Everyone back off Tom Friedman

February 24, 2009

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

February 21, 2009

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.

Raw Talent Can Outweigh Industry Experience

February 3, 2009

Fiat used to be the laughingstock of the automobile industry.  The Italian company was defined by employee strikes, staggering financial losses and flopped car launches.  Fiat had gone through four CEOs in the three years leading up to 2004.  That is when Sergio Marchionne took the wheel (pun intended).  Thanks mostly to Sergio’s leadership, Fiat has been operating solidly in the black and now sets the industry standard for time to bring a new model to market.  In short Sergio Marchionne resuscitated a dead company and made it a class leader.  Amazingly, Sergio came to Fiat with no prior experience in the auto industry and was practically a foreigner since he left Italy in 1966.

While many companies place a big emphasis on industry experience when recruiting employees, they may be better served looking for the character traits that underlie progress and success.  Sergio Marchionne was able to achieve what he did because at his core he is an exceptional leader:  he sees the talent locked within others, he allows others to take initiative, he sets ambitious goals, he holds people accountable and he questions the norm.  These virtues are instinctive and not a product of industry experience.

I have heard many entrepreneurs say that if they knew just how challenging it would be to start their respective business, they would have highly considered jumping ship at the beginning.  To a certain degree ignorance is bliss.  Dreamers achieve things because they don’t know that they can’t.

Experience is important for many obvious reasons.  However, it can also restrict people to continue thinking within the box.  It can stifle people by making it comfortable to simply accept the norm rather than challenge it.  For example, the past year my VC firm has been looking at a company that will serve car rental agencies.  This startup’s COO was the former VP of Hertz Global who was in charge of worldwide fleet operations.  Last year we asked the company to go out and land a contract with Hertz, but they never even attempted it because the COO said Hertz would not do business with such a young company.  Therefore, we kindly told the startup we were not willing to make an investment yet.  The startup subsequently replaced that COO and proactively reached out to Hertz.  Last month Hertz signed a one-year exclusive contract with the company.

Now imagine you were in charge of recruiting for an auto company and you were looking at the resumes of Sergio Marchionne and that former VP of Hertz Global.  You would not get fired for going with the guy that has auto industry experience.  But you also wouldn’t get the kind of success that Sergio Marchionne has brought to Fiat.  Be sure to look at the big picture and not be myopic about industry experience.

Twitter and Unintended Consequences

January 19, 2009

I love twitter.   It enables a public conversation via its low barriers to participation.  While traditional blogging is asynchronous communication, twitter is intended to foster banter and new ideas.  Participants deliberately choose to expose their conversations for all to see, opting not to communicate via other private mediums such as phone, email, sms or twitter direct message.  In doing so they are indirectly keeping the door open for other people to participate in the conversation.

However, there is a price associated with using twitter.  When one has achieved a level of twitter stardom, it becomes almost impossible to engage with all the people who try to converse with them.  The law of unintended consequences then rears its ugly head when those ignored people feel snubbed by the “cool kids”.  I beg you to read Clay Shirky’s thoughtful explanation of this phenomenon of power laws and inequality he wrote about in a post back in 2003.

This popularity brings with it a high degree of influence.  The correlation between one’s number of twitter followers and one’s authority was heavily discussed last month, and I will not beat a dead horse here.  Jeff Jarvis summed it up well when he asserted that a plethora of twitter followers is not indicative of authority, but rather a proxy for influence.  These days, when one’s path from zero to hero can be vastly shortened by a shout-out from an already-respected individual, I have even greater respect for the people who achieved stardom without the help of twitter.  Enter Seth Godin.

Seth needs no introduction; but for those who are not familiar with him, he is an accomplished author, successful entrepreneur, and highly regarded as an expert in marketing.  He is one of my heroes in the business world.  The strength of his influence can be seen in the following example:  on January 14th Seth wrote a post on his blog asking people to vote for his friend’s entry in a contest.  His friend’s name is Becky.  On the date of his post, Becky was 100 votes out of first place.  When the contest ended the next day, Becky took first place with 72% of the 5,000 votes!

Even with all the attention he receives, Seth keeps in touch with his readers and fans.  I have emailed Seth three different times [Feb 25, 2005 / May 20, 2005 / Dec 9, 2008] and each time he has replied promptly.  They were very succinct replies, but replies nonetheless.  You may speculate that he has people responding to emails on his behalf.  But I really don’t think so.  That would run completely in the face of authenticity – a virtue he highly values.

