Raising capital to finance growth for game and tech companies is one of the important responsibilities a leader will havem=, and to do it successfully you must realize it is not just about getting money in the bank. My post last week about Hasbro’s acquisition of Backflip Studios highlighted how smart cash management enabled the Backflip management team to capitalize on the opportunity with Hasbro (and make out quite well for themselves) largely because they did not receive significant investment. Had they taken a large investment at a high valuation, they most likely would not of been able to work with Hasbro. A recent Harvard Business Review article, Use Customer Cash to Finance Your Start-Up by John Mullins highlights the success many tech companies are having building a business through their customers’—not investors’—cash.
The Airbnb story
Airbnb is a great example of a company relying on customer cash to finance growth, allowing it to reach a point at which it was valued at over $1 billion when it did raise venture capital. For those not familiar with Airbnb, it is a virtual marketplace where people offer rooms and apartments to visitors, usually people who are looking for alternatives to hotels. In effect, though, its business model is structured so that advance customer cash helps finance growth, leaving Airbnb less dependent than most start-ups on early outside financing.
Five models to use customers to finance your growth
- The matchmaker model. This is the model used by Airbnb (and largely pioneered by eBay), in which the entire business consists of connecting buyers and sellers. First, you dramatically reduce the need for capital because you do not maintain inventory (the sellers do) and your cost of goods are extremely low. Matchmaker models have become even more popular as companies have discovered the power of “collaborative consumption:” the sharing of underutilized resources, a practice that’s increasingly promoted and coordinated by web apps and social media. Companies like Airbnb profit from matching buyers and sellers and thus reduce their financing needs.
- The deposit model. This is a model that can be used either in a business-to-consumer (B2C) or business-to-business (B2B) setting in which the work unfolds over time, rather than consisting of a single transaction. An example would be Via, an Indian travel start-up. When Via started, the company asked travel agents for $5,000 and provided a real-time Internet connection (at the time, India did not have great broadband penetration) and ticketing capacity. Like many start-ups that quickly prove their viability, Via attracted interest from investors. But by asking for deposits up front, it gained crucial early funding without having to look to outside sources.
- The subscription model. With the subscription model, you offer a short trial subscription and measure renewal rates. This model is particularly effective with consumables and services (and games fall into both categories). Because customers pay a predictable monthly fee in advance, the business is highly capital-efficient and enjoys smoother revenue growth than business that rely on discrete transactions. Netflix is a great example of a company that has grown spectacularly by relying on set monthly fees.
- The standardize and resell model. Start-ups leveraging this model develop technology or systems that do what people have been doing manually in labor intensive businesses (normally a B2B play). This strategy relies on offering a customer the process so they no longer have to do the process manually and have them provide a contract that finances your developing the tech or process yourself. The textbook example is Microsoft, where Bill Gates won a contract to provide an operating system to IBM; the resulting software served as the underpinnings of the Windows system later sold on most PCs.
- The scarcity model. Companies leveraging this model use scarcity to motivate customers to pay and buy early and quickly. This tactic takes advantage of the situation that retailers normally have credit with their vendors. A great example is Gilt Groupe, which has “private” sales that only last a limited time, thus customers place and pay for orders before Gilt commits to purchasing goods from the vendor.
How to apply these models to the game space
Not all of these models will work for game companies but they are all worth investigating to determine if there is a creative solution for player-financed growth. The models that seem particularly promising are the deposit and subscription models, but I can also see applications of the matchmaker model in the game space. The point is to look outside traditional fund-raising and see if you can create a model for your business that relies on customers and not venture capitalists.