Steve Johnson on Product Management

More notes from another Business of Software 2008 lecture by Steve Johnson from Pragmatic Marketing. He talks about what product managers' role is, what they actually end up doing, and what they need to do, in order to be meaningful representatives of the actual product's users.

• Companies tend to start off as technology-driven, then become sales-driven (each new sale requires custom development), then become marketing-driven (lots of money spent on their brand image).
• Then they cut costs, and go full circle to technology-driven, and repeat the cycle. Good product management can help to break this cycle.
• Illustration of how wills are only executed: you are already dead when the will gets to court. So the document needs to be long enough to deal with all possible arguments.
• Application specifications have the advantage that the specifier is normally still alive when the development teams come to implement them!
• But we keep writing specification documents (product requirements, marketing requirements, functional specifications...) in order to cover all managers' worries/requests.
• The right answer is not to create more artefacts. Tightening your grip will mean more slips through your fingers. Instead it's to have someone who really understands what's needed, and can back up their assertions with evidence.
• Many companies are like Star Trek (original series): Spock (development) logical, trying to be human. Bones (marketing) upset about what he hasn't got, or what he's being asked to work with. Kirk (sales) always committing the ship to more than it can do. Scotty (product manager/sales engineer) lies to Kirk at all times, then says "OK, let's go!".
• Agile development crowd wants to improve these development/specification processes by having a customer representative on hand to try out each iteration on.
• Problem: most of us don't program for individuals. We program for multiple customers!
• Agile/Scrum methods seem to make us more introspective. We spend so long in development team meetings that the product manager does not go out and talk to the customers!
• Sales don't tend to understand why some of their development requests are not possible. An interesting idea is to turn this round and ask similarly unrealistic questions to sales. Example: "Why can't you give me a well-defined feature set by a guaranteed date?" is replied to with "Can you tell me what hour of the day and the exact amount that you're going to close this contract for?"
• In many cases, the only people who talk to customers are technical support. But are they talking to all of our users? (Hopefully not!) They're only talking to the people with problems, and not even all of them. What comes out of this? "Remember the 'L' in (L)user is silent". "Losers" are those who you have to teach basic computing to. "Power Losers" are those who are trying to use your product in ways that you never intended. But you can't just try to market to "smarter" users!
• Biggest contribution that a product manager can make is to be representative of users. That means the PM has to leave the building, and talk with users, and potential users!
• Causing customers to switch is one target, but selling to potential customers is hugely important.
• Three groups: current customers, evaluators (people currently shopping: only sales talk to them. If they don't buy, then product management analyses why), and the untapped potential market. The last group is very important.
• Customers tell us what new features they want, but potentials tell us what would convince them to buy. Get evidence for what features are really asked for by customers. That helps choose which of the many ideas that come out of our company are to be implemented.
• Development and Sales have different views of product managers should do. Sales tend to want people who can demo/explain the product. This is probably best done by sales engineers. (See Steve's post on sales people as order takers.)
• Work out what areas of the business that are thought of as product management are not actually officially assigned to someone at your company: they will be happening, but are they happening well, or "just being done"?
• Jargon: Inbound marketing is understanding what customers want the development team to do (product management). Outbound marketing is about actually selling the product (product marketing manager).
• The product management triad: executive direction, marketing, and technical management. All require different skills. May end up splitting into three separate roles.
• Sales people tend to think one deal at a time, which is as needed. But when sales comes back with a new idea, put it in the list of possible new features, but wait and see how many people actually want it, rather than just the one deal that that salesperson is currently progressing.

To me, it's interesting how broad the role of product management can be. It's also a salutory reminder that when two companies recruit for a position with the same name, it might well be for totally different roles...

How to Value an Investor's Stake

I'm currently looking at a draft version of an entrepreneurship course written by, among others, people from Cambridge's Judge Institute, and hosted by Epigeum. Something that I found particularly helpful was how to decide what percentage of a company to sell to an investor for the particular amount of money the company needs. I've summarised it here.

The Value of a Stake

If the company is seeking capital worth c, then the issue is to calculate s, the percentage of the equity that should go to the investor providing that capital.

Firstly, assuming this is venture capital, the investor will look to exit probably within five years. Call this number of years y. Let r be the amortised annual rate of return that they desire, say 45%.

Hence, we can say that when the business is sold after those y years, the investor's stake should be worth w = c(1 + r)^y, as this provides the desired rate of return.

Therefore, the stake is simply the fraction that w is of the selling price (market value), p, of the business. Of course, how does one estimate p?

The answer lies in using the Price/Earnings (PE) ratio for a similar, established, company, which details their worth as compared to their sales. Assuming that we can predict the likely earnings of the company in y years' time, then we can multiply this by the PE ratio in order to obtain p.

Investors may well discount the PE ratio, either because they do not believe it to be realistic, or because of the perceived risk, or because the expected revenue is uncertain.

As an example, assume a £1 million investment is needed, that r = 45%, and y = 5. This means that w = £6.4 million. If projected sales in year 5 are £1 million, with a PE ratio of 15, p = £15 million. Thus, the initial stake would be 6.4/15 or 43%.

Which is food for thought. It does very clearly show how VC investors "need" to take very large equity stakes in order to make the desired rates of return. Hardly surprising, but it's nice to at least vaguely understand the mathematics behind it all.

Understanding Dilution

This brings us neatly on to what actually happens when you sell the stake.

Let's say that an investor offers you the £1 million for 43% of the equity. That means that the investor is valuing the entire company (prior to the investment) at £2.33 million, and in particular, valuing the 57% stake you will be left with at £1.33 million.

Suppose that prior to the investment the total number of issued shares (all owned by the founders) is 10,000. This means that the price placed on those shares is £133/share.

Why is it not the case that the price is calculated based on £1 million for 43% of 10,000 (giving £233/share), leaving the founders' 57% stake being worth £1.33 million?

Whilst the ownership percentages would be correct, this is not done because dilution takes place. In other words, the company issues new shares to the investor, rather than re-assigning existing shares.

In the above example, given a price of £133/share, the investor must be given £1 million/£133 = 7,518 shares. Post-investment, the company will be worth a total of £2.33 million, divided into 17,518 shares. The founders will hold their 10,000 shares (as before), but these are now only 57% of the company, whilst the investor will hold 43% (17,518 shares), worth a total of £2.33 million * 0.43 = £1 million.

There you have it: the end result is as proposed, i.e. the investor bought the agreed percentage for the agreed price. The only somewhat potentially confusing part is how this is brought about by dilution, rather than share re-distribution.