Do you still believe freemium has not run its course?

Let me start by reiterating my past objections about giving Apps away for free in the hope of getting attention now and monetization later. Call it by whatever portmanteau you wish – freemium etc. or use the justification that free is free marketing. It does not matter if customers are not hiring your App for a job they are willing to pay for and you do not take the time and effort to understand customer jobs and position your App for the right job.

The App economy tempts us all with billion customers – small percentage of a large number is still a large number. But trying to target billion customers is what SurveyGizmo CEO described as shotgun approach to marketing.

And guess what? You are not the only one with the same shotgun – the App ecosystem has made the same shotgun available to everyone. There are many just like you and their App just like yours with the same hope of converting the same 1-2% of users into paying customers.

With hundreds of thousands of games, productivity tools and other apps already on the market, and thousands more launched every week, many startups are finding that their ideas aren’t so unique after all. (source)

With all these thousands of look alike Apps, the small percentage of large number becomes small fraction of the small percentage of a large number. Which I assure you is a really small number.

The odds of striking gold in the apps business are quite long. While there are more than 800,000 mobile apps available in Apple Inc.’s App Store, only 80 of them generated more than $1 million in revenue during the fourth quarter, according to research firm Distimo

That is the chances of an App making $4 million a year is 1 in 10,000. And there is no point in trying to do expected value math here because the winner takes it all.

And it turns out Free is not even close to free marketing or to be precise marketing is not free even for free Apps. If you want any thing close to decent installs (let alone frequent usage) it takes considerable marketing resources.

In this environment, well-heeled companies with big marketing budgets hold sway.

It gets worse than Free – you end up paying users to install and tell others about the App as the App maker Mouthee found out

Mouthee ran promotions—giving out free iTunes gift cards or other gifts to users who signed up their friends—which would bring a spike in downloads, but the boost would taper off after a week or so,

Let us recap the App situation

  1. There are hundreds if not thousands with App just like yours
  2. They are free as well
  3. Free isn’t free marketing and marketing isn’t free
  4. Building passionate user base is a myth and the chances a newbie App maker without marketing resources will make it into Top 250 is less than 2%
  5. Chances your freemium App will make $4 Million a year is 1 in 10,000

Finally even when you gain millions of installs, your users can stay on free version longer than your startup can stay solvent,

There are so many startups that die with a whimper

Do you still believe freemium has not run its course?

Cast aside these fads and start with the business first principles to go from plan to profit.

Start with the customers, not your App. The App could be new but the customer needs are not. Whether it is a “bits” product with zero marginal cost or “atoms” product with non-zero marginal cost, customer needs come first. In fact, it is not a product until you have identified a set of customers whose needs you meet and who want to pay you for that value.

Make your choice. Successful strategy involves making choices. You cannot treat billion users as customers. Getting 90 percent of customers to take free Hershey’s chocolates with the hope that they will pay more for extras or will upgrade later is not a strategy.

Get your fair share of the value created. Charging for the product is still the simplest of all business models. Product and platform innovation do not mean business model innovation like freemium (which should never be called a business model). If your product adds compelling value to customers, charging for it is simply getting your fair share of the value created. You do not have to be ashamed of making a profit.

How do you go from plan to profit?

When segmentation fails do you pivot to a new one?

A few months back this is what I wrote about economic value add for business vs. consumer segments while writing about price of LED bulbs,

Here is a case study done by US Department of Energy for LED bulbs. The initial price is almost twice as much as traditional lighting systems. While consumer segments most likely are not willing to pay twice the price for LED, business segments are. That is if you show them the value.

For instance, you and I may not mind changing light-bulbs every year because our opportunity cost is $0. But for businesses there are real costs associated with maintenance. Every bulb change avoided is not only savings in bulb cost but savings in maintenance costs.  If you add these all up, despite the high initial cost, the LED systems  deliver 9% in total cost savings over the lifetime.

Then I went on to show the economic value add from switching to LED bulbs

led-evaIt seemed no brainer to start with the business segment that had real costs and savings (and budget to spend),  show them value using hard numbers and gain adoption. So did Cree, the maker of LED bulbs, think. Cree based their strategy on a similar analysis that pointed to increased adoption by businesses because of energy and labor cost savings from switching to LED bulbs.

As it turns out their segmentation strategy did not work out and they decided to shift focus from business segment to consumer segment,

the company is making an about-face. Durham, N.C.-based Cree is putting out a new line of bulbs built around light-emitting diodes, or LEDs, for the masses in hopes that greater use by consumers will eventually affect the choices made at their offices

Why did their initial segmentation fail to pan out? There are two main reasons I see,

  1. Value Waterfall – As someone who defined value waterfall, even I failed to take this into account while I did the economic value add math for LED bulbs. Despite the real value there are several aggravating factors like cost of doing business, trust discount, switching costs, etc. that knocked down perceived value.
  2. Pricing Model – The LED bulbs are priced twice as much as incandescent bulbs and deliver their value over long period of time.  That is the LED pricing captures value upfront while delivering customers value over time. A better model for businesses would have been a subscription pricing model based on usage. Cree needed monetization model innovation to go along with their product innovation.

