Friendster was a social network pioneer that enabled users to view profiles and connect with strangers, along with other features. It acquired a large user base, raised capital from lucrative investors and was the greatest Internet promise in 2003.

By 2006, it all fell apart: Friendster suffered a massive exodus of users, an unsuccessful search for buyers, and four CEO changes in 24 months. Friendster became the subject of a Harvard case study, and the media (e.g., New York Times and Inc. Magazine) thrived on chronicles of its failure.

Friendster actually had much better chances of success than an average startup: it received significant seed financing and had an all-star board of directors.

Or maybe it wasn’t such a great board?  

Startup Board Nomination Mistakes

Boards of directors impact startups dramatically: a strong board can pave the road to success; a poor one may harm the venture. Thus, board nominations must be thoroughly considered. A recent VentureBeat article of mine detailed 5 types of board nomination mistakes:

1. Nominating the wrong people to the startup’s board
2. No alignment vis-à-vis the role of the board
3. A board that is too homogenous
4. Too many people on the board
5. Lack of organizational fit

Did Friendster make these mistakes?

Friendster’s Board of Directors

Friendster got early financing from Silicon Valley icons such as Mark Pincus, Reid Hoffman, Peter Thiel and Ram Shriram.

The board of directors was equally impressive: after raising $13m from VCs in 2003, the board consisted of talented, experienced and business-savvy pros, including:

• John Doerr from Kleiner Perkins (an early investor in Google and Amazon)
• Bob Kagle from Benchmark (the first to spot eBay)
• Roger Lee from Battery Ventures (an investor in Angies’s List and Groupon)
• Tim Koogle (ex-CEO of Yahoo!)
• Jonathan Abrams (Friendster’s founder and CEO)

This board attracted and recruited top Silicon Valley talent. However, it failed to make Friendster a success. Even worse: according to Abrams, “the all star-team was a kiss of death“.

 Was Abrams right?

The Major Problems at Friendster

Between 2003 and 2005, Friendster suffered from serious issues, whose cumulative effect created a negative chain reaction. Some key problems included:

• Engineering / technology

Since the beginning, Friendster suffered from a slow and unstable website. Risky or costly moves, such as a software rewrite from java to PHP and the installation of a storage area network (SAN) made things even worse.

• Functionality and user experience

The technology problems also prevented Friendster from introducing new features and remaining competitive with fresh players, such as MySpace.

• User base:

As a result of the mentioned problems, many users left and went straight to MySpace. Further, it became clear that a majority of the user base was located in Southeast Asia (where it is still very active to date), and Friendster’s prevalence there did not help it target US advertisers.

Who Was Responsible?

The management team

Managing a firm and fixing its problems is the responsibility of the management team, particularly the CEO (at Friendster, it was Abrams until April 2004).

Moreover, Abrams’ consistent presence in the media during 2003 led critics to question the CEO’s attention to day-to-day management.

The board of directors

Abrams (and other insiders) claimed that many problems were board-related. Some of their arguments included:

• Demographics

Abrams felt that the board’s demographics (three board members were around 50 years old) detached the board from target users. He claimed that those members rarely used Friendster themselves, so they failed to experience firsthand the severity of the technical problems.

• Governance

Boards are responsible for nominating and replacing CEOs. Friendster’s board removed Abrams in April 2004, only to nominate 4 different CEOs within 24 months. In the meantime, the critical engineering issue was handled slowly: the VP Engineering was asked to leave at the end of 2004; a new one was appointed only in 2006.

• Focus

Kent Lindstrom (who became Friendster’s CEO) felt that the board found technical difficulties (e.g., the homepage’s 40-second download time) too mundane, claiming that the board preferred discussing potential competitors and new features.

Board Mistakes and Friendster

Did Friendster suffer from any of the 5 types of board mistakes?

Clearly, Mistake type #1 (wrong people on the board) did not occur at Friendster: the board members were serious, committed and experienced professionals. Neither did Mistake type #4 (Too many people): the board’s size was appropriate.

However, it’s a different story with regards to the other types of mistakes:

• Mistake type #2: Lack of alignment

 According to two Friendster CEOs, Abrams and Lindstorm, the lack of alignment was clear: the board was looking for the next thing instead of ensuring lasting solutions to technical problems, as the CEOs believed that the board should have done. 

• Mistake type #3: A board that is too homogenous

During Abrams’ tenure as CEO, the board had several experienced VCs, including the mutual board member, and Abrams was concerned about Friendster’s clear VC domination. As Joel Spolsky explained, most VC investments fail, and the few that don’t must generate huge returns to compensate for all the failures. VCs search for the next Google, whereas founders, like Abrams, may settle for much smaller, safer goals.

• Mistake type #5: organizational issues

Founder and Chairman Jonathan Abrams became increasingly isolated and less influential, and he was stripped of his chairmanship in 2005. Afterwards, he stopped coming into the office regularly. This situation was far from ideal for a startup fighting for its life.

The Bottom Line

The Friendster story offers lessons on diverse subjects from strategy and marketing to engineering. One key lesson is that no matter how lucrative a startup may seem or how experienced and successful the investors may be, startups can fail if they do not pay enough attention to the basics:

• Make sure you find a comfortable, mutual fit with future partners.
• Be aware of potential board mistakes, and do your best to avoid them.
• Make additional effort to maintain healthy and cooperative organizational relationships.

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There are many models for revenue generation, and the accelerated development of the Internet, social networks and smartphones is expanding the possibilities.

 Listed below are 26 common revenue model types and examples of their effective use. It doesn’t contain all possible models, and some may have overlaps, derivatives, and combinations, but it’s a good place to start.

 For those interested in a lengthier, more thorough discussion of some models, we recommend Fred Wilson’s articles on this topic.

 Finally, we must distinguish between decisions about revenue models (e.g., monthly subscription vs. pay per transaction) and pricing decisions (price of $10 vs. $50). Pricing is important; many methodologies have been developed and pricing books were written (e.g. The Strategy and Tactics of Pricing by Nagle). However, pricing is not the topic of this post.

Commerce and retail

Physical goods have been sold as long as markets have existed; later, services were offered, too. In recent decades, digital products have also been developed.

 The basics of selling to private clients (B2C) and business clients (B2B) are similar. Usually, major challenges may include:

• Turning a one-time sale into a repeat sale or into a pre-sale of future products (e.g. adding the customer to the firm’s loyalty club)
• Adding extra components to a basic product (e.g. insurance, financing, extended warranty, and premium accessories offered to car buyers)
• Selling a product that bonds the customers (classic examples: razors and blades; printers and ink cartridges)
• Finding a way to price with premium to market segments that are willing to pay for the additional value (e.g. first class on airlines)

 1) Selling physical goods

 The traditional retail world (high-street stores and malls) changed in the 90′s when companies like Amazon emerged and, due to savings on expensive real estate costs, offered through e-commerce lower prices than stores did.

