Stop asking “But how will they make money?”

Business models are important, but today they’re commoditized
Let me first state: Business models are important. Of course businesses have to make money, that’s a given. But that’s not my point – my point is:

Business models are a commodity now, so “how will they make money?” isn’t an interesting question. The answers are all obvious.

So when you see the next consumer mobile/internet product with millions of engaged users, let’s stop asking about their business model expecting a clever answer – they’ll have dozens of off-the-shelf solutions to choose from – and instead, let’s start asking about the parts of their business that aren’t commoditized yet. (More on this later)

Outsource your monetization
Between the original dotcom bubble versus now, a lot has changed for consumer internet companies. Thankfully, monetization is now a boring problem to solve because there’s a ton of different options to collect revenue that didn’t exist before:

There’s 200+ ad networks to plug into
Payment providers like Paypal, Amazon, Stripe
“Offer walls” like Trialpay
Mobile payment solutions like Boku
… and new services coming out all the time (Kickstarter)

Not only that, consumers know and expect to pay for services, something that was novel back in the late 90s. If you offer some sort of marketplace like Airbnb, they’ll expect a listing fee. If you are making a social game on Facebook, they’ll expect to be able to buy more virtual stuff. They’ll expect to pay $0.99 for an iPhone app.

Contrast this with the dotcom bubble, in which you were creating brand new user behavior as well as building these monetization services in-house. In eBay’s case, people just mailed each other (and eBay) money for their listings. Small websites had to build up ad sales teams in order to get advertising revenue, instead of plugging into ad networks. Building apps for phones involved months of negotiation with carriers to get “on deck.” At my last startup, an ad targeting technology company, we encountered companies like ESPN which had written their own ad servers because they didn’t have off-the-shelf solutions when they first started their website back in the late 1990s.

Let me repeat that: They wrote their own ad server as part of building their news site. And that means they had engineers writing lots of code to support their business model rather than making their product better.

Product experience renaissance
Let’s be thankful that we don’t all have to build an ad server every time our Ruby on Rails app is successful. This lets consumer product companies focus on what they’re best at. Also, building a new website doesn’t require $5M anymore. The number of risks in getting your company off the ground are vastly reduced when you combine cheap server hosting, an open source software stack, and multiple bolt-on revenue streams.

This frees us up to be able to work on what’s really important: Building and marketing great products.

These days, the primary cost for any pre-traction company is the apartment rent of the developers who are coding up the product. The profitability of any post-traction company is just based on how fast the team wants to ramp up headcount. If a team can hit product/market fit, a lot of other problems are taken care of.

The lesson behind Facebook’s $3.7B in revenue
Once upon a time, I was skeptical about Facebook’s business model because they received a mere 0.2 cents in advertising revenue per pageview they generated. In 2006, I calculated that maybe they could generate $15M in revenue per year maximum – a nice business, but not a world-changing one. I wrote about this topic here: Why I doubted Facebook could build a billion dollar business, and what I learned from being horribly wrong.

As I wrote in my post, it turns out I was wrong, and Facebook in fact generated $3.7B in 2011 and will generate more than $5B this year. I was wrong in an interesting way though – it turns out that they didn’t dramatically increase their revenue per pageview, but rather they just grew and grew and grew, to ~1 trillion pageviews/month. My mental model was all wrong.

In fact, we have a lot more experience with advertising and transaction based models. It’s pretty clear that an engaging social website will have 0.1% to 0.5% CTRs on their ads, and net an average $0.50 CPM. If you sell something, or have a freemium site, then you can expect 0.5% to 1% of your active users to convert. There’s lots of benchmarks out there, which I discuss in this older blog post. The point is, if you have the audience, you can find the revenue – it’s getting the big audience that’s the main problem.

