Business model

Selecting a business model: moving down the pyramid

Robert Ness Statistical machine learning in systems biology

February 21st, 2014

For web app and mobile app based businesses, the default mode of thinking in today's tech startup culture is to build an inexpensive app or similar that could immediately scale to a very broad set of people.  

An example is the freemium model of a web app, or a cheap or free mobile app with a pro-upgrade.  The idea is to get as many users as possible first, then later "move up the pyramid" to customers who will pay or pay more.

I am curious about the community's opinion with the opposite of this approach -- rather than targeting millions who will pay nothing or next-to-nothing, target 100s or 1000s of users who will pay 100s of dollars on a recurring basis.  How do you identify this class of customer, and how do you create enough value to justify the price? -- these questions impose constraints on the design of the business.  After you are earning revenue from these clients, you move "down the pyramid", to target incrementally broader pools of customers with less expensive and likely more scalable products.  

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Michael Barnathan

February 21st, 2014

D'oh, I misread that as "100s of thousands a month". Ok, so you're still consumer-facing. The conventional wisdom is that it's easier to monetize your platform once you have an audience than to do the reverse. I feel like that creed became popular with the rise of social networks, where the value of your network is proportional to the number of friends who are already on it.

While the model you're proposing is theoretically workable, users today are used to "free, fast, and high quality", and rely on word of mouth to discover new services. Requiring payment up front might deter that initial population from growing, unless you proactively go out and source it. I have no a priori advice about finding the segment of customers who will pay (not knowing what you're building), save to get feedback on the ones who do and attempt to identify users with similar characteristics. 

Trevor Collins Crowdfunding Entrepreneur & Co-Founder of 100 Danish

February 23rd, 2014

Hi Robert, I actually think the model you're touching on can be just as or more powerful. 

I went to an MIT event that Paul Graham spoke at the other day and he believes the same. He said it's best to really resonate with a tight niche and provide them with a ton of value. In that mode, go ahead and charge premium pricing if the perceived value is high. Plus you're going to be dealing with customers who are lower maintenance. You can call that depth. 

From that point, he said it is easier then to expand for breadth. Why? Because niches or sub-markets border other niches or sub-markets. The people in the first niche start to bleed over and influence the next.

All that being said, this approach can be more upfront in-person work to reach those first customers. Like when Airbnb went through Y Combinator. They went from property to property, in-person, selling owners on why renting their home was awesome. And they even helped take pictures to set up beautiful profiles. 

Our startup, Cloud Conservatory, is doing a similar approach. We're traveling the country this summer to recruit world-class musicians for a premium-priced service geared toward serious musicians. That target market is somewhere around 400k people in the US. Then, once that ecosystem is established, we're going to produce interactive learning modules geared toward amateur players. That market is 33m+ people in the US who actively play an instrument or sing in a choir. With that comes our scalability.

Hope the examples help illustrate the point!

Michael Barnathan

February 21st, 2014

That's an enterprise-first model. I've seen it work well in the past, but there are risks that aren't there in a consumer-driven model (e.g. if a large client drops out of the business). Salesforce also typically scales much more linearly with revenue than is common in a consumer-facing company.

Shobhit Verma

February 21st, 2014

Freemium is not a pricing strategy. It is a marketing strategy. 

Archer Hobson

February 21st, 2014

I mean theoretically any pricing model is possible, what you are proposing is forming a business around a pricing policy when typically a pricing policy is formed around a business. Its B before A. If you want to focus on high price margins and consumer facing, I suggest looking at what luxury services you could provide through an app interface. Take a business  model that implements at the low end, high user base, and transform it to its luxury reciprocal. As an example, if implements a freemium model think how you could create the luxury alternative, what would that look like, what would a customer who would pay $100s a month/year want from a product like this. I like the direction of this, however vague, but there is value in reverse engineering business ideas based solely on transformative business models. 

Anand Ramachandran Founder & CEO at IdeaGPS

February 22nd, 2014

Hi Robert,

  It would be cool if Ferrari had a 'freemium' model.  I would certainly sign up to drive one around for 6 months, and then decide if I want to pay for it or go to something else.

"But, it's a Ferrari!" you say?

I would sign up for one even if it had a Toyota engine, maxed out at 70mph, but looked like a Ferrari.
So, why hasn't Ferrari done this?  Maybe there aren't enough people like me.  Maybe most people want the engine.

Your question I believe is inherently not about price but about value.  The ultimate question is how to create enough value that people are willing to pay for your product/service.  Try to get customers to pay from the very beginning so you can identify the real sources of value - the specific features for which customers are most willing to pay (engine vs. look and feel).  This would tell you which business model best fits the market segment and value proposition.

My 3 c..


Archer Hobson

February 22nd, 2014

Be careful going down that route though, offering a cheapened version of your product could be confusing. Those brands spent more time aligning customer purchasing preferences with their brand perceived value than anything else. Brand dilution most times is not worth added sales because all of a sudden if I can get a Ferrari for 1/10th the cost from Ferrari then it cannibalizes sales at the top end because those high end purchasers who perceive Ferrari to be a luxury item no longer feel that way because of that brand dilution. Just a thought.

Michael Barnathan

February 22nd, 2014

Physical goods are depreciable, so the real-world analogy of the freemium Ferrari model is leasing. You're in theory paying only for the depreciation of the car resulting from your use.