Why too many users too soon may be a bad thing

“Just get the users, we’ll worry about making money later” has become a cliché of sorts in the consumer internet world. It’s part of the reason why anyone outside the industry doesn’t understand the workings of venture capital but it is also largely the reason why a lot of pointless ideas get funded.

This makes a lot of sense if it’s taken in the spirit of “don’t let your monetization come in the way of good user experience”. You shouldn’t focus on turning the monetizatrion engine on unless you’ve successfully demonstrated your ability to solve the customer pain point.

But there is a fallacy here if this statement is taken in the spirit of “we just won’t worry about our business model, we’ll just build it and put it out there”.

Ever since the web got big in the mid-90s, most startups went out treating it like yet another media channel: you put some content out there, get traction and run advertising to make money. The idea was that the internet’s advantage is in scale and monetization comes in the way of generating scale. So leverage the internet to scale quickly and you will definitely have a way to make money after that.

The argument above works well if your business model is some kind of advertising or even lead generation. Traction plays an important role there. The problem really arises when companies start taking this advice blindly without thinking of whether it can work with their business model.

Are you testing well before scaling?

It’s important to think of your business model before you start investing in scaling your user base. Indiscriminate user acquisition probably doesn’t work for any business other than CPM based advertising. The key metric for a CPM-based advertising model, is in fact, traction. But a bigger problem is that for certain business models, adding the wrong users could lead to unnecessarily higher costs, higher overheads or even the failure of your business.

Freemium: The common belief is that you get a large number of free users, a certain percentage of them convert and you’ve got your business. A key cost to the Freemium business model is the cost of supporting free users. If you have too many users of the wrong type (read users unlikely to ever convert and unlikely to ever spread virality to a user base that would convert better), it may be unwise to keep investing in getting those users. Ultimately, the more important metric for a Freemium business model is % converting to paid, not traction.

Transaction: A transaction business works in quite the opposite manner of a traction (advertising) business. While a traction business requires you to go broad and scale fast, a transaction business often makes more sense when you go narrow and deep, often within a geographic region or a vertical. This is because transaction businesses depend on matchmaking between consumers and producers/products/services and the likelihood of consumers finding a match increases with the depth of inventory selection available. It’s very difficult to get good selection while going broad. Also, staying small and within a niche also helps iron out the problems in the model. The key metric for a transaction business model is, well, the number of transactions.

This may seem obvious for a case like ecommerce where ‘go narrow, strike transactions, expand to other niches, strike transactions’ is the common mode of expansion. However, this logic applies equally well to any other form of match-making business. I was recently talking to an m-loyalty startup which has a consumer product (along the lines of Foursquare but not on a check-in model) and was  planning on rolling out by signing up merchants nationwide. While the approach may have its merits, given that it’s a consumer-facing product, it would be more logical to see consumer engagement on the product and then spark interactions (akin to check-ins and reward redemptions) within a small set of consumers and merchants where the consumers have the advantage of selection. If I as a user have only 3 merchants of interest in my city on the network, it’s not very valuable for me. On the other hand, if it is rolled out in a controlled environment like a college campus where most consumers visit the same 10-15 shops around their campus, match-making would happen faster and more merchant-consumer interactions would result proving out the value of the product. Moreover, most problems with a transaction-based product get revealed in the first few transactions and there is merit in being small while you’re still ironing out problems that come in the way of successful transactions.

Are your users monetizable?

Irrespective of the business model, it is also important to get the right customers rather than just build scale. This might sound obvious but there are countless cases of startups getting this wrong. One common business idea that repeatedly fails because of this reason is based on paying consumers to read advertisements. Typically, consumers who are happy to read advertisements for some money do not have a lot of buying power in the first place (typically students) and advertisers are not interested in targeting them in any case and get wise about it quite soon. Startups have tried this (and continue to try it) in India as well as the Valley and have failed. Getting monetizable users is key and whether a user is monetizable will depend on the business model.

[About the Author: Sangeet Paul Choudary leads New Ventures at Intuit Asia, actively feeds on Quora and loves the intersection of geekery and business. He writes often on Platforms and Two-sided networks on Quora. His earlier contribution was: How to seed your network in standalone mode].