How to monetize your user base – part 1: fundamental and strategic monetization

I have been approached by a fellow business developer, who works at a larger social network. He asked me if I could share my thoughts to the question: how can we (better) monetize our social network. His network has around 1 million registered users and its primary market is a non-US market. I enjoyed compiling some answers and wanted to create a post from some of it. This is a two-part post with rather long answers. In the first part I evaluate to available options which depend on the companies mindset and I then propose concrete action plans. In the second post, I will answer some questions about the options to build scalable business models for social networks.

You could start by asking what is the best way to monetize a social network, but, the “right” answer would probably be the long sought after holy grail, and in the quest to find it it is very easy to get lost. Two years ago, Sergey Brin noted, “I don’t think we [at Google] have the killer best way to monetize social networks yet.” – and I don’t think his answer would be much different today. and yes we should really look in particular at some of the successfully established models, but let’s not start with this quite yet. Instead, let’s start by asking some important questions first – some questions that will greatly influence the answer.

First question: What is you frame of thinking, is it strategic or fundamental?

The strategic vs exit-driven mindset

Inspired by a post by Sachin Rekhi (Optimizing for Fundamental vs Strategic Value), I will use the terms strategic and fundamental in the following way: Strategic means exit-driven, focused on a near-term sale, driven by the goal to maximize the share you will potentially take from an exit. Fundamental means you are in it for the long haul, you want to see your idea grow and you want to build a scalable business. There are actually two other frames of leading a startup that I have noticed: because-I-can and tactical. Because-I-can can be a typical engineer thing – let’s develop something simply because we can and because it is fun to do so. Does it make sense? Maybe not, but is it fun, oh yeah – at least for the guys who built it. Sometimes, such things become successful (not a technical example but a good one: Johnny Knoxville and his series Jackass are in this category). The tactical mindset is mostly about network effects. When you are in it for a “biggest or nothing” strategy, this behavior could make sense. Typically, Facebook can have this kind of mindset and in some part also Google. For Facebook, it’s all about having as many people in as possible to be the dominant network and to build some sort of new internet on top of that (I think that is part of Zuckerbergs plan). For Google, it is all about getting as much data as possible. os they go and don’t really care about revenue, immediate profits or any other directly measurable indicators. Both, tactical and because-I-can frames of thinking are not given in the case of the social network in question. So let’s look at the implications of strategic and fundamental mindsets:

An action plan for the strategic mindset

If your frame is strategic, you may not really need a viable business model (although it definitely helps)… Let’s consider Twitter – many companies have attempted to buy Twitter long before there was ever a sign that the company would make any revenues at all. Of course, Twitter is a special case because it’s one of those phenomena that are super successful – but strategic exits are possible for many pre-revenue companies as long as they have created assets and resources that others may consider strategic investments. The total number of users or the user growth rate can be one such strategic asset. In the case of Last.FM (see Sachins post), the startup became a suitable target because there was some initial proof of market for a potentially successful revenue model. So if you have some traction and have tested some hypotheses, you will likely be able to raise your valuation.

Let’s clean up before we continue to discuss the implications of a fundamental mindset. If you have a strategic mindset, here’s your action plan:

1. Identify your strategic assets (users, growth rates in certain areas, team & skills, algorithms, contacts, networks, etc.)
2. Identify potential buyers, in particular, focus on industries that have a growth problem or companies that are in fierce competition with others and lack a particular technology or skill that you have. The media business has a definite growth problem, the postal services have a growth problem and many others do, too. A company that is in fierce competition with another and urgently needs a new technology to catch up is Amazon for example. When Apple announced its iPad and it became a threat for the Kindle in the ebook reader market, Amazon had to respond. They did so by buying a multitouch technology company. So find the companies with a problem and analyze how you could pitch them your company (find more examples here, here and finally here). In any case, find out which specific asset you have is interesting for companies you have chosen.
3. Pump up your muscles: For that asset that your potential buyers want, go and pump it up. What I mean by that is: get very aggressive in growing your assets! If your asset is user numbers, then drive up user numbers like mad. Do co-reg, lot’s of keyword-marketing (optimize, optimize, optimize), tear down registration barriers (implement Twitter auth or facebook connect), get creative! Just drive your numbers up. The same goes for any other asset – tune up numbers, as aggressively as you can. A simple reason for this is that acquirers will look at the latest stats and if there is in any way evidence of some sort of hockey stick behavior, they will fall in love with you. As a matter of fact, not many buyer teams are experienced or qualified enough to look a bit deeper behind the curtains. Many buying teams simply are too inexperienced to have a very detailed look at the fundamental numbers. A note of caution, however: You still have to be able to look at yourself in the mirror. Many companies that dress up for a dance get a little too wild. Know your limits! Still, if you go to a dance, you dress up and girls put on make up – there’s nothing wrong in that. So for a social network, it used to be the number of registered users that made potential buyers wild, or highly viral effects around a new phenomenon, e.g. social content sharing. While there still may be buyers for registered users, many buyers would focus on active members and activity hubs today. So if you can prove to grow activity around specific centers in your network, this will be beneficial.
4. Contact potential buyers, keep on pumping, negotiate and sell your assets. It is more than just helpful to have the support of an old fox, that being a friend you have in private equity or venture capital who is seasoned in making deals in this market. So make sure to get a mentor

A fundamental mindset

Finally, let’s look at implications for fundamental strategies. A fundamental strategy will focus in any case on finding a suitable business model, scaling it up while keeping costs at bay and maintaining a healthy capital structure. With a fundamental mindset, you will want to ask the following questions:

- Do you already have a business model? If so, is it the right one?