 2) Selling digital products

 Digital goods can be downloaded and consumed instantly and usually have neither additional production, shipping or inventory costs nor major quantity limitations. Digital products include, for example, songs, eBooks, games and apps for smartphones and tablets.

 3) A service sold per unit

 The work-hour is common among lawyers, accountants, consultants, IT integrators, etc. This model also exists on platforms such as Elance.

 Other widespread units include distance (taxi rides), weight (parcel shipment), and bandwidth (internet service providers).

 4) A service with fixed price

 Movie tickets cost the same amount regardless of the movie’s length and quality or the seat’s location. Women’s hair salons sell different services for set prices: styling, coloring etc. A more recent example of fixed-price service sales: Fiverr, a marketplace where diverse gigs are offered for $5 each.

 5) Sale of services for future use

 These include pre-paid phone cards or credits for usage of photos from royalty-free sites like iStockphoto, where price per unit decreases as the quantity purchased grows (the seller enjoys receiving the deal’s proceeds before usage).

 6) Daily deals / flash sales

 Daily deals (with players like Groupon) were trendy not long ago. Consumers gain an opportunity to purchase items at a steep discount; suppliers sell large quantities via the coupon company, allowing them to reduce marketing, sales and inventory costs.

Subscriptions and usage fees

7) subscriptions

This model has existed for long time (e.g. newspapers, magazines, gym). It gained popularity in other domains, too: software (once dominated by the licensing model), movies (offered by Netflix), mobile carriers, and others.

Some subscription schemes offer unlimited usage; others have a specified cap above which they charge a higher rate.

8) Usage fees

In this model, the greater the usage, the higher the payment. Electricity, water, and gas bills fall into this category. Until recently, mobile phone carriers often used this model to charge for minutes of outbound calls and quantities of SMS text messages.

9) Rental

Rental enables multiple customers to enjoy the same asset at various times. Usually, rent is priced per unit of time (e.g., the traditional Avis and Hertz model of daily and weekly rentals). New-generation players like Zipcar rent by the hour.

Licensing

This used to be a common revenue model for software players. However, with the emerging trend of SAAS, licensing became less attractive (compared with the subscriptions model).

10) License of usage

This is a common model in Intellectual Property (patents, copyrights, trademarks). The license is usually limited by time, territory, types of products, volume, etc.

11) Certifications

A slightly different variation is the usage of certificates. For example, the McAfee SECURE trustmark for Internet websites.

Auctions and bids

12) Auctions

The traditional auction industry, led by brands such as Sotheby’s and Christie’s, changed in the ’90s with the launch of eBay. It offered an online platform to connect buyers and sellers. Price is determined in a public auction, and eBay generates revenues from a variety of fees.

Lately, there is a trend of immediate fixed-price sales (compared to auctions) on eBay, implying possible change in users’ preferences.

13) Dynamic pricing

Sponsored search results on Google’s search engine, based on search keywords, are purchased through the Adwords system, which is based on dynamic pricing. The larger the demand for keywords, the higher the cost per click.

Advertising

Advertising revenues are not new. However, the once-straightforward advertising templates have become more complex and creative, and the industry evolves constantly.

Additionally, due to constant growth in information and its availability, large-scale revenue generation requires either great traffic or niche domination.

The Internet world has many advertising models: pay-per-views (CPM) as well as pay for behavior (clicks) like CPC and CPA. We will not dwell on them in this post.

14) Advertisements (e.g., text, banners, video)

In the past, advertisements appeared only in traditional media such as newspapers, magazines, billboards, television and radio. Today, by definition, advertising also includes the Internet and expands onto apps and mobile platforms.

15) Promoted content

Unlike ads, promoted content (also known as ‘sponsored’ or ‘suggested’ content) looks similar to regular user content. Users may give it more attention or perceive it as more credible than other advertisements; some users may even be oblivious to the fact that someone paid to promote the content.

This model is common on social networks such as Facebook and Twitter as well as websites like Yelp.

16) Sponsorships

Companies may sponsor, for example, sports events, conventions, websites, and TED talks.

Data

17) Databases

High-quality data (e.g. an index of qualified service providers in a specific domain) is valuable.

• The more exclusive the information, the greater the value.
• The usage will be more valuable (and expensive) when the data is enriched with profound analysis.
• Some entities specialize in lead generation: creating and maintaining names and contact information of potential customers and selling them to 3^rd parties.

It should be mentioned that for ventures such as Google, Twitter and Facebook, which aggregate high quantities of data about users, the revenue engine is not sales of databases to 3^rd parties. Rather, these sites focus on advertisements based on customer data. The idea of aggregating and using data about users who do not pay for the services is the origin of the phrase, ‘If you are not paying for the product, you are not the customer, you are the product being sold.’

Transactions / Intermediation

18) Brokerage

The Internet and other technological and social developments hurt many intermediaries, and the future of middlemen is questionable. However, middlemen still have some important roles in connecting parties (fees are usually calculated by percentage of the transaction, but there is sometimes also a minimum payment.). Real estate brokers and M&A investment bankers fall into this category of intermediaries.

19) Transaction enablers

Some entities enable transactions between other parties. Here, too, the fee is usually a specific percent of the deal. For example, PayPal enables payments that minimize credit risk (for sellers) and increase information and purchase security (for buyers).

20) Affiliate Programs

Typical affiliate programs, common in internet marketing (from huge players like Amazon to small-scale blogs), include sellers of products/services and parties that drive traffic to the sellers. Some affiliates, but not all, explicitly state that links to 3^rd parties may entitle them to profits.

Affiliate programs often use revenue-sharing mechanisms (50/50, or another agreed upon revenue allocation). Others may use different compensation mechanisms such as CPM, CPC and CPA (mentioned earlier).

21) Creating a platform / marketplace

The Internet creates a unique and excellent opportunity to easily connect sellers with consumers:

• Airbnb enables homeowners to offer accommodation to tourists who are not interested in hotels
• Etsy links artists and art seekers
• CDbaby does the same with music

The platform manager usually maintains and upgrades the platform and takes care of customer service, payment collection, mediation, etc. Airbnb also offers insurance. Platform managers usually are not involved in creating the product shipment and do not hold inventories.

The revenue model is usually a specific percent of the deal (Apple’s iTunes and App store take a 30% cut of each sale).

• Some marketplace coordinators collect from both parties to the transaction; others collect from only one party (which subsidizes the other party).
• Some platform managers (like Kickstarter) are entitled to revenues only if the desired deal is fulfilled.

Freemium

The Freemium model has enjoyed much success in the last decade, although recently there is a debate whether the Freemium days are over.

The Freemium idea is based on providing a basic version of the product for free and charging a premium for the full version. Usually, few customers buy the premium version.

Business models involving Freemium are very common, especially for providers of mobile applications, which generate huge revenues through in-app purchases and upgrades.

