Value Models: Many Ways to Skin a Cat

As in any innovation-driven market, software vendors continue to develop and exploit a variety of business models, most recently a variety of “free” services. Unlike the period of the Internet bubble, during which companies failed because they didn’t monetize their services, many of today’s “free” services are well thought out and are likely to become successful businesses. While this article looks at the monetization side, it is equally important to note that these companies leverage Web 2.0 tools and consequently have dramatically lower development and operating costs than their Internet bubble predecessors.
In the beginning, software developers wrote applications and sold them. Actually, that’s not really true… in the beginning, big computer companies wrote applications and rented them. Since few people could afford to buy their own “big iron,” companies figured out how to sell time-slices, otherwise known as time-sharing. Old ideas die hard, and today Software as a Service (SaaS) is once again all the rage.
Many ways to make a SaaS business model work
There is no “right” or “wrong” answer, as I’ll point out in the examples of blogging software below. Here are four similar applications, with four different business models. There is no reason to believe any of these companies cannot be successful in the long run.
Example 1: Movable Type
Vendor: Six Apart
Business Model: Subscriptions
The subscription model is well-known and well-understood: you charge users a fee which (hopefully) exceeds the cost of providing the service. Today, this model is known as software as a service (SaaS), but it’s had a variety of names over the years. Because a subscription generates a predictable stream of monthly income, it is easy to understand in terms of income and expenses.
Example 2: Vox
Vendor: Six Apart
Business Model: Advertising-supported
We are all familiar with “free” services that are advertising-supported, such as Yahoo! Mail or many of the municipal internet access providers. The provider offers a service without charge to users, but forces them to view advertisements. The ads can be simple banners or sidebars, but in some cases users must sit through a pre- or post-roll commercial before gaining access to the content (e.g. CNET product reviews). The model works for services like personal email and blogs, but the mandatory advertising makes it less attractive to users trying to project a more professional image. SixApart is trying to walk a thin line, using advertising that is effective (and thus valued by advertisers), yet generally unobtrusive so it does not drive away users.
Example 3: WordPress
Vendor: Automattic
Business Model: Add-on Sales
King Gillette pioneered the loss leader business mode around the turn of the last century, selling razors inexpensively, but making profit on the blades. In this case, Automattic offers the base product for free, and the for-pay support and upgrades are optional. Yahoo! Mail uses a similar model–the base product is free (advertising supported in Yahoo’s case), but Yahoo! Business Mail and Web Hosting are fee-based. Like Yahoo! Mail, but unlike many “lite” versions of software, WordPress is a fully-featured application. Consequently, many of their users are likely to remain unmonetized. If too many users remain unmonetized, the business model will fail.
Example 4: Blogger
Vendor: Google
Business Model: Ancillary Sales
Subscription is easy to understand. Advertising-supported and add-on sales have many more unknowns, but the basic principles are not hard to grasp. Ancillary sales take a fourth route of giving everyone a true freebie, while getting enough people to do something else that generates income. The link between the service and income can be pretty unobtrusive in some cases. Those free Cokes and hot dogs at the car dealer over Memorial Day weekend are a good example. The food is free, but like fishermen dumping chum into the water, Google is seeking a bigger catch. Like any portal site, parent Google must maintain a growing flow of visitors. Google is not shy about monetizing visitors, but they often do it in less direct ways. Google is also extraordinarily disciplined about building traffic first before monetizing it. Another thing that makes Google interesting is that they have multiple ways to fish, so the connections are not always obvious. For example, rather than merely posting ads, they use AdSense to target ads and share some booty with the hosting site. The problem with this model is that it is easy to fool yourself into believing your free product is generating tons of downstream sales “real soon.”
None of these models is better or worse, except to the extent that one works in a particular situation. Understanding which model(s) are likely to work for a particular set of resources and objectives is part science and part art, but both are aided immeasurably by relevant experience. The Internet bubble taught us that whatever business model is selected, at the end of the day success requires delivery of predictable and sustained income.