Last week I wrote about finding the right business model for your startup. But many startups aren’t convinced they should even have a business model (yet). They claim “our current priority is growth.”
In my experience, the right business model not only supports sustainable growth in the long run, it can drive faster growth today. I’ve found three primary reasons for this:
- “Free only” offering freezes prospective users Site visitors often face a “what’s the catch?” moment when downloading free software that doesn’t have a visible business model. This is particularly the case when users respond impulsively to an advertisement – without the assurance of press or a trusted referral from a friend. I discovered this dynamic a few years ago when I sent visitors to a landing page that made no mention of our premium product. I had no idea why these users were dropping out of the acquisition funnel at such alarmingly high rates. Bigger download buttons and snappier headlines didn’t solve the problem. It wasn’t until we surveyed users from impulse sources that we realized the primary problem was that people didn’t trust our claim of having a free product. Once we knew the cause, solving this problem was easy. By simply giving these users the alternative to download a trial of the premium product we were able to triple the download rate of our free product. This experience demonstrates the risks of a startup that makes no mention of a premium product anywhere on their site.
- Business customers looking for sustainable solutions It takes time for a business to implement a new IT product or service throughout an organization. This implementation cost often exceeds the direct financial cost of buying the product. So when a business sees that you have free offering, they will be hesitant to standardize on your offering if they worry you don’t have a sustainable business. Even worse, they may fear that you are generating revenue through more nefarious ways such as selling their information. Business buyers are usually more concerned with eliminating risks than saving the company a few dollars on a free offering.
- Hard to get aggressive on unproven assumptions Committing to aggressive acceleration is difficult when your business is loaded with unproven assumptions. For example, imagine you get an opportunity to bundle with the next release of a popular complementary product. They want you to pay $4 per user (free or paid) and your Excel model predicts upgrade rates that will give an average lifetime value of $6 per user across your entire free and paid user base. Great, this looks like a safe bet. But when the company tells you they’ll drive 1 million new users per month, you start worrying. If your assumptions are right, you’ll generate $24 million in annual ROI – enough to put you well on your way to an IPO! However, if your assumptions are wrong, you’ll probably go out of business. Generally you won’t decisions on this scale, but the example demonstrates why it’s a lot harder to aggressively grow your user base on unproven monetization assumptions.
I realize it can be a bit nerve-racking to implement your first business model, particularly if you have strong organic growth. But it’s not a moment of truth you should dread – instead it is a baseline that you will work to improve over the life of your company. Business models can and should be honed over time to increase the value of your users whether or not the first iteration is fruitful.
Of course, if you have an extremely viral product, then a business model may in fact hamper your growth. But ultimately you’ll still need a business model to monetize this growth, so you might as well figure it out early.
One more reason, related to #3, is that charging money ensures that you’re building the right product. Behavioral economics has shown that users’ behavior changes when money is involved, even if the difference is as small as going from free to $0.01. By charging early your customer development process is often more likely to yield the right feature set for the right customer demographic.
I have a curiosity question about #1. When you surveyed those users that were dropping out of the acquisition process, did they actually say tell you that their concern was related to the lack of apparent money making strategy? Or was that something you figured out through piecing together answers?
This obviously isn’t directly relevant to the idea that a business model that isn’t “free” can actually drive growth–which is an extremely interesting one–but it brought up an aspect of the survey process that I’ve wondered about.
Interesting insights, especially the notion of “framing” the free option in relation to the paid one. A related point I would make is that making a paid offering part of your initial business plan projects confidence. Tacking on a premium later comes across as desperate (probably because it often is).
As an example, I’m increasingly coming around to the view that Twitter is a revolutionary communications platform that will have far reaching implications on many businesses. But does that mean the founders can successfully roll out an ROI-positive revenue model? I’ll believe it when I see it.
So refreshing to read this, Sean. Our beta customers, who are paying nothing for the first year, have been some of the most, ahem, time consuming to work with and have taken the longest to implement our product into their organizations. Those who are paying are jumping right in, asking less questions and are just excited to get going. They’re also the happiest with us verbally and online.
As we roll out products for new industries, we know that beta customers can be great, but we’ve decided that they have to meet two criteria:
1) Do they look good on our customer list?
2) Will they be responsive and helpful to us in the development of the product?
Luckily, in most cases, our current betas fit that criteria, but the experience has made it a lot easier to say “sorry, we don’t” when we get asked about trial periods. The perceived value is so much higher on a product people have to pay for.
@Evan – Good questions. The survey was targeted only to users that registerd but didn’t download and asked why they changed their minds. A majority said that they didn’t believe that it was really free. Once we showed them that we also had a paid version, the download rate improved considerably.
NC – sorry it took me so long to approve your comment. I just noticed that it was lost in a bunch of comment spam. Very good point on free users often being more work than paid users…
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Oh for the ability to effectively pin down that elusive viral weasel! Getting it right once is a challenge, consistently doing so is the holy grail. What are your insights on repeatedly getting viral campaigns to do just exactly that?