There are several variations on the Freemium theme (to be detailed below), and there are some mixtures and derivatives of these archetypes.

22) Paid version without advertisements

Many games and applications’ free versions include (often annoying) advertisements. The paid version enables usage without ads, thus improving the user experience. Usually, the revenues from upgrades exceed those generated by the ads.

23) Paid version without restrictions

Often the free version has usage limitations: levels in a game, storage volume, number of users, and more. Paying for the premium version enables unrestricted use. It is convenient, for example, for wireframe applications in which mock-ups should be shared between various members of a design team.

24) Paid version with additional features

One of the most effective ways to generate revenue is to sell specific features and functions that are not included in the basic free version, such as additional “lives” or exclusive weapons in games.

This model often maximizes revenues per customer, as loyal customers may spend a lot for additional features.

Revenue model types common in the financial services industry 

The financial world, offering a unique product (i.e., money), has special types of revenues.

25. Interest revenues

Banks charge higher interest for loans than they give for deposits. The gap between these figures, also known as the ‘interest spread’, should compensate for credit risks and operational risks, and has traditionally been banks’ main source of revenues.

Today, a new wave of online ventures, such as Zopa and Funding Circle in the UK, presents a small-scale alternative to banks. Since they have a smaller workforce and no physical and costly branches, these enterprises may offer borrowers and depositors better interest rates than full fledge banks do.

26. Asset management fees

Asset managers, institutional investors and similar entities that manage investments for their clients make their living from fees. For example:

• Percentage of the overall customer’s assets being managed
• Percentage of new money transfers by the customer to the money manager
• Percentage of the returns (also known as carried interest) that some investment professional generate in excess of an agreed upon hurdle rate.

Recently we witness also new players (for example, Nutmeg) offering online investment services in return for a specific percent of the managed assets.

So, having reviewed this list, what is your favorite type of revenue model?

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Many firms react automatically: new strategic plan, massive promotion efforts, upgraded products, and expectation to quickly regain market leadership. However, they often realize, to their surprise and anxiety, that the old tricks do not work anymore. Our advice to them: learn from the classic book The 3 Musketeers.

 When there is more diversity than commonality 

 The musketeers’ motto, ‘One for all and all for one,’ might make you think that the musketeers had lots in common, but actually they didn’t. The 3 musketeers – Athos, Porthos and Aramis – were all different. Athos was smart, silent, honorable, immune to women, and father figure to others; Porthos was a flashy and flamboyant womanizer, fond of social intrigues; Aramis was elegant and mysterious with an ambition to join priesthood. Each of the musketeers had unique natures and qualities; each differed from his friends in behavior, needs, and motivation.

 Similarly, today’s customers differ broadly from one another, and they present great opportunities to whoever runs accurate market segmentation. Sony and Microsoft, who had led the video game console industry, learned this lesson when Nintendo launched Wii in 2006 and, instead of targeting heavy gamers (who desired powerful hardware, improved graphics and loads of features), aimed at ‘casual users’ and families. These preferred convenience, simplicity and low prices rather than high-priced performance and graphics specifications.

 The threats to the video game consoles industry 

Today, new challenges threaten Microsoft and Sony (expected to launch new consoles in 2013) as well as Nintendo, which recently launched Wii U:

• Smartphones and tablets using iOS and Android, with larger screens, stronger processors, and superior graphics than ever. They enjoy a huge variety of games, regular updates, and frequent product launches compared to game consoles (which launch new products only once in several years). No wonder the revenues of mobile games are expected to grow from $2.7B to $7.5B in 2015, and that iPad is considered a major threat for consoles.
• Controllers for smartphones and tablets. For example, take a look at icontrol pad and Gametel. These controllers offer comfort, user-friendliness, and improved game control. The major threat, that Apple directly enters this market, increased when a relevant Apple patent application was published
• Turning smart TVs to console substitutes. This is possible through ventures such as Gamestick (which raised $8M via Kickstarter) or Ouya (which is open-source and Android-based). Here, too, Apple is a threat, especially amid rumors about an App store for Apple TV.
• Shrinking supply of console video game developers. Epic Games recently announced that its iOS game Infinity Blade was more profitable than its Xbox hit, Gears of War. Software firm THQ became an acquisition target for EA after encountering financial difficulties, and Sega closed some branches that focused on games for consoles. In the same time, the number of games, updates, and downloadable-game developers has risen.

Indeed, these are very challenging days for the console industry.

 How to cope with strategic threats on the industry

These action steps can help fight hungry competitors and disruptive innovation in the video game console sector (and other industries, too).

 1) Study the industry trends and the new and future competitors. 

Absorb the intensity and immediacy of threats. Many companies, from Kodak to Blockbusters, failed, either due to complacency or unwillingness to face the harsh reality.

 In contrast, some organizations adapt smoothly to changing environments. For example, top universities such as Stanford and Columbia understood the impact of online education providers (such as Khan Academy), and opted to cooperate with Coursera. Similarly, Harvard and MIT partnered at the edX venture.

 2) Update your market segmentation. 

Markets are dynamic and customer definitions are changing (for example, a recent customer segmentation defined hard-core, mid-core and casual video game customers). You should realize the delicate differences between the different ‘Musketeers.’ Firms should own and manage deep customer segment knowledge and not rely entirely on third-party analyst reports.

 3) Target specific customer segments.

 Look for the segments that you can and wish to serve. These may include customers who once preferred performance and graphics and are now more price-sensitive (and may even prefer the Freemium model); those for whom inter-connectivity with social media is now critical; or users who are now accustomed to tablets.

 Check: how well can you answer the needs of Athos, Porthos or Aramis? Remember that a value proposition aimed at an average customer may miss the entire market. You don’t want all your potential customers to say, “This is a nice product; I personally do not need it, but someone else definitely does.” Rather, you want some customers (ideally, many of them) to say, “Yes! Your product is exactly what I need! Where can I buy it?”

 4) Design a business model that fits your target customers.

Making changes to business models may relate to distribution channels, partnerships with external developers, revenue models, and more. The changes may be radical: for example, consider the advice that a gaming expert recently gave to the Microsoft and Sony: to totally ditch the physical consoles.

 5) Measure yourself.

Today, companies pay heavily for mistakes. Therefore, set relevant performance metrics, track your performance, and make necessary changes ASAP.

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Wouldn’t it be great if it were easy for entrepreneurs to generate startup ideas worth pursuing?

While everybody agrees that execution is crucial, generating great ideas is equally important: no founder could seriously expect investments when pitching poor initiatives.

Finding ideas may be easy for some; however, generating impactful initiatives that justify several years of hard labor and capital investments is an entirely different challenge. Fortunately, there are ways to make the ideation process doable.

Paul Graham recently published a great essay (that will be discussed below): ‘How to Get Great Startup Ideas,’ in which he details a clear ideation methodology rooted in his extensive start-ups experience.

