’d find myself in business meetings (or having a beer) where people would say “you won’t blog this, will you?  There’s a reason the vast majority of bloggers are journalists, consultants, and analysts.  There’s less conflict with those inherently commentator-oriented roles.

I’d like to thank my readers for their support over the years. I hope that my thoughts have helped you both in your careers and in running better, smarter, more people-valuing, and more rational businesses.

Best,
Dave

The book is no theoretical tome.  It’s a quick set of practical rules from marketing practitioners on how to get things done.  I decided to focus my rule not on “understanding your products” (as I might have 20 years ago), but instead on “understanding how your customers use your products.”

Hence, Rule 38:  Be the Customer Usage Expert.

Here’s a draft of what went into the book.  To see the final version and/or to find out the other 41 rules, I suppose you’ll have to buy the book.

Rule 38:  Be The Expert in How Customers Use Your Product

Most product marketers understand their products.  That’s important.  But what will change your career is becoming THE expert in how your customers use your product.  What’s the difference?

There are plenty of people in your company’s engineering and product teams who are experts in how your products work.  Over time, those people are typically seen as valuable resources for the company (as in, “No one knows more about the optimizer than Joe”).

If, however, you’re looking to both impact revenues and be seen as an organizational leader, then you must become THE expert not on how your products work, but on how your customers use them.

Here are four ways to do that:

Engage Constantly with Customers

Thanks to social media, it’s never been easier to engage with your customers.  Use a blog, Twitter, Facebook, and LinkedIn to enable direct web-based customer communication.  Make yourself easy to find on the web and easy to contact. But don’t stop there.

Run periodic and topical surveys so you can not only watch the needles move over time, but also stay on top of the market pulse.  Attend industry conferences and user-group meetings.  Give presentations so people can find you. Most importantly, work with your sales channels to set up as many live customer meetings as possible.

Ask the Basic Questions

In customer meetings, learn to say:  “I don’t know.”  Once you start pretending to understand a customer’s business, you’re sunk.  Start with “I’m sorry, I don’t know anything about medical products distribution and it will help me greatly to have a basic understanding of your business.”  Then pepper the customer with why, how, and impact questions.

• Why do you customers buy from you?
• How does our product help you make money?
• What’s the impact of failing to meet the service-level agreement?

When you later get into a product discussion, you’ll have an infinitely better understanding of their requirements.

Watch Your Language

Remember that you are delegated to the level at which you speak.  If you start talking bits/bytes or saying “orthogonal” too much, you’re likely to find yourself talking to someone in a cubicle outside the corner office.  Marketers must be bi-lingual:  speak tech to techies and business to businesspeople.  Mix the two at your peril.

Develop Legendary References

As you meet customers and learn the business impact of your products, invariably a few people and a few stories will stand out.  The stories will be easy to understand and impactful.  The people will have an unusual passion and willingness to tell them.  Embrace these few people and turn them into legendary references.  Feature them in case studies.  Invite them to speak at user groups.  Place them as industry conferences.  Connect them to the business and technology press.  Ensure they build relationships with your top executives.  Teach the entire company their stories and how your product affected their businesses.

My favorite legendary reference went from being an internally focused CIO to a repeat InformationWeek 500 award winner and right-hand to his CEO.  They’d cross the country on the corporate jet telling their customers how my product helped them provide the best service in his industry.

Do that.  And then watch what happens to your career when people say:  “Nobody knows more about our customers” than you.

The 42 Rules of Product Marketing is available here.

After 25 years or so doing high tech companies, I have a simple test:

If you have to wonder whether you are in a hot market, you’re not.

It’s really that simple.

That’s not to say that re-positioning / pivoting into a hot market is impossible.  But I have always believed the biggest strategy problem most companies face is not “step 2” — i.e., determining strategy given a situation assessment.  That’s actually not that hard.  Step 1, however — figuring out your market situation — is the killer.

Companies get it wrong because people are optimistic.  No one wants to call the baby ugly.  People confuse the potential to be in a hot market in the future with being in one in the present.  (If we just sit here, maybe Prince Charming will come along.)  And people want to believe that changing markets is as easy as putting { mobile | big data | social | analytics } lipstick on the proverbial pig.

Because the prospect of not being in a hot or soon-to-be-hot market is too grim to ponder (and/or too politically incorrect an assertion to state), companies tend to always assume that they are in a hot market.

