Make sure you handle the money

Third party monetization systems — from AdSense and affiliate programs to display ad networks and in-app “offer walls” — are a tempting drug for time-strapped entrepreneurs.

In the short term, outsourcing your revenue generation might feel smart: it lets you stay focused on on the “core” projects of building product and audience, without being “distracted” by the grueling and time-consuming work of asking customers for money directly.

But if you want to build a big, valuable business — the kind that investors like to back and strategic acquirers like to buy — what feels like a time-saving shortcut on the road to success may actually be a nasty detour down the wrong road.

If you’re the kind of entrepreneur who plays to win (and not just to make a quick buck), here’s a piece of advice: make sure you handle the money.

Here are three simple reasons why…

  1. Insight

    Every business exists by permission of its customers. If you solve a customer problem, you might get to live. Solve it better than anyone else and your customers will give you permission to grow, thrive, and maybe even lead the industry you choose to serve.

    If you aren’t talking to your customers daily about what problems you solve, what solving those problems is worth to them and how you could do better (and be worth more), you aren’t learning what you need to learn to survive, much less thrive.

    Third party monetization sets you on a path to maximizing what your money source values, not what your customers care about. You’ll probably spend lots of time doing things that aren’t good for customers but still make you more money, like increasing your rankings in search results, or generating more pageviews from the same content. The more those strategies pay off, the less time you’ll spend thinking about — and working on — what makes life better for your *real* customers.

    We are entering an era of perfect competition for software ideas — the only sustainable competitive advantage is solving a problem for your customer better than anyone else and continuing to learn and innovate so that you’re always ahead of even your most nimble competitors. If you aren’t listening, you aren’t learning, and asking for money is a great way to find out what your customers really value.

  2. Value

    Third-party monetization is subject to the same competitive laws as everything else on the web. The supply of web (and increasingly, mobile) content is effectively infinite, and more is being added every second of every day. With so much content available to them, third-party monetization networks have zero incentive to offer premium pricing to any individual participant; all but the largest publishers are functional equivalents, and the loss of any one publisher has a negligible effect on their overall yield.

    If your business creates value, it’s important to capture as much of that value as you can to generate the cashflows and profits you need to grow and thrive. If your value creation is so limited — or such a commodity — that the “best” monetization option is to give your inventory away to someone else, you should probably be thinking harder about how to create more value so you can “climb the value ladder” to a stronger and more defensible position.

  3. Control

    Price is a powerful signal: your price helps customers interpret your position in the competitive landscape, and changes in price (up or down) are levers you can use to drive or throttle demand, reward loyal customers, or steal share from competitors.

    When you set price and handle the money your customers spend on (or through) your product, you have greater control over this powerful lever. If you give that power to someone else, you have to work that much harder to differentiate your offering and manage seasonal or competitive pressures on demand. (Even when you “control” price, never forget that your customers retain the ultimate control, which is to take their business elsewhere — so use it wisely).

What does this mean for entrepreneurs working on their next business? The universe of possible startup ideas is at least as large as the supply of entrepreneurs, but here are few rules of thumb I’d consider when choosing your next project:

  • Solve a real problem – businesses exist to take away pain. The more pain they take away, the more they get to charge. The “pain” you solve with your next business could be boredom, or inefficiency, or the need to be loved — just make sure the pain is real and strongly felt by many people besides yourself, or you may spend a frustrating several years of your life.
  • Ask for money early – don’t wait until your product is “perfect” (whatever that means) before you ask your customers to pay. If they won’t pay, understand why not and what you’d have to do to move more of them from “no” to “yes”. The work of turning ‘no’ into ‘yes’ is the heart of your discovery process as an entrepreneur.
  • Don’t expect scale to solve your business model problems – every business idea I’ve ever been pitched works great at scale. Even an economically dubious idea like Twitter starts to make a ton of sense when 200 million people use it. Most businesses — yours included — won’t ever hit the scale at which that kind of magic happens, so make sure you have an idea of how real money gets made at every meaningful level of customer adoption. If you can’t make that pencil, you probably should think again.

Sounds simple, doesn’t it? You’d be amazed how many investor pitches on the market today don’t pass these screening criteria. (I also know a bunch of investors who have done fantastically well by ignoring all three, so maybe I’m the idiot…)

[PLEASE READ BEFORE COMMENTING: Yes, I’m fully aware that Demand Media built a public company almost entirely on the back of AdSense. Smarter people than me have unpacked that story already. And yes, there are lots of examples of profitable businesses that rely heavily on 3rd-party monetization. My argument isn’t that you can’t make money this way, it’s that your odds of attracting investment capital and realizing a strategic premium for your business are significantly lower if you do.]