Startup Review

HOTorNOT.com Case Study: Mixing free and premium services

written by Nisan Gabbay and Rob Finn, posted on November 12th, 2006

Why profiled on Startup Review

When HOTorNOT first swept onto the scene a few years ago, not many people thought it would amount to anything more than a short-term fad. Even today, not many people recognize that HOTorNOT has a very profitable casual dating service consisting of 500,000 – 600,000 active users. HOTorNOT is making somewhere between $5M - $10M per year in revenue with very little cost since they don’t spend any money on marketing.

I felt HOTorNOT would make for an interesting case study because of how they blend a free, viral service with a premium pay service. This is typically a difficult transition to pull off and HOTorNOT offers some great lessons learned.

Interviews conducted: James Hong, co-founder and CEO

Key success factors

Low cost of customer acquisition by tapping into basic human psychological need

HOTorNOT was probably one of the most viral product launches in Internet history. It seemed to catch everyone’s attention during October 2000. I personally remember hearing about it through friends and via e-mail exchanges. You might call ranking people’s photos on a one to ten “hotness” scale a gimmick, but I don’t think HOTorNOT would have lasted as long as it has if it wasn’t serving some basic human psychological needs around social validation, ego, and voyeurism.

For people who post their photo for ranking on Hotonot, they get to find out how they are viewed by the opposite sex and possibly gain validation and ego stroking. There are some girls on HOTorNOT who clearly knew they were attractive before posting to HOTorNOT, but getting 2,000 votes that say you are a 9.5 is a tremendous ego boost. I have to say that I felt pretty good about myself after pulling in an 8.8 ranking. (Note: conspiracy theorists might want to question the validity of the voting algorithms.) HOTorNOT.com was originally launched as “Am I Hot or Not” – a fundamental question that every young person asks themselves at some point. This desire to know how people of the opposite sex view you is what drove people to post their photo. With many photos up on the site available for rating, people can enjoy the voyeuristic aspect of checking people out.

Thus HOTorNOT was able to fill some pretty basic human needs in a way that no other online service had before. This would later translate into financial success once HOTorNOT offered its premium dating service because their cost of customer acquisition was so low - zero. The largest cost associated with operating a traditional online dating site is the cost of customer acquisition, which even for successful sites can be 50% (or more) of revenue. Because HOTorNOT attracted users with its free rating service, it could offer its dating service for the low price point of $6 per month. This is a price that traditional dating sites can’t compete with because it generally takes $15-$30 to acquire a subscriber for a traditional dating service.

Generated mainstream PR to build brand

HOTorNOT was a dream PR story: two young grad school students wanting to settle an argument, site spreads like wild fire by word of mouth, edgy service with fun and audacious branding, etc. Immediately following its launch and subsequent viral spread, HOTorNOT was featured in a number of mainstream media pieces as a human interest story. The HOTorNOT founders were very cognizant that PR would be very important to their ultimate success and made it a top priority to respond to all PR requests. Given how easy the service would be to imitate by competitors, HOTorNOT needed to establish its brand quickly and PR would play a vital role. HOTorNOT’s extensive PR coverage helped to establish its brand in the mind of consumers and drove even more traffic to the site.

Created a product that perfectly fit the need of its target audience (casual dater)

HOTorNOT found a way to monetize its enormous amount of unintended traffic by brokering the introduction of two strangers who found each other hot (called a “double-match”). HOTorNOT built a service that caters to the user unwilling to invest a lot of time or money into a dating site. Pay $30 a month to troll through profiles? Hell no! Pay $6 to contact a hot girl who already said she thinks I’m hot too? Probably. Here are some of the product decisions that make HOTorNOT a great service for its target audience:

• No lengthy profiles to fill-out or read. All that a user needs to do to get started is upload a picture – and that’s what other users primarily see. No detailed questionnaire that forces you to be witty or introspective. Everyone is on equal footing – your best picture.
• No up-front subscription fee. HOTorNOT has an almost pay for performance business model. It’s free to post and browse the site. However, if you’d like to contact someone when a “double-match” has been achieved (a lead if you will) then you are required to pay a reasonable price ($6) for that introduction.
• No e-mail exchange before a connection has been established. Given that casual daters don’t want to get bogged down in writing and responding to e-mails, HOTorNOT does not allow e-mail communication between users unless both parties have agreed to begin communication through the double match feature.

Built user trust and community - generating positive word of mouth

The HOTorNOT founders (James and Jim) have always treated HOTorNOT as a community and have made many decisions that have traded off financial value for building community and trust with users. James and Jim wanted to build a service that offered good value for users and have made product decisions accordingly. Given that HOTorNOT is so reliant on word of mouth for customer acquisition, they need happy customers more so than traditional dating sites. This focus on customer satisfaction has yielded user satisfaction ratings of 9 out of 10 on internally conducted surveys.

Some specific examples for how HOTorNOT has built user trust and community:

• They have not raised the price above the $6 per month subscription fee since the service launched 5 years ago. HOTorNOT has done price elasticity studies that indicate they could charge more, but have chosen not to.
• HOTorNOT sends its customers a warning e-mail that their subscription will be renewed for another month before the customer’s credit card is charged – making it easy for customers to cancel. It is probably one of the only dating subscription services to do so.
• HOTorNOT’s double match system ensures that users don’t waste time or money contacting someone unless minimal physical attraction has at least been confirmed between the two parties.
• HOTorNOT has created a community of 2,000+ volunteer moderators to review pictures and profiles before they are posted to the site. This engages the power users in monitoring and participating in the well being of the community.

