Sustainable Business Models
In pasts months, a number of startups have closed1. These companies raised money, launched good products, gained attention from the press... and then closed. It's not my intention to judge the decisions the founders of these startups made. Their closing is sad news. But... what happened? Even with the limited information available publicly, there are some lessons that can be learned by trying to understand the business models of some of them.
Know your operating costs
Knowing your contribution margin --the selling price minus the variable costs per unit-- is important, because if your contribution margin is negative, then you are selling at a marginal loss. The more customers you get, the more money you loose.
Everpix was a great online photo archiving and organizing service. They had nailed a problem worth solving. They also had an excellent team. Everpix got very positive reviews, the service was really good. Their user base was growing.
These graphs were published in 2013:
Everpix closed doors on November 2013.
Using Everpix's own data, which they made public2, Ivan Plenty offers an in-depth analysis of Everpix's operating costs. After converting Everpix's-provided operational to an accrual-based revenue3, he concludes that Everpix's operating income is negative, even before amortizing fixed costs. Contrary to what the Everpix team thought4, their main problem was not growth5. They were selling a paid product at a marginal loss.
If you raise money, use it for assets that generate money
"Editorially was a collaborative writing and editing platform designed to support and encourage the writing process. It featured a plain-text editor, a document version system, notes and activity feeds, discussion threads, and more."6
On February 12, 2014, Editorially announced it was closing its doors:
Editorially has failed to attract enough users to be sustainable, and we cannot honestly say we have reason to expect that to change.
That is, they had spent their initial funding and were not going for a second round of investment.
WHY NOT JUST CHARGE FOR USE? We thought of that, and in fact, it was always our plan to do so. But Editorially is a sophisticated application that requires a team of engineers to maintain and develop. Even if all of our users paid up, it wouldn’t be enough.
It would be mean to say now that Editorially should have charged its users from the start or at least adopted the fremium model. (That is, have a free tier and one or more paid tiers with premium features.) They made a decision on raising a certain number of users before charging, and how they would reach break even, and it deserves respect.
But they spend their money developing a product that offered great value for their customers, but no revenue for the company. As a general principle, you should only raise money to get or build assets that generate money. You should never raise money to pay salaries, unless those salaries are directly generating money.
Build a simple financial model early on, to see the flaws in your business model. If your users are your customers, charge them for your service, or at least adopt a freemium model.
Offering a service for free can make sense
On July 13, 2012, after a post on the founder's blog titled What Twitter could have been, App.net launched as a Twitter replacement. Meant to be sustainable from the start, it started as a paid-only service. Free accounts were added later, but they were invite-only and limited in functionality.
The first round of subscription renewals was due on April On May 6, 2014, App.net announced that because their current paid subscription base was not enough to pay their fixed costs, the service would continue to operate but without any salaried employee.
The Value Proposition of a social network like Twitter is deliverable only if they have a significant number of users. Because Twitter is extremely successful and free, there is very little incentive for users to migrate to a new network. You can't start a Twitter clone today with just a small user-base and grow from there. You need to offer something different and valuable. (That's what services like SnapChat and Secret are doing.) Also, super-fast user growth is needed, and charging for the service certainly hinders that.
Having Product/Market fit is not enough, you need a sustainable business model
A business model is a scalable, repeatable process that your organization follows to create value that someone else is willing to pay for. Having a Product/Market fit is an essential part of any business model, but it is not enough. As Seth Godin notes, the fact that you are going to work hard is irrelevant. The fact that you have risked everything is irrelevant. To be sustainable... you need a sustainable business model.
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Some startups closing their doors are Everpix, Editorially, Springpad, Readmill, Bloom.fm... ↩
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Before closing, Everpix made their numbers public. ↩
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This means you can recognize revenue not when your customer pays but when you render the service or sell the product. For example, if a customer pre-pays for a yearly subscription of Everpix, you recognize as revenue only 1/12 of the amount each month (and not the complete amount the moment he pays). Otherwise, you'll end 'using up' in advance the money you will need to pay in the following months for the user-generated expenses. ↩
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cfr High-Level Metrics: "At the time of its shudown announcement, the Everpix platform [was] generating subscription sales of $40,000/month during the last 3 months (i.e. enough money to cover variable costs, but not the fixed costs of the business). " ↩
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cfr The Verge, Out of the picture: why the world's best photo startup is going out of business, Lessons learned. ↩
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cfr. editorially.com. ↩