Beyond this must-read essay for entrepreneurs, I encourage aspiring startup founders to seek out other idea generation techniques, too. Why? First, exposure to different points of view and methodologies is an effective fertilizer. Second, these philosophies are not necessarily mutually exclusive. Third, idea generation processes – just like the startup ideas themselves – are a lot about personal preferences and fit.

Let’s review four different ideation philosophies:

Methodology #1: Solving your problems

How to Get Startup Ideas – Paul Graham

Graham is the co-founder of Y Combinator, the startup incubator that has funded Dropbox, Airbnb, Stripe, and Reddit, among many other startups.

Key Points:

• Great startup ideas share 3 characteristics: the founders need the solution offered by the ideas, the founders can personally build them, and not many others believe in them.
• The problem to be solved should be severe and urgent, at least for some people, as opposed to a problem that only mildly interests many potential customers.

 Graham’s advise to entrepreneurs:

• Notice an existing real problem; don’t ‘think about one.’ Noticing comes from looking for things that are missing, and it is much easier to do when the founder is at the leading edge of a domain. Graham cites Robert Pirsig in Zen and the Art of Motorcycle Maintenance:

“You want to know how to paint a perfect painting? It’s easy. Make yourself perfect and then just paint naturally.“

• Get to the leading edge of a domain (even if only as a user). Further, mastering two domains (e.g. programming plus life sciences) will give you a huge advantage.
• Turn off distracting filters, such as, “Can this idea really turn into a big business?” These should only be applied at a later phase, because it takes time to realize the full potential of good ideas.
• Pay attention to ideas for things that some dismiss as “toys.” Often, these lead to great products.
• Ignore competition. Graham claims that “it’s exceptionally rare for startups to be killed by competitors- so rare that you can almost discount the possibility.“

My suggestions:

• A good starting point to finding problems and solutions: try thinking about ‘a job that needs to be done.’ Many years ago, Harvard’s Prof. Ted Levitt said “People don’t want to buy a quarter-inch drill. They want a quarter-inch hole!” Understanding the real job that needs to be done – and that different customer segments may need different jobs – will improve the ideationprocess. [More about this concept could be found at the HBR article Marketing Malpractice by Prof. Clayton Christensen et al.]
• To learn more about “toy” ideas that became successful products, check Chris Dixon’s post: The next big thing will start out looking like a toy.
• Finally, an ambitious innovator who comfortably considers becoming the next Zuckerberg, Page, or Brin is advised to read Graham’s Frighteningly Ambitious Startup Ideas.

Methodology #2: Looking for places prone to innovation

How to find startup ideas – Matt Cutts

Cutts is the Head of Google’s Webspam team. His popular blog focuses mainly on SEO. 

Key Points:

• Cutts presents a structured approach to identifying ‘hot spots’ that need solutions. He defines a hot spot as: “an area of high information density, clutter, stress, disorganization, or any place that has a suboptimal solution.”

• After finding a hotspot, Cutts explains, one should think about a  solution via the web or cloud. He provides examples of hotspots (like piles of business cards and pens) and their solutions (CloudContacts and Livescribe, respectively). 

My suggestions:

• Some people are more perceptive than others, and as Cutts mentions, some are more irritated than others by everyday problems that sometimes go unnoticed. By methodically looking for potential hotspots, other people can make up for their relative disadvantages.
• Training yourself to look for hotspots may take time, but it’s worth the effort. Start with the places where you spend lots of time and energy, for example at home and work. Later, you can progress to the less obvious ones.

Methodology #3: Testing startup ideas systematically

Developing new startup ideas – Chris Dixon

Dixon is a prominent angel investor. Foursquare, Kickstarter, Pinterest, Dropbox and Skype are some ofhis investments.

 Key Points:

Dixon urges aspiring founders to keep updated spreadsheets with all their ideas and discuss them with as many relevant people as possible (in another post, he explains why entrepreneurs should be the opposite of secretive).

When listening to many people, the challenge is to sift for the signal among the noise. Dixon’s experience is that feedback often depends on the position and environment of the speakers:

• Employees of large companies are more useful for providing data and less for evaluating the strength of a startup idea.
• VCs are good at discussing other relevant companies and testing the idea’s validity through several key business filters.
• Potential customers: there is a big difference between B2C and B2B (who will most likely buy the product only 2-3 years ahead).
• Entrepreneurs: the only group Dixon suggests fully listening to. 

My suggestions:

• This post is more about idea valuation and less about idea generation (which Dixon discusses in another post, explaining why the myth of the ‘Eureka’ moment is far from reality).
• When sharing and discussing ideas with fellow entrepreneurs, keep in mind that not all innovators are alike. Some differences are meaningful and should be acknowledged when considering the given feedback. For example:

• Customer types with whom the speaker is experienced (Corporate vs. SMEs vs. individuals)
• Industry sectors (e.g., biotech, medical devices or renewable energy vs. internet or mobile apps)
• The speaker’s personal experience with VCs / angel investments, or lack thereof.

Methodology #4: Making changes to existing products

Finding Your Innovation Sweet Spot  – Goldenberg et al.

The writers of this 2003 Article built on the TRIZ (‘Theory of Inventive Problem Solving’) technique developed by Genrich S. Altshuller.

Key Points:

The above methodologies focus on identifying problems or customer needs. In contrast, this system focuses on existing products. You can change existing products in five different patterns and examine the resulting new product for feasibility and market potential.

The five innovation patterns are:

• Subtraction. Eliminating the wheels from a bicycle results in stationary exercise bikes; alternatively, subtracting bicycles’ pedals leads to balance bikes for toddlers.
• Multiplication. Gillette’s practice of adding razors to its blades is an excellent example. It started by creating double-blade razors, and led to today’s five-blade Fusion.
• Division. Many years ago, hi-fi came in integrated systems, which were replaced by standalone units over time (separate CD/DVD players, receivers, speakers, etc.).
• Task unification. Adding new functionality to an existing component, leading it to perform two tasks. (e.g., adding wheels to suitcases, diminishing the need for luggage carts).
• Attribute dependency change. Creating new dependencies between a product and its surroundings. For example, sunglasses whose lenses change depending on sunlight.

My suggestions:

The aforementioned examples may seem dated. However, the digital age offers new modern examples. Check these out to get inspired:

• Subtraction: Apple’s iPhone, released in 2008, presented only two primary buttons and moved the functionalities of most of the common buttons to the touch screen.
• Division: for years, no competitor succeeded in presenting a valid alternative for Craigslist; however, many ventures succeeded by focusing on only one domain of Craigslist., For example, ELance (in services); Airbnb (in sublets); Etsy (in art and craft); okcupid and JDate (in personals). [To see more, check Andrew Parker's post and infographic The spawn of Craigslist].
• Task unification: Today’s smartphones offer functionality that once required many different gadgets: watches, alarm clocks, cameras, GPS, etc.

