Selling pickaxes during a gold rush

There is a saying in the startup world that “you can mine for gold or you can sell pickaxes.” This is of course an allusion to the California Gold Rush where some of the most successful business people such as Levi Strauss and Samuel Brannan didn’t mine for gold themselves but instead sold supplies to miners – wheelbarrows, tents, jeans, pickaxes etc. Mining for gold was the more glamorous path but actually turned out, in aggregate, to be a worse return on capital and labor than selling supplies.

When a major new technology trend emerges – say, the rise of online video or social media – entrepreneurs can try to capitalize on the trend by creating a consumer product (mining for gold), or by creating tools to enable consumer products (selling pickaxes).  For most technology trends, the number of successful companies created in gold mining and pickaxes are comparable, yet the gold mining businesses tend to get much more attention. In online video, YouTube is often thought of as the big winner; however, to date, more money has been made by online video by infrastructure suppliers like Akamai. Y-combinator is known for their high-profile B2C startups but their biggest exits to date have been in infrastructure (most recently Heroku which rode the popularity of Ruby on Rails to a >$200M exit)*.

When you start a company, the most important consideration should be working on a product you love (a startup can be a 5+ year endeavor so if you don’t love it you probably won’t be able to endure the ups and downs).  A secondary consideration should be matching the skills of the founders to the market.  Tools companies tend to require stronger technical and sales skills, whereas B2C companies tend to be more about predicting consumer tastes and marketing skills. A final consideration should be the supply-and-demand of startups in the space.  Because B2C companies tend to be “sexier” and get more press coverage, many entrepreneurs are drawn to them. This tends to lead to greater competition even though the market opportunities might not justify it.

There are many exciting technology opportunities emerging today: some are horizontal like mobile, location, and local; others are vertical like fashion, art, real estate, education, finance and energy. If you are an entrepreneur thinking about starting a company around these trends, consider selling pickaxes.

* Note that there are many great B2C YC companies, so the list of exits will no doubt change and probably skew more towards B2C over time.

The “thin edge of the wedge” strategy

Establishing relationships with new users is the hardest part of growing a startup.  For consumer products establishing relationships can mean many things: installs, registrations, purchases, or even just getting users to think of your website as a place to go for certain purposes.  For B2B products, establishing relationships means getting internal users or testers and eventually contracts and payments. For business development partners – for example API/widget partners – establishing relationships usually means getting functionality embedded in partners’ products (e.g. a widget on their website).

One common strategy for establishing this initial relationship is what is sometimes known as the “thin edge of the wedge” strategy (aka the “tip of the spear” strategy).  This strategy is analogous to the bowling pin strategy: both are about attacking a smaller problem first and then expanding out.  The difference is that the wedge strategy is about product tactics while the bowling pin strategy is about marketing tactics.

Sometimes the wedge can be a simple feature that existing companies overlooked or saw as inconsequential. The ability to share photos on social networks was (strangely) missing from the default iPhone camera app (and sharing was missing from many third-party camera apps like Hipstimatic that have popular features like lo-fi camera filters), so Instagram and Picplz filled the void. Presumably, these startups are going to try to use mobile photo sharing as the wedge into larger products (perhaps full-fledged social networks?).

Sometimes the wedge is a “single player mode” – a famous example is early adopters who used Delicious to store browser bookmarks in the cloud and then only later – once the user base hit critical mass – used its social bookmarking features. Other times the wedge lies on one side of a two-sided market, in which case the wedge strategy could be thought of as a variant of the “ladies night” strategy. I’m told that OpenTable initially used the wedge strategy by providing restaurants with terminals that acted like simple, single-player CRM systems. Once they acquired a critical mass of restaurants in key cities (judiciously chosen using the bowling pin strategy), opentable.com had sufficient inventory to become useful as a one-stop shop for consumers.

Critics sometimes confuse wedge features with final products. For example, some argue that mobile photo sharing is “just a feature,” or that game mechanics on geo apps like Foursquare are just faddish “toys.” Some go so far as to argue that the tech startup world as a whole is going through a phase of just building “dinky” features and companies. Perhaps some startups have no plan and really are just building features, likely with the hope of flipping themselves to larger companies. Good startups, however, think about the whole wedge from the start. They build an initial user base with simple features and then quickly iterate to create products that are enduringly useful, thereby creating companies that have stand-alone, defensible value.

Timing your startup

I never had the opportunity to invest in YouTube but I have to admit that if I did I probably would have passed (which of course would have been a huge mistake). I’d been around the web long enough to remember the dozens of companies before YouTube that tried to create crowdsourced video sites and failed. Based on “pattern recognition” (a dangerous thing to rely on), I was deeply skeptical of the space.

What I failed to appreciate was that the prior crowdsourced video sites were ahead of their time. YouTube built a great product, but, more importantly, got the market timing just right. By 2005, all the pieces were in place to enable crowdsourced video – the proliferation of home broadband, digital camcorders, a version of Flash where videos “just worked,” copyrighted web content that could be exported to YouTube, and blogs that wanted to embed videos.

Almost anything you build on the web has already been tried in one form or another. This should not deter you. Antecedents existed for Google, Facebook, Groupon, and almost every other tech startup that has succeeded since the dot-com bubble.

