THE GREATEST DISCOVERY SINCE FIRE

Such was the sentiment surrounding the microwave oven in the early 1970’s.  This device was a high-priced wonder, with several companies rushing in to the market to capitalize on the hype.  In cities across the U.S., traveling salespeople conducted demonstrations whereby they cooked beef tenderloin in minutes and potatoes in seconds, leaving onlookers in amazement.  Early models sold for as much as $500.

Sharp ad in 1972

GE ad in 1972

The microwave oven was a revolutionary technological development.  It enables us to heat foods and liquids in much abbreviated time.  Yet despite its promise and capability, the microwave oven did not dislodge the conventional oven.  There are certainly uses for which cooking with a microwave oven is preferable, but for most cooking applications a microwave oven is never even considered.

Information streams, and the associated real-time search they enable, give us great insight to current sentiments and events happening at the moment.  I need not elaborate on the value of this data.  However, this value of real-time information is only relevant for a small percentage of searches (e.g. current events and current sentiments).  Try searching for information about the new Yankee Stadium, or music festivals in Europe this summer, or things to consider when selecting the right breed of dog for your family, and I can assure you that Google is a better resource than Twitter.

The Inverse of Price Gouging

Hurricane Andrew decimated Miami in August 1992.  Its powerful winds ripped the front and back doors off our house and carried one of our skylights down the block, while the accompanying rain soaked all of our walls and left three inches of water throughout most of the house.  The aftermath of Hurricane Andrew was one of the darkest moments of my 14-year-old life.  Driving around the city conjured up images of a war-torn or third-world country, families clutching each other sobbing over the rubble that was once their home.

And then there were the assholes selling bags of ice for $10 each.  They knew that almost everyone in Miami was without electricity and had to preserve as much of their perishable food as possible.  The sellers had all the power (no pun intended).  Sure, temporary market forces allowed them to charge such egregious prices, and capitalists may say these ice-swindlers were being adequately compensated for their scarce asset.  But in my view this was an insensitive and disgusting practice of price gouging.

Right now our economy is in a reverse situation.  Buyers have all the power.  As consumers [or VC investors], we are justified in seeking a good deal on a new sofa [or a startup], but we must make sure we do not exploit the situation like the guys selling bags of ice for $10.  While temporary market forces may allow us to exploit sellers, it would be insensitive and ugly to do so.  Just as what goes up must come down, what goes down eventually comes back up; and what will distinguish you from your neighbor is your reputation.

As a footnote, in the aftermath of Hurricane Andrew, Home Depot stores in South Florida sold their wares at cost for one month.  The brand equity and loyalty this engendered was felt for years afterwards.

Rev-Share Trends

A couple days ago I went to a panel on revenue-share deals.  The event was organized by the Columbia Business School Alumni Club, and companies represented on the panel were GoogleTV, Kaboose, Thumbplay and KickApps.  Below are some of the key takeaways from the discussion:

• Ad inventory share is preferable to a revenue share because each side controls its allotted inventory and thus its cleaner
• KickApps migrating to subscriptions and away from rev share, due to declining ad market
• These days you line up a sponsor prior to paying for licensing content
• Thumbplay has spent $40m per year acquiring customers
• Google TV sells the inventory that is not sold in bundle with internet and product placement
• Rev share deals should be boiler plate and standardized, particularly for unproven publishers; standard payment terms; deals can get renegotiated once performance is proven
• Audit language is not a contentious topic; there’s a lot of trust-based accounting
• Google pays every 30 days like clockwork; they haven’t mastered working capital tricks
• Promotion in exchange for exclusive content is a fair trade (e.g. Coldplay on iTunes commercial)
• CPA is the same as PI (per inquiry) advertising on TV
• Do whatever it takes to get a reference account
• The app is the new hit single; Apple’s commercials are all about apps now and not music
• Now over 50% of ad campaigns have custom integration work; it ussed to be 20%; the reason being that you now have to do more work to maintain the same level of CPM
• Advertisers won’t take on small affiliate sites on CPM basis; rather will put them on affiliate program
• 2 million pageviews per month is the baseline for a small publisher to make money from advertising

Pick Your Poison

Every so often I see a pitch from a startup who’s product can do a multitude of things for a multitude of industries.  An example is as follows, taken directly from an executive summary I just read (I have omitted the name of the company):

[Company] offers world-class technology, branded under the [product] label that represents a secure, digital communications platform that couples the ubiquity of the internet with access to virtually every known telecommunications protocol to connect organizations, people, machines, computers and physical infrastructure in both emergency and routine situations…. and supports a diversity of applications in industry, commercial business, government, military and residential sectors.

