

YC Analysis: "37signals/DHH style" companies? - davidw

Everyone has probably read about or seen DHH's talk by now, where he advocates attempting to create small/medium sized, sustainable companies with a simple, direct business model (sell something directly to your customers).<p>A lot of his examples are from 'real world' products (Italian restaurants, say), that clearly have very different economics from on line businesses.  The marginal cost of another bottle of Bardolino is not indifferent, even though the markup is also going to be good.  The marginal cost of another basecamp customer is very small.  Also, his Craigslist example was not particularly compelling for me.  Those guys dominated their market, but more because people flock to the site because everyone else does (network effects).  Their choice to keep things small/real seems like a very conscious one, but not necessarily something they could get away with if, say, they were kijiji and eBay were the owner of Craigslist.<p>So, my question: what other web or software companies make a living the 37signals way?  What are they key characteristics of their markets?  Obviously they can't be in a winner take all market dominated by network effects.
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dkokelley
Also keep in mind that DHH suggested building a product for a business, not
consumers. Consumers are used to free, but businesses are more than willing to
pay. In fact, a price tag is a way for businesses to justify their corporate
use of the product.

I'm constantly surprised when I see companies paying for a service that I get
for free (Any premium chat/voice Vs. Gtalk). The thing is, businesses don't
like to spend time looking into the best and most cost effective way to solve
a problem - they like to throw money at it and make it go away. DHH suggests
being that person who makes it go away.

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inovica
There are LOADS of companies like this. I run a few small ones myself that
generate good revenue. Software-related is our www.sourceguardian.com site.
Like most things we solved a problem for our own needs and then turned it into
a product. We have a healthy income from this which isn't far from being
'passive income'. My suggestion would be to look at a problem that hasn't been
solved, or hasn't been solved well. We pick niche markets for what we do and
that works well for us. I know of many companies like this.

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subwindow
The Craigslist comparison comes from:

1) The fact that in SF and NYC, they charge directly per listing in certain
categories.

2) The fact that they didn't take VC funding.

3) The fact that they stayed small.

4) The fact that they didn't sell the company.

All of these would have been extremely easy to stray from, but instead they
stuck to the core philosophy. What DHH was talking about was just that: a
philosophy. Any company can stick by that philosophy, regardless of how it
attracts customers or the specifics behind their product or service.

Asking the question "what other web or software companies make a living the
37signals way?" is kind of a weird question. The 37signals way is actually the
_normal_ way to run a business. It just seems weird because the scale of the
web has thus far screwed up everyone's minds to the point where everybody
forgets the past.

~~~
davidw
The problem with that line of reasoning, in my opinion, is that "normal"
businesses sell "normal" products. As a simple example, how much would you pay
for a clone of reddit? Not much. The value of the site is entirely in its
large community. Same thing for eBay, for the most part. Also, normal products
always cost something. There are a ton of information goods that are free:
Linux, Apache, all kinds of languages, compilers, editors, browsers -
everything you need to run a business, almost, can be had for free these days.

In other words, things do work differently on line, _in some cases_.
Understanding that, and understanding what happens why is crucial to being
able to do a 'DHH style' company that doesn't get crushed by a big player, or
undercut by a bit of open source software.

I highly recommend the book 'Information Rules':
<http://www.amazon.com/dp/087584863X?tag=dedasys-20>

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quellhorst
Maybe existing DHH style companies are a good area to look for inspiration to
build free alternatives with some premiums added afterwards... Like flickr
added pro accounts for $25/year. Read Wired's "Why $0 is the future"
<http://www.wired.com/techbiz/it/magazine/16-03/ff_free>

Building less of an app also means it will be easier for others to come later
and build what you made and give it away. Look at how it took 2 people at
Google a few days to build HuddleChat which some said was too similar to
37signals' campfire.

~~~
Mistone
this is true - but is huddle chat negatively impacting Campfire? Campfire
customers are not running for the doors now that some other company has built
a free alternative. Building less of an app that serves a real need and
provides an elegant solution can also mean that customers love your product
and stick with you. Alternatives will always exist, competition is a natural
part of business, giving your product away for free is not the only way to
deal with competitors.

~~~
anewaccountname
Of course it isn't negatively affecting Camfire; they had it removed from the
internet.

~~~
condor
How many other chat/messaging competitors does campfire have?

I can guarantee you huddlechat was not the only one, so now that its gone
campfire can go back to enjoying their monopoly of the chat/messaging market.

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mronge
Take a look at alot of the popular Mac software companies out there. Many of
them make quite a living, like Panic, and Delicious Monster.

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mattjung
One characteristic is that they all provide enterprise software. The end-
consumer market is very difficult since internet-users are used to get
everything for free.

~~~
RyanGWU82
The term "enterprise software" usually refers to software products sold to
very large companies, or at least "small and medium businesses" which have
200-500 employees. David's examples were geared more toward the "Fortune
5,000,000" -- the much larger market of small businesses with a handful of
employees.

The economics of the "Fortune 5,000,000" are very different than true
enterprise software, as it avoids employing a direct sales force. Obviously
37signals wouldn't turn away a team from General Motors who wanted to use
Basecamp, but they don't actively market their products to large companies.

You're right about the difficulty of charging for online products in the
consumer market. DHH said that they were having trouble getting customers for
their personal organization product, Backpack, even at $5 a month. After they
repositioned Backpack to be used by small businesses, they were able to
increase the price and sales still grew tremendously.

