Startup Review

Userplane Case Study: Vertical market entry strategy pays off

written by Nisan Gabbay, posted on December 3rd, 2006

Why profiled on Startup Review

Userplane provides hosted communications applications for online communities. They offer a suite of easy-to-integrate, flash-based applications like instant messaging and multi-user web chat. Userplane’s applications are utilized by over 130,000 websites, ranging in size from sole proprietorships to the largest social networking sites (MySpace, Friendster, etc). Userplane was acquired by AOL in August 2006 for an undisclosed sum, rumored to be in the $30-$40M range. Having never raised any external funding, the exit was a great result for Userplane’s three founders.

Interviews conducted: Mike Jones, Userplane CEO and co-founder. Jeff Clavier, advisor to Userplane starting in May 2005. Jeff is also a professional Internet investor and one of the most popular VC bloggers (see Jeff Clavier’s Software Only blog).

Key success factors

Established initial niche as provider to online dating and social networking sites (i.e. executed a vertical go-to-market strategy)

When Userplane was founded in 2001, the company was not in a great position to raise external capital. Unlike today, user generated content was not en vogue, the online advertising market was in the dumps, VC’s weren’t investing in consumer Internet plays, and the founding team was young.

As a result, for the first year and half Userplane operated as a services firm, building custom communications applications for its clients. Perhaps forced into this initial business model out of necessity, it actually contributed to Userplane’s success. Having to operate off cash flow forced Userplane to concentrate on building products that served the needs of clients. During this time Userplane developed its expertise in web-design and development, including the IM application that would later become the backbone for its product business.

Userplane successfully transitioned from services to products by taking a vertical go-to-market strategy, concentrating its sales and marketing efforts on becoming the premier provider of communications applications to online dating sites. While the competition took a more horizontal approach to the market, Userplane was very focused on its vertical. Online dating turned out to be a good initial market because even for very small dating sites, the value proposition was clear-cut. As the social networking market emerged, Userplane was in a good position to expand into this related vertical. Having won marquee accounts in online dating like Spark Networks (operators of JDate and American Singles) and Date.com, Userplane was able to land marquee accounts like MySpace and Friendster in the social networking market. These marquee accounts further established Userplane’s position in these two verticals, helping to decrease the sales cycles with other online communities.

Demonstrated ability to scale the business

While Userplane had established a nice business licensing and selling subscriptions to its products, it had yet to demonstrate the type of growth potential and upside that could command a premium exit valuation.

Userplane did an excellent job of diversifying its business model from custom application development and licensing fees, into advertising supported versions of the product. This created a much larger market opportunity for Userplane to pursue. Userplane CEO Mike Jones believes that there are over 3M sites that could benefit from Userplane products, and they have only penetrated about 100,000 of those to date. It was this larger market opportunity that made Userplane an attractive acquisition candidate.

So how was Userplane able to transform its model from serving a niche like online dating to a broader horizontal play? CEO Mike Jones believes a large part of the success was Userplane’s ability to articulate a clear value proposition for each of the verticals it served. They went to great lengths to understand the needs of their customers and become experts in those industries. Second, they did an excellent job of making the products as self-service as possible. Self-service not only from a technical perspective, but from a business process standpoint as well. Userplane makes its pricing plans visible and up-front to potential customers, thereby reducing friction in the sales process. This is one example of how Userplane established appropriate sales interaction models for different customer types. Userplane also did a great job of product tiering – offering different types of products at different price points. The free, ad-supported product had lesser product capabilities around customization than the licensed version. This helped to protect Userplane’s subscription revenue stream while still growing the distribution of the ad-supported product.

Balanced company decision making across technology, product, and business disciplines

In my conversation with Userplane CEO Mike Jones, he credits the success of Userplane to the balanced decision making and management across three key areas: business, technology, and product (creative). The three co-founders of Userplane (Mike Jones, Javier Hall, and Nate Thelen) each preside over one of these three areas of the company, and each discipline is well-represented and given equal weight when making company decisions. While we didn’t get into any specific details on how this company management model functions, I believe that it makes logical sense for operating an Internet business. Having advocates across these three areas ensures that the business perspective does not outweigh the user perspective, the technical perspective is not outweighed by the user perspective, etc. Perhaps this is a management model other Internet companies would be wise to adopt?