Seth Godin is not on twitter.  As such maybe he receives less requests for his attention than the twitter stars who are constantly pinged by their followers.  Who knows.  But I do know that he is a stud who takes the time to respond to his fans.  In doing so he strengthens the bond with his “followers” and does not jeopardize alienating them.

I believe the net effect of being a powerful member of the Twittershpere is positive.  This post is intended to show that unfortunately it does possess its drawbacks.  In an ideal world, people would have the capacity to behave more like Seth Godin.  They would be able to engage with all of the people who admire their opinions.

Lottery tickets are risk-free ???

January 12, 2009

In business school we were taught a formula that can be used to determine the expected return on an asset.  It is called the Capital Asset Pricing Model (“CAPM”) and the equation is as follows:

Ra = Rf + βa(Rm – Rf)

where Ra is the expected return on the asset; Rf is the risk-free rate (i.e. 30-year government bond); Rm is the expected return of the market (i.e. S&P 500); and βa is the correlation of the asset’s return to the market’s return.

The beta (βa) of an asset is usually positive, indicating that when the overall market performs well, the asset also performs well; and when the overall market performs poorly, the asset also performs poorly.  Some industries possess negative betas, such as precious metals.  In this case, when the overall market performs well, the asset does poorly; and when the market goes down, the asset does well.

Yesterday I bought a lottery ticket just for fun.  I got to thinking that the beta of that lottery ticket is zero.  There is absolutely no correlation between my return on that lottery ticket and the return on the overall market.  According to the CAPM equation, my expected return on the lottery ticket should thus be the risk-free rate (which these days is trending close to 3%).  Obviously it is not, and thus the CAPM equation shows its limitations.

Securities that exhibit a zero or low beta are treasury bonds and staple stocks such as Clorox, Anheuser-Busch and Philip Morris.

Outdoor Analogy to Online Advertising

January 9, 2009

Fred Wilson’s post this morning on display advertising got me thinking about its offline analog:  billboard advertising.  My retail business in Miami is located on a property that also hosts a billboard.  CBS Outdoor is the company that manages all aspects of the billboard (selling ads, maintenance, legal, etc) and they pay my landlord 30% of all ad revenue generated from that billboard.  In online terms, my landlord is the publisher, the retail center is the website, the billboard is the ad unit and CBS Outdoor is the ad network.  Ad networks for billboards operate the same model as online ad networks:  they aggregate inventory from many sources, sell that inventory to advertisers, and split the revenue with the respective landowners.

Yet there are tremendous differences between the economics of billboard advertising and online advertising.  The offline world has limited real estate and we cannot produce anymore land.  Furthermore, outdoor advertising in the U.S. is subject to strong government regulation at the federal, state and local levels, imposing restrictions and limitations on the construction of new billboard units.  Hence supply is tightly controlled.  Also there are only a handful of companies that do billboard advertising, notably Clear Channel Outdoor, CBS Outdoor and Lamar (these are the “ad networks”).  It is for these reasons, despite being a mature industry, that revenue and profit grew consistently up until the recession of 2008.  For example, Clear Channel Outdoor’s U.S. business has grown at 11% per year for several years, with EBITDA margins of 45%.

In contrast, the online world has perpetually growing real estate and ad inventory.  Millions of web pages are created every day, and most of them are capable of displaying advertising without abandon.  That is the terrestrial equivalent of us being able to create a new country every day and sprinkle it with as many billboards as we want.  If I own the land around one of these billboards and I plan on living off the advertising on that billboard, I better do something really awesome to convince people to come see me.  This is the economy of attention.  It is no surprise that with such an excessive amount of inventory there are hundreds of ad networks, all competing for the same ad dollars and driving down CPMs.  In reality very few companies can survive from online advertising alone.  Almost all online ad dollars go to Google and Yahoo.

So yes, display ads will get dirt cheap and will be sold as remnant inventory.  As Fred notes, people will deploy sophisticated targeting tools for these display ads to the point that they are as efficient and democratic as search.  However, what will transpire after that is an increase in display CPMs– a rebound of sorts.  Why?  That is exactly what happened when Google introduced AdWords.  At first it was dirt cheap to advertise through AdWords.  But as more and more advertisers came onboard to use the simple text ad-creating tool, and as demand for specific keywords increased,  so did pricing.  That too will happen when creating display ads becomes stupid simple.