You can’t be everything to everyone.  Not only does such a claim tax credulity, it also shows a lack of focus from management.  Pick one or two things your company is great at, and then target one or two industries.  Once you have proven your worth in those industries, then it is okay to expand to other industries and to augment your offering.  As a startup you need to be able to summarize your business in one sentence without invoking ironic laughter.

Bit.ly

I believe bitly will be one of the more successful startups out of New York in the past few years.  Critics posit that it is just another URL shortening service and it will die if Twitter creates its own shortening tool.  I disagree.  Yes, bitly has achieved incredible growth and adoption thanks to Twitter, but its business model does not rest upon the microblogging platform.  I believe bitly can survive beyond the twitter ecosystem.  The analytics it provides can be valuable to small- and medium-sized businesses conducting their own email marketing campaigns (whether through Constant Contact or an in-house system).  The timeline component illuminates the effects of externalities on a message’s response rate.  This understanding is priceless for an email marketer.  Additionally, bitly links can be placed behind banner ads for more robust reporting.

Beyond marketing uses, a bitly link within an email tells me how many recipients have read my email, closing the loop on the message without using a read receipt.  Plus I can safely assume if the email was forwarded on to other people.  For example, if I send an email containing a bitly link to 3 people, and bitly tells me the link has been clicked 6 times, there is a good chance the email was forwarded to others (of course it is possible that each recipient clicked the link twice).

Now on to the bitly vs Digg argument.  I like the fact that bitly is more distributed and thus it more accurately represents popularity of content.  However, I do not think that the metric used to determine rankings within bitly should be clicks.  For example, if Steven Johnson tweets a link to his 270,000 followers, the site behind that link will instantly get a huge number of “votes” simply because of the influence Steven Johnson has, not because the content on the corresponding page is of value to all those people.  So clicks on bitly links is more about who says what rather than what is actually said.  A better criteria would be the number of bitly links pointing to a page, plus the number of times those links have been retweeted or forwarded somehow.  I am not a techie, and so I have no idea whether it is possible to measure how many times a link has been retweeted or forwarded.  Yet a “vote” for a webpage is more genuine when it involves attaching one’s reputation to whatever is being linked to, rather than an anonymous click.

Google Voice is the holy grail

The more a brand knows about your interests, the better it can be at showing you advertising relevant enough to grab your attention.  Additionally, the more a brand knows about who you are friends with, the better it can be at showing you advertising relevant enough to grab your attention.  Your social graph is very telling of your potential purchasing decisions, for birds of a feather flock together.  These concepts were the original value propositions of social networks to advertisers.  We all know how that has panned out in reality.

Are you really that close with the hundreds of people you are connected to via Facebook, LinkedIn or twitter?  No, you’re not.  But you probably are quite close to most of the people you speak with or SMS with on your cell phone.  The reason for this is that your cell phone is more personal; and it requires more of a commitment to connect with someone through a phone call.

When I first started using Twitter I thought to myself that these guys really nailed the capturing of my personal data (interests, preferences, intimate social graph, etc).  I thought the sole use case of the service was to constantly broadcast to my friends what I am up to.  Brilliant.  But in actuality I use twitter to send a variety of messages to a mix of social and professional contacts, and only occassionally does that message actually have anything to do with me personally (aka what I’m doing).  The early adopters of twitter probably fall in this category.  Yet the masses will use the platform to speak about themselves most of the time; as such the personal data capture may still happen, but learning a user’s true social graph will not.

Skydeck came so close.  I’ve been waiting for this company to really take off and ultimately become a marketing services company.  So far it hasn’t happened and because of Google Voice it probably never will.

