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http://www.unionsquareventures.com/portfolio.html
Practice what you preach bud.
All the examples of companies who are doing a lot with a little are not in your portfolio. Digg, Craigslist and Facebook are nowhere near your portfolio. Those in your portfolio that are close, still aren't making any money.
For crying out loud.
There are lots of small companies out there who are living on revenue with a small number of employees and yet you don't invest in them? Why? You call them "lifestyle" businesses. You call them opportunities that won't grow exponentially, yet every example in your list that you invested in that have grown exponenetially did it with a product they were selling for exactly free.
If facebook started charging, how many would flee? If disqus charged to have their little comment window on your blog, how many would have it? None, it's too easy to biuld a comment window Fred.
If twitter started charging, how many would tweet? How many would subscribe to other people's tweets?
Nobody Fred.
My mama taught me a little rule when i was growing up and that rule went like this, "Practice what you preach."
Otherwise, you lose credibility and you've done that with this post.
comments, you don't use your real name. So I'll just call you hypocrisy
finder.
I do practice what I preach.
I currently work on 12 companies for the two firms I help manage (Flatiron
and Union Square Ventures):
Alacra Flatiron
Ibiquity Flatiron
Return Path Flatiron and Union Square
Boxee Union Square
Disqus Union Square
Etsy Union Square
Infongen Union Square
Outside.in Union Square
Targetspot Union Square
Twitter Union Square
Zemanta Union Square
Zynga Union Square
None of those companies had material revenues when I invested in them (Etsy
and Alacra had a little bit)
Now eight of the twelve have revenues and in almost each case, the revenues
are between $10mm and $100mm per year with a few exceptions.
We are early stage investors, we don't expect the companies we fund to have
revenues and we work with them to develop business plans and business models
and then execute them.
The point of the post was not that every company should have revenues day
one, it was that as you build the business, focus on keeping costs low so
that you can build value without having to build huge revenues.
That's what we try to help all of our companies do. Some work better than
others, but its our goal.
But what is interesting, is that the web seems to have forgotten lessons learned in the bricks and mortar world. I read a few comments and a few stick in the mind
"not possible more than 5 years ago to outsource legal, HR, development". Um, in the UK we have been doing that for more than a decade! Without the web.
Various comments about how "thye dont get it" - an example being Facebook having naff photo capabillities. Well, there is an old adage the UK about plumbers always having leaking taps at home, and mechanics always having a broken car. There is also the old adage about a new,small company able to bring a product to market in days (or make a change to product), whilst a large company [ie IBM in legend] takes years. Guess new industry suffers the same. Does facebook or ebay or Google listen to users? Nope (I have an idea that could double googles revenue, but they dont want to know)...
Good article.
Also, no one wants to talk about the life span of some of these Social Media/Web 2.0 properties. A few years ago, AOL was the hot property. Later, it was MySpace. Now, it is Facebook. Next, it looks like Twitter. These businesses are disposable -- they will eventually go the way of CompuServe, Prodigy, etc. You're not building a "GE" or "Intel" -- you're building something temporal, a company that might be "useful" until the next major tech breakthrough.
But there are some things that are different about facebook and twitter. AOL and Myspace were not platforms that others built upon. FB is and Twitter is headed there too.
And FB has become like Outlook for my kids. They run their life on it.
So I am nervous but not convinced that the TV show analogy works in every situation
Great discussion to be having
FB and Twitter still smell too much like AOL to me. Though we still don't have IM interop, so maybe it won't be a problem.
UserID = beer
A tangental but related point. Startups are creating a staggering amount of distribution (media) at a fraction of what it used to cost. Advertising no longer needs to piggyback expensive content. Pairing low cost distribution with data will completely destabilize traditional media.
Look no further that Plenty of Fish's Markus Frind. (from Inc mag...Markus Frind works one hour a day and brings in $10 million a year. How does he do it? He keeps things simple. http://tinyurl.com/7jfeur). Millions of pages, tons of user data - no cost. Magazines publishers would kill for his numbers. What premiums will marketers pay for the brand / content association in the future? Interesting times.
When I arrived at Bolt the focus was building product and traffic for an exit. Like so many others in the industry, they were constantly shopping the company to raise capital or an exit -- rather than building a viable business. We came up short on both and lost sight of our core competency, selling brand advertising.
My advice:
a.) focus on your strengths
b.) stay lean
c.) be profitable!
So the costs are just people and technology which don't inherently scale with traffic and revenue. (Yes, some technology costs like bandwidth do scale but often at lower per-unit costs due to volume discounts and Moore's Law.)
Because of this, traffic and revenue can reach huge scale while costs continue to decline as a percentage of revenue. That's how Craigslist built an ultra-high 90%+ margin business. But why aren't more companies achieving this?
I think part of the answer has to be over-staffing. Why is Facebook over 800 employees? And MySpace over 1,500? For that matter, why is Google over 20,000? I've asked lots of smart people why these and other companies hire soooo much -- and the best answer I've gotten is "because they can." (Seriously, I'm not joking!)
Until I hear a better answer, I am going to follow the Craigslist model. Does anyone have a better answer?
arguably, beyond 25-30 people it's difficult to manage and scale the headcount efectively anyway... certainly for development at least.
there may be a reason to scale mktg/sales/ cust svc since they may be indepedently scaled and perhaps linear in ROI. but certainly mgmt and product development are beat kept lean until the core biz model is discovered & refined. even then -- or perhaps especially then? -- there
may be no need to ramp any of the other groups if you can use automation & community to drive Mktg/sales and handle customer service with crowdsourced resources.
unfortunately most people hire ahead of figuring out the biz model.
done!
