Oct 23, 2013
Table of contents:
A problem that nearly every new online business faces is, “how do I significantly grow my customer base?”. Whilst there will always be the rare exception that seem to suddenly explode overnight, the majority of all online businesses will take years to really mature into a high growth revenue machine.
There are many different ways to grow an online business these days and some are most certainly better than others. One particular type of opportunity that I’ve grown interested in recently is where a company will pursue a very low margin opportunity during the formative years in order to grow quickly, and then reveal the “secret” higher margin opportunity once they have achieved traction and a strongly engaged following.
I touched upon this idea in last week’s post, Why you need to build your own distribution channel.
There are many exciting opportunities when you take this line in growing your online business and I think it has a lot of amazing advantages over trying to pursue a higher margin model from the get go.
In this post I’m going to be explaining this opportunity, how it works, what are the advantages and how you can create this model too.
Despite what you read in the media, growing an online business is an incredible amount of hard and slow work. Typically you will get waves of rises and falls, where some days you feel like you are crushing it, and others seem like you are just waiting to be found out.
Paid advertising through something like Google’s Adwords is great for scaling once you have reached product-market fit, you understand the key metrics of your business and you have a repeatable business model. However, if you are bootstrapping your company, prematurely pumping money into advertising can be your kiss of death.
For the majority of online businesses, it is always going to be difficult to gain exposure and brand recognition. When your website’s goal is to sign up new customers or get new leads, fuelling that traffic can feel like flogging a dead horse.
One of the best ways of gaining exposure, traffic and traction is through content marketing. Companies like Buffer and Intercom have gained traction and an engaged audience by creating a constant stream of high quality content.
However, Content Marketing is not for everyone, and it will still likely take you a long time before you see quantifiable results from your efforts.
Whilst investing in Content Marketing will allow you to reap the fruits of your labour eventually, a more immediate growth opportunity is to pursue a lower margin model that is likely going to have the potential to grow traction for your company much quicker than a higher margin opportunity.
By sacrificing early profits, you can self fuel the growth of your company whilst still making bank. This kind of model is likely not going to grow you into a huge company, but it could be the growth spurt that you need to reach the next level.
Instead of investing time and money into Content Marketing in order to market and grow your company, you could instead invest in creating a lower profit product or service that is likely to gain traction at the bottom of the market.
This is essentially what is happening when you see companies selling loss leading products. The company is able to sustainably sell products that generate lower margins because they create opportunities to sell other products at much higher margins.
However, whilst Supermarkets can sell loss leading products like bread because they know the average shopper will buy other higher margin products, there is a much greater opportunity to be captured online.
By experimenting with lower margin products and features, and building a constant stream of feedback with an engaged audience, you can achieve product-market fit at a much lower cost. Instead of trying to fuel your experimenting stage with investor money or consulting side gigs, you can gain real world market feedback and customer development on possible future higher margin opportunities.
By building this close connection with real customers, you have a much better chance of launching a higher margin product that is wanted by the market. You will also have a ready made source of distribution that was essentially free to build.
In many ways there are close links to the freemium model. As I wrote in the post What is Freemium and how can it work for you?, when you think of freemium as a marketing cost, it becomes a much more quantifiable opportunity.
However, traditional freemium only really works with software companies. I think meta-modelling can work for a wide variety of companies with very different business models.
The most important thing is that you have a secret way of monetising that you can eventually leverage once you have built one side of your company. This is perfect for online business models because you can focus your low profit product on building distribution or a platform, and then use your secret to turn on the higher margin monetisation once you have started to scale.
Creating a higher margin opportunity is always going to be a bigger risk because it will require a bigger investment. By exploring the market and the opportunity with a lower margin product, you can validate and iterate on your idea to ensure that you have a solution to a real customer problem.
Whilst this all sounds good in theory, it really makes no difference unless it works in the real world.
In my opinion, I think this strategy can work for a number of different types of companies in different industries, with different business models and different customers.
I also think there are a number of exciting companies who are using this technique right now!
