Incumbents

Almost every startup has big companies (“incumbents”) that are at some point potential acquirers or competitors.  For internet startups that primarily means Google and Microsoft, and to a far lesser extent Yahoo and AOL.  (And likely more and more Apple, Facebook and even Twitter?).

The first thing to try to figure out is whether what you are building will eventually be on the incumbent’s product roadmap. The best way to do predict this is to figure out whether what you are doing is strategic for the company. (I try to outline what I think is strategic for Google here). Note that asking people who work at the incumbents isn’t very useful – even they don’t know what will be important to them in, say, two years.

If what you are doing is strategic for the incumbents, be prepared for them to enter the market at some point. This could be good for you if you build a great product, recruit a great team, and are happy with a “product sale” or “trade sale” – usually sub $50M. If you are going for this size outcome, you should plan your financing strategy appropriately. Trade sales are generally great for bootstrapped or seed-funded companies but bad if you have raised lots of VC money.

If your product is strategic for the incumbent and you’re shooting for a bigger outcome, you probably need to either 1) be far enough ahead of the curve that by the time the big guys get there you’re already entrenched, or 2) be doing something the big guys aren’t good at. Google has been good at a surprising number of things. One important area they haven’t been good at (yet) is software with a social component (Google Video vs YouTube, Orkut vs Facebook, Knol vs Wikipedia, etc).

The final question to ask is whether your product is disruptive or sustaining (in the Christensen sense).  If it’s disruptive, you most likely will go unnoticed by the incumbents for a long time (because it will look like a toy to them). If the your technology is sustaining and you get noticed early you probably want to try to sell (and if you can’t, pivot). My last company, SiteAdvisor, was very much a sustaining technology, and the big guys literally told us if we didn’t sell they’d build it. In that case, the gig is up and you gotta sell.

Will people pay for the New York Times online?

In Clay Shirky’s brilliant essay “Newspapers and thinking the unthinkable” one line stood out to me as odd:

“The Wall Street Journal has a paywall, so we can too!” (Financial information is one of the few kinds of information whose recipients don’t want to share.)

It is true that The Wall Street Journal is one of two newspapers (along with the Financial Times) that seems to have been pretty successful getting people to pay. It’s not clear why Shirky thinks people don’t want to share financial information. Hopefully he doesn’t think business people want to keep the Journal to themselves to keep some competitive advantage. Pretty much everyone in finance and business that I know reads the Journal every day – no one would seriously consider anything in there a competitive advantage. People send Journal links to each other all the time. It is background knowledge that everyone is expected to know.

The reason people are willing to pay for the Journal has nothing to do with their unwillingness to share or pirate financial information. It’s quite simply the fact that the Journal is a valuable business input that can’t be found anywhere else. Most people, when presented with something of value that is scarce and reasonably priced, don’t pirate (especially when they can charge it to their business). The revenue-maximizing price of any good – including digital goods – is determined by value and scarcity, not what it costs to produce it.

The fact that the cost of distributing newspapers is dropping to near zero only affects the price of newspapers if the content is commoditized. The problem the New York Times has isn’t that people are willing to share or pirate their content.  It’s that with the advent of the internet, competition for general news went from one or two per market to thousands per market. (The other big blow was classifieds getting decoupled from newspapers).

Most business people I know consider the Times an essential daily read, not just for its business and finance news, but also its section A news and op-eds. If you are a running an operating company or investment firm you want to know not just narrow business news but the broader context of what’s happening in the world.

Most smaller newspapers will go out of business over the next few years, vastly increasing the scarcity of news. If the Times creates content that is scare and valuable – and remains an essential “business input” – it can have the same success online as the Journal.

Are people more willing to pay for digital goods on mobile devices?

Mary Meeker’s presentation this year on internet trends was all about mobile. Inasmuch as data-heavy research report from a major investment bank can be said to have a “climax,” it was probably these slides:Screen shot 2009-12-27 at 11.51.18 AM

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The assertion seems to be that there is something special about the mobile internet that compels people to pay for things they wouldn’t pay for on the desktop internet.  It is this same thinking that has newspapers and magazines hoping the Kindle or a tablet device might be their savior.

It is certainly true that today people are paying for things on iPhones and Kindles that they aren’t paying for on the desktop internet. Personally, I’ve bought a bunch of iPhone games that I would have expected to get for free online. I also paid for the New York Times and some magazines on my Kindle that I never paid for on my desktop.