I think Facebook's problem is they don't have a focus on adding value to user generated content. Photo-sharing for example, though they pride themselves as the biggest destination, their photo quality is lousy and their feature set is poor -- you can't even search for photos.
If they'd take a couple of their 500 strong developers and build good features to their photo, they can easily turn it into a freemium service and be bringing in $20M a year (assume 0.5% conversion rate and $25/year). These $20M over $400K projects are exactly what Fred was asking web startups to be doing but I guess when you get that big, it's not that easy to just say, "Let do it!"
The whole point of internet business is high margins and low costs.
I was really surprised to see that error in Chris Anderson's article and went to the WSJ to leave a comment there.. but.. no comments. That too was surprising. it's 2009. We still need to check our facts/work and you should have comments turned on for the occasional mistakes.
It's perhaps telling that "make a dime", to you, means "revenue" when the whole point of Chris Anderson's and Fred's articles is that you haven't "made a dime" until you show profit.
"Meanwhile YouTube is still struggling to match its popularity with revenues and Facebook is selling commodity ads for pennies after its effort to charge for intrusive advertising led to a user backlash. And news-sharing site Digg, for all its millions of users, still doesn't make a dime."
Then comparing YT and FB to Digg is apples to oranges. YT and FB don't have profits either. They have REVENUES. And that's my point. To me, it's misleading to say that Digg doesn't make a dime. They do make dimes, just not profits. I think Anderson's stmt is in error because it implies that YT and FB do "make money" and Digg doesn't.. whether you count that money as "profits" or just "revenues."
All three services do make some "revenues." None make profits.
Also.. thanks for pointing out the WJS comment style. I've never seen comments at the top of a post before.. just the bottom, so I didn't know to look near the title of the article. Nice that WSJ has stayed with the comment convention design-pattern developed over the past 10 yrs across the internet where the comment section is noted just after the article. Would also have been nice if they'd linked from the bottom as well as the top, since they've made their own convention away from the norm.
I also think that Fred's large point totally needs to be made - these companies should be focusing on profitability. But revenue is super important too. The methods of controlling costs in web 2.0 aren't opaque, and they aren't rocket science. Having a unique, steady, healthy revenue stream, though, is still a rarity. If you have that, someone, somewhere, should be able to get your costs in line to achieve profitability.
No comments means you are still doing one way media
But at least Chris can see my view here of why I think the distinction between FB/YT and Digg seems misleading or in error to me.
However, you need to balance this essay out with your prior blog posting regarding employment. In the end, as I commented on that post, it's all about capturing efficiencies that want to break out of inefficient existing markets (e.g. healthcare, education, media).
That means these hyper-leveraged (in terms of work leveraging, not debt leveraging) teams should be expected to decimate employment.
For example - and I'm glad you brought them up - how many jobs do you think Craigslist cost in the newspaper business? I *love* Craigslist - both as a service and a business - but they simply created a super efficient system for a hereto inefficient market - classified ads. What are classifieds, in essence? One big database, with some users (posters) who are writing into the database and others that are searching/reading (seekers). With the web, all one needs are forms and views, etc, whereas it used to be a highly manual process. What the result is people doing the previous manual jobs (e.g. basic Sales and Data Entry, keeping Classifieds in mind) have to go.
I noticed in the other blog on unemployment a lot of comments along the lines of "this could be a good opportunity for people to retrain themselves". I believe the good naturedness of these comments, but I really think for 95% of the people effected, that really not realistic of solution.
Obviously, this is going to be a big debate - how to let technologies (and markets) create efficiences in a manner that everyone can participate in the economics that are unleased.
In my opinion, heathcare is the Big Kahuna for the next 10 years in terms of innovation opportunities. Companies like Athena Health are already popping up (and going IPO) but they only solve a fraction of the entire problem. But I wonder what impact the eventual efficiencies in Healthcare might have on (net) employment. I could see the argument that there is a such a backlog of processing/need that it may not actually decrease employment, at least initially.
Too bad I've been noodling in the Digital Media Industry for 10 years. That innovation train has already left the station. Maybe time for retraining myself.
I don¹t have a good answer to the question you pose
But I also don¹t think being inefficient is the solution
This approach was not possible five years ago, but the web has made it possible today. One could argue, that it isn't much different from how the web itself, works, where people come together to communicate and solve problems. Now, if we could only survive the healthcare and retirement issues, it would not be hard to imagine an economy powered by thousands of small companies working interchangeably to help each other...(dare I say) like a web.
This is a great insight and it was what some of the people were trying to
say in the comments to my unemployment post. We are most certainly becoming
an economy full of freelancers. That¹s at least part of the answer, I hope
its a meaningful part of the answer
Free is how you build viral distribution on the web
That was the genesis of freemium back three years ago when I first talked
about it
http://www.avc.com/a_vc/2006/03/my_favorite_bus...
And there are so many great examples of it at work
Look at Zynga, one of our portfolio companies. I am not going to disclose
how much revenue they are generating but there has been plenty of
speculation in the blogs recently
http://www.alleyinsider.com/2009/1/time-to-stop...
ds-zynga-profits-on-50-million-revenues
Zynga¹s games are free to play and that drives their viral distribution
model
But once you get into the game, you¹ll most likely want to pay for enhanced
game play via virtual goods
That¹s one of the most elegant implementations of the freemium model out
there and it¹s an inspiration to me
I believe there are many others. You just have to get creative.
Great post.
It¹s about low revenues and even lower costs
It's not very hard to see this happening everywhere. I interviewed for a job last week; the position was a perfect example of taking an analog business model and turning it digital, and even though you cut margins by probably 25% if not more, it's an easy thing to do because costs fall by 50-75%, and the available volume is increased dramatically by the ability to distribute the content digitally. And what's doubly scary: My example comes from an industry which is very, very slow to innovate and has a lot of regulatory restrictions and barriers to entry. That is, this innovation is a *small* one compared to what they could be doing.
