Last week, Tim Romero of ContractBeast published an article on LinkedIn on why he turned down $500K, pissed off his investors, and shut down his startup (read here). Easily one of the best articles I have read in the recent past. A quick summary on the story – Tim and his co-founders had set up the enterprise, done beta testing and received good reviews from their customers. However, what was bothering Tim was that his customers were using their product only for a small proportion of their total requirements. Deeper analysis of early adopters of the product revealed that they did not get any value from the product that provided them with something of an “instant gratification”. In the absence of a short-term value add, it was difficult to turn these free users into paying users, once the trial was over. And they decided to pull the plug on the product and the enterprise.
Scaling your startup
A lot of entrepreneurs and founders keep discussing about how to ‘scale’ their business, either to achieve traditional economies of scale or to kick-in network effects. In their attempt at scaling, a recurring theme is the provision of subsidies, at least for one set of users. Some of them provide these subsidies for a limited time period; some offer differentiated products/ services under a ‘freemium’ model; and some others provide their services ‘cheaper than free’.
Providing subsidies is a time-tested model of scaling up a business. Traditionally such subsidies were provided as a trial period, during which the customer experienced the product as the product provided the customers with some functionalities, if not all of the full version. When the trial period ended, the product reminded the customer to pay and upgrade/ renew, but pretty much stopped there. Some smart products could have collected valuable data on how and what the customers used the product for; and therefore provided them with partially customized offers. Take the example of Dropbox. It began providing me with free storage space and allowed me with more and more storage as I invited friends; and began collaborating with others (sharing files and folders). It allowed me enough storage on the cloud so that I could store files that I needed to access from ‘anywhere’, allowing me to work seamlessly from home/ during my travels (on my MacBook). The upgrade reminder kept popping up whenever I came close to using up my storage space, but it was always easy to move out those files that belonged to finished projects off the cloud and free-up space for newer projects. Eventually, it took a long time to convince me to pay up for the upgrade (I paid up when I had to share large number of files with a variety of collaborators across the globe). What Dropbox provided me was the seamless integration of my desktop folder with cloud storage without the hassle of actively uploading a document using a browser. I saved it in ‘the folder’ on my office desktop, and it was available in ‘a folder’ on my home desktop/ MacBook.
Some products provide customers with so much subsidies that it could become ‘cheaper than free’. For instance, Indian taxi aggregation market has become so competitive between Uber and OlaCabs that they are raising large sums of capital, and pumping them into the market as lower fares for riders and subsidies for drivers. These drivers get their incentives once they complete a certain number of rides per day, get to keep pretty much what they earn, and have the flexibility to sign up with other operators (or in platform-business terminology, multi-home with other operators). The story is wonderful and sustainable until the incentives last and keeps the drivers motivated. However, a caveat in the Indian market is that driver is not ‘the entrepreneur’ as what Uber and OlaCabs would like to believe. The company refers to them as driver-partners, and treats them as if they were independent. The truth in many cases is that, most of these drivers are paid employees of car-owners and their incentives are not the same as that of the car-owners. So when we introduce a third party in the transaction, a lot of traditional incentive schemes fail – does ride incentives benefit the car-owner or the driver? That depends on the terms of employment of the driver with the car-owner. Some owners lease the car for a fixed fee per day, some others pay monthly compensations to the drivers, and some others a combination of a fee and revenue/ profit shares. In this context, it would be difficult for Uber and OlaCabs to design an incentive system to shift these driver-partners from enjoying these freebies to a more (economically) sustainable model of revenue/ profit sharing. However, Uber’s ability to lock-in the driver by secularly increasing the number of rides required to earn incentives has increased the switching costs of these partners (car-driver-owner combine).
In order to scale (either linearly or through network effects), firms would need to provide some form of instant gratification to its customers/ partners. However, it is imperative that the value provided should lead to increasing the switching and multi-homing costs for the customers. Take the case of Romero’s product, ContractBeast. What Tim observed during the trial period was that the customers were indeed multi-homing with other competing products and services to manage their contracts, and were not using ContractBeast for managing a majority (if not all) of their contracts. Had ContractBeast provided a value that did not allow for its SMB customers to multi-home, the story could have been different.
Increasing multi-homing costs
I perceive three levers for increasing the multi-homing costs of customers in a platform business model – asset specificity, not absorbing sunk costs, and integration with other systems and processes. Asset specificity refers to the requirements of the customers to invest in certain specific assets to adopt your product/ service. For instance, the B2B supplier platform IndiaMART requires SMB sellers to invest time and energy in uploading their product details, photographs, technical specifications, contact information and all details about their firm as part of the registration process. Such an intensive registration process ensures that the seller will focus all his energies on a single platform rather than multi-home. Quick reference, see the registration process in the dating platform eHarmony (the relationship questionnaire)! If you have filled that long a questionnaire once, you do not want to do that again and again in multiple platforms, right?
The second and the easiest lever for increasing multi-homing costs is the absorption of partner sunk costs. For instance, OlaCabs subsidizes/ absorbs the cost of the phone that is used by the drivers. This subsidy ensures that the drivers are free to multi-home with other taxi aggregators, as they have incurred no or little sunk costs. On the other hand, firms like Tally require you to invest in the license (albeit very inexpensive) to be able to use the full functionalities of the product/ service offerings.
The third lever for increasing multi-homing costs is to integrate your product/ service with other systems and processes of the customers. Take the example of Practo. Practo has ensured that clinics need to invest in Practo Ray, the practice management software that manages a lot of processes in the clinics, including managing electronic medical records and integration with pathological laboratories. Such tight integration with the processes ensures that their customers – the clinics – do not multi-home, and increasingly use Practo.com (the doctor-patient discovery platform) exclusively for all their appointments.
Startups out there: Can you tell me how you do it?
That thing Tim Romero missed with his product! High multi-homing costs. So my dear entrepreneur friends, define (a) what is that instant gratification you offer for your customers? (b) does that value-add require temporary or permanent subsidizing, and (c) what is your strategy for increasing your customers’ multi-homing costs – increasing asset specificity? Not subsidizing their sunk costs? Or tight integration with their processes? Or a combination of these?
Would love to hear from my startup friends and followers.