~~~
mattjung
You are right. I used the term "enterprise software" only as a contrast to
"consumer software". The "Fortune 5,000,000" is probably the best target
market for a startup.

Why? Targeting large enterprises (what the company I work for does) is also an
extremely difficult market, but for other reasons than the consumer market.
Selling to large enterprises requires professionel and experienced sales
people with very good industrie contacts. You also might run into the "small
company problem", i.e. you don't sell because you look too small and you don't
have enough customer references. Not much fun!

~~~
davidw
Reaching a bunch of relatively small, and perhaps not well-connected companies
does, of course, present some obstacles of its own.

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hillel
Direct sale is an excellent model but I don't think it's a requirement. To me
it underscores the main principle which is about reducing dependencies. Why
convince two parties to do something (someone to visit your site, and an
advertiser to run an ad targeting that visitor) when you can convince one.

I'd also add that the single most important thing I've found in creating a
business like this is keeping your costs low. The same two businesses, with
the same income and customers will have very different times during a downturn
depending on their committed monthly burn rate. I know it sounds obvious, but
its amazing to me how many businesses handicap themselves from day one with
large spending commitments.

~~~
pchristensen
Exactly, direct sale = lower customer acquisition cost

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jkush
I think the beauty of these types of sites is that we've probably haven't
heard of many of them.

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ericb
I had one for a while--a shareware business that sold pop up blockers, before
they were free, along with a privacy suite. Many shareware businesses fit the
description. The Association of Shareware Professionals, which I used to
belong to, has many members living this way. Their newsletter had an article
series about how to run your shareware business from anywhere in the world.

To answer the article's question, the people who do winzip, pretty good
solitaire, clipmate and desktop tower defense are probably good examples.

------
utnick
the fortune 5,000,000 company I work at subscribes to GoToMeeting.com - ..
desktop sharing.. teleconferencing for product demos and meetings

~~~
run4yourlives
Second vote for gotomeeting. I use it a lot and have never had nothing but
good feelings for it. Does what it does and does it well.

~~~
joshwa
doesn't work on mac. :(

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thorax
We want all of out apps to be non-media. I.e. Services without ads.

Bug.gd plans to do it by selling private P2P help desks directly.

We have another unrelated service launching soon that will directly charge
users for anything above casual usage.

------
donw
FogBugz...

~~~
technoguyrob
And Eric Sink's SourceGear. [1]

[1] <http://www.sourcegear.com/>

~~~
joshwa
Was the footnote notation REALLY necessary?

~~~
Tichy
Are footnotes the subroutines of literature?

------
aaroneous
smugmug.com

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dcurtis
rememberthemilk.com kind of goes halfway, with a freemium model.

In some ways, that seems more sane to me than DHH's pay-only ideology.

~~~
run4yourlives
>In some ways, that seems more sane to me than DHH's pay-only ideology.

Well, first off, there are free versions of all 37s's apps.

Second, RTM isn't profitable (yet/ever?). 37S is. That seems more sane to me.

~~~
markbao
That's probably because RTM builds their Paid plan from their Free plan, only
offering marginal changes in features. 37signals focuses on the price and
builds from there, offering a free version on the side.

~~~
run4yourlives
I'd agree with that concept, yes. 37s's "free" is just enough to have users
say: "Well it doesn't suck, and I could really use that X feature".

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tptacek
Every Mac software company works on this model.

~~~
pchristensen
By definition, every software works on that model.

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davidw
I think another aspect of this to consider is this:

Eventually, most things will be commoditized, but this happens slower for some
things, and faster for others. How does the 'dhh style company' keep that at
bay - or do they? How sustainable is the business in the face of cheaper
competition?

~~~
run4yourlives
>How sustainable is the business in the face of cheaper competition?

This is where branding and marketing come in. Ask Apple, BMW, Mercedes, Luis
Vutton, etc etc.

These businesses all sell their products for much more than comparable
products, and they do quite well. Why? Because there are two types of
consumers that are sold by their marketing: those who appreciate high quality,
and those that want to be seen as appreciating high quality.

You don't have to appeal to everyone.

~~~
davidw
Right, good examples. But those are all physical products. Can you think of
online brands that have that kind of power? I can think of some negative
examples, like AOL, that most hackers wouldn't have been caught dead using.

...

Indeed, thinking about it a minute, a lot of my experience with 'branding'
online is that small and independent is cool. How much cooler is it to have a
@yourowndomain.com email address than @hotmail.com? Remember geocities?
Another thing that was sort of the lowest common denominator.

Maybe Google has a positive brand at this point, but I pay for very few things
there. I suppose I might pay a little bit more to them for some things in the
future to have everything 'tied together', but that's getting away from
'branding'.

