Chris Dixon

Pretty much every day now a major blog or newspaper writes an article asking whether we are experiencing another tech bubble (e.g. see today’s NYTimes). I don’t know whether successful private companies like Groupon, Zynga, Facebook and Twitter are over or under priced since I don’t have access to their financials. Regarding public tech companies, it seems to me that incredibly innovative companies like Apple and Google trading at 19 and 22 P/Es respectively is pretty reasonable.

Rather than take a side on the bubble debate, I mainly just wanted to make a few points that I think should be kept in mind in this discussion.

1) A bubble is a decoupling of asset prices (valuations) from their underlying economic fundamentals (which is why the graph at the top of the NYTimes article today is meaningless). During the housing bubble of 2001-2007, smart economists noted that housing prices were significantly higher than their fundamental value (in housing, a common way to measure this is price-to-rent ratio, which is analogous to price-to-earnings in the stock market). During bubbles, investors stop valuing companies based on fundamentals and instead invest based on the expectation that prices will continue to rise and “greater fools” will buy the assets from them at a higher price. This process is unsustainable, which is why bubbles eventually pop.  But when the economic fundamentals are strong, the last buyer can always hold onto the asset and collect a return through the asset’s cash flows, thereby preventing a pop.

2) The forces that drive the internet economy are strong and will probably only get stronger. I argue this regarding online advertising here so won’t repeat it. Since I wrote that post we’ve also seen a number of tech companies emerge that are generating significant revenues through non-advertising means – “freemium” (e.g Dropbox), paid mobile apps, virtual goods (e.g. Zynga), transaction fees (AirBnB), etc.

3) I think it’s a good thing that the speculation on large private tech companies is happening in secondary markets where the risks are being taken by institutions or wealthy individuals. This is in stark contrast to the dot-com bubble of the 90s where many of the people holding the bag when bubble popped were non-rich people who bought stocks through public markets. Obviously this could change if we have a bunch of tech IPOs.

Erick Schonfeld from TechCrunch asked me a few months ago if I’d be on a TechCrunch video show where we interviewed startup founders. I love startups. While other people watch sports on Sunday, I prefer to sit around with friends and chat about what new startups have launched, how they are doing, what product and marketing strategies are working, etc.

Erick originally called the show “Startup Sherpa.” The word “sherpa” implied that I was giving people advice. The people we invited to the show were either my peers or people who knew far more than me, so I felt very uncomfortable with that title. I really like to hear “war stories” (a term used in venture capital) but calling it that would have been disrespectful to military people who fight actual wars versus the inconsequential battles we have amongst startups and investors. So we chose “Founder Stories” instead.

I don’t get paid by TechCrunch and they don’t have a fancy editing budget so what you see is effectively live. I probably make an ass out of myself a lot. I actually haven’t brought myself to watch most of the episodes because I can’t stand all my verbal tics like saying “etc” and “you know.” The saving grace of the show is the incredible people we get to come on to share their stories. I think they participate mostly because it’s TechCrunch – the premier tech blog – and also because they know I love startups. I want to try to learn from the founders’ early experiences rather than ask questions about “hot topics” or “gotchas.” I like to think of “Founder Stories” as a show that I would have wanted to watch when I was a first-time entrepreneur. That’s how I explain the show to potential guests and also how I think about it when Erick and I come up with questions.

The show is available as a free podcast on iTunes here. It’s also on TechCrunch here.

I’ve never talked to Mike Arrington about this but I’d like to thank him for making long form and respectful content available to entrepreneurs and investors. Erick has also been great, along with Josh Zelman who is the AOL/TechCrunch video producer.

I’d love to hear feedback and suggestions for how to improve the show.

My friend and business partner Tom Pinckney started two companies with me and one company before. He invented many non-trivial patented inventions and raised many millions of dollars in venture capital, and returned capital to those investors many times over.

He got his Bachelors and Master degrees from MIT. He’s the nicest, smartest, and most decent guy you’ll ever meet.

But my favorite thing about Tom is he never got he never got a high school degree.  High school students today optimize their grades and SATs and after school activities. They speak French and Chinese, play piano and paint abstract art.  They dance around and play hockey and act like they help homeless people.

Tom grew up in rural South Carolina and mostly stayed at home writing video games on his Apple II.  There was no place nearby to go to high school. He took a few community college classes but none of those places could give him a high school degree. It didn’t really matter – all he wanted to do was program computers.  So when it came time to apply to college, Tom just printed out a pile of code he wrote and sent it to colleges.

Stanford, Berkeley and everyone else summarily dismissed his application on technical grounds – he didn’t have a high school diploma.

MIT looked at his code and said, “we like it” – we accept you.

For his Masters the best four CS schools – Stanford, Berkeley, Carniegie Mellon, and MIT — all recruited Tom  He stayed at MIT, the school that gave him a chance without a high school degree.

MIT is a national treasure.  If you believe in meritocracy and the American dream, you believe in MIT.

It was reported today that Dropbox will generate $100M in revenue this year.  Whether or not those reports are right, it is certainly a great product, beloved by its customers and will almost certainly be wildly successful. I knew the founder, Drew Houston, back before he started Dropbox. He was an MIT CS guy, hanging around Boston in 2005 when I was working on SiteAdvisor and spending most of my time trying to recruit great devs. He was introduced to me by my investor and friend Hemant Taneja, another MIT CS guy, as a super smart kid I should recruit. I tried to recruit him but lost him to another company called Bit9.

