Business Models

You should not survive long without a strong revenue model…yet you can be wildly successful with a large base of free users

A great article from David Spinks of Feast making a case for having a solid business and revenue model over and above a user base of free users.

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It all makes very much business sense. And yet as I read it I can feel the brakes come on. Yes, it is important to test your revenue model (let alone have one to test!), but I can’t help to feel positive about the prospect of building up a large user base (for free). Why is that? In part we’re conditioned to associate “large user base of free users” with success given the highly mediated examples of acquisitions and huge valuations of free user bases. Entrepreneurs (and clearly many in the startup funding community) are willing to take a leap of faith that if you have a sufficiently large user base, you will be able to convert enough of them to paying customers – somehow. So the thinking is that it is harder nowadays to amass a huge following of faithful customers than it is to come up with a business model that can generate revenue. It’s a classic case of perception vs reality. You are perceived to be successful because you are grabbing lots of users (and there is no question that it is an accomplishment to do so given the zillions of free apps and sites that get no traction). Reality is you may be far away from converting them to paying customers. But as always perception trumps reality, and our current business and cultural mindset supports that perception.

We also need to caveat that in most entrepreneur circles, acquisition or IPO is the end game. You won’t raise much money if you don’t make that your priority. That can open up an escape pod for the entrepreneur (and VC) of amassing a sufficient user base to be of interest to somebody else that will take on the responsibility of monetizing your customer base (or will buy you out to stop hemorrhaging paying customers to your free solution).

Tim Cook should be losing sleep over lower priced iPhones if he cares about the iOS App ecosystem!

In this Bloomberg interview, Tim Cook explains (“I’m not going to lose sleep over that other market, because it’s just not who we are.”) how Apple’s phone strategy follows the traditional Apple “premium margin” strategy: focus on delighting the hog-end of the market with a superior product experience and cash in the fat margin that comes with it. Let your competition kill each other over the low-end, low-margin business where product differentiation is low.

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That works well for an Apple that sells high priced products and generates $100s of margin with each sale. As happened in the PC market, by taking that stance, by 2005, Apple was able to siphon the vast majority of the PC industry profits while enjoying very modest market share. And today Apple is on top of the industry with all others struggling or bailing out. With the iPhone, Apple has a similar profit engine, a combination of volume growth, margins and attach of “pure profit” accessories. Apple enjoys  high upgrade rates within its current user base (people that already have an iPhone buying a new model), so even if it does not expand its total user base as fast, it can generate large volume through repeat buyers.

But the smartphone market is different than the PC market of 2005. With the browser dominating the app scene on PCs, Apple could afford to have a limited portfolio of software for Macs. It covered the bases with the likes of Officer and Photoshop. It lacked enterprise software, games, and many vertical apps. But it had enough to meet the average needs of the premium consumer.

The smartphone market exploded when the App market took off, morphing a (smart) phone into a pocket computer. App developers have a very different model than Apple. They make $0.7 per user for each $0.99 sale, if they make anything at all when they adapt a freemium model. The growth engine of the App developer is volume-volume-volume. And to get more App volume, you want more phone volume, which means going after the more price sensitive phone customers (for whom a $0.99 App or a fermium app can still be a decent bargain). And those repeat iPhone buyers Apple has? They do nothing for App developers when their Apps are simply transferred over to the new iPhone as part of the migration process.

In the volume game, Android already leads the pack and will further consolidate its lead in the coming years as the market moves to more price sensitive audiences (in the US and abroad). Today Apple enjoys 43% share in the US, close enough to Android’s fragmented 51% share. Add to the superior Xcode development environment and Apple remains the # platform most App developer target today. But move to a world where Apple share drops to <25% (as is projected by IDC for 2017) and things may change. Where will App developers focus to gain that volume they need then?

Sooner or later, Tim is going to need to spend a few sleepless nights…

Five things that put the console business at risk of falling like the PC market

A recent article by Horace Dediu of Asymco points to the demise of the fixed and portable console business with the advent of the smartphone, concluding that Gaming, as a business, cannot be sustained as a platform independent of a general purpose computer. As if to echo this opinion, Nintendo stock dropped 8% on Monday as it failed to re-enter the Nikkei index.

Mike Wehner posted on TUAW that Smartphones would have little effect on console gaming as we know it. His argument centers around low sales being part of the natural 5-7 year end of lifecycle of the current generation of game consoles, and that couch-based console gaming is a completely different game experience that that of playing Angry Birds on a smartphone.

Dediu may not have built the most decisive case to demonstrate his theory, but I believe he is more right than not, and people like Mike are not anticipating the full effects on the console business of the tidal wave of smartphone/tablet gaming.

