Free is Killing Us. Blame The VCs
whydoeseverythingsuck.com
whydoeseverythingsuck.com
I don't think there is anything wrong with that. It's certainly riskier and subject to the whims of a fickle public. But there is also a bigger reward for success.
Saying that a new media company should charge their customers before they become popular seems counter intuitive. IIRC, this is how the Onion and many other major media publications began...they gave their product away for free until enough people read it that they could charge for ads.
It seems to me that most of the author's points could apply just as well to starting a new magazine or newspaper. Yet, I don't think that many people would agree that college newspapers are killing themselves by giving their products away for free. I think that the expectations people have for web startups would change if people looked at them as media entities and not software companies.
I don't have any marketing data on whether advertisers prefer paying audiences or not, but I assume a lot of that would depend on the advertiser. I know that the bigger players in web media (facebook, myspace, etc) are definitely "bottom-of-the-barrel" when it comes to advertising rates because they reach such scattered demographics.
With that being said, I don't fully understand your point about advertisers preferring paying audiences. I think the problem is in the math. If I start charging for content (turning my users into a paying audience) then I'm going to most likely going to serve less page views. I don't know if the extra money advertisers are willing to spend for my now paying audience would be enough to offset the loss in page views.
The main example of a media website with a paying audience I can think of is the NYT, and I think the only reason they can get away with charging for content is because they've been established for so long. I think the rest of us are going to have to decide between 1) charging up front 2) trying to build a media property 3) trying to make money from premium subscriptions (which usually just amount to being donations from dedicated users).
Thanks for the reply, I'll definitely be thinking about this.
Printed publications make far more per unit from advertising than they do from the subscription fee. If advertisers didn't care about paid subscriptions, it would be in their interest to give their magazine freely to anyone and everyone who wanted it. But they don't because advertisers only care about paid subscribers. That is why magazines seem to try as hard as possible to give you nearly-free (but still paid) pricing on subscriptions.
I don't know why that is, but I know enough about the publishing industry to know it is true.
Nearly all newspapers and magazines are well into the black before you buy them. Consumer research just says we don't value a magazine that's free. (Vice is upsetting this current model)
It's crazy to think either that all internet services will tend to free, or that no startups can offer services for free. Like most things in life, the sustainability point is somewhere in between.
On to new business...
First of all, I still chuckle at "whydoeseverythingsuck.com" That thought is the antithesis of everything we (should) believe here. I guess it's just your little tongue in cheek thing. Cool.
You say, "it is inherently impossible to start a small self-sustaining business and to grow it". I, along with 7 million of my compatriots beg to disagree. If you don't want to play roulette, er I mean pursue VC, there are a lot of other ways: bootstrapping, friends and family, angels, debt, etc., etc., etc.
I guess the thing that bothers me most about that remark is that someone may come here, read that, actually believe it, and then become discouraged.
OTOH, maybe it's just another form of Darwinism. Anyone who pursues an "advertising = only revenue" strategy should be prepared for the worst. More prospects for those of us with sound business models.
Chris Anderson is doing the lecture circuit before his book on Free comes out. His Wired article has a list of business models beyond advertising:
http://www.wired.com/techbiz/it/magazine/16-03/ff_free?curre...
37signals makes their living off the "Freemium" model. I don't think Prince raised a VC round before he gave away his CD. As the cost of providing some services goes to zero, businesses can make some things free, especially if it helps grow other markets.
Him: It's impossible. You: It's so certain, it's basically guaranteed!
You can be a person who behaves very aggressively with what appears to be extremely risky behavior but at the same time calculate risk very carefully with as much data as possible. This is what I aim to be, a calculated risk taker. Not a foolish man who dives head first without thinking.
Motivation is really great, but I don't see a lot of value in blind optimism.
This is not a recent trend. In fact, it's practically the definition of technological growth that it makes things dramatically cheaper. I don't think this is a trend that will ever be "put to bed."
When GMail launched, it offered artificially large amounts of free storage, in the sense that they couldn't support many users at that size. That's why they had to start with invites. But they knew that disk would keep getting cheaper, so they just gave people a number that would make sense in the future.