I remember visiting an empty building with 2 guys sitting  atop a $30M venture capital sinkhole.  “We’re in big data.  That’s a hot market.”  That was funny I thought.  I didn’t think of them big data.  And I was on the board of Aster Data, one of the original “big data” companies.  And if you’re in a hot market, why is the building empty?

It’s also not to say that you can’t build a nice company or get a good return for your investors if you are not in a hot market.   Many strategies — mostly focused on developing series of market niches — can be successfully applied in these situations.

But if you get the situation assessment wrong, you’ll never correctly arrive at the right strategy for it.  (And hoping for offsetting errors isn’t a good approach, either.)

I’ve spent about 18 years of my career working in hot markets and about 8 in cold ones.  I’ve also advised a handful of companies over the past 4 years, some in hot markets and some in cold ones.  I can tell you there is a difference.  A difference so obvious that I am positive that the only people who wonder if they are in hot markets are the ones who aren’t.

If you’re in one, you know.

Why might they do this? I think it’s often just to sound visionary and bold. In rare cases it might be a clever plan to distract thing-X challengers by redefining the competitive agenda to include both things X and Y (Oracle excelled at this with many failed initiatives such as the NC).  There are certainly also cases where markets go bad and must be exited, such as when Intel needed to flee the commoditizing DRAM market.

But in the embrace-change-or-die culture of Silicon Valley, there’s also something fashionable about saying, “I know we are the leaders in thing-X. But thing-X is not strategic enough. So the future of this company is thing-Y.”

It takes guts to say it. TechCrunch and the VCs will get goosebumps.  There’s a certain burn-the-ships attitude that one can’t help but admire.

But is a good idea? I think, for the most part, no.

While it is sometimes absolutely necessary to lead companies through major transitions, I think the “future is Y” tactic is overused and often misapplied.
Sometimes burning the ships drives a high level of commitment to developing a fertile new world. Sometimes, however, it leaves a bunch of starving sailors on a barren rock.

My two favorite examples of this principle are Ingres and MarkLogic.

Let’s do Ingres first. Ingres was founded in 1980 about 2 years after Oracle and was one of the original 4 players in the relational database market. For a bevy of reasons more related to marketing and strategy than technology, Ingres lost the early relational database wars to Oracle. For example, by 1992, Ingres was struggling $240M division of the $400M struggling applications vendor ASK, while Oracle dominated the market and was about $1.2B. Somewhere around 1989 or so, it became clear to Ingres that they couldn’t win the core RDBMS market. In an epic display of bad decision-making, the company declared that the RDBMS market was commoditizing and decided to strategically focus on application development tools. I remember hearing top management say “the future of this company is application development tools.”

This was a terrible decision for several reasons:

• The RDBMS market was still in its infancy. Today, it’s a $15B (per year) market. Literally, hundreds of billions of RDBMSs were sold subsequent to Ingres’s decision that it was a poor market. It was in the top-two market opportunities for IT in the last century. (The other being PC operating systems.)

• The RDBMS market was not commoditizing. Ingres confused the growing dominance of a standard query language (SQL) with product commoditization. The products were all quite different. SQL would be extended and, in effect, re-made proprietary. The market wasn’t trending to pure competition and commoditization; it was headed towards oligopoly. Oracle drives 50%+ margins in RDBMS.

• The notion of carving a segment off the market was never considered. When someone loses the battle for dominance in market A, you don’t need to move to market B; you can segment the market instead. For example, Ingres was always very strong in query optimization. As Ingres was bailing out of RDBMS, a new multi-billion dollar segment was opening in databases specific to data warehousing, where that optimization technology would have been critical. Open source was another option was hiding in plain sight (the original University Ingres was always open-source; even before the term or concept was widely in use).

• Application development tools were a non-attractive market maybe 1/5th the then-current size with low barriers to entry, boatloads of competitors, strong downward pricing pressure (e.g., free runtimes), a powerful entry Visual Basic / Visual Studio and a bevy of other PC-based tools.

• The statement, and accompanying reallocation of resources, alienated all the database people who thought “why do I want to work at a database company not committed to databases?” The answer was you didn’t. Many of them ended up at Oracle and Sybase.

Tools were indeed the future of Ingres and that future ended up pretty bleak. In 1994, the whole struggling ASK/Ingres mess was sold to CA for $311M, a fraction of annual revenues.

Now, let’s look at MarkLogic. MarkLogic was founded in 2000, to create a hybrid DBMS / search engine based on the XML data model and the XQuery language. In 2003, Gartner wrote a note called XML DBMS: The Market That Never Was. Despite that, I joined the company as CEO in 2004 because, while I was aware that there was no horizontal momentum for the XML DBMS category, the company did have outstanding technology, strong investors, a great team, and a handful of good early customers.  I strongly believed it was a classic case of where a “bowling alley” strategy could be applied successfully.