The console business is at an inflection point that is similar to that of the PC industry a couple of years ago.In 2009 I gave Msft a thorough analysis of the impact of mobile and cloud on the productivity software market. I warned Msft that while Office would remain king of its hill, users (and competitors) were running around the hill, emboldened by the freedom and flexibility of the smartphone. The PC was on the verge of losing its prime position as best platform for productivity as users were being productive using different tools and processes through their Smartphone.

It seems unavoidable that consoles will have a similar fate – they will remain the best big tv-connected entertainment system. But Smartphones and tablets are running circles around consoles, capable of offering increasingly sophisticated games just about anywhere, including from the sofa in front of the big TV.

Here are 5 things that can contribute to console gaming’s disruption:

1) The rate of growth of the console installed base is too low to fend off mobile gaming

The current generation of consoles totals around 250 million units shipped (all manufacturers). The previous generation was at around 200 million. That is only a 25% total growth over a 7 year lifecycle, or about 3.5% growth per year. Contrast that 50 million console installed base growth to the growth of smartphone, that in the US alone grew from a base of 88 million to 170 million units between 2010 and 2012! Apple last week announced that they have shipped 700 million iOS devices in 6 years. Apple alone…add to that the hundreds of millions of Android devices, and you have a volume of mobile devices that is 10x that of consoles.

2) The tidal wave of smartphones is pushing down the share of couch gaming minutes on consoles

It is simple math, by having to share couch playtime with smartphones, the console see their share of playtime drop. And it is very likely that the volume of console playtime is also under pressure (ie. smartphone couch playtime cannibalizes console playtime). As we see in the PC world, when a technology loses user focus, purchase patterns follow, impacting growth, revenues and profits. Consoles will continue to sell, but growth is going to be very hard to sustain, and if total volumes decrease the console ecosystem will no provide enough oxygen for three contenders to survive and thrive. Some will have to exit or all will operate in very difficult financial conditions.

3) The console business model is obsolete

Recouping the investment on the console hardware by having to sell multiple $60 games purchases is obsolete in a world of smartphones sold at a profit (to carriers who pay the subsidy or to consumers full price unlocked) upfront and games available between $9.99 and $0.99, with a great many games using the freemium model. The smartphone gaming model puts the most pressure on the most sensitive part of the console business model – the necessity to sell multiple $60 games with each console to make money. Assuming that the major console game franchises (Call of Duty, Halo, Mario, etc) can sustain their enormous sales volumes at a $60 premium, over time, things get more and more iffy for less grandiose titles that can more easily be substituted by their equivalent on a tablet or smartphone, at a fraction of the cost. If the repeat purchase of premium priced games slows down, the whole console business model becomes unsustainable.

4) The console hardware engineering model is obsolete.

Console manufacturers lock their engineering specs for 5 to 7 years cycle, partly to keep the platform stable and facilitate game development but mostly to allow sufficient time to recoup the engineering and initial cogs subsidies. Smartphones and tablets get refreshed every year, for a substantial boost in graphics and processor (and other technologies) capabilities with each new generation. Consider that in the 6 years (~ 1 console cycle) since the launch of the original iPhone, Apple has boosted the iPhone CPU performance by 56x! All the while, the CPU of the Xbox 360 on sale today has the same processing capability as the one launched 8 years ago in 2005! This engineering cycle puts the console at a performance disadvantage, it also makes it much harder for consoles to offer new gaming experiences based on technologies made available after their market introduction.

5) The two principal value propositions of the dedicated game console are obsolete

As home PCs were becoming ubiquitous in the late 90s, the console maintained their position by providing two key benefits over PCs: simplicity and comfort of use. Playing a console game was a matter of turning the console on and plugging the game in. And the consoles were connected to TVs in front of sofas, providing a comfortable setting for gaming. By comparison, playing a PC game required using mouse and keyboards to navigate the Windows interface, manage graphic and audio drivers, all the while sitting at a desk in an office-like setting.
Smartphone and tablets have not only taken these two console advantages away, they’ve even made them better. Tablets and smartphones are essentially always-on, they do not require disks or cartridges to access games, they can be played in a sofa…or a bed, a car, a plane…essentially anywhere!

Disruption typically comes at the expense of an industry, but to the benefit of the end users. Clearly, couch gaming is doing very well. Kids and gamers continue to enjoy playing sitting in a sofa, solo or with friends, offline or online. What has changed is that consoles have to share that sofa time with smartphone and tablets that have proven to be very good entertainment platforms.