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How to Project Customer Retention for a Subscription Business August 6, 2012

Posted by seanrmoran in 2012, ltv, models, subscription.
Tags: , , ,
2 comments

We’ve posted before about how to estimate lifetime value (“LTV”) for an ecommerce business and for a subscription business, and have provided a sample cohort analysis for each (ecommerce and subscription).  This is one of the most important factors in understanding unit economics.

Recently, Eric Liaw sent us a very interesting May 2006 paper entitled “How to Project Customer Retention”, authored by marketing professors Peter Fader (Wharton) and Bruce Hardie (London Business School) and published in the Journal of Interactive Marketing in 2007.  In it, the professors explain how previous attempts to project retention rates using line-fitting regression models failed, even after introducing quadratic or exponential functions.  Since we had advocated essentially using an exponential line fit for subscription LTV estimation, we figured it was worth reading.  The authors show that exponential form fitting is too conservative and underestimates actual retention rates.

Professors Fader and Hardie decide to start from scratch with a simple assumption: what if each customer has a fixed probability of renewing his or her contract at the end of each period?  So if I’m a big movie fan, let’s say I’m 80% likely to renew Netflix each month, but you’re caught up on Breaking Bad and only 30% likely to renew each month going forward.  Probability varies by customer, but each customer’s rate remains constant over time.

It turns out that, based on probability theory, this simple assumption implies that the distribution of renewal rates can be characterized by a statistical model.  Over time, the difference in each individual’s probability to renew suggests that individuals with lower renewal probabilities will generally drop out before those with higher probabilities.  Incidentally, this also explains why incremental retention may appear to improve over time, when it’s actually a likely side effect of the remaining customer mix.

After some mathematical gymnastics, the authors unveil the model they’ve derived: the shifted-beta-geometric distribution.  The authors tested the model by using the first seven years of data from a given sample to project renewal rates at the end of the final five years in the sample.  The model proved to be quite accurate, within 3% of actuals, and much better than linear or exponential form fitting.

A few quick caveats: this model is appropriate only when the data reflects a discrete renewal period, such as a defined monthly or annual cycle.  Also, the model should be reserved for projecting behavior in contractual settings, such as subscription renewals and other observable customer exit points, rather than ecommerce or other businesses where the customer can remain dormant for long periods between orders.

We’ve uploaded a spreadsheet here, along with directions for how to use it yourself.

Hope this is helpful.  We look forward to hearing from you regardless, but especially if:

1)    You use the model and have any feedback on results

2)    Your company uses any other methods to capture, analyze, and project customer retention

3)    Your innovative company achieves valuable unit economics.  As previously mentioned, we like to see LTV / Customer Acquisition Cost > 2.5 and payback periods under 12 months.

If you found this post useful, follow us @lightspeedvp on Twitter.

Subscription business models are getting their day in the sun March 7, 2012

Posted by jeremyliew in Ecommerce, subscription.
6 comments

Today’s NY Times notes that subscriptions are all the rage in ecommerce. It features three of our portfolio companies. Alex Zhardanovsky, cofounder of Petflow*, and Azoogle before that, is one of the people interviewed:

But he had an idea to build the business by taking a different approach to sales. While selling online ads, he had seen other companies, like Netflix, persuade consumers to lock in monthly fees for repeat orders. Those companies, he believed, were generally more successful and thus bought more of his ads. For his new business, Mr. Zhardanovsky’s plan was to sell dog food on a subscription basis. He figured that other pet owners had experienced the same frustrations keeping the food stocked and might be willing to sign up for a monthly delivery service as well. “Dogs never stop needing to eat,” he said….

In its first month, July 2010, the company shipped about 60 orders; by January of this year, that number had leapt to 27,000. In 2011, PetFlow exceeded $13 million in revenue — with 60 percent of its sales coming on a subscription basis — and it projects revenue will exceed $30 million this year. “I’ve come to appreciate,” Mr. Zhardanovsky said, “that subscription models are, in so many ways, the holy grail of business.”

Brian Lee, cofounder of Shoedazzle* with Kim Khardashian, is also quoted:

“A subscription model allows you to establish long-term relationships with customers as opposed to selling them one pair of shoes and hoping they come back,” said Mr. Lee, who also was a founder of LegalZoom. It was his experience at LegalZoom, a legal-document business based on single transactions, that prompted Mr. Lee to look for recurring revenue: “I wanted to start a business where you didn’t have to worry as much about whether the customer would come back.” The idea of using a subscription model to sell shoes came to him, he said, after he realized how many shoes his wife was buying on a regular basis.

The Times also notes where the subscription model works best:

Given the experiences of companies like PetFlow, ShoeDazzle and BabbaCo, it is tempting to wonder why not every company is trying a subscription model. And, in fact, Brian Lee, the founder of ShoeDazzle, said he frequently heard pitches from entrepreneurs who wanted to create the ShoeDazzle of wine or underwear or some other product. “I think subscription models work best in two instances,” he said. “Where the product is a necessity or when it’s an absolute passion. It stops making sense when you try to do something like a tree-of-the-month club, which doesn’t fit either of those categories.”

