User Bases, Pricing, Revenue, and the Value of Users

Suppose you wanted to make $1 million per month by selling software. You can either go for a few lucrative customers or lots of low paying ones. A half minute in Excel and you have a table.

Dollars per user per month		Customers needed for $1M / month
$1		1,000k
$5		200k
$10		100k
$50		20k
$100		10k
$1,000		1k

Ten minutes in MS Paint and you’ve got a nice graph.

The sweet spot for high margin software offerings seems to be in the sub-$10 per month range. Rhapsody charges $13 per month. Yahoo Mail is $1.60 per month. Mozy is $5 per month. [1]

Enterprise customers pay in the same range for commoditized products. MS Exchange costs about $10 per user per month. FogBugz costs $20 per user per month. I’m sure enterprise antivirus is a brutal market for providers, but I don’t have numbers because they don’t have public pricing.

Enterprise customers are willing to shell out the cash in non-commoditized product categories, though. Salesforce.com charges about $100 per seat per month, but they’re going to have to drop their prices soon because of pressure from Microsoft and others. Bit9 is a new kind of enterprise security, so they’re set for a couple of years.

Anyway, so this is the range we’re interested in:

How do we get 100k paying users? Just for fun let’s assume that you have a freemium model. Most users aren’t going to pay, but some will because they get the bike horn that makes the moooo sound.

The rule of thumb is that about 1% of free users will convert to paying customers. The number varies greatly by vertical, product, etc., but let’s just go with 1%. Some quick math and you have another table.

Dollars per user per month	Paying customers needed for $1M / month	Users needed, 1% conversion
$1	1,000k	100 million
$5	200k	20 million
$10	100k	10 million
$50	20k	2 million
$100	10k	1 million
$1,000	1k	100,000

So if you charge $10 per user per month, and 1% go premium, you need 10 million users to hit $1M in revenue per month. For reference, Outlook has 500M users, Skype has 200M users, and Thunderbird has 8M users.

Skype had about 50M users when they were bought. At that time there were about 4M people simultaneously online, so only a fraction of those 50M were active. Why did they get bought for billions? My guess is that a large portion of active users were paying customers. They were obviously still in growth stage. They also enjoy high margins and had recurring revenue for each user.

So what would $1 million of revenue per month do for you, anyway? $12 million in annual revenue, to be sure. Beyond that you’re back in the land of heuristics. Google has a P/E (price to earnings) ratio of 50. If you got the same ratio with margins of 50% then your company would be worth a nice $300M.

Margins vary hugely by business. Grocery stores get about 2% margins in a good year. Software, luckily, traditionally has high margins because the cost of supporting an additional user is so low. 50% sounds extreme, but consider Skype. They don’t have infrastructure costs, and they probably have no more than 50 or 100 people. That’s the kind of company Xobni can be. This 50% margin on $12M annual revenues can support a burn rate can support a head count around 30 or 40 people. That’s not a bad place to be when you hit the $1M per month milestone.

Other public tech companies have similar but not higher ratios. Redhat is at 65, Yahoo is 50, Sun is 40, Oracle is 30. Microsoft is 20, but damn do they have lots of revenue! Salesforce.com is 1053, but until recently was infinite. They’re still selling the dream.

These numbers can end up all over the board. Zimbra sold for $350M on revenues of about $15M, and probably way lower profits. The list goes on. Growth and strategic value to acquirers seems to have the biggest impact. [2]

With some more elementary school math, we can use these numbers to derive a value per user. An average user on the $10 per month row gets us ten cents per month, or $1.20 per year. That’s sixty cents of profit. With a 50 P/E ratio, that’s $30 per user, not far from Fred’s numbers.

P.S. Xobni is hiring. We are currently looking for great software hackers and a senior QA lead.

Notes
[1] The sad part about these prices is that both Rhapsody and Mozy are low margin businesses. Rhapsody is net losing money per user. Yahoo Mail is a high margin business, but it doesn’t matter because the price is so low.
[2] If you want more examples, look here for a list of MS acquisitions, and have fun googling.

Comments

I think you are confusing revenues with earnings. P/E of 60 is not the same as Price/Revenue of 60. If you are only doing $1M/month and your margins are say ~10%, you will end up with a value of $60M not $600M.

[augustus]

Sorry to say this but this analysis is very basic and not always accurate as anonymous points out.

Why show the world your ignorance?

You are obviously a techie with no formal skills in finance.

-Augustus

[Dan]

Anon is right (and augustus says it a bit more rudely)--I think this article mixes up revenues and earnings. Could you do a version that re-runs the numbers with, say, margins of about 30% (relatively standard in the sw industry).

[Adam]

Thanks for pointing that out, guys. It's fixed now. Augustus -- yes, no formal skills in finance here. I love learning opportunities.

[augustus]

No offense, Adam.

You don't need formal finance skills to succeed. We have all heard of Gates, Jobs and company.

You do owe us readers the benefit of reading (reasonably) well researched articles though.

It doesn't look too good if your readers are the ones correcting your basic errors.

All the best.

-Augustus

[WhyPaint]

It sounds odd to me that you went to MS-Paint to draw the graph when you could do it right in Excel. :)