There is a widespread myth that search engines have taken profits away from news websites. A few months ago, Rupert Murdoch said: “Google has devised a brilliant business model that avoids paying for news gathering yet profits off the search ads sold around that content.”
The reality is that news is a lousy business. Period. Even Google doesn’t make money on it. For example, here are Google’s search results for the phrase “afghanistan war”:
Notice there aren’t any ads on the page. This is because ads for “afghanistan war” generate such low revenues per query that Google doesn’t think it’s worth hurting the user experience with a cluttered page. Google can afford to do this on news queries (along with many other categories of queries) because their real business is selling ads on queries where the user likely has purchasing intent. Big money-making categories include travel, consumer electronics and malpractice lawyers. News queries are loss leaders.
It’s an historical accident that hard news categories like international and investigative reporting were part of profitable businesses. The internet upended this model by 1) providing a new delivery method for classified ads (mainly Craigslist), 2) increasing the supply of newspapers from 1-2 per location to thousands per location, thereby driving the willingness-to-pay for news dramatically down, and 3) unbundling news categories, making cross subsidization increasingly hard.
The internet exposed hard news for what it is: a lousy standalone business. Google arguably contributed to this in many indirect ways, including by helping users find substitute news sources. But the idea that Google takes profits directly from newspapers is simply misinformed.
In an earlier blog post, I talked about how sites that generate purchasing intent (mainly “content” sites) are being under-allocated advertising dollars versus sites that harvest purchasing intent (search engines, coupon sites, comparison shopping sites, etc). As a result, most content sites are left haggling over CPM-based brand advertising instead of sponsored links for the bulk of their revenue.
But there is an additional problem: even among sites that monetize via sponsored links there is a large overallocation of advertising spending on links that are near the “end of the purchasing process” (or “end of the funnel”). For example, an average camera buyer takes 30 days and clicks on approximately 3 sponsored links from the beginning of researching cameras to actually purchasing one. Yet in most cases only the last click gets credit, by which I mean: 1) if it’s an affiliate (CPA) deal, it is literally usually the case that only the last affiliate (the site that drops the last cookie) gets paid, 2) if it’s a CPC or CPM deal, most advertisers don’t properly track the users across multiple site visits so simply attribute conversion to the most recent click, causing them to over-allocate to end-of-funnel links 3) if it’s a non-sponsored link (like Google natural search links) the advertiser might over-credit SEO when in fact the natural search click was just the final navigational step in a long process that involved sponsored links along the way.
What this means is there are two huge misallocations of advertising dollars online: the first from intent generators to intent harvesters; the second from intent harvesters that are at the beginning or middle of the purchasing process to those at the end of the purchasing process. This is not just a problem for internet advertisers and businesses – it affects all internet users. Where advertising dollars flow, money gets invested. It is well known that content sites are suffering, many are even on their way to dying. Additionally, product/service sites that started off focusing on research are forced to move more and more toward end-of-funnel activities. Take a look at how sites like TripAdvisor and CNET have devoted increasing real estate to the final purchasing click instead of research. For the most part, you don’t get paid for the actual research since it’s too high in the funnel.
As with all large problems, this misallocation of advertising dollars also presents a number of opportunities. One opportunity is for advertisers to correctly attribute their spending by tracking users through the entire purchasing process (in the case of cameras, the full 30 days and multiple sponsored clicks). Very likely, these sites are currently overpaying end-of-funnel sites (e.g. coupon sites) and underpaying top-of-funnel sites (e.g. research sites). There is also an opportunity for companies that provide technology to help track this better. Finally, if over time advertising dollars do indeed shift to being correctly allocated, this will allow research sites to be pure research sites, content sites to be pure content sites, etc instead of everyone trying to clutter their sites with repetitive, “last click” functionality.
VC returns over the last decade have been poor. The cause is widely agreed to be an excess of venture capital dollars to worthy startups. Observers seem to universally assume that the solution is for the VC industry to downsize.
You cannot invest $25bn per year and generate the kinds of returns investors seek from the asset class. If $100bn per year in exits is a steady state number, then we need to work back from that and determine how much the asset class can manage…. I think “back to the future” is the answer to most of the venture capital asset class problems. Less capital in the asset class, smaller fund sizes, smaller partnerships, smaller deals, and smaller exits
There are many reasons to believe that a reduction in the size of the VC industry will be healthy for the industry overall and should lead to above average returns in the future.
