New Media Hoop Dreams: The Smart Kids’ NBA

kurt-rambisAs the title of this post implies, I think “new media”, as most young entrepreneurs I meet view it, is an illusion.  They see it as a way to “get rich quick”.  Here at the RTV Incubator, we joke that in reality it’s a way to “get poor slowly”.  In the rest of this post, I’ll lay out some economic realities and conclude with where I think the smart entrepreneurs are heading.

The Economics of New Media

Classic new media companies attempt to use the instant, world-wide distribution of the Internet to build a massive audience with very little investment.  The main product categories include content, tools, marketplaces, and communities, with tools and communities taking the lead in version 2.0.  The most popular business models include advertising, affiliate marketing, and the “freemium”.  Interestingly, each of these business models require about the same economics of scale to really “hit”.  I’ve included some back of the envelope numbers below for three of the most popular:

Advertising
Page Views/Visit    3
Ads/Page    3
Ad Views/Visit    9
Value/View ($3 CPM)    $0.003
Revenue/Visit    $0.027

Freemium
Purchases/Visit    0.25%
Premium Price    $10
Revenue/Visit    $0.025

Affiliate
Purchases/Visit    0.25%
Cost/Purchase    $100
Partner Revenue/Visit    $0.25
Affiliate Fee    10.00%
Your Revenue/Visit    $0.025

Obviously the Freemium and Affiliate models depend on how efficiently you can convert visitors into purchasers and the purchase price of the final product, but these conversion rates and prices are pretty typical.  So the question this all raises is, if New Media companies typically generate less than $.05/visit, what kind of numbers are we looking at for a rational exit (which is the ultimate goal of the VC backed game that I’m specifically dealing with here)?

Well let’s assume that we’re going to take $1 million in investment and that we want a $10 million exit for a 10X return.  Real companies are typically acquired for 1X annual revenues (obviously this depends on the margins of the business and on the growth prospects), but 1X is a good number to use as a benchmark.  That means we’ll be needing to bring in $10 million in revenues to justify our $10 million acquisition price.  If we run the numbers, this gives us the following:

Traffic Requirements
Revenue/Visit    $0.05
Needed Revenue    $10,000,000
Needed Visits/Year    200,000,000

We can get these visits in a lot of different ways.  We could have 1 million dedicated users who come to our site almost daily or we could have half the population of the US come to our site once a year (or we could be Facebook and have have the population of US come to our site every day!).  Either way, anyone who’s ever done this can tell you that these numbers are VERY challenging to achieve.  To see just how hard, let’s put our $1 million to work:

Stretching Your Marketing $
Needed Visits/Year    200,000,000
Investment $1 Million    $1,000,000
Marketing Investment 10%    $100,000
Spend/Visit    $0.0005
Vists Required/$1 of Maketing    2000
Real Marketing Cost/New Visit    $0.25
# Unpaid Visits Needed/Paid Visit    500

So what do these numbers mean?  Well, if you’re getting a $1 million investment, your investors will allow you to spend about 10% of that on marketing.  That gives us $100,000 to generate 200 million visits or about $0.0005 to spend on each visit.  Since that number’s a little hard to grasp, I show that we need to get about 2000 visits for every marketing dollar we spend.  No matter how you’re “buying” your visits, you’re not going to get them for much cheaper at that scale than $0.25/visit.  This means that every visit you buy will somehow have to generate 500 unpaid visits.

There are only three ways this happens: loyalty, “going viral”, or “going Google”.  Loyalty would work if 100% of your first time visitors started using your site every day, “going viral” would work if 100% of your visitors got 500 friends to visit once, and “going Google” would work if whatever you’re offering ranks on the first page for a huge number of very valuable search terms.  More likely, it would be a combination of the three.  Consider how staggering these numbers are though–especially when you consider that the % of visitors who EVER return to a site is usually around 15%, the % of visitors who convince someone else to come is significantly lower than that, and how competitive ranking in Google’s search results is.

Entrepreneurial Risk

Given the scale you must achieve and how little money you’ll have to achieve it, you can see why investors require to see phenomenal user adaption rates before they will invest in a new media company.  How can you, the lowly entrepreneur, ever hope to build something so valuable that it can demonstrate this kind of growth–BEFORE you even get an investment to build your product?  The fact is that it takes something AMAZING to demonstrate these kind of user acquisition costs.  Which brings me to my next point, entrepreneurial risk.

It is impossible to build something valuable and defensible enough to achieve the kind of growth investors will expect to see without spending $100,000.  Does that sound like a lot of money?  Thank your lucky stars it’s not 1998 or it would have cost 50 times as much.  In spite of the persistent rumors that software is “easy and cheap” to build these days, it is in fact never easy and only relatively cheap.  If you’re a hacker and have a bunch of buddies in the industry, you may not have to pay that $100,000 in cash, but you will certainly pay for it in opportunity costs and spent good-will.

