How Much Monetization is Enough?

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*note: Last week I wrote my first post for the Superfluid blog.  Going forward, I will be posting over there once a week.  I encourage those readers interested in alternative currency and P2P exchange will check it out.

How much monetization is enough?

This is the question of our day, showing up in numerous different forms.  In some forms it comes across as a normative question, “Do CEOs deserve the exorbitant salaries they earn?”.  If you prefer, insert “bankers” or your personal favorite demonized profession in place of CEOs.

As technology allows amatuer enthusiasts to do more and more free we face a steady stream of new versions of this question.  Do creative professionals inherently deserve a minimum rate for their work (read: Should the law favor IP monetization)?  Does a society need a professional (read: monetized) class of journalists?

Though the debate is likely a lost cause as regards dying industries like traditional recording and journalism, it is more pertinent in domains that are likely to remain fixtures for some time to come.  Should a start-up monetize early or grow it’s user base first?  Should a blog be a business?  How much content should you give away for free and at what point is it reasonable to erect the freemium paywall?

Shades of this question even appear in seemingly unrelated debates.  Much of the current controversy related to the value of higher education ultimately hinges on whether you view education as a financial investment or an intrinsic reward.  On one side of the debate are people arguing that higher education is a bubble and no longer justifies its cost.  On the other side are people who insist that the value of education shouldn’t be judged in terms of financial rewards.  Ultimately these two sides differ in their answers to the question: “To what degree should you monetize your education?”.

The current trend is clearly towards less monetization.  First I want to point out one underappreciated driver of this trend.  Then we will examine the dominant monetization strategy that has arisen in response.

Friction and Asymmetry

In a recent blog post Alan Rosenblith outlined Three Types of Economic Interaction:

    1. You’ll do that (force/coercion)
    2. I’ll do this IF you’ll do that (symmetric transaction)
    3. I’ll do this

Depending on the context, the third type might be called a gift, or intrinsically motivated production, or an asymmetric exchange.  The key point for our purposes is that this third type is frictionless.  Alan explains:

Gone are any of the inefficiencies of force, or of haggling out a deal.

When people share common goals, reciprocity just gets in the way.

Here he means reciprocity in the sense of a negotiated or enforced transaction.  The need for negotiation or formal transaction is a significant source of friction that discourages value exchange.  The friction comes not only from the money required in the transaction but also in the need to transact in the first place.  Clay Shirky nailed this explanation all the way back in 2003, explaining why micropayments don’t work:

The people pushing micropayments believe that the dollar cost of goods is the thing most responsible for deflecting readers from buying content, and that a reduction in price to micropayment levels will allow creators to begin charging for their work without deflecting readers.

This strategy doesn’t work, because the act of buying anything, even if the price is very small, creates what Nick Szabo calls mental transaction costs, the energy required to decide whether something is worth buying or not, regardless of price.

Worse, beneath a certain threshold, mental transaction costs actually rise, a phenomenon is especially significant for information goods. It’s easy to think a newspaper is worth a dollar, but is each article worth half a penny? Is each word worth a thousandth of a penny? A newspaper, exposed to the logic of micropayments, becomes impossible to value.

Free is on the rise because it eliminates this friction.  It is not just that people don’t like spending money.  People don’t like being forced to debate whether they should spend money. This is the same feeling you get when you enter a car dealership or a similar high-pressure sales environment…we feel uncomfortable being forced to say, “I’m just looking”.

In a fast-moving economy, frictionless exchanges are vastly more efficient and more appealing to consumers and users of all sorts.  This state of affairs leads directly to the dominant business model for internet businesses…

Grow First, Monetize Later

Grow first, monetize later has become the default strategy for large social networks, single author blogs, leading content destinations, freemium service businesses, and internet ventures of nearly every other sort.  The goal in nearly all cases is to create some degree of user lock-in.  Once users come to rely on a given service the friction described in the previous section is presumed to be less of a deterrent as users develop a sense of gratitude, loyalty, or dependence.

