Tony Wright's Startup Front-End

I tend to disagree with 37Signals on a mess of things. Like a lot of successful internet pundits, they deal in absolutes and hyperbole. There’s no middle ground and there’s no “…well, it depends”. That’s just not as linkbaity. It’s probably not as fun, either.

But there’s one place where I wholeheartedly agree with ‘em– if you’re in the Freemium game, start charging for your software. Right now. Yesterday, in fact. Should you put a price tag on just any web service? Absolutely not. Kayak shouldn’t charge to find you a flight and (if the rumors about their success as a leadgen platform are true) Mint shouldn’t charge you to organize your personal finances. But if a big part of your revenue plan involves charging for premium services on top of a free product (freemium), you should start charging as soon as possible. Here’s why:

1. Price signals value. Where you set your price emotionally sets a value for your product. What that means is that amassing a gigantic pile of enthusiastic free users isn’t going to result in a big pile of paying users when you turn on your premium features (or worse, move some of the features behind the “pay wall”). In fact, it will likely piss off a lot of users who have grown accostomed to getting something for nothing. During the Y Combinator experience, I got a chance to hang out with Joe Kraus (founder of Excite and later Jotspot) and the fellas from Wufoo. Both had horrifying anecdotes about asking a bunch of free beta users to start paying for their software. The conversion rate was awful. When we first turned on our premium offering, we were struck by the same thing. We opened the floodgates for paying customers and found that almost none of our free users made the switch. So even with your pile of zealous free users, you’re starting from square 1 in the premium game– you’ve already convinced your current userbase that the fair price for your product is “free”.

   I mentioned this in the comments but I wanted to promote it up here as well. *”Take a minute and answer this two-part question:*

   “1. Is the percentage of African nations in the United Nations higher or lower than 65? 2. What is the percentage of African nations in the United Nations?

   This was one of the queries that Amos Tversky and Daniel Kahneman posed in their 1974 paper in Science called “Judgment Under Uncertainty: Heuristics and Biases.” It turns out that the answer you provide to the second question is heavily swayed by that first question. The average estimate for question two was above 45 percent. When question one was lowered from 65 percent to 10 percent, the average estimation of question two was dropped to 25 percent. ” Source (pdf)

   Your free beta anchors your perceived value at zero and it’s a bitch to climb out of that hole.

2. Speaking of Square one… You don’t know nothin’ about square one! Charging people money for software is a whole new set of skills that you quite likely don’t have. What do your paying customers REALLY want? What do you put behind the pay wall versus in front of it? What do you give your free users? What kind of free trial should you offer? Will a referral program work for your business? Does your value proposition resonate most with individuals or businesses? Big biz or small? Can you make adwords work for your business? What works on an adwords landing page? Will a salesperson be valuable for your business? Where do your leads come in? Telesales? Direct Mail? SEO? SEM? Viral/word-of-mouth? The problem with all of these questions is that the answers don’t transfer across markets very well. What might work great for my market/product might perform terribly for yours. The sooner you start investigating this stuff is the sooner you start being smart about your market.
3. Getting people to sign up for a free service doesn’t mean that you know they’ll spend money on it. There are lots of clever ways you can ascertain whether someone would REALLY buy your product. You can put up fake adwords ads, you can cold call people, you can throw up a permission marketing page and try to get attention for it, you can do a focus group, you can ask some pricing experts, and more. But nothing is a perfect substitute for having a buy button next to a price and seeing if anyone actually clicks on it. And they generally won’t. At first. So start learning!

We’ve been at this for almost two years and I have very few big regrets. But my biggest regret as an entrepreneur is not starting on the path of charging customers sooner. It’s taken us about a year to get pretty good at it, but we’re still learning new stuff about our customers every week (we’re pretty darn grateful to have customers who are generous with feedback).

Some additional fabulous reading on the topic of when to charge can be read on Sean Ellis’ blog here. Sean basically contends that you shouldn’t charge at all until you are certain you have product/market fit. In the comments, someone expressed concern that product/market fit isn’t real until there’s a price attached to it. Here’s Sean’s response:

I agree that price is part of the process of figuring out if you have product/market fit. I’m basically starting with the price of zero. If people aren’t that disappointed to see the product go at zero cost, then we already know that any cost above zero will very likely also result in people not being that disappointed to see the product go. Once enough people consider it a “must have” at zero cost, then the next step is to figure out a price that generates the most revenue for every thousand people that try the product.

This is an interesting thought, but I’m not convinced. I remember hearing that Wufoo and Jotspot both had pretty passionate free/beta users. I could be wrong, but I’d wager that they would’ve had a solid number of folks who would state that they’d be “very disappointed” if they had to give up the product. Nonetheless, they came up pretty empty when asking these users to start paying up. The difference between product/market fit for a free product and product/market fit for a $5 product could be a lot farther than you think. It might be a few iterations or it might be a whole new product.

But where I think Sean is absolutely right (to be fair, I think Sean is brilliant– you should subscribe to his blog!) is that you need enough customers to be able to measure and improve your product. If you can’t acquire/retain 100 paying customers, perhaps you should stick with a free/private beta.

A friend/contrarian Tweeted the following that I though was worth a discussion (the 140 character limit of Twitter quickly got too painful for me).

“What’s wrong with this world: Twitter is making $4mil per year yet is valued at $1bil. #newmath”

I think this is an important thing to talk about– it’s certainly something that would have resonated with me before I raised money from investors, but now falls pretty flat. I have two quick points to make about it, then I’ll wait for Marina to attack me in the comments.

