Why You Can Sometimes Wait For Scale To Execute Your Business Model

I wrote a long post on the plane back from Australia trying to defend my assertion that for most web apps you can wait for scale to execute your business model. After reading it several times, I think it sounds too defensive and I am not going to post it. But there is one part of the post that I like and want to share with all of you. There’s something unique to most web apps that makes waiting possible and it’s this:

if you are building a media oriented business, particularly one that has low marginal costs, meaning you build it once and the cost to serve an additional customer is negligible, then you have the unique opportunity to focus first and foremost on building your customer base or audience

Most web apps will be monetized with some kind of media model. Don’t think banner ads when I say that. Think of all the various ways that an audience that is paying attention to your service can be paid for by companies and people who want some of that attention.

If the marginal cost to service an additional customer is negligible, then you can wait to monetize. If it’s not, then you are going to have to focus on your business model earlier in the life of your business. It’s really that simple.

#VC & Technology

Comments (Archived):

  1. vincentvw

    I’m guessing this is about Twitter and it’s mysterious business-model. And couldn’t agree more with your premise, and am pretty sure that 90% of start-ups have to operate in this way, i.e. delay their business-model until they have the client-base they need.I think plenty of people are sceptical of Twitter, simply because of the internet-bust 6 years ago, and because relatively few start-up are building to go public/independent, rather, they are building to get bought. In which case the business-model becomes (slightly) less relevant.What people really want to know about Twitter is whether this is a 1-year fly, or a thriving hive, and that question has definitely not been answered. In theory there are many directions that Twitter could take—advertising, subscriptions, get bought, merge with Tumblr, etc. The question is whether, at the execution of a business-model that somehow restricts the experience, the number of users will drop or not.For instance, Twitterific on the Mac was the hype for a while. As soon as they introduced “inline-ads or pay,” I and, I’m sure, many users stopped using it. Probably because the Twitter.com experience is not much worse, and there are plenty of free alternatives. But yeah… I wish Twitter all the best, and as long as the experience remains the similar or better, I’ll probably continue to use it somehow.

    1. fredwilson

      Well this post is not about twitter but about web apps in general. My earlier post on this topic was about twitter thoughFred

      1. vincentvw

        I understand, but even if it’s not exclusively about Twitter (and I’m sorry of my comment sounded like a condemnation of that particular business), my comment was more about the users’ perspective on this.Scale is of course important to any business, but the other side of the coin is that users are entrusting their time, data, and what-not into a business too. It is a long bet for both parties, and the more reassurances users get that “it will all be ok” the better.Fair enough that some business models are only executed at a later date. That’s just common sense. But what the users want is that Twitter et al survive, that all their input was not in vain. And that, I guess, only the future will tell (though a little hint at a business-model may help :).

    2. dziewczyny

      After reading this blog makes me want to start my own.

  2. bjubb

    “marginal cost to service an additional customer is negligible” – this would be one of the true strengths of the Software as a Service model. in my experience with SaaS , the only real advantage of having a business model that you feel somewhat assured that you aren’t devoting all your time to a potential dead end. i think a big struggle for some is this jumping-off point , where you don’t know your business model exactly yet you don’t know if you actually have something solid enough to go with. is this the true essence of entrepreneurship? perhaps, but either way I enjoyed this thought provoking post.

  3. drBaher

    I completely agree with your rationale.Once you have scale and good user base, generating money is a matter of time and experimenting with known and new business models.But also starting early with business model will prove beneficial on the long term, as you will have the change to modify and improve your model based on the feedback concurrently with getting more users and improving the service.

    1. markslater

      really? hmmm. Think alladvantage. Call me crazy but as a CMGi alum i can tell you first hand that the ‘get big quick’ model has many flaws. if businesses today are to avoid these fault lines on their plans they better be pursuing scale and users in parallel with pragmatic sustainable revenue horizons. I just dont believe that the first holds sustainable value without the second anymore.

  4. howardlindzon

    simple but right on here.I guess thats why lifleock has been such a homerun. they get both…cash flow while they scale.

    1. fredwilson

      Lifelock seems like it is a great business but its not a web app. Its an insurance company. I don’t know anything about that businessFred

  5. pwb

    Don’t get defensive…get offensive!! Monetizing early can leave services vulnerable to competitors who wait. It’s easier to make money from heavy usage than it is to create a service that garners heavy usage.

  6. Emil Sotirov

    Two considerations…1. Monetizing involves the users… if you don’t try monetizing early, you cannot be sure how users would react when you start monetizing.2. Many start ups just don’t have the money to go without trying to monetize early.

  7. vadadean

    It’s really all the customer related costs that has to be low, including, the cost of serving the customer and the cost of acquiring the customer. From this vantage point my business scales while affording me the necessary experimentation. That’s critical within such a fast changing media market filled with attention saturated users.

  8. Pete Vlastelca

    I like that you qualify this headline with “sometimes.” I suppose in terms of pure economics, low marginal cost businesses do have a bit of a luxury to push out their thinking about making money. But this is more than an economic issue — it’s an organizational one, and a matter of leadership. When people running the startup set a tone in the beginning that revenue is not yet important, that attitude creates an institutional hurdle that needs to be overcome at the point when everyone agrees that monetization should become a priority. Much like user acquisition, customer development is a long, iterative process for most internet companies. If the company’s early culture doesn’t reinforce the importance of learning from that process, and it’s assumed that when the time is right they’ll just “flip a switch” and turn on revenue, it can be a shock to everyone’s system when the eventual model produces less-than-expected results.Even at a low marginal cost of adding users, in my experience, the average internet company can stabilize more quickly the earlier it honestly focuses on what makes it unique to its customers, not just its users.

