Pricing in platforms

Developer Platforms - another growth hacking trick

Companies like Stripe and Twilio have built their entire businesses around providing a better platform for developers to build B2B apps and integration off of. By providing their service as an API for developers to use, they allow for many different new products and use cases to pop up that wouldn't otherwise be built, which in-turn they receive increased revenue from when they succeed. A true win-win model for growth. 

If you look at Facebook' s acquisition of Oculus, in Mark Zuckerberg's blog , he clearly points how the $2bn acquisition benefits Facebook's developer community; including building next generation games as well as Facebook being the center of all new & upcoming gaming apps & startups; albeit, they are aware of Whatsapp  in its infancy.

Having a vibrant developer ecosystem is an essential condition to success in the new Cloud era. There are couple of reasons why companies would want to have one 
 1) Introduce new products and use cases like the Facebook and Stripe examples. Once a developer creates an app they plug into these systems - Facebook(user ads) or Stripe(payment rails) and eventually these platforms benefit from increased users or increased payments through their systems
2) Interoperability with other apps - Customers are looking to use best in class apps and they want these best in class apps to seamlessly talk to each other. If your product does not connect with other  apps, you run the risk that the customer is unhappy and not sticky and will likely switch once somebody else makes products which do. Clearly, any company does not have enough internal resources to do these integrations themselves; so if one wants to focus on their products and let the developers create these integrations it's a win-win for everyone. More ever, now that your product is visible in other apps (through integrations), the other apps become a source of new user additions. here your cost of customer acquisition is almost zero (no marketing, no development), no CFO would shy away from such growth. 

So the next obvious question is how can a company go about building a vibrant developer ecosystem - the simple answer is be in the developer's shoes and think what is important for them - develop apps easily and cost effectively (lower cost) and help market apps (higher revenue). Some companies that have done an excellent job in both of these areas are Salesforce & Box.  

1) Lower cost - Being an app developer requires one to have business logic, programming language knowledge, hosting, back end, billing, customer support skills. A lot to ask from a couple people small app developer company, at times a single app developer. Successful platforms that have been successful in this area are ones that have enabled their programmers to be the business idea guy, while they take care of the rest. 

2) Higher Revenue - Access to users as well as the ability to get to these users is paramount. This means, conducting educational seminars to create awareness about the app, promoting developers amongst the user base to help in discovery of the app, social marketing kit etc are all essential elements of this strategy. 

Developer platforms are examples of two sided networks, once you get the fly wheel going one could see exponential benefits, most prominently in customer stickiness & growth channels. But as folks know, developer platforms are tricky as well - how should your pricing strategy be, who do you charge and at what point, the classic egg and chicken situation but worth the effort.

Is this the beginning of the end?

The Whatspp acquisition by Facebook looks like we are in a bubble, where valuation is based on number of users  - granted these are  ”engaged users” however, paying $19bn is crazy, especially if you are going to make 99c per user in the best possible case. The original Whatsapp model is one where the user is not served any ads and Whatsapp has no intel on the user based off their messages. How then would Facebook monetize this acquisition?

It would take Facebook 42 years to break even, paying $42 for a user, where in the best case you are only going to make 99c per user. I want to see the assumptions in the financial model to see how Facebook is going to monetize this. Begs the question – is this the beginning of the end?

In the world where 90% of the companies are valued on profit and revenues, isn’t this crazy that we value companies based on users and expect them to be profitable one day.

Some people might argue that Facebook got the users for much lower valuation than their current base. Facebook has 1bn users with 173bn market cap ($173/user) while they only paid $42/user. But are these users the same  in terms of revenue and profitability- atleast not to the native eye. Facebook has revenue of $8bn meaning each user brings in $8 vs Whatsapp user bringing in $1/year. Clearly, wall street is sensing this and in after hours shares of Facebook were down 5%.

Why SAAS and on-premise solutions cannot co-exist?

Number of traditional software companies like Adobe, Intuit, Oracle, SAP are struggling whether and how to get on the SAAS train. And more often than not, they are reluctant to bite the bullet and go total SAAS. It is hard to burn the boats.. However, being in two boats is even worse - you are not doing justice to even one. Here I list some of the reasons why this is the sure path to slow death.

The biggest one is day to day operations of the company. In the on-premise world, it is about closing the deal. On the other hand, SAAS is all about the ongoing happy customer. The closed deal is just the beginning,  it is keeping the customer happy and engaged year on year. This means that all layers of the org have to change, starting from sales to product development to customer support.

In the on-premise world, "hunter" sales folks rule the world and one deal can make or break a quarter. In the SAAS world, if the churn rate is less than 10% which is the case with most successful SAAS companies, over 85% of the forward revenue is already baked in. So Sales  is compensated for their quota, but there is an ever increasing focus on making sure the "current accounts" are happy. 

