Startup Marketing Blog – By Sean Ellis

User Growth Vs Revenue (Why “Free Only” May Limit Growth)

Last week I wrote about finding the right business model for your startup.  But many startups aren’t convinced they should even have a business model (yet).  They claim “our current priority is growth.”

In my experience, the right business model not only supports sustainable growth in the long run, it can drive faster growth today.  I’ve found three primary reasons for this:

1. “Free only” offering freezes prospective users  Site visitors often face a “what’s the catch?” moment when downloading free software  that doesn’t have a visible business model.  This is particularly the case when users respond impulsively to an advertisement – without the assurance of press or a trusted referral from a friend.  I discovered this dynamic a few years ago when I sent visitors to a landing page that made no mention of our premium product. I had no idea why these users were dropping out of the acquisition funnel at such alarmingly high rates.  Bigger download buttons and snappier headlines didn’t solve the problem.  It wasn’t until we surveyed users from impulse sources that we realized the primary problem was that people didn’t trust our claim of having a free product.  Once we knew the cause, solving this problem was easy.  By simply giving these users the alternative to download a trial of the premium product we were able to triple the download rate of our free product.  This experience demonstrates the risks of a startup that makes no mention of a premium product anywhere on their site.
2. Business customers looking for sustainable solutions It takes time for a business to implement a new IT product or service throughout an organization.  This implementation cost often exceeds the direct financial cost of buying the product.  So when a business sees that you have free offering, they will be hesitant to standardize on your offering if they worry you don’t have a sustainable business.  Even worse, they may fear that you are generating revenue through more nefarious ways such as selling their information.   Business buyers are usually more concerned with eliminating risks than saving the company a few dollars on a free offering. 
3. Hard to get aggressive on unproven assumptions Committing to aggressive acceleration is difficult when your business is loaded with unproven assumptions.  For example, imagine you get an opportunity to bundle with the next release of a popular complementary product.   They want you to pay $4 per user (free or paid) and your Excel model predicts upgrade rates that will give an average lifetime value of $6 per user across your entire free and paid user base.  Great, this looks like a safe bet.  But when the company tells you they’ll drive 1 million new users per month, you start worrying.  If your assumptions are right, you’ll generate $24 million in annual ROI – enough to put you well on your way to an IPO!  However, if your assumptions are wrong, you’ll probably go out of business.  Generally you won’t decisions on this scale, but the example demonstrates why it’s a lot harder to aggressively grow your user base on unproven monetization assumptions.

I realize it can be a bit nerve-racking to implement your first business model, particularly if you have strong organic growth.  But it’s not a moment of truth you should dread – instead it is a baseline that you will work to improve over the life of your company. Business models can and should be honed over time to increase the value of your users whether or not the first iteration is fruitful. 

Of course, if you have an extremely viral product, then a business model may in fact hamper your growth.  But ultimately you’ll still need a business model to monetize this growth, so you might as well figure it out early.

Posted in Acquiring Customers, Business models, Freemium (Free-to-Premium), viral marketing
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The Right Business Model for Your Startup

The right business model is critical to sustainably drive scalable adoption of your startup’s product or service.  Typical business model choices for software, web services, and online media startups are advertising or direct monetization (licensing, subscription, virtual goods, ecommerce, etc).

I generally avoid customer development roles with advertising supported startups because it is very difficult to self-fund (via arbitrage) early growth.  I faced this challenge at Uproar in the mid 90s when building an ad supported business was arguably easier.  We had created very engaging online games that we were certain would eventually attract a large user base.  In the first month after launch I presented the games to the big Madison Avenue advertising agencies and they were initially excited about the integrated advertising opportunities.  However, when I explained we only had a few thousand users interest quickly faded. 

These guys had multimillion dollar monthly advertising budgets.  Even if we could offer a strong ROI on their advertising investment, it wouldn’t be worth their time setting up and managing the campaign.  Our potential contribution to overall results was a rounding error on their typical campaign.  And considering the custom integration work, it wasn’t going to appeal to anyone but the most “visionary” advertiser. 