Taking his own advice, Mr. Lee recently founded another subscription-based business, this one with Jessica Alba, the actress. It is called the Honest Company*, and it ships diapers and other baby products.

We’re proud to be backing such great companies and entrepreneurs.

* Lightspeed Portfolio Companies

How to estimate Lifetime Value; Sample cohort analysis July 19, 2010

Posted by jeremyliew in Ecommerce, ltv, subscription.
42 comments

In many businesses, repeat purchase behavior is a key driver of value. Many companies track % of repeat purchases as a key business metric. This is useful in steady state, but can sometimes be quite misleading if the company is showing substantial growth. By definition, growth implies many first time customers, and the mix of these new customers can distort the view into how much repeat purchase behavior is actually occuring.

I prefer to try to analyze repeat pruchase behavior, and hence, estimate lifetime value, by doing cohort analysis. This is approximate by definition, but it can give you some sense of lifetime value well before you actually see a full customer lifetime, which can help in accelerating decisions about marketing and customer acquisition.  I recently posted about how you can improve LTV and CAC for your subscription or repeat purchase business.  But how do you estimate Lifetime value?

I’ve uploaded a spreadsheet with a  sample cohort analysis, using representative but dummy data to illustrate how to do this.

In this particular example, I look at a hypothetical subscription business. Assume that the business has been in operation for one year. First, divide the users into cohorts depending on when they initially subscribed to the service.  I calculate retention at the end of month N by dividing the number of subscribers still subscribing after month N by the total number of subscribers that started in each cohort.  These are the numbers in blue. Obviously, for the subscribers that started in month 1, we have 12 months of retention data, for the subscribers that started in month 2 we have 11 months of retention data, and so on.

By averaging across the cohorts, you can get an average retention rate at the end of one month, two months and so on. As the cohorts age, there are fewer datapoints to average over, and hence the potential for error is greater. However, it is still a useful exercise to get an early indication of how the business looks.

A typical pattern found in subscription businesses is that after a steep drop off after an initial period, month-on-month attrition rates tend to level off. You can see a similar pattern in this example, where after the first month, month-on-month attrition rates are around -6% (ie month N subs ~ 94% of month [N-1] subs).

If you see a pattern like this, you can extrapolate forward using the same month-on-month attrition across several years. As you can see in the model, we extrapolate an average lifetime of 9.77 months by extrapolating forward over 5 years of data.

So if you were a subscription business charging $20/month with 90% gross margins (after accounting for customer service costs for example), then you would attribute a lifetime value for a new customer of 9.77 x $20 x 90% = $176. This sets an upper bound of what you would be willing to pay to acquire a customer (although in practice, you would prefer to see a ratio of CAC/LTV in the 25-35% range).

This example is for a subscription business where the key value driver is the number of active subscribers. However, you can conduct similar analysis on any type of repeat behavior business. In a social business the metric might be activity (e.g. how many users posted a photo this month), and in a social game the metric might be dollars spent in virtual goods that period. The measurement periods may vary according to the tempo of the business. Many social games do their cohort analysis on a daily or weekly basis,  whereas some ecommerce companies whose purchases are less frequent may do their cohort analysis on a quarterly basis.  This will dictate how long you have to collect data before you have enough data to project forward.

Different billing mechanisms can complicate this (e.g. an annual billing system will by nature skew average lifetime upwards) and while these can be important levers, it is usually helpful to hold billing constant and compare cohorts on a same-billing basis, at least initially. However, this cohort analysis is also useful tool to see what the impact of changes in billing, registration flow, product features etc can have on retention as you can often see an increase in early month retention from later cohorts.

The spreadsheet for the sample cohort analysis is read only but you can download it to play with it yourself.

I’d love to hear from others how they estimate lifetime value.

UPDATE: June 2012 – I have a new post describing how to estimate lifetime value for an ecommerce business using cohort analysis.

Why Lightspeed invested in ShoeDazzle April 28, 2010

Posted by jeremyliew in Ecommerce, growth, subscription.
Tags: , ,
12 comments

Lightspeed led a $13m investment in Shoedazzle, announced yesterday. We are very excited to help Shoedazzle grow.

Shoedazzle is one of the companies that I was thinking of when I wrote about startups that can quickly get to millions in monthly revenue:

… are all taking advantage of one of Lightspeeds consumer internet predictions for 2010,  that direct direct response advertising is getting more efficient. A bad time to sell ads is a good time to buy ads. All these companies are taking advantage of relatively low customer acquisition costs.

