Monday, December 14, 2009

Business ecology and the four customer currencies

Lately, I’ve been rethinking the concept of “business model” for startups, in favor of something I call “business ecology.” In an ecosystem, each participant acts according to its own imperatives, but these selfish actions have an aggregate effect. Some ecosystems are stable, others malign, and others grow and prosper. A successful startup strives for this latter case. I think this concept is necessary in order to answer the truly vexing startup questions, like: “Should startups charge customers money from day one?”

Let’s begin with the four customer currencies. I had a lot of use for this concept back when I worked on game design and virtual worlds. In order to maintain game play balance, game designers have to take into account the needs of customers who have an excess of four different assets: time, money, skill, and passion.

If players with more money than others can simply buy their way to the top of the heap, a multiplayer game fails – because this makes the game un-fun for other players. The same is true if kids who have an unlimited amount of time on their hands are guaranteed the top spot – this isn’t going to be very fun for the busy professionals who want to play only casually. Chess is only fun for those who have the requisite skill to play well – and even then, only if there are ranking systems to make sure that players of relatively equal skill play each other. If you could buy a higher chess ranking or, worse, simply grow it by logging more hours, that would ruin the system for everyone. And passionate players are often the backbone of game communities – especially online. They run the clubs, forums, groups and mailing lists that make the game more fun overall. If they are barred from participating (say, because they lack the skill needed to prevent advanced players from killing them all the time), the game is worse off.

Each of these four currencies represents a way for a customer to “pay” for services from a company. And this is true outside of games. Constructing a working business model is a form of ecosystem design. A great product enables customers, developers, partners, and even competitors to exchange their unique currencies in combinations that lead to financial success for the company that organizes them.

Here’s the ecosystem we built at IMVU, just to give one example. We cultivated a passionate community that nurtured a skilled set of developers. Those developers create an incredible variety of virtual goods: 3D models, textures, homepage stickers, music, and much more – more than three million in total last time I checked. This variety entices millions of end-users to invest their time and passion with IMVU, providing many incentives for a small fraction of those users to become paying customers. Those paying customers provide IMVU with sufficient profits to reinvest in the core experience for everyone. It’s a working, growing, ecosystem.

Having a balanced ecosystem is what game designers strive for. But startups strive for something else: growth. Thus, business ecology is concerned with both ecosystem design and finding a driver of growth for that ecosystem. In a previous post, I covered the three main drivers of growth: Paid, Sticky, and Viral. When a startup finds a working value-creating ecosystem that supports one of these drivers of growth, watch out. They’re off to cross the chasm.

And this is why questions like “Should a company charge money from day one?” are nonsensical. Some companies definitely should. Others definitely shouldn’t. In order to tell which is which, you have to understand the unique ecology of the business in question.  Let’s look at some examples:

  • In a traditional business, customers pay money for a physical artifact (a product) or a service. Companies use that money to market the product or service to more customers. This is the simplest ecosystem and simplest driver of growth. A business that strives for something like this should absolutely be charging money from day one, in order to establish baselines for their two key metrics: CPA (the cost to acquire a new customer) and LTV (the lifetime value of each acquired customer). In other words, the minimum viable product is designed to answer the question: does the product generate enough demand and margin to support a growing ecosystem?  
  • Now consider a traditional media business. By paying money to content creators (ie writers, producers, talent), the business uses builds up assets that are of interest to other consumers. Those other consumers pay for this content sometimes with money, but more often with their attention. This attention is valuable to yet another set of people: namely, the traditional businesses (see above) who are using marketing to grow, and are looking to advertise to new prospects. The value of the attention that the media company collects determines how profitable it is. In the old days, these media companies would then themselves plow this profit back into marketing and advertising, and grow. Today, many of these businesses are suffering because the ecosystem no longer balances thanks to the Internet. (Sorry about that.) If you’re starting a new media company, does it make sense to charge from day one? Probably not – you need to be finding an audience, making sure that audience will trade you their attention for your content, and – most importantly – establishing a baseline for how much that attention is worth to advertisers. A minimum viable product in this category must answer the question: does my media content or channel command the attention of a valuable audience?

  • Let’s look at a viral growth company, like Facebook. They are a classic case of a company that doesn’t seem to care about charging customers money. Here’s Andrew Chen’s description:

    “it strikes me that consumer internet companies often don’t care much whether or not they have viable businesses in the short run. If you are building a large, viral, ad-support consumer internet property, you just want to go big! As soon as possible!”
    This is a common sentiment, but I don't agree. I think it uses the phrase “viable business” in too narrow a sense. When Facebook launched early-on at college campuses, it was immediately apparent that they had a viable business, even though they weren’t charging customers for anything. Why? Because they were collecting truly massive amounts of attention and they had an amazing driver of growth. Those two factors made it relatively easy for them to raise enough money to avoid having to build a profitable business in the short term. But that doesn’t mean they didn’t have a viable one. The ecosystem worked, and was growing. Figuring out how to turn that attention into cash seems to have been pretty obvious to Mark Zuckerberg. For a true viral ecosystem, the minimum viable product is designed to answer the question: can I unlock viral growth mechanics while still keeping my ecosystem alive? As many viral companies have found to their chagrin, quite a few viral products are fundamentally useless. Although they grow, they don’t actually collect enough of any customer currency to be viable.