The team that runs the product is, basically, seven people. For them to pull of the same effect in an analog environment, it'd have to be at least 70.
Obviously driving operating leverage and getting to profitability is one big thing--the numbers have to work.
At the same time, though, the interesting thing that the power of the web over the last 5 years has been how much more leverage per person any business can create. As the infrastructure exists in forms that are *far cheaper* and *far more usable* there's no question that great companies can be built and sustained with unimaginably small teams. This -- high bandwidth factor -- attracts superstars and is another reason to consider 'staying small'. This is a positive feedback loop--both in terms of operating profits and in terms of keeping talent pools super high.
To build on the Craig's List example. 2 years ago, the WSJ interviewed Craig's List CEO, Jim Buckmaster. (http://tinyurl.com/craigslistquote101) There was this exchange, and it's one that has stuck with me and is on point for this discussion:
/start excerpt/
...When asked whether there's a Craigslist model that other companies could emulate, the unflappable Mr. Buckmaster, his eyes once more fixed firmly on the horizon out the window, waxes lyrical for a moment: "It's unrealistic to say, but--imagine our entire U.S. workforce deployed in units of 20. Each unit of 20 is running a business that tens of millions of people are getting enormous amounts of value out of each month. What kind of world would that be?"
Before I have time to object, Mr. Buckmaster comes back to our world. "Now, there's something wrong in the reasoning there," he admits. "You can't run a steel company in the same way that you run an Internet company"--more points for understatement. "But still, it's a nice kind of fantasy that there are more and more businesses where huge amounts of value can flow to the user for free. I like the idea, just as an end-user, of there being as many businesses like that as possible." As an end-user, I suppose I do, too. But there are no free lunches, even if Craigslist--and the meal Mr. Buckmaster and Ms. Best provided for me--sometimes seem to come close.
/end excerpt
again I think optimal company size is probably a function of Mgmt skill, and may likely be the same size as historical hunter-gatherer societies... our brains & culture have evolved over millions of years for these sizes (25-100? sorry not an anthropologist). only in the last 10,000 years / 500 generations have we lived in maximal-humanity city-state agrarian societies.
being able to manage groups / companies over size = ~100 is probably the exception rather than the rule.
since Internet startups optimize for online leverage vs human leverage, it's
likely more startups will win with less rather than more, unless their leaders are exceptional at org structure.
prob more important for them to be excellent at product development, marketing, design, or business model engineering.
@rickg: As a business model coach I must admit that I agree with you... how can't people understand or implement these obvious business basics...
How come you are not on the Midas list????!!!!
http://www.forbes.com/lists/2009/99/midas09_The...
If companies are valued by DCF, what is Forbes valuing VCs by? Coz it sure ain't IRRs...
Do you think you'll be able to somehow pick up the pieces of your shattered life and move on?
Here's what I don't understand: the lady who is normally in charge of these lists ran a nice feature on you in the NY Times. Is she no longer in charge? Or did you offend her somehow? Intriguing...
VCs?
I follow a couple of Seattle tech blogs, to stay in touch, and they made a big deal that there is a Seattle VC on the list this year (God, Seattle feels like such backwaters at times... ):
http://www.techflash.com/venture/McIlwains_Mida...
Then I remembered reading this article about you in the NYT and the author's bio boasted that she was compiling the famous annual Midas List of VCs. I don't remember her name, just that it was a young(ish) lady...
Anyway, if you want me I can dig more about it... My thinking is that it is some kind of a gimmick, but who knows it maybe a big deal for some. Maybe some firms take it seriously and send out nominations, and that's how you can get on it... What I can say for sure is that they don't rank them by IRRs, which is like ranking the top 100-dash sprinters, NOT counting on how fast they run.
with entrepreneurs that matters in this business. TheFunded has the right
idea but the execution is not ideal.
"Before joining the San Francisco bureau of The Times in 2008, she was a senior reporter at Forbes and co-produced the Midas List, the magazine's annual ranking of top tech dealmakers."
http://topics.nytimes.com/top/reference/timesto...
Krassen- Freds not on the list because he has never been one of the top 100 VC investors based on the returns of the companies he has backed.
Sandy Miller
Institutional Venture Partners
IVP is one of the premier later-stage investment firms in the United States. Sandy was recognized by Forbes Magazine as one of the leading venture investors in the U.S. by inclusion in the 2007 and 2008 Midas List. We believe he will bring that touch to Zynga!
service. Although there are times when constraints are very powerful.
Tumblr¹s one music upload per day has created a culture of song of the day
on tumblr which is wonderful. Same with fotolog. And the 140 char constraint
has worked well for twitter.
But I think the cost savings are mostly about headcount, not infrastructure.
Amazon s3 and other cloud based storage services are driving the costs of
storage way down.
I don't know what they're doing that is high cost / low profit because it seems to me that every product they develop just extends their targeting base for the ads, right? Gmail, Reader, etc. all just serve up ads. I wonder how many ads get served up by Gmail alone.
effective. I think the bigger oppty for google in the apps business is smb
where they¹d have a business model that looks more like constant contact.
I am saying search+keyword advertising is worth $100bn and the rest is
valued by the market at zero. It can be worth a lot more if they really
focus on it.
Usage based billing. Cap a single user's yearly internet bill and then divide amongst the sites/services used the most.
Got a bit carried away - hence the initial edit.
I'd make a crap spy.
The temptation to outsource it is really a bi-product of the bad math you are rightfully objecting to. Profit = Revenue - Costs.
