Back to Basics: User Generated Revenue As A Business Model

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Back to Basics: User Generated Revenue As A Business Model

 



In 2006, we saw a lot of energy and interest in user generated content.  Many companies like MySpace, Facebook, YouTube and others made the headlines in both traditional media and the blogosphere.  It’s not surprising to see all of the enthusiasm for these companies.  They created billions of dollars of value and made those involved pretty wealthy.

Here’s how I think about the business models behind these types of companies:
  1. Startup develops software
  2. Users use the software for building content and/or community
  3. The user content/community drives traffic (i.e. captures “attention”)
  4. This user attention gets monetized (usually with advertising)
  5. Startup makes money


There’s nothing particularly wrong with this model.  But, I think it has its limits and challenges.  For one, we’re competing for people’s time and attention (of which there is a limited supply).  Also, the model is based on large economies of scale (i.e. the volume of traffic generated has to be really, really large in order to exceed the costs to develop and support the software).  Finally, as software developers, we are faced with balancing the conflict between the end user and the advertiser.  The end user wants to get something done, the advertiser wants to interrupt what is being done and convey a message.  This is a relatively new phenomenon for us software people.  Back in the “good old days”, we developed software for end users exclusively.  There was a symbiotic relationship between end user and software developer.  Both could work together to improve the software and help it solve the users problem better.  Everybody wins.  Now, this “virtuous loop” is interrupted to some degree by the advertiser footing the bill for everything.

As such, I’m going to go out on a limb and say that many software entrepreneurs should avoid the common trend of building software that makes money through “user generated content”.

I’m hoping 2007 is the year of user generated revenue
 
There are lots of good things that come out of the classic “user generated revenue” model:
  1. Your customers/users and you have mostly aligned interests.
  2. You don’t have to bet the farm on getting the required scale before the cash runs out.
  3. Even if you are not a spectacular success, you can at least have a chance at a modest success (which beats a fantastic failure, in my book)
  4. Though users have limited time/attention they have a near infinite number of needs.  Instead of competing for their “attention”, I think it’s more fun to collaborate with them to help solve their problems.
  5. Though paradoxical, It’s easier to keep a paying customer than it is a non-paying user.  
  6. Revenue is the new black.  Don’t knock it till you’ve tried it.  When you deposit your first customer check (or process your first credit card payment), you’ll experience the unique thrill of actually making money.


What do you think?  Have I gone off the deep end?  Is writing software that solves real problems that real people are willing to pay real money for old-fashioned?  Would love to hear your thoughts in the comments.  Until then, I’m going back to work on my user generated revenue startup.

Posted by Dharmesh Shah on Thu, Jan 04, 2007

COMMENTS

Again, another great article! I think with all of the innovation in the user generated media/content space, many folks forget that revenue is the key driver. At the end of the day, you have to operate in the black or you're going to end up out of business (burning thru cash). Even a little "black" on your balance sheet looks good.

posted on Thursday, January 04, 2007 at 9:50 AM by Darren Herman


Only in this day and age could the idea of providing a service and charging for it be regarded as going off the deep end. Working for a publisher, I know at first hand how the demise of the consumer revenue side of the business model (i.e. cover price) unbalances things. The trick is to sift through the good ideas and find the ones people are actually prepared to pay for. Covent Garden is near where I work and crowds of people love to stand and watch the performers. They are prepared to pay with their attention, but when the hat goes round at the end, the crowd disperses. Would they be prepared to pay up front - I doubt it. On the internet we have to distinguish more sharply between ideas good enough to attract attention and those good enough to attract payment.

posted on Thursday, January 04, 2007 at 9:55 AM by Angus Swan


Not strictly on the same topic as your post but I do think that many software developers discount the value of popularity. Being popular is very, very important. Popularity pays. Even when you are selling licenses and making user generated revenue, your popularity is still the primary thing that will set the value of your company. Love it or hate it, we're just like Hollywood: the movie stars and blockbusters are decided by popularity, not necessarily by merit.

I also think that MySpace, Facebook, YouTube and others never intended to make money on advertising. They set out to create something that was extraordinarily accessible and popular in the hopes of selling that popularity to somebody else. They understood that being very popular has value, even if you personally don't have the ability to extract dollars from that popularity. And, of course, entities like Google have a shot at taking a popular company and pasting it together with their advertising expertise to make a very good business. In actuality, the product of MySpace, Facebook, YouTube and others is popularity; if they fail to produce popularity, it is like any other company that fails to produce its product.

You might look at MySpace, Facebook, YouTube and others as a company that produced popularity and only ever had one customer: Google (or whoever). If they either failed to produce popularity or failed to sell the popularity, it is just like a company producing software licenses and either fails to produce the software or fails to sell it successfully.

posted on Thursday, January 04, 2007 at 10:10 AM by Dan Howard


Dan: Fair point on the value of popularity.