If you understand your customer lifetime value, and you can acquire customers for 20-30% of the lifetime value, you are going to make money. Understanding lifetime value is hard for media companies, but it’s easier for gaming companies, ecommerce companies and subscription businesses. They have predictable customer behavior cohorts that can be extrapolated from a few months of data from a representative sample.  Running an aggressive positive arbitrage while online media is cheap has allowed all of these companies to grow revenue very fast once they get the micro-economics right.

The company is based outside of Silicon Valley (LA) and is definitely built on the back of business model innovation, as are many of the current crop of fast growth companies.

Shoedazzle has a terrific user value proposition. A member first takes a style quiz to assess her taste. Then, on the first of each month, she receives an email with five pairs of shoes that have been specially selected for her. If she likes one of the pairs, she buys it. If none of them grab her, she can either skip that month, or request a re-selection and give specific guidance as to what she is looking for (e.g. boots, or higher heels, bolder colors). Women get personal stylist advice and recommendations brought directly to them, helping them to keep abreast of the latest fashion trends.

Thematically, I am very excited about the move towards entertainment shopping, and Shoedazzle falls squarely into this category:

One of the most exciting trends in e-commerce over the last couple of years has been the trend towards “shopping as entertainment”. Traditionally e-commerce has been a chore type activity. Customers know what they are looking for (a digital camera, a new laptop) and are looking for the best product and best price with a very “research” based mindset.

This is quite unlike the real world, where a customer might walk around a mall without any particular purchases in mind, and perhaps opportunistically buy something that caught their eye in their wanderings. There is no real “intent to buy” in a trip to the mall.  It is more like entertainment time which may, or may not, lead to a purchase.

SheoDazzle captures the wonderful serendipity of finding something great as you wander the mall, and brings it into your inbox.

Kim Kardashian is one of  the co-founders of Shoedazzle, and has been instrumental to the success of the company, both through her promotion of the site, and through her fashion input into the shoe selection. But this company is about much more than Kim alone. The company prides itself on delivering terrific experiences to its members, and this has resulted in an incredibly strong and positive community, as reflected by the vibrant wall on its facebook page, the constant tweeting on twitter, and even the unboxing videos on youtube.

Notwithstanding Kim and the community, Shoedazzle is about the shoes.  And that is what has let the company grow through word of mouth. This isn’t the manufactured virality that works so well for facebook apps and early social networks, riding the transports of notifications, invites, wall posts or email importation. This is the real thing, with one happy member telling another about where they got their great shoes.

On the flip side, online commerce is an operationally intensive business. With physical goods, you get lower gross margins then you see in online media. In shoes, return rates can be high (Zappos’s average return rate is 35%). If you care as much about member satisfaction as Shoedazzle does, client care needs a lot of resources. And breaking through the noise and clutter on the consumer web is always difficult. Building a business like shoedazzle is not as easy as simply hacking all night for a few days and standing up a website. It requires deep knowledge of merchandising, logistics, customer care, marketing and promotion.

Shoedazzle has a terrific team of experienced, passionate people (with great shoes!) who are tackling this challenge, and at the end of the day, that is why we invested in ShoeDazzle.

Interview with CEO of Zoosk April 8, 2010

Posted by jeremyliew in personals, subscription, virtual goods.
3 comments

Atul Bagga, the gaming analyst at the investment bank ThinkEquity, published an interesting research report today where he interviewed the CEO of Zoosk. I am republishing it here with his permission:

________________________________________________________________________

THINK SUMMARY: We had a chance to speak with Shayan Zadeh, the co-founder and co-CEO of Zoosk, a multi-channel dating service with presence on social networks, online, iPhone, mobile Web, and a desktop application, revenue growing at 20% M/M, and with revenue at more than $2.5 million per month. Zoosk differentiates itself from the traditional dating sites by focusing on relatively younger audience and monetizing users through subscription and virtual currency. The company expects to maintain growth momentum in 2010 through more-aggressive user acquisition, international expansion, and a couple new products. KEY POINTS:

  • Zoosk is a multi-channel global online dating service with presence on major social networks, online, mobile Web, iPhone application, and desktop client with 50 million registered users/14 million monthly unique users, a $2.5 million monthly revenue run-rate (as of October 2009) and a 20% month/month revenue growth. The company expects its revenue to be more than $200 million by 2011.
  • Since Zoosk uses social media and online as user acquisition channels, it has been able to establish a more-global footprint compared to other dating service sites. Zoosk’s user breakup is equally split between the United States, Western Europe, and rest of the world, and the top six or seven countries make up the majority of revenue.
  • Since Zoosk doesn’t focus on traditional success metrics for its dating service (i.e., marriage), its service appeals to younger audience, and 90% of its audience is younger than 40 years old and 60% is younger than 30 years versus the 38-50 years sweet spot for most other dating sites, according to Zadeh.
  • Zoosk uses virtual currency and subscription model to monetize its users, with subscription contributing a major portion of revenue. Conversion rates are in double digits for subscription and higher for virtual currency.
  • While social networks used to be the largest channel for customer acquisition, Zoosk sees a much-bigger audience outside social networks and is now getting more users directly on its destination site via search, display advertising.
  • Since 2007, the company has acquired a chunk of its user base from social networks at nominal cost, and the window for this acquisition channel is now closed, according to Zadeh. He said that creating this size of user base could be very expensive for an incumbent and represents a major entry barrier.