(A bowling alley strategy is a systematic vertical market development strategy described in Inside the Tornado by Geoffrey Moore. The idea is simple: in the absence of strong category momentum, a vendor can be successful nevertheless by focusing on specific needs in specific industries and then bridge across markets by solving similar problems in new industries or new problems in the same industries.)

To me, it was clear cut and, God bless Geoffrey Moore, it worked. Of the dozen or so XML DBMS vendors in existence in 2004, the only one who succeeded in building a real business was MarkLogic. Some went out of business. Some repositioned into XML publishing applications. Some were sold for a pittance.  Do you remember any of these names:  Tamino, Ipedo, x-Hive, TigerLogic, Ixiasoft, Xyleme, eXist? It wasn’t exactly a hot category.

Despite the fact that 90%+ of the revenue was coming from the media and government verticals, several “important people” persisted in believing that the future of the company was enterprise. (Meaning, selling horizontally to F1000 IT.)  I never liked that because a horizontal enterprise assault had played no role in the company’s success to that point, and the data I saw suggested that wasn’t going to change in the future. To me, anyone paying close attention to the present might well conclude that if enterprise were the future, then that future might be pretty bleak.

Several things happen when leaders of thing-X companies declare the future of the company is thing-Y.

• You make counter-intuitive investment decisions. For example, if I told you that thing-X salespeople sold $2M/year and thing-Y salespeople sold $1M/year, you might expect that a company would consist of 100% thing-X salespeople. (For a given number of salespeople that maximizes revenue.) But once thing-Y is declared strategic, the company will seek to hire more of the lower productivity salespeople to support the strategy.

• Thing-X employees feel disenfranchised. I’d always felt that Oracle never forgot it was a database company. No matter the timeframe,  a top database engineer was a prestigious job. At Ingres, after about 1989, it wasn’t prestigious to be in the database group. Oracle never said tools or apps were the future of the company. Oracle, in effect, said: we are the leader in database and will leverage that to expand into tools and apps.

• Thing-X customers can potentially get rattled. I’m told that at the first MarkLogic User Conference after I left, that new management explained to an audience almost composed of media and government customers that the future of the company was enterprise.  It’s risky to treat your customers like your high school sweetheart on the day you went off to college.  (Hasta la vista.)

• Your best employees will want to move to thing-Y. By saying the future is thing-Y, you are announcing to your team that the past is thing-X. Your best and brightest will quickly get the message that to maximize their career opportunity, they should be working on thing-Y.

I firmly believe that there are situations where companies must leave an old market and enter a new one. Cognos’s exit from mid-range application development tools into BI is a great example. In 1996, you could safely say that the future of Cognos was BI. I’m sure that created many transition issues internally for them and, for the record, I believe that Cognos managed those issues extremely well. But given what was happening to VAX/VMS and MPE/XL Cognos had no choice. They needed to burn the ships and move to a new world.

But for, the most part, I believe that VCs, board members, and executives make one of two mistakes when they say the future of a thing-X company is thing-Y.

• They are hoping the future is thing-Y because for some reason they find that market more attractive than the market for thing-X. Often this may be a case of boredom with your own market (i.e., grass-is-greener syndrome) or a lack of creativity in developing it. Recall that Google was in part born by Yahoo declaring search non-strategic, and instead choosing to focus on portals and content.

• They are creating an artificial rhetorical “or” for dramatic purposes when the real message should be “and.” Follow the Oracle model instead:  we are going to lead in databases and, by hook or by crook, we are going to build an applications business because we believe that both are strategic to our future.

So the next time you hear anyone say the future of your company is Y, challenge them. Ask about X. Ask about Z. Ask about X and Y as opposed to X or Y. Then consider the real consequences of having your entire organization — and customer base — truly believe that the future is Y.

If you like that picture, stick with it. If you don’t, think a bit harder and change the plan.

To me, Wallit is Twitter meets Facebook meets Foursquare meets augmented reality.  (Thank goodness, I’m not their marketing guy.)

• Like Facebook it supports walls that you can write on
• Like Twitter those posts can be public
• Like Foursquare it is location-centric.  But, much better, it enforces location — to write on a wall you need to be there
• And, coolest of all, it’s augmented reality.

