The four stages every app startup goes through and why revenue is just another feature

This is something that I talk about quite regularly with our teams at Team Hike. Today, I’ve penned down some of these thoughts about how I look at startups that are building apps in the internet space and what it means to build a business over time.

There are typically four stages to every startup building an app in the consumer space:

1. User engagement

2. User growth

3. Revenue

4. Profitability

Startups that successfully navigate all four stages are the ones that make it big. Here’s a brief overview of what each stage involves.

1. User engagement

Consumer products are kicked off by what we call an MVP, a minimum viable product. An MVP is version 1 of the product: the first ‘feature’ or first ‘set of features’ that are launched in the market.

The goal at this stage is to find a small set of users, early birds who give you that “hmm…maybe there’s something here” indicator. And if you’re lucky enough to build something where you find that, the focus during this stage is to continue optimising the early engagement to get to a small but sizeable user base that’s highly engaged.

2. User growth

Once you have a sizeable highly engaged early-user base, you’re probably raising your Series A to kick your user growth into higher gear. This usually drives the second ‘set of features’, the ones that are built to grow the userbase. This is stage 2. This is arguably the most difficult part of scaling a startup. You have to continuously ask and answers questions such as:

• Are those early users indicative of a bigger market?
• Are there tweaks you have to make to your products to find more users?
• How do you drive more word of mouth?

From our own journey, we have great examples of stages 1 & 2: Hike2SMS, which was the highlight of our very first version of hike. Back in 2012, in a world of 2G and limited data connectivity, we built a bridge between the worlds of IP and SMS so that the very few who had smartphones and those who did not, could communicate. It was a hit and got us that early user base but we quickly realised the market for it was limited.

The market also was evolving rapidly, so on top of a continued effort to grow the initial product, we also innovated and moved the product forward with newer features. One of the big hits (and this continues to be a hit) was ‘stickers’ in 2014. Then there was ‘hidden mode’ in 2015. We also had many features that didn’t gain significant traction like our local keyboards and Hike direct.

So, in this phase, a lot of it is about trial-and-error, and you have to do this in a way where the cost of doing so is not high. In other words,

"You have to continuously make big bets, without betting the company."

The amount of time a startup spends in this stage is often significant. Why? Because one has to get to a certain critical mass, a certain level of distribution before you can move onto the next stage. Competition is fierce and networks - if not built right - can unravel very fast. And it’s clear that for startups building for a market that is just emerging (India being a prime example of this) this period is even longer. For example, when we launched our V1 in 2012, there were no more than a few million people that had data connectivity. That too was 2G. Today, of course, the world is very different and thus the product has also evolved tremendously.

The main goal in Stage 2 is to Move Fast, Try, Fail, Learn, Repeat. Double Down on what works and Throw Away what doesn’t with one focus — grow users and engagement to get to a critical mass.

3. Revenue

Next up is Stage 3, Revenue. This stage differs wildly depending on the type of business you’re building. B2B/SaaS businesses are great examples of those that generate revenue from Day 1. However, with a B2C business - particularly those focused on recurring users and time spent as key metrics - things are usually quite different.

To generate meaningful amounts of revenue, you need to be at a critical mass of users and engagement. We’re looking at least 50 million, if not 100 million daily active users (DAU) with high engagement to start generating meaningful revenue given the business models that exist in the B2C world. This also assumes that the fundamentals of the market that you’re building in are strong.

For a transaction model you need:

1. High data penetration
2. Ubiquitous payment instruments
3. Enough disposable income to spend online

For an advertisement-driven model you need:

1. High data penetration
2. High enough eCPMs (effective cost per 1,000 impressions)
3. Arguably enough, disposable income so that the targeted audience can spend

In India, significant progress has been made on no. 1 over the last few years but the rest, while growing, still have a long way to go, disposable income in particular. So, it’s not a surprise that in India we have companies continuing to discount heavily and paying users to use their products and grow their users and engagement.

Here’s a very basic model that I put together that would describe how an ad business model would look like.

Assumptions:

• Each app session has at least 1 monetisable impression
• App sessions/day grow with DAU as network effects build

As you can see from the table above, it is hard to generate meaningful revenue unless one has sizeable scale and heavy engagement, more so in countries like India where ad CPMs are not very high.

But when one does have scale and high engagement, a business model like this can be brought to life by doing what we did in Stage 2, i.e. building features. That’s right. Revenue is just another feature. A new ‘ad unit’, a ‘premium sticker’ - all of these are just ‘more features’.

To generate revenue, you have build new features and that takes resources, resources away from features that are meant to grow users and drive engagement. And given startups like us have limited resources, we choose to focus all our resources on the later until we get to a certain critical mass.

Why did I write this?

Because while world over we’ve seen companies emerge and grow like this, in India this approach of building products and thus a company is rather unusual. It’s new. We are now amongst a few others who have emerged that follow such a pattern and it’s important for people watching on the sidelines to understand this point of view.

For the foreseeable future, India is the last battleground in the Internet space. Consumers are coming online for the first time straight onto mobile devices and there are incredible opportunities.

However, India is unlike the US, where startups were competing amongst themselves for new markets given that the US was the first true sizeable internet market.

India is also unlike China, where companies were also competing amongst themselves given China’s regulations to protect their companies.

In India, we are fighting a battle not only with the companies of the West that literally own most of the distribution on the internet, but also the fast moving companies of the East, who now are now not only generating enormous of amounts of revenue in their home countries but are also using that to acquire distribution in India.

It becomes clear very quickly that average products with great distribution will always win over great products with little or average distribution, which places even more importance on startups to get to critical mass as quickly as possible while battling the might of distribution of the big internet companies from all over the world.

Startups win because they do less and do it better and faster than anyone else. Focus is key, as we’ve learnt through 2017. For those startups that are in Stage 2, it’s important to keep your head down and focus. Focus on growing users and engagement until you get to a critical mass. Build the muscle to un-emotionally move fast, try, fail, learn, repeat at high quality because when you enter Stage 3, like the earlier stages, you’ll have to build the next ‘set of features’. But this time, the features will be focused on generating revenue.

I’m a big fan of Spotify. It is my go-to Music app. Incredible product. On their latest earnings call, there’s something that their CFO Barry McCarthy mentioned that is worth highlighting here. Here’s an excerpt from the transcript:

“If you think back to our commentary during Investor Day, I made two important points. One is profit margin is a managed outcome. It’s a byproduct of the pace we choose to invest in new features and functionality to drive growth.

“… for those who aren’t familiar with the company, it’s an engineering-driven org, very product-focused, and so, the incremental investments are all about building features and functionality that make for a better user experience, and the point is to accelerate the growth of the business as a concept lens.”

Revenue is just another feature. And some can add it later. The question is, ‘when’ do startups like us add them, not ‘if’.

This is a long game

Our best guess is that India as a market is somewhere around 175–200 million DAU today. Within 24 months, we expect this number to grow to at least 250–275 million in an open smartphone ecosystem (the rest coming from closed platforms). Along the way and over longer horizons, payment instruments will become more ubiquitous, and disposable income will increase as well.

The market is still early, and only those who are here for the long game will break out. Time and time again, it is been proven that people always overestimate what happens in the short term and underestimate what happens in the long term.

Case in point: Tencent. Founded in 1998, IPO in 2004

Revenue in 2004: $100 million

Revenue in 2017: $34 billion