It was at this point that I realized the life savings I invested in Uproar was in serious jeopardy.  I asked our CEO for the opportunity to focus on user growth so that we could eventually attract big budget advertisers.  We managed to generate a substantial audience (becoming the world’s biggest game site), but even then still suffered from rapidly dropping ad rates that plagued the entire web.  It seemed each time we doubled traffic, the online advertising rates cut in half.   

What I like least about an advertising supported business is that it is almost impossible to always do the right thing for your customers.  Your two primary customer groups have opposing needs.  Each time you try to please your advertisers, you damage the user experience – and vice versa. 

Of course it is possible to build a valuable advertising supported company that overcomes this challenge – just look at Google.  Google reconciled the needs of advertisers and users, improving the user experience and advertiser results with perfectly targeted advertisements.  In fact Google’s advertising results were so good that later as an advertiser I was able to scale a profitable marketing spend to millions of dollars without ever speaking to a sales person (the results sold the ads). 

Today most online marketers buy on tracked ROI.  So if you are considering an advertising model, I highly encourage you to develop one that delivers results that will minimize the need for a sales team.  I do not envy the salesperson that has to make a case on the abstract branding value of their web property.  As tracking continues to improve, it going to be a much harder to incubate a startup with advertising.  Long-term success will require years of high burn.

In my experience, it is much easier to build a lean startup using a direct monetization model such as subscription, software licensing or ecommerce.  With these business models, your customer acquisition can be self funded from the beginning because it works at a very small scale.  For example, if your users have an average lifetime value of $100, your breakeven acquisition cost is $100 less any direct costs of serving this customer (such as storage or bandwidth).  Of course if you can acquire the user for $50 and there is no marginal service cost, then you’ll generate a $50 marginal profit on this user.  With a good arbitrage model, it becomes much easier to sustainably build a customer base from day one keeping burn at a minimum.  And eventually enough marginally profitable users offset fixed costs – creating an overall profitable business. 

Arbitrage supported customer acquisition can even work on a freemium model, but your allowable acquisition cost for a free user will be much lower when you average revenue across the whole free user base.  Still, over time you can add additional monetization channels to boost your allowable acquisition cost and expand the number of viable acquisition channels.  Ultimately freemium businesses become more defensible than “premium only” businesses, because you’ve built the premium portion of your business to compete in the toughest economic scenario.  I’ve blogged about freemium several times already, but have a lot more thoughts to share as I’ve helped several additional startups implement the model since my last freemium post.  Look for a more comprehensive post soon, but in the meantime here is a link to my earlier freemium posts.

Posted in Acquiring Customers, Business models, Freemium (Free-to-Premium), Pricing Your Product
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What is a Perfect Startup Launch?

Conventional wisdom says “launch” is a big bang event that happens in a very short period. It includes a press tour, an expensive launch marketing campaign, and if you could shoot balloons out of your homepage, most would think that’s a key element. The hard work is in orchestrating it all, so on the day of launch there is a big party where everyone drinks champagne and congratulates themselves on a job well done. New product launches that follow this conventional wisdom fail more than 80% of the time. 

I’ve always launched the way it should be done – initially because I was an untrained marketer. A perfect launch lasts several months and is a very iterative, metrics-driven process. It should start with the understanding that all of your assumptions are probably wrong. You don’t know who your most passionate users will be, you have no idea how to position the product and can’t understand what will prevent potentially passionate users from reaching a gratifying experience. I once heard Vinod Khosla describe this period as watching a flock of sheep grazing in an open field. The flock always gravitates towards the best grass. The launch period is about watching the flock to identify this best grass and figuring out how to describe it to drive as many of the right people (or to stick with the metaphor, sheep) toward this grass.

Those that follow the conventional “big bang launch” waste a lot of money incorrectly positioning their products and attracting the wrong types of users.  Executing the launch phase correctly improves results from external customer acquisition intiatives by 200% to 1000% within a few months.  For this reason alone it is better to conserve marketing dollars until after successfully completing the launch phase.  

