A better way to fight Facebook & Google

Facebook & Google are in hot water. And for good reason. However, when I ask people why they’re upset I find that two different & distinct reasons are given.

One one hand are people who are upset for political reasons. These companies have adopted various censorship tactics, and in doing so, the underlying political agenda of their employees have shown through. (And diversity of political opinion within Silicon Valley is notoriously absent.)

On the other hand are people who are upset for privacy reasons. They’re finally waking up to the realization that massive privacy invasions might not be a good thing. In a breath of fresh air, those who bemoan the loss of privacy come from BOTH sides of the aisle. And in today’s climate, nearly everything is seen from a political lens. And that lens is polarized.

Simply explained, those on the left tend to distrust corporations. Because, let’s face it, corporations tend to be run by those who crave power. And they’re capable of doing some evil stuff. So the left argues that a large government is the only way to fight the problem.

And the right tends to distrust government. Because, let’s face it, government tends to be run by those who crave power. And they’re capable of doing some evil stuff. So the right argues that a small government is the only way to fight the problem.

Thankfully the left and the right can agree on something — when your privacy is invaded constantly, and massive amounts of data are collected about you, that data can be used for objectionable purposes. Both from corporations and government. The only question is — how do we fight it ?

And unfortunately, the answers put forward so far all miss the mark.

It’s all about business models

Facebook & Google have a similar business model — they sell ads. You are not the customer. You are the product. The advertisers are their customers. This should not be news to you.

But the reason they’re so successful is because the software industry doesn’t realize there are alternative business models that can be used to fight them.

To understand the power of business models you need only look at the solar panel industry. A decade ago, everybody wanted solar to succeed, but nobody was buying. The upfront cost of purchasing the solar panel was off-putting to most everybody. But then “zero-money-down” solar was introduced (leased and managed by the solar company). Sales skyrocketed, and the industry saw exponential growth.

In the early days of the software industry there was only a single business model: buy the app. And when version 2 came out: buy the upgrade. A one-time purchase in exchange for unlimited use, but not unlimited upgrades.

Eventually the industry realized that some customers were annoyed by the “not unlimited upgrades” part. And so the business model of subscriptions took off. For a monthly fee, users get unlimited use of the app & unlimited upgrades. This tends to work particularly well for critical business software. And particularly bad for indie apps.

And with only these 2 business models to compete with, it’s easy to see why the advertising model is leading the industry. To see how to fight it, let’s take a trip to an alternate universe:

Collective States Postal Service

The newly formed Collective States of Amerika (spelled with a ‘k’ in this alternative universe) is in need of a postal service. A strapping young entrepreneur steps forward and offers the service for FREE for all US citizens. (No taxes! No stamps!) With one small catch — his company is allowed to open mail at will, and read the contents. Politicians and important people are exempt from this rule. And naturally some US citizens are outraged at the idea. But since it’s the only game in town, it quickly rises to prominence. And eventually people start to rationalize about it: “there’s so much mail going through the system they probably won’t bother reading MY mail”.

Before too long the corporation is huge, and the citizens begin to realize the monster they’ve created. Thanks to unforeseen technological advances, and an army of speed readers, the company is able to sell all kinds of information. For example: Are you looking for newly widowed women who have inherited a farm, but have no way to work the land? No problem — they can get you this information almost as fast as the neighbor gets it. And that’s just the tip of the iceberg.

Of course, the company realizes its walking a fine line. So it’s careful to always downplay its power publicly, and sidestep privacy issues by highlighting the good it does. Behind closed doors however, politicians are being greased, and generous “favors” are being dolled out to important people all over the country.

(By the way, if you think this is far fetched… have you heard of Gmail ?…)

Now in those days it was also common knowledge that it was “impossible” to fight this corporation. Why? Because the one attempt to do so didn’t work very well. Here’s what happened: A competing company was announced, and for a fixed monthly fee, you could send mail with them. And, of course, they wouldn’t open your mail.

But the company didn’t get that many customers, despite the fact that most people wanted the company to succeed. When newspapers polled people for opinions, the same responses kept popping up over and over:

• “I don’t have anything to hide”
• “I don’t send that much mail”

And so the privacy invasion continued unabated for years. Until one day another competitor popped up. This time there was no monthly fee. It was purely a pay-as-you-go system. Want to send something securely ? It’s 10 cents per envelope. At first people and companies only used this system to send sensitive documents. But as more information was publicly leaked, more and more documents were seen as sensitive.

Pay-as-you-go: the business model software forgot

So on one end of the spectrum is a product that’s free, but requires you to sacrifice your privacy. And on the other end of the spectrum is a product that requires a large financial commitment in exchange for unlimited use. What’s in the middle ???

