Sorry this is long, but it covers over 20 years, is relevant, and has a
happy ending!
I'm just old enough to have lived through a full cycle of: Charge, Don't
Charge (don't even worry about profit), then Maybe Charging is Good.
When I started my first tech company in 1987, there was no thought
to giving stuff away, except to magazine reviewers, resellers, etc. It
was clear: you make something, add value, and charge for that value
so you can feed yourself and your employees and go on to serve your
customers over the long-term.
When I joined a VC-funded startup in 1999, the basic premise of
charging had flown away somewhere.
It wasn't this startup's fault. It was mainstream thinking, which was
allowed by relatively easy investment capital and an enthusiastic
public, which included part of the public willing to buy IPO shares. It
was a lot of fun for a number of years! And yes, I was part of the
public buying shares in Red Hat and others.
But VC taken before a business has any concept of revenue hurts most
businesses. It works out great for 5-10% and terribly for 90-95%. It
may actually be fine for the investors because they're investing for an
ROI over an entire portfolio (and there's nothing wrong with that -
that's their business).
But for most of the entrepreneurs and their employees, they never
found sustainability and their businesses (and many jobs)
disappeared.
Entrepreneurs and investors started to see the mistake over the past
decade. I think it's really refreshing.
I think we're seeing a return to centuries of basic business: offer
something of value and charge for it. Money is just a means to express
& exchange value. A growing, enthusiastic, paying customer base is
validation that you're onto something real, something long-term
that's not a one-in-a-million exception.
I've read the book, "Free," and I know there are other currencies that
are not monetary, such as Reputation & Attention. Those currencies
express value, but as the book points out, you still need a way to
convert some of that currency into cash, because you still have bills to
pay.
I co-founded Engine Yard in 2006 with 3 other people. We saw a
market need and went after it. The market responded quickly and was
happy to pay cash for the value we offered. By the time VCs called us
the following year, we had strong customer & revenue growth.
VC made sense to expedite things we thought were really important to
the whole community, such as supporting a number of full-time
open-source contributors in our technology space. Investment is not
bad or evil, it's just a tool. A good business model is the foundation.
When I left Engine Yard this year, I looked back at the pain points.
One big one was summed up with the thought, "Billing is a B*tch!"
Pardon my language, but it was indeed for us and for hundreds of our
customers who also have recurring revenue businesses.
When we started out, we were happy to get a new customer every few
days. It was pretty easy to put their credit card & monthly amount in
one or another system from our bank or accounting package and let it
do recurring charges each month. But that breaks down VERY quickly
as the business grows.
Customers have a long-term relationship that changes often: they add
& remove services, charges need to be prorated, their credit cards get
declined or expire, and we need reports on all of that activity. We
wound up with data in several places and with several people involved
to make sure everything stayed on track.
It's not easy when you have 100 customers and it's a rat's nest when
you have 1,000 customers. It gets to a point where there are invoicing
and payment issues every day that need to be followed up with
customers. And customers don't like mistakes with their money!
Engine Yard developed software internally and bought software
externally to solve these problems. But the effort and expense was
still pretty high, and far out of reach of most entrepreneurs and SMB
customers.
So I joined Chargify to help solve this problem affordably for
businesses of all sizes. Frankly, I don't know why the world didn't
offer such a service years earlier from a great company like 37signals,
but I guess the timing was right for someone to start this in 2009.
2010 may be the year when business thinking comes back to basics
at the same time that it becomes simple & affordable to manage a
recurring revenue business.
Happy New Year!
A recurring theme ever since I started writing this blog (and indeed before) has been my concern to see more robust business models adopted by SaaS and cloud players. The second most-trafficked posting here in 2009 (and the most liked by those expressing a preference) was What have we done?, which appeared in February at the nadir of economic pessimism. In the ensuing months, optimism has made a comeback, and with it I’ve noticed a renewed enthusiasm for the revenue-lite business models I rued in that post. At a time when traditionally we wish each other prosperity in the New Year to come, it seems appropriate to review the arguments on both sides of the free-versus-paid debate. Is it better to use viral marketing to reach the largest possible user base in the belief that revenues will surely follow, or should entrepreneurs and start-ups rely on predictable customer revenue streams right from the outset?
