[A version of this article appeared on YourStory last week.]
One of the tenets that stock market investors live by is diversification. As their advice goes – if you invest in several (uncorrelated) stocks, you reduce the risk of a sharp fall in one stock damaging your income significantly. An extension of this argument is that traders should maintain a mix of low-risk and high-risk assets in their portfolio; even if the risk materializes and your high-risk assets blow up, you still have some income. This is called the ‘barbell strategy’.
This is a very useful concept in stock investing. But can we take advantage of this in other businesses?
Before we try and answer this question, let’s understand the ‘barbell’ concept a little better.
The reason this investment strategy is called a ‘barbell’ is that all your investment goes to the two extremes of low risk-low return and high risk-high return, much like the weight of a barbell is concentrated at its ends.
Thus, you deliberately plant your feet at both ends – low risk and high risk; low payoff and high payoff; short-term and long-term.
Sounds like a great investing idea – limit your potential losses, even while pursuing high-risk investments. But, you may ask, how does this help those of us not in the financial sector? If you’re not a trader, how can you take advantage of diversification in general, much less a ‘barbell’?
There are several different avenues of business where a barbell approach can help cover downsides, and allow you to test new channels of growth.
1. Startup Marketing: There are several different channels through which you can market your product (Traction, an excellent book on the subject, lists 19!). But not all of them are equal – channels like TV advertising, SEO, and viral growth have a high ceiling on saturation (i.e., you can acquire millions of users through these channels), while others (PR, social media, community emailing, etc.) are far less scalable. But there’s a flipside – the former ‘moonshots’ are also more expensive, far more risky, and take longer to optimize.
When you’re selling a new product, you should definitely explore some of the moonshots – if any of them work, they can make your company’s destiny. But you should also invest in the more near-term, less-scalable channels, to ‘keep the wheels turning’ with a small flow of users. This also gives you time to perfect your product and plug the leaks in your user acquisition funnel, so that when one of your moonshot experiments suddenly delivers a deluge of users, you are able to effectively retain them.
2, Short vs. long-term value propositions: Sometimes, startups also need to bet on a combination of short and long term opportunities. Your product vision may be very ambitious, but you often can’t offer that proposition from day one. In fact, the more ambitious your vision, the longer it will take to start delivering it. So, if you want to survive long enough to achieve your dream, you need to sell something else till that happens.
A great example of this is Zomato – they started as a pure-play information source on restaurants around you. Gradually, as the user base grew, they began overlaying restaurant promotions. Now, they’ve just started an even more lucrative food delivery service. And I bet they’ll add other services soon – allowing you to book a table, pay for your meal through the app, etc. (I predicted this in an early March blog post, maybe 10-15 days before they started the food delivery service :P).
3. Multiple product lines: More mature businesses also employ the barbell strategy. They often have one-two cash cow product lines, which they can milk till the cows come home (I had to take the metaphor to its conclusion, didn’t I?). This gives them the freedom to invest in potential breakthrough products – many of these will fail, but a few will succeed and make up for all the losses and more.
Think of skincare brands – they all have some stable products like fairness creams and face washes, and periodically introduce more cutting edge products (e.g., anti-aging elixirs) to test the market.
4. Your own entrepreneurial career: The above examples are at a company level. But even individuals can employ a barbell strategy. For example, I have a startup, and have been working on a couple of products for 2 years now. At the same time, I also do some freelance consulting, and am about to run a taxi on Uber / Ola. Not only does this small but steady income give me the staying power to explore more opportunities at my startup, it also gives me a reserve to tap into, should any of my experiments work and I want to step on the gas. You may say I’m hedging. I don’t disagree, but I’ve found this safety net invaluable – I can apply myself to my venture in the best frame of mind, without worrying about a fast-falling bank balance.
Thus, you can employ the barbell strategy in several different situations, to reduce your risk even as you take on high-risk opportunities. And that, ladies and gentlemen, is how you can have your cake and eat it too!
I’d love to hear what you think of the barbell concept. Can you think of any other applications? Comment here, drop me a line at email@example.com, or tweet at jithamithra.
A friend called me out of the blue a few days ago, and said he had a great business idea. Before I could get a word in edgeways asking him what it was, he blurted “And I’m quitting this Friday.” As I controlled my surprise and readied to respond, I flashed back to the time when I quit my job, two years to the day.
I first got an idea for a new venture about 6 months before I quit. My co-founder and I spent a couple of months testing the idea with friends working in the target sector. Once we got feelers that we may be on to something, we spent another 2 months finding a good guy to helm product development. And then we started building the product. By the time I quit, we had a prototype ready, and our website also went up the same day – I could proudly mention it in my farewell email.
Less than 6 months later, we shut the business down (surprised you with the shock ending, didn’t I?). As we pitched the offering to prospective clients and started a couple of customer pilots, we saw severe structural limitations to the idea, and decided to shelve it. As the military saying goes, “The best laid plans seldom survive first contact.” Or to quote this generation’s premier philosopher, Mike Tyson – “Everybody has a plan, till they get punched in the face.”
All of this is to say – there’s a lot of uncertainty when you’re starting up. And while the uncertainty will never go away, there’s a lot you can do while still at a 9-5 (or 9-8 in case of this friend) job to answer the most primary question regarding your startup – is there a paying customer who’ll find value in your service?
1. Build out the product concept
Outline clearly what the product will do. This will be very useful later when pitching customers, but it is also important at the initial stages to make sure you’ve thought of all sides of the idea. If you have a co-founder, then it helps make sure you are on the same page.
You also need to think about the concept at different levels – now that you’re going to execute on an idea and it’s not just a castle in the air, you need to descend from your 20,000ft view. I found it useful to do these three things:
First develop a 30 sec elevator pitch
Then dive a little deeper, and think about a 2-3 min description of the product and its benefits
Develop a 5-10 min presentation on the product – at this stage, you’ll start detailing how you plan to successfully and scalably deliver your value proposition.
This can be in any format, but I find making a PowerPoint presentation an incredibly useful cure for a muddled mind.
You can use the template below to sketch out your product concept and business model – it ensures that you think through all the elements of your business model.