The last dotcom bubble conditioned many of us to think about a different world than the one we face today. In 1997, there were a mere ~100M users on the internet, mostly on dialup modems. Let me repeat that: The entire dotcom bubble, with all of its bubbly goodness, was based off of 100M dialup users. Compare that to today, where we have 20X that number, over 2 billion users on broadband and mobile. The graph, courtesy World Bank via Google, is incredible.

The point is, the consumer market has grown by so much that the upside opportunity is tremendous if you get a product exactly right. Given all the growth opportunity, and given the plug-in revenue models, the main bottleneck for building a great company doesn’t seem to be the business model at all.

In fact, the business model seems like a second or third order problem. So again, I argue, let’s stop asking about it.

At over 450 million uniques per month, let’s stop wondering what Twitter’s revenue model will be. Obviously it will be some form of advertising, and maybe they’ll experiment with freemium or transaction fees somehow. You can debate if you think they will ultimately be a $100B company or a $10B one, but let’s skip the conversation on whether or not they’ll fail because they don’t have a business model.

The new question to ask
If you agree with me that business model is no longer a first-order question, then what’s the real question to ask? The thing that makes the business model work is really about getting to the scale where the business model becomes trivial.

Let’s ask a more important question:

Could this product engage and retain 100s of millions of active users?

For the first time ever, hitting 100+ million active users is actually realistic. First off, how incredible is that? In recent years, many startups have done it, such as: Zynga, Facebook, Twitter, Groupon, Linkedin, etc. I think we’ll also see Dropbox, Pandora, and others get there too.

For an early stage company, asking this question is really just a test of the team’s ambition, their initial market, and an evaluation of their product/market fit. Obviously if their product isn’t working, they won’t even be close.

Once a startup has product/market fit and is scaling, then the answer to this question revolves around marketing and technology competence. Also, the product might have to evolve as the initial market gets saturated- like Facebook with college and Twitter with their early adopter audience.

To sum this all up:

Making money as a business is important, but commoditized
You can plug into 100s of options for monetizing an audience, if you have one
We’re working with 20X the internet audience compared to the dotcom bubble, and 1/10 the cost of starting a company
Facebook is hitting $5B in revenue via sheer growth, not monetization innovation
You should aim to hit 100 million active users, and get an off-the-shelf monetization solution later
Evaluate new companies on market size and ability to grow to 100 million actives, rather than monetization methods

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http://www.mehulkar.com mehulkar

I think business models need more innovation and creativity now, more than ever. Maybe more so than the actual product.
http://www.hypedsound.com jonathanjaeger

I agree that for many businesses it isn’t important to think about money on day one — but we’re talking about the small percentage of businesses that should be shooting for ridiculous scale. A medium-sized B2B or B2C idea can be a great lifestyle business, and there’s a lot more realistic opportunity there than in building the next 100+ million user company. Both can be noble causes. If you are shooting for the stars though, sometimes early on it’s a bit much to tell an investor you’ll just slap on advertising to make money.
http://twitter.com/fettemama fettemama

yeah, ignore cash flow. just give stuff away for free till you win the startup lottery …
http://paddlinglikemad.com Marko Vasiljevic

Business model = revenue model? There are a lot of already baked strategies for consumer internet products out there, so I mostly agree. However, there’s always going to be innovation in the revenue model part of the business model which will provide a competitive advantage to companies that get it right. I do agree that initial focus on engagement and retention is essential.
http://www.bahadircambel.com bahadir cambel

The last bullet point sounds like a VC is talking :) Great post Andrew!
http://www.screenius.com Seth Cohen

Another great post!
Keep ‘em comin.
http://twitter.com/StevenLoi Steven Loi

I was curious where you derived the $6B rev for this year from? SAI stated this in their recent post for FB’s FY 2012 estimates:

Lowered full year revenue estimate for 2012
Morgan Stanley — $4.854 bln (new)from $5.036 bln (old)
Bank of America – $4.815 bln (new) from $5.040 bln (old)
JPMorgan — $4.839 bln (new) from $5.044 bln (old)
Goldman Sachs — $4.852 bln (new) from $5.169 bln (old)