I agree that the software industry is much like Hollywood in that the goal is to create the "blockbuster hit".

posted on Thursday, January 04, 2007 at 10:15 AM by


If the site shares revenue with the creator of the content (ala hubpages, squidoo, etc), then the interests of the site and the user are more aligned.

posted on Thursday, January 04, 2007 at 10:55 AM by Mars


We've tried to do something like this with some success, though one of the problems is, unless you get 10 million dollars of venture capital and put the word "WEB2.0" all over your site, it's damn near impossible to get anyone to pay attention to what you are doing.

I wrote an article about our ideas here:
http://www.donationcoder.com/Articles/One/index.html

posted on Thursday, January 04, 2007 at 11:41 AM by Jesse


Like epinions.com? They pay anyone to write reviews.

posted on Thursday, January 04, 2007 at 12:19 PM by Julio Nobrega


Very insightful Dharmesh. I've been having many of the same random thoughts, but haven't taken the time to organize them into anything meaningful. I see new sites being launched daily, but, as mentioned, the challenge is that they are all competing for the same User's time and attention which is finite. The incumbents have a strong advantage here because it's human nature to go where everybody else is going. Looking at the User revenue side of the model certainly has merit. The Industry continues to evolve and we have to continually stop and look at what's coming.

posted on Thursday, January 04, 2007 at 1:03 PM by Scott


So what does your user generated revenue startup do exactly? I think most software companies (e.g. Adobe) are based on the user generated revenue model, it is the few (e.g. MySpace) that are ad supported.

And what about free software, how do you see that fitting in? See http://www.orangesoftware.net/articles/opensource.html

posted on Thursday, January 04, 2007 at 1:22 PM by Gerry


Gerry: My user generated revenue startup (HubSpot) is focused on providing small businesses with online marketing software to help them increase sales. We charge a monthly subscription fee for the software.

posted on Thursday, January 04, 2007 at 1:35 PM by


Great read. That's something we (MyFreeImplants.com) have been focused on since day one. Take the stickyness of social networking and give the users a value they will pay for. I still get that thrill every time a transaction comes through.

posted on Thursday, January 04, 2007 at 1:36 PM by Jason


Yet again, you're on the money (do I sound like a fan boy yet?).

I don't see any way the current advertising-driven model is sustainable. There has been so much growth in the number of companies that use this model that the effectiveness of online ads _must_ be plummeting. And since the costs are staying about the same, that means results are getting progressively more expensive.

And as you point out (with a shout out to Seth Godin, I think), the current model is all about interupting the user in progressively more blatant ways.

Going with the Hollywood analogy, there are two kinds of success. The big blockbusters that cost $150+M and (if successful) return $300-400+M is the story everyone focuses on. Those movies _have_ to hit it out of the ballpark to "win". Therefore they mostly have to play it safe so that their appeal will be broad.

But there are quite a few independent movies that cost less than $5M and return $20-40M. While not the focus of adulation, the independent movie risks less, returns the same or better percentages, and usually contributes something new and different. They don't have to be huge to be successful and can risk chasing a niche audience.

And what's more, the independent movie guys usually have more fun, more control and a generally more rewarding experience.

I for one would rather be having fun and doing something innovative rather than building a business that has to be big just to survive...

posted on Thursday, January 04, 2007 at 1:43 PM by fewquid


i hate the advertising model, too (even though i founded a company that uses it). it IS all about interruption instead of value created. trouble is, people expect information to be free because of decades of ad-supported media. and online ad spending is growing at an rapid clip.

some sites like angie's list have been semi-successful charging money for content, but it's an uphill battle.

(i invented the business model and technology for helium.com)

posted on Thursday, January 04, 2007 at 5:08 PM by Greg Gibson


Nice article - just got me thinking (a bit off-topic, but still): Doesn't it strike you as odd how little people value their opportunity cost? Take traditional TV, when you watch a prime-time movie, you'll also watch about 3/4h of commercials. For the money that this time is worth in terms of your opportunity cost, you could easily order the DVD from Amazon or purchase a wealth of films on the Internet.

However, I believe that people are going to become more and more aware of this oddity, and both in old media (recording devices, pay TV, TV on demand, etc.) and on the Internet (ad-blockers, "ad blindness" etc.), the old-style advertising model will be less and less sustainable as users will know how to circumvent these "distractions" or understand that, indirectly, by wasting their time, they are actually paying money.

That being said, I think the main reason for having paying customers, as you mentioned in another article as far as I recall, is that it not only gives you a better idea of the actual value of your product for the user but also makes your users more likely to provide you with detailed feedback/feature requests, etc.

posted on Thursday, January 04, 2007 at 9:05 PM by Christian Flury


They need not be mutually exclusive, an ad based model and a user revenue model. Also there are other ways to monetize software besides ads and user generated revenue.

posted on Thursday, January 04, 2007 at 10:28 PM by Dean Fragnito


You wrote - "Though paradoxical, It’s easier to keep a paying customer than it is a non-paying user."