Imagine standing the Marin headleads with your girlfriend, looking at the Golden Gate bridge, holding your iPhone up, seeing an augmented reality wall appear on the bridge, and written on that wall is “Jenny, will you marry me?”  If you’re geeky enough that’s goosebumps, folks.

Or imagine writing the same message on the full moon.  Or, more practically, imagine the dating/mixer possibilities of writing on a shared wall at a jammed nightclub.  Or the fun you could contributing to a shared wall at the Shark Tank, talking about the game.  Or imagine, real-time restaurant reviews at Morimoto (e..g, “the tartare is awesome tonight” or “avoid the special”).

Basically anything you’d want to tweet about, you can now write on a virtual wall, where anyone else writing actually has to be there.  And you see it all in augmented reality.

The company has launched to some amazing press, below.

• With Augmented Reality, Wallit Assigns Virtual Walls to Physical Places (Mashable)
• With $1.2M of Seed Funding, A SoMoLo App for Augmented Reality Fans: Wallit (TechCrunch)
• Wallit lets you leave your digital mark in locations, with an augmented reality twist (VentureBeat)
• Wallit iPhone App Creates Virtual Wall Posts In Almost-Real Life (WebPro News — includes video)

Congrats to Veysel and the Wallit team. And check it out.

• Whenever you can
• Right now

Whenever You Can
Most startups typically go through ups and downs. Say you’ve just completed 4 consecutive quarters above plan. You growth is high and your burn rate is reasonable. You have enough cash to go three more quarters before you need money. What should you do? Unless you are virtually certain that your quarterly streak will continue, I’d say raise money.

Why? Because the increase in valuation / decrease in dilution from adding 1-2 more quarters to the streak is nothing compared to the decrease in valuation / increase in dilution from tanking a quarter along the way. Whether you’re a subscription or perpetual company, investors will always want to see new sales / new bookings as your primary growth metric. While the SaaS model does damp revenue volatility, that’s precisely why a VC will want to see bookings. And, in my experience, bookings are volatile. During my 24 quarters at MarkLogic, we hit our bookings targets about 90% of the time. But I can say, sometimes when we missed, we missed. I remember one quarter coming in around 50% of target. Right after that quarter is exactly when you do not want to be raising money. And, by the way, it’s usually precisely when you need it.

The fastest way to end up bridge loans – where you lose almost all control of your company and are fed milestone to milestone – is to not raise money when skies are blue and instead try to raise money in a storm. Much as I love them, VCs are not in the business to be nice people:  if you’re coming to them, hat in hand, with 30 days of cash in the bank, I can assure you that you will not raise money on favorable terms. You could have done that 90 days ago. But, if you’ve tanked the quarter, now it’s too late.

To show this in reverse, one trick VCs love is to sneak a peek at an extra quarter. I remember one time when I was raising money, we’d agreed on terms, and the lawyers said it should take 2-3 weeks to close the round. It was June 12th, so if everybody pushed hard we should have been able to close the round before the quarter ended on June 30th. But suddenly everyone disappeared. Hello? Hello? Why aren’t the VCs calling back? How come their lawyers have gone silent and are taking forever to turn paper? Hello? Hello?

We made the quarter and the round closed July 5th. Arguably, I could have gone back and asked for a higher valuation based on having made the quarter – i.e., knowing that 2Q would be successful wasn’t priced into the round. But the VCs are good, they knew I wouldn’t do that – and they wouldn’t have let me if I tried.  So they got a “free peek” at the 2Q results. I’ll bet you $1000 that if we’d tanked that quarter, they’d have come back to me seeking to lower the valuation. The game is neither fair nor symmetric. (So time your round to close before the first day of the last month of the quarter.)

Right Now
Particularly for new companies, I believe the right time to raise VC money is right now. Too many would-be entrepreneurs treat fund-raising like going to the Senior Prom. I need to find a date. I need to book a limo. I need to do my hair. I need to get a dress.

Translation: I couldn’t possibly go talk to VCs about raising money until I have a great slide deck, an advisory board, a CEO, a Beta product, or some customers.

To me, it’s all avoidance. Traditional A-round VCs want to catch you in your dorm room. They are used to talking PhD students (or drop-outs) about their visionary ideas. They are not worried about whether you have a CXO. (In fact, they would be more than happy to help you find a CXO which, by the way, I wouldn’t recommend.)  They are worried primarily about the market opportunity, your idea, and your technology. As Don Valentine always said: great markets make great companies.

