South Park, Season 2 Episode 17 “Gnomes”
In a classic episode of South Park, Tweek has his underpants regularly stolen by a group of gnomes. The boys (Stan, Kyle, Cartman, and Kenny) are partnered with Tweek on a school project and stay over his house for the night. During the sleepover, the boys chase after the gnomes to their headquarters where the underpants are being stockpiled. The boys ask why the gnomes are collecting underpants and are then have the business strategy explained to them as “Phase 1: Collect underpants. Phase 2 (silence), Phase 3: Profit”.
This sounds like a purely comical idea. A group that just goes out and does something with the end goal being profit. Even more comical is the fact that even when questioned about this lack of a plan, those implementing it repeat the same statements “Phase 1: Collect Underpants……..Phase 3: Profit” and continue to go about their routine. Despite not knowing how to connect Phase 1 and Phase 3, business continues along as usual. Back in 2001, Selena Maranjian used this exact example to point out the flaw in Yahoo’s business model saying “Phase 1: Build a huge website, attract the highest traffic volume possible, Phase 2: , Phase 3: Profit”
This isn’t a problem only faced by bootstrapping startups. In May of 2012, the world’s biggest social network Facebook went public in a now famously bad way. After the initial public offering (IPO) the price of the shares of stock didn’t pop, it fell and continued to fall for weeks afterwards. The stock price didn’t decline because Facebook wasn’t popular, it was the single largest social networking site and it continued to grow. The stock price declined because despite all of those users and the troves of data collected, Facebook was not turning all those eyeballs and clicks into revenue. Even with numerous new monetization initiatives started in 2012 that increased revenues to $1.26billion, Facebook still had a loss of $59million.
While this “Phase 2 Problem” can affect any business, it’s very common in startups. Anyone who has worked with startups will be familiar with this scenario: The founder(s) has a good (or maybe even great idea) that she or he dives in and begins developing. When asked about the business they proudly tell all about their idea, how great it is and get into the nitty gritty of the features. If then asked about their business model, they will go back and talk about their great idea (Phase 1) and how it will be hugely profitable (Phase 3), completely skipping out on how and why people are going to use this product and who is going to be paying for it.
This “Phase 2 Problem” is addressed by having a monetization strategy. The word “monetization” is often looked at in a dirty way. It is seen as a way to exploit the users of the product into paying for something they shouldn’t. It’s similar to the caricature of the sleazy salesperson tricking the customer into buying something they don’t want
Monetization (or sales for that matter) is not bad. Monetization is the process of deriving revenue from the value you offer to your users. The key here is that your product is offering value to the users, and value should be compensated. This revenue creation may come from your users directly or it may be through another means. But regardless of the source, it is fair and equitable to assume that by offering value to a user, you receive compensation in exchange.
It is important to point out that some startups are never intending to make money directly. In these cases, the product or company is being developed purely to be sold out to another company at some point in the future. For these businesses, their “Phase 2” is to be attractive enough to be bought. An example of this is “Siri” which was originally developed as a stand-alone app in 2010 but was acquired by Apple and bundled in with their iOS operating system. Siri never had to monetize users directly as its monetization was in its acquisition.
For other startups, their monetization requires they first achieve a critical mass of users so their focus in early stages is purposely not focused on monetization. This doesn’t mean that monetization strategy should be ignored, because once that critical mass is achieved then the company will want to monetize what they have created. Take the dating app Tinder for example (or any other bilateral search product). In order to have value, there must be a sufficient amount of other users of the product. Users of the free app may be willing to accept limited choices in other users, but they wouldn’t be willing to pay for it. To create the value to its users, Tinder originally focused on growing its user base before attempting to monetize the product. When the user base had reached a critical mass it began offering in-app purchases and premium versions. The monetization methods were helped by easing constraints that the users had grown accustomed to through the original UX design (things such as geographic constraints and limited number of ‘swipes’)
Businesses are not limited to only one form of monetization. Many businesses seek multiple avenues of revenue generation, especially early in their development or during growth stages. There are numerous different ways to monetize a product or idea. Sometimes it is an obvious sale of a product or service. but other common monetization methods are:
Advertising — This type of monetization works best for products that will have lots of views, so sites and apps that are content heavy or that incentivize regular visitation. Many news websites and mobile games rely on advertising for some or all of their revenue. Because users regularly visit these sites, the number of ‘eyeballs’ is large enough to make advertising worthwhile. Advertising is also often able to be added on to an existing site or product without large changes. Even for companies that do not use advertising as their primary means of revenue generation it can be an easy expansion of profit.
Agency — This type of monetization works best for products that are acting as a service connecting users who will then engage in business. Agency based monetization has become very popular with the growth of the gig economy and a large number of suppliers and customers looking to meet. Some of the most famous examples of companies that monetize through agency are Uber, Lyft, and AirBnB.
Subscription/License — This type of monetization works best for products that provide a software or service on a regular basis. This is a more direct method of monetization, but many companies use a free service as a proof-of-concept for users or to grow their user base and then monetize through those users who choose to upgrade the service. Companies like Dropbox and Adobe offer free versions of their products but monetize through those users (often businesses) that want to expand the capabilities.
Micro-transactions — This type of monetization works best for products that have a large user base of regular users and is very common in mobile gaming. Products that look to monetize through micro-transactions only earn revenue from a small number of users. The majority of users will solely use the free version of the product, but by increasing the total number of users, the business will increase the few paying users. This monetization strategy generally makes the game or task easier to accomplish if payments are made and often relies on gambling mechanics to entice spending.
Data Sales — This type of monetization works best for products that have a large user base that it is able to collect data on. For many social media and other online sites and communities, the users themselves become the product. By collecting data and information on the users, the company is able to offer data to other companies as a product.
During product development and the startup phases of business, it is important for monetization strategies to be clearly defined. Without a clear definition of a path to monetization, no matter how great the developed product is, it will not lead to a sustainable business. Articulating the way that users will receive value and that the company will earn revenue allows the company and product to grow in a way that allows for continued exchanges of value. As Paul Freet once described it, “A business is a repeatable process that makes money. Everything else is a hobby”
Developing a strategy of how your product will be monetized helps create better products that are more valuable to all involved, and you’ll never be stuck having to answer “How does collecting underpants turn into profit?”