If you use an ad network, ad sales costs go to zero on the books. An ad sales team shows a cost. So if you look at operating margins, a company which outsources its ad sales looks much better than the same company which does it themselves. To use made-up but descriptive numbers, imagine one company makes $100k in monthly ad revenue using ad networks, at $75k in costs but $0 in sales costs; but a second makes $130k in monthly ad revenue using a direct sales team, at $100k in costs, $25k of which is their sales team.
Company one has a net profit of $25k; company two at $30k. Given your formula, the right way is company two's way. I think that's right, especially when you factor in the control you gain by doing it yourself.
However, a lot of people see company one as having the better model, as they have a better margin. Does that make it the right move? I can see why, but at a larger scale (say millions instead of thousands), I don't buy it.
sustainable
But what if display advertising is worth $1 CPM and the only reason a sales
force is getting $5 to $10 is that they play golf and wine and dine
Is that sustainable and worth investing in?
Take Pajamas Media. They're closing their ad network down in a few weeks, and their publishers are going to be scrambling. There isn't a good match out there in re: premium networks for those publishers, and they aren't set up well to manage a daisy-chain of remnant networks. If they had managed their own ads, though, the machine would have been built.
I am just not sure that there is
There¹s premium audience for sure, and it varies for each marketer
But you can get that audience all over the net
The context of placement next to premium content is losing its value with
the advent of exchanges and data for targeting
That¹s the point I was trying to make
fred
I wonder, however, how better targeting (and erosion to "privacy" online) swings that door. As that improves, so does a semantic understanding of content consumption. Let's say that the technology gets so good that the NYT can produce a list of articles which were disproportionately read by attorneys living/working in the NYC metro area. They could probably use that data as a value-add for ad buyers -- if you give us an extra $1 CPM, we'll give you the data you need to tailor your marketing pitch. At some point, to mix metaphors, the pendulum swings back.
1. The right-wing ideology they peddle is becoming only attractive to a lunatic fringe slice of society that has no money to spend. Why would anyone want to advertise when the content features Joe the Plumber rambling about the benefits of censorship?
2. It is well known that they were getting covert political contribution money in the form of business revenue, to spew out propaganda (wildly known as "wingnut welfare"). Now these sources are drying up...
In any case, this has nothing to do with business models, anyway...
1. Forget Joe the Plumber, who in their right mind would advertise on a network featuring freaks like this, a crazed-out fundie nun who brags about the size of her mammaries:
http://www.sadlyno.com/archives/16744.html
2. They were getting cash-flow from right-wing "sugar daddies" to support the propaganda going, but now this is drying up, too...
I don't see what is so hard to understand here. The country has moved forward, the right-wing fringe is left behind.
Great post and a lot of good dialog. I come from the physical industrial world where costs, in general, scale much more directionally linearly with revenue. Because my equity sponsor pays me to generate EBITDA and my bonus and eventual exit monetization are based 100% on EBITDA we generate, I stay highly focused on revenue AND costs. I would assume that Union Square and other VC's in the internet space also comp their principal operators using some sort of EBITDA or OM formula, no? We humans are Pavlovian, and what get's measured and rewarded gets done.
It's staggering for me to think of a business like Facebook with (on a relative basis) probably low physical assets having $300MM of costs. I would love to understand how the costs breakout in such a business. Even with $100MM in people costs for 1000 employees, there's a lot of other "stuff" in there that I obviously don't understand.
Not sure if the old school framework of measuring period costs and unit variable costs separately could be helpful in these situations as well:
Unit Variable Costs: Cost per subscriber, or ad, or whatever generates the Revenue. I would imagine these costs are pseudo-linear with some attractive scale breakpoints. Have management focus on design or procurement strategies to keep these unit costs as low as possible, increasing the direct contribution per unit sale.
Period Costs: These are the fixed / semi-fixed costs. 90% of these costs better be either designing the next generation of services or selling today's generation of services, or they should be challenged. Outsource everything that isn't core competency. Zero base budget these cost pools, as they are there whether you are selling or not.
If one uses the simplified math that Profit = (Volume x (Unit price - Unit Variable Cost)) - Period Costs and drive the operators to optimize each part of the equation, the profits will flow.
Obviously this is Business 101 and I am in no position to lecture a successful VC on how a business works, I am just trying to understand what is different in the sponsorship relationship between a VC and its PortCo that allows costs to balloon to the levels discussed in your post.
Great post and great blog.
@JeffreyJDavis
President & COO, AGY
www.agy.com
to them
1) When people raise venture, they feel obliged to "spend" even though they don't know how the equation works for revenue - so they "ramp" the cost structure ahead of the revenue. Very seductive to hire and spend all those folks to build a real "team," (yes i have made those mistakes myself!)
2) In general too few people remember that its ALL ABOUT THE CASH FLOW and not enough CEOs have lived through 01 and 02 to remember that - so they get seduced into all the crap. In Digg's case I know they shopped themselves around at crazy valuations that had nothing to do with any multiples
3) You have CEOs of big and small who don't get the whole its all about the cash flow. What people forget about $GOOG is that the reason there so impressive is the 4-5 years of unprecedented cash flow growth in the history of business. THAT'S the story - they realized their potential. FB has similar potential but you need to actually CARE about cash flow - looks like $yhoo turning ship around right now.
time
IMO this is round 1 of how the systemic meltdown we're in sets the stage for a rebirth of capitalism. round 2 comes when dollar devaluation resumes. that will also force investors to look at hedging strategies. and revise valuation methodologies to account for greater currency risk.
key questions: how much operating leverage is there really (i.e. what kind of profit margins should internet companies expect); how much dollar devaluation are we going to see; how will ongoing and increasing govt intervention impact opportunities; what does a multi-year time frame look like, i.e. how fast will these trends develop (personally i think we are going to see great acceleration over the next years [even greater than in recent years past], a common conviction of those who are students of political conspiracy and cosmology)
build those new businesses and kill the projects that don¹t work. They also
need to attract and retain the best people. There are some concerns on both
counts but I am also bullish on google
Craigslist is such a unique example because they are content with doing one thing well and stopping there. Pretty unusual.