Based on framework from strategyzer.com
2. Test the product concept with prospective customers
Unless you’re building a visionary product that people don’t yet know they want (are you the next Steve Jobs?) or there are strong reasons to be in stealth (e.g. Siri), you must absolutely talk to a lot of customers or industry experts. You’re not selling anything yet – this is more about validating the idea itself and ensuring that this is something people would pay for.
I would hesitate to put a number to these interviews – it really depends on the space you’re in and where in the value chain you’ll play. But, roughly speaking, let’s say at least 50 customers in case of a B2C product, and 5 in case of a B2B one.
The aim should be to rapidly iterate on the idea and improve it. For instance, when we were validating our idea, there were times when we would meet one person, return home and change the pitch, and then go to the next meeting. Such early conversations are invaluable in refining your idea significantly, before you spend a single penny on development.
You should also use these conversations to test your financial assumptions. How much would people pay for this product? How much would it cost to acquire the customer – distribution costs, marketing costs, etc.?
Let’s stop for a bit – at this point, all you’ve done is understand your idea, and test it with a bunch of people. No need to quit yet. But let’s move on.
3. Design a strawman / prototype
Once your customer interactions show that your idea has legs, and you refine your idea with customer inputs, it’s now time to design the product. You’re not actually building it right now – you’re just giving your product concept some form and shape. You can use Just in Mind for this – this tool allows you to draw out your product’s different features, and create the usage flow (I used this tool to create the first design for my current app). For example, if you’re building a mobile app, you can create a series of screens with the rough functionality you envisage. You can also map buttons to specific other screens – so that when you’re showing the prototype to someone, you can also demonstrate how the app transitions will take place.
Doing this can be challenging – it’s the first time you’ll be doing something concrete about your idea (and even more so if you’re a first-time entrepreneur, like I was). But if you don’t start enjoying it soon, then that’s a valuable learning too – maybe you’re not yet ready for the uncertainty and vagueness of starting up.
4. Test the prototype with customers
Once you’ve built the prototype, you hit the road again. Test it with the same or different customers – would they actually use this product? How much would they pay for it? You’ll learn a lot – just like creating a concrete design helped you clarify your own thinking on the product, users will give more actionable feedback when they can actually see the product in some form. All of which will improve the first version you launch significantly – without quitting your job yet.
5. Build out your initial financial model
I’m biased towards drowning in large excel models, and therefore I hesitated to put this down – is it really necessary so early on? But on second thoughts, it absolutely is. Not only does it help you acknowledge your assumptions, estimate the cash burn rate and plan your runway, it also gives you one more concrete element to test in the market – running this by customers can again help you verify that your business is attractive. And as long as your assumptions reconcile with user opinion, you can continue to the next stage – developing the product itself.
6. Start developing an MVP
Assuming the previous steps went well (i.e., people liked the product and you liked the experience), you then start building the Minimum Viable Product, or MVP – the most basic product that fulfils your core value proposition.
If you’re the technical lead, then this may be the time to quit your job – but only if you can’t manage this in addition to your regular job. And if you’re not the technical lead, then there’s still not enough for you to do at the venture to justify quitting. Spending your weekends working with your team and meeting customers is more than enough. In my case, our tech lead worked closely with a couple of freelancers to build an MVP – while it wasn’t ready yet by the time I quit, we were more than halfway there. (There may be divergent opinions regarding using freelancers / outsourcing initial tech, but let’s leave that for another day).
An advantage of hacking together an MVP quickly is that you can validate and refine your product much faster, which brings us to the next point…
7. Test the MVP with initial pilot / alpha customers
The next step is to share this MVP with some of the customers you spoke to in the previous steps, and see how they use the app. You’ll find that if you did the previous steps correctly and the customers are indeed captured by the product vision, they’ll forgive a lot of UI issues, buttons that don’t work, etc. – as long as the core value proposition is delivered satisfactorily.
[Tweet “As long as your MVP delivers your core value proposition, early users will forgive everything else”]
Only once this MVP works do you really need to quit – before this, there’s more than enough time on the weekend.
Thus, there’s a lot you can do to get your product off the ground before you even quit your job. In retrospect, I think even I quit too early. I could very easily have continued working till the time we found that the idea didn’t work!
Now, delaying your resignation is certainly easier said than done. I had a very supportive employer, and I could keep my boss in the loop from the very beginning. As long as I fulfilled my responsibilities at work, no one had a problem with my moonlighting. But other companies may be different, and I can easily imagine cases where this may be frowned upon.
Another factor that could make juggling everything difficult is the intensity of your day job. If that itself requires you to burn the candle at both ends, then you may not have any energy left to fuel your own venture. In such a situation, you may need to take a leap of faith, and take a short sabbatical (if you have a great equation with your bosses) or quit with the confidence that you’ll find another job if your venture doesn’t succeed.
And of course, there is the mental angle – most of us, to begin with at least, can’t compartmentalize our different roles. In such situations, one may feel that cutting a bond, however tenuous, with the previous employer is critical to fully seizing the new opportunity. So it’s definitely not as simple as I make it sound.
But to tilt the scale yet again, there are a few more underrated benefits of quitting later.
If your entire career thus far has been a salaried job, a clock will start ticking in your head the day you quit – especially if you’re paying a salary to your team. It makes a difference whether you’re paying this salary out of your (paltry) net worth, or from your own monthly salary. This happens to the best and best-paid of us – there’s no escaping it. Delaying your exit till a time when your product value proposition and customer validation are more solid can do a lot to assuage those frayed nerves.
This cash in hand aspect is particularly important early on, when you’re still experimenting. Having a fixed cash inflow gives you the staying power you need to try different value propositions, business models and consumer interfaces. Otherwise, every next experiment will pinch you – not the best frame of mind to unleash your creativity. In my case, I had already quit when my first idea failed! So I went back to working as a freelance contractor for 1-2 days a week, to fund my next product and keep me in the game.
You’ll have to work very hard initially, juggling your job and startup. Those few 100 hour weeks, working yourself to the bone, will tell you whether you’re really passionate about your venture, or just interested in the hype!