I’ve recently begun calling 12in6 a “launch accelerator” because the true value we offer is the ability to quickly uncover key information by engaging early users and iterating/improving the complete customer acquisition process based on their feedback and measured results.  The five startups launched with this approach have become leaders in their respective categories (2 filed for IPOs). Luck is only part of the reason.

Posted in Acquiring Customers, Launch, Positioning
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What Makes A Great Startup?

That’s the zillion dollar question.  And no one knows the answer definitively.  Even the most successful VCs have major duds in their portfolios.  But every startup that becomes a large profitable company has the following two elements in common. 

1) Product/service people really want or need

A “product/service people want” is the starting point for any successful startup and part of the reason that I love working with Y Combinator startups.  They drill the mantra “make something people want” into hackers’ heads who are actually capable of executing the vision. 

MBAs often spend way too much time obsessing over the business model before they’ve figured out how to create a useful product. A great business model can never make up for a product that doesn’t meet a want or need. 

I don’t really consider myself an expert on creating useful products.  In fact, I’m not sure anyone is an expert.   Steve Jobs may be considered the world’s best product visionary, but NeXT Computer was hardly a smash hit.  And the executive behind Microsoft’s lucrative Xbox business has added much less value with the Zune. 

I was lucky in my first two startups to work with great products - the original founder’s vision really resonated with users.  I helped both companies reach their potential, but I didn’t create that potential.  Luck of stumbling into great products can’t last forever, so I now obsess over finding better ways to figure out if a product has potential before committing to take it to market.  Every launch program starts with a discovery phase where we dig into how well the product is resonating with users, who really needs it, and why it’s resonating.  Then we decide a timeline for going to market.

The only way to know if a product will resonate is to get actual users on it – and the sooner the better.   If the product isn’t striking a nerve, it’s better to delay an aggressive go to market push.  Many startups succeed with a refined vision rather than their original product.  See this list for examples.  

Sean O’Malley’s blog and Eric Ries’ blog are both great resources for helping you hone your product.  But remember, the only way to know if you’ve succeeded is to trickle some users onto it.  Sean O’Malley’s slideshare presentation below is also very helpful.

2) Business model that works

Ultimately startups get VC funding based on their potenital to create a thriving business.  This requires combining a needed product with a business model that pays the costs of building a lucrative business.  There is as much art in creating a strong business model as there is in creating the perfect product.  It is a thing of beauty when all the pieces fit together in a perfectly tuned economic engine.  Each ingredient is relatively simple, but making them work together at scale is extremely difficult.  

These are the key variables to consider when developing a business model that supports profitable, scalable user acquisition channels:

• Lifetime value of a user
• Cost of acquiring a user
• Marginal costs (besides acquisition cost)

The lifetime value of a user must exceed the cost of acquiring the user and any marginal material/service costs (costs that increase incrementally with each customer).   This is generally pretty easy to achieve if you have low marginal costs.  Most traditional software has zero marginal cost, which is why freeware is possible (it may not be profitable, but it is sustainable).  If you’re lucky, the lifetime value of each user is significantly higher than the marginal cost.  In this case you have a lot left over to spend on profitable customer acquisition.  On the other hand, if you have marginal costs that exceed the lifetime value, then this is a non-starter, no matter how useful the product is. 

If your product is useful and the basic business economics work, then the next part of the business model puzzle is figuring out ”customer acquisition channels.”  VC funded businesses must have very scalable customer acquisition opportunities.  No VC is interested in funding a business that maxes out at $1 million/year in revenue – even if it has 90% profit margins. 

Once you have a basic engine that works, keep tuning all pieces to make it work better (improve conversion rates, bring marginal costs down, find ways to increase LTV…).  This will open additional profitable customer acquisition channels.  And obsessively tuning all these areas has been a major factor in my ability to attract 10’s of millions of users for startups that ultimately filed for NASDAQ IPOs. 