Entrepreneurs should always ask themselves “why will I succeed where others failed?” If the answer is simply “I’m doing it right” or “I’m smarter,” you are probably underestimating your antecedents, which were probably run by competent or even great entrepreneurs who did everything possible to succeed. Instead your answer should include an explanation about why the timing is right – about some fundamental changes in the world that enable the idea you are pursuing to finally succeed. If the necessary conditions were in place, say, a year ago, that might still be ok – YouTube happened to nail their product out of the gate, but if they hadn’t a company started later might have succeeded in their place.

Often the necessary conditions are only beginning to emerge and knowing when they will do so sufficiently is very hard to predict. We all know the internet will become fully social, personalized, mobile, location-based, interactive, etc. and lots of new, successful startups will be built as a result. What is very hard to know is when these things will happen at scale.

One way to mitigate timing risk is to manage your cash accordingly. If you are trying to ride existing trends you should ramp up aggressively. If you are betting on emerging trends it is better to keep your burn low and runway long.  This takes discipline and patience but is also the way you hit it really big.

The “ladies’ night” strategy

Many singles bars have “ladies’ night” where women are offered price discounts. Singles bars do this for women but not for men because (heterosexually-focused) bars are what economists call two-sided markets – platforms that have two distinct user groups and that get more valuable to each group the more the other group joins the platform – and women are apparently harder to attract to singles bars than men.

Businesses that target two-sided markets are extremely hard to build but also extremely hard to compete against once they reach scale. Tech businesses that have created successful two-sided markets include Ebay (sellers and buyers), Google (advertisers and publishers), Paypal (buyers and merchants), and Microsoft (Windows users and developers). In some cases individuals/institutions are consistently on one side (buyers and merchants) while in other cases they fluctuate between sides (Ebay sellers are also often buyers).

In almost every two-sided market, one side is harder to acquire than the other. The most common way to attract the hard side is the ladies’ night strategy: reduce prices for the hard side, even to zero (e.g. Adobe Flash & PDF for end-users), or below zero (e.g. party promotors paying celebrities to attend). Rarer ways to attract the hard side is 1) getting them to invest the platform itself (e.g. Visa & Mastercard), and 2) interoperating with existing hard sides (e.g. Playstation 3 running Playstation 2 games).

If you are starting a company that targets a two-sided market you need to figure out which side is the hard side and then focus your efforts on marketing to that side. Generally, the more asymmetric your market the better, as it allows you to market to each side more in serial than in parallel.

Some thoughts on incumbents

Reposted from Oct 7, 2010 from cdixon.posterous.com

By “incumbents” I mean the big companies that are loosely competitive to your startup.

– The first thing to do is try to understand the incumbent’s strategy.  For example, see my analysis of Google’s strategy.

– Being on an incumbent’s strategic roadmap is a double-edged sword.  On the one hand, they might copy what you build or acquire a competitor.  On the other hand, if you build a valuable asset you could sell your company the acquirer at a “strategic premium.”

– Incumbents that don’t yet have a successful business model (e.g. Twitter) might think they have a strategy, but expect it to change as they figure out their business model.  An incumbent without a successful business model is like a drunk person firing an Uzi around the room.

– Understand the incumbent’s acquisition philosophy. More mature companies like Cisco barely try to do R&D and are happy to acquire startups at high prices.  Incumbents that are immature like Facebook only do “talent acquisitions” which are generally bad outcomes for VC-backed startups (but good for bootstrapped or lightly funded startups). Google is semi-mature, and does a combination of talent and strategic acquisitions.

– Understand the incumbent’s partnership philosophy.  Yahoo and Microsoft are currently very open to partnerships with startups.  Google and Facebook like to either acquire or build internally. If you don’t intend to sell your company, don’t talk seriously about partnerships to incumbents that don’t seriously consider them.

– Every incumbent has M&A people who spend a lot of their time collecting market intelligence. Just because they call you and hint at acquisition doesn’t mean they want to buy you – they are likely just fishing for info. If they really want to buy you, they will aggressively pursue you and make an offer.  As VCs like to say, startups are bought, not sold.

– Try to focus on features/technologies that the incumbents aren’t good at.  Facebook is good at social and social-related (hard-core) technology.  Thus far they’ve kept their features at the “utility level” an haven’t built non-utility features (e.g. games, virtual goods, game mechanics).  Google thus far has been weak at social and Apple has been weak at web services.

– Try to focus on business arrangements that the incumbents aren’t good at.  Facebook and Google only do outbound deals with large companies.  With small companies (e.g. local venues, small publishers) they try to generate business via inbound/self service. Building business relationships that the incumbents don’t have can be a very valuable asset.

– Be careful building on platforms where the incumbent has demonstrated an inconsistent attitude toward developers. Apple rejects apps somewhat arbitrarily and takes a healthy share of revenues, but is generally consistent with app developers.  You can pretty safely predict what they will will allow to flourish. Twitter has been wildly inconsistent and shouldn’t be trusted as a platform.  Facebook has been mostly consistent although recently changed the rules on companies like Zynga with their new payment platform (that said, they generally seem to understand the importance of partners thriving and seem to encourage it).

– Take advantage of incumbents’ entrenched marketing positioning.  The masses think of Twitter as a place to share trivial things like what you had for lunch (even if most power users don’t use it this way) and Facebook as a place to talk to friends.  They are probably stuck with this positioning.  Normals generally think of each website as having one primary use case so if you can carve out a new use case you can distinguish yourself.

– Consider the judo strategy.  When pushed, don’t push back.  When Facebook adds features like check-ins, groups, or likes, consider interoperating with those features and building layers on top of them.