What do you guys think? Do you feel it’s hard to work on your business idea while also doing a day job? Would love your perspective – mine’s based on only a few sample points. Comment here, email me at firstname.lastname@example.org, or tweet at jithamithra.
Thanks to Abhishek Agarwal for providing inputs on an earlier draft of this post. And for sharing this excellent article, on the same theme. Just as I was ready to publish this post 😛
We constantly read about companies that have created barriers to entry – through technology, intellectual property, large-scale manufacturing, or sometimes even by throwing a ton of money at a problem. For startups, this barrier to entry is a constant refrain, especially in conversations with potential investors – “What’s your barrier to entry? What asset are you building that’s hard to replicate?”. And this is a hard question with no easy answers, especially for a young company that’s not building a high-tech, proprietary product – a bigger competitor with deeper pockets could appear at the ramparts anytime, and replicate exactly what you’re doing.
But what if just focus on a particular user segment could help you develop a competitive advantage? What if expending all efforts to serve a particular market niche or user segment could help you unearth a resilient barrier to entry?
I read a book called ‘Good Strategy Bad Strategy’ last year and was struck by how insightful it was. I’ve revisited my notes from the book at least twice now, each time capturing a new nuance. It’s a must read for students of strategy, advisors on strategy, and practitioners. Having been all three (in that order, oddly enough), this is right up my alley.
The book had many great ideas on sources of power for companies – what gives a company lasting supremacy in its market. One idea that stayed with me was of single-minded focus – how focus on a particular type of user can be a sustainable source of power or competitive advantage. How would this work? Let’s dig in – this feels like another 1800 word post.
Any company’s business model has 9 different parts, as below:
The author, Richard Rumelt, points out that to focus on a specific user segment, you need to make coordinated changes across multiple or all parts of your business model. Thus, your final offering to the customer is a sum of many moving parts that have all been finely configured – a sum that, as the cliché goes, is more than its parts. Applying such focus takes incredible coordination of policies, which, along with their interlocking and overlapping effects, can then confer unassailable advantages and make you a hard act to follow.
I know this seems very philosophical (a little like bad strategic advice!), so let’s look at a few examples to illustrate this better:
Rumelt uses the example of IKEA to illustrate this concept. IKEA is a furniture retailer that sells ready-to-assemble furniture. It targets do-it-yourself or DIY users, who love the feeling of putting something together. It has been hugely successful across multiple countries, but 70 years since its founding, no credible competitor has appeared or lasted. That’s sustainable competitive advantage!
IKEA has no secret sauce in terms of patented technologies for furniture, greater marketing strength, etc. The source of IKEA’s lasting advantage is, instead, the coordination between the different elements of its business model to serve its target segment. For a competitor to challenge IKEA, they don’t just have to sell ready-to-assemble furniture – they’ll have to change their whole business model.
They’ll have to design new types of furniture;
They’ll have to start carrying larger inventory;
They’ll have to create their own, branded stores; and
They’ll have to change their selling models.
Thus, copying IKEA is not a simple matter. IKEA’s policies are so different from the norm in the furniture industry that any competitor would have to replicate ALL of them to meaningfully compete for the same user segment. Adopting one or two of these policies and implementing them, even perfectly, would be useless – it would add huge expenses without providing any real competition.
Apple is another example. Over the years, Apple has targeted its products at premium customers who want a superior experience – well-designed products that just work. They’re not interested in the most technologically advanced products with the most bells and whistles – they want products that do their job simply and well. Oh, and there’s snob value too.
Apple has made several interdependent decisions to target this group:
Complete ownership of the product: Take the iPhone. Unlike its closest competitor, Android, Apple controls the entire product – the OS, the hardware, user interface, etc. This allows it to deliver a very coordinated and quality user experience.
Complete ownership of computer ecosystem: Moreover, Apple coordinates the experience across all its products. The Apple ecosystem can satisfy all your computing needs – desktop, laptop, tablet, phone and music player. All of these products follow the same design language, and work together seamlessly – they sync with each other very easily, without any need to fiddle with system settings.
Branded retail stores with a luxury experience
Marketing mainly to premium customers who don’t mind spending more – this not only raises product revenue, but also increases the long tail of revenue from app store downloads, music downloads via iTunes, etc.
The reason Apple’s position in the market is unassailable is that a competitor can’t just copy one or two things to start selling to the same group of customers. The competitor would have to copy everything, a formidable task even for very nimble companies. And copying sequentially won’t work – you can’t begin to deliver the Apple or IKEA value proposition without copying everything from the outset, in a coordinated manner. Which is why, even though Android and its partner OEMs have copied a lot of product design elements from Apple (in fact, the first Samsung Galaxy S was an iPhone in all but name), they haven’t been able to displace Apple from its position as the proprietor of all things cool.
Thus, the business models of IKEA and Apple are like a chain – multiple independent elements interlock to engineer a truly durable value proposition. As for a competitor, the flipside of a chain-linked model applies – your proposition is only as strong as your weakest link. Focusing on strengthening just one or two aspects of your model won’t increase your ability to compete even one bit – you need to strengthen everything, all at once.
Let’s try and apply this mental model of a chain to a few other sectors. Are there other companies as well, which have used focused, chain-linked business models to derive competitive advantage?
3. Wal-mart: In the 60s and 70s, Sears and Kmart dominated retail. But they mainly served large towns or cities that could ‘support’ a large retailer. Wal-mart changed the game by creating large-format stores away from cities, allowing enormous spaces at lower costs. It positioned itself as a ‘discounter’, something other players avoided like the plague. And it was able to make money while offering deep discounts, through several interlocking innovations:
Extremely wide product portfolio with deep discounts on some products, cross-subsidized by other high-margin products
Cutting-edge technology to track customer purchase behavior, and tailor portfolio accordingly
Agile supply chain, keeping its stores well-stocked with the right products very efficiently
Thus, several innovations, all focused on offering products at the lowest prices, gave Wal-mart lasting competitive advantage. By 2002, Wal-mart was the largest retailer in the world, and Kmart was bankrupt.
