Breaking down a crowdsourcing business model

I have been in looking into crowdsourcing business models for the last couple of months. Personal and professional interest. As often the case, when a subject is on your mind, you stumble upon it. So, when ads like this one started popping up on my Facebook page I clicked through.

The ads send you to Logo tournament (LT), a crowdsourcing play on logo design services. It’s quite straightforward. Company needs a new logo, it submits a “contest” to LT and sets a price. Designers send in one or more designs. The best design wins and the designer gets paid.

I tried to figure out how a business model like LT’s would look like.

Revenue

LT charges designers a 15% transaction fee. Companies set the price they are willing to pay in advance, with a minimum allowed of $250. Paypal transaction fees are passed on to customers.

Note that LT will take the money from companies in “escrow” and select and pay a winner at the end of the contest even if a company does not select a winning design. That means that if a contest is listed, the money will be paid and the commission earned.

LT lists all open and closed contests at any given time. I counted about ~165 open concurrent contests with an average age of 5.1 days and ~1,800 closed contests. I sampled 100 contests at random and calculated an average prize amount of ~$315. Assuming a steady flow of contests, that means about ~1000 contests a month (i.e. 30/5.1*165=971).

With commissions at 15%, that adds up to a monthly revenue of close to $50,000. The estimate is obviously highly sensitive to the monthly contest count estimate. Here’s a back of the envelope revenue estimate (with lower and higher estimates to test for sensitivity).

Operating Expenses

To estimate how much LT is spending to run its crowdsourcing marketplace, let’s look at staffing, infrastructure, customer acquisition marketing and payment processing. For the sake of this exercise, I’ll bundle the rest (e.g. legal, accounting, office rent, insurance, travel, etc.) as a miscellaneous overhead charge. WARNING: broad, sweeping assumptions :)

Staffing

I do not personally know the LT team, but I’d suspect it to be pretty lean. Let’s assume a team of 3 full-time employees (marketing/support person, developer, designer). The company being Canada-based, depending on seniority and benefits, average cash-out monthly cost per head would be in the, say, $5,000 to $7,000 (US$) range. Let’s assume also temporary and specialized staffing needs to be met with contractors or offshore resources adding anything between 10 to 20% to the cost of payroll.

Marketing

Let’s assume that LT is primarily investing its marketing budget on CPC campaigns on Facebook and similar CPC networks. Assuming an average CPC of $1 and a conversion rate from landing page to paying contest customer of 3% (Averaging out typical eCommerce conversion rates), LT must invest $33 to acquire one customer.

Not all customers are acquired this way, though. To account for repeat business (i.e. customers running more than one contest) and the fact that some will become customers through word-of-mouth and other “pull” channels, let’s assume a word-of-mouth/viral/returning-customer factor of 1 to 1, i.e. one “free” customer every 1 customer acquired though direct-response campaigns. That reduces the effective unit acquisition cost to $17. To get to the total monthly acquisition cost, one can multiply the unit cost times the estimated number of contests per month.

Finally, let’s assume that other marketing programs and channels (e.g. social media, events, schwag…) account for an incremental 15 to 25% in marketing spend. This is a measure of the activity that is necessary to generate some pull demand for the service and promote it to the design community. With marketing programs overhead at 20%, LT should invest in marketing ~$19,400 per month.

It is easy to see how rapidly customer acquisition costs can get out of control if LT does a poor job of (a) converting customers after they click on an ad, (b) getting repeat business and © attracting customers through word-of-mouth.

Infrastructure

Let’s assume an average storage capacity requirement of 2MB per design submission (Submission file + JPG previews and thumbnails). Of a random sample of 100 completed contests, each contest averaged 275 submissions. Let’s assume LT archives past contest graphics for an unlimited amount of time, in which case its storage capacity needs grow over time. Assuming that LT list of ~2000 contests includes all contests ever run, its cumulative required storage capacity today would be about ~1.1TB. At an average estimated cost of $0.150/GB (Amazon AWS pricing) the total monthly storage running cost estimate is ~$165.

To estimate monthly data transfer costs, let’s look at the site traffic. Data from Compete.com estimates about 16,000 monthly uniques. Assuming 10 page views per unique and average page load of ~0.4MB, the total monthly data served adds up to ~64GB. Assuming a price of $0.17 per GB transferred per month (Amazon AWS pricing), the monthly data transfer costs are a whopping ~$11.

Even after adding another estimated $2,000 a month in hosting, database and other infrastructure costs, it seems infrastructure expenses account for a small share of overall operating costs.

Payment processing

LT passes Paypal charges on payments received to the company that submits a contest. It however pays Paypal fees on its payments to the winning designer. Let’s take the basic Paypal fee of 2.9% + $0.30 as a base. The processing fees add up to a hefty ~$7,800 per month.

Other Operating costs

To estimate additional operating costs, including rent, insurance, travel, IT, etc.), let’s assume a percent overhead related to the size of the team, ranging from 10% to 20% of payroll costs.

Bottomline

Internet businesses are hard to make work and a crowdsourcing marketplace is no exception. Below an estimated operating earnings summary.

Some considerations:

• Marketplace size is key. All things equal, if LT were able to grow its contest intake by a factor of 10, it would turn a 15% loss into a 35% profit. The trick is to be able to scale the marketplace size while at the same time keeping customer acquisition and marketing costs down.
• Marketing is key. Poor customer acquisition performance can kill a business like LT’s. Specifically, it is essential to keep conversion rates high through well targeted ads and flawless user experience when a prospect enters the conversion path. “Free” marketing is also critical. LT must be able to leverage WOM from existing customers and repeat business to keep effective customer acquisition costs in check.
• Cash from Customers. Where does LT gets its working capital from? Well, since a costumer pays into LT’s Paypal account when their contest starts, but the prize money is only paid to the winning designer after the contest is closed, one to three weeks later, customers are effectively financing LT’s business. In fact, the faster customer acquisition grows, the more cash can LT float to finance growth. Brilliant!
• Transaction costs are not trivial. Paypal fees of almost 3% on a 15% brokering commission amounts to 20% of net revenue after the designer is paid!

You can find the calculation sheet here.