I wonder what the internet would look like if ad inventory was controlled the same way billboards are.  We would certainly see more creative business models generated.  We would probably witness fewer entrepreneurs see their dreams falter.  Yet we would gain a lot less value from all the content and data the free internet gives us.  Long live the American dream.

Update on post regarding Consumer Credit:

January 9, 2009

Yesterday Fitch Ratings issued a report showing that charge-offs on credit cards hit a three-year high last month, up 49% from a year ago, while payments more than 60 days past due were 34% higher than they were in July.  The perfect storm is forming…

Why Consumer Credit Will Remain Frozen

January 6, 2009

One topic that is vastly misunderstood is a consumer’s credit score.  It is not taught in school and it is seldom a point of discussion.  This is frightening as we enter what appears to be the perfect storm of a frozen consumer credit cycle.  While there are several variables that contribute to one’s score, the two main factors are punctuality and credit utilization.  In fact, these two variables account for 2/3 of one’s credit score.  Unfortunately, macro-economic factors are making it difficult for many Americans to remain whole in these areas.

For the past several years, easy credit has been a substitute for low wages.  Beyond the well-known mortgage debacle, credit card issuers doled out lean credit terms and high credit limits.  Drunk consumers continued to drink and pushed their debt balances to those limits, hoping to just be given more credit when they needed it.

Now strapped for cash due to layoffs and a shrinking economy, these consumers are not able to make their minimum payments on time.  That crushes the punctuality component of the credit score.  The other component I mentioned – credit utilization – is being sabotaged by the credit card companies who will no longer grant credit line increases.  In fact, many credit card companies are going so far as reducing credit limits and canceling cards that haven’t been used in a while.  Alas, many consumers will soon see their previously decent credit score plummet even if they refrain from making any more purchases with credit.

A credit score is a proxy for a consumer’s cost of capital.  With these scores tanking, money will be very expensive to borrow and hence the consumer credit cycle will remain frozen.  To make matters worse, newly-risk-averse lenders now have stricter credit score requirements.  A thaw will only come if either:  1) ratings agencies employ more lenient scoring metrics (e.g. forgive some late payments and allow higher credit utilization), or 2) banks re-calibrate their definition of a good credit rating.

Should things progress the way they are with plummeting credit scores and rising credit requirements, there will be a large funding gap to fill.  Therein lies the opportunity for peer-to-peer lending companies like Prosper and LendingClub.  Yes they have recently run into issues where they need to register with the SEC, but they will get past the regulatory hurdles (LendingClub already has in most states).  We may also see credit unions rise in popularity, given their lower interest rates on loans and higher rates offered for deposits compared to traditional banks.  Either way, profits will migrate away from monolithic banks and move toward the people.  The bad news is that this market will take a long time to develop, and until then the consumer credit cycle will remain frozen.

Keeping Perspective

January 5, 2009

My name is Andres Moran and I have finally chosen to start a blog after much resistance.  I made fun of bloggers years ago for thinking that anybody actually cared about what they had to say.  Now that I spend most of my time on the web reading blogs and valuing the information they contain, I figured I would jump on the bandwagon.  It is my hope that I can impart a fresh perspective to a few readers out there.

The tech world is something easy to get overwhelmed with.  With new applications and services being launched daily, the learning curve is steep and long.  People take great pride in knowing what the latest release is, and obsess over how many followers they have on Twitter.  I admit to falling victim to the fomer, but not the latter.

I have not built an internet company.  I am not considered a person of influence in the NY tech community.  I do not know how to write code and I certainly don’t speak that language.  At the moment I only have 43 followers on Twitter.  I’m sure no more than 5 people will read this blog in the next month or so.  But none of this matters!  What does matter is that I come home to an amazing girl who I can’t wait to marry.  I have a family that always loves and supports me.  My friends would do anything for me.  I have friends all over the world that I have met in different stages of my life.  I have visited distant countries people have only seen in movies.  And I have my health and positive spirit.

This is what Keeping Perspective is all about:  a thoughtful discussion of business and the internet, all with the undertone that there are more important things in life.  Hence all posts should be taken with some thread of levity.  Yes I am infatuated by business and I love the startup mentality.  Yes I obsess over new business models and strategies for making huge profits.  Yes I try to learn as much as I can about new technologies.  However, I try to keep it all in perspective of the bigger picture of life, because none of those things will pick me up when I’m in a funk.  They won’t laugh with me and give me the joy that comes from genuine relationships.

Come keep perspective with me.