Chaotic Flow

Streamlined angles on turbulent technologies

The Internet sector is rife with companies that seem to have great product ideas, but can’t seem to monetize their offering. Strategically, this is almost embarrassing. I honestly can’t think of another industry that has this issue (feel free to clue me in if you know of one). While most small businesses and startups fail to ultimately turn a profit, Internet startups seem to stand alone in not having a clue as to what they intend to sell in the first place. It seems the only exit strategy for these startups is to be bought by a larger, cash rich company that offers something others are actually willing to pay for, like Microsoft, Google or Amazon, where they become a permanently free service or are absorbed into some larger tech stack as simply another feature. At any rate, because this blog is about strategy, many of the posts can be very critical. So, in the interest of balancing things out with a little optimism, I’ve decided to start a series called “Joel’s Picks” The companies I plan to highlight in this series are those that IMHO have real substance (read not hype) to their business model and exemplify sound business strategy and execution (and only time will tell if my judgment is sound).

LinkedIn recently announced it’s first baby step into the open social network platform game, and received no end of criticismin and around the social network futurist blogosphere. So, I’d like to go on the record as saying that while this criticism may be accurate from a technology evolution viewpoint, it is absolutely wrong from a business strategy point of view. LinkedIn is right to move slowly, because, a) their target audience is not using it for entertainment and doesn’t need all the newest gadgets now, b) isn’t on the bleeding edge of Web tech sophistication, and c) will not be as forgiving as Facebook’s if they screw up (and they could still screw up…social networking trust and privacy are risky business.)

So, why LinkedIn? Find me another social network that has a real chance right now of becoming huge based on subscription revenue alone. When I think of the recent trials and tribulations of Facebook, my first reaction is that “you get what you pay for.” While I know that most users do not pay the subscription fee on LinkedIn, this does not damper my optimism. The fact that some do exemplifies the value of the service. I can remember when Salesforce.com was free for licenses of 5 users or less; it isn’t anymore, in fact the license price is higher across the board. Too many social networks are going after target markets that simply don’t pay. Or at least they think they won’t. Haven’t these guys ever heard of market segmentation??!! I am talking to you Facebook.. My main point here is that it is strategically important to put a pricing structure in place that maintains a very low barrier to adoption, but does not preclude future revenue, i.e., users expect that once Facebook is free, it should always be free.

Rather than go on and on…here is a list of some of the things I really like about LinkedIn.

• A HUGE target market that truly leverages the inherent global reach of SaaS.
• A segmented, balanced revenue portfolio based on recruiter posting, limited advertising, and user subscriptions.
• Solves a problem for users, and it not simply entertainment that is used to capture users to solve the problems of marketers (like me).
• 2 and 3 imply that LinkedIn has all of its stakeholders coming and going and they LIKE it.
• Balanced revenue, plus a professional target audience encourages a proactive approach to privacy and trust, limited risk and liability.
• Social relationships/processes mirror their real-world counterparts, i.e., recruiting, networking, getting and giving advice, etc. These processes are enabled, not distorted by the technology or the business model.
• SIMPLICITY in design ala Google

So, please LinkedIn, don’t prove me wrong.

The software/Web/Internet industry is a tight community and SaaS vendors routinely recruit sales, marketing and engineering executives because they possess unique experience, knowledge and relationships within an industry sector, e.g., ERP, CRM, BI, retail, supply chain, etc. While this may often be a valid decision, every SaaS CEO should be aware of its pitfalls: old enterprise habits die hard. Knowledge and experience with the high volume, low cost approaches required to build a successful SaaS business, e.g., telesales, Web marketing and multi-tenant architecture, often hold greater importance, depending on the skills and experiences of the overall management team.

The wildly successful revenue model of enterprise software was built on solution selling, feature dominance, customization, and proprietary IP—all of which were expensive, because they were expected to delivery competitive advantage to the customer. Whether or not this was always the case may be debatable, but it is clearly not the case in B2B SaaS. The value proposition of SaaS is the exact opposite, which is why it poses a threat to enterprise companies. SaaS delivered under the value proposition of outsourcing non-strategic, commodity capabilities at the lowest possible cost. This is the essential conflict of the innovators dilemma in SaaS, and why you don’t see a lot of enterprise software companies jumping on the SaaS bandwagon.