Read more: http://www.businessinsider.com/exclusive-heres-the-inside-story-of-what-happened-on-the-facebook-ipo-2012-5#ixzz1wOJdESAW
http://andrewchenblog.com Andrew Chen

Good point- I should probably use one of the restated estimates. I read an older analysis that had $6B in it, and that stuck with me.
http://andrewchenblog.com Andrew Chen

I would hope that evaluating whether you can build a great, sticky product experience that appeals to a lot of people is something every entrepreneur would lead with- not the financial results.
http://andrewchenblog.com Andrew Chen

As with my caveat at the beginning, I definitely think the business model is important and there will be plenty of innovation there. However, it’s better for most entrepreneurs to lead first and foremost with the product experience, and making sure you have something really great and really sticky.

Innovating on the business model if it’s a core part of the experience (i.e., buying coupons from Groupon) or once you have scale. Otherwise, do you really want to have a blah product but a really innovative business model? Sounds backwards to me.
http://andrewchenblog.com Andrew Chen

Sure, there’s definitely innovation to be had. But would you focus on innovating on your business model OVER innovating on your product? Sounds like the tail wagging the dog.
http://www.mehulkar.com mehulkar

I just don’t think advertising is a very solid model. Very low barrier to entry. Absolutely I would spend at least as much time building an innovative, or at least solid (in my mind they’re the same thing) business model.

But then again, maybe that’s why I’m still broke. :)
http://andrewchenblog.com Andrew Chen

My point is true even for medium-sized B2C cases. The problem is that people convert at 1% from free to pay, or at a <1% clickthrough rate. Those are pretty fundamental laws of gravity on the internet that can't be changed much. So given that, if you work backwards from $5M rev/yr (a small business), then you still need 80,0000 customers paying you $5/month. Or you need 400M pv/month.

Basically your product has to rock and you need a lot of growth. So I think you have to figure that out before figuring out how to monetize better.

Even if you could improve the above stats by 2x or 5x, you're still talking about pretty serious numbers. If you do the math and look at the industry comps, you can't get away from the fact you need a great product that has a lot of growth in order to get to something interesting.
http://twitter.com/IvanKreimer Ivan Kreimer

Excellent post Andrew! I’m so tired of hearing about all these monetization methods and business models that this post is a breeze of fresh air.

Now that I’m starting a new business here in Argentina (it’s a kind of social commerce business) I’m starting to see the HUGE benefit of all your essays. They are perfect for me and my (new) company.
Thanks!
http://twitter.com/andyidsinga andyidsinga

Really liked the post. I would love to see another version of the post but for businesses that might only get 100k users. I think several of your points will hold up …
http://andrewchenblog.com Andrew Chen

The easiest high-value thing you could do for 100k users is probably enterprise. Just get them to pay you $1000s or $10,000s per month and you’re all set. Much harder to build a small customer base in consumers and still be happy- how many products are you paying for right now where you pay over $100/month? Your rent, maybe your car, maybe your cable bill. But It’s very few and far between, which is why you typically need a low price point (<$20/month) combined with a lot of mass.

That said, why limit yourself to 100k users? Pick something big, but do it well, start with a small base, and go from there. Maybe there's a bunch of upside and you'll surprise yourself.
http://twitter.com/noizwaves Adam Neumann

Couldn’t agree more Andrew. This topic begs the question: Would Twitter, Facebook, or Google have survived an incubator or accelerator? I doubt they would have.
http://petegrif.tumblr.com/ Pete Griffiths

Great piece – completely agree. Steven Carpenter pretty much laid out the business model options a year of so ago and market scale has only made the reality you both set out more attainable.
http://techcrunch.com/2010/10/10/teardown-13-ways-10-million-revenues/
http://techcrunch.com/2010/10/12/tc-teardown-13-ways-10-million-part-ii/

This post is also related to one of your earlier posts about the way VCs want big wins but often get stuck looking for familiar patterns. For big wins your post makes the key question ‘how big can this scale no matter how unfamiliar?’
http://petegrif.tumblr.com/ Pete Griffiths

I think andrew’s point is that the primary barrier to entry stems from the quality of the product.
mdudas

Making money is far from commoditized.