Startup ideation: the bottom line

There are various ways to go about startup ideation; one of them should fit you. Just do it!

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What caused all the drama? Well, it was about the notion of providing products for free. It started when Anderson published his book ‘Free’, suggesting that the future lies in setting the price of zero – free – to products. He claimed that marginal costs for digital units have declined so much that they are almost zero.

In response, Gladwell argued that Anderson was wrong, since the marginal cost per unit – even if low – is above zero, and distribution of many free products costs a lot of real money. Cuban expressed, in several blog posts (this is the first one) an opinion similar to Gladwell’s. Then Godin joined the debate, claiming that Gladwell was actually wrong, as zero had become a reality.

This controversy could have merely been an entertaining commotion, had “Free” not become a major part of our lives. In particular, the Freemium model (in which the basic products are allowed for free while added-value versions are offered for a premium) abounds in many industries. We have all met the Freemium model: from antivirus services (such as AVG), through photo sharing (like Flickr) to iPhone games (e.g, Angry Birds).

Recently, some have claimed that the Freemium model does not work and that it has run its course. So, in this post, we will examine the Freemium model, its advantages and problems and determine whether or not it is still valid.

How the Freemium business model works

1. What is considered Freemium?
   In Freemium, the free version constitutes a complete, basic product that satisfies most users. The goal is to convert a small percentage of users into paying customers who generate revenues. Sometimes (but most often not) the free version also generates direct revenues, usually through advertisements.
2. What would NOT be considered Freemium?
   Not Freemium: a limited-time demo; a partial product that does not give a real solution unless upgraded to the premium version; a prototype / alpha; etc. These all aim to check or demonstrate the capabilities of the product, generate feedback from customers, or persuade customers to buy the real product (i.e., the paid version).
3. What are the added values for buying the premium version?
   Entrepreneurs exhibit a variety of creative ideas on this subject. For example:
   • Quota limits (e.g., number of users; number of units to be used; number of stages in a game; storage capacity)
   • Tools to maximize the product’s efficacy (for example, in the gaming world: powerful weapons, additional “lives”)
   • Useful features that are exclusive to the paid version
   • Additional fun features (in the gaming world, ability to acquire ‘cool’ characters)
   • App developer’s logo removal and the ability to add the user’s own logo
   • Advertisement removal
   • Privacy and security enhancement (preventing others from accessing private files)
   • Access to a desktop version (allows usage of applications offline, without the ‘cloud’)
   • High quality service / call center (as opposed to a free version with no support)
   • Online forums for paying customers only
   • Warranty / Guarantee
   • Consulting by a relevant professional
   • HD versions for tablets

   The above list is by no means exhaustive.

The power of Freemium

The Freemium business model has several advantages:

1. No usage barriers: Consumers today navigate amidst countess marketing messages regarding new products, and are forced to constantly filter them. ‘Free’ has a special appeal for customers, as evidenced by research by Professor Dan Ariely. People who read about a free product or hear about it from friends do not hesitate to check it out.
2. Creating a large user base: A free version is an effective way to create a large customer base. Startups can use it to acquire users and fans, demonstrate the quality of the product, and build a brand that could later on be leveraged for product upgrade or cross-sales.
3. Differential pricing: Todd Hopper, the CEO of Zipline who developed Wolf Toss, revealed that the Freemium model is profitable for his venture: some avid customers play 100 times per month and generate revenue of 10 to 20 dollars each via add-ons purchases. This income would not have existed if, instead of this business model, his team had chosen a fixed price tag of 99 cents (as many game developers do).
4. Advertising revenues (in some cases): Usually the advertising revenues are low, and represent between 10% to 30% of revenues by upgrades and add-on purchases. But some ventures do profit from ads. For example,who.unfollowed.me brings in advertising revenues five-fold the paid versions’ revenues.
5. Cost savings: paying customers expect a certain level of service, but there is no such commitment to non-paying customers. For example, in the WordPress themes and plug-ins world, the maintenance, updates and service levels offered to paid versions often differ greatly from those for free products. Providing service only to paying customers can save significant costs.
6. Identifying customers for the premium version: Box, the file sharing venture, takes an interesting approach: The free version enables it to identify relevant customers for upgrades, whom the sales reps then approach.

The problems with Freemium

1. The need to acquire many customers. Only a few free customers convert to premium customers (A Flurry research revealed that for games, the conversion rates are usually between 0.5% and 6%). Therefore, a venture often needs millions of free version users (and the capacity to serve them all) to acquire enough paying customers.
2. Attracting the wrong customer segments: The free version aims to attract many customers, expecting that a certain percentage will buy the premium version. Stormpulse moved from Freemium to a payment-only model when it realized that its free-version users were organizations which did not benefit from or buy the premium version. Basically, they attracted and served the wrong customer segments.
3. The risk of customer rage: If it is impossible to enjoy the free version without upgrades (or wasting lots of time), then customers may become frustrated and angry. For example, many customers spent money to decrease harvesting time of virtual vegetables at Farmville, leading to criticism at Zynga. True, this did not seem to harm Zynga’s successful IPO, but it is not guaranteed that other ventures could get away that easily.Further, several iPhone applications got negative public relations when parents found out that their children’s joy from seemingly innocent games actually cost hundreds of dollars. It turned out that 15 minutes after downloading a game, users (in this case- kids) could make add-on purchases and perform other paid actions with no need for a password. Anger grew even bigger, when neither Apple nor the games’ developers took responsibility. This led to legal proceedings and witty criticism at Jon Stewart’s Daily Show.
4. Complex payment process: (in some cases): when the payment is relatively complicated (as with Android app purchases) potential customers may abandon before paying. A Flurry research showed that Android apps generated only 24% of the revenues produced by identical iOS apps. Many users will also drop out if credit card details are required in a relatively early stage of the registration process.
5. Lack of commitment: Spending money on a product strengthens users’ commitment and perception of the product (and increases expectations regarding the product and service quality). In contrast, free products – unless designed so that the value for customers increases over time- generate less loyalty and appreciation. The entrepreneur Tyler Nichols openly admitted that the free customers often seek support without bothering to read operation manuals and FAQ, unlike his paying customers.

So, is the Freemium model still valid?

Freemium is not for everyone, and sometimes it is less advantageous than other models (such as paid-only, or limited-time-trials) especially when serving niche market segments or large enterprises. In addition, Freemium requires patience and capital to build and maintain the venture until sufficient cash flows in through product upgrades and add-on purchases. Some entrepreneurs, like Tyler Nichols, have abandoned the Freemium model in favor of paid-only.