I do not believe their segmentation failed nor do I believe they need to switch from business to consumers. But Cree believes,

The bet is that light bulbs might follow the same trajectory as touch-screen smartphones, whereby consumers grew comfortable with the technology at home and then insisted on having it available at work.

While that worked for phones that we use everywhere and at work and think of it as part of our self the same logic does not extend to light bulbs what are simply part of the environment.  Besides how can they get consumers to pay twice the price when the economic value add math does not add up and the fact that it does not have aspects of conspicuous consumption like a smartphone does?

I wrote recently how monetization model innovations follow segmentation. Cree’s segmentation was not wrong it is their product positioning and monetization model that need to be realigned to the business segment.

When your well thought out initial segmentation fails it does not mean you chose wrong and you must switch to a completely new one. Segmentation is a strategy and changing it is not like a product pivot. And there is no guarantee you will succeed with the new segment if you commit the same mistakes you committed with targeting, positioning and pricing with the first segment.

How do you choose your segment and what do you do when your product fails to get traction?

The Simplest of all Business Models

Wi-Fi Signal logo

If you want to use Wifi at Pete’s Coffee & Tea you will have to buy something first.  At the counter they give you a code to use, that allows you about an hour of surfing time.

In many local coffee stores you technically have to buy something but once you do, you can stay parked in their tables for hours without buying anything. In Pete’s bigger competitor, Starbucks coffee, it is the similar unlimited free access plus access to premium extras like The Wall Street Journal.

Coffee shops complain about those who occupy tables for hours at a stretch, buy little or nothing and mooch on their bandwidth as well as electricity. Customers who do spend money at coffee shop and need good connectivity for an hour or two complain about the poor speed and difficulty in finding tables near outlets. General customers (who hire the coffee shop for, coffee) complain about the crowd and lack of seats to simply sit and enjoy their brew or have a conversation.

Free Wifi became a popular perk for coffee shops, restaurants and hotels to attract customers and keep them in their shops. If the customers chose your business over others because of free Wifi, you win. If the customers stay because of free wifi and continue to spend during their stay, you win. You have successfully used free wifi as lead generation tactic and customer retention  tool. (Freemium?). For instance, Panera bread saw its sales increase by 15% when they introduced free wifi.

On the other hand, what is free to customers, is not so to businesses. There are costs of operation (making sure there is enough capacity) and opportunity costs (both for the money spent on their big pipe broadband and the moochers). When everyone else offers free wifi it becomes difficult for a business to either stop offering it or start charging for it. Add to this customer dissatisfaction from providing poor internet service.

Look at where we are in the discussion. We are not talking about the compelling value proposition a coffee shop (or a restaurant) offers but talking about a perk. Let us not forget the primary job these businesses wanted customers to hire them for. If customers’ choice is made based on secondary and tertiary factors, the primary value proposition has become irrelevant. If a business fears their customers will walk next door for free wifi they are admitting that their product is an easily replaceable commodity.

That is a bigger problem they ignore while fretting about wifi costs. In focusing on free wifi as lead-gen activity they ignored the core customer segment they started with and the customer jobs they hoped to serve. While some may call free wifi (and Freemium?) as business model innovation, this is essentially losing sight of customer needs and your core competence.

If the customers didn’t hire your coffee shop for coffee, should you tie your business model to selling coffee? That is an incongruence between value creation and value capture.

On the other hand your strategy – to serve the most amazing coffee – need not be fixed. You can see the customer shift and decide your strategy is to serve those customers who have a connectivity need and are not satisfied with existing alternatives. You recognize customer issues with poor speeds in free wifi places and provide reliable speeds as differentiated feature. In such a case you cease being a coffee shop and become a workspace provider. And guess what, you now can charge for that value delivered.

The business model is back in sync with value capture matched to value creation.

That is exactly what is happening in Russia’s Clock Cafe.

“You don’t have to pay for coffee or tea or cookies. You should pay for time, and time costs — I hope — [are] not that expensive.”

And their target segment? Students and business folks who hire them for connectivity and hence pay for the value they get.  Nicely done. However, I think they fixed one mistake but introduced another – making coffee free. There really is no reason for them to offer free coffee, especially the premium kind they claim they deliver,

We have cappuccino, latte, espresso, Americano, and our coffee is not the cheap one

They are committing the flip side of free wifi at coffee shop mistake. Sooner or later they will run into the free wifi problem in reverse. Why bother with coffee or why not charge for it? Especially if the customers didn’t hire you for coffee?

