Business Models For Dummies
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The Internet has brought a new mentality to the business world in which users matter more than profit. The concept is to capture a large audience and figure out how to make money from the audience later.

What do Twitter, Groupon, Solar City, biofuel companies, Webvan, and most blogs have in common? They’ve all attracted a vast number of customers but failed to profit from them.

For Internet companies, an underlying presumption indicates that free users can be converted to paying users later. For solar, biofuel, and other hot technology companies, the underlying assumption is that customer adoption of technological gains will fix the “make it for $10 and sell it for $5” problem.

For every that did move from large losses to large gains, you can find a Groupon that moves from large losses to larger losses. In 2011, Groupon had an impressive $1.6 billion in sales but managed to lose $238 million.

That’s not impressive for the industry leader selling a digital coupon with little cost. Sure, sometimes you need economies of scale in order to achieve profitability. Amazon proved this to be true. But at $1.6 billion in digital coupon revenue, doesn’t Groupon have critical mass?

Your investors don’t want to hear that your business model doesn’t convert sales into profits. It’s simply too big an assumption.

The following list addresses three key distinctions that merit discussion for these “we’ll make money later” companies:

  • Companies that have sales (just not enough of them): The first group consists of the solar power, wind power, bio fuel, and Groupon-type companies. They have sales, just not critical mass.

    The key assumption in question is the growth of sales and the decrease in cost per unit sold. Is everyone going to be driving electric cars or just 0.001 percent of drivers? Overly aggressive predictions of customers’ willingness to adopt new technologies can doom the business model.

  • Companies using the audience to monetize through advertising or indirect methods: The companies in the second group are primarily Internet-related offerings that capture large audiences, and then make money via the indirect model.

    These companies use the television model — selling advertising or selling access to their audience. Free iPhone apps, technology blogs, Google, Facebook, and Pandora make money not from selling access to their sites/products but by selling access to their audience to advertisers.

  • Companies using a freemium model: The third group is the most dangerous. Companies that spend significant effort building an audience or customers and figure the money will come later are following the Field of Dreams plan — if you build it, they will come.

    The problem with this plan is that the customers are trained to think the product is free or underpriced. When the customers are asked to pay fair value, they simply matriculate to the next free provider.

There is much chatter regarding Twitter charging a token $5 per month for a service that many users value deeply. To date, it’s simply chatter. Twitter has 500 million total users and 200 million active users yet doesn’t make a profit. A few million of these users paying $5 a month would make Twitter a profitable business. So why doesn’t Twitter flip the switch and go from a money loser to a money maker? They know most of their users would flee, that’s why.

The Internet has created the culture of free. This “they’ll pay later” plan doesn’t work very often. Be careful. It’s a better bet to use an alternative monetization plan for the customer base than to charge for use. The profit model portion of your business model may be weak with a monetize-later approach.

Clayton Christensen, author of The Innovator’s Dilemma (Harvard Business Review Press), wisely recommends “be patient for growth and impatient for profit.” If you follow his simple rule, you can avoid this issue altogether.

About This Article

This article is from the book:

About the book author:

Jim Muehlhausen is the founder and President of the Business Model Institute as well as consultant and speaker to businesses large and small. He is the author of The 51 Fatal Business Errors and How to Avoid Them and a frequent contributor to Entrepreneur, Businessweek, and dozens of other publications.

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