This article is co-authored by Maia and myself. Maia is an associate at our investment firm LeadX Capital Partners.
As growth capital investors, we see many B2B tech companies that have already generated product/market fit and product/channel fit selling digital solutions to medium-sized and enterprise customers. Many times, these companies want to raise growth capital in order to accelerate growth by expanding internationally, developing new products and services or targeting new customer segments. As growth experts, we love to discuss these growth topics with the respective management teams. In our experience, however, some management teams specifically underestimate the complexity that comes with (additionally) targeting the long tail of small business customers.
While there are very often many small business customers, their willingness to pay is likewise often significantly reduced. Their needs may differ too. And most of the times, small business customers can only be acquired through different channels.
In this article, we first explain why selling to the long tail of small business customers can be difficult, before we then share our insights in terms of how this new target customer segment can be added successfully to the key target customer mix.
The Product/Market Fit Problem
Having found product/market fit with regard to the market segments of medium-sized businesses and enterprise customers does not necessarily mean that product/market fit has also been achieved in the small business customer segment.
The needs of small business customers very often differ significantly from the needs of medium-sized and enterprise customers. It is therefore important that management teams explore the exact pains in this new target customer segment and how the existing products and services need to be adapted so they provide a compelling return on investment and a great customer experience for the new target customer segment of small business customers. In a nutshell, this means that management teams must generate product/market fit again in the small business customer segment.
While the adaptions required usually depend on many different factors and must be explored on a case-by-case basis, there are some patterns.
We have seen the pattern that small business customers tend to require a stripped-down product offering, meaning a product with less features and less complexity and that companies need to adjust their product offering accordingly.
In this context, we have also seen that adjusting the product offering can become very difficult and burdensome for companies with a monolithic technology infrastructure where all business processes, interfaces, and databases exist together in one code repository and are running together in one server environment. Under a monolithic technology infrastructure, the new product offering for small business customers cannot be developed independent of the existing products. Developing, maintaining and updating the new products and services will always affect the existing offering for the existing medium-sized and enterprise customers. In contrast, companies that work in a microservices environment, in which all services are loosely coupled, can develop, maintain and update new products independently from the existing product offering. This is also one of the reasons why we recommend founders to make scalability, especially tech scalability, a priority from day 1.
Finding product/market fit in new target market segments is very often easier for companies that are already working on a microservices tech infrastructure.
In connection with generating product/market fit, management teams must also decide upon the right pricing for the product or service. As a general rule, we notice that small business customers, which may only need a stripped-down version of the product, are often characterized by a correspondingly lower willingness to pay or ability to pay. At the same time, and again only as a general rule, we very often also see lower retention rates in the small business customer segment. A lower willingness to pay, potentially coupled with a lower retention rate, will lead to a significant reduction of the customer lifetime value (CLV) of small business customers.
The Product/Channel Fit Problem
Targeting the long tail of small business customers is not only challenging due to differing demands regarding product/market fit and a lower customer lifetime value. There is also the challenge of finding product/channel fit, meaning a distribution channel through which this new target customer segment of small business customers can be served on attractive economic terms. Small business customers may congregate at different places, have different decision makers or can simply not be cost-efficiently acquired through high-touch channels that often work when companies sell to medium-sized and enterprise customers.
For instance, some B2B tech companies acquire their customers with extensive human touch. Prospecting in terms of reaching out to potential customers, guiding qualified leads through the conversion funnel and the actual sale are very often being done by humans. Human touch and especially a field sales force is very expensive and usually leads to comparatively high customer acquisition costs (CAC).
Companies that sell to medium-sized and enterprise customers may afford to pay high customer acquisition costs (CAC) in light of the correspondingly high customer lifetime value (CLV) of these customers. But companies that want to (additionally) target small business customers may run into a severe unit economics problem.
The Unit Economics Problem
Strong unit economics in terms of a high customer lifetime value (CLV) to customer acquisition costs (CAC) ratio show that a company acquires customers profitably. In addition, a high customer lifetime value (CLV) and relatively low customer acquisition costs (CAC) usually translate into short payback periods. The customer acquisition costs (CAC) can be recouped fast and the respective money reinvested in acquiring more new customers. Typically, companies with strong unit economics need less external financing in order to fuel further growth.
Given the relatively low customer lifetime value (CLV) and the relatively high customer acquisition costs (CAC) that companies experience that sell to the long tail of small business customers, such companies can run into a cash flow problem. If the CLV to CAC-ratio is smaller than 1, the company loses money on each customer acquired. If the ratio is only slightly higher than 1, the company acquires customers profitably, but it can take a long time until the profit generated covers the costs incurred to acquire customers. As a rule of thumb, a CLV/CAC-ratio of 3 reflects a viable business model.
Hence, if companies want to sell successfully into the small business customer segment, their management teams need to do so very cost-efficiently.
How To Solve The Problems
Customer acquisition costs (CAC) are calculated dividing the marketing and sales costs in a specific period of time by the number of customers acquired in this specific period of time. This means that management teams need to find channels that are cheaper in terms of marketing and sales costs incurred. Everything that reduces the costs incurred in order to acquire a customer is helpful. First and foremost, this means that management teams should try to reduce the expensive human touch required to acquire customers.
We usually work with management teams on analyzing the complete conversion funnel in order to understand where digital tools can replace or reduce human touch. Can leads be generated organically through content marketing, a referral program or through partnerships? Can we find ways to automate the lead nurturing process in order to reduce the human touchpoints potential customers have with the company’s marketing team? And what can we do about the costs associated with salespeople? Can we introduce a self-signup process for small business customers that enables the company to acquire small customers without salespeople being involved at all?
In a nutshell, if companies want to target the long tail, they need to work hard on reducing customer acquisition costs (CAC) and usually this means that this specific target customer segment needs to be targeted through a low-touch or no-touch acquisition process.
At the same time, targeting the long tail is not only about reducing customer acquisition costs (CAC). Management teams should also explore ways to increase the customer lifetime value (CLV). This has certainly to do with finding the right price point. But there is often significant potential also in increasing the contribution margin per customer by reducing onboarding, activation and support costs associated with small business customers.
Again, digital tools and self-onboarding and self-activation tools can play an important role and need to be explored. With regard to the support function, self-help tools, chatbots and one-to-many solutions where one support person handles many customer tickets at the same time could be an option. Nevertheless, companies should always keep in mind that customer success (a high return on investment and a great customer experience) is highly important. Digital tools are only insofar helpful as the customer is still delighted by the product offering and customer service. If customers end up being disappointed, they will churn fast and leave bad reviews.
The long tail of small business customers may not be the appropriate target customer segment for each and every company. However, small business customers do have a significant revenue potential that should not be ignored out of hand.
We recommend management teams to carefully analyze whether they can find ways to efficiently and profitably acquire these customers and what cash flow implication this will have, before they target the long tail.