The Ultimate Startup

The ultimate startup would be one where the product meets a critical need for a huge addressable market, users have a very high average lifetime value, there are no marginal costs  and there are very scalable user acquisition channels that are completely free  (ie viral).  Unfortunately I don’t know any businesses like this.  Facebook comes close, which helps explain their valuation of $15 billion (who knows what it is now??)…  The only piece they are missing is a high lifetime value per user. 

The science behind viral marketing has rapidly evolved in recent years, so I’m axiously waiting for this ultimate startup to launch. Hope I can get some of the early equity in it.

Posted in Acquiring Customers, Business models, Uncategorized
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Recruiting Startup Marketers from Wall Street

Rather than wasting their time on Wall Street, Mathematicians should be guiding online marketing for startups. 

For years Wall Street has used brilliant mathematicians to create investment models that they hoped would reduce risk and generate billions of dollars in investment returns. They increasingly leveraged their investments falsely believing that they had eliminated most of the risk – which of course added more risk.  Unfortunately most Wall Street investments are based on speculation which makes it is nearly impossible to remove risk regardless of the sophistication of the model.  Before I stopped watching the news CNBC was blaming these mathematicians for creating the complicated investment instruments that led to the recent collapse – claiming that even the CEOs didn’t understand them. And it’s not the first time that too much trust has been put into the abilities of these whiz kids. The financial crisis of 1998 has also been blamed on overconfidence in mathematicians ability to predict speculative markets.

I have zero confidence in really smart people being able to predict speculative markets. I’ve never trusted mutual fund managers with my cash – instead always putting most non-angel investments into S&P 500 index funds.

However, this is a place where mathematicians can create vast wealth – and that’s in startups.  The returns in online marketing are a lot more predictable than investment banking.  By knowing the lifetime value of your users, you know exactly how much you can pay to acquire new users with an acceptable profit margin.  As long as you don’t saturate a source, it generally delivers the same ROI with each campaign.  The beauty is that a very small investment can give you excellent guidance for the returns of a much larger investment.  Even with 7 figure monthly budgets, I’ve always insisted my teams test every new media with $5o0 buys.  I’ve used this approach to discover ways to spend millions with a very fast return on investment.

At my last long term VP marketing role, my first hire was a trained actuary (the guys that calculate risk for insurance companies).  And the marketers at two startups I’m working with now are both sharp mathematicians – one recently graduated from MIT with a math major.

I first witnessed the power of marketing number crunchers when I was at Uproar.  In 2000 we acquired a startup called iWin.  In a very short time they had created the second most popular casual game website in the world on cashflow positive results.  Their secret weapon?  Several math whizzes in their early 20s who had spent a year in investment banking before running the iWin marketing and product teams.  They were so effective that they took over the marketing and product leadership at Uproar (I had already moved on to President of Uproar Europe).

The math behind viral marketing is even more intriguing.  Read Andrew Chen’s Blog  for the inside scoop on how it works.  Viral Marketing has created some of the fastest growing companies in history and most have never spent a dime on marketing.  And who is dominating the field of viral marketing?  You guessed it – mathematicians. 

Unlike investment banking where leverage increases both risk and reward, in online marketing leverage only increases the reward.  The 12in6 Methodology is all about focusing on high leverage projects that improve the ROI of every future marketing initiative.

Looking to hire someone to lead your marketing?  Hire one of the recently unemployed Wall Street analysts (and show them this post to get them excited about the potential of their new job).

Posted in Acquiring Customers, Metrics Driven Marketing, viral marketing
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My Favorite Online Marketing Tactic – Doesn’t Work

That’s a pretty safe prediction for two years from now.  I’ve seen many hot online marketing tactics lose their effectiveness over the last decade.

The key cause: Online tracking makes it easier for marketers to quickly figure out what actually works.  As a result we start piling into the most effective tactics.   Eventually they get saturated.  An equilibrium is reached where most of the big profit potential is lost. SEM (Google Adwords) is the best example of this.  A few years ago I was able to spend 7 figures per month on SEM with a tracked payback of three months.  Today very few keyword categories offer that fast payback at any kind of meaningful scale. 

