“How will they make money?” is the wrong question
Seems like every year we hear about a few new consumer networks raising large amounts of money at high valuations. And right on cue, we hear cynics asking, “But how will they ever make money?” let alone “enough money to justify the valuation.” Just this weekend, the rumors (and doubts — for example, read the comments) were all about Snapchat.
This is not a new phenomenon. Back in 2004, I had left business school to join LinkedIn, and a group of my friends came to do a project on LinkedIn and its future. They got a C+ on the report, and the professor said he thought social networking would never make any money. Oops. When I joined Twitter in 2009, many of my friends were equally shocked. The company had just been valued at $1 billion and had zero revenue; most of my friends didn’t use it and couldn’t figure who cared about what other people were having for breakfast.
In all of these cases, the primary challenge with building a large consumer company is not “how will you make money,” but “how do you get to be a long-standing durable network and define a new set of behaviors or verbs?” Once you can do that, it’s very likely you will be able to monetize at significant scale. (Side note: Not all businesses need to look like these large platforms and networks. There are plenty of other ways to build a successful and profitable company. I’m specifically focusing on that kind of large social network here.)
The key question I ask when I see interesting new consumer networks is whether they are durable, or just fads or flash-in-the-pans. From a user behavior perspective, I like to ask four things:
1. Is there a new behavior here that you can see 100M+ people doing?
No metrics can tell you this. You have to believe whether or not the product addresses a core need people have or don’t know they have yet. It helps to have the entrepreneur paint a vision for this new world and define the path for how adoption will grow. When I joined Twitter, the founders described a new world where information flowed faster, more accurately, and more openly. They convinced me that Twitter could become that primary way for people to access what they were interested in and what was happening in real time.
One way I like to think about this is whether there is a default “verb” that is changing the way people think about the world. Five years ago, we were not a world of sharers, but Facebook changed that. Now, when we see an interesting link or picture, for many people, the first instinct is to “share” it with friends. Tweet, Snap, Connect, Friend, Pin, Check-in — all are on that path of changing behavior.
2. Is the product evolving in a way where people are getting more and more engaged and committed over time?
Often, you can see this from data — both qualitative and quantitative. Good cohort charts can show how early users are contributing more and more to the system each month they use it, and can also show ongoing engagement. Evernote is a great example: As you add more and more notes over time, they see further and further into your commitment to the product. With Facebook in the early days, once the product was active on a university campus, people used it more and more every day and filled in more and more information such as their classes, activities, and friend lists.
3. Will the growth be sustainable?
The best growth of a product happens when someone is using a product so actively, they tell all their friends about it and try to drag them into the product. This can happen via viral channels like invitations or general word of mouth. But more than just rate of growth, it’s important to see that new users are becoming locked in similarly to early users. Later users are less likely to work as hard to join and learn a new product, so it’s crucial that over time, the product and network draw them in more directly, and the product improves to help them.
Some data on activation rates of new users, sources of new users, viral strength, and engagement and conversion over time can really help you determine this. It’s also important to understand qualitatively why people are signing up and whether the product is addressing what they were looking for in the first few sessions.
4. If the product succeeds at scale, can you monetize the key behaviors?
Lastly, monetization does matter. If you believe that the behavior can be big, and can grow big, then you’ve answered the biggest questions. But once you have that, it is a good idea to gut check whether at scale there will be enough of the primary use case and behavior that can be monetized in a meaningful way. Monetization is generally either direct spend by consumers or advertising to get your users to spend $$ somewhere else. With Twitter, people go to the product many times a day to see what’s happening in the world, so introducing advertising to help people see other interesting things happening seemed like a reasonable idea. With Pinterest, people go to the product to discover new interesting products and images, so it seems likely you can monetize this with either advertising or directly from purchases.
Having a large number of users and the inability to monetize them is a non-existent problem. People talk about it all the time, but it doesn’t really happen—at least it doesn’t happen in today’s world. I’m not even sure it ever did.
While valuations may seem high when they happen, in the case of a network like Facebook, LinkedIn, or Twitter, where the behaviors stick at scale, they end up looking like bargains. And in the cases of networks that don’t end up scaling and remaining durable, those crazy valuations look like a big mistake. So back to Snapchat — the big question here is whether it will stick, and not how it will make money.