What’s more, they want to invest in people they know. One way to get known is to build a relationship over time as you think about raising money for your company. The best way to do this is to find someone in your network who can connect you to a top VC partner and who’s spent time getting to know you and your company (e.g., someone who’s perhaps done some advisory work or an angel investment). Then you want that person to send a top VC an email that looks like:

Dear Joe,

I have been working a bit with Mark Smith who just (ideally, either left great company or completed or ideally dropped out of a great PhD program) and who has a very interesting idea for a company. They are thinking about raising money and thus weighing the pros and cons of bootstrapping, an angel round, or a VC round.

I’d suggest meeting with him.

This way you remove the “prom factor” from your VC meetings because are not going on the big one-shot date. You’re not raising money. You are thinking of raising money. So it’s not awkward for them to not invest – in fact, they never even need to say no. But if they like your idea and your company they’ll be shoving money in your pockets whether you ask for it or not.

Better yet, you can invoke their competitive instincts by noting that you’re chatting with several VCs about whether you should raise money. Best of all, this approach lets you benefit from their wise (and free) feedback as you develop a relationship over time. If they are even moderately interested, they are going to want to track you (i.e., “hey, come back in a month and let’s have a coffee”).  If you continue to make good progress during that time (i.e., accomplish what you say you will in a given timeframe), you not only build credibility but also slowly transform yourself from stranger to interesting person who I’ve been tracking for the past 6 months. That becomes even more helpful when the VC needs to convince his partners to invest in you, as he invariably will.

So, now you know the secret. When’s the right time to raise money in a startup? Either right now or whenever you can depending on your situation. No business ever died from a little extra dilution. But, as the ever-quotable Don Valentine also pointed out: “all companies that go out of business do so for the same reason; they run out of money.”

Founders might be motivated by changing the market, popularizing a product, or just proving they are right. Salespeople, almost all the time, are motivated by their compensation plans, so the compensation plan should be the de facto expression of what you want them to do and how they should spend their time.  Ergo, as mentioned in this post, you should get them done before kickoff. And put a lot of thought into them.

Why? Because a typical salesperson will spend the whole weekend after you give them their comp plan in Excel modeling how much money they will make under various scenarios. I’d also say to make them as simple as possible both to make it clear what you want salespeople to do and to avoid the inevitable unintended consequences that often accompany complexity.

One huge question is whether comp plans should be capped. Almost all salespeople would say no. Part of the reason they’re playing the game – particularly at a startup – is for the lottery ticket.  Think: while I know my on-target earnings are $250K, I want to have a shot at earning $1 or $2M – that’s what drives me to work those killer hours.  So while I recommend leaving comp plans uncapped, I also recommend that management model the full range of scenarios and, for example, accelerate rates in the 100-250% of plan range but to greatly decelerate them after that.

You can always hedge your bets in the compensation plan terms and conditions (e.g., plan can be changed at any time to correct for errors or unforeseen circumstances), but if you actually use that language the whole salesforce will know and you will quickly lose the lottery-ticket value in your comp plan. It is far better to put some more thought into the plan on the front-end. I know one guy at a startup who did a $10M deal off a $1M quota and received only a fraction of his stated comp. Because he didn’t want to burn bridges, he just quit. But in this scenario, everybody loses.

Outliers, however, can take several forms. I know one sales manager who groups salespeople into three buckets:

• Those who clearly understand their comp plans. They sell what’s incented, when it’s incented, and make the most money per sales dollar.
• Those who mostly understand their comp plans. Those who do a good job following the plan incentives, but not a perfect one.
• The “independently wealthy” who seem to pay no regard to the incentives in the comp plan

I love bucketing reps in this way both because it’s funny and it immediately prompts an important question. Why are these reps not following the plan? Perhaps it’s just sloppiness or stupidity. Or perhaps there is more going on. My advice is to analyze reps in this way, show them that if they had sold different products at different times how their pay would have varied and then ask them why they didn’t. While some people invariably just miss the point, you might also discover “good reasons” why your people aren’t following your plan: maybe it’s too complicated and they don’t understand it, maybe they don’t think the higher incentive offsets the additional risk of selling a new, strategic product.

Or maybe they truly are independently wealthy and just doing sales for fun. But I doubt it.

Thus February is a month that requires great operational discipline.  I’ll tell you a story about my old friend Larry to explain why.  For the first few weeks of every year Larry would stroll into the office around 10 AM with a few different newspapers in his hands.  Then he’d sit in his office, with his feet on his desk, and quite visibly read the newspaper.  If you went into his office and said, “Larry, what the heck are you doing?” he’d reply:

“I’m reading the paper because I don’t know what to do.  I haven’t received my compensation plan yet.”