4. Dell: If you wanted to buy a desktop in the US in the 80s or 90s, your only options were to either buy a standard configuration through a retailer, or buy individual PC components to customize the machine yourself. Unless you built the PC yourself, you did not get much choice in the product or configuration you wanted. Dell saw an opportunity to change this by offering customized configurations, and thereby targeting the more technologically adept consumer.
Dell took a number of hard decisions to make this happen. It created an easy to use online / phone interface for users to configure computers of their choice. It delivered this promise through a mass customizing production process, and built a direct-to-customer distribution channel. None of these decisions were easy to replicate even singly, much less in lockstep. The result – a lucrative business model that stood unchallenged during the PC boom of the 90s.
OK, these are standard business school case studies. Let’s look at a few newer companies.
5. Innocent: The British healthy drinks / smoothies player has built a strong position in its home market. Innocent offers health-oriented users very fresh fruit-based drinks – their promise is, zero preservatives, only natural fruit. Offering this focused proposition means a number of business model decisions – sourcing the best fruits only, producing for short shelf life, faster cold chain logistics to get the product to retailer shelves very quickly, and so on. All separate decisions, coordinated to deliver user value. Competitors have found it very hard to replicate this – Pepsico, after years of trying to compete in this market, finally bought a smaller competitor to gain a toehold.
6. Zara: Zara has carved itself a preeminent position in the ‘fresh fashion’ space. Zara’s stores are always stocked with the latest trends – Zara gets clothes from design to outlets in 10-15 days flat. And it has done this by tailoring multiple parts of its operating model to accentuate this speed:
Much larger design team than other apparel brands – its 200 designers ensure a steady flow of new designs, taking advantage of the latest trends and feedback from customers.
While most apparel brands manufacture in China, Zara manufactures in Europe close to its main markets – this gives it a head-start of at least 1.5-2 months.
Short production runs, with limited quantities – Zara doesn’t run more than one production cycle for most of its products. If a particularly striking outfit runs out at its stores, that’s it. You won’t see it again. From a user’s point of view, this drives a purchase decision faster. If you plan to come back tomorrow to buy a dress, it may not be there.
Putting these aspects together, other brands find it very difficult to catch up with Zara – all of these are major business model revamps that are difficult to pull off, whether alone or in coordination with each other.
These and several other successful companies show that focus and coordination can create a massive barrier to entry and lasting competitive advantage, keeping challengers at bay for years to come. It’s a telling reminder to businesses – you don’t need cutting-edge technology or a massive fund-raise, just good old-fashioned customer service will do!
What do you think? Are there any other consequences – positive or negative – of focusing your business model on a specific user segment? Would love to hear from you – mail me at email@example.com, tweet at @jithamithra, or comment here on this blog. And do subscribe here – I post roughly once a week, on startups, business models, consumer behavior, etc.
PS. I’ve just started a newsletter called The Startup Weekly with Abhishek Agarwal, a close friend, curating the most interesting articles, case studies, etc. for startups that we come across every week. Would be a good addition to your inbox (so much for conquering it). Sign up here – first issue goes out this Saturday!
What comes first, the chicken or the egg? An idle question on which children (and sometimes adults) can spend hours shooting the breeze. The question is, however, not so innocuous when it comes to businesses.
Some of the most exciting ventures today have a unique characteristic – they’re multi-sided businesses. What’s a multi-sided business? It’s one which connects two or more distinct user groups that provide each other with benefits. Think of Uber – it connects cab drivers and passengers, who benefit each other. E-commerce marketplaces are also examples – they connect buyers with sellers.
Such companies, once established, have a high barrier to entry. While that’s wonderful, it also means that they’re incredibly hard to build. Users on one side of the business model find the platform useful only if the other side also exists. For example, people buy video game consoles only if there are games they can play. And game designers make games for a console only if there are enough people who own it. The proverbial chicken and egg problem. How do one solve this impasse?
I face this problem too, in the product that I’m building – connecting advertisers with consumers (launch coming soon – watch this space!). How does one break the deadlock between the two sides? Unlike the philosophical question of which comes first, here the only right answer seems to be both!
There are four ways in which successful multi-sided platforms have overcome this stalemate.
Slow and steady: Build the two sides together in lockstep
Jumpstart: Get one side up quickly, and then build the other
Fake it till you make it: Build one side gradually with a makeshift offering, and then bring in the other
Bait & switch: Start with a single-sided value proposition to build one side, and then introduce the multi-sided offering
1. Slow and steady
In such a model, your offering needs to be valuable to your very first customers on both sides. One way to achieve this is to start small – very small – at a level where it is possible to get both sides onto the platform and provide the necessary cross-network effects. Focusing on a single city, area or even a neighborhood first can help you prove the model to both sides. Once that happens, you can expand gradually, building the two sides in lockstep one neighborhood at a time.
This is what Uber did in San Francisco – getting the model going in one city, and then applying it to other cities one by one. Going small could also mean focusing on one specific customer or product segment before expanding to others. Amazon, and more recently Flipkart, started with selling just books, building a user base and brand recall before expanding to other products.
Tinder, the dating / swiping app, built initial traction in a very creative manner. In its early months, the marketing lead toured several college campuses. At each campus, she first convinced the girls to download the app. After that, when she showed the app to the male fraternities, they quickly jumped on, seeing the number of girls they knew on the app.
Growing both sides of the business slowly in sync is great, but what if you want to speed up growth? Speed is often critical initially – given the high barrier to competing in this space, multiple people with the same idea would try and hustle into pole position. Maybe you don’t need to have both sides up and running from the get-go?
There are many ways one can quickly get one side of the value proposition up, and then build the other gradually.
a. Partner with someone who already has a large user base
One way to break this stalemate is to opportunistically partner with someone who already has a large user base on one side of the platform. This could be another product with mass acceptance in your target user base, or someone who has strong existing relationships that could be leveraged. Once one side is thus engineered into being, you can then build the other.
