Forget unicorns and rainbows. Building a successful software product is more like juggling chainsaws on a tightrope while blindfolded. It sounds thrilling, but the real challenge lies in the cold, hard economics, not the coding. The hidden economic realities can sink even the most promising app, no matter how many millions love it.
There is a common misconception that achieving product-market fit is sufficient to launch a successful app or service. While product-market fit is indeed a critical milestone, it is merely the first significant hurdle in transforming an idea into a viable product. Many modern entrepreneurs romanticise software development as a swift and inexpensive pathway to impactful innovation. Although software can be more cost-effective and faster to develop compared to other alternatives, it presents its own set of unique challenges that are often overlooked by both founders and venture capitalists. This oversight contributes to the high failure rate among software startups.
Understanding Economic Reality
In the world of business, return on investment (ROI) reigns supreme. Before any product sees the light of day, it must be expected to generate returns that at least match what the company could achieve through alternative investments. Let's consider a typical Software-as-a-Service (SaaS) product in India. Developing the initial version (v1.0) often takes two years and roughly Rs 5 crore, encompassing engineering, marketing, and maintenance costs. While the average stock market return sits at a tempting 21.5 per cent, this might not be the most realistic benchmark for a startup due to the inherent risk involved.
Here's why, startups operate in a high-risk environment. To compensate for this risk, investors typically expect a higher return than the average market offers. A more realistic benchmark ROI specific to Indian SaaS startups would provide a clearer picture.
Now, let's delve into the example with a million active users, a dream scenario for any marketing team. Assuming an average in-app purchase of Rs 10 per user (remembering this can vary depending on your user base), the monthly revenue would be a cool Rs 1 crore. Over two years, this translates to a healthy Rs 24 crore, surpassing the initial investment. However, this is gross revenue, not net profit.
Platform fees like the 30 per cent charged by Google and Apple take a significant bite, reducing revenue to ₹16.8 crore. While ongoing maintenance, scalability, and cloud computing are crucial, their costs shouldn't necessarily mirror the initial development expense. Let's assume these ongoing costs reach Rs 2.5 crore per year, totaling Rs 5 crore over two years.
Factoring in platform fees and ongoing costs, the net revenue settles at ₹11.8 crore. While positive, this still suggests a longer path to profitability than the initial rosy picture might have implied. This example leans towards a worst-case scenario, highlighting the importance of considering factors like market competition, inflation, and salary increases. Remember, achieving profitability took Uber 13 years, and even giants like Snapchat, with minimal logistics, needed nine years.
Can your product generate a return higher than this benchmark? This question, despite its simplicity, represents a significant challenge. The typical business model of most software products—whether business-to-consumer (B2C) or business-to-business (B2B)—often requires substantial ongoing investment to gain market share and establish user habits. To illustrate, let us examine a best-case scenario.
Revenue and Costs Analysis
Imagine a software product with one million monthly active users, a highly desirable metric for any marketing department. Assuming an average in-app purchase of Rs 10 per user (depending on the distribution of paying users from non-paying free users to high-paying “whale” users), the monthly revenue would be Rs 1 crore. Over two years, this equates to ₹24 crore, comfortably exceeding our baseline ROI of Rs 7.38 crore. However, this figure represents gross revenue, not net profit.
Platform fees, such as the 30 per cent charges imposed by Google and Apple, reduce this revenue to Rs 16.8 crore. Additionally, ongoing maintenance, scalability, cloud computing, storage, and user research costs can be as high as the initial development expenses. Assuming this, that’s an additional Rs 5 crore per year, totaling Rs 10 crore over two years. Consequently, the net revenue after platform fees and maintenance costs is Rs 6.8 crore, meaning the product would only surpass market investment returns after approximately seven years. This is the most optimistic scenario, as it assumes no market competition, no inflation, no salary increases, and a stable user base—conditions that are rarely met in reality. Case in point, Uber took 13 years to achieve profitability, and even pure software giants with minimal logistics or operational costs like Snapchat took nine years.
Strategies for Improving Profitability
There are three primary strategies to enhance profitability: increasing prices, expanding market share, and reducing costs.
● Cost Reduction: In the software industry, the most significant expense is manpower, including engineers, designers, and testers. Cutting costs here might involve layoffs or hiring less expensive, potentially less skilled staff, which could compromise product quality. Essential costs such as computing, storage, and infrastructure are
non-negotiable with most cloud providers, leaving limited possibility for cost reduction and most scope in increasing operational efficiencies, which is largely not enough.
● Total Addressable Market: Markets, particularly in India, are expanding as more individuals gain access to smartphones and disposable income. However, growth rates vary by industry, with sectors like gaming and fintech expanding faster than others. Internet penetration is increasing, but there is a ceiling once critical mass is reached.
● Price Increases: This is the most common lever most companies pull. Regular price adjustments can help, but they must be carefully managed. Price increases below the average inflation rate of 6% will not improve real income, while significant hikes might alienate customers, prompting them to seek cheaper alternatives.
The Challenge of Switching Costs
critical yet often neglected aspect of product development is the concept of switching costs. The first-mover advantage is significant due to these costs. It is not enough for a product to be marginally better than its competitors; it must be substantially superior—often perceived as ten times better—to justify users switching from established solutions. Achieving this level of superiority requires significant investment in development, research, and marketing, further eroding profit margins. This is often seen as diminishing returns for most leadership.
The Road Less Travelled
Building a successful software startup is a marathon, not a sprint. It requires a deep understanding of economics, a relentless focus on efficiency, and a willingness to confront brutal realities. Many founders, inspired by passion and fueled by venture capital, find themselves years deep in the game before realising the path to profitability stretches far beyond the horison. This harsh truth isn't a call for cynicism; it's a call for calculated risk-taking. For those who dare to venture beyond the easy wins and into the unforgiving landscape of disruptive innovation, the rewards can be immense. But for the rest, a sober understanding of the economic realities of software development is the only compass that will guide them through the storm.
