How to Build a Profitable Startup by Knowing Your Users Better
How to build a $50M online company is a topic that Dan Mitchell at the NYT explored recently, taking his cue from Jeremy Liew of Lightspeed. A few weeks ago Jeremy wrote about the scale a business has to achieve to get to $50M in revenue. I have summarized the scenarios from Jeremy's post in the table below:
RPM = Revenue per thousand impressions (including CPM, CPC, and CPA models)
Scott Karp of Publishing 2.0 had an interesting take on Jeremy's piece, saying that it "exposes a deep flaw in the way online media is currently valued and sold to advertisers". Scott's view is that the real issue is who is viewing your site. Or as Scott put it: "10 million uniques is great, but not so much if you don’t know who these people are". Because of the this, Scott believes that advertisers are getting too good a deal for their advertising dollars.
I think Scott is onto something here. Take Google AdSense, which shows ads on different sites based on keywords. These keywords provide valuable context for targeting ads. But still, without understanding the users the ad-targeting can go completely off. As an example, say we have two users: one interested in football and another in politics. If each is shown a targeted ad based on the keywords "defense strategy", they will be shown similar AdSense ads. Whereas what the users were really interested in is not the same.
Now imagine a system that somehow understands the users a little bit better. In our example, such a system would be able to understand that the user is looking for football strategies in the first case and advice on warfare/geopolitical maneuvering in the second case. This system could then present each of the two users the appropriate ads, thereby dramatically increasing the effectiveness of those ads. Such an ad placement system, given reliable user information, could make a website financially viable with a lot less traffic - thereby empowering alternative voices and making the Internet a richer and more vibrant environment.
Technology landscape
Based on the potential for financial upside, it seems like this area should be rife with innovation. But the problem is not as easy as it sounds... If the system mentioned above were to work, it would need to effectively deal with issues of privacy and user control of their data. To address this problem, one approach that is gaining some currency is the idea of user-controlled Attention data (see R/WW's analysis on this and also my take). The way user-controlled attention data works is that it provides tools to users to collect and manage data about their preferences and browsing behavior etc. Users can then allow businesses they trust to access this data. This preference data will improve the richness and quality of interaction between the user and the business, while addressing all the privacy and user control issues. In the example above related to the "defense strategy" keywords, a user's attention data will help web sites understand a user's interests in politics or football and thereby show the right ads. While this solution sounds pretty good, it hasn't yet gotten enough traction - because it relies on the users being sophisticated enough to create and manage their attention data.
Another approach being explored by some big players is the old idea of Personalization. The way this works is that large businesses collect enough information on users to understand their preferences. These businesses then use this understanding of their users to better target ads. As one would expect, Google is leading the charge here - you can read more about Google's personalization technology from Read/WriteWeb's interview with Matt Cutts of Google. So Google collects information about the users via all their interactions with Google properties - like Gmail, maps, blog, calendar etc. - and uses this information to improve Google search results and ad targeting. To revisit the example of "defense strategy" we talked about above, Google will look at the totality of all user interactions and infer a user's interest in politics or football. With this inferred data, Google will be able to show the right ads to the right person. While this approach is likely to work well for big companies that have tons of user data, what should small businesses do?
Most businesses should really work on modeling their user data for targeting as soon in the product development cycle as they can. They have to realize that understanding the users is really key to competing with the big guys and being viable.
Conclusion
While some of the traffic numbers required for a business to hit $50M in revenue look scary, startups should not lose hope. They should focus on really understanding their users and then utilizing this understanding to improve their RPM rates. This will help businesses get viable with a lot less traffic and ensure that they get proper value for their traffic.
What other technologies do you think can help small business become viable, without achieving massive scale?
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Jitendra,
You raise very important set of issues! Richard and I and John Milan have been chatting about this for a few weeks now. To me, in the chain: Millions of users => A lot of ads => Value to retailers, the last link is the weak one.
And in terms of non-ad monetization, 37signals has got it right - not all software is free ;)
Alex
Nice post Jitendra. :)
Why couldn't a "broad reach" site target their advertising as well as others? On bebo, for example, they collect/have access to data about their users location, age, favorite music, movies, TV, interests, etc. One would think if they can offer advertisers ads targeted base don that info they have access to, it would be just as attractive as specialized niche sites.
Also, do those Microsoft numbers include MSN, hotmail, etc.? In which case, would that not be even more of a "broad reach" set than bebo?
Not questioning the point, just the data Dan Mitchell may have used to arrive there. ;)
Alex: the "freemium" model is one of the best for web apps to use, in my opinion. :)
Cool article. Thanks for bringing it up.
Well the thing is not everyone can have 50 million page views.
It depends on your services. If people are happy with video from YouTube, Photos from Flickr and email from Yahoo.
Why would they use revver, zooomr or gmail?
The keywords here are Value and Innovation.
The only thing that will keep any of these sites going is if they keep their doors open and don't make registration an absolute to upload/share etc... But then there is the spammer problem.
Vicious Cycle huh!
