Companies that make more profit as customers use them less
Most companies make more profit as their users or customers use the company’s product more frequently.
However, some companies make more profit as their users or customers use their product less. Companies with negative gross margins are the first example of this, but they’re not the topic of this post.
The other classic example is a subscription business that takes revenue up-front and then incurs the cost of providing the service in the future. The less the customer uses the service in the future, the more profit the company makes.
The problem with this is that the less the customer uses the service, the less likely they are to be a repeat customer. This also makes them less likely to recommend the company to others. So while the company experiences a boost in short-term gross margins, this comes at the expense of long-term retention, referrals, and new customer acquisition.
One way to address this problem is to avoid companies that make more profit as users or customers use their product less. I can’t think of any very successful companies that have this characteristic. So avoiding companies with this characteristic doesn’t result in missing out on much.
The other is to invest in companies which make more profit as users or customers use their product less only after carefully reviewing the company’s retention, referral, and new customer acquisition metrics.
Originally published at Thoughts of a VC.