The Penny Gap
Josh Kopelman writes:
Here at First Round Capital, we see a lot of business plans for consumer-facing internet services. Most assume a significant portion of their revenue comes through advertising — but almost all of them have a “premium/subscription” option. Typically that subscription revenue accounts for 20-40% of total revenue, and is based on a very low ($1-5/month) subscription fee. When asked to support these subscription revenues, entrepreneurs almost always say “well, it’s very cheap ($2 a month) and we’re only assuming 5% of our users take advantage of it).” On the surface, a reasonable position.
However, that is rarely how things play out. Most entrepreneurs fall into the trap of assuming that there is a consistent elasticity in price – that is, the lower the price of what you’re selling, the higher the demand will be. So you end up with hockey stick looking revenue charts that go up and to the right, all supported by an “it only costs $2 month” business plan.
The truth is, scaling from $5 to $50 million is not the toughest part of a new venture – it’s getting your users to pay you anything at all. The biggest gap in any venture is that between a service that is free and one that costs a penny. I can’t think of a single premium service that has achieved truly viral distribution.