Monthly Archives: December 2009

Lean startup viability: how to know when to quit

This post was prompted in part by a discussion a few weeks back by former Joost COO Hedrik Werdelin’s post, “Twitter used to be a crappy idea”,  about Twitter and their viability as a startup based on user metrics. While I think the article was more linkbait than reasoned analysis, it did raise an interesting question. How do you determine the viability of a lean startup? Or more importantly, how do you know when to quit?

In a VC or even angel-backed startup your viability, assuming you are not profitable, is generally based on one thing…. The ability to raise additional funding. When the money runs out either you raise more funds or you go home.

In a lean startup however, there is no such Darwinian fate. By the very nature of a lean startup and its iterative customer development process, a lean startup can live virtually forever and perhaps never find success. Therefore it falls to the entrepreneur to decide when to cut bait.

In this post I have applied the customer ecosystem model below (also see examples for Zynga and Twitter) as a means of determining lean startup viability.

Wederlin’s point was that Twitter had poor user acquisition growth and user numbers in the early years of the business.

Now, I think this point is debatable, but let’s assume for a moment that this is the case for StartupX.  StartupX launches and sees low to moderate user adoption. Despite this, there is no reason to necessarily throw in the towel. However (contrary to Wederlin’s assertions), mere faith in the technology or the team is not enough. You need to have strength in one of the following customer ecosystem areas: conversion, upsell, or retention.

Conversion

Almost more important than user acquisition is converting those new users once they arrive at the site. Obviously each type of web startup has has its own metrics, but  if conversion and usage is high it can more than make up for poor acquisition results. Consider the case of Twitter. Sure it’s user base may have been growing slowly, but is that how they were measuring success? More than likely they were looking at other metrics as being important:

  • % of unique visitors who register
  • % of users who send a tweet
  • % of users who follow someone
  • % of users who have followers
  • % of users who tweet 5 times a day
  • % of users who have more than 100 followers

Merely looking at the number of new registrants is a poor way of measuring success, but also growth. Internally, even though acquisition growth may have not been growing as they had hoped, my hunch is that metrics like those above were growing strongly, indicating that they were on the right path. They weren’t just flying blind.

Now let’s look at imaginary StartupX:

After a brief write-up in a techblog, StartupX gains 15,000 new users. Six months later they are adding only 500 new users a month and the active userbase is steady. Time to cut the cord? Not necessarily.

Consider:

  • 65 percent of unique site visitors register and create a profile (up from 33% just two months ago)
  • 35 percent of users post content on StartupX (up from 25% three months ago)

Metrics like these are good and would indicate that (contrary to the acquisition numbers) that StartupX is still viable. There obviously are acquisition issues (wrong target market, poor virality, etc.), but when one aspect of the customer ecosystem is executing well, it means that with a sufficient pivot, the startup is viable.

Upsell

Are people paying money for your product? Usually this excludes about 90% of web startups, but cash money can be an amazing salve for a startup which is not experiencing substantial new user growth. If you are able to get users to pay either a one-time fee or a subscription then you have something to build upon.

Let’s look at the StartupX upsell scenario.

StartupX has a premium service for active users which includes and enhanced profile and unlimited uploads. Despite the fact that user growth is slow, more than 5% of active users pay for the premium service. Not only that, only 1% of users paid for a premium membership 4 months ago. Growth in premium subscriptions is a much more valuable metric than total user growth. Some users are more equal than others.

The trick here is that if you are getting people to pay for your product, you need to work to identify how large the realistic addressable market is and determine strategies to get traction in this market. If you’re bootstrapping, it does you no good to be exaggerating your addressable market (as opposed to when you’re trying to raise VC). However it behooves you to look far wand wide and identify other groups that may pay for your product. The key here is to continue growth in this revenue stream.

Retention

Retention is the kissing cousin of conversion in the customer ecosystem model. For conversion, is the content/experience compelling enough to for you to register or participate? For retention, is the content/experience compelling enough to keep you coming back.

If, for example, 80% of registered users are coming back on a weekly/monthly basis, there’s a lot of potential in what you are doing. Even low to moderate user growth with high retention levels can be a success.

Overcoming Acquisition Issues

In order to be successful, every startup will eventually need to figure out the acquisition puzzle. Sometimes there are businesses where the acquisition costs are just too high for a viable business. The point however of this blog post is that startups need not initially live and die by acquisition numbers. Other components of the customer ecosystem model are equally important components to figure out and basing viability on initial acquisition efforts is foolhardy.

