In social networks, the function of ‘friends’ is primarily to heighten narcissism by granting attention, as consumers, to the ego exhibited as a commodity.
— Byung-Chul Han, The Burnout Society, p. 43
Cal Newport, in his book Digital Minimalisn, explains that there are two forces that encourage behavioural addiction when using social networks.
The first force, intermittent positive reinforcement, exploits the fact that rewards delivered unpredictably are more enticing than those delivered with a known pattern. The expectation of likes/hearts/retweets after posting online is comparable to gambling.
The second force is the the drive for social approval. Social media is tuned to offer us a rich stream of information about how much (or how little) our friends are thinking about us at the moment.
We didn’t sign up for the digital lives we now lead. They were instead, to a large extent, crafted in boardrooms to serve the interests of a select group of technology investors.
— Cal Newport, Digital Minimalism
A quick test to see how deep these two forces have taken hold of your behavior: delete your Facebook and Instagram apps from your phone for just one day, and see if you show signs of abstinence syndrome. You can always reinstall the apps later if you want.
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.
- Some startups closing their doors are Everpix, Editorially, Springpad, Readmill, Bloom.fm… ↩
- Before closing, Everpix made their numbers public. ↩
- 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. ↩
- 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). “ ↩
- cfr The Verge, Out of the picture: why the world’s best photo startup is going out of business, Lessons learned. ↩
- cfr. editorially.com. ↩
Andrew Chen has written an interesting article titled How to design successful social products with 3 habit-forming feedback loops (2400 words). If you are interested in social networks/social products and their business model, you should read the article.
Chen explains that three feedback loops drive the success of social products:
- A feedback loop that rewards content posters when they push new content into the network.
A feedback loop that rewards passive content consumers with relevant and valuable content.
A feedback loop that rewards (and culls) connections within the network.
When the tree loops act in harmony, the players in the ecosystem produce and consume valuable content for the network. When one loop starts to fail, reverse Metcalfe’s Law1 goes into effect, leading ultimately to network collapse.
Innovation in social networks, Chen explains, can come from looking at each loop in isolation, and adding a twist in content creation, consumption, or how people are networked. (Think, for example, in recent products like Secret.)
- Bob Metcalfe, the inventor of Ethernet and co-founder of 3Com states that the value of a network is proportional to the square of the number of users of the system (n^2). Applied to social networks, the idea is that every new user in the network connects with every current user, increasing exponentially the number of interactions between the users of the system.
The inverse Metcalfe’s Law simply states that every time a user leaves the network, the network value for the rest of the users decreases exponentially, not linearly. ↩
On April 14, 2014, App.net initial backers will have to decide whether to renew their accounts for $36 a year or downgrade to the limited free version.
For background, App.net is an ad-free online social network that appeared as a reaction to Twitter’s policies changes in 2012. Created by Dalton Caldwell and promoted inside a technically-oriented community, App.net was crowd-funded as a Kickstarter project, raising over $800.000 and 11.000 backers.
App.net business model is simple: they are not a free service. Their main income comes from subscription fees. While they offer a free account, it’s pretty limited and more intended as a trial of the service. In Caldwell’s words,
I believe so deeply in the importance of having a financially sustainable realtime feed API and service that I am going to refocus App.net to become exactly that. (…) This isn’t vaporware.1
But having a great product and a solid financial model is not enough. You need growth. There are some crucial metrics in social networks’ business models, like the number of active users, and user growth rate.
Despite its efforts, App.net current user numbers don’t look good2. After reducing its fee from $50/year to $36/year, and launcing free accounts on February 25, 2013, in May 2013 App.net reached 100.000 users3. App.net also advertises itself as a great API for application developers. You can’t see a huge following there, either.
Despite its technically superiority and the openness of its design –and having raised $2.5M from Andreessen Horowitz on August 2013 doesn’t hurt–, App.net still faces the challenge growing past being a plaything for developers, and amassing a critical mass of users.