Another thing just occurred to me: I've been reading more and more that page views is becoming a dead metric. As more and more sites start using AJAX and flash, page views are decreasing. I know this is happening at Yahoo. So measurements are being made based on things like "stickiness" (time each user spends on site) and unique visitors. So that might be another reason to question Mr. Mitchell's analysis.
Good Point Josh...
I guess having a certain attributes like location, age, favorite music, movies, TV, interests, etc. is just not the same as having the kind of data Google, Yahoo! or Microsoft has access to on a users...What with all the emails, calendar, mailing lists, blogs, transactions etc.
I don't understand the obsession with $50 million. Facebook did $50 million in revenue last year, and has to qualify as one of the top five biggest online media successes of the past few years. The reason why $50 million looks so tough to get to is that it is exceedingly difficult for all but a handful of extremely successful online media startups to get there; those companies are generally rewarded with high nine or low ten-figure valuations.
Online media entrepreneurs should think twice about taking VC money given the prevailing "all or nothing" attitude amongst VCs, particularly in any deal involving preference multiples. Just because a VC "needs" to do what it takes to get to $50 million in revenue to pay for their other portfolio failures doesn't mean that's the best approach for your own business.
"[...]Bebo had the 10th most Pageviews in the US in the January 1007[...]" Nice :)
Bebo was, of course, the favorite social networking site of Leif Eriksson.
Jitendra:
This is an important post. Your article and the Times article are a valuable wake-up call to ensure that we are not once again heading toward an Internet bubble. This time the bubble is not the stock market, but the people who are working for something that is simply not possible.
For several years, I have been writing that it is increasingly possible for individuals or small groups of individuals to create large businesses without raising cash or hiring lots of employees. The best easy-to-use, low-cost Web services to make this happen are the focus of my blog Ventures Without Capital and the process is described in my book from HarperCollins Go It Alone!. So, the questions for most people should not be can I create a business that is effectively an empire with $50 million, but can I create a business that meets my financial and personal needs?
Your article makes it clear that it's awfully tough to create sites with $50 million in revenue. And, why should that surprise anyone? How many magazines or "similar media" outside the online world, that are ad supported reach this threshold? The answer is very few.
However, the online world does make it uniquely possible for an individual or a small group to create a business that provides a very high income per individual. I am familiar with a large number of people who are understandably quiet about their online incomes, but are earning substantially in excess of $250,000 per year online (and have the freedom to run their own businesses). In recent discussions, I found their reaction to the Times article to be surprisingly similar: "Anyone who needs to read that in the newspaper does not belong in this business. The economics of an undifferentiated audience, or even a large targeted content site are obvious." They are not the route to financial success or personal rewards.
Once again, thanks for highlighting these critical issues.
Bruce Judson
Ventures Without Capital
Great article.
With regards to "personalization", take a look at what MSN/Windows Live has achieved with identity based search. I believe there are something like 30 million Passport/Windows Live ID registered users with public profiles that can be exposed to advertisers.
Of course, this is not Microsoft's first attempt at this type of personalization system. The first one came in the form of "Hailstorm", which was disolved mostly due to privacy concerns(http://query.nytimes.com/gst/fullpage.html?res=9403E4DC1F3DF932A25757C0A9649C8B63&sec=&spon=).
However, that is not the case today as users and advertisers want a platform that saves them time and exposes only the information that they want and when they want it.
Lots of interesting comments...
I agree that businesses should not really obsess about $50M revenue number and by knowing the users better, it should be possible to have online businesses that generate a lot less then that.
My main point in the article was really that small businesses are not applying the Marketing 101 principle of segmentation and further segmentation to a number of online businesses. If they really spend time working the segments out, they can be viable with a whole lot less page views.
Thanks, Jitendra
on #12, you make a very good point "they can be viable with a whole lot less page views". It's not always the quantity of eyeballs that are valuable, but rather the eyeballs that take action which is desired by the site's owners. For example, a car dealer might get 10,000 visitors, but it'll be a waste if he/she does not gain any sales. However, if the site gets 5 visitors, and it leads to 5 sales, then it's incredible.
Thanks for writing this article/post. The points are important to remember.
Sorry, but your entire premise of how google AdSense works is flawed.
Google AdSense does NOT operate strictly on keywords, it takes into account the context of the webpage and website where the ad is displayed. It also takes into account the ads previous users have clicked on and which they haven't.
Over time, it refines it's ads based on the conext of the website, the context of the web page and the history of previous user's interests'.
Sure, it can always improve how well it understands it's users, and it will, but it DOES understand it's users far more than you give credit for.
Jeff,
Not sure I understand...Quoting from your comment below:
"Google AdSense does NOT operate strictly on keywords, it takes into account the context of the webpage and website where the ad is displayed."
I fully agree.
"It also takes into account the ads previous users have clicked on and which they haven't."
I am not sure this is the case...What is the source of this information? I actually looked at the a number of sites that display adsense ads and I don't see Google using any tracking cookies etc.?
In any case, there is a lot of context missing from AdSense as the typical RPMs for adsense publishers are close to $1 compared to $30-40 RPM for Google.