So how long does it take to get into a position to take that shot?  If you’re really young and have the actual coding skills, you can take your shot right out of school.  Be warned though, you’ll be going against savvy vets like me, and we will crush you.  Like I said, building great software (nonetheless a business based on that software) is REALLY hard.  Believe me, you learn a thing or two after doing it for decade.  I would swat the young me aside without even noticing him on my way to the hoop.

Of course, getting older and savvier has it’s own costs–often in the form of a family.  I can’t just take a year off to pursue something new without saving up for the occasion.  By my reckoning, it takes about 4 years for a full entrepreneurial cycle if you’re really going for a big hit–spend a year building, a year failing, a year recovering, and a year saving (if you succeed the path is a year building, a year succeeding, a year turning it into a business, and a year serving your acquirer).

Either way, the risks to the entrepreneur are huge.  Unlike VCs, we don’t get to cherry-pick companies that have already started to show traction, we don’t get to start with other people’s money, and we don’t get to spread our bets across dozens of companies.  We start from nothing but an idea, have to take all the early stage risk ourselves, and get ONE bet every four years.

The Smart Entrepreneur: Small is the New Big

So why do we do it?  Most of the entrepreneurs I talk to do it because it’s the only thing they know how to do.  If you’ve spent your whole life building software and the organizations that support it, it’s pretty hard to take (or even get) a job as a VP of Who Gives a Shit.  So what’s a smart entrepreneur to do?  I see a clear trend with the smart entrepreneurs I know: going small to go big.

Essentially there are three components to this new model: spend nothing, go niche, revenue first.  Spending nothing means getting yourself to a point of validation on as little as possible.  Jon Steinburg, the EIR at Polaris told us at the incubator that he restricts the budget for every new site he builds to $500.  I often suggest entrepreneurs validate their numbers using Google Adwords and a fake site before investing any money.  Just have an image of a site with one real button (the one you need people to click) and see how many click it.  If it converts, move forward.  If not, re-evaluate.

Going niche means not trying to take on a huge market (like online TV for example!)  How about trying to be the best coat hook site on the Internet?  David Wurtz has a great article called “Smart People Should Do Stupid Stuff” where he talks about how he abandoned his trying to commercialize Ferromagnetic fluid to start selling TV Wall Mounts.  His point and mine is that by focusing your brains and your energy on a smaller, less sexy market, you RADICALLY improve your chances of success.

“Revenue first” is the last thing I’ll say, but it should be the first thing EVERY entrepreneur does.  Building something cool that no one is willing to pay for and hoping to squeeze out $.03 a page view is not a path to riches.  Here’s an idea for you: build/sell something people care enough to pay cash for.  It’s an old simple business plan, but it’s worked for thousands of years!

I know this whole post is a little outrageous coming from me.  I’ve put $100,000 into SetJam hoping to squeeze pennies from a pageview.  What can I say though, if you’re Kobe Bryant, you gotta play in the NBA!  Of course, I’m as likely to blow a knee as the next guy, and I promise if it happens this time, you’re looking at the new best coat hook salesman in the world!

  • davidkpark

    Great post. Nice (or someone could say harsh) splash of cold reality to the wide eyed newbie new media entrepreneur. One minor quibble…Sometimes you should wait a little before charging, ie you're creating a new market; so iterate like hell to get the right product/market fit, and as Ellis says, when 40% of your customers say that would be very disappointed if they no longer could use the product, then start charging.

    • http://www.setjam.com drstarcat

      I agree with you for a New Media company, but not for a Niche Sales company.

      New Media company: Don't charge at first (or ever probably). Your user
      numbers are all that matters. Niche Sales company: Charge right away.
      You're starting a business, not a phenomenon, and you need to make sure
      people are willing to pay.

      • davidkpark

        Was told by a seed VC that a new media (consumer) startup needs 50K monthly repeats before they would even consider having a meeting, let alone investing.

  • carolinewaxler

    Sobering indeed. But good stuff. Thanks for posting this, RJ.

  • http://www.netmix.com djtonyz

    I definitely appreciate your point of view. However, I argue that in a niche with a decent amount of traffic, you can convert at a higher CPM or CPC should you get some stickiness. I'm about to embark on reinventing my Netmix.com brand as an online music service in a niche. I have no intention of competing on a mass scale against the Real Rhapsody's, Napster's and iTunes of the world. In my market, freemium might be a bit more than $10 a month. I guess it all depends on the niche and your costs. The goal is to keep costs as low as possible, while increasing users, and you'll somehow get to that holy grail of profit over expense.