(Funny side story about Bit9:  After we sold SiteAdvisor to McAfee in 2006, I encountered Bit9 again when I was visiting SF and crashed a party hosted by one of their investors.  This investor was a lifetime middle manager from Symantec who had never started a company and was now a partner at a big VC firm.  He spent 30 minutes giving a speech about how the Internet was dead and people investing in it were stupid and his firm was focused on Cleantech instead, and then started talking about how rich he was and how many wineries he owned (yes, seriously). He barely mentioned the poor startup that sponsored the event. It was totally embarassing and represented everything wrong with the old, dead VC world. When I was introduced to this jackass VC after his speech as someone who had just sold his company to McAfee, he said to me “Bit9 is going to eat McAfee’s lunch.” Trying to neg a startup guy by saying a startup is going to beat an incumbent just shows how incredibly clueless and middle-managery this guy was.).

Anyways, the next time I met Drew was after I left McAfee and rented a small temporary office space in the garmet district in NYC. We were on the 19th floor of this awful shared place called E-merge (this was before the resurgence of incubators) in a tiny room infested with fruit flies. I was sitting there with my pals from SiteAdvisor Matt Gattis and Tom Pinckney coding some random machine learning ideas which eventually led to the seeds of Hunch. Drew came by to get advice on his new startup and we met for an hour or two. We chatted about strategy, recruiting, fundraising etc – the usual early stage conversations. He then moved off the California – I think to do Y Combinator. Next time I heard from him he had just closed a round of financing from Sequoia. I was never offered to invest in the company but probably I could have if I asked Drew since he had come to me for advice. Sometimes when people come to you for advice like that they are really hoping you will ask to invest and I didn’t. I’d have to say in all honesty if I were offered I probably would have passed.  2005-6 saw about 100 consumer backup/storage/file sharing companies raise funding. I remember after Drew left my office I looked at some article on RWW or Mashable or someplace that listed page after page of consumer backup/storage/file sharing companies. It just seemed like an insane idea to start another one and it seemed like Drew’s only thesis was that his product would work better.

Well, it turned out storage is a hard problem and having an MIT storage guy who builds a great product actually matters. I don’t know how under any investment philosophy that emphasized theses, areas of investment, roadmaps, etc you could have decided to invest in B2C file sharing company #120 in 2007. Obviously Sequioa knew better than me and invested. I think the only way they could have made that decision was by ignoring the space, competitors, etc. and simply investing in a super talented person/team.  Dropbox is one reason I now have a strict rule to only invest in teams. There are other examples of companies I missed and other examples of the converse – companies where I invested in mediocre people chasing a great idea and the company failed – but Dropbox is emblematic to me as to why you should always invest in people over ideas.

Many of the today’s most successful informational sites such as Yelp, Wikipedia and TripAdvisor relied heavily on SEO for their initial growth. Their marketing strategy (whether deliberate or not) was roughly: 1) build a community of contributors that created high-quality content, 2) become the definitive place to link to for the topics they covered, 3) rank highly in organic search results.  This led to a virtuous cycle where SEO drew more users, leading to more contributors and more inbound links, leading to more SEO, and so on.  From roughly 2001-2008, SEO was the most effective marketing channel for high-quality informational sites.

I talk to lots of startups and almost none that I know of post-2008 have gained significant traction through SEO (the rare exceptions tend to be focused on content areas that were previously un-monetizable). Google keeps its ranking algorithms secret, but it is widely believed that inbound links are the preeminent ranking factor.  This ends up rewarding sites that are 1) older and have built up years of inbound links 2) willing to engage in aggressive link building, or what is known as black-hat SEO. (It is also very likely that Google rewards sites for the simple fact that they are older. For educated guesses on which factors matter most for SEO, see SEOMoz’s excellent search engine ranking factors survey).

Consider, for example, the extremely lucrative category of hotel searches. Search Google for “Four Seasons New York” and this ad-riddled TripAdvisor page ranks highly:

(TechCrunch had a very good article on the TripAdvisor’s decline in quality).

In contrast, this cleaner and more informative page from the relatively new website Oyster ranks much lower in Google results:

As a result, web users have a worse experience and startups are incentivized to clutter their pages with ads and use aggressive tactics to increase their SEO when they should just be focused on creating great user experiences.

The web economy (ecommerce + advertising) is a multi-hundred billion dollar market.  Much of this revenue comes from traffic that comes from SEO. This has led to a multibillion-dollar SEO industry. Some of the SEO industry is “white hat,” which generally means consultants giving benign advice for making websites search-engine friendly. But there is also a huge industry of black-hat SEO consultants who trade and sell links, along with companies like content farms that promote their own low-quality content through aggressive SEO tactics.

Google seems to be doing everything it can to improve its algorithms so that the best content rises to the top (the recent “panda” update seems to be a step forward). But there are many billions of dollars and tens of thousands of people working to game SEO. And for now, at least, high-quality content seems to be losing. Until that changes, startups – who generally have small teams, small budgets, and the scruples to avoid black-hat tactics – should no longer consider SEO a viable marketing strategy.

A while back I wrote blog post about Graphs, talking about social graphs, communication graphs, interest graphs, taste graphs, etc.  Google was kind enough to invite me to speak about the post a few weeks ago at their NYC HQ.  I brought along two of my Hunch colleagues Matt Gattis and Hugo Liu.  Here is the video:

And here is a full screen version of the presentation I used.