Digg, Facebook, etc. are going the normal route (well, normal for the last decade / internet economy). They believe they are just starting out and maximizing growth rather than profits at this stage is the right thing to do. For a very successful example, think of Amazon. Amazon was undeniably popular, had ever increasing revenue but was also always losing money. The advice, quarter after quarter, was to lower costs and to start maximizing profit TODAY. Amazon wouldn't be anything like it is today if Bezos didn't go all out building his vision of what Amazon could be and by deferring future growth for todays profit.
But my brother will only listen on vinyl
Different strokes for different folks it seems
This is at once both informative and surprising. Informative because it's the reality of the current business climate, but surprising because the principles of cost, cash flow and profit are the building blocks or DNA of business, and second nature to anyone building a company. Have "entrepreneur" and businessperson become that grossly disconnected over time? In the dorms at school in the 80's, an entrepreneur was someone making money (aka profit) through wits, creativity, hustle and an understanding of basic accounting. It makes wonder if our fascination with technology, fans, followers, and usage has overshadowed the basics of "can you make any money doing it?"
Why would a leading VC of web-based companies have to write a post explaining that profit equals Revenues minus Expenses. Are the people really running these companies really that dense?
Another point I would add to the conversation is this: Why does Internet-land ignore the concept of winners and losers? Clearly, the way that a lot of these companies are capitalized, there are market projections and financial models where every company is going to achieve Google/FaceBook like traffic and population numbers. Although the reality is that less than 10% will. Is the VC community incapacitated when it comes to assessing which companies will achieve escape velocity and which won't? If so, hire me: I don't think it's that hard to figure out. Sometimes I think being a VC is just a function of luck, not skill. You just have to be lucky enough to have been in the right place at the right time.
VC is all about luck
Just look at me
http://www.avc.com/a_vc/2008/05/i-got-lucky.html
I wonder how your value equation works for mobile platforms. Taking a simple example with iFart where 10k revenues / day where reported it would sum up into something like 50 mm. Thats pretty impressive for a small thing and the mobile platforms have really just started.
Do you think the emergence of mobile platforms with better monetization models, even wider reach and equally low cost will see more companies build on the principles you have outlined in the post?
More specifically, I tend to agree with your intuition that Facebook doesn't need 1,000 employees. However, it might be beneficial for them to grow as quickly as possible just so long as they're sporting a sustainable growth rate. Who cares if they're only netting $50 million? The real carrot for Zuckerberg is an exit via Microsoft. Keep in mind that a strategic buyer with hoards of cash won't be so impressed by financial discipline if it means conceding any shred of market share. Microsoft wants to partner its own services with THE dominant player in social networking. Period.
At a startup, you focus on what you're good at. The few small things that make the company great. If you don't you fail. Quickly. It's like running from a lion. There's no time for dessert.
Once a hefty amount of money comes in (revenues or VC) there is a huge temptation to explore other avenues.
Adding features to "keep up with the competition" or to "add new potential rev streams" becomes more commonplace. It's easy and often exciting work growing and expanding. Leadership gets to whiteboard new fun ideas (all ideas are fun in the beginning), design gets to design new things, engineering gets to build new stuff! It all seems logical from the inside. The problem is that the company is getting chubby. It takes amazing leadership at the very top to keep the company and it's aggressive managers in line.
In summary:
-getting fat is fun when there is the means. it's fun and easy and seems logical.
-staying lean when there is money to burn is difficult.
-getting lean once fat is near impossible and requires something dramatic (like a tanking economy) to get kick-started.
Taking your post and Buckmaster's conjecture to another possible conclusion, does it follow that corporate expansion into new product lines and businesses generally doesn't make sense for emergent companies in the new economy? Would each of these new companies (and old ones, for that matter) be better served just to do one thing well, and not try to "get bigger" in what could be described as an "inorganic" way (e.g., through M&A or launching a new product or division?).
Said another way, are we reaching a point in which the frictionless firm anticipated by Coase is the most desirable end-state, and to try to push a company past its "natural limits" is value destroying?
70 years later
The only thing I wanted to call out is that a nice chunk of Facebook's revenue, is generated by emotion rather than reason. The money's still green, but I think on shaky ground. There's a ton of press heat around social media, CEO's pushing CMO's to get in there, clients looking for agencies that have cracked social media, agencies throwing a lot of coin Facebook's way to demonstrate they get it, but the actual value of advertising in that space is hardly clear and certain. The mainstream press and CEO's are moving onto other flavors of the moment, recession strategy, cost cutting, etc... The bureaucratic grease for bigger investment in Facebook is getting low, they FB has to make a more tangible value case.
I see Facebook taking a big revenue whack in 2009 unless the team over their can transform how they deliver and communicate solutions for advertisers.
With the web implosion in 2001, we were able to buy back the Webshots assets from Excite@Home and were faced with the immediate need to generate revenue. We chose the route that later became "freemium" -- in fact, Webshots is probably the first example of a successful foray at that model built around a web application and UGC. By 2004 we had 35 employees and were tracking on $15M in revenue with 50% margin and true to Fred's equation we sold to CNET at a 10x multiple.