All of these analyses start with the assumption that aggregate venture-backed exits (acquisition and IPOs) will remain roughly constant. I don’t see why we need to accept that assumption. The aggregate value of venture-backed startups, like all valuations, is a function of profits generated (or predicted to be generated). In technology, profits are driven by innovation. I don’t see any reason we should assume venture-backed innovation can’t be dramatically increased.
For example, innovation has varied widely across times and places – the most innovative region in the world for the last 50 years being Silicon Valley. What if, say, Steve Jobs hadn’t grown up in Silicon Valley? What if he had gone to work for another company? Does anyone really think Apple – and all the innovation and wealth it created – would exist if Jobs hadn’t happened to grow up in a culture that was so startup friendly? Jobs is obviously a remarkable person, but there are probably 100 Steve Jobs born every year. The vast majority just never have a chance or give a thought to starting a revolutionary new company.
Some people blame our education system, or assume that there is some fixed number of entrepreneurs born every year. I think the problem is cultural. As much as we like to think of our culture as being entrepreneurial, the reality is 99% of our top talent doesn’t seriously contemplate starting companies. Colleges crank out tons of extremely smart and well-educated kids every year. The vast majority go into “administrative” careers that don’t really produce anything – law, banking and consulting. Most of the rest join big companies. As I’ve argued many times before, big companies (with a few notable exceptions) aren’t nearly as successful as startups at creating new products. The bigger the company, the more likely it suffers from agency issues, strategy taxes, and myopia. But most of all: nothing is more motivating and inspiring than the sense of ownership and self-direction only a startup can provide.
Whenever I see a brilliant kid decide to join Goldman Sachs, McKinsey, or Google, I think to myself: a startup just died, and as a result our world is a little less wealthy, innovative, and interesting.
For some reason when you are selling information technology, big companies are referred to as “enterprises.” I’m guessing the word was invented by a software vendor who was trying to justify a million-dollar price tag. As a rule of thumb, think of enterprise sales as products/services that cost $100K/year or more.
I am by no means an expert in enterprise sales. Personally, I vastly prefer marketing (one-to-many) versus sales (one-to-one), hence only start companies making consumer or small business products (advertising based or sub-$5000 price tags). But I have been involved in a few enterprise companies over the years. Here’s the main thing I’ve observed. Almost every enterprise startup I’ve seen has a product that would solve a problem their prospective customers have. But that isn’t the key question. The key question is whether it solves a problem that is one of the prospective customer’s top immediate priorities. Getting an enterprise to cough up $100K+ requires the “buy in” of many people, most of whom would prefer to maintain the status quo. Only if your product is a top priority can you get powerful “champions” to cut through the red tape.
My rule of thumb is that every enterprise (or large business unit within an enterprise) will, at best, buy 1-3 new enterprise products per year. You can have the greatest hardware/software in the world, but if you aren’t one of their top three priorities, you won’t be able to profitably sell to them.
One final note: enterprise-focused VC’s sometimes refer to products priced between (roughly) $5k and $100K as falling in the “valley of death.” Above $100K, you might be able to make a profit given the cost of sales. Below $5k you might be able to market your product, hence have a very low cost of sales. In between, you need to do sales but it’s hard to do it profitably. Your best bet is a “channel” strategy; however, for innovative new products that is often a lot like trying to push a string.
Howard Lindzon was nice enough to have me on his Stocktwits.tv show recently. For those who don’t know Howard, he writes a fantastic blog. He writes in such an irreverent way it’s easy to overlook the wisdom behind what he says. My favorite recent Howard-ism was, talking about investing, “I like to look outside and see my [investments].” I take this to mean he likes to invest in things he understands, can touch, go visit, etc. This is probably the single best piece of advice in order to have survived the recent financial crisis. Fancy things like CDOs, Auction-Rate Securities, etc turned out to function much differently than advertised. Diversification across asset classes (CAPM etc) turned out to be useless: when things got bad, correlations went to 1. One reason I like investing in startups is you can go visit them – they are something tangible and understandable.
Howard is also the founder of Stocktwits. Stocktwits is potentially genuinely disruptive in that it dis-intermediates Wall Street. It is one of those things that some people think is a toy now but could end up being the next big thing.
The TV show The Wire is an incredibly instructive lesson on how the modern world works (besides being a great work of art). The recurring theme is how individuals with good intentions are stymied by large institutions. As the show’s creator says:
The Wire is a Greek tragedy in which the postmodern institutions are the Olympian forces. It’s the police department, or the drug economy, or the political structures, or the school administration, or the macroeconomics forces that are throwing the lightning bolts and hitting people in the ass for no reason. In much of television, and in a good deal of our stage drama, individuals are often portrayed as rising above institutions to achieve catharsis. In this drama, the institutions always prove larger, and those characters with hubris enough to challenge the postmodern construct of American empire are invariably mocked, marginalized, or crushed. Greek tragedy for the new millennium, so to speak.
