Free Sample--The Middle Ground

Jesus said it is in giving that you shall receive. But I'm not sure Jesus ever ran a retail store. What about the free sample? To what extent should a business entrepreneur integrate this strategy into his or her business plan?

The first question has to be what does the free sample cost you? In the electronic world, the answer to this question is often zero. My online legal forms business gives away free samples of its legal forms. The system is self-service and the form are created on-the-fly through a web based app. We provide user support via email but that is generally minimal for the free trial. But what about the opportunity cost? The legal form given away is a form that could have resulted in a sale. For a struggling small business, every sale counts.

Years ago, we hit on the middle ground strategy. Users have a right to toy with the online app, see how it works, ease of use, and (importantly) view the actual form they will be purchasing. The kicker: free trial users only get an encrypted, non-printable PDF version of their legal form. Purchasing users get a printable PDF or a document convertible to MS Word. Is an encrypted PDF hackable? Sure but how many people are going to go through the trouble of hacking an encrypted file just to save $13? For our business, this middle ground compromise has been a win-win.

There has been a proliferation of free trial for PC based and online apps. Most are of limited duration and do not allow the user full access to all features. I, as a consumer, appreciate the ability to monkey with the program prior to plunking down my hard earned benjamins. Fast forward to the music download controversy fueled by the fanatical position of the Recording Industry Association of America (RIAA), a front organization for the major record labels. They've taken to suing kids, mothers, and grandparents over what they have determined to be illegal downloads of music. Rather harsh to bite the hand that feeds you. From their standpoint, the record labels view free downloads to be their death sentence. Maybe they are right but, I note, electronic sales of music (including ring tones) have ultimately saved the record labels collective butts. Sales of CDs are as dead as 8-tracks. Apples' online music store sells songs for a modest $1 apiece. A nice compromise.

But what about the free music trial? Well, under current formats, you can hear the first 30 seconds or so of a song for free on the Apple music site and other sites like Amazon. I want to listen to the entire tract and more than once to let a thumbs up or down sink in. last.fm is shooting for this middle ground in the music sample business. They have 5 million songs in their library and let you listen to any song in their library free, the entire song. The catch: after three plays of any song, the free listen is cut off and the users is direct to one of last.fm's online partners for purchase. I've been listening to Van Morrison and the Grateful Dead on last.fm while writing this post. Seems like a fair compromise to me. I wonder how they track the 3 free plays? Must be by IP address. If so, I get 3 free plays on my PC and another 3 free plays on my laptop! Nice deal. The downside for the user: they only list four songs for each artist. How can a fan be limited to four Grateful Dead songs! If last.fm wants this format to mature and blossom, they'll need to ditch the 4 song limit. I imagine that limit was imposed by the RIAA members while evaluating the model. Needless to say, these girls are skittish about giving away anything.

Evaluating Internet Ad Revenue Potential

The story of plentyoffish.com is astounding. As of October, 2007, this one man dating web site was generating $3.5 million annually solely in online ad revenue (expected to go to $10 mill in 2008). As an internet entrepreneur, I applaud Markus Frind as one man wrecking crew in the online social networking space. But something else caught my eye in regard to POF--it's high click through rates. Companies such as POF which rely mainly on online ad revenue get paid when visitor clicks on an ad. Therefore, the most important metric for the company is not number of daily unique visitors or even page views but, rather, how many ad clicks. A web site with a high click through rate can generate larger revenue on a smaller number of page views than a site whose click through rate is lower. "Markus told me that per page view, Plentyoffish has 5-10 times the click through rate of Facebook. So by his calculations, POF's 1.2 Billion page views per month is the same as 5-10 Billion Facebook page views per month." Link.

To be sure everyone is one the same page, "click through rate" is percentage of online ads that are clicked on by a visitor. For example, a web site with 1000 daily online ad views and 12 clicks per day has a click through rate of 1.2%. If you have a Google Adsense account, they give you the click through rate in the ad campaign reports. Frind argues for a valuation for his company using Facebook as a baseline and each company's monthly clicks. Good luck Markus.