Larry was lucky not to get fired, but his management was lucky to have him around to make the point so dramatically.  I am a salesperson.  I am, by definition, coin-operated.  My compensation plan is supposed to be *the* definition of the behavior the company would like to incent in the new year.  So, if I haven’t received my comp plan, then I don’t know what to do.  QED.

I learned a simple trick from my old boss John Olsen to help your thinking when it comes to the timing of comp plans:

Your signed compensation plan is your admission ticket to the sales kickoff.

This is a fantastic rule for many reasons:

• It forces management to reverse-engineer the timeline to get things done early.  Making comp plans (and dividing territories) is hard, iterative work that takes time.  Most salespeople want to negotiate certain terms, which adds time as well.  By putting this stake in the ground you are committing to starting early.

• It creates a deadline.  Comp plans often linger for months into the new year and while most salespeople won’t overtly act like Larry, they may well be operating at reduced productivity until they understand what they’re supposed to do.

• It lets kickoff be a real beginning.  Sales reps enter the room with your comp plan and territory.  They hear great things about last year.  And they hear what’s coming this year in terms of new products and new go-to-market strategies. So when reps get home, they can start selling. 

So have a great kickoff.  Fire up your salesreps about what a great year they’re going to have.  Send them home with new messaging and tools.  Whip them into a frenzy.  But, please don’t let them into the event unless they’ve signed their comp plan.  And make sure you’ve done work on your end, in advance, to make that a reasonable request.

I also like Splunk because many months ago, they let me riff with Godfrey and many members of the e-staff about marketing and strategy.  They were smart and it was fun.  They even gave me a superb bottle of wine for my troubles.

I like Splunk because, unlike Jive, Godfrey hasn’t turned the e-staff into a crony club.  Building great teams is about finding the right people for the right job, not just carrying around an entourage.  Exercise:  search Spunk’s management page for Hyperion and then search Jive’s for Mercury.  (Answer:  2 and 6.)

I also like Splunk because they pivoted.   When I first heard of them, they were positioned as “IT search.”  I had no idea what that was or who would buy it.  When we met for the strategy riff, they were in middle of re-positioning around machine-generated data, a message that I liked.

Most folks make software that analyzes human-generated data; we focus on machine-generated data.

Clear, simple, and true.  Instead of piling on as a YABDW (yet another big data wannabe), Splunk built a message that was sexier than “log file analysis” but still true to their essence and still generalizable to a broader vision of “operational intelligence.”  A+ marketing.  Bien fait.

Finally, I like Splunk because they haven’t burned through lots of cash.  They’ve raised $40M.  They have $23M in the bank.  $17M net burn isn’t bad for what they’ve created.

Splunk’s fact sheet does a great job of telling their story in two pages.

When I heard that Splunk had filed their S-1 to for an initial public offering, it was no surprise.  I’ll spend the rest of this post analyzing it and pulling some highlights.  Those looking for controversy will not be happy.  I’ve read the S-1 over the past few days and found few surprises.  Overall, the company looks pretty clean from where I sit.

Let’s start with the income statement:

• FY11 revenues of $66M, up 88%
• Trailing 9 month (T9M) revenues of $77M, up 78% so there’s a slight deceleration in growth
• FY11 gross margin of 89%, on the high side for an enterprise software company and reflective of the high license revenue mix (75%)
• S&M expense in FY11 of 60% of sales, which rose to 62% for the T9M period.  They’re not afraid to spend on growth.
• Healthy R&D expense of 21% of sales in FY11, which stayed roughly constant.
• Small operating loss of 5% in FY11, rising to 10% for the T9M period, probably due to costs associated with the offering.

In my opinion, this is a VC’s dream income statement (with one notable exception that we’ll cover in a minute).

• High revenue growth = big opportunity
• Small operating loss = sustainable, but spending it all on growth.
• Small net loss = nowhere to go but up in profitability
• High license mix = software-focused

The only part of that VC formula I dislike is the license mix.  Boards like high license mix because market share is measured in license dollars, license dollars are seen as the engine of a software business, license dollars drag other dollars with them (e.g., maintenance), and finally because boards get tired of companies missing their high-margin license target and covering the gap with low-margin services.  They see it as soybean filler in their hot dog.