1. Valuation does NOT equal market value for the company. Founders don’t like to give away a lot of equity when raising money (nor should they!). So, to bring the #s back to earth, let’s pretend that I have a seed stage idea with a little promise/traction that I’d like to raise $1m for. During the fundraising process, there is NO discussion about what the company is WORTH. Instead, the discussion is about how much equity I want to sell (say 25%) and how much I think I can get for it ($1m). This establishes a post money VALUATION of $4m (i.e. 25% of the company is worth $1m, so 100% is worth $4m). No one is saying that anyone who buys companies would even DREAM of buying it at a price of $4m… We just need a mechanism to decide how much equity the founders get to keep if we want to raise $1m. We could fix this offensive math by either selling stock in a company based on the market value (what someone would buy it for), but I think you’d find that good entrepreneurs are not interested in working for free/cheap when they own a tiny percentage of their “fairly” valued company. This model scales all the way up to Twitter. The conversation is more about how much founders and previous investors own after they raise their big rounds than “So, whaddya think we’re worth if we put this puppy on the auction block?”

2. Supply and demand. There are two markets here. One is the scarce (and not always rational) market of GOOD entrepreneurs/startups. If an investor wants a stake in startup that’s growing, they have precious few opportunities to do so. This market has VERY little to do with the current cash value/revenue of the company (at the early stage), but instead is based on the size of the market/opportunity, the entrepreneurs involved, growth patterns, long-term market trends, and how much competition there is for the deal. If Ev Williams punted Twitter tomorrow to start a new startup, he’d get huge valuations if all he had was a sketch on a post-it note, just because there are very few opportunities to work with a guy who has made VCs rich in the past (i.e. had an exit). And because the upside of a successful exit/IPO is so high it makes sense to buy the opportunity at that cost even if Ev’s post-it note probably wouldn’t sell for much on the open market.

Whether you think Twitter is or ever will be worth $1B is immaterial (I think it will, for what it’s worth). The real question is, should an an early stage investor buy stock in a company with a valuation that doesn’t reflect current market value of the company? I think the answer is a resounding yes– if it wasn’t, you’d have a lot fewer startups in the world.

I think the solution for the disconnect is to stop equating the phrase “valuation” (especially when talking about early stage startups) with market-value in your head. We back into those numbers in funding negotiations to make sure that entrepreneurs have the cash resources they need and enough equity to be motivated by the upside at the end of the rainbow.

And, remember: don’t be held back by common sense. There’s a great quote about an insane idea being a necessary but not sufficient requirement for startup success. Early stage investors have been in the business of funding companies without revenue forever, and the smart ones seem to make a lot of money doing it. Monetizing Twitter on a grand scale right now seems insanely hard. But a LOT of smart pundits were saying that the search market was a dead end when Google started spinning up. Markets change, smart people innovate, and magical things happen…

As a business with public contact information, we are inundated with sales calls. The process generally runs roughly like this:

1. We get a phone call from a number that is often “blocked” for caller ID. We’ve learned to screen those calls. Some leave a voicemail, some do not. If they aren’t blocked, we’ll answer the call, and we’ll generally get blasted with a run on sentence. If it’s a short introduction, I’ll politely decline. If it’s a long monologue, I’ll hang up.
2. We get a followup email from the caller describing their service. They will ask for a 15-30 minute introductory discussion/presentation. Depending on how good the email is (in terms of grammar and presentation), I’ll drop a reply saying that we’re not interested or ignore it entirely.
3. I’ll often get a 2nd email saying something like, “when would be a good time to follow up with you. How about I drop you a line in 3 months to see how things are going?” Um, no thank you.
4. The really well-trained salesfolks will often also say, “Do you know of anyone else who might be looking for our services?” The answer to this is always no. I’m not going to make an introduction (which is often tantamount to an endorsement).

5. I don’t want to be a jerk to salesfolks. I’m sure they are by and large good folks and are just trying to do their job. But we NEVER BUY ANYTHING THIS WAY. Between a few Google queries and a few “lazyweb tweets or emails”, I can drum up a short list of vendors who are thought well of by SOMEONE, and perhaps can get a list that are actually recommended by people that I know and trust. Why would I ever buy from the salesperson who happens to be calling me? Even if they were introducing me to a class of software/service that I wasn’t aware of and really wanted, the first thing I’d do is thank them for the info and start googling.

   As people get smarter about searching and social networking (and thus social recommendations) go mainstream, I continue to wonder at the future of outbound lead generation via phone/email.

   So, I’ve got a new canned response in Gmail:

   Thanks for your inquiry.

   RescueTime does not respond to unsolicited sales requests and we’d prefer to not receive them.

   When we’re interested in software or services, we prefer to do some combination of searching on the Internet and asking trusted people in our network for their recommendations.

   If you’re interested in earning our business, your best bet is to serve the customers you have well so that when we ARE looking for what you offer, you’ll be highly recommended in our network and across the web.

   Thanks for your understanding.

   Cheers,

   -Tony Wright, founder of http://rescuetime.com

   http://blog.rescuetime.com (company blog)
   http://tonywright.com (personal blog)

I saw Brad Feld speak last night at Beer, Brad, and Boulder (you can see the recorded stream and chat here) and was really struck by something that he said.

In response to the question: "How broken is venture capital?" he said (paraphrasing, among other things): "It's not broken, but it is saturation.  It's absolutely cheaper to build companies nowadays, but it's not necessarily cheaper to build them and scale them.  Venture Capital is still necessary to scale businesses from the prototype stage, but no longer quite so valuable to get to that prototype stage."

(note: this is a test using Posterous to automagically post to this blog– sorry for the brevity!)

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