Launch strategy and marketing

Userplane’s customers are not consumers. While Userplane’s end users are consumers, the company’s sales model more closely mirrors that of a traditional software company, albeit one where all the customers are operators of websites. Userplane employed a number of different marketing tactics to reach these customers. As mentioned in the “Key Success Factors” section above, Userplane started by providing custom development services. As they shifted into a product company, they targeted the online dating market as their first vertical. Userplane went to online dating trade shows, spoke at conferences, and highlighted the success stories of its reference customers. Given the relatively tight nature of this business community, positive word of mouth spread quickly. Userplane also conducted a large amount of direct marketing campaigns from search engine marketing to cold calling of target sales prospects. CEO Mike Jones did a good job as spokesperson for the company, generating trade press and speaking appearances.

Exit analysis

AOL announced the acquisition of Userplane in August 2006. While the acquisition price was not disclosed, PaidContent.org believes the price was in the $30-$40M range. While I have no first hand knowledge of the transaction, my feeling from some informal conversations is that the price was in this range, or actually a little bit higher, but clearly under the $100M mark. As for the revenue of the company, this is also up for speculation, but I would suspect full year 2006 revenues were under $5M, but above $1.5M. Userplane had about 15 employees and was cash flow positive, so it is probably safe to say they had a revenue run-rate of close to $2M. Furthermore, if their ad supported model was generating one billion ad impressions a month at a $0.10 CPM yield, then they would be generating $100K per month in ad revenue. Assuming that monthly subscription revenue was at least equivalent to ad revenue, the company was probably targeting a revenue plan of $2-3M for the year. If I am in the right ballpark with all these numbers, the acquisition represents a fantastic revenue multiple of 10-15X current year revenue. Userplane must have done a nice job of selling their future growth prospects.

Userplane was in the process of completing a VC investment when they were approached by AOL with an acquisition offer. After some negotiation, the Userplane team decided to accept the offer rather than remain independent and take VC money. Could Userplane have continued to build the company’s value and achieve an even greater exit down the road? Possibly. But given that the Userplane founders each owned a large percentage of the company, it was hard to turn down that much money at the present time. As Userplane was the team’s first big entrepreneurial success, it was hard to justify swinging for the fences when you’ve been living paycheck to paycheck for 5 years. Anytime a first time entrepreneur is offered a payday in the $5-$15M range, that’s a tough offer to turn down. Better to take a nice, solid double the first time around, and swing for the fences on the next one.

Food for thought

Userplane had an interesting business model evolution that went counter to the approach that most Web 2.0 companies are taking today. Userplane started as a services company out of necessity, graduated to selling products, and then offered a free service to gain scale. Most Web 2.0 companies today plan to take the opposite approach: start with a free product to gain mass adoption and evolve into offering premium products and services. What were some of the benefits and drawbacks of the Userplane approach? On the benefits side, Userplane was able to establish at the very start whether customers would pay for their product and hence validate the market opportunity. This also helped them do a better job of product development. Finally, it enabled them to control their own destiny in terms of financing, company direction, and exit options. How about the downside to this approach? For one, it took a long time. Userplane spent the first year and half mainly focused on services rather than selling products. Second, it forced them to prioritize short-term revenue over building long term company value.

Obviously the best approach for any one company will vary based on a myriad of factors. However, since most of the recent case studies on Startup Review have focused on the get big fast viral distribution model, I thought it was important to point out that successes can work in the opposite direction as well. The Userplane strategy, whether it was intentional or not, is another good option to consider when determining business models. Validate market need with a pay product, control the direction of the company, and then decide how to expand for scale.

Reference articles and further reading

TechCrunch profile on Userplane, July 2005
Profile is a bit dated, but provides a nice overview of the Userplane product lines, including product snapshots.

“AOL acquires Userplane to expand AIM network,” Jeff Clavier’s Software Only blog, August 14, 2006
Jeff Clavier, whom I interviewed to help create this case study, writes about his experience advising Userplane.

“AOL Acquires Userplane To Expand Web-Based Chat and IM; Social Networking Angle,” paidContent.org, August 2006
This is the only source I could find to comment on the rumored size of the acquisition.

“Interview with Mike Jones, CEO of Userplane,” podcast, socalTech.com, May 2006
This podcast has a good description of the products that Userplane offers, their future product directions, and evolution as a company. No amazing insights, but good background on the company’s products.

“Conversation with Mike Jones, Userplane,” Stowe Boyd’s /Message Blog, August 2006
Short post discusses the acquisition by AOL.

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