I think that view is myopic because it is not customer-oriented.  To the extent your software is truly easy to use and requires few services, then I guess it’s great.  But to the extent you are selling typical enterprise software, it can be hard to use, setup, and configure.  In that case, keeping your services org tiny may win you cheers at the board meeting, but jeers at the user conference.

Personally, I’d like Splunk even better if they had the same license revenue and more service revenue on top, even though it would reduce the license mix and gross margin percentages.  (Note:  not gross profit, both revenue and gross profit would be higher in my ideal company, but the license mix and gross margins would be lower.)

I worry that Splunk could end up in No Man’s Land on the services issue:  too small an opportunity to entice big consultants to build serious practices around the product, but too great a need to be satisfied by a small (6% of sales) professional services organization.  For example, we are customers in my current job, and — far as I can tell — we get some good value from the software, but could probably get a lot more.

Now, if you’ll pardon the pun and the mixed metaphor, let’s find the cloud in the silver lining:  Splunk is not a SaaS company.  OMG.

For example, we typically enter into perpetual license agreements, whereby we generally recognize the license fee portion of the arrangement upfront, assuming all revenue recognition criteria are satisfied.

Personally, I’m OK with it.  In some ways, I admire Splunk for swimming upstream on this issue.  While SaaS is wonderful and has many advantages, not all customers in all categories want to buy on a SaaS basis.  Splunk has evidently decided that in machine-generated data, people primarily want perpetual (yet they also offer term as an alternative).

Splunk’s sales are backloaded:

As is typical in the software industry, we expect a significant portion of our product license orders to be received in the last month of each fiscal quarter.

The combination of this backloading with the more volatile revenue stream associated with perpetual model should make Splunk’s earnings more volatile than its peers.  We’ll see if that turns out to be the case.  (See here for my generic analysis of SaaS vs. perpetual businesses.)  But they do have some ability to manage it:

We typically ship products shortly after the receipt of an order. We may have backlog consisting of product license orders that have not shipped and maintenance, professional and training services that have not been billed and for which the services have not yet been performed. Historically, our backlog has varied from quarter to quarter and has been immaterial to our total revenues.

The astute reader will notice they’re saying that they may choose to not ship all orders at the end of quarter.  This is common in perpetual software businesses both due to order volume and because experienced managers know that if you’ve hit this quarter’s targets it’s time to slow down the order processing desk.  You’ll never know if you’ll need those orders next quarter, so let’s not put them on the midnight truck.  And while a few million dollars here or there may be immaterial to revenues, in the case where expenses approximately equal revenues, these orders can have a big impact on earnings.

I always read but rarely analyze the risk factors.  For Splunk, there are about 25 pages of them, in which the only tidbit I found was this:

We employ a unique pricing model which subjects us to various challenges that could make it difficult for us to derive expected value from our customers.

We charge our customers for their use of our software based on the customers’ estimated daily indexing capacity. As the amount of machine data within our customers’ organizations grows, we may face pressure from our customers regarding our pricing, which could adversely affect our revenues and operating margins.

I wasn’t aware of this, but it makes a lot of sense.  Increasingly, software vendors  want to sell the copier machine priced by the copy.  The desire here is always to hook your pricing to “something that goes up” (e.g., the old MIPS-based pricing model).  Splunk is betting that data volumes will go up and ergo that customers will need to buy more licenses as they do.  This should help offset the volatility argument above — while existing customers aren’t setup on renewable contracts, if they have the perpetual right to analyze only half their data, I suspect they’ll be back ordering more software.

Let’s talk about equity now.

• It appears to me that there are about 1o2M shares outstanding before the offering based on 79.4M outstanding on 10/31 plus 23.2M shares issuable upon exercise of stock options.
• If they raise $125M in the IPO with a typical share price of $15, then that’s another 8.3M shares, so that means about 110M shares outstanding after the offer.
• This implies a target valuation of around $1.6B which I find high, so high, that I’m wondering if I’ve made an error.  This article says the valuation may be $1B.   Either I’ve mangled the math or they will reverse-split their way out of the problem.  Either way, let me assume they’re targeting a ~$1B valuation after the IPO even though I can’t yet see how that pops out from the math.

Here’s a graph of Splunk’s common share price as seen by the strike price of options during the year.

While there are literally pages of math explaining how they calculate the fair market value (FMV) of the stock to me this curve looks a big flat and a bit low.  The point of periodically performing section 409a valuations is to ensure that boards didn’t hand out in-the-money stock right up before the IPO.  If the company goes public at $15 and even just stays flat, I’ll let you explain to the IRS and the SEC how the stock was really worth $4 in October and $15 in February.