When it comes to business strategy, starting with customer needs and choosing the ones that you can serve better than others remains the best approach. And when it comes to business models, charging for value you deliver remains the simplest of all approaches.

What is your strategy? What is your business model?

Should your startup be business model driven?

Zipcar CEO Scott Griffith described Zipcar as business model company. He was likely alluding to the shift  from buying and owning for expected future usage to on-demand rent culture. You likely are thinking isn’t that what other car rental companies do, but I will give benefit of doubt to  Zipcar and interpret this fine granular renting. The essence here is how he saw his venture – as an entity that is business model driven and if I may take it to extreme, a business whose sole purpose is about business model disruption and business model innovation.

There is considerable obsession around business model. When you read advice columns from startup accelerators and their ilk., you will see the chatter on business model canvas, what is the right canvas, business model innovation, recurring revenue, subscription model etc.

In the words of Netflix CEO Reed Hastings I would like to say here, forget the focus on business model and business model driven venture strategy. All this obsession about business model is just plain wrong.

Now that I made by bottom line, let me start over from the beginning by asking

What is a business model?

Most treat business model as just monetization models – Ad revenue, affiliate income, subscription model, pay per use etc. That is only part of the equation. Scamming is also a monetization model but is that a viable business model?  Does the money you take as your revenue represent your fair share?

The correct and complete definition of business model should include first the total value created and then how you get your fair share.

Business model is how you create value for your target customers and how you get your fair share of that value.

If you did not help create value you cannot get your share – well you can but you should not and it isn’t sustainable. Value creation is the prerequisite.

If you look at value creation, the obvious step before that is customers with their unmet needs. You create value through your product or service innovations that fulfill those unmet needs better than any other alternatives available.  If you see customers and their unmet needs as the invariable here then it is not too hard to see that there is no such thing as a business model company. There are only customer driven companies. And if you choose to be business model driven company at the expense of customers and their needs you will find yourself getting disrupted.

Once you established clear value the simplest way to get your fair share is what Instapaper’s Marco Arment said – charge for it. Does this mean there is no need or room for innovations on the second part of equation – the monetization model (what most incorrectly call as the business model innovation)?

Absolutely not. Such innovations should be second order after you have clearly established your customer segment and your value creation innovation. Examples of such monetization model innovations include (but not limited to)

  1.  In the value chain with just you and your customers you can introduce a third (or a fourth) player with each indirect value flows. You create content that is of value to customers, who create value to third parties and you get your share from these third parties.
  2. If customer value realization occurs only in spurts then you can design a subscription model that is aligned with value realization.

But if the job customer hired your product for gets better alternatives and your product gets fired because of that reason then it does not matter how you choose to get paid for the job.

The questions you ask are not

  1. Does by business produce recurring revenue?
  2. Does my product create switching costs?

but

  1. Do customers get recurring value from my product (and hence am I getting a fair share of that recurring value add)?
  2. Does my product continue to improve to stay relevant such that it creates better value than any other alternatives?

Not the shift from you to customers in the second set of questions.

There are no business model companies, only customer centric companies.

Surely you are not surprised by Groupon woes?

Update 11/1/2012: Groupon valuation is back in news because of its rival LivingSocial’s woes.

In Amazon’s 10-Q filing late Friday afternoon, it disclosed that Living Social saw revenue of $372 million for the nine-month period ended Sept. 30. While that is up 120% from the same period last year, it reflects third-quarter revenue of just $124 million – down 10% from the June period.

If that sequential drop reflects an overall weakness in the daily deals business for the third quarter, then it implies potentially disappointing results for Groupon when it posts its own results for the period next week,

When valuing a company’s stock it pays to understand what pressing customer needs it serves and what unique value it adds. That is assuming you are Benjamin Graham, Warren Buffett type investor who takes the time to understand the business before investing.

Business model is value-creation and value share. A business that creates net new value for its customers gets to share in it. A business cannot get its share of value it did not help create, let alone grow exponentially.

If you are such an investor then Groupon’s announcements about lax controls should not come as a surprise to you. I am not referring to the $2 drop in its stock today but the news that led to it.

It is hard to describe Groupon’s business. In fact even Groupon is not clear about what it is.

For starters, it is a two sided market. It essentially brings together small businesses on one side and end consumers on the other side.

In general a two sided market adds value by unlocking value, creating new value or removing inefficiencies. It then gets its fair share of the net new value added. A two sided market must be consistent in its positioning – it must serve as the enabler for the jobs the two sides are seeking to do. There should be no asymmetry.

