Adoption: When is it Too Much of a Good Thing?

The primary challenge for all start up technology companies is adoption. How do you get people to buy something new from a company they have never heard of? To be sure adoption is a good thing. However, it does not necessarily follow that maximizing adoption is always best. Remember, the ultimate goal for companies is to maximize revenue and there are many cases where the two are not necessarily linked.

In the past, when the predominant business model was selling high ticket item solutions to enterprise IT, adoption directly drove revenue. However, today, where many business models are predicated on providing low cost or even no cost entry level versions, the relationship between adoption and revenue is no longer a sure thing.

At Topline Strategy, we break markets into three categories – high, medium, and low – based on the correlation between adoption and revenue and recommend companies set their strategy accordingly.

High: These markets are ones governed by the network effect. Under the network effect, the intrinsic value of a product or service increases exponentially as the number of users increases. Therefore, more adoption drives more value which in turn drives more adoption, etc. For these companies, the strategy is simple – acquire users. YouTube, where more users means more videos, and eBay, where more users mean more products up for auctions and more buyers, are both examples of network effect businesses.

Medium: These are businesses, like technology platforms such as databases or application servers, where the value of the company’s products is enhanced by a community of companies offering value added products and services. While adoption is important for generating a community, it is not necessarily true that the company that has the most adoption wins the market. Instead, it is the company that generates the most robust community. These companies strategies need to focus on community development.

Low: These are markets where the fact that one user has adopted a new technology has little bearing on the value that the next user receives. Application software companies, online content providers, and search engines are all examples of businesses where the intrinsic value of adoption is low. For these companies, the strategy needs to focus on acquiring profitable users, not just any user. The most common mistake companies make in this segment is to under price their offering based on the assumption that all adoption is good adoption.

One example where this dynamic has played out is the Vulnerability Management (VM) market. VM solutions are corporate security solutions that scan devices attached to corporate networks to identify vulnerabilities to hacker attacks. Two of the main competitors in this market are the SaaS company Qualys and the Open Source company Tenable. Since Tenable gives away the base version of its solution, it has a total user base that is over thirty times larger than Qualys. However, Tenable has been able to convert only 250 of its 75,000 free users into paying customers. In contrast, Qualys has over 2,000 paying customers, nearly ten times as many as Tenable. Ultimately, Qualys gained adoption where it mattered most, among paying customers. It didn’t matter that Tenable had the most total adoption.

Social Networking Meets Economics 101

My recent post on VentureBeat addressed analyzing venture investing trends from a suppy (of companies) and demand (of customers) point of view.

Under normal conditions, the supply of venture-backed companies is not a problem. There are only a handful of companies chasing any given market. Yet occasionally, there are categories where a slew of companies jump into a market all at once. This happens when a category with low barriers to entry takes off quickly. Seeing a market with explosive demand and little competition, entrepreneurs rush in to fill the void. Ultimately, demand is spread across so many companies no one wins.

That may be the case today with Social Networking as companies have rushed into the market behind MySpace, Facebook, and YouTube. Our Follow the Money report for Q2 showed that 25 Social Networking companies received $500K or more during the period.

The economics of Social Networking favor first movers and established players. Social Networking, like auctions and marketplaces, is governed by the network effect. The more people using a site, the more valuable it becomes, which in turn drives even more usage. This opens up a gulf between the leaders and everyone else, and once that occurs, it becomes next to impossible for anyone to succeed. Only established players who can bring their existing user base to the table to provide critical mass have a chance.

So where are the opportunities in social networking if starting MySpace or YouTube for <fill in the blank with your favorite demographic or interest niche> is untenable?

• Creating the truly differentiated offering. Where MySpace and YouTube will make their money by giving away their service to tens of millions of consumers and charging advertisers, the next round will need to be able to drive revenue from much smaller user bases. Think 250,000 users paying $20 per month each. To charge a consumer $20 per month, there needs to be a compelling and difficult to reproduce competitive advantage.
• Serving the established players. Given the consumer interest in social networking, established players will need to add these features to their site. It's unlikely that Kayak, the leading metasearch site for travel will sit back and allow the two new metasearch+social networking start ups to go unchallenged. Same goes for Match.com and other leading dating sites who are facing new competition from dating+social networking start ups. Soon, everyone will be a <category>+social networking site.  There is money to be made in serving those companies.