________________________________________________________________________

Atul Bagga, ThinkEquity (AB): Please explain your business and why should investors care about Zoosk?

Shayan Zadeh, Co-CEO, Zoosk (SZ): Zoosk is an online dating service that serves users through numerous channels. We are present on all of the major social networks; we have our destination site on Zoosk.com; we have our mobile Web property, and an iPhone application, and we have a desktop client. From an investor’s perspective, Zoosk is interesting in a few ways. First, Zoosk is the only global online dating company at this scale. The dating business has traditionally been a very local business because user acquisition was usually through old media, which required a lot of expertise in offline advertising conditions in each geographic market. So you have companies like Match.com and eHarmony that are very strong in the United States, Meetic in Europe, RSVP in Australia, and so on. For the first time, we have leveraged social media to get a global reach without having an office in each country that we are presently active in. We are monetizing in 52 countries right now with the service localized in 20 languages.

The second thing that sets us apart is that we approach dating from a different perspective. Usually the success metric for the industry is the quantity of marriages, and how fast your users get married, which ironically results in losing those customers. At Zoosk, we want to give you the choice. If you want to just date that’s absolutely fine with us, and the product doesn’t force you to think about marriage. Because of this positioning, we appeal to younger audiences. We see a lot of users coming back to the site, subscribing, and using the service again.

Finally, our business model is very innovative in the online dating space. While the gaming industry has adopted a hybrid virtual currency slash subscription model for a long time, this is the first time that we are doing it in a dating context, which helps us to maximize customer value by offering services in a la carte fashion, with coins in addition to subscription.

Zoosk was founded in Jan. 2007, and we launched the product in December 2007, and so far we have raised $40 million from investors like ATA Ventures, Canaan Partners, Bessemer, and Amidzad Ventures.

AB: What is the target audience for Zoosk?

SZ: Ninety percent of our users are younger than 40 years old, 65% are younger than 30 years old. This is very different from the normal 38-50 years sweet spot for most traditional sites in the dating industry. And that is a function of two things (a) our positioning, and (b) our acquisition channels. Not a lot of 20-somethings are glued to their TVs, which makes it hard for Match.com, as an example, to reach a 28-year-old living in San Francisco, whereas through Facebook and MySpace, it’s a lot easier for us to do that.

In terms of geographic distribution, a third of our users come from the United States, another third come from Western Europe, and then the remaining countries make up the last third.

AB: Is the revenue distribution in line with the traffic distribution or is that more lopsided towards the U.S. and Western Europe?

SZ: The top six or seven countries make up the lion share of the revenue. Our pricing is localized, so it’s GDP-adjusted. So a user in Mexico doesn’t contribute as much as a user paying in the United States or Canada. We see a lot of opportunity in emerging markets where we are basically laying the seeds.

AB: You mentioned that you monetize your audience through virtual goods and subscription. Do you also do any advertising?

SZ: We used to do advertising, but we pulled it off during the downturn in the advertising market over the past couple of years. We are looking at this again this year to see if we can add to the monetization without disturbing the user experience.

AB: What’s the breakup of revenue between virtual currency and subscription revenue now?

SZ: Subscription is the lion’s share of the revenue. Virtual currency just fills up the gaps. We had virtual currency from day one, but it was only in the form of virtual gifting. Since the summer of 2009, we started adding a lot more product features for users who want to use the virtual currency and that’s when the virtual currency became a more-meaningful part of our revenue. Even our subscribers use virtual currency, so it’s not a mutually exclusive universe.

AB: What is conversion rate from free users to paying subscribers and those paying for virtual currency?

SZ: We’re in double digits, percentage-wise for subscription and obviously the volume on the virtual currency transactions are much higher than subscription because of repeat purchases.

AB: How does the conversion compare on different platforms? Can you help us understand the users propensity to spend on Zoosk.com versus on Facebook application, versus iPhone application?

SZ: One of the cool things about Zoosk is that for a user, all of their accounts are connected in this ecosystem and they can log into their account from Facebook or from Zoosk.com; or from the iPhone. What we have found is that the monetization usually happens on Zoosk.com. That doesn’t mean that users who sign up on Facebook don’t monetize. It means that users who sign up on Facebook also use Zoosk.com and usually when they have intent to pay they come directly to Zoosk.com for that experience.

