Time for a new Business Model

Time to talk to that big competitor in your crosshairs!

Introduction

It is time British entrepreneurs have a serious rethink regarding the traditional entrepreneurial model, particularly in the IT/internet industry. The model that I have seen repeated numerous times goes something like this: an entrepreneur decides to develop a new online service or application taking advantage of “cloud computing”, the low barriers to entry for internet plays or the growth in smartphones, etc.

They decide to bootstrap their business, recognising the powerful set of factors driving this methodology as the preferred choice for entrepreneurs (the ability to work remotely, outsource, buy services on a variable cost basis, use “on demand” software rather than acquire expensive hardware, avoid outside interference from investors, etc.) However, within a year or so, the signs that all is not well are all too evident: no more Twitter updates, a dated copyright sign on their site, perpetually broken links and an empty blog. 

These entrepreneurs are innovative, passionate and smart and, when they start off they believe they are on the road to riches. But in many instances, they fail to understand one of the key tenets of why it is so hard to launch a successful business – that it is very hard to gain market traction.

The problem

In short, in an increasingly busy world and a fragmented media landscape, creating awareness of your business is extremely costly and difficult. We are all competing for consumers’ attention in a world where attention spans are limited, often fleeting and typically costly to acquire. The misguided reliance on the old adage of if we build it, they will come’ has proven to be the downfall for entrepreneurs on more than one occasion.

Before the emergence of the internet, the model was slightly different; barriers to entry for most businesses were a little higher (often bricks rather than clicks), and competitors were more local than is the case these days. If you wanted to advertise your product or service, the choice of medium was much narrower (limited number of TV/radio stations, broadsheets, etc). Recent years have seen an explosion in media ranging from TV channels to magazines, to internet sites.  Accessing your target customer in a cost-effective manner has arguably gotten much more difficult (aside from via pay-per-click [PPC] advertising).

The incumbents

On the other side, there are numerous (often bureaucratic) business incumbents who are in the crosshairs of these start-ups. For example, in the software industry, you get incumbents with feature-heavy products, installed via CD’s and designed to run off hard drives (and created in an era of software patent protection, customer lock-in and switching costs).

However, they often have a number of strong legacy advantages when it comes to market awareness including: 1, by dint of their domain age, they often occupy top organic search positions in Google; 2, many of their costs were sunk many years previously so they can focus resources on marketing; and 3, they have often bought up the key brand domain names in your market, forcing you to pick an obscure brand name.

In other words they have much greater access to the target market of customers, even if their product set is arguably inferior and innovation is not as pressing a requirement for them as it is for you the entrepreneur.  One of their key advantages is the potentially huge amount of (free) organic traffic Google sends to them on a daily basis, meaning they can focus on competing with you through PPC, forcing your costs up (by bidding against you) so the cost of customer acquisition makes your online marketing unsustainable.

The Accountancy Software Industry

Consider the accounting software industry in the U.K. It is dominated by a small number of players with one clear market leader, Sage (established 1981). Their business model is predominantly based on reselling boxed software through a mix of online and offline retailers, with an emphasis on upgrade revenue and fees for access to customer support. Their programmers will predominantly be Windows-based programmers, lacking the skill set and experience to develop in newer, more flexible programming languages which ‘embrace the cloud’ (accessing your data via an Internet connection, rather than from a file on the hard drive of your PC). As a result, maintenance of the status quo (including in terms of the dominant operating platform) and distribution channels will be a key aim.

In recent years a number of start-ups have entered the market focusing on the growing niche of cloud-based solutions.  They compete on price and service and many offer compelling solutions. When I assess the industry, I see most software innovation happening among these start-ups, as well as strong social media presence (given the low cost benefits), free trials and the like. However, I do not see the level of traction amongst these players to seriously challenge the incumbents (although one of these players at least may beg to differ!).  I also see the same characteristics I describe above playing out in many other industries.

Why is this a problem?