When breakeven looks like it is years away, it can become incredibly difficult for managers to exercise the required discipline to avoid undermining the company’s long term strategy and inherent cost advantage. In the short run, it can quite sensible to pursue that six figure deal with unique functional requirements (after all the customer only needs this one thing!) , even if the sales cycle will take a little longer and the roadmap needs to be adjusted for this one customer. The enticement of this low hanging fruit can be further complicated by the strategic needs of the company. But, if these activities undermine the company’s attention and effort in building a low cost, high volume customer acquisition and product delivery machine, that million dollars in revenue will soon be overshadowed by multiple millions of dollars squandered in wasted effort.

As the classic R&B song by the Persuaders goes, “It’s a thin line between love and hate.” The Annie Lennox remake of this is one of my favorites from her album Medusa. But, this post is not about my musical tastes. It is about the thin line that major brands are walking as they seek to deepen their interaction with consumers through social computing and other highly interactive Web 2.0 technologies. As anyone familiar with the song can tell you: the thin line is quite simply TRUST. Trust is created through personal investment, interaction and disclosure, the very things that these technologies enable. When trust is violated in a relationship, the deeper the relationship, the deeper the anger. So, the lesson of Facebook’s Beacon stumble is one that every Web 2.0 company should pay close attention to—the trust ante has been raised. Just as Web 1.0 privacy and trust issues sprung from Web 1.0 technologies, such as cookies and tracking a user’s Web surfing behavior, Web 2.0 issues will center on the much more delicate and private matters of personal profile information, social relationships and heretofore private interactions among friends, colleagues, acquaintances, customers and strangers. In Web 1.0, the solution was to never track a specific user’s identity for marketing purposes and to implement permission based marketing schemes. Mark Zuckerburg’s recent apology for making Beacon opt out by default, highlights the fact that in the frenzy of Web 2.0 even the basic Web 1.0 lessons have been forgotten. When in reality, we need stronger rules of the game to safeguard identity at the network and associated behavioral level.

Most of the excitement around Web 2.0 and social networking to date has centered on the unbelievable advertising opportunities it will create by directly leveraging word-of-mouth and micro-targeting. In recent posts, I’ve argued that this is fundamentally bartering a consumer’s privacy (because the service itself is free). I’d like to propose here that there is a better way. The safest and most effective way for a company to leverage Web 2.0 and social computing is by applying their inherent strengths of interactivity and personalization to establish trusted relationships with new customers and strengthen relationships with current ones—not manipulate them and weaken trust in their brands. For example, real-world word of mouth is driven by referrals. Online social networks can easily facilitate this process without disclosing identity or altering it in a fashion that is unnatural to consumers. Let’s take a look at Facebook’s Beacon in this regard. Below is the text from the Facebook site describing the benefits and details of Beacon for businesses using Facebook (clearly the pre-apology policy…but it is still up in this form as of today…need to get those departments in sync Facebook!):

“Simply determine which user actions you would like publish to Facebook and add a few lines of code to your web page. Facebook Beacon actions include purchasing a product, signing up for a service, adding an item to a wish list, and more. When a user performs the action, they will be alerted that your website is sending a story to their profile and have a chance to opt out. No additional user action is needed for the story to be published on Facebook, and users remain in control of their information.”

While Facebook has fixed the “opt out” problem (what were they thinking??!!), my personal feeling is that the service is still not a natural process for consumers in that you usually decide to recommend a service or product after you have tried it, not when you buy it. A much more natural process, would be to ask the user if he or she minds if the business checks in with them in a few days to see what they think. Maybe let them rate the product, and if the rating is good, ask them if they would like to recommend it to their friends. For another angle, compare Facebook Beacon to Amazon’s reviews. Amazon has it right, because it is helping consumers and publishers in their common interests, not one at the expense of the other.

