To build successful digital products, design for three growth engines

Efficient customer acquisition, efficient customer expansion and connected ecosystems are central to building a digital product

As I have written before, digital transformation requires building exceptional user experiences. Today, more and more these experiences are being delivered through software products. Understanding the characteristics of great software products needs to become part of every organization’s DNA.

Growing a software product requires leveraging each one of three engines of growth:

Growth Engine 1: Efficient Acquisition — Great software products are designed to be extremely efficient in acquiring new customers.

Growth Engine 2: Efficient Expansion — These products are then able to efficiently grow usage among existing customers leading to up-sell and cross-sell opportunities.

Growth Engine 3: Connected Ecosystems — Great software products then drive even more usage growth by building connected ecosystems with other third-party products. If done right, the software product starts resembling a platform.

These drivers of software growth are not new. Most of us recognize these in the best products we use daily. The best products naturally and effortlessly lead us down these pathways, and we follow those pathways as we discover new sources of value. If there is a surprise, it is that many teams still build software that isn’t architected from inception to take advantage of these pathways. As a consequence, they are unable to take advantage of these growth engines and hit major barriers to growth.

Growth Engine 1: Efficient Acquisition

Early on, the goal of any product is to get the user to an “aha” moment. Merriam-Webster’s dictionary describes “aha” as the moment “.. of sudden realization, inspiration, insight, recognition, or comprehension.” Extended to a product, the “aha” moment is when the user realizes the product solves a problem they have — or, as often happens to many of us, solves a problem that we did not even realize we had.

A common early mistake is to focus only on the product’s features and functionality, without paying equal attention to product experiences that enable a user to get to the “aha” moment. A well-designed trial experience or a brilliant demo experience can make it really easy for a user to get there. A well-constructed freemium offering can accomplish the same for products that require a somewhat higher level of user engagement. Passionate early users create word-of-mouth publicity and give great reviews. This, combined with the right pricing strategy, can make customer acquisition highly efficient. B2C products have always had to design early user experiences to make acquisition efficient. More and more, this is becoming extremely desirable and even expected in B2B software products as well.

So what is a good way of measuring acquisition efficiency? There are many ways, but the simplest one is to measure sales and marketing costs as a fraction of total revenues. Best-of-breed software products spend significantly less than their peers on sales and marketing. The products literally sell themselves. Exceptional product experiences generate “aha” moments that continuously bring new users without necessitating high-touch sales engagements.

Building exceptional experiences has another advantage. The low cost of customer acquisition enables these products to allocate more of their limited resources toward improving the products themselves versus selling them. As a consequence, these experiences improve faster, which further lowers the cost of acquisition, creating a virtuous cycle. This becomes a huge competitive advantage, and these products soon become some of the fastest growing products in the market. In some cases, this “product-led” acquisition becomes a core philosophy of these companies that extends beyond software products.

Growth Engine 2: Efficient Expansion

It is a commonly known fact that the median company spends about $1.34 for every $1.00 of ACV from new customer acquisition. Relying only on acquisition-driven growth is highly risky and generally unprofitable. Meanwhile, expanding revenue from existing users is highly profitable. The median software company spends around $0.50 for every dollar of expansion ACV. Having an expansion growth engine is, therefore, a must-have.

Up-selling and cross-selling are the primary ways to create expansion revenue:

• Up-sell customers by upgrading them to larger plans as their usage of the product grows.
• Cross-sell customers additional features, add-ons and services to augment the product they already have.

Ironically, the key to efficiently driving up-sell and cross-sell has less to do with selling and more to do with product adoption. It is a fact of life that most customers use only a fraction of a product’s capabilities. The customer’s ability to consume features always lags the availability of those features, and this results in an adoption gap (also commonly known as a consumption gap). The adoption gap significantly widens as the number of features and the complexity of using those features increase.

It then stands to reason that efficient expansion requires a product team to design a highly effective adoption experience. This involves both the first-time experience of using a new product as well as each subsequent experience of adopting new features in the product. Furthermore, the more complex product features get, the significantly more time product teams need to spend on creating the right adoption experiences. The product also needs to be architected to allow for varying tiers of feature adoption — i.e., basic, intermediate, advanced, etc. The product experience needs to have pathways that maximize user adoption of features within each tier. In addition, the product needs to create pathways that enable users to seamlessly upgrade to higher tiers without requiring high-touch sales engagements. The extent to which a product is able to minimize friction in adoption and continuous use determines the efficiency of the expansion growth engine.

Expansion efficiency can be measured through Net Dollar Retention (NDR). A simple way to think about NDR is as the percentage of revenue from current customers that is retained from the prior year, after accounting for upgrades, downgrades, and churn. A NDR of 100% implies the product retained the same revenue from existing customers; anything over 100% implies expansions grew faster than downgrades and churn.

NDR = (Starting MRR + expansion – downgrades – churn) / Starting MRR*100

NDR benchmarks average around 105%, with best-of-breed companies averaging around 130%. Anything below 120% implies that the product may be too reliant on the new customer acquisition engine as the only growth engine. This should call for a deeper evaluation of the health of product adoption and retention.

Growth Engine 3: Connected Ecosystems

A product that has figured out efficient acquisition and expansion obviously has a lot going for it. By most financial and operational measures, these products can look extremely healthy and capable of achieving and sustaining market leadership. Yet, the last decade has taught us that there is a new breed of competitor in the market that competes on network effects. These so-called platform players (e.g., Apple, Google, Salesforce) can outcompete fairly successful products using the power of their extensive ecosystems. Today, software products need to be aware of this competitive threat and proactively respond to it by building vibrant connected ecosystems of their own. Connected ecosystems accelerate product growth through network effects while concurrently creating a moat that helps the product survive the competition from dominant platforms.

So what do I mean by a connected ecosystem, and how does a product build one? In simple terms, it is about creating mutually beneficial connections between your product and other third-party products and services in order to deliver more value to users. These connections transform the go-to-market of the product from a single dimension go-to-market — “I make, I sell” — to a multi-dimensional go-to-market — “We make, we sell.” The deeper and more meaningful these connections are, the stronger the resulting network effects will be. Over time, strong ecosystems drive the majority of growth.

A product needs to plan for potential ecosystem integrations long before the need arises. Building an extensive ecosystem requires open APIs, data integrations, workflow integrations and various forms of interoperability with third-party products. These are easier when the product is built on an open architecture and adopts open standards. For many products, building connected ecosystems involves building a connected marketplace of related products and services that integrate, add, extend and enhance the product. While common in B2C, this is becoming very common in B2B as well. Examples include Red Hat, Segment, Adobe, just to name a few.

What are some ways of measuring the value of these connected ecosystems and the network effects they create? There is extensive research on this topic and it could be a subject of a future article. Products with vibrant ecosystems see significant increases in customer Life Time Value (LTV). Ecosystems can often generate over 60% of a product’s revenue.

Summary

The three growth engines of efficient acquisition, efficient expansion and connected ecosystems are important for building successful digital products. These engines complement each other and can drive significant growth for best-in-class digital products. Planning for these growth engines early makes a big difference and is significantly less expensive than rearchitecting products. Product teams need to incorporate key drivers for each engine in the architecture of a product, the design of user experiences and the go-to-market. Together, the three growth engines provide a connected playbook that can help product teams create successful digital products.