On the topic of business plans, it is important for online companies who intend to rely in any meaningful way upon online advertising to discuss click through rates in making your financial projections. Hopefully, your company has past operations data to use for establishment of click through rates (CTR) and ad revenue per thousand ad impressions (CMP). Thus, when projecting future revenue for the business plan, you will possess historical revenue percentages that can be applied to future traffic projections. Get a solid projection on future page views then use the historical CTR and CMP to project revenue. For example, let's say your online business is a social networking site for Wiccan priests and priestesses. You're about to expand to other pagan faiths. Current daily page views are 20,000 (one ad per page) with CTR of 1.2% and CMP of $8. Thus, ad revenue is $160 per day. I have no idea the actual number but let's say there are twice as many Celtic worshipers as Wiccan in your target geographic market (North America). Thus, within one year, you are projecting 40,000 daily page views on your sister Celtic site (twice the Wiccan number) with combined daily ad revenue of $480. The historical CTR and CMP rates are what give your projections teeth, thus, helping the entrepreneur sell his business to investors.

Beware When Piggybacking

So you're a small startup looking for a competitive edge allowing you to make it in that big bad market out there. Why not hitch a ride on a passing behemoth? Makes sense and many a small business has been successfully launched using this strategy. Suggestion: have a backup plan for long-term viability outside the shadow of the big dog. Why? Elephants might not turn on a dime but no one is quite sure when a turn is coming and, after it happens, they trample everything in their path. Coattails are long but easily snap. The following is a cautionary tale for the piggybackers.

Brokering web page text links is a cottage industry spawned by Google. Its search engine algorithm is heavily dependent upon inbound links from other web pages. Not only the shear number of links but, also, the page rank value and content of the referring page effect your web site's score in Google search results. As with anything in the business world, once the competitors learn the rules, they immediately strategize on ways to game the system. The first strategy on this front was trading of links, "you scratch my back, I'll scratch yours", a strategy as old as the ox cart. But it's cumbersome to find link trading partners whose web site content matches up with yours and who have links of comparable value to trade. As with any barter transaction, the value of the thing each side offers is up to interpretation. This makes it harder to arrive at agreement on a swap. The inefficiencies of the link barter market led to a new market in the buying and selling of links managed by middlemen, i.e., link brokers. The advantage: much easier and quicker to close a transaction. Through the link sale market, a web site owner, if possessing the money to do so, could quickly build up links to specific pages within one's site. Furthermore, to defray the cost of the link purchases, the web site owner can turn around and sell outbound link from his web site through the same broker. As one can see, the broker makes money on both ends of the deal (links in and out of the same customer's web site). Nice!

And so the cottage link brokerage industry continued to prosper for several years ... until 2007. That's when Google dropped a thermal nuclear warhead on its head by banning the practice of buying and selling links. See Link and Link. The sole reason to purchase text links (i.e., to help increase pagerank for Google search results) evaporated in an instant. This entire cottage industry has gone down the toilet. Piggybackers beware.

Finding Your Niche

Small business thrives in the niche. Yes, we all aspire to grow our business from the garage to godzilla but mighty mouse is a more realistic short term goal. Strolling through my neighborhood this Sunday morning, the diversity of the local coffee house market struck me as a fitting for study of niche strategies. Starbucks has not penetrated the neighborhood, as yet, so there is no godzilla on the scene to stiffle the small innovators. Here is a quick case study of niche strategies employed by the coffee houses of South Grand (St. Louis City).

St. Louis Bread Company (Panera Bread outside of STL) is the big dog. Their calling card is, of course, the bread. But coffee and bread go together like water and wine. They are the biggest competitor in the neighborhood seeking no particular niche while providing coffee, free wi-fi and good, reasonably priced lunch food. The customer base is diverse but heavy with students and business types looking for a place to caffeine up while connecting to a wireless device. They have African blends of coffee and espresso drinks. There is outdoor seating with sidewalk tables but it is cramped. St. Louis Bread Company is the benchmark, the hurdle all other coffee houses within walking distance must get over to compete. You have to meet what the industry benchmark offers plus give the customer a reason not to go to the Bread Company. To recap, the benchmark offers: (a) African blend coffees and espresso drinks, (b) good, reasonably priced lunch food, (c) outdoor seating, and (d) free wi-fi.

The Niche Competitors.