    • http://www.setjam.com drstarcat

      I don't think any of the New Media models work in a niche very well. If you
      go niche, you can compete, but then you don't have the numbers to scale
      where you need to. This only applies if you're looking to go big. If
      you're going solo, there are lots of people who make a rather meager, but
      livable income from their blogs. As you said, if you're going that route,
      just keep your costs low!

      • http://www.netmix.com djtonyz

        I can point to Beatport.com as a successful niche startup in the music space with revenues of $40 Million from 10% of all traffic to the site. After employee costs and marketing, they are still generating a pretty decent profit. I argue that you may have some generic numbers that fit a certain mold, but when it comes to niche sites, even you have invested $100K in something that's not proven. I hear your point, but I'm a little confused by laying it all out, then saying you're throwing caution to the wind too? It seems like you're telling people, “hey…if you start your thing, expect these numbers to be the lowest numbers possible, that's if you follow the new media models I've laid out.” In my niche, I may have some offline revenue combined with online revenue, but you haven't factored that in at all. I just don't agree you need 200,000,000 million visitors a year to make money. I think that's a bit of a stretch. There are many companies out there who do far less traffic and are profitable.

        • http://www.netmix.com djtonyz

          After looking at your model again, I guess I can see where if you just put all of your eggs in that basket, that could be expected revenue. If you look at LinkedIn, they charge 24.95 a month for 3 InMails and they get rev from recruiters and job postings. So, they step it up a notch. I think you have to mix the minimal with a few other things to grab a larger slice of the pie.

  • http://avc.com fredwilson

    i don't think CPM, CPA, CPC, or anything of that ilk is going to be the long term monetization model in social media. i like to think of monthly revenue per daily active. Facebook is probably about $1. Zynga is probably a multiple of that. so if you need to get to $10mm per year or $833k per month, you'd need hundreds of thousands of daily active users. many of our companies don't spend a dime on marketing and have achieved that level of daily actives. sometimes on a few million of investment. it's not as hard as you think. but you have to have a killer product/service

    • http://www.setjam.com drstarcat

      Just so I can understand this, I think you're saying two things: Monthly
      Revenue/Daily Active is a cleaner metric and the revenue won't be generated
      by what is essentially advertising.

      If I understand #1 correctly, Monthly Revenue/Daily Active would be how much
      money a site would make in a month off of a user who comes to the site every
      day (even if that “user” isn't really the same individual).

      If that's the case, that person on my model would generate about 30 visits,
      90 pageviews (3 pageviews/ visit), and 270 ad impressions (3 ads/page), and
      at a $4 CPM would generate about $1/month, which is exactly the number you
      say FB makes.

      If all of the above is correct (and I'm really asking), then it still seems
      like we're playing the same game (with you using a cleaner metric that
      bundles some of the assumptions).

      My question, I guess, would be, how does this change the enormous burden of
      user acquisition? And if the revenue isn't coming from CPM, or Affiliate,
      or Freemium (all of which produce roughly the same numbers), is there
      something else that will generate BETTER numbers?

      I know you cite Zynga, but do you really believe it's all going to come from
      virtual goods and that virtual goods will beat lead gen for real goods on a
      rev/visit or rev/MAU long-term? If not that, then what?

      The final point is indisputable–your product has to be SMOKING hot, which
      goes back to my original point: as an entrepreneur you'll have to take
      something like a $100k personal risk to even hope to produce something
      incredible enough to show those numbers and justify an investment (which
      will then hopefully take you to the $10 million point).

    • http://www.setjam.com drstarcat

      Friends, Family, and Once and Future Colleagues,

      I’m writing to let you know that today SetJam was acquired by
      Motorola Mobility. We are all very excited about this transition
      here at SetJam. Motorola and SetJam share the vision of making content delivery, discovery, and consumption seamless across any screen, and as a world leader in video technology, Motorola will provide us with unprecedented levels of reach and distribution.

      I want to take this moment to personally thank you for your continued encouragement and support over the past two years. None of this success would have been possible without your backing and belief in us. While this acquisition was in process, we’ve had to be far less communicative than we normally would be. We greatly look forward to reconnecting with all of you in the New Year. In the mean time, we wish you a happy and healthy holiday season!

      Cordially,

      Ryan

      Ryan Janssen
      (Former) CEO, SetJam

      ______________________________________________________________________
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      New York, New York 10013
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  • Dan

    Amen. In many verticals (social), a $3 CPM in hard to achieve (how many sites get anywhere near a 100% sell-through on branded or high-value DR)? Particularly since with 3 Ad units on a page in your model, at least one is below the fold.