Take for example, eBay. It positions itself as the market place for buyers and sellers to find each other. No asymmetry here. EBay adds value by enabling transactions that otherwise would not have been possible.

What about Groupon’s role as two sided market?

What is its positioning to deal seekers? It tells them about, “one ridiculously huge coupon everyday” and its tag line is, “Collective Buying Power”. In other words it wants the deal seekers to hire it as a sales channel to buy products at steep discounts.

What about its positioning to small businesses? It tells them about, “guaranteed new customers”, “big exposure”, and “measurable marketing”. The story line goes, “these customers fall in love with your service and visit you again and again, paying full price”. In other words it wants the businesses to hire it as a marketing channel.

That is asymmetry (to put it mildly) in its messaging. Groupon cannot be a sales channel to acquire ridiculously huge discount and a marketing channel to acquire valuable customers at the same time.

What value does it add?

Businesses bring value to the table in the form of 50% off discount. Deal seekers add no value but get 50% off. Groupon gets its share of 25% from the businesses.

 

You bring a full pie.
Give half of it to my email subscribers.
Give half of what is left to me.
Take home the rest and wait.
It will not only grow to become a full pie, it will multiply into many full pies.

To repurpose Omar Khayyam, “the deal seekers having scored a deal, move on. No level of customer service will bring them back to pay full price for your cupcake they can get for 50% with their next coupon in the bakery next door”.

There is no net new value add. Just value distribution – from businesses to deal seekers and Groupon.  Groupon cannot take its share of value it did not help create.

So we have a business that most do not understand, even it does not have clarity on the needs it serves and adds no new value. How can you place a valuation on such a business?

Surely you are not surprised that such a confused business finds itself again in the accounting hot water?

There is a WSJ report that SEC may investigate Groupon. I see no reason for such an investigation at the expense of taxpayers. If irrational investors want to bet their money on a business they do not understand or chose not to understand, why should they be protected?

We need regulations because our original business plan didn’t consider these disruptions …

A Cajun food cart in a food cart cluster in SE...

For anyone studying business model disruptions, a rich case study is unfolding across the nation, from coast to coast, one food cart at a time. Let us not make this a culinary argument and look at this purely from business perspective. If you have not been following the stories here is a summary,

Food carts are restaurant on wheels. They come in all flavors and with clever names (Curry up now). They are showing up in office parks and business districts, catering to the lunch crowd. And that is the problem for traditional  brick and mortar restaurant owners – the trucks are right at their doorsteps and eating their lunch (pun intended). The restaurant owners don’t like it!

Let us look at this in two parts to see the disruption. As I am wont to do, let us start with customers.

Customers/Customer Needs: Anyone with money to spend during lunch is a customer. Why are some willing to give up the sit down comfort and service of restaurants and try food carts? There is no one reason, there are always utilitarian and emotional reasons and it is the degree of intensity that varies for different customers.

Some were hiring the restaurant just to satisfy their hunger and they are happy to hire any other service that does the same job faster/better/cheaper. Some hire the restaurant for the experience but not likely all the time. In some cases they may be hiring the food cart just for the novelty and experience.

If you look at the comprehensive list of purchasing occasions you will find there were enough jobs for which the restaurants were hired only because there was no alternative. When food carts arrived the customers are happy to fire the inferior candidate and hire the new one.

The Incumbents: The restaurant owners had a nice run. Their product was hired by customers for lots of jobs even though it was not the right fit. Do not get me wrong, there are many other jobs for which restaurants are the right fit and rightly capture their share of the value add. But the rest of their customers incurred higher transaction cost for the value delivered. These segments were right for picking by anyone. Restaurants were however only too happy to serve the same product at the same price to all their customers and now see that advantage vanish.

Their reaction can be summed up nicely by the comments made by their rep in KQED’s Forum interview,

“Our original business plan did not take into account these food carts taking away our customers”.

Isn’t this a luxury every business would like to have?

That is the core problem. Disruptions don’t telegraph their arrival. Uncertainties are the unknowables. You can’t ask for protection because of your failure to model these uncertainties.

If disruptions these are the unknowables how can they model these?

There is really only one way – starting with customer segments and asking what jobs are the different segments hiring your product for.  If your product is not the best candidate for each one of those jobs it is currently hired for it will be disrupted. The flip side of my earlier statement, “anyone with money to spend is customer”, is , “anyone goes after that money is your competitor”. And they do that by doing the job faster, better, cheaper.

If the customers hired your product  only because of lack of alternatives are they really your customers to begin with?

Your failure to focus on customer needs cannot be fixed with newer regulations to stop the disruptors.

We all hear about customer loyalty and the need to focus on increasing loyalty. Loyalty cannot stop disruption. If you do not want to be disrupted it is you who should show loyalty – loyalty to the job your customer hired your product for, doing the job better than anyone else can.