As 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:
Page Views/Visit 3
Ad Views/Visit 9
Value/View ($3 CPM) $0.003
Premium Price $10
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:
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
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.
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!