
How to create a profitable Freemium startup (spreadsheet model included) - prakash
http://andrewchenblog.com/2009/01/19/how-to-create-a-profitable-freemium-startup-spreadsheet-model-included/
======
daveungerer
As someone who's been building financial models for a living up until
recently, I have to say that this model isn't very useful as it doesn't answer
the most important questions.

The OP focuses entirely on the time period where the revenue line finally
catches up with the cost line, i.e. profitability has been reached. But guess
what? See all the time periods before that, where the business is running at a
loss? Where is the money coming from to fund those losses? That's the up-front
investment required - VC, loans or digging into your own pocket.

So that's the first important yet unanswered question: what is the up-front
investment before the business can sustain itself?

The second is to calculate the ROI for the above investment, but with a twist:
calculate the average ROI at every time period, taking into account all
periods before the period being calculated for, but ignoring all future
periods. This will provide you with a very important result: you will see that
the average ROI remains negative long after your business becomes profitable.
You will also see in which time period your ROI reaches an acceptable level -
a very important factor when risk is considered.

Yes, it's just a model driven by assumptions. But with the above metrics, you
can play with the assumptions (worst, best case etc.) and get meaningful
results for decision making.

Disclaimer: The above explanation has been simplified quite a bit. Liberties
have been taken with definitions. All your base are belong to us.

~~~
andrew_null
I am the author of this blog post - good points on this from a financial
perspective. I can tell you were building financial models for a living,
because you think ROI is the most important question for entrepreneurs ;-)

For startups, the most important things are good products and good markets.
Successful angels and VCs know that, and will invest based on product and
growth, NOT financial metrics. Thus, in very few VC pitches will you ever see
stats on ROI or payback rate, that's more something you'd seen in the
accounting or I-banking world. (I know this from personal experience, having
spent the last year at a silicon valley based VC and seeing dozens of pitches)

So if entrepreneurs are primarily focused in the world of products, features,
etc., then the key thing is to figure out the metrics that measure how these
products tie to external market value. So things like conversion rates in
funnels or cost per acquisition become super important, because the features
are the steering wheel to your revenue engine. As a result, the spreadsheet
model is mostly focused on things that are granular enough to relate to
product and functionality, rather than things like valuation multiples or ROI
or other overly-broad financial metrics.

~~~
daveungerer
If financial metrics are not important for entrepreneurs, and if the most
important things are good products and good markets, then why did you write a
whole article on creating a PROFITABLE freemium startup? Do you think profit
is not a financial metric?

Of course it is, just not as useful in this situation. Hence my suggestion to
use metrics that are more meaningful. The metrics that are useful should show
you what the risk / reward is for pursuing the business.

It is very important for any entrepreneur to estimate how much investment is
required to cover initial operating losses and capital expenditure. It is just
as important for them to determine whether this investment is worth the
expected future profits.

Just to drive the point home: you can spend 1 billion dollars in year 1 on
advertising, if you had the money. And year 2 will be profitable. But you have
a terrible business if the profit curve over the next years isn't steep enough
to offset the original investment. Simply making profits is not enough.

------
steveplace
That revenue model in the graph is quite Madoff-esque.

~~~
jwesley
I was hoping the included spreadsheet model would be enough to secure funding.

~~~
steveplace
First you have to overlay an exponential curve of user growth, and then you're
set.

~~~
alain94040
It was enough 6 months ago.

Today, the only extra thing you need to add to secure funding is that instead
of your data coming from Excel, it must come Google Analytics.

Replace projections with reality. That's all it takes.

<http://fairsoftware.net> \- geeks and businesses combined

------
sayrer
so, this guy who founded an ad network is telling you to spend 35k on ads when
you first start your business.

who voted this up? do you people even know what Y Combinator does?

~~~
andrew_null
I'm not suggesting that.

You should run small experiments (<$50) per day until you figure out that you
get can profitable. Only then do you scale up. The point is understanding what
the microeconomics look like, so that you know how to grow the business over
time profitably.

If you can go viral, that's even better obviously. I've written extensively on
that also - and it's my preferred approach. But it's just true that for most
subscription products, it's easier to buy the users than to acquire them
virally.

~~~
rrhyne
His post is very valuable for those apps where value is not derived from how
many friends you have using the service with you.

------
pclark
a lot of "social" startups are services where advertising online does not
generate _users_.

~~~
jfornear
I'm not sure what you mean by that.

I run a small social network, and advertising has 'generated users' at a much
higher rate than any other method.

------
rokhayakebe
If you must spend 80k to make 120k you are in a bad business. EDIT: Really
Bad.

~~~
utnick
really?

a 50% ROI seems pretty good compared to traditional businesses

~~~
rokhayakebe
Lets note that 95% of small businesses make less than 250k.

If a business spends $800 and makes $1200 that is great. The risk is small. If
the same business spends 8k to make 12k that is great. The risk is bigger but
relatively small. If the new hired gun, self-proclaimed-marketing-guru,
decides to jack up ad spending to 80k to make 120k, someone is betting too
high now.

Asking if this model is scalable is bringing emotion into this scenario which
will guarantee you failure sooner or later.

At one point you will reach the amount at which spending more on ads will not
increase your revenue. I guess that is when justifying "branding" comes.

