Odysseus could not help himself. He knew the risks, but he had to hear the alluring sound of the Sirens’ song.
In Greek mythology, the Sirens were a combination of birds and women who sang to passing sailors, enticing them to approach the shore and crash on its hidden shoals.
To avoid wrecking his ship, Odysseus instructed his crew to plug their ears and ignore his orders, no matter how much he implored them to approach the Sirens’ island.
Many entrepreneurs encounter a similar dilemma. They often identify expeditious ways to make money in the early days of their adVentures, which allow them to reduce the amount of capital they must raise from outside investors. Unfortunately, such initially alluring business models can ultimately result in their ruin. Thus, entrepreneurs must decide when to stop listening to the Sirens’ song of a quick buck and position their company to take advantage of long-term, sustainable business models.
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Bad Profits
WebEx learned the hard way that some profits are better than others. During a market’s formative period, there are often opportunities for a First Mover to extract outsized profits. In the short-term, such opportunities are enticing. However, in the long run, entrepreneurs always benefit from delivering Maximum Utility for a fair price.
WebEx was the early leader in web meetings. Perhaps in part due to its dominant market share, WebEx adopted telecom-style pricing, which effectively penalized their users. The more a customer utilized WebEx’s services, the more they had to pay. A typical 60-minute meeting with one attendee cost $54. The costs increased as the length and size of a meeting expanded. WebEx also charged exorbitant setup fees (again, much like cellular carriers), averaging about $4,000. Rather than encouraging users to maximize the value from their service, they effectively punished them for their increased usage.
WebEx’s predatory pricing made it vulnerable to a new entrant. As noted in Fast Followers II, when Expertcity (acquired by Citrix) launched GoToMeeting, we devised a straightforward, easy to understand pricing scheme, which we dubbed “All You Can Meet.” We charged $49 per month, irrespective of a customer’s usage.
WebEx’s management was understandably hesitant to modify their pricing because the company’s shares were publically traded at the time we launched GoToMeeting (the company was subsequently purchased by Cisco). They knew that price restructuring would significantly impair their gross revenues as well as their net income, which would dramatically impact their stock price. They were effectively hooked on the bad profits which were seductive when they initially launched their service. Even though WebEx eventually modified its pricing, it was too late. GoToMeeting took advantage of WebEx’s inhospitable pricing and emerged as the ubiquitous online meeting solution.
Arbitrage Is Fleeting
Below are descriptions of three companies which each faced short-term, lucrative opportunities. In each case, they successfully migrated their go-to-market strategies to one based on long-term sustainability. Even though such enduring strategies are often difficult and expensive to execute, they generally result in greater value creation for the company’s customers, founders, employees and investors.
Exploring The Campus
In the spirit of Conventional Wisdom Isn’t, the founders of Campus Explorer did not, “flow with the go” when they founded their higher-education website.
Campus Explorer earns most of its revenue through lead-generation. When they launched the Company, the lead generation market was based almost exclusively on arbitrage. Companies purchased keywords, placed ads and sent emails in an attempt to entice users to complete a lead form. They then sold the leads for more than it cost to generate them. For several years, this was a lucrative business model – the sirens were singing loudly and many companies answered their call. The founders knew that such profits were fleeting, as market efficiencies eventually eliminate such “buy low / sell high” opportunities.
As the founders predicted, the market eventually became more efficient, causing the margins available to traditional lead generation companies to diminish. In particular, the Google AdWord market matured, making it increasingly difficult for lead generation operators to profitably purchase keywords that would motivate qualified users to complete a lead form.
Campus Explorer eschewed a pure arbitrage strategy and instead, focused their efforts on building a site that provided value-added content to users, which informed and shaped their college search. This approach was neither quick nor easy to implement.
However, as the arbitrage opportunities in the lead generation market diminished, Campus Explorer flourished. Their cost to obtain leads was extremely low (essentially the cost to create and maintain the content), while the quality of their leads was high, which made them more valuable to their college-lead purchasers. Campus Explorer created a classic trifecta win: one that was good for the students, the colleges and, ultimately, Campus Explorer as well.
Scaling Right
Cloud computing pioneer RightScale is a prime example of a company which utilized a consultative go-to-market strategy as a means of funding its initial operations. In order to create a SaaS platform which acts as the “last mile” to public clouds, RightScale began operations by providing consulting services to companies who wanted to access Amazon’s EC3 services.
However, the Founders understood the inherent limitations of a services business. The size and scope of law firms, medical practices and consulting firms are all constrained by the number of employees they can hire and keep gainfully billing hours. Although such service businesses can be highly profitably from the start, they are difficult to scale, hence they are often referred to by the derisive term “body shop.” You can only increase revenue by hiring more employees, yet each time you hire a “body” you incur a step cost before you invoice a client for a single billable hour.
As a Seed Investor and addVisor, I witnessed firsthand how RightScale’s Founders avoided the structural limitations of a body-shop business. The company artfully repurposed the tools, dashboards and scripts which it delivered to its initial consulting clients and created a SaaS solution. Management wisely retained the intellectual property associated with these “works for hire,” which they eventually combined to form the foundation of RightScale’s initial Minimally Viable Product.
Graph The Effect
As noted in my interview with GraphEffect’s Co-Founder, Clark Landry, GraphEffect is focused on leveraging Facebook’s API to provide advertisers with much more effective ad units, while maintaining the integrity of the Facebook users’ privacy.
As with many emerging markets, the Facebook advertising ecosystem is relatively inefficient. Similar to the state of the lead generation market at Campus Explorer’s outset, these inefficiencies have spawned profitable arbitrage opportunities. Despite the compelling reality of these quick-buck opportunities, Clark and his Co-founder James Borow are evolving their business into a SaaS offering. Thus, GraphEffect has largely foregone near-term arbitrage revenue in order to focus on building a software platform that can be effectively used by third parties to optimize their social media ad expenditures. This latter approach affords greater predictability and scalability while creating more enduring long-term value.
9 Women And A Baby
As Mark Suster noted in a recent blog entry entitled 9 Women Can’t Make a Baby in a Month, the allure of near-term profits is a powerful Siren song. However, successful entrepreneurs balance the need for immediate cash with the enduring necessity to create a self-sustaining company that will not crash upon the shoals of financial ruin. This requires the maturity to initially heed the Siren’s song and make a few quick bucks, while having the willpower to ignore it before the vagaries of the market shut it, and your company, off forever.
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Note: I am an investor in all three of the companies mentioned in this article via Rincon Venture Partners.
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