Now, what I want to talk about are the tradeoffs! Freemium was great component. We managed a healthy ad business on the free portion and also did some merchandising, BUT it is important to know that any form of paid service will limit your growth. Anywhere you remotely mention that payment may or optionally could be involved, you'll see limits. Anyone who hasn't read Daniel Ariely's Predictably Irrational should! Now, limiting growth didn't particularly bother us because at the time we had no peers/competitors in the "photo sharing" category. Plus, we enjoyed proving that a web business could also be profitable.
It is also to point out that any web enterprise has its own "money potential" -- and these are not created equal and they can only really be modulated so much with skillful marketing or optimization. There simply be nothing that a digg user would want to pay for (at any substantial level). It is the same way that Flickr will never be more than a blip on Yahoo's balance sheet. Here's the thing that most people don't like to talk about. Making money on the Web is actually really really difficult! The day twitter figures out how to generate $1M in revenue will be a major event. That's not to say they won't, it is just important to celebrate along the way. Similarly, digg could certainly bring costs in line to have a solid small business, but there is no reason to believe that would necessarily grow year over year.
Now, on to the cost side. "Better, faster, cheaper" is an essential way to look at any business. But, be careful not to let the service suffer! Webshots carried the bulk of college and high school photo sharing prior to Facebook. The service could have been even bigger but we were unwilling to invest heavily in infrastructure and that ultimately constrained growth (until CNET added some muscle). Similarly, if you are overly focused on the bottom line you may not react to competitors or huge emerging trends (even as a small company). I can remember being unimpressed with the emergence of blogging and similarly uninterested about PhotoBucket and the growth of widgets and distributed elements of web services.
When hiring, keeping costs low can also be a problem. It is hard enough to find great people and it gets even harder when you are trying to keep salaries in line.
Remember the tradeoffs and take heart that every single day a new opportunity is born online.
FWIW, Facebook could probably be run with 150 people filling 150 highly coveted jobs and be wildly profitable.
I love that you were doing freemium well before the word came into vogue
the cost of traffic acquisition (sometimes called marketing)
i have no idea why Digg has so many staffers but beyond product development and management and ad sales they desperately need and use marketingh/traffic acquisition resources
even mighty google itself pays out huge sums for traffic acquisition -- but they are able to monetize that traffic at a much larger income than expense
digg, apparantly not so
facebook apparantly not so
and isn't the big secret to zynga's success that they brilliantly arrived first on facebook app opportunity? honestly, if the same people launched the same zynga games and apps and stratgies today (rather than figuring out how to get first in line before facebook opened to third party apps) would zynga be as successful? i seriously doubt it - because their traffic acquisition costs are so wonderfully low, a situation almost impossible to replicate
for me this is the single biggest strategic need for new media startups -- low cost traffic acquisition. everything else is a commodity (including brilliant app or content ideas)
discuss one of our portfolio company¹s businesses
So we¹ll have to take this up when we are getting together soon
Looking forward to that
Millions of people run businesses without the benefit of venture capital financing. To people like them, like me, these insights are a little puzzling because the idea that "a business has to make a profit" is something most business owners, investing their own money, don't need to be told. They learn this and live this and are reminded of this almost every single day. Operational efficiency is the only way that the majority of businesses can even survive. For example, people aren't hired in most companies until there is strong evidence that that person's salary will be covered by real cash flow, usually within as little as a few months! Can you imagine if Digg's investors insisted that they produce, say, $20k/month of additional revenue within 3 months for every new hire? And then had to let people go when revenue dropped below run rate for more than a few months? Well, that's how most companies work.
I know this is a VC blog, and VC-funded businesses almost always operate with a kind of "grace period" before operational efficiency becomes a make-or-break factor for the business. Maybe the problem is that we're always comparing VC-funded companies to each other, rather than to self-sufficient companies for whom operational efficiency is the norm. VC funded firms need to constantly demonstrate that they are evolving into a company that resembles existing successful operationally-efficient businesses. The timeframe of that evolution, then, is equivalent to the firm's and the VC's appetite for risk.
(This may seem obvious to you, so please forgive me if my "this is not news to me" argument is not news to you. :-) )
And just what is that?
For example, what's Apple's "true value"? Computers? OS? Apps? Phones? Stores? Or is it "Technology for the rest of us"? If so, should Apple get into the automobile business? How about cameras? Kitchen appliances? Indie music marketing? Health care appliances? Innovation consulting? Where does it stop?
Apple had no "true" calling in digital music or cellphones. Flickr didn't start as a photo sharing site. Google didn't start as a (keyword) search/advertising company. If you're not constantly mining your own internal stats and hawking over your KPIs in search of significant trends, it's just as easy for your "focus" to turn into blinders.
All this advice without context is so much lazy "best practice" nonsense.
The alternative is to spend a lot of energy and time on project which aren't really going anywhere.
If you go, go big is what Flickr and Apple did. Once they dipped their toes and found the water to their taste, they dove straight into the deep end. In Apple's case, even if another company had Apple's exact business plan for digital music two years ahead of time, I don't think they could have executed (possible exception Sony).
however, Craig did announce that 'death is his exit strategy.'
this is from their fact sheet:
Q: Why doesn't craigslist focus more on generating revenue?
A: We rely on local communities to suggest ways to make money without compromising craigslist.
in my view, this is why craigslist is so lean...
for example, Oodle and OLX (revenue focused via ads) as well as players outside of the US as craigslist is still US focused and in English. Yes craigslist has expanded to other countries - however number of languages is still limited.
not surprisingly, the other players have more then 25 employees ;)
Most people value having more power and importance over having more money.
1.) Is there too much free on the revenue side? I have seen and participated in a lot of interesting discussion on this lately.