AB: You mentioned that the social networks have helped you a lot in terms of distribution. Is that the primary user acquisition channel or do you also use other online or offline campaigns for user acquisition?

SZ: We haven’t done offline campaigns yet, so the user acquisition is a combination of online advertising and viral growth on social networks. Social networks used to be our largest channel of customer acquisition. That has changed significantly over the past year or so. We have put a lot more emphasis on the destination site and it’s working great for us. Now, instead of coming from Facebook and going to Zoosk.com, users go to Zoosk.com and then they add their Facebook account to their Zoosk.com account. We are looking at offline channels for user acquisition in 2010.

AB: Can you talk about the reasons? What changed last year that your acquisition shifted from Facebook to your site? Is this a reflection on the saturation on Facebook?

SZ: We are still acquiring very aggressively on Facebook and other social networks, but what we have realized is that the universe outside of social networks is orders of magnitude larger. Our goal is to become a global online dating company, and we look at social networks as one of the distribution channels. We want to be on search, on display advertising, on offline channels. So it was a strategic shift for us to start focusing more on our destination site.

AB: Outside of Facebook, what other social networks are generating traction for Zoosk?

SZ: I will say MySpace, Hi5, Friendster, and Bebo. We recently started a partnership with IMVU, and we are looking to get on some other properties.

AB: How big do you think the market for dating applications could be?

SZ: I think analysts peg the industry size at $1.0-1.5 billion for the U.S. market and $4 billion worldwide. We think that we can expand that market significantly by targeting a younger audience that are potentially going to being dating for 10 years before they choose to settle down.

AB: What is the average lifetime value of a user on your platform? How long does a user remain with Zoosk after the initial sign up?

SZ: That’s one of the interesting things about Zoosk and how it’s different from traditional online dating sites like Match.com. In our company’s life, we have had about 50 million people sign up for Zoosk, and last month alone we had about 14 million unique visitors, which suggests an uncharacteristic stickiness compared to traditional online dating sites. The reason for it (a) our audience is a lot younger and so they date for longer, and (b) the positioning of Zoosk as a social network for singles.

AB: I was just doing some mental math. You said 14 million active last month, and you mentioned that your conversion is more than 10%. Does that mean you have more than 1.5 million paying subs?

SZ: Given the design of the product and tight integration with social networks, we have a very wide funnel. Fourteen million users were at the top of this funnel last month. We measure the conversion rate further down the funnel once the user shows more engagement with the service in order to make our metrics comparable with the industry standards.

AB: Who do you see as potential competitors? What makes it difficult for someone to replicate what Zoosk has done so far?

SZ: I think that a major barrier to entry in this business is the size of our user base. In 2007, we rode the wave of social network platforms to grab a huge market share with low acquisition costs. That window doesn’t open every day and now that window has closed down again. The barrier to entry for online dating is to get to a critical mass without spending millions of dollars in marketing. In terms of competition, we recently crossed Match.com in traffic in the United States according to comScore. Next up is to catch up with them in terms of revenue numbers.

AB: What are your major growth drivers in 2010?

SZ: There is a lot of product innovation happening right now that will help us hit our goals. We’re also accelerating our acquisition through online and offline advertising, which will be a brand new territory for us in 2010. There is a lot of room for us to grab more market share in existing markets, and also places like Germany where we are starting; and Asia could be another big opportunity for us.

AB: What is your product roadmap that you talked about?

SZ: Our desktop client will play a big role and also rich mobile applications, with iPhone being the starting point. We see a lot of traction in those areas to be able to expand on what we have.

AB: Are you offering any location-based dating service on iPhone or other smart phones?

SZ: We are not doing location-based dating right now. We have seen it fail multiple times. It has a lot of privacy issues attached to it. For us, rich mobile applications such as the iPhone application are an extension of our service, and we have found a lot of users who use Zoosk.com also use it on their iPhone when they’re on the go, so it’s additional value to them. So the draw has been mobility more than location awareness.

AB: How big might Zoosk be, and how fast is it growing?

SZ: We are about 50 people. In October 2009, we announced that we were at $30 million on a run rate basis, and we have grown quite significantly since then. In 2009, we had a consistent 20% month-over-month revenue growth and we’ve been able to continue and even surpass that growth rate since then, so the sky is the limit right now.

AB: What’s your outlook for 2010? Do you expect the same growth throughout the rest of the year?

SZ: So far it looks like that. Revenue for the top three online dating companies hovers between $200-300 million, and our goal it to surpass that in 2011.

AB: What do you see as big challenges for Zoosk over the next two or three years?

SZ: The next three years is all about execution. 2008 and 2009 was about finding the right market fit, to position our product, to acquire users and to become profitable. 2010 and 2011 is going to be execution; scaling the business, scaling the revenue run rate, and continuing to be as efficient as we have been so far.

AB: Where do you see Zoosk three years from now? Do you see yourself as a public company, as a standalone private company or as a part of a bigger platform?

