November 8, 2005

Extreme Funnel Economics- Aiming Toward the Economic Singularity

Posted in Economic Model, management, marketing, Product Development, Sales at 7:12 pm by scottmaxwell

As I have been working on trying to frame out some of the strategies related to Funnel Economics over the last few years, my favorite is the strategy of companies putting much more energy into building better, simpler products (from the user perspective), charging less for them, and using very efficient sales and marketing approaches (rather than building an acceptable product and trying to have as high a price as possible through a value-based sale and aggressive sales and marketing efforts).

The Strategy Has Help Shape Many Success Stories…

Some notable example companies deploying the strategy are Microsoft and Intuit, which have been successful for a long time, and Google, Skype, Salesforce.com (and many others) more recently (the internet has been an important recent enabler).

How it Relates to the Funnel

Funnel Economics is essentially the (inflowing) cash flow generated by “sales and marketing” activity divided by the “sales and marketing” expenses. If you shrink the denominator faster than the numerator, the limit is a singularity (the singularity is actually zero in the denominator, but try dividing a really small number by a really really small number on your calculator and you will see that you get a large number). From a business standpoint, if you aim for this economic singularity in a very large market, it could be a formula for a very successful company and huge wealth creation (i.e., take the previous number on your calculator and multiply it by a very large number and you get an even larger very large number).

The strategy has some really basic, but powerful elements

  1. Make something useful and make it really, really, really easy to install, configure, use, and update. This approach increases the value to the user base, increases use, and reduces product abandonment. (The idea works with all technology products including, but not limited to, appliances, server applications and both browser applications and rich client applications so long as they follow the “really easy” principle)
  2. Constantly make the product better with rapid development cycles. Economically, this continues to increase the value to the user base (by better meeting their needs), gives the users something to “sing” about, and reduces the cost of customer service (the customers don’t need service, as the product works and is easy to figure out!).
  3. Design into the package one or more “features” that will compel users to tell people about it and influential people to write and talk about it. The most prevalent approaches either build in the network effect or have unbelievable usability or other characteristics that make people want to talk about them (see Jeremy Levine’s posting for a pretty amusing extreme example of this). If you can’t come up with any ideas here for your product, focus on points 1 and 2 (above) even harder. Economically, this leads to very low sales and marketing expenses, as others are doing the selling for you!
  4. Give it away free for beta and trial purposes, and price it competitively once the free period ends. No one wants to be oversold these days. Give it to the users and let them see if it is worth using, and make sure that they feel they are getting a great deal when you actually charge them for it (note that looking at advertising counts as payment here)! This approach increases conversion rates of prospects to customers (assuming the product works!).
  5. Make the “purchase” transaction as simple and easy as possible. For consumers, the extreme version of this seems to be the “micropayment” vehicle called “advertising” (at this point in time), although SkypeOut allows you to make a single credit card purchase that will last for a very long time and Amazon.com has one-click purchases, both of which are very simple and easy. For business customers, the credit card model or simple contract/billing model seems to be acceptable, although it would be great if something better came along. (Perhaps my friends at IPCommerce will create something to address this issue better for both consumers and businesses!). Economically, this approach increases value to the user and conversion rates of prospects to customers.
  6. Keep the sales and marketing expenses (the denominator) as low as possible, and put your resources toward the first five elements of the strategy, which should drive customer adoption. Economically, bringing this cost to zero creates the singularity! (Note: I expect that most B2B and many B2C companies will still need sales and marketing, at least in the current environment. The key is to keep pushing for the efficiency and to keep this cost as low as possible relative to the gross profit generated by the activity).

Don’t confuse this approach with just eliminating sales and marketing and calling it a day. If a company sets the right operating point in the right market situation, the company should still be growing, possibly explosively, just growing for reasons other than a purely aggressive sales and marketing effort.

To perfect the execution, you need to determine the optimal operating point…

I am a strong believer in the six themes outlined above, but there are four major issues that every company needs to address:

