Tuesday Aug 23, 2011 by Tom Eisenmann - Professor, Harvard Business School
This post is part of a series on business model analysis for entrepreneurs. The first post in the series presents a comprehensive list of issues (available as a downloadable PDF) entrepreneurs should consider when designing a business model. Others delve into specific issues; this one provides an overview of viral customer acquisition dynamics.
A product grows virally when its use spreads through direct, customer-to-customer transmission. Viral growth occurs through four different mechanisms listed below. With the exception of incentives, these mechanisms do not entail any marketing expenditures, so business models that harness strong viral growth can be very attractive.
Virality and network effects are often conflated and confused, so the distinction between them warrants clarification. It should be clear from the list of mechanisms above that not all products that spread virally exhibit network effects. Likewise, not all users of products with network effects are acquired through viral, customer-to-customer transmission mechanisms. Specifically:
Many startups combine more than one viral mechanism in their go-to-market plan. Dropbox, for example: 1) harnessed a direct network effect when users employed the service to collaborate on documents; 2) benefited from word-of-mouth referrals from loyal customers; 3) acquired customers through casual contact when users emailed links that allowed recipients to download (without installing Dropbox) files stored in the sender’s public folder on Dropbox; and 4) offered a two-way “user-get-user” bonus, that gave both the inviter and recipient an additional 250MB of free storage.
A firm’s viral coefficient is calculated as the number of additional customers subsequently acquired through viral mechanisms for every new customer initially acquired. Startups that rely heavily on viral growth should track their viral coefficient overall and by customer cohort—that is, for each “vintage” of new customers acquired during a given period through different types of marketing program employed by the firm. As shown by the table below, a viral coefficient greater that 1.0 yields self-sustaining growth from an initial “seed”—that is, a batch of new customers acquired in period 1. In the table, we assume that a seed group of 1,000 new customers each purchase one unit of a firm’s product in year 1. These seed customers do not repurchase the product, but through viral means, they attract some additional customers who purchase in year 2, who in turn attract some more customers in year 3, and so forth.
|Number of New Customers|
|Viral Coefficient||Year 1||Year 2||Year 3||Year 4||Year 5|
When modeling viral growth dynamics for customer relationships that have a multi-year life, it is important to be specific about whether the viral coefficient should only be applied in year 1, or in each year. In some contexts, new customers are likely to quickly exhaust word-of-mouth recommendations or other viral mechanisms (e.g., opportunities to leverage “member-get-member” bonuses).
Tom Eisenmann is the Howard H. Stevenson Professor of Business Administration in the Entrepreneurial Management Unit at the Harvard Business School. You can find this post on Tom's blog called Platforms and Networks. You can also follow Tom (@teisenmann) on Twitter by clicking here.