I agree that this elimination of competition is bad for the consumers, bad for innovation, and bad for those more capable companies that didn't get the huge funding. It's just making the rich richer.
For the record, I don't agree with him either. Standing around saying "I wish I could do x but I can't because of y" is just another dangerous procrastination tactic, for any value of y.
The author compares launching big and launching small, but really they're apples and oranges. Yes, to launch big, you need to make a big splash and either be free or very low priced. But the alternative is still there: get the niche market, and launch slowly and by word of mouth of your users.
I don't think we're in a situation where you can't launch small and make a living.
Smugmug is one of the biggest customers for Amazon.com web services (meaning they could be invoiced if they wanted to be). However, they are billing everything on a American Express Platinum corporate credit card with the highest credit limit ($100K). Jeff says every month they probably earn three or four first-class tickets based on bonus points.
According to Jeff, their rate of growth is astonishing (Jeff said that they are storing about 15TB (yes, Terabytes) a month in S3). What happens to images in Smugmug ceases operations? Well, apparently the family has committed to a multi-generational commitment.
Plus, with the cost of hosting a small service being so low, a service of this sort ought to be making a little money fairly quickly (maybe not to where you're making a decent living yet, but enough to work at it and get it there if it's something people want and will recommend).
Being a small software biz owner (and so someone who pays for software), I find the mindset of my friends, who can't fathom paying for anything, kind of strange.
Not that I pay for everything, but I would rather use a better tool for a fee than an inferior one that costs me time. And judging by the Basecamp numbers, I'm definitely not alone in that one.
http://www.squeezedbooks.com/book/show/7/information-rules-a...
I should add that there's also certainly space between a new product's entry into the market, and when it becomes commoditized. If you're doing something that's not easy to replicate, even if people do start trying, you might have a number of years to make some money at it.
Assuming you can scale. ;-)
This type of article is a complete waste of space, other than it serves as an example of how not to deconstruct a type of behavior.
"Business" is about making money. Let's just agree that without revenue, you have no "business". And this suggests that even Google is having problems with monetizing products aside from their golden goose. This probably slightly irritates Google, but it should really scare those of us who don't have a golden goose yet.
We shouldn't be interested in creating products that are "built to flip", as my ex-CEO liked to say. We should be interested in creating products that create tangible, sustainable value... and that means making money.
Some startups can do that by offering products for free, and scaling up. Others will have to charge for their offerings, commensurate with how targeted and value-creating their offering is. It will be a combination of the two. The idea that every internet startup can survive by giving away their service will lead to one thing: disaster.
At some point the Googles and Yahoos of the world will not be able to explain acquisitions to their shareholders, because they have a fiduciary responsibility to create wealth. If the acquisitions do not create wealth, they will stop making them. But that lesson will take years to learn, in my opinion.
For example there are very wild problems affecting almost every internet user, like email. I bet that there are many hacker teams around that are able to come up with a better gmail, or simply a web based email system more biased towards advanced users: but how can you compete with an alternative that is good enough, is under this big name, and gives you all the space and free access to POP, IMAP, ...?
Result: no enhancement over gmail, we just need to wait for them to release the next feature.
Is this really better for users? Mostly not, the email or other core internet services are such an important thing for users that to pay 30$/year is nothing compared to the advantage of having a better internet experience.
"niche thyself."
don't believe me? may i present exhibit a, smug mug's article in business week: "Competitors such as Ofoto, Snapfish, and Shutterfly (SFLY) were well-established, and free. The business that wasn't already taken by them was split among the likes of Canon (CAN), Nikon, and Sony (SNE), which offered photo sharing as a service to camera buyers. But today, SmugMug is the destination of choice for professionals and serious amateurs, with more than 450,000 customers, including nearly 120,000 subscribers who pay $40 to $150 a year for the service. Revenues doubled in 2007, as they have for the past three years, to $12 million. With only 29 employees (including seven MacAskills), it's profitable."
sorry to interrupt, have fun.