In my last post, I argued that while Web 2.0 technologies offer great promise for more interactive and personalized marketing, they also entail commensurate ability to offend the consumer with SPAM, and therefore require greater vigilance to protect the trusted relationship between a brand and its customers , i.e., the more personal and interactive the communication, the greater the offense when trust is violated. But, I believe this is only half of the Web 2.0 privacy and trust dilemma.

At some point, we must stop and ask ourselves why so many of these great companies, that offer so much value by making the Web more personal, social and interactive are pursuing advertising-based business models where real revenue can only be achieved by asking consumers to barter their privacy in exchange for services. While it may not be much, most of us pay for mobile voice, text and wireless services, cable TV, books on Amazon, movie and game rentals, toys for the kids, and believe it or not, a premium profile on LinkedIn. The best advertising-based businesses, such as cable TV, Google or the Wall Street Journal are completely non-intrusive and often offer enough value to supplement this revenue with direct subscriptions. Are we really supposed to believe that a company like Facebook, with a multi-billion dollar valuation can’t charge for its services?
User adoption often becomes such a religion for Internet startups that it isn’t always obvious when, who or how to start charging for services. In this regard, I think that B2C companies can learn something quite valuable from the experiences in B2B software and SaaS: the cost of time and effort it takes to adopt a new application usually outweighs the price you ultimately would pay for it by at least a factor of 10X. The result is that you just can’t even give away bad software. If you are building a company that is purportedly delivering a service of such great value, but can’t conceive of a business model where some segment of business customers or consumers at some level of adoption will pay for it without bartering consumer privacy, you really should question the inherent value of your offering. Otherwise, you will most certainly end up on the same garbage heap of all the Web 1.0 companies that chose to venture down this same treacherous path.

I find it truly frustrating to watch Web companies continue to make the same mistakes regarding consumer privacy and trust, such as the recent Facebook fiasco. Are all these new wunderkind CEO’s who supposedly grew up on the Internet and therefore really “get it” just too young to remember the privacy and trust related stumbles of the Web 1.0 boom? Or, is this industry just so dynamic and chaotic that it erodes long term memory for those of us who did live through it? (I may have this problem myself, but I don’t believe it is Web-related) If there is one long standing marketing maxim that should be ingrained upon the memory of every Internet executive it is this: NEVER VIOLATE THE TRUST A CONSUMER HAS IN YOUR BRAND. For all the dinosaur bashing that offline marketing has had to suffer over the last 10 years, I will say this much in its defense: a consumer always has the option to turn off the TV, change the radio station or throw away a piece of junk mail with minimal effort or affront. One of the inherent advantages of passive, mass media is that you can always opt-out by tuning out at the very last minute without it becoming all that intrusive. This is not the case with interactive, personalized media (think telephones and telemarketers), because the offensiveness of SPAM grows in proportion to the level of engagement. Despite all the hoopla about micro-targeting that social media and other Web 2.0 technologies will ultimately enable, they will never provide the same level of protection to privacy and trust as the good old fashioned act of consistently asking for permission and enabling the consumer to control the experience.

Most software executives are familiar with the concepts of using the “bowling alley” strategy to usher a new product through early adoption to market acceptance as presented by Geoffrey Moore in his book “Crossing the Chasm.“ However, they may not be aware that this strategy has unique pitfalls when it comes to launching an on demand Web application. When you introduce a new product, the initial design often needs minor (or major) adjustments to gain general market acceptance. In addition, target customers may have requirements that are unique to their segment or that conflict between segments. In order to resolve these issues, a vendor will enter a number of iterative cycles of trial, feedback and revision of the offering with representative customers. Moreover, in order to “cross the chasm” it becomes critical to capture reference customers to begin the process of dominating each “bowling pin” segment.

In these early stages, the company must engage in strategies and behaviors that are the exact opposite of the ideals required to achieve the highly efficient, low cost, high volume, commodity-oriented execution required to deliver a successful on demand application. Salespeople may have to invest large amounts of time and effort in securing initial strategic reference accounts. Engineering may have to modify the product to satisfy the requirements of early adopters. And, the company runs the risk of being derailed by enticing short term revenue opportunities from customization and consulting services that are ultimately low margin and non-strategic.

