Issue v0.10 – Business models aren’t changing, but the way we use them is

written by Brad McCarty

Money. If it weren’t for those five little letters and what they represent, life for startups as well as established companies could be so much easier. But as honorable as the pursuit of a business that simply fills a need may be, at the end of it all the bottom line will still matter. We’ve seen one grand-scale bubble burst and, with rising valuations, it’s argued that we’re on the verge of yet another. But how are today’s companies different? What are they doing to make a viable business out of thin air? Let’s dive in, talk to the experts and get their take.

From Whence It Came

It could readily be argued that the methods by which companies are earning money are absolutely nothing new. In fact, as Foundry Group Venture Capitalist (VC) Brad Feld states, “we have twenty-five years of looking for new business models but we’re yet to actually find one.”

I had posed to Feld the general questions of how companies today were monetizing themselves, what was working and what wasn’t. In response, his answer was simply that there’s nothing new being done. Subscriptions, advertising and freemium models abound, but the same has been true for the past two decades.

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Though Christine Tsai of 500 Startups would argue that perhaps the innovation is in how the traditional models are being used. Much like Netflix changed the way that we rented movies, companies like Birchbox, Uber and Twitter are changing the way that we see transactions.

Uber’s method is quite transactional, but manages to be simultaneously transparent and invisible. You’ll order a car via your phone, then you’ll see your total when you arrive at your destination. If there are up-charges, such as often happen during times of peak activity, you’re forewarned. But the very fact that you only enter your card information once means that you’re not constantly being so heavily reminded of the money that you’re spending. For many, the very act of swiping a card through a reader is enough to turn them away from a purchase. Uber’s answer? Get rid of the reader.
Birchbox, for instance, provides “beauty, grooming and lifestyle” products. But unlike heading to your local drug store, these items are likely not ones that you’ve ever tried before. Every month a new box lands at your door and you have the ability to sample products from upstart as well as big-name companies. The entire process is handled via a subscription and it charges to your card of record at a regular interval.

Seeing Reality

But it’s important for companies to enter any sort of long-term subscription agreement with a healthy dose of rationality. Feld is quick to point out the caveat of such setups, stating that companies absolutely have to “understand the long term value of the customer.” TechStars Boulder Director Nicole Glaros takes that a step further, riffing on the Valley-centric mentality of “users first, money second.”

“I really like to see companies that have clear revenue models and that have revenue potential. It’s OK if they have multiple potentials because often they’re wrong anyway. But the “we’ll figure out it out later” companies are scarier.”

Glaros says that it’s not just a matter of having a singular idea, but rather there has to be a viable long-term revenue potential.
“If you can’t figure that out then you’re in trouble.”

But what about the exceptions to the rule? We’re six years into the life of Twitter, three years into Foursquare and even the behemoths like Facebook are still finding the right model to monetize their massive base of users. It’s important to note that the methods that worked six or even three years ago are less likely to be successful today.

“Freemium models work,” says Glaros, “with enough user traction. But you have to understand that, with freemium, 1 to 2 percent is a high conversion rate to paid.”

So where are the problems? Glaros continues, saying that an issue she often sees with TechStars applicants and the companies for which she is a mentor is that of undervaluing their products, though she’s quick to admit that finding the right price point is hard.

“Look at the market. If you have a better product, don’t charge less money. We don’t live in a world where people are competing on price. We’re competing on value. Companies are starting to understand that users are willing to pay for things that they see value in.”

She uses Dropbox, the cloud-based file storage and synchronization service, as an example. “Once you use it you won’t use anything else. The [free, included storage of] two gigabytes just isn’t enough space.”

What’s Next?

If the models aren’t changing, but the ways that we use them are, what is the next step for bringing more numbers to the bottom line? For that answer, we’ll head back to Christine Tsai and her example of Twitter.

“Companies that are doing native monetization are interesting. These are the ones who can generate revenue with their own platform or product. For Twitter that’s sponsored Tweets.”

Sponsored Tweets, for those unfamiliar, are called “Promoted Tweets” by Twitter. These are Tweets which will display prominently within all official and some third-party clients. They’ll appear in search results and they are priced on a scale of relevance, which Twitter calls “cost per engagement” (CPE). This CPE model means that a buyer only pays when the message is favorited, retweeted, replied to or clicked.

Facebook has recently expanded its own version of the same method, allowing some users to “Promote” a status update for as little as $7. Though it’s interesting that the promoted status product is only being tested on users with fewer than 3,000 connections, and it’s not yet available to businesses and their Facebook Pages.

Circling back to Brad Feld, he brings up the interesting point that perhaps the payment providers are due more credit than they’re being given in the revenue race. While, for years, processing credit cards required expensive contracts with large companies, upstarts such as Square and Stripe are opening the market to individuals and companies that might not otherwise have had the ability to accept cards for payment.

But Tsai asks whether it’s a chicken-or-egg solution, in that it’s unknown whether these companies arose due to an increased desire for more people to use them, or if their existence is directly leading to an increase in revenue-bearing companies.

Of course there are also the alternative revenue streams, such as data, but even those are reaching the point of being tenuously-viable. As Tsai tells me, to 500 Startups, data as revenue “isn’t that exciting. Do they know how they’re going to make money? It’s not that convincing unless they have a lot of traction by the time that they meet with us. It’s just not a very promising business model.”

The discussion comes full circle when we refer back to TechStars’ Glaros. “Build a product that your customers love. The rest will come.” Then, referring to the viable-but-shady model of unnoticed subscriptions, “If you truly love your customers you don’t want them paying for something because they forgot about it.”

The models haven’t changed, but the systems are more democratic than ever. Finding new and innovative ways to use the tools that are already at hand is something that startups have been doing for decades. Applying that same methodology to making money is just second nature.