2.) Costs. On the cost side - what I want to know is: where's the CFO? I'm currently in my 5th VC-backed CFO gig. And I have to say, I have a big voice when it comes to the spending. It's not just about saying 'no'. Anyone can do that. It's about showing what we can achieve in a very lean way.
Another startup in town (Montreal) recently downsized 2x in recent months - going from 75 to 30 people. It's pre-revenue. They have a CFO. Why did this spend level make sense?
Finally, I note that both companies cited in the WSJ piece (Digg, Facebook) have raised large amounts of capital from BIG funds (Accel, Highland, Greylock) - I wonder if they aren't exacerbating this issue and encouraging them to spend more. It only takes 1 or 2 home runs to make a fund. Digg is not in homerun territory yet, but Facebook is. If I was a VC on those, I'd want more of them and I'd be exposed to temptation to push the spend level and keep them needing more capital. Not saying this is their game plan, just pointing out the potential for it.
Thanks again for posting this. I think it is good to have more of these conversations taking place, especially in light of the meltdown occurring around us.
At any rate, I made a comment a while back about the two things I would do if I wasn’t working in finance:
1.) Run a dairy farm in VT and make artisanal cheese on a grass only diet.
2.) Design an MMOG so totally unlike anything out there in the market that it would redefine the game space.
Well, I’ve been putting a lot of thought and work into #2, reading developer diaries, reading forums, books, etc.
I think one of the problems facing the tech industry is similar to my own problems. A lot of people start with a dream or an idea or concept that they can do “it” better, and they are quickly told it’s impossible and here are the reasons: 1.2.3. In this case, so the soothsays say, developing an MMO on an indie budget is impossible because you must compete with WoW (or some other major game). You must have enough content to satisfy tens of thousands of players in three years – and it take 5 years to develop if you are serious. You must have a class based level ranking reward system. And on and on with “you must do X”. All of these “musts” add up to a budget of 25mm and dozens of staff over a continuous period with no revenue. Why?
Now, there have been at least two major 3-D MMOs which started as small indie companies and went on to do great things. One is CCP from Iceland, the maker of Eve Online (and recently purchased Whitewolf) and the other is Egenesis. The later decided to stay small, catering to an audience of about 1.5K, the former probably has over 300K, where they started with less than a tenth of that number several years ago. Both games are so radically different from “normal games” that they are almost never brought up in terms of comparison, and yet they are both successful companies, and CCP amazingly so.
Again, why is that?
I think part of it is that techies are great with coming up with new tech, but they aren’t always the best at running a business (and they really like shinny toys). For example, I was reading about licensing fees for middlewear (which is very expensive on any budget), and yet, there is some excellent opensource stuff out there that will do the job just as well – but you do need to sink some more time into to make it fit your needs, there is no “24 hour customer support”, etc. Take a look at Boxee – I’m fairly certain it’s using SDL (opensource). Boxee has the advantage of using this library at little cost. Maybe they sunk some manhours into the library to make it work for them. But even if they did, there is an active community ready and willing to help them, should they run into stumbling blocks. Could they have purchased some custom-ware that would have fit their needs exact? Sure, but eventually the CS contract would run out and then what? Who’s going to improve the source? Renew the contract? Should they buy a source license? Pay royalties? What if their custom shop goes vapor? Too many start ups don’t take advantage of the open source community – and that is bad business sense.
The other part is people stick with what they are used to and what is proven. To invent is risky and people (and investors) are generally risk averse – especially right now. Once someone finds a winning model, it will be repeated and repeated until there is no margin left. Sometimes going with what is proven is the right course of action, but other times a better course of action is to innovate. The later is risky, the former is known. We can model the known and build this into our spreadsheets and we like that. We can run our montocarlo’s and pitch it to investors with a certain degree of confidence under a certain set of assumptions with so many degrees of freedom and within a certain number of standard deviations. All of this makes sense. But the later… ah now that is a harsh mistress indeed. How would you even begin to model that? Thus getting capital can be a tricky endeavor at best – even for an all volunteer (or deferred comp) shop working in off hour for a few years. So the system is part of the problem.
Every now and again certain nuggets of wisdom come through the cave walls and we try to glean those with our panning troughs as best we can: Google, Facebook, Amazon. Even so, we aren’t willing to let go of everything, but only incrementally and slowly over time. In fact, there is an entire branch of Philosophy covering this phenomenon. Read “The History of Scientific Revolutions.”
I firmly believe it is possible to create an excellent gaming firm on a fraction of the budget and most of this comes from cost management (of course, that’s what my model thinks, and as we all know, our models are always right, right?) and I am more or less convinced that this is the same for many of the businesses out there. Thanks for writing this article; I found it insightful.
Also, I think your X10 valuation is a little aggressive in today’s market. Ebitda/.14 is more realistic, but certainly something greater than (.10).
Thanks for sharing all of that
I don't think Hulu actually paid cash for that ad. I think they got a marketing allocation from both NBC and Fox as part of the formation of Hulu and that's what they spent. So it's "monopoly money"
Lastly, I would like to add one thing. There is a difference between net profit, and net cash flow. To me, the profit number is less important than the net cash. You can have a killer income statement, but if your cash flow statement is not comparable, you can grow yourself right into bankruptcy.
I've often found that the URL's and API's they send in response are far more valuable than the time spent on the phone, and if you provide online tools to younger/smaller startups, you'll notice that the LAST thing they want to do is to set up a conference call -- they're basically saying "just send me the docs."
So the irony is that these high employee costs are not only holding back operating leverage, they are GETTING IN THE WAY of real progress that moves faster. I look forward to the day when performance reviews are someday quantified based on the "Alpha" that humans can provide on top of the web services on which they rely, I guess.