The pages on  compensation and the fees paid to compensation consultants always make me ill.  The CEO loses a lot of control in the IPO process, consultants make a lot of money, and executive pay is not constrained in the process because the exercises are based on benchmarking. By the way, despite those general objections my reactions to Splunk executive compensation are:

• The bases seem reasonable
• The on-target earnings (OTEs) seem reasonable
• They have a highly leveraged compensation plan (Godfrey is a salesman, after all.)
• They blew out their numbers
• Ergo, they made a lot of cash compensation

The VCs own 70% of the company, which had raised a total of $40M in venture capital.  If the company ends up with a $1B valuation, then the VCs will on average — which is both interesting and misleading because different people bought in at different valuations — get a 17.5x on their money.  Not bad.

Godfrey Sullivan owns a hefty 8.1% of the company — quite a lot for a hired CEO (as opposed to a founder).  This is because Splunk is successfully running what I call the “new VC play.”   Because:

• Consolidation means there is an oversupply of very senior executives
• There are relatively few portfolio companies with the potential to go public
• It now takes 7-10 years as opposed to 3-5 to go public
• There is ample venture to fund the promising companies through IPOs that now happen closer to the $100M revenue bar than the $30M bar of the 1990s

You then go get the biggest guy you can find, load him up with options so a $1B CEO will run a $20M company, and then fund him for high growth over the long haul to get to the IPO.  This is true of Jive (Zingale) and Splunk (Sullivan).  It is true to a lesser extent at Lithium:  Tarkoff was a billion-dollar GM (which isn’t quite the same league) though the VCs are certainly backing him with money.

Hence, if things go I think, my guess is that Sullivan’s share will be worth $80 to $100M after the IPO.  Nice work if you can find it.  Or, as I believe was the case in this instance, have the vision to see the potential and pick it.

I’m fizzling here about page 120 of what looks to be 175 or so pages.  If you find anything interesting in those pages or have thoughts on what I’ve presented here, please share them.

And, in conclusion, congrats to the Splunk team and best of luck with the IPO.

(Be sure to read my disclaimers.)

Both are bad behaviors.  But the one that will stall your career inside your company — or wreck a salescall outside of it — is not answering the question.

In my career I’ve had the good fortune to meet with many senior executives.  Almost without fail, they share these qualities:

• They are direct.  They speak clearly and in simple language.  Buzzwords and spin are the province of middle management, not the C-suite.
• They go fast.  They are busy.  They don’t want to waste time.
• They want to drive the agenda (and are used to getting their way).  This is a key reason why you should not present to senior executives unless asked.
• They have a series of questions that they want answered.

So the best thing you can do in front of a senior executive is answer the question.

• Question:  On a scale of 1-10 how is the team working?
• Bad Answer:  Well, you know, the guys have been trying hard, things haven’t been perfect, but the team has really been pulling together lately, and I think things are improving.  We’ve filled the open headcount and are making real progress.
• What the Executive Hears:  Blah, blah, blah this fool is not answering my question blah, blah, blah.
• Good Answer:  7.
• Best Answer.  7, but there one or two key problems to work out.

You should answer the question because the executive wants it answered.  You should answer it succinctly because there is a 90% chance he/she has a line of questioning prepared and wants to move through it quickly.  I believe the last answer, above, is the best one because:

• It answers the question.
• It’s succinct and doesn’t interrupt a potential line of questioning.
• It leaves a thread the executive can pull if he/she desires.

Verbal hedging can be used to leave such threads open and avoid the huge “disclaimers” that people often insert before answering questions.

• Question:  is the project tracking to finish on time?
• Bad Answer:  well, you know, you can never be sure about these things, but it is going pretty run, the head PM has had a cold, and we got behind on a few tasks and — gosh you never know if an Act of God is going to interrupt things — and the long pole in the tent is getting some new servers delivered, and risk, yes risk, there’s always risk in managing such projects.
• Good Answer:  Yes, but one item on the critical path — server delivery — is holding us up, but not so much that I think we’ll miss the deadline.
• Best Answer:  Yes, mostly.

I like the last answer best, because — if I care — I can simply ask:  what do you mean by mostly?  And if I don’t, then I can proceed.

My advice:  in the meetings you attend, start tracking how often people actually answer the question and observe how much time is wasted on useless filler.  My guess is that once you start paying attention to this issue that you’ll first be shocked at how often it occurs and second become a much better answerer in the process.

And, if all else fails, then mail people this link.