  9. Arne

    Thanks. I like your thoughts. Considering start-ups will most likely change their product specs before the service is good enough for gaining mass, the business model is also likely to change. But in the end, we all want to know how a web app will become profitable.

  10. Sean Ammirati

    I understand your concern it sounds too defensive, but I’d love to read it. Maybe you could just put a disclaimer at the top of the post and then run it? This is something I discuss all the time and would love to get your thoughts.

  11. Matthias

    Fred,1. what’s your take on getting customers used to the business model? Not as important as growths if you have the opportunity to scale?2. the above question is only relevant to a small proportion of businesses, others are just not growing fast enough, right? but what would you call “fast enough”? Let’s say, start-up, six months after launch, team of five.Thanks, Matt

  12. lawrence coburn

    Dang Fred, I kind of want to read the whole post. Aren’t folks supposed to be defensive / biased about their portfolio companies?

  13. aizheng

    肺癌 胃癌 肝癌

  14. markslater

    the paradox here is that freds investment in twitter is fascinating. it has network effects, its application limble, it is going to grow, and its going to challenge – buts its business model is unclear (at least to us users). This is freds delicious investment all over again! whatever you ‘twits’ have up your sleeve – i like it!

    1. fredwilson

      I like being called a twit!

  15. Elia Freedman

    Fred,This post seems to be a constant theme on VC posts and, frankly, I am tired of the generalization. It completely depends on the customer, not the costs to deliver the product. The costs give the providing company the flexibility to consider it but shouldn’t be the deciding factor.I agree in many cases that free out the door is the right model. Twitter, which is mentioned here, is a good example. I think so is Facebook and MySpace. But they shouldn’t be free because the cost is low. They should be free because the customer isn’t willing to pay. Would you pay to watch videos on YouTube? I don’t think so.In other cases, however, having customers pay is important because they often don’t derive value without it.The beauty of the web is that it makes the conversation possible. There are many cases, however, where free should be ill-advised.Thanks for the entertaining my perspective.Elia

    1. fredwilson

      Excellent pointThanks for making itFred

  16. chadrussell

    In sort-of relation to my comment on the Twitter post you did, which in re-reading it, it sounds more like I’m being authoritative on the subject rather than speculative which I was trying to be, do you think that the majority of deals are now happening after the product is built and the scale is gaining or do you think that just coming to the table with a prototype or idea is still feasible? Or does it really just vary on a case-by-case basis?

    1. fredwilson

      It variesWe prefer to fund companies post launch thoughFred

  17. Doug Kersten

    What do you mean by negligible? $1, $10, etc.? Or is it based on what the business has in it’s bank account? Do you think worded this way it follows the vein of what you are talking about: If the marginal cost to service an additional customer is negligible when it relates to the resources the business has on hand , then you can wait to monetize. Or am I misunderstanding what you are saying?Doug K.

  18. LauraAdams

    While not a comment on business models (ever-changing beasts with no single or right answer and that no one really believes until the money comes rolling in), I found this very exciting use of Twitter- http://frozenpeafund.com- by @susanreynolds. You may already have come across it. Certainly shows the potential for Twitter to generate social value beyond the community created and conversations carried out with it.

  19. Jim Duster

    assuming you can get users, say 5K a month, what are the best ways “to monetize” that won’t infringe on user’s rights nor feel like they are getting the short end of some stick. Our premise is to make media content downloads across a broad set of categories available to consumers, but I need to come up with a set of ways to monetize it, beyond the small % of love we get from the content owners.What is the short list that Klavdia speaks of: “generating money is a matter of time and experimenting with known and new business models “Thanks!

  20. Aruni S. Gunasegaram

    Thank you for this post. As I start the process of raising angel funds and if anyone requires that I have the business model 100% defined, I am going to point them to this post. The marginal cost to service an additional customer for my apps/business is negligible. Thanks! I’m being a bit sarcastic because I don’t think that will go over very well here in Texas and I agree with Elia Freedman’s comments.I have a question related to Twitter’s (or other social related web apps) market size analysis. When they (or other web app plays) were raising funds how did they quantify/illustrate their market size? How did they anticipate growth in users and where users would come from?

    1. fredwilson

      In twitter’s case, they didn’tWe approached them about an investment. We saw the opportunity clearly and wanted to be involvedFred

      1. Aruni S. Gunasegaram

        So when you “saw the opportunity” how did you get comfortable with market size/user growth? I am really curious about this to understand how potential investors might think about my or other web app business. Did you think “wow, they will get a ton of users because the tech community/entrepreneurs will love this (early adopters) and spread the word? So let’s get in now?” Was it the “cool factor” that you thought could be sold or part of a suite of apps to form a company that could be taken public? For instance, I will be integrating some twitter-like functionality in our new social networking app.By the way, I know you are extremely busy but if you ever had some time for a phone call (or if you are in Austin sometime or I’m in NY) would love to listen to your thought stream about this stuff since you are one of the leaders (go-to-guys) in investing in web apps. I’m @aruni on twitter.

        1. fredwilson

          I posted the reasons we made the investment at unionsquareventures.comI’ll try to find the permalink but am on my blackberry.Try googling unionsquareventurs.com twitter. That should get you thereFred