  1. The larger the market, the better the strategy works. Companies that sell to consumers and the universe of small/midsized businesses will have a better outcome than companies that only have a few hundred (or fewer) possible customers.
  2. Each company needs to find its optimal “operating point.” The best way to think about this is that each of the six elements above have knobs controlling them that company management can rotate to set the “level” for each element. The optimal set point for each element has to do with how sensitive user response is to that element (this gets more complex when you build in the issue of path dependent outcomes, which I won’t cover here). The ultimate goal is to have the right set points for each of the knobs. The core assumption that needs to be tested is that you can improve your results by decrease sales and marketing resources, increase resources spent on the product, and reducing the price (or eliminating it for a period of time).
  3. Once you set your initial operating point, it is easier to move away from the singularity than toward it. That is, it is easier to move from a simple product to a complex product than a complex product to a simple product and it is easier to add sales and marketing activities and expenses than it is to subtract them! As an example of an extreme starting point, the concepts around Web 2.0 are essentially the extreme version of the strategy aimed at consumers. (I particularly liked Charles O’Donnell’s posting “10 Steps to a Hugely Successful Web 2.0 Company” as an example of the web 2.0 themes). In my view this is a great starting point for these types of companies, as it is the extreme from which to start turning the dials to tune in the optimal operating point.
  4. You can use this strategy against your competitors (and they can use it against you). Some people say that Google is out-Microsofting Microsoft. Essentially, the point is that Google has set its operating point closer to the singularity and it will be difficult for Microsoft to respond (harder to move toward the singularity!)…It will be interesting to see what happens. It will also be interesting to see if someone eventually out-Googles Google (perhaps Microsoft?)!

    I have seen these themes in place in companies selling to consumers, small businesses, and large enterprises in all areas of information technology (infrastructure, applications, software as a service, etc.) and entertainment (particularly gaming). The strategy can be deployed in different forms at different operating points by every company selling to any customer segment (so long as it is a large enough segment!)…All you need to do is focus on aiming toward the economic singularity (also, make sure that you start closer to it than your competitors do)!

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8 Comments »

  1. Chris Patton said,

    Scott – great thoughts and blog. Keep it up – you’re definitely adding value here. I’m in the category you described in your first post – ‘have a product, have some customers, now it’s time to grow.’ Posts like this are a big help – especially when I try to not so eloquently explain to others what the strategy is!

  2. Dan Cornish said,

    Scott, You hit the nail right on the head. How is this for some crazy idea. To compete with Microsoft, enterprise software will need to become free. I can see Microsoft creating a Salesforce.com clone and giving it all away to support their operating system, of course it would only work with VISTA. Enterprise email, web hosting will become like hotmail. Accounting apps, CRM, all of it ERP will ultimately become free. This seems to be the inflection point. Crazy???

    I have been getting myself ready for this moment for years. How to survive when what I make becomes free. We have a good core group of customers, but to continue to grow they need more for less. Can advertising support enterprise software? Can consulting? Is the open source model the right way. How about a mixed blend of free, and paid software?

    A giant has awoken(Microsoft), It seems to me that they will build very rich web apps, which only work on VISTA and then give them away. They can then drive new revenue as people will HAVE to upgrade. The quote by Gates “Services designed to scale to tens or hundreds of millions will dramatically change the nature and cost of solutions deliverable to enterprises or small businesses.” clearly states their intentions.

    In my humble opinion, they are going to take your advise, charge nothing for them and then use their monopoly to market them. The reason why I am so long winded here is your point about ” focus on aiming toward the economic singularity” probably is the most insightful comment I have read in a very long time. This is clearly the new roadmap to compete in this new world. Thank you for holding the torch to light the way.

  3. […] I have been trying to decide if this strategy is an independent strategy or if it is just an accumulation of prior strategies. I have not completely made up my mind, but I think the approach has strategic importance, at least for certain product markets, so I am including it in the list. I have already written a lengthy (wordy?) post on the topic titled “Extreme Funnel Economics- Aiming Toward the Economic Singularity,” so I will not recreate it here. […]

  4. […] From day one, set your pricing and business model at a point of efficiency that will be difficult for the large company to meet. This will reduce the large company’s interest in the market and set you up in a very economically defensible position if the large company does enter your market (see “Aiming Toward the Economic Singularity” for some ideas on this). […]

  5. […] Make the customer economics appear very lean or opaque, at least at first. If you aim for the economic singularity, you will have a much larger install base before your draw goliath’s attention. In terms of making the economics look opaque, the advertising driven economic model is an example of business economics that are very opaque to outsiders (whereas, a product with a set customer price is easier to understand). […]

  6. […] The idea is that once the company has a solid set of users, it can either introduce paid features over time that allow the business to grow existing monthly recurring revenue (MRR), or it can start developing approaches that target larger prospects. […]

  7. […] The idea is that once the company has a solid set of users, it can either introduce paid features over time that allow the business to grow existing monthly recurring revenue (MRR), or it can start developing approaches that target larger prospects. […]

  8. Danke fuer die schoene Zeit hier. Macht weiter so. Da kommt
    man gerne wieder vorbei. http://www.sellweddingdress.net/author/vernellfgk/


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