Google hacked its way to an initial user base using partnerships. It partnered with Netscape to become its default search engine in the late 90s, and also tied up with Yahoo! to power searches on that platform.
b. Make it easy, low-cost and low-risk for one side to come on board
At the same time, you need to make it as easy as possible for one side to say ‘yes’. Drivers are much more open to trying Uber when all they need to do is accept a phone from Uber and keep it on. It’s simple, and it’s low-risk – there’s plenty of upside if any ride requests come on the app, but there’s no downside at all!
Belly, a loyalty program for small businesses, did the same. It gave retailers a very low-risk, easy to install and low-friction loyalty solution. Once a critical mass of retailers had it, localized network effects began to take shape – customers and other retailers, noticing this in some shops, started demanding it of others.
c. Subsidize initial adoption for one side
A subsidy or ‘free’ offer always helps give the initial nudge. This is what video console companies like Xbox or Sony PlayStation do. The console is sold at a subsidized rate to users, and the company takes royalty on the flurry of games that follow. Uber subsidizes both users and cabs initially, to speed up adoption.
3. Fake it till you make it
Sometimes, it’s difficult to obtain one side of the model quickly enough. In this case, you have to build one side gradually with a makeshift offering, and then get the other.
a. Be the counterparty till the real counterparty appears
Most large e-commerce marketplaces started with an inventory led model, where they stocked products themselves. Once user base was built, they found it easier to make the shift to the more lucrative marketplace model, connecting product suppliers to buyers.
b. Use existing systems or services
Sometimes, you don’t need to build the entire solution for all sides of your platform – winging one side of the platform is an option, at least until you demonstrate user traction. I’ve heard the story, possibly apocryphal, of how the Flipkart founders would actually go buy books from stores to fulfill their initial orders. Look for a repetitive, non-scalable way to fulfil one end of the bargain initially, rather than investing in building service infrastructure, supplier base, etc. for a model that is yet unproven – not only is the latter risky, it also delays your product’s launch.
4. Bait & switch
A very nifty way to build a multi-sided platform is to first offer a single-sided service, that doesn’t need a counterparty. Once a user base is built, you can layer on the multi-sided service. Sounds complicated?
a. Build a user base on one side with a focused (different) offering, then introduce the second side
Square is a payments solution for small businesses in the US. It’s really cool – a small chip-sized device that plugs into a mobile’s headphone slot and allows you to start accepting credit card payments. At least this is what it was initially. Once it built a sufficient scale of retailers, it added a second business model. Today, Square also runs a discounting app offering consumers great deals at its partner retailers, card-less transactions, etc.
LinkedIn also did something similar. It started as a pure play network for professionals. Today, a huge user base allows it to be much more – it now offers unique solutions to recruiters, job seekers, and professionals.
b. Start as an information portal
Another way to do this is to start as an information portal for one side of the platform, offering users a directory of information about the other side. Zomato started as a pure-play information source on restaurants in your neighborhood. Gradually, as user base grew, they started overlaying restaurant promotions. I bet they’ll add other services soon – allowing you to book a table, pay after your meal through the app, etc.
These are the four different approaches that companies have used to resolve their chicken and egg deadlocks. What do you think? Have you faced chicken and egg situations of your own? Would love to hear from you – mail me at firstname.lastname@example.org, tweet at @jithamithra, or comment here on this blog. And do subscribe here – I post roughly once a week, on startups, business models, consumer behavior, etc.
PS. In the actual chicken and egg problem, the egg comes first (there’s absolutely no doubt about that).
Roughly a year ago, Facebook bought Whatsapp for $19Bn. When I heard, my first reaction (as it was for many others) was, “What!!! 19 billion? 380 million per employee. And they don’t even have a proper business model!”. And this was after Evan Spiegel of Snapchat (poster-boy of the business model-less) refused a $3Bn offer from Facebook. Today, their search for the elusive business model just begun, Snapchat is also planning a raise at a $19Bn valuation, and Spiegel looks like a visionary. What’s happening here? Is a business model expendable?
Amid the spate of headlines screaming bubble, I read a couple of articles by Andrew Chen on how the business model is not the main bottleneck for a startup at all. It’s the audience. As Andrew says, the biggest risk, regardless of your monetization model, is whether you can get millions of users or not. This sounds like a corollary of the power law – whether you succeed will depend far more on the size of your audience than on what you sell. If you have the users, you can find the money. So go build that audience instead.
The biggest risk isn’t your business model. It’s whether you can get millions of users or not.
Wait, are we saying you do not need a business model at all? Of course not – you do need to make money. But the point is that it’s not your critical constraint. Build a product that enough users want, and there are any number of off-the-shelf business models you can tag on to it.
Take Facebook – even a year after its IPO, people were concerned it didn’t have a solid business model. Today, Facebook is hitting annual revenue of over $12Bn not due to any innovative business model, but driven by its user base and growth alone. Maybe I’m belaboring this a bit, but especially for a consumer startup, it’s often far more valuable to focus on growing user base from 100K to 2 million, than to try and optimize revenue per customer.
OK, this is all talk – every business can’t use the same models that Facebook does. What are all these off-the-shelf business models we’re blabbering about? Well, I looked around online, but couldn’t find a comprehensive list. So I chose the next best option – I built it myself. I’ve listed 25 business model patterns below, that you can plug onto your business.
But first, you need an audience. And for that, you need a value proposition. Let’s say that you’re a platform where users come for widgets – these widgets could be physical objects (e.g., furniture, books, etc.), or digital ones (photos, updates from friends, online services, etc.).
This entrepreneur has bigger problems than his business model.
Now, if the widgets have direct monetary value, the business model options are fairly straightforward:
1. Manufacture and sell directly to customers 2. Outsource manufacturing, and sell directly to customers 3. Manufacture and list on other marketplaces 4. Become a marketplace and collect brokerage
But I’m guessing that if the widgets have physical value, then the business model wouldn’t be as big a question. Amazon India and Flipkart don’t take much ‘brokerage’ today on their e-commerce marketplaces in India, but their belief is that they can in the future.
It becomes more interesting when the product that your audience comes to you for may not be a physical one with direct value – how do you make money then?
Ever since Google revolutionized search by putting ads next to search results, advertising has become a default monetization approach. And let’s not forget that the newspaper industry has revolved around ads since forever. The digital advertising industry today has matured considerably, offering several options to tag onto your product / service.