However, the Freemium days are definitely far from over:

• A Flurry study revealed that 65% of the top game revenues at Apple’s App Store were from upgrades of the Freemium model. These accumulated to billions of dollars.
• The successful games Temple Run and Mega Jump were both initially offered for 99 cents, with no free version. Both games failed to gain meaningful traction and pivoted to a Freemium model, promoting their games through Free App a Day and OpenFeint, respectively. This decision led them to great success.
• Mailchimp, an e-mail distribution software, is also an excellent case study. It moved from a paid-only model to Freemium, and, in one year, increased the number of paying users by 150% and profits by 650%.

Therefore, the Freemium model remains valid, especially for certain industries (such as gaming), specific platforms (such as iOS devices), and particular customer segments (individuals, not enterprises). It can greatly contribute to a venture’s success, but also requires a thorough analysis of the venture, a deep understanding of the market and customers, and coherent business model and strategy.

This post was published in Hebrew at Newsgeek.

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A look at the defining characteristics of winners in these two worlds (professional sports on the one hand and entrepreneurship on the other hand) reveals many common success factors, but also one big distinction.

In this post we will use this analogy to examine what leads to success in these two arenas, realize in which aspects entrepreneurs should try to imitate professional athletes, and, finally, identify the major difference between them and its implications.

1. The statistics

Sports: Out of millions of people who practice sports, only a few become professional athletes, and a very small percentage reaches the professional panacea – the Olympic Games. Olympic athletes and coaches have specific parameters for success: Did the athlete qualify for the finals? Did she win a medal? Was it gold or “just” silver? Thus, a small error in a gymnastics exercise, a momentary loss of focus in judo, or a split-second delay in a race can, cruelly, end with an athlete weeping and a coach talking about a big failure.

Startups: Most startups do not produce the desired return on investments, and a tiny fraction achieves economic prosperity. Often one may claim that the startup is not a “failure” even when it does not meet its financial expectations: developing an innovative product, selling products to satisfied customers, and contributing to the advancement of the human race (in certain cases) are all impressive and tangible accomplishments. Yet, from a purely economic point of view, the majority of startups fail (there are different opinions regarding the exact figures).

Insights for entrepreneurs: the statistics should not discourage entrepreneurs – they merely reflect the reality. Acknowledging this reality should encourage entrepreneurs to learn what is necessary for them to become successful.

2. Realizing potential

Sports: There are countless stories, in all sports fields, about ‘the next Michael Jordan’, who unfortunately never managed to realize his/her potential. Evidently, a great physique and a natural talent for a given sport do not guarantee success. Accomplishments depend on how much athletes develop technically, physically and mentally; they must strengthen their weaknesses and acquire essential competitive abilities.

Startups: Entrepreneurs know that investors look for excellent products, large markets, and substantial competitive advantages (e.g. intellectual property, exclusive distribution, or strategic partnerships). Investors also look for the ability to realize the startup’s raw potential and turn it into a successful business while dealing with many future challenges, (e.g. key customers withdrawing from a pilot, forced delays in market entry, or unexpected competitors).

Insights for entrepreneurs: an idea, no matter how good, is far from sufficient. The real challenge is in realizing the potential and turning an idea into a successful business while overcoming multiple obstacles. If a startup’s team does not have the skills to do it, then the venture is likely to face serious challenges in the future.

3. Commitment

Sports: Athletes arrive at big competitions after years of preparation. Some of them follow intensive training schedules, starting in childhood, at the expense of social life, hobbies, sleep, etc.

Startups: From the moment when a theoretical idea turns into a real project, there is a need for focused dedication. This may sometimes lead to dramatic actions: Jeff Bezos left a well-paying job in New York in order to establish Amazon in Seattle; Sergey Brin and Larry Page gave up PhD studies at Stanford to found Google; and Bill Gates and Mark Zuckerberg left Harvard to devote themselves to Microsoft and Facebook respectively.

Insights for entrepreneurs: Major commitment is required in terms of time, energy, and loss of alternative income. Entrepreneurs must be straightforward and honest about it with themselves and with spouses, partners, and employees.

4. Team

Sports: The importance of teamwork in team sports such as football and basketball is obvious. But in individual sports, too, the importance of support staff is tremendous. Coaches, physiotherapists, fitness trainers, psychologists, physicians, nutritionists, and others enable athletes to improve, maximize their potential and reach top shape and performance at the right time.

Startups: Many entrepreneurs do everything by themselves: product development, design, quality control, customer acquisition, etc. However, high-quality support can help them avoid critical mistakes and can ultimately make the difference between success and failure. Such support may be granted, for example, by UX experts who help improve user interfaces, lawyers who help with investment agreements, and mentors who provide leads to strategic partners.

Insights for entrepreneurs: Despite limited budgets and a common tendency to bootstrap, entrepreneurs must have access to the knowledge, skills and experience of various experts. They may do this in several ways: internally (hiring the experts as employees), externally (as consultants or coaches), through mentorship, or by forming a board of advisors. The appropriate form depends on the specific circumstances.

5. Environment

Sports: some young athletes often relocate to remote countries in order to realize their potential. Maria Sharapova moved at the age of 7 from Russia to a prestigious tennis academy in Florida; martial artists travel to learn from masters in Japan. They do so to enjoy tradition, expertise, professionalism, and years of experience in talent development.

Startups: The business world, too, has clusters of knowledge and expertise. Silicon Valley is the most prominent example: huge companies like Apple, Intel and Hewlett-Packard, great universities such as Stanford and Berkeley, leading venture capital funds, and others are there contributing to an ever-growing virtuous cycle. Of course, one must not relocate to the Silicon Valley to enjoy a productive environment: many cities worldwide have become major startup hubs, and many others offer entrepreneurs open houses and shared office space where entrepreneurs can enjoy mutual feedbacks, access to mentors, investors and various professionals and exposure to the latest relevant developments.

Insights for entrepreneurs: entrepreneurs must seek a supportive environment rather than operate independently. They can, for example, share space with other entrepreneurs, attend conferences and meetups, or join relevant internet communities.

The big difference between athletes and entrepreneurs

There’s one major area where the two groups differ – the adherence to workplans.

Sports: athletes preparing for the Olympic Games need detailed workplans for various topics: the physical fitness, nutrition, tactics, etc. Athletes train for months and years in order to reach tournaments in top shape, ideal physical ability and strong mental state. Tournaments’ ultimate results depend, of course, on many external factors (such as the competitors, the weather, or injuries), but this does not reduce the importance of specific and detailed workplans to achieve top form at the right time.

Startups: Innovative startups operate in great uncertainty. The business plan of a new product, usually based on many assumptions regarding the future, will never fully materialize as planned. There will always be uncertainty, usually in one of two categories.

The first category: technological feasibility of the product (e.g. bio-tech projects, medical devices, renewable energy and other complex developments). For this category of uncertainty, each enterprise requires a specific examination.

The second category: difficulty to forecast customer behavior (e.g. regarding new websites or applications for smartphones), even when conducting market research in advance. Even if one displays prototypes to potential customers and runs focus groups, the behavior of real customers with the actual product, ‘outside of the laboratory’, remains uncertain.