The other reason that popular tactics fade so quickly is that popular tactics generate a lot of noise.  Potential customers start tuning out the whole channel as it gets cluttered with advertisers.  In the 90s, I used to get 20X higher click through rates on banners than what’s typical today.  There were several months in the late 90s at Uproar where we ran the most viewed banner on the entire web (according to Nielson NetRatings).  Today banners rarely appear in the marketing mix for my startup clients.

And now it appears Facebook apps are quickly fading as a viable marketing channel.

So what can startups, marketers and VCs do to combat the short shelf life of online marketing tactics?

Advice to Startup CEOs: Don’t pay a premium for a marketing veteran’s many years of tactical online marketing experience – only the last couple years really matter.  And most of the critical go to market projects are very different from traditional marketing functions.

In fact I generally encourage startups to hire a complete rookie.  The marketing leader is one of the most challenging roles for a startup to hire.  The best marketing vets are looking for startups that have a bit of “wind at their back.”  It’s the rookie that can create this momentum.  Their lack of experience often means it’s easier for them to adopt new effective tactics as well as concentrating their efforts on the pre-tactical projects.  In exchange for coming in early, give them a legitimate shot at the long-term marketing leadership role.  After a year they will be intimately familiar with your customers.  And they will likely be every bit as effective as a veteran marketer but available for a fraction of the equity and cash.

Finally encourage your VCs to hold regular marketing summits so your marketer can trade effective customer acquisition tactics with other marketers (share “Advice to VCs” below with your VC).

Advice to Marketers: Don’t specialize in a single tactic. This is counter to the advice of most people, but hopefully by now you understand the flaw in focusing on a single tactic.  They fade too fast and then you have to start building a new specialty.

Instead, focus on developing marketing skills that will always remain relevant.  These include things like marketing psychology, diffusion of innovation, company building, customer research methods, persuasive website architecture, actionable marketing metrics…  Stay on top of the latest tactics, but always balance this with developing expertise that will remain important in the long term.  And when you discover effective new tactics, really analyze them to understand why they work.  Those principles will remain important and will help you create/spot the next effective tactic.  

And encourage your CEO/VCs to arrange marketing summits with other startup marketers where you can learn from each other (and please invite me).

Advice to VCs: Encourage your portfolio companies to exchange their most effective tactics.  Most VCs get their CEOs together, but rarely do I hear about VCs bringing together their marketing leaders (mine never did in any formal way).  Marketers probably have much more relevant insights to offer each other than CEOs.  Effective online marketing tactics are surprisingly effective across different business categories.  The collective insight across your portfolio of what works is enormous.  

I recently attended one of the rare marketing summits at a VC and found it to be extremely valuable.  Expertise in the group ranged from viral marketing to creative ways of generating press.  I was happy to share my insights at no cost – well actually in exchange for their insights.  I also shared some of my tools/projects that can be leveraged to get better results out of every tactic.  I’m sure the other marketers would agree that it was an extremely valuable use of a few hours of our time.

Posted in Acquiring Customers
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Startup and Online Marketing Secrets Exposed

This presentation by Dave McClure is the best concentration of online marketing information I have ever seen.  It is a direct contradiction to my recent rant that startup marketers are too protective of their ideas. Dave is definitely open to sharing his very valuable online marketing insights.  Almost everything you need to know about online marketing is included in the presentation. 

I wish I would have had a presentation like this when I began online marketing. Of course in the mid 90s no one had accumulated this knowledge yet.  

It also expanded my existing knowledge – particularly the last few pages on viral marketing. 

I plan to start following Dave’s blog very closely and I’m sure I’ll learn lots of new marketing tricks.

Posted in Acquiring Customers
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Awareness Building is a Waste of Startup Resources

It’s surprising how many CEO/Founders of startups tell me that they want to hire a VP Marketing to “build awareness.” 

Consider this: according to Inc Magazine , the average US consumer sees about 3,000 advertisements per day.  Can a startup really spend enough money to break through that clutter and build awareness?