5. Ad networks: Ad networks collect an inventory of ad content from advertisers. You can tie up with one as a publisher, and the network will then start showing banner ads, pop-ups, etc. on your platform. For every ad seen or clicked on, you collect. A lot of mobile apps today, especially games, use this as an earning model. There are over 200 ad networks around the world today, that you can partner with – Google AdSense, Tribal Fusion, InMobi, etc.
6. Affiliate networks: Fundamentally similar to an ad network, but here the focus is more on driving actual sales. You showcase product ads on your website, and you get a percentage of any sale originating from a click here. Some companies do only affiliate sales – check out Cashkaro.com, for instance. Anyone can become an affiliate to one of the large e-commerce players, or join an affiliate network – just search for ‘Affiliate network’ on Google, and a bunch of them show up.
7. Promoted Content: Ads that look native to your website / app, rather than banners. This is the Facebook model – where your news feed also contains a few ads in the same format. Twitter does the same with Promoted Tweets, and Snapchat Discover is also a variant of this. Some of the smaller apps also do something similar – QuizUp, from time to time, has Quizzes on upcoming movies – these are likely promoted.
8. Sponsored Content: Sometimes, your regular content can also be sponsored. This is the model sometimes followed by digital magazines / newsletters – an issue may be sponsored by a particular company, and free to the user.
Now, let’s get into slightly more complicated advertising solutions:
9. Offer Wall: Sometimes, rather than showing banner ads (which can be distracting), mobile games allow you to gain virtual assets (say a missile launcher in a first-person shooter game) by watching a few ads, downloading promoted apps, etc. For each ad you interact with, the game gets paid by the advertiser, and you get that missile launcher! This is called an Offer Wall – Tapjoy is one of the biggest providers of this service.
10. Retargeting: What users do on your site can be valuable to advertisers, even if they don’t actually advertise on your site. For example, the kinds of pictures you pin on Pinterest could be valuable information for an e-commerce player – they can then offer you the right deals when you visit them. You could help make that connection by integrating with a retargeting solution like Adroll or Perfect Audience.
11. Special Offers: You can also run exclusive offers from time to time for your users, in collaboration with advertisers – e.g., a special discount code that they can use in shopping. Often, this can be designed in a way where you get a cut for every user that converts.
12. Special Campaigns: Similar to the previous solution, you can also run special campaigns for advertisers to drive engagement. “Do you love Coke Zero? Upload a video telling us why, to win an exciting hamper!”
13. Behavioral Analytics: Observing how users engage with your platform and with other users on it can be very helpful in understanding their behavior. And this behavioral understanding could be very useful to corporates. Sharing this data with them could be a good way to monetize. Now, this is not really advertising, but it’s similar in that a separate entity pays you for your users and their actions.
B. Charge the User
The other option is to charge the user herself. Of course, setting an upfront fee for usage could scare away a lot of users, and hence the need for more creative solutions.
Some of the business model patterns that exist here are:
14. Rent / Subscription: A simple monthly subscription fee for use of the service – users are more likely to convert for this, as it’s a smaller amount than buying the software outright. This is a primary model in SaaS solutions, but it’s also used by others. World of Warcraft, the hugely popular multiplayer online game, charges $14.99 per month for usage.
15. On-Demand / Pay as you go: The opposite of the Subscription model is the On-Demand one – users pay only when they actually use a service. Cab services like Uber and Ola are great examples of this – you pay only when you use the service.
16. Bait & Hook: The bait and hook model involves having a low entry barrier for users, with regular, high ongoing charges. Printers and razors popularized this model, with relatively low-cost devices and high cartridge costs. But this is something we see among newer companies as well – US telecom players sell mobile handsets at a loss but have expensive paid plans with lock-in periods. Video game consoles are similar – cheap consoles, costly games.
17. Retainer + Usage: Another model to reduce upfront costs (and increase adoption) is to charge a low retainer for accessing the product / service, and then pay-as-you-go, depending on the amount you use. This is halfway between subscription and on-demand, and hence potentially less attractive to users than either.
Freemium business models
Freemium business models, where some consumers use the product for free and others pay a premium and cross-subsidize them, have gained a lot of traction over the years. There are several examples of the freemium pattern:
18. XX no. of uses free: Many services allow you to use them a certain no. of times per month for free, beyond which you need to pay. For example, the Financial Times website allows you to read 3 articles a month for free, after which you need to pay a subscription fee. Tinder is experimenting with this – it is considering limiting free users to only 100 swipes a day, with an option to upgrade to Tinder Plus. Some of us will now need to find something else to do at lunch unless we’re ready to pay.
19. XX no. of users free: An app that involves collaboration could limit the no. of people collaborating on the free plan. For example, an office chatting app could limit the number of colleagues you can add on one account to five. Todoist, the task manager that I use, allows you to add only 5 people to a project in the free version.
20. Limited scope for free users: Services sometimes limit scope of use for a free user, and you need to upgrade to do more. Taking the example of Todoist again (I love the tool, btw!) – the free version allows you to list and complete tasks and projects, but you need to pay if you want to label tasks, write comments, etc. Similarly, many content websites allow you to see the latest reports for free, but you have to become a paid member to access their archives. LinkedIn also uses this freemium model to great effect – they have different premium plans for job seekers, recruiters, and so on.
21. In-app purchases / virtual goods: This is popular among mobile games. Reduce the entry barrier by keeping it free, and allow users to purchase virtual goods within the app. If you’ve played Angry Birds, you’ll remember the Mighty Eagle. In a particularly difficult level, you can buy the Mighty Eagle (only $0.99) to kill all the well-sequestered pigs. And the stickers that you can buy on WeChat or Viber are also examples of in-app purchases.
22. Trial period: A variation on freemium is to allow consumers to use your product for free for 1 month, and then start paying. Most online software tools offer this – in fact, even if they are freemium and have a paid plan, they offer a trial period on the paid plan. The trick here is to use this first month to really sell your product and convince the user that she can’t live without it. A good onboarding process, assuming your product really adds value, can work wonders.