To use your Twitter example, they’ve created entirely new ad products (promoted tweets, accounts, and trends; enhanced profile pages). To use your valuation example above, the quality of the ad products will have as much to do with whether Twitter is a $10B or $100B company as the quality of the core consumer product.

The quality of Facebook’s revenue products will determine whether it is a $30B or $300B company. Can Facebook create new ad formats that engage users and enable new types of brand-to-consumer connections, can they find a way to generate mobile revenue, can they find a way to generate revenue from a user’s logged in ID and preferences on 3rd party sites, can they create a new type of search w/ associated revenue, can they generate significant commerce or payments revenue, etc?
http://www.facebook.com/profile.php?id=1302721541 John Walters

I think you would like what this this article has to say:
http://estrategypro.com/monetisation-is-crook-word-for-dead-businesses/

The article seemed quite extreme when I first saw the title but I can see where the author is coming from. For the vast majority of businesses, they are not going nowhere near the scale that Andrew is talking about. For them, monetization is not going to work.

That’s what I suspect. There has got to be a better way for small fries like me.
http://www.facebook.com/mmaksin Misha Maksin

“Startup is a temporary organization designed to search for a repeatable and scalable business model”. I guess, Andrew decomposes “business model” into “product/market fit” + “monetization” and urges to focus on the first component.
http://www.facebook.com/bugeja Alex Bugeja

100m users is a bit of a long way to go before thinking about monetization…
David Lam

Andrew – great post and very inspiring to focus on the big questions. Do you think this applies more for B2C than B2B startups? In my experience, selling to business without a revenue model really hurts you because businesses tend to have a low viral coefficient and hence you need a credible way to sustainably fund growth (e.g., through an acquisition cost that is lower than the lifetime revenue from a customer). Also, I like your encouragement to think big, but it seems like the 100+ million users figure might only apply to <1% of startups out there?
http://bernardi.me/ Stefano Bernardi

One of the best posts I read recently. I wrote about some of your points on my Bubble vs Growth post, but really love your angle. Biz models are definitely commoditized and the real question is if companies can sustain growth and build high enough barriers to entry to retain those users.
http://andrewchenblog.com Andrew Chen

Well-said.
http://andrewchenblog.com Andrew Chen

The vast majority of businesses are shitty and usually fail. If that’s the kind of thing you’re trying to start, god help you :)

My point is that exceptional new businesses start with a great product and a lot of growth, and monetization is an important component of that, but doesn’t lead. Especially in today’s market.
http://andrewchenblog.com Andrew Chen

Obviously not saying you should wait until then- but if you are able to have a good enough product and growth to hit millions of users, then you have a shot at actually building something good.
http://andrewchenblog.com Andrew Chen

Yes, but even then, you still lead with a great product experience with a lot of growth, and think about monetization a function of that.

If I state it in the opposite, I think you’ll find that you agree with me more than you disagree. The opposite would be- before coming up with a great product or growth strategy, you should work hard to define the business model because that’s the most important thing. Lead with the business model.

Contrast that to the first sentence of my comment and I bet you’ll agree with me.

IMHO, twitter’s model is nothing special. It’s just direct ad sales, and they are trying to make the ad creative more aligned with their product. But advertisers are stilling paying on a CPM/CPC/fixed basis, just like any other advertising product. It’s innovative but within a small sphere.

