Economic Model Part 4: Optimize Now or Later?
December 20, 2011
This is the Fourth in a series of posts that I am writing aimed at helping entrepreneurs maximize their economic performance. You can find a summary of the economic model series here. My last post described how you can discover your optimal economic model. This post addresses a current issue, should you discover your economic model now or wait for a future point in time.
Optimizing Now vs. Later: a Key Question!
There is a lot of conversation these days, particularly in the consumer Internet markets, around the benefits of focusing on user growth and engagement and sorting out their economic model at a later point. To put it another way, whether to stop or go. There are some benefits to not creating your economic model now, but there are also some risks.
Why You Should Wait
Not working on your economic model at this point has some merit. For example,
- It allows their teams to focus on providing product features that people want to use and engage with to build user acquisition and engagement. The team doesn’t get distracted with additional work associated with sorting out the economic model and figuring out how to optimize it.
- Adding revenue-creating features too early might slow user growth and engagement, thereby slowing the success of the company overall.
- Your perceived value may be higher to investors and buyers if your economic model is NOT clear. That is, investors may have hopes and dreams for what your economic model could be (and pay you good money to purchase part of your company), but those hopes and dreams may go away once your economic model has been developed and the data is available. In other words, the idea of your economic model may be more valuable than the real data associated with your actual economic model.
- Your perceived value may be lower to potential competitors if your economic model is NOT clear, thereby reducing the number of competitors aiming to attack you. In other words, not knowing may keep competitors away.
Why You Should Do it Now
Not working on your economic model also has risks. For example,
- The users who sign up and engage with products that don’t have revenue-producing features may not be the same customer segment that would engage with the products that do have revenue producing features. In other words, you may end up gathering the wrong users.
- Even if the user segment is “right,” many users may get pissed off and leave once the revenue producing features are created (the Netflix story is not quite this situation, but it demonstrates how changing pricing models can potentially damage customer relationships). Setting up your product with both user features and economic features might be better at attracting users who are comfortable with engaging in both sets of features.
- Since economic models relate to value creation, some companies may be building features that attract users and user engagement, but their features may not be the same features that they would build if they were optimizing for what customers will pay for. In other words, not focusing on what people will pay for might lead to creating the wrong feature set.
- You don’t have the opportunity to fail fast and move onto something else. It is really difficult to figure out if you can have a successful economic model without trying. You may not have a product that can have a viable economic model, but you won’t be able to find out unless you try. In other words, you might be wasting your time on something that won’t be economically viable and won’t find that out quickly.
- There is a funding risk associated with this approach. Essentially, the company is not viable until it has a minimally viable economic model (the cash coming in is greater than the cash going out), so if the company runs out of cash and there are not additional funds available from investors then the company will go out of business or need to be sold to another company that is willing to support the cash burn.
Waiting to optimize your economic model is definitely an option, but it has both benefits and risks. There are some successful companies that have been built “users first, economic model later” including Google, one of my favorite most valuable companies. There are also a huge number of companies that have gone out of business with this approach.
My personal “tastes” are around building lasting companies for the long term, so I personally am more comfortable with approaches that build optimal economic models while you are building your company. That said, this isn’t always the optimal approach and all management teams should consider what is right for them.
My next post is on the “Characteristics of the Best Spreadsheet Models”
If you want to learn more about economic models, keep reading. I would also appreciate any comments or suggestions that you have, as I plan on turning this series into an e-book and I want to make sure that it is as clear and complete as possible.