So here is an overview of some interesting companies who I think are using meta-modelling to grow their business. As you can see, these companies, whilst all primarily online based, have very different products and business models and they all fall into different industries.
I already covered Birchbox in last week’s post, so I will just give a brief overview here so I don’t end up repeating myself.
Birchbox has basically used the stuff in a box business model to build their customer base. Birchbox started out by sending beauty product samples out to customers for a relatively low subscription price. This was a really good way for customers to try and experiment with new products and get advice on how to use them.
However, if the customer wanted to purchase the full product, Birchbox could supply it through their integrated ecommerce store. Birchbox have affectively used the stuff in a box subscription model as an onboarding ramp to their ecommerce opportunity.
Stuff in a box is a low margin, logistic intensive business model. However, Birchbox has essentially leveraged the model to build a much healthier ecommerce model. The customer benefits by getting a monthly surprise in the mail of new products she can experiment and learn about, and Birchbox benefits by building trust and learning all about what their customer’s want through timely and frequent deliveries.
The stuff in a box model was Birchbox’s low margin model to acquire customers and the ecommerce model is their secret to higher margins and an increased life time value per customer.
WordPress is one of the most popular open source platforms ever and powers something like 20% of the entire Internet. Open source business models were a radical idea just a few years ago as it was unthinkable that you would ever give away your entire source code.
However I think WordPress has been a pioneer in showing that this business model can actually work.
Automattic, the company behind WordPress, is able to sell high quality premium services like Akismet, VaultPress and WordPress VIP because WordPress has become so ubiquitous on the Internet.
The model works perfectly for small businesses because they can very easily set up a WordPress site for their company. However once the website is actually functional, the company will often be happy to pay to ensure that it is backed up and protected from spam. By creating a product that has a very low risk of experimentation, you can sell high margin premium services once your customers have adopted your product. To read more about this opportunity, check out my post on Building a profitable Open Source business from Cross Subsidisation.
Without WordPress, Automattic would just be another web shop offering customisations and add-ons to websites and web applications. By creating the WordPress ecosystem around their open source application, Automattic is able to leverage the platform they have created to sell high margin services. Creating an open source platform was Automattic’s low margin model, leveraging that position to sell higher margin services was their secret.
Square is one of those companies where you look at it and it just makes sense. Square facilitates transactions between small business owners and their customers by taking all of the hassle out of accepting credit cards.
However when you really start to look into Square’s business model, taking a cut from the transaction cost really isn’t such a great business model. Facilitating transactions is very much a low margin opportunity.
However, Square is much more than just a facilitator of transactions. By leveraging the low margin opportunity of facilitating transactions, Square is able to position itself into the much more lucrative opportunity of being the layer between the transaction. By forcing itself into the traditional customer to consumer stack, Square can become an integral part of this traditional industry.
You can see this play out as Square spreads into becoming a marketplace and a digital wallet and even a consumer to consumer email payment service.
Square would not have been able to attack these opportunities if they had not already become ubiquitous for payments. Facilitating transactions was Square’s low profit model whilst becoming an integral component in the payment industry stack was their secret.
Two of the hottest online companies of the last couple of years are Dropbox and GitHub.
Both of these companies followed basically the same opportunity of providing an amazing consumer application for essentially free. High usage users could eventually upgrade their account for more storage in Dropbox, or GitHub users could pay for private repositories. However in each case, the entire product was offered free to all users.
This is an extremely clever strategy because both companies are fuelling tomorrow’s growth by offering their product to individuals for free today. As more and more individuals start to use these amazing free services, they will naturally start penetrating into the workplace.
Once a certain density of employees have started using a product or service without anyone’s permission, management or the IT department won’t be able to force them to use something else without backlash. However, both Dropbox and GitHub also provide enterprise versions of their products to allow greater control over how their employees are using them.
Both Dropbox and Github have created their higher margin enterprise opportunity by providing a much lower margin product to individuals and consumers. Selling enterprise software into large organisations is typically arduous, cut throat, costly and takes along time. Yet Dropbox and Github have found a way to become so ubiquitous amongst users that they do not need to go through this process.
