The tech industry still fails to understand basic business.

Jason Fried, founder of 37signals recently posted a reality-check for the tech industry.

This pattern — “success” based on forecasted future success instead of current success — shows up all over the tech-business press.

He goes on to questions the false measures of success that so many companies use. Things like page views, or new customers, only matter if there is a clear deliberate way to gather a return on investment. He has a very good take on the phenomenon.

It got me thinking in all kinds of tangental areas as well. How many companies have made it their model to come up with a clever or novel solution, spend a chunk of capital figuring out how to identify or create the problem that it fills, then miss that last step where they actually profit from their efforts? Oh sure, they have some nebulous future bullet-point that will magically turn all of the wasted capital into shiny new profit. However, that seems to be more for the employees and investors benefit than actually guiding business decisions. The profit from this endeavor isn’t in the business, or even for all but the earliest shareholders. The profit from this type of endeavor is to create the smoke and mirrors, spin up a good story, sell it off, and move on to the next venture. Back in the late 1800s and early 1900s, these types were called snake-oil salesmen. This practice has been legitimized, and refined such that the first groups into any business — as long as an interesting enough story, pitch, and demo can be created — will stand a reasonable chance of getting 2 to 10 times initial investment regardless of the actual viability of the business.

Fortunately with the economic turmoil, some of these “opportunities” are likely to fall flat, and the practice can become at least a little bit less popular.

An interesting side-effect of the current turmoil is the likelihood that a larger percentage of new companies are going to be required to not just bullet point the profit stage, but actually plan out to that stage and beyond. In fact, since a lot of venture funds and angels are sitting put on their current projects, these new companies will have to plan much farther out than they otherwise would. This gives reinforcement to self funded ventures. A novelty in the tech field — though by no means unheard of.

Another component of Fried’s post deals with “freemium” (*shudder*) products and services. These are the online version of demoware. Get a free, low powered version of a service up, and use it as the marketing tool to hook customers onto your revenue generating service. I don’t see anything inherently wrong with this practice, as long as there is enough markup in the premium services to offset the costs of the free service. Of course in order to be able to judge whether you can do so is to actually measure how much your free service is costing you. Not just in servers and development costs, but in opportunity costs, support, broadened focus and so forth. Not all services can be chopped up cleanly into free and for pay. Those that can need to have strict metrics attached. If the free service is too capable, then customers won’t upgrade. People are amazingly adaptive creatures. If you are offering a new service to them, and not charging anything for it, they will likely just adjust their usage habits to incorporate those features and no more. If they run into one of your limitations, unless there is a definite value add, most of them will just make due with what is provided in the free version. Just giving them “more” of the same, but charging for it will not always work.

Case in point. Twitter is starting to whisper about a premium service. What will they be able to provide that isn’t already “good enough” in their current free system? Priority traffic? Sticky posts? Better follower management? Good will? I look forward to hearing what ideas they come up with to turn their very expensive hobby into a profitable business. They have put themselves into an interesting position. They have so much traffic, and so much infrastructure investment supporting that traffic, that I can’t see how someone would want to buy them. There isn’t a clear path to capturing a return, and the capital loss writeoff will only take you so far. Scary for a service that is starting to generate virtual riots when their service goes down.

It seems that the tech industry attracts more snake-oil salesmen and bad businessmen than other industries. Hopefully as the free-flowing river of capital dries up a bit, we can get back to the fundamentals where cash-flow is positive, and the business plan includes something other than ??? before profit.


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