In these early stages, it is critical to continually reinforce the longer term strategy and vision in order to highlight the fact that these actions are merely a means to an end, and not the end in itself. New feature requirements should be carefully weighed against overall market needs and only those that will prove useful to large groups of customers should be accepted in order to maintain a standardized product offering. Sales and marketing should carefully monitor the penetration of each target market segment, so that a conscious, smooth transition can be made from high touch, strategic account selling to high volume, transactional selling as soon as the initial critical mass of reference accounts and demand generation is achieved to knock down the “bowling pin.” And, managers must realize that achieving this smooth transition requires more than simply establishing a plan. It can become very difficult to walk away from a deal, a customer or a product idea once it has lost its strategic value, because people have established behaviors and made personal investments of time and energy.

Recently, Fred Chong proposed a 4th force to driving Long Tail markets (in addition to the three Chris Anderson identifies in his book), which I attempted to clarify in my last post as corresponding to the Price component of marketing’s 4Ps. One of the unique aspects of this particular “P” is that it is the final piece that must fall into place to close a sale. In some ways, it is the dividing line between products that are sold to a market and products that are sold by a salesperson in that if a list price is not set, then a direct negotiation must take place between buyer and seller.

If we take Fred’s proposal seriously (I asked Chris Anderson to check it out and here is his response: “I agree that there is a fourth force, involving dynamic/flexible pricing. I hinted at that in the book, both with the “Rule 2: Cut the price in half. Now lower it.” theme from the original article and the “economic of abundance” chapter and its embrace of free. And, in a sense, my next book, FREE is all about this grand experiment in making money by giving things away. ), then a natural conclusion is that SaaS/Web applications that provide the ability to automate the negotiation process between individual buyers and sellers and set deal-specific pricing in real-time have the ability to drive the Long Tail to it’s natural limit, a market of one. In other words, Web 1.0 made content/information free, enabling companies to profitably service the long tail, but Web 2.0 is making interaction/communication free, enabling them to push out on the Long Tail from mass market to niche market to individual buyer/seller transactions. While it isn’t necessary to use a Web 2.0 approach to achieve this (e.g., eBay arguably was the first hughly successful offering of this nature), it will be interesting to see how much farther out on the Long Tail we can go by leveraging applications that directly connect individuals, such as social networks, chat, VOIP, etc. and offer very flexible and granular pricing capabilities, such as microfinancing and ad serving.

I can’t take credit for any creative thinking here, but I had such an epiphany reading Fred Chong’s most recent post on the Long Tail that I had to write about it. In his post, Fred proposes a 4th force to be added to the three identified by Chris Anderson in The Long Tail:

• democratize production
• democratize distribution
• connect buyers/sellers

To which Fred proposes to add “democratize capitalism.” My first impulse was confusion,
having had a fair amount of economic theory drilled into me at the University of Chicago,
and knowing that “capitalism” is clearly too broad as it encompases virtually all capitalistic economic theory.

But, then I realized what Fred was really talking about was pricing, or monetization in
Web lingo. And it hit me! If you add pricing, the long tail forces correspond
EXACTLY to democratizing the 4ps of marketing, i.e., the go to market “forces” that every MBA student learns in marketing 101 and have solid microeconomic underpinnings (just the sort of perfectly structured idea that appeals to an ex scientist geek like me).

More plainly

product = democratize production
place = democratize distribution
promotion = connect buyers/sellers (or how about democratize promotion!)
price = democratize pricing

The microecconomic equivalents being commodity, transaction costs, information, and price
for the other econ geeks in the audience.

The relevance to SaaS and Web Applications being (as Fred discusses in his post) that
often pricing must be adjusted at the customer/transaction/user level in real time to bring SaaS and Web applications, e.g., Search advertising. But, the examples are not limited to SaaS products. Consider eBay and Priceline, both strong Long Tail examples that rely heavily on democratizing pricing, i.e., allowing a Long Tail seller negotiate or set a price directly for an individual buyer.

Notwithstanding my earlier post on the Long Tail, this (arguably more complete) model of the forces that enable the long tail provide the roadmap to mass customization for SaaS and Web applications.