For at least the first year or two, online consumer/prosumer/smb targeted startups should focus 100% of their non-PR media budget on acquiring customers.  Rather than buying a microsecond of awareness, you can actually use your limited funds to engage users in a real brand experience. Even for users that don’t convert to paying customers, you create a deeper impact by engaging people on your website.  And you can gain intelligence about such things as where and why potential customers are abandoning your acquisition funnel.

Focusing on customer acquisition over ”awareness” takes discipline.  There is always some amazing advertising opportunity that could lead to explosive growth.  Your odds are probably better buying a lottery ticket.

Building a strong customer acquisition engine is the best chance you have of creating long-term awareness.  At a certain scale, awareness/brand building makes sense.  But for the first year or two it’s a total waste of money.

Posted in Acquiring Customers, Building Awareness
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Great Viral Marketing Post by Andrew Chen

Here’s another great viral marketing post from Andrew Chen:

http://andrewchen.typepad.com/andrew_chens_blog/2008/03/facebook-viral.html

It even includes a downloadable Excel sheet.  It’s pretty heavy on the math side of viral marketing, but I highly recommended it for anyone looking to develop/polish their viral marketing skills. 

Posted in Acquiring Customers, viral marketing
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The Science Behind Viral Marketing

Many people don’t realize the advances in the science behind viral marketing.   Experts often known as ”Viral Tuners” are applying a systematic data driven process to creating viral customer acquisition drivers.  By testing and optimizing the viral elements of a widget or websites they are often able to push the viral coefficient above 1.0.  This essentially means that each new user generates more than one additional user.  In other words, growth accelerates geometrically until saturation.

Even if you can’t get the viral coefficient above 1.0, you can still greatly benefit from virality.  The echo effect of a viral coefficient that falls below 1.0 is still important. For example, if a tracked user from a campaign costs $1 to acquire and you have a .75 viral coefficient, you actually acquire about 3.5 customers for that $1 and therefore your average customer acquisition cost goes down to less than 30 cents. If you can find a way to generate an ARPU (average revenue per user) of $.50 you have a strong business – even if you spend $1 to acquire that first user.  The higher your viral coefficient, the bigger the echo effect of every dollar spent. 

Again, if you can get the viral coefficient above 1.0, the echo effect is infinite and your cost per acquired user approaches zero.  Any time you can acquire users for free, a viable business model becomes almost inevitable.  As long as you don’t have a significant marginal cost per user outside the acquisition cost, you simply need to micro-monetize these people and you’ll easily be able to grow a profitable business.  

All of the above is pretty abstract, so I’ll give you an example of the only viral growth driver I’ve ever created. Ten years ago I launched a YouTube sized game widget called Trivia Blitz that appeared on over 35,000 websites. Each widget carried an “add this game to your website” link, helping it to spread virally between sites.  We acquired several million users with this widget, paying the referring site 50 cents per user (a small fraction of the average lifetime value each user generated in advertising revenue).  To achieve a high average lifetime value, it was important to transition users from the referring site to the engaging multiplayer games on the Uproar.com website – which was already among the stickiest on the entire web.

During these irrational dotcom bubble years, our competitors were wasting millions on crazy marketing campaigns like expensive branding campaigns on TV or multimillion dollar AOL deals.  By focusing our resources on Trivia Blitz and tightly tracked direct response marketing drivers we were able to take leadership of the game category, surpassing Microsoft, Sony, Yahoo, and many gaming startups backed by leading Silicon Valley VCs.  Trivia Blitz was such an efficient customer acquisition tool that it eventually helped position Uproar.com for a NASDAQ IPO.  Among public companies, Uproar was able to achieve the lowest customer acquisition costs for a free registered user (about 1/6 of Yahoo’s cost which was considered pretty good at the time).  

While we didn’t optimize the virality of Trivia Blitz, it is still illustrative of the results that are possible if you can create a viral coefficient above 1.0.  I’m now focused on learning the skills of viral optimization, so I can take something that is slightly viral and fine tune it into a major viral marketing driver.

If you are interested in reading more about viral marketing, I highly recommend Andrew Chen’s blog.  I’ll blog about any other great resources that I find.

Posted in Acquiring Customers, viral marketing
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