If Google Voice can get enough people to use the service, it would seize the holy grail of information that advertisers want.  It will know your real-world relationships and the strength of those relationships.  It will know who is a business contact and who is a personal contact.  Through its transcription service, Google will know the content of messages people leave for you and of any calls you ask it to record.  It will know the content of all your text messages.  That is all powerful data, especially when combined with data harvested from Google’s other products such as Gmail,  Talk and Latitude.  Google Voice will expose your real social graph.  And because it’s on your cell phone, dozens of new data points are harvested each day.  Last, but not least, once hooked you will feasibly use the service forever because your Google Voice number is yours to keep and Google isn’t disappearing anytime soon.

I really can’t wait to try out the service.  I hope you feel inclined to leave a comment regardless of whether you agree with me or not.

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• Google Voice: A push to rewire your phone service (news.cnet.com)
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Just Add Balls

Yesterday the Xconomy blog shared an email interview they conducted with Paul Graham.  The prominent early-stage investor posits that Silicon Valley is a more nurturing environment for startups than Boston because startups put the Valley on the map.  Paul also states that he thinks entrepreneurs and investors should spend more time trying to understand why the Valley is a better place for startups.  That got me thinking about the U.S. as a whole being better than most other countries at fostering a startup culture.

In order for a startup culture to be successful there needs to be a whole ecosystem in place to support it, and the U.S. is founded on such an ecosystem.  In my opinion, the five main components of a startup-friendly environment are: 1) access to knowlege, 2) ease of incorporation, 3) funding sources, 4) viable execution, and 5) exit opportunities.

Spawning entrepreneurial activity requires access to knowledge.  Whether it be via a formal education or information resources such as publications, lectures and the internet, entrepreneurs need to know as much as possible about the space they intend to enter.  This is obvious.  And the U.S. is wrought with educational opportunities.  Of American adults over the age of 25, more than 85% have completed high-school and 27% have a college degree.  The U.S. government encourages advanced education via its numerous financial aid programs and tax deductions for interest on education loans.  Even without a formal education, though, entrepreneurs can tap into books, magazines, conferences and contacts with domain expertise.

Nobody would want to start a company if it was a nightmare process to get incorporated.  The U.S. makes the incorporation process incredibly easy.  In Delaware this can be done by filing one simple form and paying $89.  To illustrate the system in other countries, a potential entrepreneur in Mexico must file 8 forms in different government offices, and the process takes about one month.  The U.S. also offers a variety of incorporation types, such as C-corp, S-corp, LLC and Partnership.

A huge reason for the existence of a startup culture in the U.S. is access to moderately cheap capital and established bankruptcy proceedings.  Other than the turbulent economic times we are in today, the historically stable U.S. economy has limited systemic risk to both debt financing and equity financing. Our economy has also not been characterized by highly volatile inflation rates (again, present circumstances excluded). This stability, when combined with the aforementioned limited systemic risk lead to low interest rates levied on debt and moderate returns demanded from equity.  These forces have engendered entire industries of venture financing such as venture funds, seed funds and SBA loans.  Most startups in the US first get seeded by individuals with enough net worth to afford an angel investment. Due to the more even distribution of wealth in the U.S. relative to other countries, angel investors can be found in every corner of America.

Bankruptcy workouts are also more efficient in the U.S. than other countries. For example, in much of Latin America, secured creditors typically do not have priority to their collateral, and the judicial system that governs bankruptcy proceedings is weak and slow. On the contrary, the U.S. has an established Bankruptcy Code that determines the pecking order of different classes of creditors. This introduces additional confidence in financing a startup. Consideration must also be given to the standards of corporate governance that govern a Board of Directors. In the U.S. these principles have arisen from decades of legal precedence and shareholder activism. Most countries in the world do not benefit from a rich history of legal precedence and government involvement.

A critical success factor of any enterprise is a strong team to execute the company’s vision. Even in the U.S., where there is a large universe of talent, finding the right people to fill key positions is one of the biggest challenges for any entrepreneur. This challenge is magnified tremendously in foreign countries where there is only a small pool of highly-educated workers, and where many of the most qualified workers seek opportunities elsewhere, leading to a “brain drain” in local economies. Attracting strong team members in the early days of a venture is usually accomplished with stock options that are only worth something in the presence of healthy exit markets, which leads to the final point.

