You might have heard this lament before, “People will pay $5 for a cup of coffee, but $0 for an app…” Yes, this is weird, and unfair, and depressing (for app developers), but it is a fact, especially on the Android side. It can be very difficult to get people to pay for things in certain domains:
- Many people expect websites to be free (e.g. ad supported)
- Many people expect apps to be free
- Many people expect music to be free
- And so on…
So given a choice, you want to pick a product idea where people don’t expect it to be free. For example, no one expects a cup of coffee to be free. People will pay for cup of coffee without giving it a second thought.
You also, given a choice, want to pick ideas where you will not have to compete against a lot of free stuff that is already out there. Competing against free can be difficult unless you have something much better than the nearby free stuff and you have a rock-solid value proposition. Or…
Find a creative way to let people pay for your product
Find a creative way to let people pay for your product. Dropbox is a great example, probably the best-know purveyor of the freemium model. Dropbox is free for most people, but if you need a lot of Dropbox, then you need to pay. But you are more likely to pay because you are familiar with Dropbox (because you have used it for free for awhile), and you like Dropbox. So now you pay Dropbox and it is OK.
The vast majority of Dropbox customers pay no money. Making the product available for free increased resonance dramatically. And it is a great value prop: “store your files in the cloud for free.” If you don’t have that many files, you can essentially duplicate Carbonite for free using Dropbox. The free version of Dropbox then acts as an ad, or a Trojan Horse maybe, for the paid version.
You may be able to invent a new revenue model that customers find appealing. Here are several examples of this process:
- Think about Netflix. When Netflix started, it was competing against Blockbuster. Blockbuster’s revenue model was, “come rent a video for 3 days for $X, but if you return it late we charge you a rather hefty late fee.” That’s a perfectly valid model, but people tended to hate it, because it was easy to forget to return the video and the late fees felt like a spanking. Netflix comes along and, in its original revenue model said, “Pay us $20 a month, and we will send you three DVDs of your choice. As soon as you mail a DVD back, you can get a new DVD of your choice. Do this as often as you like, even every day if you like. No late fees at all.” Psychologically this is a dramatically better revenue model, and Netflix took off.
- Think about Blue Rhino. Prior to Blue Rhino, if you needed to refill the propane tank for your grill, you would go to a gas station or U-haul and someone would fill up the tank and charge you $X. Refill places were not very common, and it always felt like a pain in the ass. Blue Rhino’s model was, “come to your local convenience store, Walmart, Home Depot or wherever (much more convenient) and exchange your empty tank for a full (and inspected) tank in about 2 minutes.” Blue Rhino actually charged more money for the propane, but it was OK because of the convenience factor.
- Wikipedia and NPR have similar models. They are free to consume, they do not have ads, but then they have periodic fund drives where they beg for donations from the audience.
- Dollar shave club is famous for its revenue model. Anyone can go to a grocery store, a drug store, a Walmart or Target, and they can buy razor blades. Dollar Shave Club came along and said, “sign up for a subscription, and we will send you 4 new blades once a month at a lower price.” Dollar Shave Club did not invent anything – they simply took an existing product and applied a new revenue model to it.
- Venmo came along with a simple idea: “send money to your friends digitally for free.” The “for free” part – the lack of fees – is the appealing thing for many people. Venmo makes its money off the float from millions of user accounts.
There is a lot of room for creativity with your revenue model.
Ad-supported free sites can work…
What if you want to create a product that is free, and is supported by advertising revenue? Typically this will be something like a web site or an app or a game. This can work if you have sufficient traffic volume, and if your users will actually click on ads, and if you can fit the ads in to the experience without pissing off customers. Plenty of Web sites are ad-supported, so it can work. But it does not always work.
What is a reasonable profit level?
Your price needs to cover ALL of your costs. And then, beyond these costs, your price needs to support a profit over and above these costs. Why? Because investors expect there to be a profit, and the level they expect is typically on the order of 20%. A lot of ideas die because they cannot support a price covering all of the costs plus a reasonable profit.
What are “all of the costs”? It is easy to forget everything that a “real business” needs to cover in terms of costs, especially if you are a new entrepreneur. Costs for a “real business” include:
- All normal employee wages and benefits, including hiring costs, firing costs, turnover costs and HR costs
- Any bonuses or commissions needed in addition to wages
- Any raises necessary for retention
- Parties and other “company culture” perks that keep employees happy
- Any education and conference fees for employees
- Any travel costs, especially associated with sales
- Any trade show costs
- All of the raw material and/or component costs
- Office space, warehouse space, manufacturing space, etc.
- Manufacturing costs, especially if using contract manufacturing
- Office equipment, employee equipment
- Utilities costs (water, electricity, phone lines, phone systems, Internet, cell phone plans, etc.)
- Server costs (e.g. AWS, hosting, etc.)
- All of the advertising costs, including ad creation and ad placement
- All of the support costs
- All of the mortgage payments on all of the loans for the land, buidlings, etc.
- All of the research and development costs for new products
- All of the costs for failed products company tries, but that don’t work out
- All of the lawsuits and legal fees and settlements
- Any recalls
- And so on…
The real costs of running a real company can be significant. And then, on top of all this, you need to make a profit of 20% to boot.
Sometimes it is OK to be free, with no revenue anywhere
If your play is, “I am going to create a free thing until I have 10 million active users, and then I am going to monetize it”, this might be OK. This approach has worked for a select number of sites like Youtube, Whatsapp and Instagram. But you need to have enough money in the bank to support the company while the audience builds.