Nov 06, 2013
Table of contents:
The Internet has come a long way since the early days of banners, skyscrapers and popup advertising, however the majority of large scale, online first, consumer companies still use advertising as their main source of revenue. Companies like Google, Facebook and Twitter have shown that you can earn billions of dollars every year once you reach scale.
Whilst it is easy to believe that advertising represents a flip of the switch business model, making advertising really work is a much more complicated process. Advertising should not be seen as the automatic choice for online companies.
In this post I’m going to be looking at the choice of business models for consumer internet companies, what are the advantages, the disadvantages and what you should base your decision on when choosing a business model for your product.
Choosing a business model at the very early stages of building a product is hard because it is extremely difficult to accurately predict the future. It’s a given that your product, proposition and target customer will probably dramatically mutate once you start to get paying customers using your product.
There are many different types of online business model and many different ways to monetise an online product. In this post I’m going to be comparing and contrasting advertising verses subscription. Of course there are many other business models that you should be considering, but I feel advertising verses subscription adequately covers the majority of approaches.
Advertising and subscription business models are two very different approaches to generating revenue and so it is usually fairly difficult to create a product that could do both. Often when you see a company trying to hedge their bets, the product ends up stuck in the middle with a business model that doesn’t work. The choice between advertising and subscription really forces you to have a different outlook, approach and strategy to how you design, develop and grow your company.
As I mentioned at the top of this post, advertising seems to be the automatic choice if you intend to build a large scale, user generated content product.
Advantages - The advantages of building a business based on advertising are basically the following.
Firstly, there are a number of pre-existing services that essentially allow you to turn on advertising at a flip of a switch. Tumblr was renowned for being unprofitable, but at the same time they could of added Google Adwords at any time.
Secondly, once you have reached a certain scale and you have enough inventory, it is possible to create your own ad network and tools for analysis and targeting. This is what Google, Facebook and Twitter have all done over the last couple of years. Each service has it’s own propriety method of targeting the right audience for an advert and each company controls the inventory and who has access to it.
Disadvantages - However, there are also many disadvantages to choosing advertising as your business model.
Firstly, in order to truly make this model work, you need to build a network of gigantic scale. The only way of doing this is to raise a whole lot of money in order to build that scale at a huge loss for many years. There are only a handful of companies that have managed to achieve this despite the thousands that have attempted it. Building a network of this type of scale is a big swing for the fences.
Secondly, advertising is a fickle business that consumers often hate. Whilst Google has been printing money for 10 years now, the advertising business is subject to change. Advertising is also usually interruptive, and has an ever decreasing value as the inventory of advertising space increases.
Product you should create - Creating a business around advertising requires that you build a product that has mass consumer appeal. You will need hundreds of millions of active users to make this work so you really need to have a bigger plan beyond your initial beachhead niche. User generated content is really the only way you can build this kind of network and keep it growing sustainably.
Your focus should be - You need to be focused on growth and capturing the market as quickly as you can. As I mentioned above, there is only ever one winner and there are only a handful of companies that have made advertising work. With that being said, you should also ensure that your users are actually engaged with your product. Whilst growing your company should be your focus, if you are churning users as quickly as you are acquiring them then you are in trouble.
Subscriptions are the most commonly used model for online service applications and niche products.
Advantages - Subscriptions are a really good business model for a number of reasons.
Firstly, recurring revenue is predictable and allows you to scale your growth based on revenue. If you are earning more money, then you will need more employees to service those customers.
Secondly, when someone stops paying for a subscription it provides a much better mechanism for understanding why they stopped engaging with your product because the customer has to actually signal their intent by cancelling. Products that are sold as a one time payment don’t have this kind of feedback loop.
Thirdly, subscriptions aren’t just for SaaS products. Even consumer products that have a much more constrained niche can become very attractive companies without ever requiring to grow to huge scale.
Disadvantages - I think there are two main disadvantages to choosing a subscription.
Firstly, subscription based business models usually take a long time to grow, especially if you are bootstrapped. Once you can prove that you have a product the market wants and you have a repeatable model for acquiring customers it will be easier to raise money and grow quicker, but up until that point be prepared for the slow ramp of death.
Secondly, even if you are the first person to stumble upon the problem and create a solution, you certainly won’t be the last. You will no doubt have direct competitors all chomping away at your potential market. Even companies that are as big as Salesforce have hundreds of competitors at any one time.
Product you should create - You should try and create a product that solves a painful problem. Customers will take both painkillers and vitamins. Painkillers remove a serious headache, whilst vitamins incrementally make you a little bit healthier. You should always be a painkiller.
Your focus should be - The product you should create should really be focused on one specific use case. If you try to be all things to all people it will be much harder to gain a footing in the market. Consumers want to solve a specific problem with a specific product. Your product should become synonymous with the one thing you are trying to solve.
Generally speaking, if you are creating a product that has utility value, you are always going to be choosing a subscription business model. This is particularly the case if your product will be used by business owners, there really is no reason not to simply go with a subscription model.
However many products do fall into the grey area of the choice between advertising or subscription.
For example, if you have a small niche community around photography, do you try and scale usage up and monetise through advertising, or do you offer a subscription service where hardcore users can get access to extra tools, options, features and content?
Generally speaking, Advertising works where the transaction cost is smaller than the ad price.
For example, what is the value that you are providing? and what form of monetisation will complement that process of value creation?
In the photography niche example, you might be providing a platform for new photographers to learn, connect and promote their work. This kind of value is likely going to greatly exceed the price of serving and advertisement to a user, even when that advertisement is highly targeted to a specific niche.
An interesting new product that is currently facing this decision is Exposure.
Choosing the correct business model for an online product is difficult because it will ultimately have a huge impact on the product you create. It is often the case that the business model is obvious because your product is quite clearly perfect for a particular objective.
However, it is the products and companies that fall into the grey area between two very different business models that face the difficult decision. When choosing between advertising or subscriptions you need to either swing for the fences and create a mass market product, or keep it focused on a tightly knit community of people passionate about a niche.
It is certainly not an easy decision to make, but I think it ultimately comes down to the product you want to create. Do you want to build a mass market product that is used by millions? Or do you want to stay true to your focus.
I don’t think either path is wrong, but you do need to make the decision as early as you can.