Just about the entire value harvested from a startup’s efforts lies in the amount of money generated in a liquidity event (or “exit”). The two main exit opportunities for a company are public offering and acquisition. Market conditions are paramount to reaping the greatest possible value from an exit, even if the company has impressive performance and growth potential. An IPO will mainly only be considered when the public markets are stable in order to minimize the risk of an offering trading at or below its issue bid, which would in turn lead to the perception of an undesirable offering and further selling. Acquisitions are also dependent on market forces such as high equity prices and cheap sources of debt financing.  Both of these exit markets have been robust for most of recent history in the U.S.  Though they are not palpable at the moment, they too shall rise again.

So there it is.  The recipe for creating a startup culture.  We should feel blessed to live in a country that fosters capitalism and an entrepreneurial spirit.  The foundation is there.  Now for the most important ingredient of all:  balls!

(Please be aware that the use of the term “balls” is a colloquial reference to taking big risks and in no way suggests a bias towards gender)

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Blogs are like ATMs

Before the days of ATMs, if I wanted cash I had to get it from my bank. It wasn’t particularly convenient because I was at the mercy of the bank’s schedule and limited reach. Furthermore, if I consumed all of the cash the bank gave me, I would have to wait until the next day to get more cash. With the advent of ATMs, the tide switched in my favor. You see, I don’t really care that much about where I get cash from. I just want the ability to get it whenever I want regardless of where I am. While I would prefer that the ATM be associated with my bank because I trust my bank, I ultimately just care about convenience and thus will get cash from the most readily available ATM that has a minimum level of trustworthiness. Banks do offer more value than just dispensing cash, but the vast majority of the time cash is all I want. That is the reason ATMs are here to stay and the old way of getting cash seems absurd.

In the above paragraph, simply replacing the word “ATM” with “blog”, “cash” with “news” and “bank” with “newspaper” yields the following result:

Before the days of blogs, if I wanted news I had to get it from my newspaper. It wasn’t particularly convenient because I was at the mercy of the newspaper’s schedule and limited reach. Furthermore, if I consumed all of the news the newspaper gave me, I would have to wait until the next day to get more news. With the advent of blogs, the tide switched in my favor. You see, I don’t really care that much about where I get news from. I just want the ability to get it whenever I want regardless of where I am. While I would prefer that the blog be associated with my newspaper because I trust my newspaper, I ultimately just care about convenience and thus will get news from the most readily available blog that has a minimum level of trustworthiness. Newspapers do offer more value than just dispensing news, but the vast majority of the time news is all I want. That is the reason blogs are here to stay and the old way of getting news seems absurd.

I find that to be rather interesting!  Now newspapers just need to learn to embrace the tidal shift and monetize it.

Everyone back off Tom Friedman

This weekend Tom Friedman wrote an op-ed piece in the NY Times postulating that the $20 billion of government money that GM and Chrysler are asking for would be better utilized by the top 20 venture capital firms in the U.S. because they fund companies that drive innovation and create jobs.  Tom gave a strong endorsement to the venture capital model.  Yet VCs all across the country took offense and backlashed at the suggestion.  Below I will list some of the reasons the VC community gave for their pushback, along with my humble two cents on each.

1)  The venture capital industry does not need a bailout, especially the top 20 firms.

• True.  But Friedman’s post is not about bailing out VCs.  It’s about the wisest allocation of $20 billion.  The only statement he makes that could potentially be misinterpreted as a suggestion the VC industry needs a bailout is regarding LPs having trouble keeping their funding commitments.  This is a well-known fact and does not suggest the VC industry needs a bailout.

2)  The top 20 firms don’t need help raising money.

• Usually true.  But that doesn’t matter.  I don’t need help opening a door but I do appreciate when someone holds a door open for me.

3)  There is already a glut of capital in the VC system.

• Perhaps true over the entire industry, but not necessarily at the top.  Several prominent firms are raising annex funds or are concerned about their levels of dry powder.  Kleiner, Bain Capital, Onset and Battery are just a few of the firms that fit this description (though it is a seed fund, First Round is also raising an annex fund).  Admittedly, the $20 billion Friedman writes about is a large amount for the VC world, given the average amount raised annually by the industry over the past four years is $30 billion.  However, Friedman used this number because that is the latest amount under consideration for GM and Chrysler.