Further, external changes can render plans irrelevant quickly. Such external factors may include, for example: changes in social networks, developments in mobile phone technologies, economic crisis, and regulation.

So, how does one deal with this kind of uncertainty?

What entrepreneurs must do given the uncertainty of markets and customers

1. Make sure that customers are satisfied with the product
   If they are not – improve the product. If still not – improve again. Without happy users, a startup cannot succeed.
2. Design a business model and check its validity
   Many entrepreneurs do not pay enough attention to the business model in the early stages, believing that it could be improved after product development is done and the product is released to the market. Well, it may be too late then. Attention should be given to the business model early on, taking into account the customer needs and behavior, the business environment, and the competition.
3. Choose appropriate performance metrics
   B2C ventures, for example, may like to measure their customer acquisition and activation using parameters such as the number of users visiting their websites, number of registered users, number of paying customers, etc. B2B enterprises, however, will have different parameters that reflect long and complex sales cycles, and therefore their metrics may include the number of prospects, number of leads, and the concrete opportunities.
4. Measure the metrics and adapt quickly
   It is necessary to drive forward while constantly and gently adjusting the steering wheel. For example, a slight modification of the features, UI or design might be necessary. Re-check the results after the change.
5. When necessary – pivot
   When it is clear that the current path will not lead to success, one must stop, analyze, review existing alternatives, and take the most suitable direction (which will then be tested all over again). Pivoting, as thoroughly explained by Eric Ries, may mean making a major change in the product, in the distribution channels, in strategic partnerships, or even in the target customer segments.

This post was published in Hebrew at Newsgeek.

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Many factors, on top of having developed a very cool product, have contributed to Twitter’s growth and success since startup days: the marketing strategy, business model, and customer focus, to name a few. Patents were not among them.

This seems like a deliberate decision: Twitter’s founders could have probably figured out inventions to patent early on if they had really wanted to. But, instead, they focused on building an excellent company with great products and on selectively investing in Intellectual property (such as trademarks).

This strategy is remarkable, as many technology companies and social networks invest heavily in patenting early on. For example, Facebook already filed 35 patent applications by 2008.

The Twitter case raises the question: should startups invest in patents?

Patents’ great past

The current patent system, rooting centuries ago in Europe, had an important role in technological progress. It provided incentives to spend time, energy, and money on innovations by granting inventors exclusive rights to benefit from their inventions.

The inventors’ rights were, however, balanced with public interest through several means: limiting a patent’s duration, constraining it to specific claims, and using a thorough examination process. In order to be patented, inventions must be novel, non-obvious, useful, and fit a specified statutory class.

Overall, the system seemed to work fine. Many novelties, such as Bell’s telephone and many of Edison’s inventions, were patented. Pharmaceutical firms have invested billions of dollars on drug development thanks to this protection, and many companies from other industry sectors did the same.

Patents’ less-than-great present

Recently, there have been many voices, especially in the US, claiming that the current patent system does not work anymore and no longer supports technological progress, economic growth, and new jobs. Among the issues stated by critics are:

• Long queues
  Due to backlogs, the average patent application process takes almost 3 years (and for software patents it is often longer) in the US. True, the USPTO recently launched an accelerated 12-month examination program, but it is limited to 10,000 applications per year.
• Excessive litigation
  The threat of costly lawsuits contributed to the emergence of phenomena such as patent trolls, claimed to be responsible for $29B in annual losses. Corporations spend big bucks to buy portfolios they do not need as armory for patent wars. Apple, Microsoft and Facebook are among the firms that followed this expensive strategy.
• Too many things can be patented
  Many things can be patented, leading to lots of criticism: business methods and software patents, are often critized for constraining innovation (it should be mentioned that software has been protected, and still is, by copyrights, too). Biology patents are criticized for ethical reasons, among others.
• Weird things get patented
  IBM got a patent for translating “LOL” into “laughing out loud”, and another one was granted for a crust-less peanut butter and jelly sandwich. These and other examples raised concerns about the current examination process.

As a result, critics, such as Mark Cuban, claim that the current system must be totally revolutionized to restore its historic role. Others claim that open source development, which is an opposite philosophy to patents, generates faster innovation.

Understanding the current patent world, we can now look at the relationships between startups and patents.

Why startups should NOT patent

Recently, opinions against startups’ investment in patents were voiced by experts such as a patent agent, an intellectual property lawyer, and a Nobel-prize winner physicist.
Commonly mentioned arguments are:

• The long process
  By the time startups eventually get patents (especially for software), they may be of no relevance.
• A patent may not be granted
  Most of the applications are not granted utility patents by the USPTO.
• Costs
  Applications handled by professionals cost at least thousands of dollars. The examination process and maintenance fees are expensive too, not to mention the additional costs of filing abroad for those choosing to do so.
• Limited resources
  Startups are usually very lean, and dealing with patent applications consumes lots of time, energy and managerial focus.
• Litigation is for big guys
  The patent wars between Apple and Samsung may give the impression that patents trials are mainly a territory for 800 pound gorillas. Indeed, patent lawsuits cost millions of dollars, so a startup’s patent may not deter infringement by big guys (unless the startup has exceptionally strong backing).
• Poor Return on Investment
  The reality is that most patents don’t get commercialized (or licensed), and their investments are never returned. Similarly, many startups do not generate revenues, let alone profits. This means that a lot of thought should be given to any investment.

In which cases SHOULD a startup file for a patent?

It may seem that “Do no apply for patents!” is, then, the best recommendation for startups. However, the situation is more complicated, and there may be good reasons to apply (provided, of course, that the startup developed a patentable invention):

• Patent applications are very relevant for some industries
  Biomedical devices, pharmaceuticals, renewable energy, and complex hi-tech, are some industries in which the costs and duration of R&D require maximal protection.
• Patents may be crucial due to potential competitors
  Without early patent applications, Mobileye, who developed a great proprietary system for driving security, could have been seriously threatened by large and powerful automotive industry players, when it was founded in 1999.
• Many VCs prefer investing in startups that apply for patents
  This position is supported by an iam-magazine research conducted among VC-backed startups, demonstrating a positive correlation between Intellectual Property and success. However, it should be mentioned that some VCs strongly criticized these findings.

What should a startup do, then?