~~~
run4yourlives
As for brands with power, off the top of my head:

37 Signals

Salesforce

Flickr (picasa is free, and people still use flicker)

expedia/travelocity (not startups anymore mind you)

------
webwright
blinksale.com followed a 37s path-- consulting firm that eventually gave up
consulting, I believe.

~~~
maurycy
Any informations if they're profitable?

~~~
webwright
I think they stopped consulting base on customer demand for BlinkSale... But I
obviously don't know their costs. I'd wager they're profitable, or are
sacrificing profit at the alter of growth in the near-term.

------
cstejerean
Github.com, Lighthouse, a lot of companies that make Mac software (think
TextMate).

~~~
tptacek
GitHub and Lighthouse are two examples of unproven products. 37signals makes
millions of dollars a year, which is what makes them credible.

~~~
pius
What makes you say they're proven or unproven? They've each got hundreds of
users and I can say that they each have at least one paying customer (my
company).

~~~
tptacek
Hundreds of users, you say!

~~~
pius
_Hundreds of users, you say!_

Oh, the sarcasm! Perhaps if you'd actually watched the talk before commenting
on it, you'd have gotten the point and wouldn't be so unknowingly ironic. ;)

<http://news.ycombinator.com/item?id=168378>

~~~
tptacek
Tell me right now that the talk establishes that GitHub and Lighthouse are
financially successful (cash flow positive after investment) and I will:

* Apologize

* Watch the video

I don't think I'm going to have to do either.

The point I'm trying to make is, just because geeks love something (like,
inexplicably, GitHub) doesn't mean it's necessarily a financial success. Also:
hundreds of end-users? A tiny customer base.

~~~
pius
It doesn't really matter much to me if you watch the video or not. I did want
to take the opportunity, however, to give you a taste of your own medicine
after this incident: <http://news.ycombinator.com/item?id=135296>. ;)

All that aside, the whole point of the talk was that one can live very well
off one's web application even if it's only moderately successful. I think the
example he gave was 2,000 small business users at $40/month ~= $1,000,000/year
in gross revenue. Or 400 users at the same rate if you don't mind only
grossing $200,000 a year.

His argument was that you don't need to stress about investors, 12-hour days,
and viral loops as long as you're willing to "settle" for a pleasant,
financially viable, and capital efficient business with a niche of users who
really appreciate your approach to solving their problems. That's the irony of
making fun of an app in this thread for only having several hundred users.

You probably would enjoy the video; I certainly did.

(Incidentally, GitHub and Lighthouse didn't require massive capital
investments [1] and I'm pretty sure that they're hosted "for free" on Engine
Yard. Having a few hundred users would practically guarantee that they're
cashflow positive.)

[1] [http://www.akitaonrails.com/2008/4/21/chatting-with-chris-
wa...](http://www.akitaonrails.com/2008/4/21/chatting-with-chris-wanstrath-
err-the-blog-github)

~~~
attack
You could generally get 100 million free users for every 2000 40/month
customers. Price curves, check them out!

Very, very, hard. See my 1% comment.

~~~
pius
There's a big difference between courting small businesses (which is what DHH
was talking about) and courting individual consumers (who are preconditioned
not to spend money on webapps). Depending on the sector, people won't even use
your app _unless_ you charge for it.

------
goelp
dropsend.com - surviving in a particularly crowded market of sending big files
over the web and charging for it when there are free services available.
Though, they are backed by a HUGE marketing power of Carsonified.

------
nazgulnarsil
a few people mention it but it doesn't seem to get zeroed in on.

don't just build a solution, build an elegant solution. ideally one that is
practically transparent to the people using it. I think people constantly
forget that the vast majority of computer users wouldn't know the difference
between the internet and their desktop much less between campfire and
huddlechat.

------
dominiek
freshbooks.com

------
terpua
lessaccounting.com

Key characteristic: a real problem being solved and customers willing to pay
for a solution. In the case of lessaccounting, mom-and-pop shops (online and
off) that don't use quickbooks or find quickbooks too complicated.

~~~
davidw
Seems pretty new. We have information about things like smugmug or 37signals
being profitable for a number of years...

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agentbleu
How about all the many online shops that sell actual products, and others that
fall below the radar, that sell everything from property advertising to job
listings.

------
agentbleu
virtualmin

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asdflkj
"37signals/DHH style" companies--in other words, not startups? This is
interesting, because his advocacy of non-startups is an oblique way of saying
"don't start startups". I wonder, did PG and others even know what the talk
was gonna be about?

~~~
davidw
This doesn't deserve to be at -5. Let's leave that kind of trashing of
comments to other sites, unless it's something blatantly trollish.

~~~
petercooper
It does. He seems to be implying that small companies (or companies with
modest expectations) cannot be considered "startups" when, in fact, that's
nearly always what they are.

~~~
davidw
I agree that he's wrong. So vote him to -1. No need to keep going after that.