SZ: We are looking at building a billion-dollar business over the next couple of years and depending on the market conditions, a public company. Becoming a global leader in online dating is definitely in our sight, and that’s really the de facto plan for us right now.
AB: Thank you so much for speaking with us, Shayan.

How can startups quickly get to millions in monthly revenue? April 8, 2010

Posted by jeremyliew in Ecommerce, gaming, local, subscription.
18 comments

The ’05/’06 vintage of web 2.0 startups took advantage of much lower development costs and faster iteration cycles to build compelling products and sizeable user bases without thinking too much about monetization right away. For companies like Youtube and Facebook, this approach worked incredibly well and led to very fast value creation, often in advance of revenue growth.

One of the hallmarks of some of the current generation of “hot companies” is an early focus on business model and revenue generation. This is a cross genre phenomona, including social gaming companies like Zynga, Playfish and Playdom (a Lightspeed portfolio company), flash sales companies like Gilt, Ruelala and HauteLook, local deals sites like Groupon and Living Social, and subscription businesses like LifeLock or Zoosk. All of these companies have seen revenues grow into the millions per month within 12-18 months of launch, which is a pace that has not been seen from previous generations of internet startups.

The success of Zynga, Playfish and Playdom has been well documented. Zynga is doing 10s of millions in monthly revenue, and Playfish and Playdom in the single digit millions per month, all within 24ish months of launch.

In the Flash Sales category, last July Business Insider said of Gilt:

Yesterday, we reported the impressive success of Gilt Groupe, a two-year old ecommerce company that expects to generate about $150 million in revenue this year…

First, growing from $0 to $150 million in revenue in two years is pretty fracking impressive, no matter how you look at it.  That’s way faster than Amazon grew in its first two years, for example.  (Yes, the Internet is much bigger now).

The fact that Gilt’s US business is reportedly cash-flow positive is also very impressive.  It’s one thing to generate a lot of revenue.  It’s another to generate a lot of revenue with enough margin to put the company in the black, which Gilt has reportedly done in the U.S.

Part of the company’s cash-flow generation is the magic of the online sales cash cycle: When you sell online, you often collect cash for your product sales long before you have to pay the vendor you bought the products from.  Amazon benefitted heavily from this dynamic in its early days, and was cash-flow positive long before it started to generate net income.  But part of the cash-flow success is also the power of the business model.

Gilt thinks it can get to $500 million in revenue next year, which seems plausible.  The company is expanding both horizontally into other product categories (it started with fashion, and is now moving into kids, travel, etc.) and other geographies (it already has 20 employees in Japan).

The Economist reported in September that RueLaLa wasn’t far behind:

Ben Fischman, the boss of Rue La La, which started in 2008 and expects to have revenues this year of around $130m, thinks the “theatrical environment” of his site keeps customers hooked. He says retailers became complacent during the boom years and failed to make the most of new technology.

Groupon is on a similar growth path. Since they put  the number of sales and price of each day’s groupon on their website, it is relatively simple to estimate their revenue by adding the implied daily revenue across each of their cities. They went from around $100K in revenue in January 2009 to around $10M in revenue in January 2010 – a 100X increase in just twelve months.

Atul Bagga, Internet Equity Analyst at ThinkEquity, recently published a report based on an interview with the CEO of Zoosk where he notes:

Zoosk is a multi-channel global online dating service with presence on major social networks, online, mobile Web, iPhone application, and desktop client with 50 million registered users/14 million monthly unique users, a $2.5 million monthly revenue run-rate (as of October 2009) and a 20% month/month revenue growth. The company expects its revenue to be more than $200 million by 2011.

Of course, not all the current “hot” companies have taken this approach. Some, like Twitter or FourSquare, have seen enormous growth in usage that has outpaced their revenue growth.

But the categories I outlined earlier are all taking advantage of one of Lightspeeds consumer internet predictions for 2010,  that direct direct response advertising is getting more efficient. A bad time to sell ads is a good time to buy ads. All these companies are taking advantage of relatively low customer acquisition costs.

If you understand your customer lifetime value, and you can acquired customers for 20-30% of the lifetime value, you are going to make money. Understanding lifetime value is hard for media companies, but it’s easier for gaming companies, ecommerce companies and subscription businesses. They have predictable customer behavior cohorts that can be extrapolated from a few months of data from a representative sample.  Running an aggressive positive arbitrage while online media is cheap has allowed all of these companies to grow revenue very fast once they get the micro-economics right.

I get really excited about these types of companies. If you’ve got microeconomics that work like this, email me!

Which companies might prosper in an ad recession? October 13, 2008

Posted by jeremyliew in advertising, Ecommerce, freemium, gaming, Lead gen, recession, subscription, virtual goods.
15 comments

I have previously posted on which online media companies will survive the ad recession. Clearly, all online media companies will feel the advertising recession, but some companies will hold up better than others.

