Friday, November 1, 2013

Common problems in information businesses

As I've mentioned in previous posts, there are so many information businesses that have the potential to be great...but just aren't.

In fact, most of the information services deal flow I see these days falls into this category.  Often small-ish ($10-25m), often run by their founding management team, often undercapitalized, and often lacking clear/coherent strategy, these firms have wasted a great opportunity.  

Sometimes they can be fixed.  But they're mostly not worth the time it would require to do so.

Some of the most common problems I see:
  • Faulty pricing (often hard to fix).  When executed properly, pricing in information services businesses is a very sophisticated undertaking, rooted primarily in a clear assessment of the value delivered to the buyer.  But all too often, mediocre information businesses have set their pricing far below the real value to the customer.  And when that disparity is too large, it's very hard to fix.
For example, I looked last year at a potentially interesting healthcare informatics business.  It ticked all the boxes for me - proprietary data, embedded in a business process, and delivered through software.  By my calculus, the value - in terms of revenue generation and cost avoidance - was measured in thousands of dollars of month.  But the firm had priced their offering at hundreds of dollars a month - and I could see no way to make a 10x price increase stick.
  • Wrong allocation of resources (quite fixable).  Great information businesses are zero marginal cost businesses - once the product is produced, there should be little to no cost involved in delivery.  That, in turn, implies an appropriate allocation of resources - specifically, relatively small expenditures in creation of the product and relatively large expenditures in distribution.  Note that I didn't say that it must be inexpensive to produce the product - rather, that the cost to do so should be a fraction of the money spent on distributing it.
For example, I recently looked at an information business that spends approximately 55% of revenue on producing their information product - and less than 20% of revenue on sales/marketing.  By my estimation, that ratio is backwards.  The fix?  An injection of capital and a rapid expansion of the salesforce.
  • Lack of embeddedness (nearly impossible to fix).  Lots of information products are really nice-to-have.  But nice-to-have doesn't cut it when the economy takes a downturn - and it conveys little or no pricing power to the business.  In other words, it's a product that will produce only modest, cyclical returns.  Again, not worth the time invested.
For example, I once was part of an information business that was intensely nice-to-have.  But it wasn't need-to-have, because it wasn't embedded within a customer's business process.  The result?  A 40% drop in revenue during the next recession.

There are many more problems of course - but these are the most common ones I see.  How do these observations compare with your own?


2 comments:

  1. Well said. In regard to the pricing challenge I would add the following:

    - I've only ever seen the "initial price is too low" problem successfully solved as follows. 1) Multidimensional pricing = fixed fee + variable kicker attached to value that can scale 2a) Funneling all new customers into the new pricing model and requiring renewal from current customers if they wish to stay in the old model. 2b) All of the subsequent product enhancements are aimed at the customers in the new model. As you alluded, even if you do all that, it may still now work.

    - There is often a big gap between list and street price both in SaaS and the info biz space. This is partially a function of being in a business with high fixed and low variable costs, but also because the SaaS vendors are bringing the proverbial knife to the gunfight. Fortune 500 corporations have armies of very good procurement teams. Fortunately for the smaller SaaS vendors, the capital markets seem hyper focused on revenue and growth at this stage in the business cycle...not so much on operating income.

    ReplyDelete