There is quite a bit of sense to this model.  Creating a worthwhile product requires significant investment of time and money.  If entrepreneurs succeed in creating a valued product then eventually they deserve to be rewarded.  Moreover, honest consumers should presumably want to reward creators, both as compensation and as support for future value creation.

The problem with this model is that the very existence of user lock-in creates a moral hazard.  Time and time again, businesses that succeed with this strategy proceed to shift towards the opposite extreme and attempt to exploit their dominant position.  This is what Sebastien Paquet referred to in a comment as the “milking” phase.

One prominent example, Apple was just recently forced to backpedal on app store subscription rules because some prominent publishers were leaving the app store platform altogether.  And this temptation is not restricted to industry dominating bohemoths.  I have witnessed dozens of high quality blogs become cheap profit-maximizing content marketing businesses as soon as they gain popularity.  Products like Pandora, popular but hardly dominant, are increasingly plastered with advertisements as they enter the milking phase (Pandora just IPO’d at a valuation of $2.6 billion).

I do not bring this up to demonize profit motive, but instead to point out that the milking phase is destructive.  In the large majority of cases, products become worse once they enter the milking phase.  The quality of the early product allows these companies some room to run, but the focus on profits becomes unsustainable and eventually drives users away.  We are witnessing this currently with Facebook, which was reported today to be losing US users.  Though Facebook will almost certainly maintain it’s position for some time to come, it’s focus has clearly shifted away from features that benefit users and towards features that maximize revenue…and to the user’s detriment.

So, How Much Monetization is Enough?

Ultimately I return to the question I started with.  When revenue opportunities are divorced from any obvious direct costs, how does a company know when monetization has gone far enough?  I can’t claim to offer any obvious solution.  However, there are counter-examples we can look to that have avoided the milking phase and enjoyed remarkable longevity as a result.  Craigslist is one example of such a company at the far opposite extreme, surviving virtually unchanged for over a decade.

What examples have you seen, positive or negative?  Who strikes this balance perfectly?

photo courtesy of Jim Rees

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  • Danny Iny

    Hmmmm… good question, Greg. It all comes down to the question of WHY – why are you in business, why are you getting the education, etc.

    If it’s for fun, then monetize as much as you want or don’t want.

    If it’s with the intention of having a return on your investment, then it becomes a strategic question of how much return do you want and is reasonable, and what is the best way to get it.

    Does that make sense?

    • GregoryJRader

      Hey Danny,
      That last part, what is reasonable and how best to get it, is the part I am most interested in.  Obviously there is a balance somewhere between the worst offenders and something like craigslist.  I would say google has managed this relatively well.  For the most part their advertising has remained understated and avoided diminishing the value of their product and their dominance for 10+ years reflects that.  

      Ultimately this is a question about what customers or users view as fair.  I doubt many people think google is “milking” them.  Many developers did think apple was milking them and threatened to abandon the platform until the app store rules were changed.  It is well within any company’s rights to attempt to maximize profits, but there is a balance to be struck such that a short term profit focus doesn’t lead to a short life span.  

      • Danny Iny

        I agree, and it’s really a strategic choice; if the customer doesn’t perceive it as fair, then they won’t continue paying it unless they really have to… it might mean more profits for the company in the short-term, but less in the long-term.

        • GregoryJRader

          As I think about this more I am focusing in on two issues.  First, when you are monetizing indirectly then I suspect the user response is also less direct.  Users who have invested in a given service might put up with an interface plastered with ads for some time, but they will gradually become more likely to experiment with other services.  

          I also wonder whether a ‘scale first, monetize later’ strategy makes you particularly vulnerable to disruption by competitors/alternatives that are still in the scaling phase.  Myspace is an obvious example of a company that overestimated the strength of their network effects.  They got huge, decided to cash in, and in short order were on the decline.  

          • Danny Iny

            I think it depends on the extent to which the monetization impedes/complements the user experience. Look at Google, for example – the ads actually add value.