    The good news is that you don't need $10M in revenues to justify a a $10M sale if there's a good growth rate. I've sold a company making (significantly) less for more. But the tech behind it was good…

  • http://twitter.com/porlando Paul Orlando

    Nice back of the envelope assessment. Such simple calculations and yet lots of startups don't think through this. I came across the fallacy of a pure Ad or Freemium model when studying this a few years ago for a client.
    A thought on your Freemium numbers. I've seen the purchase % move up, for example in Evernote, which has raised that % over time. The latest number I saw for them was about 1.5%, though that is still not enough to cover their costs.
    The thing about these models is, they are just so tempting. Imagine, you can build something without having to worry about the hard stuff like how to make money.

    • http://www.setjam.com drstarcat

      Thanks for the real numbers on someone doing this well. Just build cool
      stuff and hope the money comes, it is tempting isn't it? Maybe we should
      just give up the business pretense and call ourselves “digital artists”
      instead!

    • http://www.setjam.com drstarcat

      Friends, Family, and Once and Future Colleagues,

      I’m writing to let you know that today SetJam was acquired by
      Motorola Mobility. We are all very excited about this transition
      here at SetJam. Motorola and SetJam share the vision of making content delivery, discovery, and consumption seamless across any screen, and as a world leader in video technology, Motorola will provide us with unprecedented levels of reach and distribution.

      I want to take this moment to personally thank you for your continued encouragement and support over the past two years. None of this success would have been possible without your backing and belief in us. While this acquisition was in process, we’ve had to be far less communicative than we normally would be. We greatly look forward to reconnecting with all of you in the New Year. In the mean time, we wish you a happy and healthy holiday season!

      Cordially,

      Ryan

      Ryan Janssen
      (Former) CEO, SetJam

      ______________________________________________________________________
      If you no longer wish to receive these emails, please reply to this
      message with “Unsubscribe” in the subject line or simply click on the
      following link:

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      ______________________________________________________________________
      This message was sent by Ryan Janssen using VerticalResponse

      SetJam
      154 Grand Street
      New York, New York 10013
      US

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  • http://innonate.com/ innonate

    Ryan,

    I think the key here is to always bet on a fulcrum and a funnel, not a mere “idea.”

    Here's the hypothesis:

    The fulcrum is the value of your company. Its your unfair advantage. Maybe its insight into a mass of customers, or foresight into the future of your competition, but the fulcrum is the value you create and the value you leverage off of.

    The funnel is how you get people to push a lever (on the Web, it's a button) and realize the company's value. In the funnel is an Experience — Usability, Findability, Likeability, Ability, etc — which leads people to you and to press the lever which outputs the value.

    That, is what a startup is about — and it's the use-case for VC investment — and if the economics of your fulcrum and funnel aren't good enough, you haven't addressed a large enough market problem or solved it in a compelling enough way.

    Thoughts?

    • http://www.setjam.com drstarcat

      I like the metaphor. The fulcrum essentially seems like your “idea”. That
      problem that you have unique insight into. For a new media company, it had
      better be very tall because you're going to need to generate a lot of
      leverage.

      The funnel is your execution. It's the tactical things you do to get people
      to do what you need them to in order to make money.

      Of course, the fact remains that building and adequate funnel for a fulcrum
      big enough to pay-off in the new media space is extremely hard and resource
      (i.e time and money) intensive. You probably get 1 shot every four years,
      so you BETTER make sure the market is right and that you execute perfectly!

    • http://www.setjam.com drstarcat

      Friends, Family, and Once and Future Colleagues,

      I’m writing to let you know that today SetJam was acquired by
      Motorola Mobility. We are all very excited about this transition
      here at SetJam. Motorola and SetJam share the vision of making content delivery, discovery, and consumption seamless across any screen, and as a world leader in video technology, Motorola will provide us with unprecedented levels of reach and distribution.

      I want to take this moment to personally thank you for your continued encouragement and support over the past two years. None of this success would have been possible without your backing and belief in us. While this acquisition was in process, we’ve had to be far less communicative than we normally would be. We greatly look forward to reconnecting with all of you in the New Year. In the mean time, we wish you a happy and healthy holiday season!

      Cordially,

      Ryan

      Ryan Janssen
      (Former) CEO, SetJam

      ______________________________________________________________________
      If you no longer wish to receive these emails, please reply to this
      message with “Unsubscribe” in the subject line or simply click on the
      following link:

      http://cts.vresp.com/u?366f85468a/7bd84f5c8e/mlpftw

      ______________________________________________________________________
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      SetJam
      154 Grand Street
      New York, New York 10013
      US

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  • Pingback: The Fulcrum and The Funnel | innonate

  • davidkpark

    Was told by a seed VC that a new media (consumer) startup needs 50K monthly repeats before they would even consider having a meeting, let alone investing.

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