Founders must make a sound assessment of the startup’s situation:

1. Analyze the specific circumstances
   At one extreme, there are startups (like Mobileye) that definitely require patent protection when founded. At the other extreme, standard e-commerce sites with zero innovation should not consider it. In between, there are startups with some innovation. For them, a patent’s relevance should be considered given the industry sector, the specific level of innovation, the startup’s resources, etc.
2. Forecast expected patent expenses
   Some entrepreneurs do not realize the full costs of patenting. Therefore, it is highly recommended to consult with trusted patent professionals about the expected long-term costs, as well as the strength of the applications.
3. Estimate non-monetary costs
   The founders should get a realistic estimate of what a patent application would cost also in terms of time, energy, focus and managerial attention, and, as a result, the potential negative impacts on crucial activities such as product development and sales efforts.
4. Consider other intellectual properties that may be more appropriate
   Copyrights (protecting software, among other things), trademarks, and design patents could provide powerful protection for some startups. There is also another type of intellectual assets, i.e., website domains and social media usernames (like on Twitter), that may be very relevant for others.
5. Assess whether financing by VCs or angels will be needed
   If an external investment is required, check whether lack of patent applications would be a serious obstacle for fundraising. For example, could the startup raise capital through crowdsourcing platforms such as Kickstarter?
6. Get mentored
   On top of patent professionals, the founders shuld seek advice from knowledgeable entrepreneurs or friends who have been through the patent application process. Their experiences may be priceless.

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There are many other sectors in which technology, innovation, and shifts in customer behavior dramatically changed the business models, marketing strategies, and identities of key players.

The middlemen’s crucial historic role

The ancient barter system – I give you vegetables and you give me eggs – enabled families to consume much more than what they could raise and grow alone. However, the real growth of commerce occurred when markets were established and intermediation between hundreds of people took place. Markets enabled families to purchase all the goods they required and suppliers reached a broad customer base.

Over time, new goods from remote places became available and more intermediaries joined the process; silk, gems, and herbs imported to Europe centuries ago passed many hands in transit from Asia.

Middle-men – wholesalers, re-sellers, distributors, agents, retailers – contributed to industry growth, offering solutions to several problems:

• Geographic distance between continents, countries, and cities were broken down by middlemen into smaller units that were easier to manage in terms of inventory, logistics, and shipping.
• Transaction risks (i.e., product quality and full and timely payment). A trustworthy middleman increased confidence through personal relationships with both suppliers and buyers.
• Language and cultural barriers between sellers and buyers were broken down by middlemen’s personal knowledge of both sellers and buyers.

The intermediation had a toll, however: each layer, demanding profit margin, added markup to the final price. The last step – the retailers – often kept the highest margin, reflecting the challenge of actually selling goods to end-customers.

This raised understandable attempts to cut the middlemen with innovative marketing (e.g., mail catalogues). While these attempts impacted some industries, they did not change the traditional middlemen-based commerce world.

The changes brought by the WWW

In the 90s, the internet enabled immediate and direct contact between millions of people, eliminated geographic distances, and created a new “global village.” Problems that had previously required middlemen were diminished:

• Geographic distance became a lesser issue since millions of people gained real-time global interaction and shipping worldwide became accessible.
• Transaction risks:Smart ranking systems such as those found on eBay dramatically reduced risks and increased the level of confidence and trust.
• Language and cultural barriers became less of an issue too, as English increasingly became the de facto standard business language. Moreover, native language websites were created to serve local populations.

The internet revolution had diverse impacts on industries and business models. There were sectors in which the middle men:

• Were completely cut out due to direct access between sellers and buyers
• Were replaced by new and modern intermediaries
• Survived, but were joined by new middlemen (often serving niche segments)
• Were not impacted at all because of the specific nature of their business

Let’s see how this happened.

The initial industry shakers

The sectors impacted first were those with obvious and instant disintermediation benefits. For example, industries in which:

• The middlemen’s main role was to link multiple parties. E.g., real estate agents handling apartment leases were replaced by Yahoo! Real estate and by Craigslist.
• The goods were commodities or well defined products with no customization: books, CDs, and DVDs; basic financial services (car insurance, stock trading); and travel. Amazon, ETrade, Expedia, and Travelocity were some noticeable new players.

• Low value/low priced goods: a good example is today’s DealExtreme, where most items cost a few dollars and global shipping is free.
• Major market inefficiency existed. For example, artists could not publish their art in industries dominated by powerful publishing companies. Eventually CD Baby was founded and enabled amateur musicians to publish and sell their music online. Lulu did the same to aspiring authors.

The second wave

The next generation of disintermediation initiatives benefits from current trends, such as:

• Crowdsourcing:. Unless backed by savings or family and friends, startups traditionally rely on professional financing. Nowadays, initiatives such as Kickstarter, GoFundMe, and Crowdrise offer crowdfunding to entrepreneurs as an accessible alternative to angel investors and VC funds.Additionally, Zopa and Funding Circle are small scale substitutes to banks, connecting between small loans seekers and capital providers.
• Smart Phones and App stores. The combination of GPS-enabled smartphones and application-rich marketplaces created many chances to cut traditional middlemen. One great example, the location-based GetTaxi app, links between taxis and those seeking a ride and applies both B2B and B2C models.
• Social networks. The power of social networks and referrals enables Surge to offer an employee-sourcing platform as an alternative to traditional HR recruiting firms.
• There’s more. Innovative companies that leverage current trends include, for example, Brayola, which offers women the ability to purchase underwear online, answering both comfort needs and style preferences. This used to require women to arrive to brick and mortar stores.

New industries feel the heat

More sectors are now threatened, and some of them are just realizing the danger. For example:

• Newspapers Originally threatened by online news resources, they are now challenged also by quality content and analysis on blogs and websites like Tech Crunch and Mashable.

• Mobile phone carriers. The strategy of Nokia – once the mobile phone’s market leader – was focused on the carriers. However, Apple’s business model changed the market when the iPhone was launched. The App Store bypassed the carriers while providing Apple a 30% commission.
• Cable TV/Broadcast networks: with Netflix producing its own TV series, House of Cards – and directly accessing millions of users – there may be a new threat to former kings of content.

Who is immune to disintermediation?

Despite the abovementioned trends, some middlemen are unlikely to vanish. This is especially true in these cases:

• Complex/large/customized transactions, Billion-dollar M&A deals usually need experienced investment bankers to get the deal done.
• Scale, brand, and operational excellence are crucial. Leading online marketplaces such as eBay, Amazon, etsy, elance, and Apple‘s iTunes offer a huge selection of products and solutions, a large user base, reliable intermediation, and robust operating systems, making these players unlikely to vanish.
• Industries where trust and confidence are essential, especially B2B sectors such as the defense industry.
• Wealthy customers. Owners of expensive houses enjoy the benefits of potential buyers’ screening provided by realtors.
• Middlemen have access to many customers or leads. Affiliates, a major force in internet marketing, connect websites with guidance-seeking users.

Having said that, we can still expect the disintermediation process to continue in many other industries.

What Next?

So, the questions now are:

• How far can this trend go? Will HMOs ever give up their position as middlemen between patients and medical services? Are universities likely to lose their role as the main providers of higher education?
• Who will be the visionary entrepreneurs to disrupt stable industries and which existing players will adjust their business models to avoid the destiny of travel agencies?

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