If you’re deploying a freemium model, you should initially assume that only 0.5%-1% of your users will convert.
Offering other services
Sometimes, you can offer other products / services to your customers to earn revenue.
23. Value added services: Offer users tools or services to help them better use your core offering, which remains free / inexpensive. For example, a photo-sharing software could offer certain paid filters that you can apply to your photos before sharing. Similar to the many paid Instagram filters that exist for iOS and Android today.
24. Diversified services: Sometimes, companies also offer completely unrelated services to their user base. WeChat has gradually added a myriad services to what one thought was a messaging app – mobile games, peer-to-peer payments, e-commerce, you name it.
25. Events: An offering which has a community built around it can also monetize by running events or get-togethers. And if the company can procure advertising / sponsorship for the event, that’s an additional revenue stream. VCCircle, a content company in India focusing on startups and investing, runs a large number of information / networking events that its subscribers and others can attend for a fee.
Thus, there are several business models that you can use, provided (and this is the million dollar question repeated for the millionth time) you have a large enough audience. Can’t find one that fits your offering in this list? Don’t fret – continue to build your product and user base. As long as you add value, you’ll eventually find a way to share part of it.
What do you think – is a business model a commodity yet? Would love to hear your thoughts. And if you want more information on any of these – how they work, how you can integrate them, tools you can use, etc. – do comment here / email me at email@example.com / tweet at @jithamithra. And yes, do subscribe to this blog – I post roughly once a week on startups, consumer behavior, books, etc.
Over the past year, sanitation has hogged headlines in India like nobody’s business. And rightly so – it’s everybody’s business. Two out of three households in rural India don’t have a toilet. And many of those who do don’t use them. Against this intimidating backdrop, over two years ago, my colleagues and I at Monitor / Monitor Inclusive Markets set out to develop a market-based solution to the sanitation problem in rural Bihar. And over these two years of selling the idea of a toilet to rural consumers and working closely with people selling toilets there, I’ve learned a lot regarding consumers and how to sell to them.
With the Swachh Bharat Abhiyan (the new avatar of the Nirmal Bharat Abhiyan, itself a new avatar of the Total Sanitation Campaign), the government wants to make India open defecation free by 2019. In less than five years, all 1.2 billion of India’s population will use a toilet. Today, we’re at least 600 million shy of that. In fact, as people in the sanitation sector often say:
[Tweet “India has a majority of the world’s open defecators, and a majority of Indians open-defecate.”]
According to the 2011 Census of India, Bihar is a laggard in toilet coverage – only 18% of rural households have toilets. In 2012, we set out to develop a market-based business model to resolve this – could we harness market forces to drive adoption of toilets? After talking to 1000+ villagers in Bihar, meeting 150 value chain players and visiting sanitation interventions in many other areas, we developed business models that are now being implemented in parts of Bihar (see post-script for more details on the models). It has been fascinating to put together a business model and see it take shape on the ground. Along the way, I have also learned a lot about how consumers think, and how to sell to them.
1. Your value proposition needs to be concrete, tangible and real to your consumers
Your product’s value proposition has to make sense to the user, which means three things:
Concrete: Your product’s benefits can’t be nebulous – they need to be specific. For example, just telling consumers that using a toilet is good for health is not convincing – you need to explain step-by-step how open defecation means you’re eating your own shit.
Tangible: Sanitation NGOs today are doing a good job of making the health benefit concrete. But it’s not tangible. Even after you explain the benefits, people still need to be able to see it – just logic won’t do. And health benefits are particularly hard to demonstrate because (a) they start accruing only after a majority of the village stops open defecation, and (b) even after safe disposal of faeces, people still fall ill due to unsafe drinking water and other factors. And if something so axiomatic is hard to prove statistically, try convincing your village consumer anecdotally! Instead, what we found from speaking to people is that they want toilets for safety (vs. traveling early in the day / late at night for open defecation), convenience (especially when ill / for the elderly), and privacy – all far more tangible.
Real: While the benefit may be tangible, it’s important that there be a need for it – else you’re just a very good solution in search of a problem that may not exist. A hallowed business model in rural sanitation is that of a one-stop shop, and one of its main value propositions is convenience. Of course it is more convenient, but do consumers value that? What we saw was that farmers or agricultural workers finish their day’s work in the morning and have a lot of free time later – they’d rather use this time to buy all the materials, than pay someone a commission to do it for them.
[Tweet “Your value proposition needs to be concrete, tangible and, most importantly, real.”]
2. Even if affordability is an issue, people don’t want a ‘cheap’ solution
With toilets, as with cars, people want quality, albeit at a low price. ‘Cheap’ is not a value proposition, ‘value for money’ is. And when offered a cheap solution, people who otherwise wanted toilets did not buy. “If we have to get a toilet, it has to be a quality one”. Convincing people that your low-cost solution is also high-quality is critical.
[Tweet “‘Cheap’ is not a value proposition, ‘value for money’ is.”]
3. To convert customers, ability and triggers are as important as motivation
According to BJ Fogg’s Behavioral model, behavior change is driven by motivation, ability and triggers. This holds even for sanitation behavior – if you want a consumer to construct a toilet, driving ability and triggering purchase are at least as important as motivating purchase. One single step to increase ability to purchase – financing – has disproportionate impact on toilet adoption. Similarly, from a usage point of view, a household that constructs a toilet will not use it if procuring water is inconvenient – ability or ease of use is critical.
Financing also triggers purchase among households that can already afford toilets. One such household took a loan of Rs. 5,000 to construct a large toilet, with an attached bathroom, a shower, and a large septic tank – and they use it religiously (toilets vs. temples, anyone?). This cost at least Rs. 60,000 to construct – they could have, of course, constructed a toilet without financing, but that was the trigger.
4. Skin in the game is important, to drive usage
Over the last 10-15 years, toilets have been constructed with government subsidy for rural households across the country. But usage is markedly lower when households contribute neither materials or money, according to last year’s SQUAT report on sanitation usage – none or only a few household members use it. Financial participation keeps people’s skin in the game and drives long-term usage. Maybe it’s a good thing most people don’t understand sunk cost.