But some companies might do more than survive – they might prosper. Companies that buy advertising (rather than selling it) will find that they can now buy advertising more cheaply than previously.

Ecommerce companies, subscription businesses, lead gen businesses and online game companies are all buyers of online advertising. In the last advertising slowdown, companies like Expedia, Zappos, Quin Street, Lending Tree, Lower My Bills, Netflix, Classmates.com and Ancestry.com were all able to grow to over $100M in revenue by taking advantage of cheap media.

Will history repeat itself in this recession? It is hard to know. Certainly lower CPMs can lead to lower customer acquisition costs if all else is equal. But the difference between this recession and the last one is consumer confidence, which is markedly lower today than in the 2000-2003 time period. As a result, there may simply be less buyers out there to acquire. Compete recently noted the marked drop in “in market auto buyers” over the last two years for example – down 37%:

Certainly, consumers are deferring “considered purchases” including homes, cars and other big ticket items. Etailers selling “necessities” that cannot be deferred, such as diapers or business cards, will do fine. The question is what will happen to the demand for small ticket consumer discretionary spending. Starbucks might be considered a proxy for this sort of spending. Unfortunately, the news for Starbucks isn’t good. Notes Seeking Alpha:

There was a time when getting a coffee at Starbucks Corp. (SBUX) – whether a basic “tall bold” or a souped-up venti concoction – was considered a relatively cheap treat, though those of us with a daily Starbucks habit might think otherwise.

However, a report from RBC Capital Markets analyst Larry Miller indicates that even that daily cup of store-bought java is one of the victims of the credit crunch. Mr. Miller lowered his 2009 earnings estimates – to $0.90 from $0.95, and said:

[The move] reflects our proprietary survey work, which suggests Starbucks sales continue to weaken as consumers are changing their habits and brewing more coffee at home.

This does not bode well for small ticket discretionary spending.

One potential brightspot may be gaming. The games industry has historically been considered counter cyclical. The argument has been that for $50s you can buy a game that will give you 50-100 hours of enjoyment, versus $10 for a 2 hour movie or $5 for a magazine that you’ll finish in an hour. Free to play games make this argument even more compelling. Free to play games may be able to take advantage of cheaper customer acquisition costs in an advertising recession.

For other forms of discretionary small ticket spending, the jury may still be out.

How many of your MMOG’s monthly users can you get to pay? June 11, 2008

Posted by jeremyliew in business models, games, games 2.0, gaming, mmorpg, subscription, virtual goods, virtual worlds.
3 comments

I recently concluded that good MMOGs can expect $1-2 per user per month from a free to play model, with Second Life as an outlier at almost $10 per user per month.

This relatively tight band of monetization masks some fairly high variability in the ratio of paying users across games and virtual worlds. From the highest to lowest, here is some data available on the web:

Second Life reports 860k residents logged in over the last 30 days, and 383k customers spending money in world in May. As you can only spend Linden dollars if you have Linden dollars, and you can only get Linden dollars by buying them or becoming a premium members, this suggests a 45% paying ratio. (Likely the ratio is lower than this as some Second Life residents may buy dollars one month but spend it over several months)

Club Penguin at acquisition reported 700k paying users and had 2.6m UU in that month according to Compete, or a 27% paying ratio.

NCSoft’s Dungeon Runners self reports a ratio of 3:1 free to paying users, or 25% paying ratio.

Jagex’s Runescape claimed 1m players paying $5/mth in May 2007 and 6m players per month in October 2007, for a 17% paying ratio.

3Rings’ Puzzle Pirates has been reported to have 30k paying users out of its 200k unique monthly users, for a 15% paying ratio.

Frankly, all of these public numbers are on the high side of the industry. An NPD survey found that:

… 91 percent of online gaming among kids ages 2 to 17 is free; of the 9 percent that pay to play, these kids are more likely to hail from higher income households. In addition, the likelihood of a child to pay for games increases along with the child’s age and time spent on gaming.

Monetizing kids is more difficult than monetizing adults since kids have more limited access to payment mechanisms (e.g. credit cards), so the overall industry ratio of paying gamers is likely higher than 9%.

Most MMOG publishers do not publish their monetization statistics, but private conversations with many publishers suggest that getting to a 10-12% monetization ratio of active users is a stretch but achievable target.

Do readers have other data that they can share?

Successful MMOGs can see $1-2 in monthly ARPU June 9, 2008

Posted by jeremyliew in freemium, games, games 2.0, gaming, mmorpg, subscription, virtual goods.
43 comments

There are not many publicly available statistics on the free-to-play industry in the western world. Here is what I found on the web for some of the popular virtual worlds and MMOGs:

Second Life

Second Life’s economic statistics are reported monthly. In May 2007, Second Life reported:

$165m Linden dollars sold by Linden Lab through the Linden Exchange in May
$127m Linden dollars paid via weekly stipends in May
860k residents logged in over the last 30 days

Since Linden pays $300 Linden dollars in weekly stipends to premium members, there are around (127m/300/ 4 weeks=) 100k premium subscribers paying $6-10/mth. Lets call that $800k in monthly revenue from premium subscribers.