As with Birchbox, I have already covered Thrillist in last week’s post, so I won’t go over too much of the same material here.
Thrillist basically started out as an email newsletter focused on young, affluent, urban males. After building up that newsletter for a couple of years, Thrillist was able to sell advertising to brands who were looking to target their exact audience demographic.
One such advertiser was JackThreads, a small company that was spending it’s entire marketing budget at Thrillist.
Thrillist decided to acquire JackThreads and in turn, created an ecommerce opportunity to pair with their already considerable distribution power.
Thrillist is now able to use it’s own distribution network to sell items on JackThreads. The best part is, Thrillist is able to completely control both it’s distribution and the products JackThreads sells. This gives them a unique distribution competitive advantage over the market, and unique insights into what their target demographic is interested in.
Thrillist has been able to use the low margin advertising model to grow their content distribution channel to fuel the growth of their much higher margin JackThreads ecommerce opportunity. Building your own distribution channel is the low margin model, selling your own products is the high margin secret.
A very interesting of meta-modelling is where you start off with providing a service, but then you transition that into a marketplace.
MyTime is a service that allows you to book appointments with any number of different services, such as health and beauty treatments, repairs or maintenance. When providing online to offline services like this, you need to have a high density of inventory to make the service work. MyTime is focused on Los Angeles and so the company is trying to build up inventory in that single location to start with.
What is interesting about MyTime is though, if the company that the customer wants to book with is not currently using MyTime, MyTime will manually book the appointment for them. This allows MyTime to provide the customer with a seamless experience, but also is a good way to show companies that their is demand for their services through the MyTime platform.
This low margin service is incredibly important for building up the two sides of the marketplace and can be seen in other service to marketplace companies like OpenTable or ZocDoc.
Providing a manual service is always going to be low margin because you need to employ people to do repetitive jobs. However, once you get the right amount of density, you can turn the opportunity into a much higher margin marketplace opportunity.
I really love marketplace business models. You can read more on my thoughts about them in How to build a two sided marketplace and How to fuel the growth of a two sided marketplace.
So how do you go about creating a meta-model business? Well, like I said at the top of this post, this is going to be a long, hard journey, so always bare that in mind.
Generally though, here are the things I would start to think about if you want to create an online business in this footprint.
Before you invest any time or money into this new venture, first it is important to find your secret. As I’ve highlighted in the article so far, this strategy only really works if you have a secret that the market does not know.
For example, Square’s secret was that facilitating the transaction was not the real model, the secret model was becoming an integral component of the transaction stack.
You need to identify your secret before you start working on building the platform you intend to leverage. Finding a secret about an industry is very difficult, and it often requires that you work in that industry for a number of years before you can see it.
Having a secret will differentiate your from competitors. As you start to grow your company, you will naturally see competitors who are doing similar things to you. However, because you have your secret, you shouldn’t worry about what they are doing, you should only focus on executing on your plan to get to your secret.
When the time is right, you should be able to turn on your secret as a high margin component to your existing business model. Once you have a defensible platform and a repeatable and cost effective way to distribute through your own network, selling the high margin product or service will be much easier than starting at the bottom with nothing.
Once you have discovered your industry secret, and you are confident in your high margin business model, it is now the time to start thinking about all the possible ways that you can create a high growth, defensible platform.
This will really depend on your company, industry and chosen business model, but hopefully the examples above will give you something to think about.
For example, Birchbox used subscriptions, WordPress used open source, Square used transactions, Dropbox and Github used freemium and Thrillist used content.
If you are bootstrapping your company, you will need something that is at least low margin. Selling advertising, having a premium version of the product or selling some sort of subscription are all good ways of keeping your head above water as you grow your network.
There are no get rich quick schemes or one step solutions to building a successful online business. Just about everything you try will take a lot of hard work and a long time before you ever see the fruits of your labour.
However, it is these prerequisites that separate the wannabes from the people who go on to great success.
Starting out with an already defined strategy and a plan on how you are going to grow your company, distribute your products and build a defensible and highly profitable company is just the first step in a long journey.
But at least you are getting off on the right foot.