In short, true innovation in the industry is stymied by the structure and the manner in which incentives are aligned; why innovate as an incumbent if it is costly to do so (and may mean the need to develop for a different platform)?  Why innovate as an entrepreneur if customers do not get to see the fruits of your innovation in meaningful numbers due to your lack of awareness in the market? The result is not surprising: frustration all round!

Have I not just described a very common situation in many diverse industries?  Well, yes, I believe I have, but I feel there is an alternative ending that should be considered more often, particularly amongst internet businesses.

The solution

Entrepreneurs need to understand the importance of constantly monitoring the traction they are receiving, and whether they need a Plan B or need to pivot to a new idea (or even source external investment to fund marketing initiatives). If external funding is needed at this stage, it needs to be smart money, ie, an investment from someone who can bring a lot more to the table over and above a cash injection, eg, access to your target market.

Entrepreneurs tend to be very optimistic in their outlooks, and often focus on further development of the product or service despite any clear evidence of customer demand or an obvious route to accessing customers in a commercially viable manner. They often plough on, wasting time and effort, without ever interrogating their internet analytics account in detail to see whether page views and unique user numbers are growing exponentially, and whether these users are converting to sales in large enough numbers. Why is this?

Because often the data exposed via analytics is frightening. Frightening in the sense that the user numbers are simply not there, growth rates are flat and the traffic is simply too expensive to acquire through non-organic routes. They are stuck in a bind.

For me, there is one obvious solution. Entrepreneurs should stop focusing on trying to build a customer base themselves and approach the main players in the market, where they should look to commercialise the innovation through some licence arrangement or trade sale. 

I do not believe this behaviour plays out that frequently, despite it being such a simple idea. That is not to say that entrepreneurs do not approach their main competitors, because they do. But in the instances that I have seen this in action, the approach is characterised by one primary fear; that of disclosing the actual numbers using their service. Married to this is often incredible financial projections and astronomical valuations based on cash burn/sunk costs or some notional value of the cash out they need to retire successfully.

The scenarios all play out the same – after a slightly awkward conversation with circular arguments[1], both parties go their separate ways. Roll on a few months or years and the incumbent has caught up, launching their own less innovative SAAS (software as a service) application, while the entrepreneur’s site shows clear signs of decline (a blog that has not been updated in six months) and a skeleton staff to keep costs down. 

My recommendations are clear – if you are an entrepreneur managing a business similar to what I described above, recognise early on that customers are very costly to acquire in sufficient volume to make many businesses commercially viable, particularly as a start-up.

If you have created a truly innovative solution that is not gaining traction (due to some of the reasons stated above), you need to make a call to your main incumbent competitor early on. In planning your call, recognise the following: (a) they are not stupid – they know the industry inside out, (b) they are probably not going to acquire you at what you perceive is a fair value when revenues are negligible, (c) they are probably developing something similar to your proposition (or may have discounted it as not being commercially attractive enough) and (d) they are probably not be as innovative as you. However, you will offer them an opportunity to get to market more quickly and you may have assembled a team with a skill set that is much more aligned to newer platforms, etc.

The incumbent will also have the lion’s share of the audience that may be interested in your product or service and the discussion should relate to how you could get access to this audience in a manner which works for both parties. One of their main concerns will be the risk of cannibalising their existing product set so you’ll need to be clear on your arguments regarding why strategically the benefits outweigh any short term risks.

A clear revenue share/licensing deal may be your best option, as otherwise the circular arguments I mentioned above will result in no one capturing value from your innovative proposition. However, it is also worth exploring whether a trade sale would be more appropriate. While not privy to the details, I suspect the above scenarios were at the heart of Mint’s decision to sell to Intuit in 2009 [2].

In summary, no matter how innovative your application, or no matter how backward the incumbent in your industry may be, the only thing that really matters is running a profitable business. If the cost and pace of customer acquisition is not at anything like the level it needs to be to deliver profitability, it is time to look for some smart money or to make that call to your main competitor.

Wednesday 20th October 2010, 8:32 am

By Alan Gleeson

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