The 3-tiered revenue model for hosted web services

For years, pundits have been saying that software as a service will replace licensed software.  But it’s a tough business. For a hosted web service (especially one tuned for business problems), think about having three tiers in your revenue model.

  1. Free, ad-supported version
    This is what 99% of your users will choose, and where maybe 5% of your revenue will come from.  Sounds like a bum deal! But we know the threshold where a customer will part with their money for software is high (just look in the mirror). You need to have them use your stuff, understand you, believe in your value, trust you, and rely on you before it’s worth their while to pay you.  On the bright side, the cost of providing this free service largely serves as your marketing budget.  This is your cold-call salesforce.  These are your demo/sample units. And nothing grows mindshare as quickly as the right service, offered at an irresistible price.
  2. Premium ad-free subscription
    Maybe one in every few hundred users will find your service useful enough, important enough, that they want to get serious and lay down their dollars to get more.  Get rid of the nonsense (advertising).  Know that you have their back today, and tomorrow (service level agreements).  And provide some extra features to give them their money’s worth. This might be where 25% of your revenue comes from.
  3. Licensing
    As a customer, it’s wonderful to have someone else hosting your software — not having to worry about installing, maintaining, etc.  And you don’t have those big, up front licensing fees. But it’s like giving your car keys to a stranger.  It’s a no-no having corporate data floating around on someone else’s servers, on the Internet, and out of your control.  You have a firewall, and you want your corporate data to stay within it.  So the hosted web service is a great way to play with the software and see what it can do for you.  But at that point, you want to be able to say “sell me your backend software, so I can deploy it on my corporate network”.  Or, perhaps better, make it an appliance or a VM.  And this is where 70% of your revenue as a “hosted services software company” will come from.  Back to the future.

Companies that use this 3-tier approach are everywhere.  How does VA Linux (LNUX) make money on sourceforge?  Why does Google sell an appliance search box?  But there are still plenty of companies that stop at tier 1 or 2, and they may be leaving most of their opportunity on the table.

Selecting a Project: Instinct or Analysis?

Why choose to go after this need for web charting?

There’s no magic analysis. From a lean perspective, it’s a matter of triangulating at least 3 things:

  1. What are the market opportunities/needs
  2. How close is the available technology to filling them
  3. When can our group fill the gap vs. our competition

For a lean-style micro-isv, we would hope for projects that can launch in weeks, not years. In my case, it’s been 7 years since I’ve done this kind of development. I’m starting from zero on nearly all the technologies I’ll be using to create these web sites and web services: ruby, rails, lots of gems, css, subversion, new editor, etc. I know It’ll be slow going on the first projects. And as I experiment with openly blogging about this project as I work on it, the time window of my head start will be short.

For these reasons — and all the other reasons why short iterations, feedback, and adjustment are important — I have to be especially cautious about scale to keep the project managably short.

Personal interest in the space is also an important factor — even with trying to keep each project as small as possible, it’ll still be a large chunk of life working on it.

Data visualization has gotten my attention in recent years. I’ve spent a bunch of time on large software projects. Large-scale software development is an amazing challenge. Microsoft, which does a lot of it, has been pursuing a strategy of collecting and analyzing a ton of data for the purposes of managing their projects. So much data that it’s simply overwhelming. If you can’t summarize it with charts, teams can’t really digest it. Both inside Microsoft (where they can throw people at the problem), and on the wider Internet — we don’t have tools yet to make this visualization easy enough.

There is competition in this space — one can search for companies offering charting, graphing, visualization web services. This is a good thing, as long as there is breathing room for technical or business model innovation. http://www.graphmagic.com/ is one example, that offers 1000 graphs for $12.95 a month (with lots of other pricing options) with a free trial that requires registration.

There are interesting new ideas around for doing things better, like Joe Gregoria’s sparklines service 2-year P/L for single project. This is a wonderful example of taking a underused form of visualization, and making it more approachable with a very well designed, simple site for creating the images, and hosting so the images can be easily included on other pages. I’d like to see something similar which makes it as easy to create larger visualizations.

And there are some exciting technologies to build on. Geoffrey Grosenbach’s awesome Gruff library, manni.us’s beautiful SWF/XML charts, and web frameworks like Ruby on Rails to speed development.

So, out of a long list of potential ideas, this one seemed to stand out as one where the need, and the technology gap to fill it, seemed to be a match. Instinct backed up by a bit of analysis.

And, in typical lean fashion, I shouldn’t be betting the farm on this one project. I should complete several projects in a year — and expect that I’ll have several failures and a few successes. It is through that feedback loop with the market that leancode as a business can succeed.

Thinking about a first project

The Internet has enabled us to flood ourselves with data. To make sense of this all, we have to be able to prioritize and summarize what we look at. We have a lot of web tools and web services to help us, but not surprisingly, most of it is text based — and sometimes a picture is worth a thousand words.

For those pictures, we already have many vertical market sites which provide great charts (http://finance.yahoo.com/ being one common example for stocks, etc.). What we don’t have is a service — and a business model to support it — to bring this kind of data visualization to the “long tail” of other data on the internet. Charting for things like: bugs or checkins to open source projects, historical government spending, census data, or the # of daily classified job postings in your field etc, etc.

In order for that to happen, you’d need a freely available service which lets you point it at data, generate nice charts and visualizations, and have them be hosted so you can link to them from web pages, blogs, wikis, discussion boards, etc.

This is not a big business — there are limits to how much this visualization is worth to people. And for one-off stuff, you can always hand data to your buddy who is handy with Excel. But it’s a nice niche, and it’s part of a much larger category of knowledge mangement and data mining tools, which is an area of work which I love for some reason, and keep getting drawn back to.

What do you think — is this something you could ever imagine using (or seeing someone else use)?

But ideas are cheap — it’s really all about execution. For that, see coming posts.

Lean close and tell me what you’re up to

I love that technology has given individuals the tools to strike out on their own, craft solutions to problems they care about, and (well, this part is shakier) make a living at it.

It is through this kind of massive, decentralized innovation that we’ll see continued, accelerating progress of humanity.

“Lean” is what (successful) small, unfunded startups naturally are — growing both the products and the business organically and flexibly, through a rich feedback loop with customers. It’s the antithesis of the funded startup that spends 2-3 secretive years getting a big-bang product out. We need those secretive companies occasionally, but get them too often.

We’ve also seen the rise of the “portfolio” product company. The realization that — in software and web services at least — you can both tackle projects incrementally (frequent releases) and leverage synergies of technology and customer mindshare across products to make the whole more than the sum of the parts. Google, 37 signals, Fog Creek, Geoffrey Grosenbach are inspirations at various levels of scale — it’s possible to have an ongoing product portfolio down to the 1-person-company level. The book Micro-ISV is another recent inspiration for software businesses.

This is where leancode.com is coming from. But, with no customers yet to guide us — where should it go first?