What’s amazing about the show is you see in a very realistic and compelling way how, say, 1) the well intentioned mayor needs to get the crime numbers down to get his school reform passed so 2) he pressures the (well-intentioned) police chief to do so, 3) who in turn cuts off a (well-intentioned) investigation that wasn’t going to yield short term metrics, 4) which emboldens the gang leader being investigated, 5) who recruits a sympathetic high school student into a life of crime. And so on.
This blog is mostly about startups so let me tell a true Wire-like startup story. There is a large, publicly-traded company we’ll call BigCo. BigCo has a new CEO who is under heavy scrutiny and expected to get the stock price up over the next few fiscal quarters. Wall Street analysts who follow BigCo value the stock at a multiple of earnings, which are driven by Operating Expenses (“OpEx”), which are ongoing expenses versus “one time” expenses like acquisitions (called “CapEx”). (If you read analyst reports, you’ll see that stocks are generally considered, correctly or not, to have key financial drivers. The stock price is often those drivers times a “multiple” which in turn is often determined by the company’s expected growth rate). The “smart money” like hedge funds may or may not believe these analysts’ models, but they know other people believe them so place their bets according to how they think these numbers will move (see Keynes on the stock market as a “beauty contest”). (Financial academics who believe in “efficient markets” would say none of this is possible but anyone who’s actually participated in these markets knows the academics are living in fantasy land.)
All this means the CEO is fixated on growing BigCo’s revenues while keeping operating expenses down. A great way to do this is through acquisitons, which analysts consider one-time expenses (CapEx). Let’s say BigCo is currently growing at 20%, but their multiple suggests they need to grow at 30%. So the M&A team goes out and looks for companies they can acquire growing at, say, 50%, to get the average up. BigCo spends lavishly to buy these companies since the costs can be considered CapEx. They even have elaborate dinners and incur other large expenses that can be counted as part of the acquisition. Once the deal is closed they immediately start planning how to cut operating expenses from the newly acquired company. They decide the best way is to move the engineering offshore. This rips the heart out of the engineering-driven culture and as a result morale drops, product quality falls, and key people quit. But the short term revenues are up and operating expenses down, so BigCo’s CEO keeps her job and makes a lot of money off her stock options.
The winners here are the people who understand the system and play it cynically (hedge funds, BigCo’s CEO & board, perhaps the acquired company’s founders & investors). The losers are everyone else – the company’s customers, the employees who lose their jobs, and the stock market investors who don’t understand the game is rigged.
It is almost religious orthodoxy in the tech community that “open” is better than “closed.” For example, there have widespread complaints about Apple’s “closed” iPhone app approval process. People also argue Apple is making the same strategic mistake all over again versus Android that it made versus Windows*. The belief is that Android will eventually beat the iPhone OS with an “open” strategy (hardware-agnostic, no app approval process) just as Windows beat Apple’s OS in the 90’s.
With respect to requiring apps to be approved, consider the current state of the iPhone platform. There are over 100,000 apps and thus far not a single virus, worm, spyware app etc. (I don’t count utterly farfetched theoretical scenarios). As a would-be iPhone developer, I can report firsthand that the Apple approval process is a nightmare and should be overhauled. But what’s the alternative? Before the iPhone, getting your app on a phone meant doing complicated and expensive business development deals with wireless carriers. At the other end of the spectrum: If the iPhone OS were completely open, would we really have better apps? What apps are we missing today besides viruses?
With respect to the strategic issue of tightly integrating the iPhone/iPad software and hardware, a strong case can be made that Apple’s “closed” strategy is smart. Clay Christensen has given us the only serious theory I know of to predict when it’s optimal for a company to adopt an open versus closed strategy for (among other things) operating systems. The basic idea is that every new tech product starts out undershooting customer needs and then – because technology gets better faster than customers needs go up - eventually “overshoots” them. (PC’s have overshot today – most people don’t care if the processors get faster or Windows adds new features). Once a product overshoots, the basis of competition shifts from things like features and performance to things like price.