Mokabe's caters to the gay-lesbian crowd. They feature vegan food with an awesome and spacious patio facing Tower Grove Park. The patio is dog friendly with water bowls provided. The food and patio seating allow Mokabe's to extend their customer base beyond the GBL crowd. They also have free wi-fi and serve as an unofficial headquarters for local anti-war protesters. Mokabe's biggest regular draw is Sunday brunch which is not served by any of the other coffee houses or restaurants in the neighborhood. Downer: according to my wife, the coffee is average.

Hartford Coffee Company is the mommy coffee house. I've never seen another like it. Almost half of the customer dinning space has been converted to a children's play area. The mothers turn their kids loose to play while drinking coffee and socializing. My wife pointed out that a second shift of stay-at-home dads also gather at this coffee house late morning. The food is good, reasonably priced with more diversity than Mokabe's. They also have dog friendly patio which is important as many customers on their way to the park leave their dogs on the patio while inside getting coffee. This coffee house is 1/4 mile from the epicenter of the neighborhood (Grand Avenue) upon which all its competitors are located. Thus, they still pull a fair number of students and work at home business types who might not care to hike it 1/4 mile to the other coffee houses. But it's hard to block out the noise from the kids while working on your laptop at the mommy coffee house (I've tried). And on Sundays they have live bluegrass music that drives me out the door (unlistenable).

Gelateria Del Leone, a combo coffee / gelato house on S. Grand. They are the only seller of gelato in the neighborhood. A coffee house a few store fronts down catering to the grunge crowd closed a year ago. Gelateria Del Leone gives off an adult vibe, hard wood floors, exposed brick, tin ceiling, dark leather furniture. Also, they are located right next door to the most popular restaurant in the neighborhood, Pho Grand. When summer hits, I gotta believe there will be a nice flow of customers migrating from Pho Grand for dessert. According to my wife, their coffee is superior to others in the neighborhood. They also have free wi-fi, espresso drinks, and a limited food menu.

So there you have the big dog and the three niche players. Mokabe's caters to the GBL crowd, vegans, and leverages its awesome patio facing the park. Hartford is the mommy coffee house. Gelateria is the Italian dessert, adult coffee house. The grunge coffee house went under, I believe, because (a) they targeted too small of a demographic and (b) the neighborhood is in the process of gentrifying meaning even fewer grunge types.

Crunch The Numbers Before Writing The Plan

Want to start a business? Everybody says the first step is writing a business plan. I beg to differ. In my view, the first step is calculating your breakeven point and your cash burn rate. Why are these numbers important? They tell you how much cash you need to reach your breakeven point. Without this information, an entrepreneur is raising money in the dark. Only a fool opens the doors without first raising enough money to sustain the business to breakeven. And an even bigger fool invests in a business which by it's own calculation can't stay in business without raising new money at some point after launch. The #1 reason new businesses fail is that they are undercapitalized from their inception.

How does one calculate the break even point? Here are the two basic formulas for the task.

Breakeven = Fixed Costs / Gross Profit Percentage

Gross Profit Percentage = (Revenue - Variable Costs) / Revenue

Thus, the first step to calculating a business's breakeven point is determining gross profit percentage. Let's take an easy example.

2007 Revenue, Joe's Bar & Grill	$350,000
2007 variable costs, Joe's Bar & Grill	$250,000
Gross Profit Percentage	28.5% (350-250/350)

Now we are in position to calculate the break even point. Fixed costs are, as the name implies, those costs that do not changed with variations in revenue (i.e., they are fixed). Sometimes these are referred to as sunk costs. In the case of Joe's Bar, let's say Joe has the following fixed costs:

Real estate lease payments	$36,000
Equipment lease payments	$12,000
Salaried Employee	$40,000
Insurance	$15,000
Utilities	$6,000
Total Fixed Costs (yearly)	$103,000

This results in a breakeven point for Joe's Bar & Grill of $361,000 in sales. The bar business was not kind for our hypothetical Joe in 2007 as the business's revenue was $11,000 below breakeven level for the year.

If you are a new business running these projections, the question then becomes when do you reach the projected breakeven point? What is your burn rate? Do you have enough cash raised to make it to breakeven? Remember that every new business runs into unexpected expenses and/or revenue hiccops. You need to have a cash cushion built into your projections.