-Jitendra
Hi Jitendra
I've witnessed initial problems with ads not matching context only to see the issue resolve itself in a matter of hours/days. This, combined with the fact that Google is a fairly savvy group of people leads me to believe that they do collect data on which ads get clicked and which do not in effort to help them further understand the context of a page and the interest of the customer. Can I prove it? No. But they don't need cookies to do this.
There are two components overlooked here; The optimization tools Google Adsense & AdWords offers to further refine the context of ads. For example, If I'm paying for ads to get traffic to my football website and I see that customers are coming over from military related websites... well, I'm able to conclude what is going on and have the tools to put an end to that. Conversely, if I'm hosting ads on my football website and I see that military website ads are being displayed... well, that's obviously not going to interest my customers so again, I have the tools to put an end to that.
Not only does Google do a great job in determining ad relevancy, (how many people complain about their AdSense? None), but both the advertiser and ad hosting websites can and do further refinement of which ads get displayed, and it's in both of their interest financially to do so.
So I don't feel there's a case to be made about Google AdWords/AdSense not being efficient or effective enough to really understand it's customers. It's not a merely based on keywords, it's a very sophisticated tool that figures out the context of a page and therefore the interests of the customer. And both the AdSense and AdWords customers have tools to further refine and smooth out any inefficiencies. These tools are continuously being improved. In conclusion, AdSense relevancy is far from being the issue you portrait it to be.
Concerning your overall article. You make the point that in order to maximize RPM, understanding the user is key. Businesses who can best understand their customers and serve up the most appropriate ads for them will earn the most money in ad revenue, so understanding as much detailed information about the customer is imperative.
I disagree.
First, I'm confused who your audience is? Are you talking to the ad intermediary software vendors like Google or startup business owners? You seem to address both groups. On one hand, you are telling the business owners... "hey, don't lose hope, here is how you can improve your RPM...". But then the solutions you offer are catered to the vendors, telling them to make better product with greater granularity in understanding the customer. Business owners can obtain as much information as they want on their customers but it doesn't do them any good if the ad software they are using doesn't make use of it.
Next, I disagree that understanding the customer is the most important thing for improving RPM. It is a factor, but far from the most important. I have websites and pages that range in RPM from zero to $80, I've studied all possible reasons and angles of why this is for a long time and I can confidently say that understanding my customers is not a big issue.
Your solution of gathering greater information on surfers in order to serve them more appropriate ads serves to benefit the advertisers but it would have little positive impact on ad revenue for websites hosting the ads.
As this website knows, placing vertical columns of ads on the right side of the screen versus the left side of the screen will have a far bigger impact on improving your RPM than gathering and mining through a ton of data on your customers in order to discern the differences between wehther they are interested in "the best possible defense strategy" of a football team or "how coaches determine the which defense strategies to use".
How can positioning the ad to the right be more effective? Because your customers are more likely to accidentally click an ad while scrolling or resizing their browser when ads are positioned up there. Split hairs all you want over the nuances of customers interests, piss them off by invading their privacy and it still doesn't compare to understanding mass user behavior or a whole array of other ways to improve one's RPM.
Lastly, you make the case that a lot of context is missing from AdSense because typical RPM's for AdSense is $1
compared to $35 RPM for Google. I don't grasp how you draw this conclusion when you point out that sites with "endemic advertising opportunities" average $20 RPM's... well don't you think Google falls into this category?
Comparing RPM of the average AdSense website versus Google isn't an Apples to Apples comparison. People go to Google to find another website, people who are at a typical AdSense website aren't actively seeking to go somewhere else. People at Google enter plain English into a form field what it is they are seeking, people visiting the average AdSense website usually aren't seeking anything, nor is the website catered to ask them what it is they are seeking.
Jeff, Thanks for your detailed comment...
First up, I believe that AdSense is Stateless so there is no optimization based on user. (I confirmed it with a Google buddy of mine as well).
Overall AdSense revenue for most startups that I have talked to, has been dismal with poor RPM being the main reason. The $20 RPM case is more of the exception for most sites rather then the rule...Typically it is in the lower single digit.
Quoting below
"Next, I disagree that understanding the customer is the most important thing for improving RPM. It is a factor, but far from the most important. I have websites and pages that range in RPM from zero to $80, I've studied all possible reasons and angles of why this is for a long time and I can confidently say that understanding my customers is not a big issue."
Did you consider the user attributes as a potential variable in these analysis? Also did you look at other ad networks besides AdSense (AdSense doesn't allow user based targeting)?
Overall, my article is focussed on site owners. They should focus on collecting user data as more and more big ad networks (not just specialty ones) are going to allow sites to better target their ads based on that data.
I think Jeff must have gotten distracted by the details of google adsense, since one of the fundamental principles of any business (online or otherwise) is to understand the customer - regardless of whether or not you are successful of making revenue from google ads.
Maybe the fact that Jeff doesn't understand his users is why they click on ads to get away from his site as fast as possible. I've actually seen this as a deliberate tactic on making money with adsense.