And yes, maybe FB will be worth $30B or $300B, but once you’re debating that, you’ve already won the product/growth side of things.
http://andrewchenblog.com Andrew Chen

Great links, well said.
http://andrewchenblog.com Andrew Chen

This can apply to SaaS products (like Dropbox) that are very consumery in nature. I have no doubt that Dropbox might one day have 100 million users. It applies much less to B2B.

And yes, if lack of monetization limits you in your growth strategy, you gotta solve that too. My main point is not to lead with it as if were a super important problem, because it’s not.

As far as getting to 100+ million, it’s much more achievable than it’s ever been, and not only that, I think it’s the goal we’d all strive to hit to build a meaningful business.
http://twitter.com/travisaacson Travis Isaacson

Interesting article. Thanks.
http://www.facebook.com/brad.weinberg Brad Weinberg

Companies first need to understand if they are building a business that will have 100 customers, 10,000 customers, or 10+ million users. If you are building a business with 100 customers, you better be solving a big pain point for those customers such that they will pay you a lot of money. Healthcare often involves companies that sell to 100 to 10,000 companies. Many enterprise SMB companies sell to 10,000 customers and they also need to understand how they are going to get $100+ a year from their customers (probably not in ads). But validating the cost of acquisition is just as important here too. If you are building a company that aims to have 10+ million users, then everything in this article is valid. Focus first on your viral co-efficient which in turn relates to your cost of acquisition and your retention – this all has to do with how good your product is and how much people are talking to their friends about it.
jselby1

I actually disagree with this Andrew (don’t get me wrong I am generally a huge fan of your blog) I think the reliance on acquisition / attention / engagement makes a company at risk of too many macro factors for it to be ultimately successful.

If you look at iOS for an example, wherein the business model for apps has adapted to accomodate the increasing difficultly to acquire an audience (Freemium); it shows that if a business is reliant on acquisition, in the current environment it’s profit margin will ultimately decrease (as it has to spend more to acquire audiences and attention span) , whilst a company that can come up with a unique business model that increases profit margin whilst being less dependent on new audience acquisition should become a much more successful company.

Looking at the dotcom era of 100M users isn’t helpful as the amount of companies out there that could monetize that audience was minimal compared to today (ask some one about the latest company that is working on mobile / social / cross platform / viral / gaming and see how many different responses you get). I think if you look at the dotcom era compared to today they both had to deal with monetizing finite audiences.

Just my two cents (again – huge fan of your blog!)
http://twitter.com/StartupTable Glenn Gutierrez

Right on man! Plugging into revenue sources is pretty easy once you get to a certain threshold of users or traffic in general, especially for consumer applications. Total agreement on commoditized biz models for high traffic properties.
http://blog.hegranes.com/ jonathan hegranes

I think the bleeding edge of the angel / VC community has stopped asking this question… I hope that the masses begin to realize what a time waste this uninteresting question is.

Fantastic post!
http://blog.hegranes.com/ jonathan hegranes

Some very good points, but the message I got from Andrew is that there are so many options to monetize now (dotcom was different) that it’s pretty obvious which handful a company is going to be able to choose from. E.g. for the people who don’t get it, the Instagram purchase confuses the fuck out of them. For the people that do, they realize that question is a waste of time.

This isn’t to say that unique business models will continue to evolve, but in the end you’re selling something, renting something (SaaS, etc), or advertising.
http://www.facebook.com/TravelingAmerican David Whitt

Andrew .. thanks for the thought provoking article. It has always been my belief that a companies focus should always be on the product/service 1st… Not all product/services ideas will need 100M users to be successful.. but all product/services ideas will need to stand out from competitors and embraced by their targeted users for sure… and your point is well taken that if you do have a lot of users… it allows more options for monetization.
http://pralbin.com/ Albin Stoop

When you say “You should aim to hit 100 million active users”, what kind of business models / businesses are you referring to?

As I see it, only platforms with some kind of function/software can reach this, such as Twitter, Linkedin, Pandora etc (as you mentioned). But not all has this big target group.