I know that many VCs still favor the approach espoused by the likes of Twitter and Facebook, which uses venture funding to grow a dominant user base before worrying about revenues. Personally, I see some big flaws in this model:
- It’s difficult enough to pull off in the consumer market, much tougher still in the business market, even if you’re targetting the volume small business market or professional individuals.
- If people are going to point to Facebook’s growing revenues as proof that the model works, I’d urge them to look under the covers at where exactly these revenues have been coming from.
- It looks a bit too much like pyramid-scheme economics to me. There are a handful of well-publicized success stories, and hundreds of forgotten or unheard-of failures. That’s fine for the VCs who back the winners, but it’s tough on the entrepreneurs and angels who lose out.
My preference, often expressed throughout the year, is for sound business revenues, earned in exchange for delivering real business value. I think this is especially true for providers that target the small-to-mid-sized business market, since these in the main are organizations that themselves earn their revenues by producing real goods and services of value and selling them to customers. This is a sound, stable, reliable source of revenues that’s relatively recession-proof if you spread your footprint wide enough. Selling concrete, measurable services plays well with larger enterprises, too, but it takes longer and costs more to close each deal, so you need to be careful you’re not spending more on customer acquisition than you’ll earn back once they finally sign up.
Giving away some services for free still has a role as part of a marketing strategy to help get your company in front of prospects for your paid services — popularly known as ‘freemium’. But it must be carefully costed, monitored and managed — for more on this, see How to make freemium pay and What your bank can teach you about freemium. Too many start-ups are masquerading as would-be Facebooks or YouTubes — persuaded that they’re ramping up user numbers in readiness for future revenues, an IPO or a successful sale to Google — when in fact they’re just executing badly on a freemium strategy. Even Chris Anderson, whose 2009 book, Free: The Future of a Radical Price, doesn’t actually believe in giving stuff away without a sensible freemium strategy in place, as he told John Gapper of the Financial Times:
“When I refer to a ‘new economic model’, I’m not referring to slapping advertising against stuff, which dates back centuries. Instead, I’m talking about the underlying economics that allow Freemium to work … I think that creating business models around Freemium — what to charge for and what not to, a question determined as much by psychology as economics — will be the most interesting, and lucrative, efforts of this online era. And the book, both in its chapters and its tactical advice at the back, is intended to help guide that.”
It’s important to think about diversified revenue streams, rather than pinning everything on a single source, whether it’s subscriptions, advertising, or some other mechanism. A company like Google may seem to be an unchallengeable leviathan with its billions of dollars in revenues, but it’s far too dependent on the single engine of Internet advertising for my liking. Its enterprise division is crucial to the company’s future in establishing a second, subscription-based revenue stream, and if I were in charge over there, I’d be putting even more energy and investment into ramping up that part of the business. On the other hand, most SaaS vendors are too dependent solely on monthly subscriptions. Consider several different revenue options:
- Subscription is widely used but can be complex to administer and is often difficult to price in relation to variable costs before you get a broad base of customers from which to establish usage patterns. Adding some element of pay-for-usage helps to offset some of the risk of bundled pricing but instead lands customers with the forecasting headache.
- Advertising can help fund freemium plays and viral marketing strategies but doesn’t always play well in the business market. Be careful where you use it, so that users aren’t distracted by advertising from completing tasks; and beware of ads that give competitors a presence inside your application or which introduce content that undermines your positioning.
- Transaction fees are often overlooked but in fact are the most proven Web revenue generator. This is how web giants including Google (by taking a cut on advertising transactions), eBay and PayPal all make pots of cash. Done well, it can be a huge, invisible money-spinner.
- Digital goods is the new term for any virtual, third-party service you sell within your own online service. I find the term misleading; it originates in the games industry, where digital goods are usually performance aids that players buy, but in a business environment the service may often be performed by a real person acting remotely. I’ve called it promotion or placement in the past and I see it becoming bigger than (and partially replacing) online advertising over time.
My final word of advice is, remember to collect! It’s astonishing how often SaaS and cloud providers belatedly realize they have a huge backlog of unpaid invoices, disputed bills and canceled credit cards clogging up their cashflow. Make sure you think about the entire order-to-cash cycle (and how to automate it), not just producing the bill. For more on this topic, watch this short video I recorded a year ago: Phil’s top 3 SaaS monetization tips. And I wish all my readers a happy — and prosperous — New Year.