            That’s a good question about whether scaling first makes you vulnerable, but I think it depends a lot on the configuration of value. I also think that MySpace’s problems were more to do with having targeted a very fickle market with a “good enough” kind of solution. That’s just asking for disruption…

          • GregoryJRader

            Yes, that is it exactly!  If monetization actually makes the product better then you have yourself a clear win.  Your google example also applies to craigslist – when people repost the same listings on  a daily basis, charging a small sum for listings actually improves the user experience, removing clutter.  Also when you are dealing with something that is actually scarce there is no conflict.  Monetizing consulting hours obviously makes sense because the supply of such hours is scarce.  Potential problems occur when we lose sight of what is actually in low supply and/or high demand.

            I agree that the Myspace case is more complicated than my simple description but it alludes to a more general point congruent with your reference to a “‘good enough’ kind of solution”:  

            If you can’t find the google/craigslist win/win solution then your monetization efforts are opportunity losses to users.  Another example I love to hate on is Twitter’s sponsored trends…absolutely useless to users.  The more effort and resources Twitter dedicates to building “sponsored” features, the less effort they dedicate to building features that are actually useful to users.  Perhaps the vulnerability I hypothesized in my last comment results from the fact those sorts of features tip both ends of the scale adversely for the user at the same time – adding distraction/annoyance while also taking resources away from beneficial developments.

            As usual Danny, thanks for the conversation.  I need a devil’s advocate to keep me in line and I always enjoy it when we at least converge towards similar (if not identical) conclusions ;)

          • Danny Iny

            Always a pleasure, Greg. Ultimately we’re both about value to users, and companies getting fairly compensated by offering good stuff – that’s a pretty good point of convergence, no? ;)

  • Gene Linetsky

    I think Danny’s “WHY” is the flipside of what I think is a key line in the post: “People don’t like being forced to debate whether they should spend money”.

    By now we may as well rephrase it as “People don’t like being forced to debate whether they pay attention”.

    If I know why, I don’t have to debate. At the moment, the debate-elimination mechanisms most people use when they don’t know upfront what they want (in which case they go to Google, Wikipedia, or Amazon) is group filtering. If it’s coming from a person I like or filtered down to me by people I like, I’ll pay attention.

    So Twitter and FB and Quora work precisely because they remove the attention-worthiness debate. Secondarily, of course, they are personae broadcasting platforms that create tiny illusions of control and influence and thereby make us a bit happier, post by post.

    To the extent monetization jeopardizes either of these value propositions, it’s too much. FB has had a pretty long history by now of overshooting on and relatively quickly correcting the monetization burden it places on users. If it can keep up this balancing act, the future is still ahead of it.

    So the answer is, I think, straight out of The New Kind Of Science: there only way to find out is to run the program and see what happens.

    • GregoryJRader

      Nicely done Gene.  This brings to mind one of my favorite features on the various services I use, Pandora’s “Why was this song selected for me?”.  Even when Pandora gives you a song you absolutely hate you can hit that feature and find that at least it had some basis for the selection.  So part of the equation is demonstrating to the user that the platform is trying to work for them, that there is some effort being made to find those monetization opportunities that do produce win/win solutions.  Otherwise you end up in the domain of banner ads, where users train themselves to ignore completely.  

      • Gene Linetsky

        Totally agree. I wish FB explained why it shows some posts in Top News and hides others. Not in general terms that are more or less obvious, but in particulars related to my interactions, direct or indirect or deduced, with this one poster.

  • Stefan King

    Maybe it depends on the power relations between the investors. Google is indeed a good example of maintaining a balance. The founders still control enough of the company to keep executing their vision and set the pace.

    A case similar to Craigslist is PlentyOfFish, a fairly successful dating site that is run by the founders. Because it takes so few people to run, they get rich individually, without having to cash out to satisfy VCs.

    The more investors you have, and the bigger their investment, the more likely they want to cash out fast and move on.

    • GregoryJRader

      Yes, this is a great point, and particularly true when the investors are only fiduciaries (VCs) acting on behalf of the primary investors (LPs).  This is classic principle/agency problem.  Founders are likely to have significant intrinsic interest in the success of a company/product/project.  Direct individual investors (investing their own funds) likely have less interest than the founders but will tend to gravitate towards businesses in which they have some intrinsic interest.  By contrast, managed investment through VC funds and the like will necessarily emphasize financial return above all else.  

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