“Strategic” customers are a myth.


Big guy vs. Little guyLots of small companies will do anything to sign up a big customer. Startups often make concessions of two varieties:

  1. We’ll give you more stuff (read: features/support).
  2. You give us less stuff (read: money).

Often, when we meet companies who have made big concessions for a customer, we often hear the justification that Company X is a “strategic customer.” The word “strategic” here is taken to mean that, by virtue of signing up this particular customer, your company will be able to gain some proprietary advantage in the marketplace: greater legitimacy, a new sales channel, lots of PR, etc.

Calling certain customers “strategic” is dangerous, however. There are no strategic customers, only anti-strategic ones; and here’s why.

Let’s say the concession goes down path #1. A good example is a customer who asks you to build a special, but idiosyncratic feature into his implementation of your product. You spend lots of management attention and engineering resources to complete a feature that only one customer will ever use. Even if you charge for maintenance and/or services to make that extra work profitable, you are still stuck with the legacy costs of supporting that feature. Those legacy costs can seriously hamper the productivity of a startup with limited resources and a tendency to lose focus. Unless this feature is useful to a few other customers, you may be better off not taking this customer’s business at all.

Now, for concession path #2. We often see startups give deep discounts to their first few customers for strategic reasons. Discounts for startups are somewhat of a arbitrary distinction, since the pricing is still in flux anyway. That said, if you sign up enough customers at a discount, your discount will often become the upper limit on your price. Why’s that? Because the market talks. Customers will often call up one and other and ask, “Hey, are you using [your company]’s product? Did they budge on the pricing? How much? Oh good, thanks.” Once again, would you be better off lowering customers’ expectations of you in the future, just to make a few bucks today?

If you are tempted to treat a customer as strategic, ask yourself the following question: “If I treated all my customers this way, (1) would I still have enough resources long-term to scale my business, and (2) would I still be able to make enough money from a given deal?”

If the answer is no, then this customer is actually anti-strategic. Consider spending your time elsewhere.

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4 Responses to “Strategic” customers are a myth.

  1. I’m generally with you, Alex, and I’ve seen #1 kill initiatives in companies that were orders of magnitude bigger than a startup. (Think of any “commercialization of a defense-related technology” initiative.) However, I do believe there’s a bit of wiggle room on #2, if you structure things properly.

    Consider a startup that needs to get to a certain scale to have a viable offering. For cloud-based startups, for instance, that scale is often defined by the ability to run instances in multiple geographies and/or to begin to leverage economies in load balancing and reliability (not that individual AWS data centers ever go dark, har har). It’s very difficult and perhaps highly unprofitable to get there via small “retail” customers… through a self-serve signup for people who will pay $0.99/month and cost $1.00/month until you get to scale. It’s much better for the business to sign a strategic customer that gets you quickly to that scale, and it’s worth making concessions to get that deal.

    But here’s where the indirection comes: you need to make “the pricing is in flux anyway” — the uncertainty — your ally. For that first deal, the structure has to ensure that the customer is taking on some risk or is otherwise making some concession (like a commitment to significant investment on their side). You can’t simply discount on the size of the client or the fact that they’re first. If you do, as you say, you’re simply locking in a volume price discount. The deal with that *one* first strategic customer must be different, and you can ensure it’s different by having a unique pricing structure (e.g., profit sharing rather than straight pay-per-use).

    And the deal with that one customer must be at least a bit better than breakeven at the envisioned scale, if for no other reason, so you can fund further expansion. If you can’t get there, you’ve got a fundamental problem of market-product fit that you need to resolve internally… not by giving a bigger discount to get the deal!

    That said, you do have to come back to #1: the uncertainty and customer investment has to be captured in pricing structure, not in idiosyncratic features. The strategic client gets the same product as the market as a whole, but a better deal because they are getting you off the ground and putting their money at risk.

  2. Mike says:

    Alex, nice post. Very well thought out. You made some salient points, especially concerning how clients discuss pricing amongst themselves.

    -mike

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