Here's a link
http://www.caterina.net/archive/000996.html
Backed by First Mark Capital
I wonder if there is a dearth of great CEOs who can actually make those calls on ROI in absence of hard data
We have at least one in ouir portfolio who is doing a killer job on that but its super hard and takes a lot of experience and instinct
Not a pairing that many have
"While anyone has ideas on what business models could work for a number of websites, the enterprise market is almost never part of the answer. Yet, using it in combination with the consumer market rather than as two separate silos can yield startups dramatic improvements on both sides of the profit equation. "Consuprise" plays should be surprisingly powerful.
If you are a start-up with a pure consumer play web application enabling one activity in a simple and elegant way, then you might want to exploit the enterprise market. Strategically, it can be used with different angles, but we'll focus on the simplest in this post: take one offering focused on the consumer side and developing a new revenue stream on the enterprise side.
Consumer applications have unique competitive advantages for the enterprise market
Google Apps for large enterprises is an example of a consumer product being scaled in the enterprise market. The largest deployments need a specific sales force and system integrators involvement. But the mid companies market does not add any costs to Google, with self-service online subscriptions.
Most web applications will be served as a service, thus lowering the costs for enterprises. But they have other and unique competitive advantages. Their usability level and User Interface design are generally of much better quality, because they competed for individual consumers before enterprise buyers. While the former are their own decision-makers, based heavily on design and usability, enterprise decision-makers are not the end users and focus on enterprise infrastructure aspects. This is critical in terms of user adoption and time to proficiency for new tools rolled out by the corporate IT function.
Change Management processes are an order of magnitude easier with a web application which has earned its reputation in the consumer market. This competitive advantage is growing more acute as a larger base of employees are exposed and using to standard "web 2.0" applications. Although not entirely fitting our starting definition, Gmail is a perfect example: give a young employee Gmail, and it will be business as usual. Give her Outlook, and you will wait for a long time before she is fully confident with it.
Economies of scale in the enterprise market
Network and viral economies of scale are mostly thought of as attributes of the consumer market. But the enterprise market is not made of individual clients without any relationships with each other. The interweb of personal relationships and professional associations make it possible to achieve such economies of scale on the enterprise market as well. Not using the exact same dynamics, but achieving the same effects. The scale is smaller, but each head is a paying customer.
True, organizational contingencies and political agendas add overhead to any sales, making it scary for consumer companies. But if you develop a large base of opportunities at a low enough cost, you can let those opportunities mature and evolve at their own pace. You do not have to increase your burn rate other than marginally to achieve this.
You don't have to customize
The main objection to this line of thinking is: "When entering the enterprise market, each company will request some customization, and that will increase our costs proportionately with any additional revenue." Indeed, it makes no sense strategically to customize your offering, as this will lower your profit margin drastically. But you don't have to customize to win in the enterprise market.
True, companies will often request customization. Just state your position and refuse to do it. You will be surprised how quickly they will accept to use your standard offering. Of course, this is not valid for all consumer web applications. But if your product:
caters to a standard need which is the same in all large organizations
enables an isolated workflow
needs little to no data integration
...then customization is not a requirement.
If you are concerned about the customization requirements or simply want to improve your competitive positioning, offering a public API or becoming a platform hosting plug-ins, applications or widgets will work positively just as well as in the consumer market.
I'm convinced, any practical advice ?
Of course, there's still work to do, but the ROI should be worth it.
Authentication and account provisioning: you need to provide integration with the systems used by your clients, such as LDAP or Active Directory. You need to (re)-architecture your application to support easily these systems. Even if such systems are quite standard, for each new client, you will have to do some quick manual work. My advice: set expected revenue limits to avoid a barrage from small clients, charge it at cost (enterprise are used to this) or waive it for larger clients. This is the single most important point as the main danger is unauthorized access from a former employee to the application. If your "enterprise" is expected to become large, hire a specialist that will whip through the manual phases without problems.
SSO: nice to have, but not 100% required. Employees are used to their credentials by heart and if the cost to input them outweigh the benefits of the application, the problem is much bigger.
Web security: must have of course. Enterprises will want to make sure your application, accessible from the internet and hosting their data, cannot be hacked easily. Those audits are fairly standard as well, and after 2-3 large clients, you will probably have to provide the results from past audits, not perform new ones.
Data segregation and security: of course, you will have to come clean on those points. Segregation is your responsibility, as well as choosing a hosting provider you can trust.
Note that these points do scale: once in place, there will be little costs to add more corporate clients. They also benefit the consumer side of your business.
Accelerate and reduce the cost of Product Development
If you focus on a standard enterprise need, take advantage of an early partnership with 2 or 3 representative clients. Most will welcome the opportunity to provide you with their needs and requests, even if the product is still being developed. That will cut your development time as well as improve your product. And chances are your consumer side will benefit from the same improvements.
Enterprise plays provide a unique opportunity to refine your product safely, even before you take it to the consumer market in fact: large organizations avoid litigation risks by all means. So you can be sure your IP is in safe hands, they won't take any risks. Such partnerships are beneficial for both partners.
So if your a large organization: are you organized to take advantage of this new wave of offering? And if you are a consumer web startup: how can you leverage the enterprise market to improve your profit margin and your competitive position on your core consumer play?"
Full post here
Or the other, we need to be spending more then we earn, to look like we are growing.
SaaS companies could make for pretty straightforward business models by simply charging for their products rather than looking for alternate models. Early SaaS companies have built very financially viable businesses by following this simple model. All this will work, unless biggies like Google ruin it all by using their incredible economic clout to offer free business products and run loss making business units, and compensate for it from profits from other business units (advertising)
Thanks.