Paying Customers – What A Concept!

2 Dec

This week one of our companies made the critical decision to start charging for its suite of online applications. Hardly earth shattering, one could argue, but it was a harder decision to arrive at than one might imagine. More broadly, given the funding environment, I suspect this is a frequent conversation taking place in the conference rooms of many emerging web services companies.

As a Board, after much debate we came to the conclusion that to fully validate the company’s value proposition we needed to accelerate the path to generating recurring revenue from customers, and that involved customers voting for the company’s solution in the most blunt and unequivocal way of all – with their wallets. Reliance upon a “freemium” or advertising-only based model was no longer sufficient in the eyes of the Board and management.

The notion of customer value is being re-appraised across the start-up community. It is hardly a news flash to say that investors and the market at large are no longer paying for eyeballs, click-throughs or other squishy metrics of a company’s value and overall viability. That said, there still exist many companies that continue to craft their strategies toward accumulating users for the sake of accumulating users without extracting any cost or imposing any particular burden upon them. What too often sustains these approaches is the notion that big media partnerships, sponsorships, revenue-share promotions, or other similar opportunities will eventually come along to monetize the company’s user base.

I’ve never been a big fan of this approach and the tightening funding market in the past year has only made me more wary of companies that are basing too much of their very survival on this kind of revenue model.

To be sure, migrating a company from what was initially designed to be a free model to an all-pay platform is fraught with peril. Customer churn can be significant and the threat of email inboxes at the company being filled with irate customer complaints is a real issue. More importantly, products can be rushed to market that are still somewhat undercooked. Asking a customer to pay for a skeletal, less-than-stellar product that was heretofore free is a tough sell on its own; in an economic downturn it’s even tougher, and the risk of customer backlash is significant.

All these real dangers aside, we are sensing a renewed focus on the investor side toward web products and services that are robust enough to begin charging customers for at launch or very shortly thereafter. Falling into the trap of giving things away for free with the idea that you will make it up on volume is a trap that is extremely hard to extricate yourself from later. Once acclimated to the idea of using web products and services gratis, customers are loath to pay for them — even customers that claim to love the company and evangelize it to their friends and colleagues. Given the tough funding environment and investor insistence upon clear paths to profitability, the better strategy might be to focus upon fewer, paying customers as early as is feasible for the company so as to hit those critical validation points and to prove that, yes indeed, customers WILL pay for the product or service; it’s not just a notion. If the market you are in is sizable enough, there should be plenty of opportunity to grow that paying user base, but at admittedly slower rates of growth because you are no longer giving away the store to anyone and everyone in cyberspace. As one of my CEOs put it, “My 30,000 paying customers beats your 300,000 non-paying looky-loos any day of the week.” At least that’s what his team has decided and the Board has gone along. Admittedly, it’s a huge gamble and it is not an overstatement to say that the future of the company rests on the wisdom of that decision. As to whether he is correct, the market will let us know soon enough.

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One Response to “Paying Customers – What A Concept!”

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  1. The Care and Feeding of Early Customers « Adventure Capitalist - January 7, 2010

    […] a recent post, Paying Customers – What a Concept!, I proposed that many early stage companies were having to accelerate their products more than was […]

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