At first glance yes but not really - The proportion of paid users for any service is much less. What follows is that most people will carefully evaluate a service before paying or in other words people mostly pay only for what they like and if you like something you don't need further incentives to stick to it.

posted on Friday, January 05, 2007 at 12:32 AM by Tarique Sani


My father taught me a long time ago that you must have paying customers in order to qualify as a business. Everything else is a hobby.

As such, we've built an online community for the small-cap stock industry. Rather than trying to generate advertising dollars by opening up hundreds of free forums and hoping enough people used them, we decided to only open value-added forums for public companies that were willing to pay for them.

50 companies x $3k/month ... we never could have achieved these numbers from advertising. In fact, we ran Google AdSense for about 6 months and generated about $750/month. Thank god we didn't build on that model.

Bottom line - Build software or applications that solve a problem customers are willing to pay for. It is far more lucrative and satisfying.

Best,
George

posted on Friday, January 05, 2007 at 5:47 AM by AGORACOM


I'm not sure I understand what you're saying. If you're saying that startups should forus on making money from their users directly by license or subscription fees then I'd like to say that this is not anything new, it had temporarily gone out of popular fashion.

In 1999, profit had gone out of fashion. You could go IPO with no visible profit because heck, it was 1999. If you were actually making profits people raised an eyebrow. But that doesn't mean companies like Microsoft died. Or SAP. Now suddenly asking users to pay is out of fashion; so what? The licencing/subscription etc. model will probably survive for a long time.

But it has to evolve. You are now competing with open source. You are now forced to build an ecosystem where the opensource companies will just borrow from other open source systems, and you can't. So client side products are off the scale - even Microsoft will have to struggle to compete with online spreadsheets and documents, and worse, themselves (Windows XP and Office 2003).

Server hosted models will have to be the way then. Guess who is there in that space? Companies like 37signals. Open source models there too. And your competition is either 10 times too big or just three programmers with a userbase so admiring that they will even take the lack of features as a good thing.

It's not going to be easy this year, but you are right - the time for eyeballs is over. It's time to make money from those who benefit and use your product. It's time also to start accepting that your favourite web based newspaper, magazine or news aggregator will no longer be free. Learn to pay up and learn to collect.

posted on Friday, January 05, 2007 at 6:31 AM by Deepak Shenoy


How about a mix of the two?
As a 24/7 streaming crafting channel www.QNNtv.com) our core strength is the amount of how-to video available (almost all ever aired on TV plus that which we and others produce for the network) for the sizable, passionate interest group that wants to make things.
In our model the how-to video is the advertisement in the form of welcomed product placement. Welcomed because viiewers want to know what tool and product the host is using. So, it's a form of advertising and therefore revenue.
Then we make it easy for viewers to buy the tools and materials to make the projects themselves NOW!: a second source of revenue.
And, of course, with VOD, once they get to working on the project they come back to us for a refresher and find more cool projects and things.
You hit it on the head: Revenue is the new black!

P.S. The network was started by a woman who tried to attract viewers with freebies and expected advertisers to foot the bill. As an observer said: "It's not wise to train your customers to expect free." The number of eyeballs didn't impress advertisers and the viewers weren't going to the site to buy anything. Now if one has millions of eyeballs that doesn't matter, but there aren't many You Tubes out there!

posted on Wednesday, January 10, 2007 at 2:56 PM by Jodie Davis


Thanks for the great article. The idea of user generated revenue has a huge potential but not many entrepreneurs and VC's realize it. I'll explain why. We have the startup in which everyone can become a guide , record excursions on their places or travel routes and sell it via our site. We get the comission. Though everyone come to understand that simple social networking and communities are very hard to generate revenue from ads, still dozens of startups (many of them are VC backed) make it all the same. We talked to best professionals in VC companies, they all tell the same. Make your product free and then turn to advertising in your guides. We just can't agree! The percent of people who generate really good content now including blogs is very few. Why? Because they don't have money motivations. Make money motivation the crucial point of your business and you'll win (but unfortunately not in VC's mind). Let's wait some time and see weather social web 2.0 companies will be able to monetize their traffic via advertising or maybe the "sell content" model will prevail.

posted on Thursday, January 18, 2007 at 9:08 AM by Pavel Burian


Finite source of user attention and many contenders after the same brings back memories of DotCom's "Get Big Fast" business model. In my humble opinion, blind followers of web 2.0 will have same faith as DotCom followers (unless business is driven by something more than just making money through advertisements). A comprehensive take on web 2.0 and DotCom - similarities and differences at http://techbiz.blog.com/1654021/

posted on Wednesday, June 13, 2007 at 3:20 AM by PTC


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