A percent of the total possible market is a more realistic and usable measurement in my opinion. What do you think?
http://engag.io/ William Mougayar

Andrew, that’s a great post with lots of good ideas in it. Re: FB, if you do the math, they are monetizing at $4/user on average. There’s a lot of upside after that, and it could be scary if they could monetize at $50-$100 per user. I think it’s possible.
http://engag.io/ William Mougayar

Only issue there is with Outsourcing your monetization is that you’re not having an organic monetization model which is more robust than the outsourced one. Actually, there could be several monetization methods inside your networks.
http://twitter.com/CReichert88 Christian Reichert

Can’t agree more. Today there are tons of ways to monetize a business. There is a book called “Simply Seven” that adds up all possibilities. Here’s the link: http://www.amazon.com/gp/product/0230308171/ref=as_li_tf_il?ie=UTF8&tag=myf04-21&linkCode=as2&camp=1638&creative=6742&creativeASIN=0230308171

I think it’s awesome!
http://www.kickofflabs.com Scott Watermasysk

You can’t be serious with this post.

Yes, assuming you are next Facebook or Twitter (and I think you could make a strong argument that not even Twitter applies) you can figure your business model out later.

For the rest of would be businesses, not planning a business model is an absolutely ridiculous suggestion. In addition, the fact the profits from advertising continue to shrink makes this even crazier.
http://abdallahalhakim.tumblr.com/ Abdallah Al-Hakim

Andrew, this is a fantastic post. It reminded me of a recent interview on wired with Dick Costolo from twitter where he indicated how amused he was that so many people were worried about twitter’s business model – instead he mentioned all the other questions that keep him busy. I think that interview fits very well with your thesis here!! Here is the link to the video http://tmblr.co/ZfKP5yKoHl2y
http://www.facebook.com/profile.php?id=1302721541 John Walters

The problem is how will you know your new business is going to be a shitty one or exceptional? We know what exceptional ones are because they are exceptional after the fact.

Sometimes, even shitty businesses get the lucky break and get bought. E.g. the Draw Something
http://pulse.yahoo.com/_RA6RHOJBWOKEM4KP7UGZYP6O54 Artie

There is absolutely zero chance that twitter has 450 million uniques. I’d say 100 million max
venkatg

All the very best for your new initiative.
http://andrewchenblog.com Andrew Chen

Twitter says they have it, and so does Google Adplanner. Here’s a quote from the Twitter CEO:

“Twitter is also getting 400 million unique visitors a month total, this points to a huge number of users that visit Twitter just for information without participating. “The 400 million monthly uniques number shows that people are getting value out of Twitter without logging in,” said Costolo.”

From http://thenextweb.com/twitter/2011/09/08/twitter-100m-users-per-month-50-log-on-every-day-55-on-mobile/
wmdmark

So what’s the moral here for startup founders? Build a service and get 100+ millions of users or go home? This is just playing the lottery. Sure some companies have done this with good success but they’re still a very small fraction of startups. I prefer Seth Godin’s advice on this topic: http://sethgodin.typepad.com/seths_blog/2004/07/the_cliff.html
http://twitter.com/taariqlewis Taariq Lewis

I’m sorry Andrew, but as alluring as your argument against business model focus goes, you focus on the success outliers, Facebook and Twitter, that have successfully delivered product innovation before Business Model innovation or revenue generation. The fallacy is to look at the HUGE wins and then formulate a theory around a very small sample of success players.

I think if you took a look a the business model focused companies, you’ll find more companies create value out of business model innovation than those that succeed at product innovation aka Platform Innovation for FB and Twitter. Source: http://youtu.be/2DMJ8cHwD0I. See pic.

EDIT: My roommate just mentioned that you were talking about “revenue models” vs. business models so maybe I missed your point, but then we should correct the definition of “Business Model” for the purpose of your piece because I was confused.

Rock on!
Taariq

@andrewchen