Digital does have a lower overhead (less cost per user gained) than physical. But Web 2.0 products are part product, part community. Their value is largely derived from the bustling community that uses the product. FB would be worth nothing with no subscribers, both from a consumer and investment perspective. Remember how FriendFeed became suddenly awesome when the closed beta ended? The value for myself (and others) is the relationships that form. If payment is a barrier to usage, the growth stagnates and users don't get the best experience.
I'd highly recommend the 'Information Rules' book I linked to elsewhere (via my site:-) to anyone interested in this stuff. Most of it is pretty intuitive, but it's nice to have it all grouped together and explained.
Using jargon to explain new concepts is taking the easy way out. Figuring out how to communicate complex ideas with plain, straight-forward language? That's the name of the game.
We make small beautiful web apps and offer sponsorships to brand advertisers. What we don't offer is an audience. Our apps are basically for rent to marketers who can get an audience elsewhere but need a place to send them to interact in a way that accrues value to their brand.
We believe that this notion that advertising needs to be something that has value for the user (and not a distraction) is the wave of the future for brand marketers. These apps will need audiences, but there are literally hundreds of ad networks that can provide those. What those ad networks can't provide is useful destinations that are tuned to be complementary to a single sponsor.
There is hope. At least, we think there is. :)
Which is exactly the author's point. He says that small companies are forced to swing for the fences in terms of user-base because a) that is all advertisers are interested in and b) the competitors (such as Yahoo! and Google) offer free alternatives.
I dont think it reasonable to set Yahoo or Google as the measuring stick of success as those companies are clearly way out ahead of anyone
Suppose you start a company to compete in an industry (any industry) where your rivals are profitable despite offering free services.
The fact they're able to do that is going to force your hand in that direction, too.
So it's the market which dictates those conditions, not your investors.
You're right. And this will lead to a massive market correction at some point. Companies that had the balls to listen to reason (a la 37signals), will be the ones that weather the storm. They'll end up being the Berkshire-Hathaway of the internet industry because they a)focus on the long-term, b) concentrate on what they know and do best, and c) fiercely execute on value, and not trends.
There's a reason Warren Buffet came through the dot-com crash unscathed. And it's the exact same reason why companies like 37signals will as well.
Either way, though, it's not the fault of the VCs.
Another example: PC operating systems (where the cost of the OS license is subsumed into the price of the PC).
I think it's possible to do, but not as easy as "hack some website together and hope for the best". Some things are going to be easier to market than others. 37signals products (while I think they're useless) appeal to a lot of business-type people (who have money so spend), so they do well.
If you look at startups like Reddit, they set themselves up for advertising-only revenue. There is nothing worth paying for there, so of course nobody is going to pay them. (Yes, I know that reddit sells the reddit engine. But the most public part of reddit is reddit.com.)
I agree with a lot of this...
But VCs aren't going to change (and it isn't really in their interest to do so). VCs ONLY win in two cases-- someone buys the company or the company IPOs. Sustained modest growth rarely gets you to that destination.
It's not irrational for VCs to push for growth at the expense of revenue/profit. For their "business model" (the hits in their portfolio paying for all of the duds), it makes perfect sense.
I suspect that if a VC tried a new model (focusing on sustainable growth and revenue/profit), they'd find that they'd have a healthier portfolio that was largely illiquid.
Well, if VCs were to concentrate on sustainable growth and profits, maybe we'd see a resurgence of the flacid IPO market. It wasn't too long ago that tech entrepreneurs were motivated to make profits which then allowed them to take their companies public.
Seqouia would not have made a crazy-multiple on their investment if Google had focused on being bought pre-revenue in preference over creating profits and taking themselves public. Google's IPO absolutely dwarfs YouTube's acquisition.
I think a VC model encouraging profits over growth would be a healthy thing for everyone!