We need to start by realizing that not all users are the same. There are a few users who use a particular app a LOT. But most users will use it sporadically. Which leads to a somewhat predictable user/usage curve:

(This graph plots users on a graph according to their app usage. For example, if Alice uses the app constantly, she would get a large X value. Bob, on the other hand, uses the app maybe once a month, so he gets a small X value. Perform this task for all users, and then count up the number of users at each X value to get the corresponding Y value. In other words, there are a lot more “Bob”s than there are “Alice”s.)

Naturally the software company wants to maximize their profit. But what business model to choose?

The oldest model is a simple one-time purchase for software. It works great for games. But outside the gaming industry, there are certain complications. There’s the large upfront purchase price. And the business requires a steady stream of new customers. Which eventually tapers off, requiring the release of a new version — with enough new features to convince existing customers to purchase the upgrade.

This cycle inevitably leads to bloated software products, and customers annoyed with the upgrade costs.

The monthly subscription model was introduced to solve the pay-once problems. But it has a sweet spot: business software & online services. Outside these industries, it’s a hard sell to convince customers to cough up a fixed price per month.

​The problem is that fixed monthly costs have a cognitive barrier. Potential customers already have many fixed monthly costs. Mortgage, car payment, cell phone, home insurance, car insurance, health insurance, garbage, Netflix, etc. Adding yet another item to that list is not appealing.

This isn’t to say they don’t want to spend money. It’s just that they need to use your app a LOT to justify the fixed cost in their mind.

The promise of the advertising model was that you no longer had to convince users to pay for your app. They could use the product for free, and revenue would come from the advertisers. This has been the most popular model for the past several years, but customers are starting to wake up to the negative consequences of it. If the user isn’t the customer, then they must be the product.

More importantly, there is a financial incentive to compete with other advertising sources. Thus a constant need to improve the efficiency with which advertisers can target very specific audiences. Which translates into an ethical race to the bottom in terms of customer privacy.

The primary reason the advertising model hasn’t been disrupted is because of the large gap between FREE vs a FIXED COST (whether that fixed cost comes in the form of a monthly subscription or an upfront fee). What the industry needs is a model that can bridge that gap.

The beauty of the pay-as-you-go model is that it correlates the user’s product usage with the price they pay. This bridges the gap between the free (advertising) model and the fixed price models. And customers ultimately see it as a fair pricing model.

More importantly, it allows you to maximize your user base and maximize your profit. (And I’ll argue just how that’s done momentarily.)

The naysayers

Of course, any deviation from the norm will have its fair share of naysayers. Let’s hear some of the arguments:

• “It can’t be done.”
• “It’s a bad fit for the single product category in my mind”
• “But what about calculations such as revenue projections or break-even analysis…”

It CAN be done. For starters, just look at the cloud infrastructure giants. Amazon, Microsoft, Google & IBM all manage massive global fleets of server infrastructure. And they all use pay-as-you-go pricing.

It’s important to connect the dots here:

• A software company builds an app atop cloud infrastructure
• The cloud provider bills the software company using a pay-as-you-go system
• The software company turns around and… uses a completely different billing model with their customers ?!?!?

But why? Do we really believe that only businesses are capable of understanding pay-as-you-go? And that consumers are much too stupid for it?

With modern cloud infrastructure, nearly every request that comes into the server can be tied to a particular user. And the actual cost of servicing that request is known. Translation: the true cost of servicing each and every customer can be tracked to a very fine degree of detail.

Now, in terms of product fit, I’ll be the first to admit that the pay-as-you-go model isn’t a universal solution. If you can think of particular apps that work better under a subscription model, then congratulations — so can I. And so can my grandmother. That’s not the argument. The argument is that the pay-as-you-go model should be just another tool in the software business tool-belt. But for some reason, it’s missing. And because it’s missing, well…

If your only tool is a hammer then every problem looks like a nail.

It’s about time we introduced screws, and took those arrogant nails down a peg.

And if you’re wondering about monetization & financial projections — nice work 😎 Lets dive in and explore the tricks of the trade.

Tricks of the Trade #1 — Different pricing tiers

On the low end, you’ll have customers who hardly ever use your app. And on the high end, you’ll have customers who use it constantly. The secret is that you don’t have to bill them using the same rates.

For example, say the pay-as-you-go model for your app is based on the number of messages the user sends. What’s important to understand is that the customer doesn’t ultimately care how much you charge them per message. Their primary focus will be on how much the total monthly bill costs.

In other words, on the low end, the customer won’t care if their total bill is 1 penny or 2 pennies. The difference is negligible to them. But on the high end, the user is primarily concerned with ensuring that their total monthly bill is comparable to the competition.