This means customer support & operations are very important groups in the online world. The servers need to be up 24 hours and customer support ready to resolve issues. User analytics and big data can give you a lot of insight into whether the customer is using the systems and to what extent.  This also means the ability to know beforehand  your red accounts and be able to manage them so they do not fall off the cliff is ultra important. No wonder, more and more companies have C level customer success VP's and Operations.

As all of us know, a company only has finite resources - the challenge becomes where would you want to put your best and brightest resources and how would you create the incentive structure. Putting some in both, does not cut it. It is like having a cash cow subsidizing a fast growing start-up. With complementary products, which is often the case, SAAS is often seen to cannibalize the growth of on-premise solution. This creates an interesting dynamic not only in the sales group but also product development. The answer as to where product development needs to focus it's energy  - should it have two code bases or which feature enhancement should go in SAAS vs desktop brings very interesting dynamics to the table.

One of the ways some of the companies have tried doing this - Oracle incentivizes its sales folks double the quota for a SAAS product than for the on-premise solution. Adobe & others put all the new features in their online solution and so customers who want the latest and greatest features are incentivized to buy the SAAS solution. 

Why managing churn is so important for SAAS companies?

Churn is the single most important metric for SAAS companies. Most finance professionals, especially  if they come from the on-premise world, will continue to look for traditional profitability metrics like profit margin and gross margin or total revenue.

The primary difference between a SAAS company and an on-premise company is that the revenue from the customer is not guaranteed on day 1 as is the case in the on-premise world. Once a sale is done or a CD is shipped the entire $240 can be booked as revenue. In the SAAS world, it would take two years of a happy customer to bring in the same amount of revenue. Inherently, the customer is highly unprofitable the first few months as the company just spend dollars on customer acquisition (CAC) and the customer needs to stay on the product to deliver the full lifetime value. Any amount of churn eats into the potential lifetime value of the customer. Inherently, the newer customers are way less profitable than the longtime customer and hence customer support & care is a very important department, a department that had traditionally taken a backseat in the conference room.

It is interesting to note that a 2.5% difference in monthly churn can make things look dramatically different. Take this example, where a company acquires 100 customers each having a monthly recurring revenue of $25. Cost of acquiring each customer is $100. Assuming a churn of 2.5%

Contrast that with a churn of 5% . Pay close attention to the green colored area and how that changes dramatically to the point that the negative value of the customer in the initial period almost cancels the positive lifetime value of the customer.

Contrast that with the 7.5% monthly churn. Here you have no profits and goes back to why CAC to LTV ratio is so important to track.

Why is it so hard for big tech companies to innovate ?

Why is it so hard for big tech companies to innovate ?

 

You look around in the valley and see behemoths like Oracle, Cisco, Nokia, Google etc spending so much on innovation(almost 15-20% of their revenue) but unable to introduce any new credible streams of innovation, with the exception of a few. Might want to ask this question - what really spurs innovation and why cannot large companies innovate? Possibly comes down to the organizational structure and incentive structures -

1. Business unit managers - Usually, ideas are funded at individual business unit levels, whose focus is to keep the lights running and  grow the main business line. Investing and spending time with "other" innovative ideas is not a priority, rather taking too much risk with such nascent lines of business may be detrimental to near term growth . In Steve Blanks words  "people who are best suited to search for new business models and conduct iterative experiments usually are not the same managers who succeed at running existing business units". He further argues that Instead, internal entrepreneurs are more likely to be rebels who chafe at standard ways of doing things, don’t like to follow the rules, continually question authority, and have a high tolerance for failure. Yet instead of appointing these people to create new ventures, big companies often select high-potential managers who meet their standard competencies and are good at execution (and are easier to manage).

2. Lack of a sense of urgency - A start ups CEO is compelled to innovate and turn an idea into a product that people are willing to pay. There is a sense of urgency, a burning desire to "pivot" and create a product that customers will find value. On the other hand, well established companies have the luxury of time, as the cash cow brings in revenue for the next paycheck. The sense of "do or die" sometimes gets lost and innovation remains a buzz word or "good to have" water cooler talk.

SO, then how can they improve? Can we learn something from people who have been able to make changes in their business models -

1. Focus on automating tasks rather than increasing headcount or off shoring -  Facebook focuses its energy on automating and making tasks efficient rather than hiring more and more people or sending work offshore. No wonder, Facebook has the highest revenue/employee among its peers as well as able to turnaround and innovate on its mobile advertising platform.

2. Do sensible growth acquisitions  - Most large companies try to buy their way out of organic growth. However, there are only few examples where the acquirer has made something big out of their billion dollar acquisitions. The key is to "date" the target before the marriage, be very clear what you want to achieve with the acquisition and get your company ready for it as well.

3. Have a separate group to manage innovation - Have a separate team and organization manage new business ideas. A venture capital firm will rarely invest in a private equity deal and vice versa, why then do we expect our mature business managers to nurture and grow nascent business lines?