I came across a post by Anthony Tjan (a VC) on the Harvard Business Review which talks about how at their VC firm, they’re constantly on the lookout for business with the following monetisation model:
recurring revenue + fixed cost leverage = superior cash flow
I think he convolutes the message a little bit, and using a words like recurring and leverage just confuse the matter.
What it comes down to is very simply, build a business where your costs stay fixed or close to fixed, and your revenue keeps climbing and you’ve built a successful business.
The opposite of this model, if you’re interested, is to receive linear revenue per cost, something which is typical of the service and retail industries.
There are only a few industries where this model really is viable, Technology, Biotech, Finance and Securities trading. What Taleb refers to as Extremistan. (Almost done with his book, so will post on it soon)
Tjang further goes on to expand and clarify the idea,
…a business model where you get the vast majority of your customers coming back every year, where the cost to deliver an additional customer approaches zero at scale, and where you get a lot of the cash upfront…
This is a great business model, but the three basic premises are very important to get right:
- High retention rate,
- 0 cost of customer acquisition, and
- cash up front
If you look at those individually, there are very very few business that do match this, and more importantly match it in the long run.
Running out of retention:
If you’ve got product that no-one reuses, you’re not going to last long unless you fix it, lack of retention when its your fault is fixable. The big problem comes in when you are highly reliant on others for your customer retention.
As an example: The humble roadside attraction.It used ot be a great familly business, you have an initial outlay to build some weird and wonderful thing, and customers just walk in off the road. your cost is fixed, you get a high number of people coming back, normally with their kids in tow, and they have to pay before they can go in and see your world of wonders (and then you sell them a t-shirt on the way out).
Then someone builds an interstate, and your customers are simply not there anymore. Nothing the roadside attractions did in the 50s saved them from the interstate.
The biggest fear of most internet “content” sites, is someone switching of the tap of traffic. If that happens, their revenue tanks, their costs stay the same, and they’re screwed.
If I look at some online businesses, they relied on Google for either traffic, revenue or both. Without exception, all of them started doing really well, well enough to get the Execs on the board to sit up and start adjusting budgets, and then tanked.
The key is retention. These sites were reporting traffic numbers in the millions per month, and the numbers were going up, so they thought retention was in the bag.
They didn’t pay attention to the stats that tell them how many users are coming from external sources, or how many of them are new vs. returning. When those external sites found somewhere else to send the traffic, or launched a competing product, the fountain of plenty dried up. For the interested, these numbers were usually around <1% direct traffic, and 10% returning.
Simply retaining numbers isn’t good enough, you have to retain individuals, or more clearly, people have to choose to use your product over others.
Customer Acquisition doesn’t stay 0
Another business is subscription based, with very high numbers of retention, they built a complicated technology offering but once it was up and running they didn’t have to spend much to keep it running, so their acquisition tended to 0. They are and have been successful for a very long time.
Their big issue that they target a very specific role in an industry. As it pans out, they’ve run out of customers to sell to.
By itself, running out of customers isn’t really a problem, what it means is that your cost of acquisition all of a sudden tends towards infinite, if there aren’t any new customers, it doesn’t matter how much I spend, I’ll not get any new customers.
So you can stop spending on acquiring customers, but you still have to spend something to keep your retention high, otherwise someone will steal your lunch, but you can bake that increase of cost back into your charge to customers. This kind of business needs to batten down, start figuring out how to save money by being efficient and shore up their market.
What it doesn’t need to do, is to try and build a whole new product, which they hope will work for their existing customers and attract an entire new market.
Know your limits in a market, and be comfortable with them, if you’ve cornered the market, that’s a good place to be, make sure you stay there rather than find a new market.
Cash up front
Gift vouchers are the bane of the Service industry. Cashflow is normally quite tight, so by the time the customer comes round, the initial money has already been spent and then you’ve got to tie up one of your employees in an activity that makes no money, but costs you lots.
You’d expect your customer acquisition costs to balloon right? Except for the cashflow issue however, there is no additional cost to getting that customer, after all you did get the money already. Even better, you’ve now got an opportunity to sell additional services or products and to market your business directly.
A beauty salon till recently was putting an expiry date on their gift vouchers, primarily to try and avoid the cashflow issue. Needless to say, customers that had received a gift voucher and ended up not being able to use them got rather upset about the whole affair.
They ended up not only losing out on the opportunity to sell more to a customer, they also created bad marketing for themselves by letting people down.
When you take cash up front, don’t forget what people have paid for, they must feel that they are better off by having paid in advance, there’s nothing in it for them otherwise.