The key difference today between desktop computers and mobile devices is that mobile devices still have a long way to go before customers don’t want more speed, more features, better battery life, smaller size, etc. Just look at all the complaints yesterday about the iPad - that it lacks multitasking, a camera, is too heavy, has poor battery life, etc. This despite the fact that Apple is now even building their own semiconductors (!) to squeeze every last bit of performance out of the iPad. Until mobile devices compete mainly on price (probably a decade from now), tight vertical integration will produce the best device and is likely the best strategy.
*It’s worth noting that Steve Jobs wasn’t the one who screwed up Apple. Jobs co-founded Apple in 1976. He was pushed out in in May 1985 when the company was valued at about $2.2B. He returned in 1996 when Apple was worth $3B. Today it is worth $187B.
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.
Apple has entered the online advertising business for the first time with its purchase of Quattro Wireless. They are now also competing head-to-head against Google in the mobile advertising market.
Mobile ads will be displayed to users either in a web browser or in a mobile application. Thanks to the iPhone and now Android, web browsing on mobile devices is becoming just like web browsing on the desktop. Sites are often running the same HTML – and the same ads – whether the browser is on the desktop or mobile web. Thus, if an ad network supplies ads to the nytimes desktop version, they’ll also supply ads to the nytimes mobile version. The battle for web publishers on mobile browser-based ads would seem to be the same battle already happening on the desktop web. This battle is dominated by Google, Yahoo, Microsoft etc. and I can’t imagine Apple is trying to seriously enter the battle at this late stage.
Thus, Apple’s interest in Quattro must be about ads in mobile applications. Apple is currently in a very strong position with respect to app developers, given their tight control over the dominant app platform. How could Google supplant them there? For one thing, Android and other platforms could gain significant market share. But Google could threaten Apple even on ads in iPhone apps. Unless Apple forced developers to use their ad network, iPhone app developers would select the ad network that provided the highest payouts, which – as with all ad networks – would depend heavily on which had the most advertisers.
So the Quattro purchase seems to be mostly about Apple getting a base of mobile advertisers (not publishers) that will allow them to offer competitive payouts on mobile app ads (not mobile browser-based ads).
One of the amazing things about the internet economy is how different the list of top internet properties today looks from the list ten years ago. It wasn’t as if those former top companies were complacent – most of them acquired and built products like crazy to avoid being displaced.
The reason big new things sneak by incumbents is that the next big thing always starts out being dismissed as a “toy.” This is one of the main insights of Clay Christensen’s “disruptive technology” theory. This theory starts with the observation that technologies tend to get better at a faster rate than users’ needs increase. From this simple insight follows all kinds of interesting conclusions about how markets and products change over time.
Disruptive technologies are dismissed as toys because when they are first launched they “undershoot” user needs. The first telephone could only carry voices a mile or two. The leading telco of the time, Western Union, passed on acquiring the phone because they didn’t see how it could possibly be useful to businesses and railroads – their primary customers. What they failed to anticipate was how rapidly telephone technology and infrastructure would improve (technology adoption is usually non-linear due to so-called complementary network effects). The same was true of how mainframe companies viewed the PC (microcomputer), and how modern telecom companies viewed Skype. (Christensen has many more examples in hisbooks).
This does not mean every product that looks like a toy will turn out to be the next big thing. To distinguish toys that are disruptive from toys that will remain just toys, you need to look at products as processes. Obviously, products get better inasmuch as the designer adds features, but this is a relatively weak force. Much more powerful are external forces: microchips getting cheaper, bandwidth becoming ubiquitous, mobile devices getting smarter, etc. For a product to be disruptive it needs to be designed to ride these changes up the utility curve.
Social software is an interesting special case where the strongest forces of improvement are users’ actions. As Clay Shirky explains in his latest book, Wikipedia is literally a process – every day it is edited by spammers, vandals, wackos etc., yet every day the good guys make it better at a faster rate. If you had gone back to 2001 and analyzed Wikipedia as a static product it would have looked very much like a toy. The reason Wikipedia works so brilliantly are subtle design features that sculpt the torrent of user edits such that they yield a net improvement over time. Since users’ needs for encyclopedic information remains relatively steady, as long as Wikipedia got steadily better, it would eventually meet and surpass user needs.
A product doesn’t have to be disruptive to be valuable. There are plenty of products that are useful from day one and continue being useful long term. These are what Christensen calls sustaining technologies. When startups build useful sustaining technologies, they are often quickly acquired or copied by incumbents. If your timing and execution is right, you can create a very successful business on the back of a sustaining technology.
But startups with sustaining technologies are very unlikely to be the new ones we see on top lists in 2020. Those will be disruptive technologies – the ones that sneak by because people dismiss them as toys.