- If you do not already have a business model or you have not yet found the right one, how should you go about identifying a suitable business model?

The right business model will be the one that will allow you to scale revenues up, the one where you can scale successful sales at respectable margins. A lot of companies are social networks in one way or another and have naturally started with a subscription model where they limit certain features – typically images, files, etc. But only in a few situations will this be the best model to create a scalable, profitable business on top of a given user base. So for many social networks that have a business model already, the question “is it the right one” will have to be answered with no if you do not see a larger uptake of the model and if you have to fight to get at least a couple of sales for your feature driven subscription bundles.

So how should you go about finding the right business model? Books have been written about this topic, so I will not even try to answer this adequately. I will, however, try to identify some points that I think are vital.

First, there ultimately is one big question in the room that will again greatly influence your scope of action.

How long do you have to live?

Action plan for near death companies

A pre-revenue company or one that burns cash at a high rate and my have cash for another four to six months or even less has fundamentally the same action plan as a company who is not low on cash, but a much greater sense of urgency to show hints of a potentially viable business and to identify investors that will refuel the company with cash. If you are running out of money and do not have the right business model in place, your are in a very challenging and certainly not entirelly painless situation, one in which many probably tend to respond poorly due to either “pumping adrenalin” or “too many voices”. “Pumping adrenalin” is typical for a stressful situation: our brain shifts into survival mode and we do not make rational decisions anymore. “Too many voices” can occur when you have too many advisors telling you what to do.

Your action plan will be

1. Squeeze out the lemon and lose the fat, as long as you do not significantly hurt your business. What I mean by squeezing out the lemon is to maximize revenue from all sources there are. You may have the opportunity to add some more ads to your site or there may be someone who’d pay to appear in your newsletter. The goal must be to stretch out the time to death as much as possible. If your burn is 10k and you can add 5k in one month you have effectively halved your burn for a month. Repeat this in month two and you have stretched your time to death. What I mean by loose the fat is quite straight forward: reduce burn even more. Ask your team to sacrifice some of their (already too little) pay – you can pay them back once you have new funds. If you are still working in an office space, consider moving to your living room. It’s painful, terribly so, but it will again reduce your burn and maybe you can squeeze out another month. A month more or less could possible just tip the scales in the run for funding.
2. Identify potential viable business models: it helps to quickly look at potentially viable models for social networks (I’ll do that a bit later) and brainstorm. At the same time, analyze your data and engage in lots of customer discussions. Find out what your customers are doing before while and after they use your products. Find out about where yohu create value, both directly and indirectly. Draw up 5-10 potential models and for each try to identify what you know, what you assume or feel, what you don’t know and how you could go about finding out. Get the data, analyze and make a shortlist of at most 3-5 models.
3. Prepare “mini prototypes” to test the viability of your top 3 models and run tests. Read more here, here, here and here
4. Gather lots of (the right) data and evaluate the viability of the business models based on market opportunity and your ability to leverage your core competencies around building it successfully.
5. Improve and retest the most successful or the two most successful ones, repeat step 4 until you are sure you have something to build upon, then jump to 6
6. Select the business model with the highest market potential and draw a first rough action plan on how to build this market, how to reach customers (marketing & sales) and how to scale.
7. Find new investors or revisit your existing ones, pitch them your company (again), tell them what you did and why you did it. Show them that you have signals that there is a good market chance and convince them to (re-)invest in the company.
8. Get the cash, potentially reduce the team and then iterate extremely fast around building the business model. Do heavy customer development, read lot’s of Steve Blank and optimize around what you have learned from the master of 500 hats.

For the not so near-death companies

If your are not low on cash, the process is the same as the one for startups who are, but it starts at 2 instead of 1.The big difference for companies that are low in cash lies in the comfort of testing several models. While a company that enjoys the benefit of stable cash reserves may invest more time into identifying a viable business model, a company in survival mode cannot. In that case, the company can benefit from the advice of independent experts who are not too closely tied to the current investors or even management. A neutral perspective can in many cases help to discover some mental models that may inhibit thinking openly about the full range of alternatives and can be a mediator in the process of discussing the viability of each alternative as well as the suited steps to select and test an option.

What do you think? Can you share experiences of your own that would support or speak against a proposed action plan? Would you agree with the notion about the importance of strategic and fundamental mindsets in the process of drawing up action plans for monetization? Let me know per email or in the comments!

What do you think about the alternatives, in particular about the importance of clarifying the strategic mindset before drafting a master plan?