5. Choice is helpful. But don’t make a user choose between a Nano and a Mercedes
Giving customers choices (but not too many) is definitely more helpful than one-size-fits-all. This is not a new insight. But when you offer three toilets at prices of Rs. 10,000, Rs. 15,000 and Rs. 25,000 respectively, consumers buy none of them – this was an unexpected response during our business model pilots (easily explained in retrospect of course – hindsight is 20:20). The reason is that over 90% of people in most villages in Bihar cannot afford a Rs. 25K toilet – it’s the rural toilet equivalent of a Mercedes. And when you offer a middle-class prospective buyer a Nano and a Mercedes in the same choice, you cause decision paralysis. He may have come in considering a Nano, but he changes his mind on seeing the Mercedes – “Maybe I can save up over the next few years to get a Merc.” He may come back 5 years later or he may not, but he’s no longer a prospective customer today.
[Tweet “Choice is helpful. But don’t make a user choose between a Nano and a Mercedes.”]
Choices need to be from the same cohort – Nano vs. Alto vs. Indica is an easier decision to make, and even easier is a choice between A/C and non-A/C variants of a Nano.
As I’ve been setting up my own business, I’ve remembered each of these learnings multiple times – initially as rationalizations for observed user behavior, but later more and more to predict user reactions. But my most important learning of all – reinforced by every piece of user feedback I receive on my app and every user grievance I address every day – is that users are who they are, and they want what they want. Take that as a given, and try to deliver that value through your product. If you’re trying to tell a consumer what to want, well, good luck to you!
PS. You can read more about our Bihar work and the business models we developed here.
PPS. I must thank Monitor (now Monitor Deloitte) and Monitor Inclusive Markets (now FSG India) for the opportunity to work in sanitation for so long. Of course, this post doesn’t necessarily represent the views of these two companies, and the people I worked with.
Throughout your academic life, you’re told, variously, “There’s no substitute for hard work”, “Work hard and don’t think about the results. They’ll take care of themselves”, “It doesn’t matter what you do, as long as you do it well”, and so on. Mildly put, that’s completely false.
I read Peter Thiel’s Zero to One a couple of months ago. In this book, Thiel, who founded Paypal and has backed many successful startups (including Facebook), talks about startups and how to create value in the world. The book itself has many highs and lows, but I found his discussion of power laws very thought provoking.
So, what is a power law? A power law describes an exponential distribution – where a few individual points account for a majority of the value in the population. Simply put, it’s the Pareto principle (80:20) on steroids:
Normal distributions assume that the entire population will be distributed across, with a huge majority of people around the average. For example, if you were to plot a distribution of the weights of a country’s entire adult population, it would probably resemble a normal distribution – a large proportion of people near the average, and the no. of people going down as you moved away from the average on either side.
On the other hand, populations that obey a power law are completely skewed to one side. Think about wealth distribution – you know how they bandy around the statistic that 1% of people account for 50% of the world’s wealth? That’s a power law. I read somewhere that whenever a book from Chetan Bhagat is released, it almost outsells the next 500 best-selling books combined. I was quite surprised, but I shouldn’t have been – book sales also follow a power law.
Why is this important? Power laws have always played a huge part in nature. For example, a vast majority of earthquakes are relatively minor, but a tiny proportion cause almost all the damage – that’s a power law. They also explain a lot of our societal context – language (a few words dominate usage), city populations (the largest cities account for an inordinate proportion of urban population), and so on. And more and more, entire industries are beginning to resemble power laws – especially in the Internet era. Think Search (Google accounts for 88% of the market), Social Media (Facebook has 33x the no. of visits as Twitter, its nearest competitor) and so on. This phenomenon, where the winner takes (almost) all, is becoming more and more pervasive. You dominate or you die (separate post on this later).
But coming back to the main focus of this post, what does this mean for you as an individual? A few things, actually:
What you work on matters, and matters far, far more than how hard you work. Till the early 1900s, there were people called ‘knocker-uppers’ who would help people wake up every morning, by walking down the street with a long stick and tapping windows till people woke up. Many of them worked very hard; but lost their living in a jiffy once alarm clocks started being mass-produced around 1920. As Thiel says, by all means work very hard on what you’re good at, but first think hard about whether it will be valuable in the future. In a world where the returns on your efforts follow a power law, you must think hard about where you stand on the curve. [Tweet “What you work on matters, and matters far, far more than how hard you work”]
If you want to start up, seriously consider working for another one (with stake / options). One of the corollaries of the power law is that very few startups will succeed, but they will succeed hugely, enormously. So, being at the right startup is far more important than your role in the startup and how much stock you own. A little simplistically, 0.01% of Google is probably worth a lot, lot more (35 million dollars) than 100% of a startup that you’ll start. And most startups fail, in which case you’ll own 100% of nothing. So if there’s another startup / early stage company that you think is promising, it may actually be a better bet to join it with stock / options than starting your own.
If you have a startup already, don’t hoard stake. Many startup founders are very miserly with stake. I’ve heard many say “Your company’s stock is the most valuable thing at your company.” While technically true, many take this to mean that you should give away as little stake as possible. Rather, I’d read this as meaning that you should do whatever you can to raise its value. And if a particular investor can actually help you succeed and raise the value of your company significantly, then giving them slightly higher stake (within limits, of course) is worth it. This is especially the case early on, when the growth in the pie will affect your personal shareholding’s value far more than the proportion of the pie that you own.
Realize that the power law will permeate all your decisions. Whether the markets you choose to play in, your distribution channels, your product features or your decisions themselves, few or one will dominate in terms of creating value for you.
Now, you can’t predict the future, and so you don’t know which of your choices will matter. The only way to set yourself up for breakout success in an uncertain world is to go for the big prize – where even if chances of success may be low, the value created (for you and others) in the event of success is immense.
These are the different ways in which power laws affect us as individuals. I would love your feedback – how else do you think power laws affect our daily lives and work?
And yes, please subscribe on the right for regular updates from this blog – I blog roughly once a week on startups, growth hacking, consumer behavior, books, etc.