This allows you to collect customers on the low-end of the product usage curve, which would typically be inaccessible to fixed cost pricing models. Not only that, but from the software business’ perspective, these customers are paying a fairly high markup.

Tricks of the Trade #2 — Top-Up Billing

There are 2 challenges when it comes to billing.

The first challenge is that payment processing companies will eat all of your profits if you attempt to charge customers every month. (For example, Stripe charges 2.9% + 30¢ per credit card charge. Thus if you attempt to charge a customer 50¢, you’ll lose most of your profit.)

The second challenge is that low-usage customers don’t want to be charged every month. There is still a cognitive barrier for adding another recurring charge to their credit card statement every month, even though the price isn’t fixed. Neither is their utility bill, after all. Only high-usage customers can justify a monthly charge.

The solution is to use a top-up billing system. This is similar to how metro cards work. And the benefits are many:

• The customer can make a one-time payment to top-up their account balance at any time.
• Since a one-time payment is not an automatic monthly payment, the cognitive barrier is removed. Instead, low-usage customers see the purchase as a one-time splurge. (As it will last them months or even years.)
• A monthly bill will be generated at the end of every month, and then the amount is simply deducted from the user’s account balance. So, for example, the user will see their balance go from $9.50 to $9.01.
• In order to reduce the fees from payment processing companies, a minimum top-up amount is set. For example, $5 or $10.
• For high-usage customers, a credit card may be stored for automatic top-ups. The system will automatically top-up their account balance whenever it falls below zero.​
• Finally, once this system is in place, you’ve unlocked everything you need for sub-cent billing. Your rates don’t need to be rounded to the nearest penny. Because we’re simply dealing with balances in a computer system, the customer can be billed 42.751¢. And their balance might be $9.54321.

Tricks of the Trade #3 — Flexible Onboarding

There are marketing costs associated with software apps. And when one analyzes the marketing costs (e.g. Google Adwords), they quickly realize there is a certain cost associated with acquiring a new customer. For the pay-once model, these marketing costs are generally huge. The subscription model rightly understands that the marketing cost can be reduced by allowing users to try the app for an extended period of time. This builds confidence in the product/company, and helps form a habit involving the app. Which hopefully leads to customer conversion.

The problem with subscription models & free tiers is that users find ways of staying within the free tier forever. And the cognitive barrier associated with monthly costs also prevents them from becoming customers.

But with pay-as-you-go there’s a better alternative.

​Rather than having a free tier, you simply give the user some free credit for signing up for the app. For example, a new user may receive $5 credit. For low-usage users, that $5 of credit might last them a year or more. That’s plenty long to form a habit around your app. And high-usage users already have a habit surrounding the service your app provides. (Plus, if the user deletes your app after 2 days, you didn’t actually spend $5.)

​The beauty is that when their credit eventually runs out, they’ve become accustomed to using your app. A one-time purchase makes the problem go away, and they can get back to their daily habits.

Tricks of the Trade #4 — Revenue & Profit

Calculating & forecasting your revenue & profit works differently from other models, but is still easy to understand.

The usage graph for your product will look something like the graph shown in all the images. That is, a large number of users who use the app infrequently, with fewer users who make heavy use of the app. (As you get more users, the shape of the graph can be predicted with better accuracy.)

If you’re using different pricing tiers (tricks of the trade #1), then each slice will have a different profit margin. And so you can calculate the area under the curve for each tier. (Calculus is BACK !) The sum of each area will give you your revenue & profit.

There are a couple of neat things to notice here:

• your profit margin for low-usage customers can be significantly higher
• thus having a lot of low-usage customers can be just as profitable as having a few elephants
• you can make money from each group, and you can adapt your pricing as needed (as your curve & costs come into focus)

I thought we were fighting Facebook and Google

Rome wasn’t built in a day. And neither was it destroyed in a day.

If you want to fight Facebook, then show me a Facebook alternative that has 2 things:

1. A similar rewards system for the end user (i.e. dopamine hits related to being social)
2. A business model that makes money and does NOT rely solely on advertising

This entire article has been about how #2 is impossible IF one uses a FIXED pricing model. And the “collective states postal service” section was obviously a metaphor for fighting the privacy nightmare that is Gmail.

But the reality is that the solutions remain impossible until the industry becomes comfortable with pay-as-you-go as a business model. Today there are a plethora of tools to support the other 3 business models. There are all kinds of financial tools to track, project & analyze such businesses. Venture Capital is cool with all of them. And even Apple’s App Store supports all three. But mention pay-as-you-go for a consumer app, and more often than not you’ll be met with blank stares or wide-eyed disbelief. This needs to change, and it probably has to start small.

The cloud infrastructure is already in place. All we need to do now is separate the brilliant engineers from the naysayers.