    In fact, the viral metaphor is actually more apt than many people realize, once you look at it from an ecological perspective. Facebook is actually quite rare – many other viral products didn’t really build their own working ecology: they colonized someone else’s. That was true for Paypal cannibalizing eBay, YouTube and MySpace, and could still be true of Slide, Zynga, or RockYou – we’ll see.

    Now, Andrew’s excellent piece that I quoted from above correctly diagnoses two situations where consumer internet companies often get in trouble:

    1. They focus too much on short-term revenue, getting caught in a local maximum via constant optimization. They aren’t really engaged in customer development, they aren’t getting inside their customers’ heads, and they aren’t crafting a robust ecosystem. For a consumer internet company in particular, this is often due to a lack of design thinking.

    2. They get focused solely on growth. This isn’t helpful either, as countless companies have shown. If you haven’t figured out the ecosystem, growth is useless – whether it is a acquisition-only viral loop, like Tagged, or an advertising blitz like countless dot-bombs.

  • Let’s consider one last example, a sticky-growth company like eBay or World of Warcraft. Here the goal is to create a product whose ecosystem makes it hard for customers to leave. eBay offers their customers an opportunity to monetize their skill and passion via online trading for hard currency. World of Warcraft offers beautifully balanced and addictive game play, for which customers trade all four currencies in bewildering combinations. Like eBay, these investments are best understood as trades between players, which is what makes multiplayer game design so much harder than its single-player counterpart. What these products all have in common is the question their minimum viable product is attempting to answer: does this product have high natural retention built-in?

Understanding the four customer currencies allows us to avoid these problems, and also unify a number of different concepts that have been floating around. Take the minimum viable product, for starters. How should the word viable be understood? Here’s the original definition I proposed for MVP:
“the minimum viable product is that version of a new product which allows a team to collect the maximum amount of validated learning about customers with the least effort.”

Of course, this begs the question: what are we trying to learn? Now I think I can answer this question with some certainty: we want to learn how to construct a business ecology harnessed to the right driver of growth. And how do we validate that learning? By creating a model of the ecosystem we want, and showing that actual customer behavior conforms to that model. And, of course, if customers don’t behave the way we expect, it’s time to pivot.

That necessarily means that different types of startups will be seeking to learn different things. Minimum viable product is a tactic for mitigating risk. It doesn’t say anything about which risks it should be used to mitigate. Startup founders need to use their own judgment to ask: which is the riskiest assumption underlying my business plan? In each of the ecosystem examples I gave above, the tactics of the minimum viable product are quite different. In some cases, Tim Ferriss-style landing page tests will suffice. Others require Steve Blank-style problem/solution presentations. And others require an early product prototype. The level of design required will vary. The level of engineering quality will vary. The amount of traditional business modeling will vary.

And now we can answer the biggest question of all: how do we know it’s time to scale? Or, to borrow Steve Blank’s formulation, how do we know it’s time to move from Customer Validation to Customer Creation? I think I have a solid answer here too: when we have enough data that shows our business ecology is value-creating and also ready to grow via a specific driver of growth.

Founders struggle with this question. Successful startups don’t. In almost every case I’m aware, the question never had to be asked. When an ecosystem is thriving and growing, it takes work just to keep up with its scaling needs. This was true at Facebook, eBay, and Google – and at countless other successful startups. Marc Andreessen has already coined a phrase for what it looks like: product/market fit. One clue that you don’t have product/market fit – you’re trying to evaluate your business to see if you have it. It’s probably time to pivot.

These concepts have important implications for any lean startup. My whole goal with the lean startup movement has been to learn how to tell the difference between value-creating activities and waste in startups – and then to start eliminating waste. In an entrepreneurial situation, this is hard, because artifacts that we are creating (products, code, marketing campaigns, even revenue) are of secondary importance. The real value we create is learning how to craft profitable ecosystems. Even then, it’s the learning that’s the real value. So, when evaluating any activity, ask: is this helping me learn more about my startup’s ecosystem? If not, eliminate it. If so, ask: how could I get even more learning while doing even less work?

Most of all, beware one-size-fits-all startup advice. In order to figure out what applies to your unique situation, focus on the principles. Who are the customers? What currencies do they have? And what problems do they need solved? Look for a balanced ecosystem and a driver of growth. And be sure to hold on to the reins once you find it.
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