It seems like this would be a good model for seed-funding businesses like YC to try, because they've got many more at-bats than big VCs. It might be hard for a big VC firm to generate enough cash for this: if the average investment is $5M, they take 50% of the company, and 90% of their investments fail, then their "hit" needs to churn off $100M in profits to sustain the next round of startups. But if you target hundreds of niche businesses, your investment is $20K, you take 10% of the company, and 50% of the companies survive, then they only need to spin off $400K/year in profits to fund the next round. That seems a lot more achievable.
Then again, one of the reasons Berkshire is successful is that Buffett refuses to invest in businesses that don't have predictable streams of cashflow. Startups are anything but predictable, so maybe the model's fundamentally flawed when it comes to startups.
How does cash get thrown off? Are you suggesting a "dividends off of profits" type of thing for growth companies? Aren't growth companies supposed to be reinvesting profits in their own growth?
The problem with dividends is that they are really only good one the initial investment is liquid. So if Berkshire invests in a value company that throws off 3% dividends per quarter, that's great. But it's only great because they can get their cash out at any time.
If a VC invests in a startup (say $1mm), how exciting is the prospect of 50% chance of failure, but a possible 3% quarterly dividend IF the company succeeds? With no actual market to sell their initial investment of $1mm?
I can't make these numbers look attractive in my head.
Yeah, dividends-off-profits. The growth-company thing is an issue for the initial ramp-up phase: it'd probably be 10 years or so before the fund would start having additional capital to invest. But in the steady-state, older non-growing businesses throw off cash that can be reinvested in small growth businesses.
"So if Berkshire invests in a value company that throws off 3% dividends per quarter, that's great. But it's only great because they can get their cash out at any time."
Berkshire can't cash out of their value companies at any time. Their typical modus operandi is to buy 80% of a successful privately-held business, leaving the other 20% to the founders. The companies remain privately held, and their stock is not sold on the open market. The only way Berkshire can cash out is if they find another buyer, like a private equity firm or large conglomerate, to take the whole business off their hands at once.
Also, dividends thrown off by private companies are often a lot more than 3% (public companies have such lousy dividends largely because shareholders lack bargaining power). Take See's Candy, one of Berkshire's early acquisitions (http://valueinvestingresource.blogspot.com/2008/03/sees-cand...). They bought it in 1972 for $25M on earnings of $5M. Since then, See's has required capital infusions of $32M and spun off dividends of $1.35B. That's a dividend-to-profit ratio of 98%, in comparison to the normal Wall Street averages of 30-50%.
Of course, few startup entrepreneurs would be willing to sell 80% of the company from the outset. Berkshire functions in reverse to VC firms, providing liquidity and multi-million-$ payouts to firms that have already gotten successful. But what if you reversed the terms? 10-20% of the equity for the chance to be your own boss? With the investor's dividend payouts protected by a legal clause in the investment documents, guaranteeing that after certain profitability and cash reserve milestones are met and growth has fallen below a certain amount, X% of the profits are distributed as dividends?
This is all idle speculation, since I don't have money to put where my mouth is. But if I had a billion dollars or so, I'd definitely want to try it. Because if these assumptions are true:
1.) Startups are the most productive part of the economy
2.) A small initial investment would let many more people quit their day jobs and found startups
3.) Getting bought destroys most of the efficiency advantages of being a startup
Then a logical consequence is that a firm that buys-and-holds small profit-oriented startups should do better than one that invests in large public companies.
Besides, it'd be a cool financial hack.
I wrote about how to properly use the FREE software model today at http://www.onlineepiphany.com/2008/04/04/how-do-they-give-th...
Markets don't disappear because they're too crowded. When they're too crowded, some people are forced out and it moves down to a more reasonable equilibrium. That's like saying that a theme park will fail because it gets too crowded -- when something is too crowded to be worthwhile, people stop going and it then becomes not too crowded anymore.
This is unfortunately not the case since VCs know that for companies like Google and Yahoo is valuable to buy a startup that is not able to be profitable from itself, but added to a core of other free services it will be worth the money.
the rest of the article fails because it was built on a faulty premise.
its true that there are lots of sites built on ad revenue, but it is definitely not the only revenue model.