Launch strategy

When HOTorNOT was started in October 2000, the founders never intended to create a business, thus there was no planned launch strategy. They started by e-mailing their friends, 40 friends to be exact, and it just grew from there. HOTorNOT integrated the MeetMe service into the site about 3 months after launch and started charging the $6 subscription fee 2 months later. Thus, HOTorNOT achieved viral customer adoption and proved its business model in 6 months from launch. James credits HOTorNOT’s initial traction to the fact it was something new and edgy. It caught people’s attention as either a joke or something fun to play with and kill time – sort of like people watching in the real world. The game-type element of quickly rating people’s photos and seeing how your scoring matched popular opinion was addicting for users. All in all, it was a site that everyone could understand and gain some amusement from upon initial glance. This was enough motivation for people to want tell friends about it.

Once HOTorNOT generated its initial buzz, mainstream press coverage contributed greatly to driving more traffic to the site. As mentioned above, James placed great emphasis on responding to PR inquiries to create competitive advantage. At no time did HOTorNOT spend any money on marketing.

Exit analysis

One month after James and Jim launched HOTorNOT they had an acquisition offer to be bought for $3-5M. Not a bad result for a couple months of work. However, they rejected the offer for several reasons. For one, they thought they could launch the premium dating service and make more money that way. Since the dating service had yet to be launched, this was a big gamble. Luckily, it paid off and Jim and James have been paid the $5M several times over. They were also fearful that the acquirer would not run the service the way they intended – as a community.

Jim and James also did not take venture capital money, but for a different reason than most founders. Given the timing of the Internet bust in early 2001, they were skeptical of the intentions of any VC trying to invest in the Internet at that time. Given the nosedive taken by the online advertising market and the lack of exits in the space, they didn’t think that HOTorNOT made for a good VC investment. Given market conditions, they felt any VC that would want to invest in HOTorNOT at that point in time was crazy, and they wouldn’t want someone like that on their board. As it turned out, HOTorNOT became so successful on its own, that it did not need any outside investment as it became cash flow positive in under one year.

So what is HOTorNOT worth today? By generating $5M worth of profit per year and applying a low 5X EBITDA valuation multiple, HOTorNOT would be valued at $25M. This seems like a fair number to me. According to Comscore, the HOTorNOT Meet Me service has close to 1M UVs per month in the US and James claims it has approximately 500,000 active users. An active, engaged community of this size has potential to be leveraged for launching other Internet services as well. However, given the relative lack of potential acquirers in the US online dating market, its hard to see HOTorNOT being acquired for the
15-20X EBITDA or 5-10X revenue being paid for other online communities and content sites.

Food for thought

My big lesson learned from HOTorNOT was the clever way in which they created a pay service while still maintaining the viral nature of the free service. One of the toughest transitions for an Internet business is to transition from a free service to a pay service. Adding a pay component to a service will often kill the viral nature of the free service, because users no longer receive value without paying. Compromising the free service is a slippery slope because you may lose the ability to acquire users at low cost.

The key to mixing the free and premium services is to be sure that they are two separate, self-contained processes such that the user receives differentiated benefit from each. In the case of HOTorNOT, they never changed the initial free service of rating photos. Anyone who comes to the site can easily post a photo to be rated or rate photos themselves. A user can benefit from this service without ever being asked for payment. The casual dating service is placed on top of this service, but does not interfere with the original value proposition of the free service. The premium service has a completely different value proposition from the free service, one based on the promise of communicating with someone, as opposed to the entertainment or ego gratification value prop of the free service. Users are willing to pay for the premium service because it is clear that they are getting a different benefit from the free service. Furthermore, by never tampering with the free service, HOTorNOT enjoys the continued benefit of zero marketing cost for its pay dating service. While other dating sites have high customer acquisition costs, HOTorNOT has none, allowing them to charge a much lower price. Up until recently, this created a sustainable competitive advantage as being the low price leader in the casual dating market.

Another lesson learned is how a cash cow business can be a double-edged sword. James pointed out to me that given how successful the business had become in generating cash flow, the founders became more conservative in terms of changing the product or experimenting with new ideas. This is somewhat counter intuitive given that the founders now had the money to invest in the business. However, any product change had the potential to negatively impact the significant cash flow being generated, so it was hard to justify adjustments. Could HOTorNOT have grown much larger or changed directions if it had not been run as a cash cow business? After all, it was one of the most successful user generated content sites with a demographic proven to demonstrate viral behavior. Might it have successfully expanded the scope of its services with a more aggressive growth strategy? Possibly, but it’s hard to say whether they would have been successful. Relying on ad revenue was a hard business model from 2000 – 2004. In any case, it’s hard to argue with maintaining a strategy that earns millions in profits with minimal management overhead. HOTorNOT is currently exploring new services and a change to its business model – expect to see some innovation in the future.

Reference Articles / Further Reading

Update June 28, 2007: HotorNot founder James Hong has a great post about recent changes at HotorNot and some of the history.
Reinventing HotorNot, Part I, June 27, 2007
“’Am I Hot or Not?’ Is Red Hot”, Wired News, November 27, 2000
This article from Wired has some good stats on HOTorNOT’s initial traffic (3M page views per day after 6 weeks, 7M per day on weekends). The author claims the success of the site is due to a simple interface and appeals to people’s vanity.

“Facing the World With Egos Exposed,” New York Times, June 2004
This article discusses the psychological reasons why people use rating sites like HOTorNOT.

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