4)  Government money would lead to reckless investing.

• This is ridiculous.  The best VC firms enjoy that reputation because they invest judiciously in companies that exhibit strong upside potential.  These VC firms then nurture these companies with industry connections and a Board presence.  I cannot imagine Sequoia making imprudent investments just because it received a large injection of investable capital.  These firms aren’t the nouveau riche types.  They’re not like hip-hop stars who blow all their money on cars and yachts the first chance they get.

5)  Government money would have lots of strings attached.

• Possibly.  Given the restrictions placed on banks receiving TARP money, this is a safe assumption.  Yet it is not certain.  Besides, LPs invest in a VC fund under the premise that the partners will invest that money within parameters defined in the fund’s charter.  These parameters can be broad or specific, and there are always exceptions, but general partners are accustomed to considering the charter before making an investment.  Furthermore, from an administrative perspective, it is much easier to have a small number of LPs in a fund.  Having the government as a fund’s sole LP would be far easier to manage than a roster of hundreds of LPs ranging from institutions to wealthy individuals.

So everyone should back off Tom Friedman a bit.  He made a statement that speaks highly of the venture capital model and the role venture capitalists play in driving the country forward.  As a taxpayer I would be delighted to be an LP in the country’s best venture capital funds.

Own the Channel

Having control of distribution is one of the most powerful cards a business can hold in its proverbial hand of poker.  It allows you to greatly influence the rules of the game and determine how draconian or democratic they will be.  Either way, this power pays off in spades.  According to quantcast, Comcast.com gets over 14 million unique visitors per month to its site (Compete puts this number at a little over 6 million).  Splitting the difference, we can estimate that 10 million people visit that homepage at least once per month.  10 million???  Are you kidding me?  And why do 10 million people visit that useless site?  Because it is the default start page for Comcast’s 14.9 million internet subscribers.  The only way this stops being a Comcast subscriber’s browser homepage is if he or she actively changes it, which clearly is not a frequent occurrence.  So let’s say that of the 10 million montly uniques, 8 million of those are internet subscribers who probably open their browsers 20 times per month, and the other 2 million uniques just land on the site once in that month.  That’s 162 million visits to comcast.com each month.  At a $10 CPM, with 2 ads on the page, that’s $3.2 million per month and almost $40 million per year.  Owning the channel sure has its privileges!

Liquor distributors control the distribution of alcohol in most states and thus benefit from huge margins.

Twitter owns the channel and thus can control who gets access to the real-time conversation and how often.

Facebook owns its respective channel.  Though they have taken quite a bit of heat for trying to control users’ data, it is hard to deny that Facebook has the ultimate say up until users revolt by closing accounts.  Microsoft and Google both acknowledged the power of owning this channel, but Microsoft won with an expensive ownership stake in the social network.

Hulu owns the channel.  Yes, content providers strong-armed the company and demanded they discontinue streaming videos through Boxee, but very soon we will see that Hulu will win the battle.  It’s just too obvious.  Hulu can ultimately do whatever it wants because it has incredible distribution and the content providers will have to bend to the company’s wishes.  It’s just that right now young Hulu is still figuring out how to play in the tug-of-war between supplier and consumer.  Boxee will eventually own the computer-to-TV channel.

Apple owns music distribution through its iTunes application, which locks consumers into using an iPod.  The company makes no money on the music and doesn’t really care whether you buy music through the iTunes store or other sources, but they make plenty of money on the player (i.e. counter to many other business models, they make most of the money from the razor and not the blades).

Newspapers used to own the channel.  Their prowess depended on it.  Once they lost control of distribution, they became rudderless ships at sea.

Owning the channel is why Amazon created the Kindle.

Owning a channel is not synonymous with being a monopoly, though the associated power is similar.  Owning a channel is about providing access.  OpenTable owns the channel of access to diners.  Sysco owns the channel of access to restaurants.  ZocDoc will one day own the channel for doctor appointments.  Outside.in will one day own the channel for local news.  If you find a potential channel you can control, get in there fast.  And if you can’t own the channel, at least try to move upstream.  Otherwise you have to hope that you won’t get crushed when dancing with the elephants.