But longer term, the question is whether this is because of something fundamentally – and sustainably – different about mobile versus desktop or whether it is just good old fashioned supply and demand.

I think we are in the AOL “walled garden” days of the mobile internet. Demand is far outpacing supply, so consumers are paying for digital goods. I don’t pay for news or simple games on the desktop internet because there are so many substitutes that my willingness to pay is driven down to zero.

What are the arguments that the mobile internet is sustainably different than the desktop internet? One of the main ones I’ve heard is habit: digital goods providers made a mistake in the 90′s by giving stuff away for free. Now people are habituated to free stuff on the desktop internet. Mobile is a chance to start over.

I think this habit argument is greatly overplayed. The same argument has been made for years by the music industry: “kids today think music should be free” and so on. Back in the 90s, I bought CDs, not because I was habituated to paying for music, but because there was no other reasonably convenient way to get it. If tomorrow you waved a magic wand and CD’s were once again the only way kids could buy the Jonas Brothers and Taylor Swift, they’d pay for them. It’s the fact that there are convenient and free substitutes that’s killing the music industry, not consumers’ habits.

As the supply of mobile digital goods grows — the same way it did on the desktop internet — consumers’ willingness-to-pay will drop and either advertising will emerge as the key driver of mobile economic growth or the mobile economy will disappoint. I was going to buy a Chess app for my iPhone this morning but when I searched and found dozens of free ones I downloaded one of those.  At some point there will be lots of Tweetie, Red Laser, and Flight Control substitutes and they too will be free.

Why did Skype succeed and Joost fail?

Skype and Joost are interesting companies to compare – they are about as close as you can get to one of those sociological studies that track identical twins who are raised separately.  Skype was a spectacular success.   Joost never got traction and was shut down.  Both were started by Nicklas Zennstrom and Janus Friis, two of the great technology visionaries of our time.  Both were big ideas, trying to disrupt giant, slow-moving incumbents.

There are likely multiple reasons for their different outcomes.  Joost had day-to-day management that didn’t have much startup experience.  The P2P technology that required a download made sense for chat but not for video.  The companies were started at different times:  Skype when there was far less investment in – and therefore competition among – consumer internet products.

But the really important difference was that Joost’s product had a critical input that depended on a stubborn, backward-thinking industry – video content owners.  Whereas Skype could brazenly threaten the industry it sought to disrupt, Joost had to get their blessing.  Eventually the content companies licensed some content to Joost, but not nearly enough to make it competitive with cable TV or other new platforms like Hulu and iTunes.

Real life, non-techie users care almost exclusively about “content.”  They want to watch American Idol and listen to Jay-Z. They don’t really care how that content is delivered or what platform it’s on. Which is why Joost failed, and why so many video and music-related startups have struggled. Skype, on the other hand, didn’t have significant dependencies on other companies – its content, like its technology, was truly peer to peer.

The importance of institutional redundancy

Every system built by a single institution has points of failure that can bring the entire system down.  Even in organizations that have tried hard for internal redundancy – for example, Google and Amazon have extremely distributed infrastructures – there will always be system-wide shared components, architectures, or assumptions that are flawed.  The only way to guarantee there aren’t is to set up completely separate, competing organizations – in other words, new institutions.

This insight has practical implications when building internet services.  One thing I learned from my Hunch co-founder Tom Pinckney is, if you really care about having a reliable website, always host your servers at two data centers, owned by different companies, on networks owned by different companies, on separate power grids, and so forth.  Our last company, SiteAdvisor, handled billions of requests per hour but never went down when the institutions we depended on went down – which was surprisingly often.  (We did have downtime, but it was due to our own flawed components, assumptions etc.).

The importance of institutional redundancy is profoundly more important when applied to the internet at large. The US government originally designed the internet to be fully decentralized so as to withstand large-scale nuclear attack.  The core services built on top of the internet – the web (HTTP), email (SMTP), subscription messaging (RSS) – were made similarly open and therefore distributible across institutions.  This explains their remarkable system-wide reliability.  It also explains why we should be worried about reliability when core internet services are owned by a single company.

The principle of not depending on single institutions applies beyond technology.  Every institution is opaque to outsiders, with single points of failure, human and otherwise.  For example, one of the primary lessons of the recent financial crisis is that the most important form of diversification is across institutions, not, as the experts have told us for decades, across asset classes.  The Madoff fraud was one extreme, but there were plenty of cases of lesser fraud and countless cases of poor financial management, most of which would have been almost impossible to anticipate by outsiders.