Linden dollars currently exchange
at 264 Lindens to the USD, so Linden Labs made $165m/264 = $625k in currency sales.

These are the two primary sources of Linden dollars into Second Life’s economy, so Linden Labs made at least $1.4m in revenue from the 860k residents that logged in over the last 30 days, or roughly $1.70/active user.

UPDATE: Several comments note that I have ignored the bulk of Second Life’s revenue which is derived from land maintenance. An updated analysis is here.

Club Penguin

When Club Penguin was bought by Disney in August 2007, it was reported to have 12m registered users and 700k paying users. As the monthly charge for paying subscribers is $6, this suggests monthly revenues of around $4.2m. Compete reported 2.6m UU to Club Penguin in that month. Dividing these two numbers we get around $1.62/active user (where an active user is defined as a unique user in that month).

Habbo Hotel

At AGDC in September of 2007, Habbo Hotel‘s lead designer, Sulka Haro gave some statistics on Habbo Hotel’s usage:

Habbo Hotel has approximately 7.5m unique players per month globally — nipping at the heels of World of Warcraft. In the seven years since the game launched, 80 million accounts have been created. Globally, the game typically has 100,000 concurrent users playing at one time.

Furthermore, Habbo was estimated to do $77m in revenue in 2006. In the middle of 2006, Habbo had around 53m accounts. Assuming a similar ratio of monthly players to total accounts in mid 2006 to what Habbo has today, that suggests that there were around 5m unique players per month at that time. Dividing $77m by 12 months by 5m unique players suggests about $1.30 in revenue per active users.

Runescape

Finally, Jagex’s Runescape claimed 1m players paying $5/mth in May 2007 and 6m players per month in October 2007. That suggest $5m/mth in revenues from 6m players, or around $0.84 in revenue per active user.

In summary then we have:

Second Life: $1.70/mthly user/mth UPDATE: Should be $9.30/mthly user/mth
Club Penguin: $1.62/mthly user/mth
Habbo: $1.30/mthly user/mth
Runescape: $0.84/mthly user/mth

The average across these four is $1.40/mthly user/mth*. UPDATE: excluding Second Life, should be $1.25/mthly user/mth.

Having spoken to many other MMOGs and virtual worlds on a private basis, this estimate seems to be a good gauge for what a well performing MMOG can aspire to from a free to play business model.

Do readers have any datapoints that they can add to this survey?

* Note that this is based on monthly users. Many MMOGs calcuate their average revenue per user (ARPU) based on Peak Concurrent Users. On this basis, ARPU can be more than an order of magnitude higher than the $1.40 guideline.

Freemium service models – paying for convenience in games February 20, 2008

Posted by jeremyliew in asynchronous gaming, business models, digital goods, freemium, mobile, subscription, virtual goods.
4 comments

Last week I noted that free-to-play games will become increasingly dominant. I’ve also noted in the past several use cases for the digital goods business models that will be one of the primary monetization mechanisms for free-to-play games. Selling increased functionality can result in user dissatisfaction if players perceive that the only way that they can “win” is to buy more powerful in game functionality. This can be managed through the use of a dual currency system, as Matt Mihaly noted in a guest post.

One other monetization mechanism that free-to-play games can offer is services. Some games, especially real time strategy games, can be somewhat inconvenient to play because they require constant monitoring and occasionally require actions to be taken in game at a certain time. Gameplay can inconveniently interfere with other activities, like work and sleep.

Travian is a good example of this. In Travian each action takes a certain amount of time, and there is no way to “queue up” orders (e.g. if you want to upgrade your mine after you’ve finished upgrading your farm field), or to “schedule” orders to be carried out at a certain time (e.g. if you want to time a raid on another village to be coordinated with another attack). Instead, Travian requires a player to be in the game at a specific time to give an order.

Offering a player the ability to queue up orders or schedule orders as a premium service is a non controversial way to monetize users. Players who do not want to play can be just as effective as players who are willing to pay (they just need to be able to get online at the right times to give their orders). Players who pay for the service are paying simply for convenience, not for additional in game power.

Managerzone‘s mobile premium service is another example of such a service. As I noted previously, the mobile service gives a player certain alerts and allows a player to take a number of actions in the game from their mobile phone, without having to log on to the website from a computer. This makes the game much more convenient to play, but again doesn’t disadvantage a player who choses not to pay for the mobile service since they can still do everything from the website. It looks like Blizzard may also be considering a mobile version of World of Warcraft.

I’d be interested to hear from readers of other examples of games monetizing premium services.

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