Knowing When To Quit

If your acquisition efforts are failing, there need to be signs from other places in the model (conversion, upsell, retention) that the business is on the right path. If you’ve been at it for a long time and acquisition is poor and everything else is muddling along, then it’s time to quit. However, if you have found that you can either convert, upsell or retain customers well, then keep plugging away.  The feedback from users is that your startup is on the right path…. now it’s time for incremental improvements in the other areas of the model to allow the business to reach the next level.

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Why Twitter shouldn’t pursue an advertising business model

First, a confession. I made the decision recently that when I start an internet company it will not be dependent on advertising for revenue. As an aficionado of the lean startup model and customer development process, I believe it imperative to have paying customers from the get-go. When I developed the Customer Ecosystem model, I explicitly included a revenue component that was independent of advertising. The simple fact being that as VC funding becomes more tight and companies need to show their worth more quickly, advertising as a revenue model is going to become a relic… a bubble throwback that we will all talk about, but probably not think about employing.

Recently, Twitter co-founder Biz Stone and COO Dick Cost0lo have  made comments about the first substantial real revenue stream that we’re going to see from the über-hyped microblog company. And if you chose chose advertising (really cool, non-traditional advertising) in the pool…. prepare to collect your winnings.

Even though Twitter has millions of users and can probably become profitable rather quickly, I think it is a mistake for Twitter to pursue an advertising model.

Who has succeeded, and I mean “knocked it out of the park” succeeded in using an advertising model? Google…and that’s about it.

The internet is strewn with the living dead of companies that have tried to become internet kingmakers and failed using an advertising revenue model: AOL, Yahoo, MySpace, MSN Digg, and countless others.

And then let’s look at the key players in the market who generate their revenues from ads, the up-and-comers like Glam Media. Well, they recently took Series E (!) funding.

Many of the businesses that are reliant upon advertising are getting CRUSHED. Look at the the New York Times, NBC Universal, Clear Channel etc… the simple fact of the matter is that it’s becoming very hard to be a business that matters with advertising as a revenue model.

Sure, Facebook may be able to pull it off, but like Google they are also turning the advertising world on it’s head and there’s still no promises of success. Consider:

Google: Changed the advertising world on its head by making ads relevant, practical and contextual. And of course, they executing the living bejeezus out of their  biz model. Anyone with any doubt about about their ability to execute should try to advertise on MSN or whatever the hell they call it now.

Facebook: In the process of changing the advertising world through massive amount of demographic/psychographic data that allows for targeting via affinity. We still don’t know if they will be able to pull it off. Smartly though, Facebook is hedging its bets and looking seriously at other business models.

Twitter: Trying to re-do advertising model. The problem is that they just don’t have the numbers compared to Facebook and their growth is slowing.

I’m not saying that Twitter is in trouble, far from it. I’m just saying that an advertising model, no matter how innovative, will have a hard time succeeding.

So let’s look at what Twitter does have:

  1. Loyal, active (not to mention affluent) users
  2. The attention of the corporate world
  3. A core technology that would be difficult  for competitor to supplant/replace

If this doesn’t spell subscription model, I don’t know what does.

I was excited last week to read that Twitter was considering a subscription model in Japan, only to have them put the kibosh on those plans the next day.

It’s too bad. Because Twitter could have a very strong customer ecosystem:

Acquisition: (Good) Despite somewhat stagnating growth compared to Facebook, and an unremarkable viral coefficient in the truest internet business sense, Twitter spends virtually nothing on acquisition, gets tons of free press and is promoted actively by many corporations and individuals.

Conversion: (Fair) More than half of twitter registrants never follow anyone, tweet or get followed. This is not so bad considering their acquisition numbers, but it speaks to and underlying weakness in conversion to a mass market.

Upsell: (Good) Obviously, we’re in pure speculation territory here, but I see huge potential in multiple subscription levels on both an individual and corporate basis. I can imagine a $5.99 a month subscription for individuals who for the following features:

  • Ability to send direct message
  • Ability to send more than 25@ replies per month
  • Backup/storage/offline accessibility to tweets
  • Support for more than 500 followers

Obviously the corporate subscription would have some similar features, but would focus on marketing/support and would have robust analytic tools.

Retention: (Good) If there was a ever a trapped customer it would be the Twitter customer. Sine Google killed Jaiku (and I’ll never understand that one) there has only been one microblogging platform. Additionally Twitter users love the service and promote it heavily. Eventually, a new technology may come and replace Twitter, but not in the near future.

Twitter is a great company with a world-changing product… let’s just hope that their revenue model (when it eventually comes) won’t consign them to the garbage heap.

UPDATE: Twitter testing enterprise tools. Looks like a good first step.