ChaCha trims employees, modifies biz plan

November 17, 2008
In an economy this chilly, even the hottest companies must cool their jets. This month, Carmel-based startup ChaCha Search Inc. laid off eight of its full-time employees and trimmed interns. It also cut off the perks — like free haircuts and massages — that helped attract its top-notch talent.

Most significant: ChaCha has begun limiting the number of answers it gives away free. It's a key change to ChaCha's business model aimed at protecting its potential for solvency. But it also risks hobbling a company whose prospects are pinned on rapid growth.

" Every startup company in this economy should turn over every rock to find ways to cut costs," wrote ChaCha co-founder Scott Jones in response to IBJ's questions. "For companies large and small, this is going to be a rough ride."

Founded in September 2006, ChaCha bills itself as a human-assisted Internet search engine. It's best known for the mobile-phone service that launched last spring. Users submitting questions receive free responses from "guides" via text message — until they hit the new limit of 20 guide-researched answers per month.

The service has become ubiquitous, particularly among the middle school and high school set. Jones said ChaCha responded to 14 million queries in October.

The challenge for ChaCha and its 100 remaining employees is to turn that surging popularity into profit. That means delivering those young users to advertisers. In theory, they'll rush to embed their hyper-targeted marketing messages in the text messages ChaCha users receive.

But in practice, wireless industry analysts say companies now are cutting back on all forms of advertising. And as businesses clip their own costs, they're reluctant to try something new — especially if they can't count on reaching ChaCha's core users, the ones most likely to max out on the query limit.

Young people won't stop text messaging during a recession, said Greg Sterling, president of San Francisco-based mobile market analysis firm Opus Research. But advertisers won't push to reach them via an untested format.

"In a recessionary environment, there isn't necessarily going to be the experimental budget around to try stuff like this," Sterling said. "When the clouds part economically, mobile into the future is going to be an important medium, an interesting and different medium than the Internet. [Startup] companies just have to survive until that time."

"It may take three to five years," he added.

Analysts say ChaCha's opportunity in the fast-developing wireless sector remains as big as ever. But the threat of a deep recession has steepened ChaCha's path, and dramatically tightened its margin for error.

Since inception, ChaCha has raised $16 million from heavyweight investors like Amazon.com founder Jeff Bezos and Compaq Computer founder Rod Canion. These days, even billionaires feel the economy's pinch. On Oct. 23, The Wall Street Journal reported that Bezos personally lost $4.2 billion this year, one of the country's biggest drops in wealth.

With far less cash available, investors like Bezos will become much choosier. And when they do risk bets on high-tech startups, they'll want larger ownership stakes in exchange. That means ChaCha must make its $16 million last as long as possible. That's why ChaCha is acting now. "You have to be very proactive and make those tough decisions to reduce your costs early rather than late," ChaCha co-founder Brad Bostic said in a telephone interview. "At the end of the day, the life of the business is the most important thing." Jones and Bostic say they still are hiring salespeople, and they continue to believe ChaCha will begin making money on a per-query basis early next year.

Meeting that goal is crucial. ChaCha faces stiff competition from bigger search engines, like Google and Yahoo!, noted Tole Hart, research director for Stamford, Conn.-based technology research firm Gartner Inc. They're rapidly rolling out their own search applications for smartphones using IT algorithms, not 45,000 costly human guides.

ChaCha is counting on slow smartphone adoption. Its text-message and voice-based services are more appealing to users with simple flip phones.

"They haven't been in the market long enough to have the brand recognition of leaders like Yahoo! and Google," Hart said. "To me, there's still a question mark. They still have to prove ... they have a viable business model in terms of advertising."

Human guides are central to ChaCha's business, but the company never has expected them to respond to every question. ChaCha stores all its answers in an ever-growing database. So when a new user repeats a previous query, ChaCha can send back the guide's original reply. Eventually, ChaCha aims to reach a critical mass, when the vast majority of its answers are automated.

Under ChaCha's new rules, after users access 20 free guide-researched answers every month, they're notified that their limit has been temporarily reached. Even so, Jones said, users still can access an infinite number of automatic answers from the database about simple subjects like the weather, stocks, jokes, trivia, pickup lines, word definitions and Yellow Pages information.

"Importantly, fewer than 10 percent of our users experience hitting any limit, ever," Jones wrote. "That means 90 percent of our users experience unfettered use of our valuable services."

ChaCha has little choice but to trim costs, which are more significant than users realize, said Vik Rant Gandhi, an analyst with California-based Frost & Sullivan, a research-and-consulting firm that awarded the company its North American Product Innovation Award this summer. For example, he said, cell phone carriers often make mobile application providers like ChaCha pay a premium for every "free" text message they send.

But ChaCha must be careful, he said. Advertisers won't be as interested if answer limits discourage user interest. And ChaCha is still ironing out the kinks in its system.

"It's a fine line they're trying to walk here. A big subscriber base is vitally important to them. That's what they bring to the table," he said. "Their system is still learning automated answers. The biggest challenge is to manage these [human] guides and make sure the answer quality is consistent."

Ever the optimist, Jones expects opportunity where others spot challenge. He noted that ChaCha's new paying advertisers in the last few months included Coca-Cola, McDonald's, Best Buy, the Lifetime television network and Barack Obama's presidential campaign.

"ChaCha benefits from a down economy, both in terms of an ample supply of independent contractor work force serving as our guides as well as the need for advertisers to reach our coveted young demographic," he wrote.

"We feel that we are in a good position to bring revenue to other businesses, because we can make offers to our users at a time when they may be most interested."
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