Category: business

the nature of their game

~ ginsu ~ 3 Comments

Pleased to meet you
Hope you guess my name
But what’s puzzling you
Is the nature of my game

Facebook may be overplaying its hand, but do we really understand the game they are playing?

We’re mad at Facebook because we feel like helpless pawns in an environment we need but don’t control.  Even though I’m included in that “we,” I have some sympathy for Facebook because I was once on the other side of a similar divide between the consumer and the company.

At Second Life, we (this time I mean we-the-company) had a seemingly omnipotent grip on the environment our users needed.  In theory, we knew our users intimately, knew who their friends were, knew where they went and what they did.  We owned their means of payment and communication, we set policy for their leisure and commercial activities.   This is a level of control that Facebook dreams of, not in a virtual world but for the entire Web . . . and it’s scary that they actually seem to be on the path to getting there.

Some of our most devoted customers were also our most vocal critics, because they were so deeply invested in the world they helped create – and every change in the service affected their lives deeply.  A few critics assumed that since our every change seemed to hurt some users, it should be easy to build a competitor that would satisfy all users.  But Second Life “killers” and open-source alternatives never gained traction, while Second Life continues to grow long after the hype cycle forgot about virtual worlds.

One lesson in all of this for me was that most critics and competition never really understood our business.  Our operation was so multifaceted and complex that every competitor only focused on the one or two things that they believed were important, and individually or collectively they never assembled a cohesive whole that could challenge our market dominance.

I’m seeing the same thing today with Facebook’s critics.  Competitors who think an open (source or otherwise) alternative to Facebook will bring down the giant simply fail to understand the business they are competing against.  Open identity, open interests and open social graphs are very difficult to grow and support without an overriding service reason to spur adoption and use:  People have an online identity and social graph because of the services they use, not the other way around.

Facebook and the end of the Web

~ ginsu ~ 1 Comment

This week Facebook released a barrage of announcements that reveal a stunning level of ambition.  You have to ask, are they really the next Google, but with evil?

I can’t speak to the question of evil, but I do have a mental benchmark for the next Google, and it isn’t simply about being the next giant tech company.  The next Google would have to create an entire sector of economic activity, keeping a dominant position worth many billions of dollars while also creating many billions of dollars of value for other companies.

Before Google, the commercial Web was motley mix of emerging media, with some interesting economic opportunities in portals, ecommerce and auction.  Google created and dominated search advertising, but the utility that search brought to the Web was a major driver in the overall economic growth of all advertising on the Web, including display advertising.  Today the entire commercial Web runs on advertising, and Google helped create many more billions of dollars than it captured for itself.

If Facebook merely becomes the world’s best ad network, they would not be the next Google.  They would simply be the biggest winner in the economy that Google helped create.  They could even suck all the oxygen out of Google’s room and thereby kill Google, but that wouldn’t make them the next Google any more than John Wilkes Booth was the next Abraham Lincoln.

I think Facebook’s ambitions go far beyond advertising.  I’ve got no crystal ball showing the future, but the analogue from the past that seems relevant to me is television.  TV was once a wondrous new technology, giving rise to a new world of entertainment and news media.  Businesses quickly hooked the economic engine of advertising to the media of television, and decades of fantastic growth followed.  It once seemed a given that television would hold a central place in our media lives forever, and that it would always be free.

And then cable TV came along.  You might not remember this personally, but cable TV was initially a terrible affront to consumers.  People had become accustomed to getting a huge amount of media for free, and now these horrible new companies wanted outrageous fees every month for the same kind of media.  This could be very painful for a consumer with devotion to a particular kind of content, for example a sports fan seeing important sporting events disappear into the hole of paid TV.

Could the same thing happen to the Web?  An entire generation has become accustomed to Web media as free media, and assumes that will be true forever.  But cracks in that assumption have appeared recently.  We’re seeing a new wave of paid content efforts on the Web.  More importantly, we’re seeing platform owners make good money from Web-like content, like Amazon with Kindle and Apple with iPhone/iPad.

Amazon and Apple have shown that you can make money from digital content if you own all the important parts of the value chain, from digital content rights to an ecommerce store to a payment service to a physical device.  Facebook could be about to find out whether you really need the last link of that chain.  They might not need control over the physical device, because they have something even better in the social graph and identity management.

Facebook knows who you are and knows who your friends are, and they own that information in a way that no one ever has before.  Add in the right content relationships, a payment system, and a universal interest indicator, and that becomes a complete enough platform to enable more paid content on the Web.  A hidden key may be that their payment system is a prepaid credit system, which allows small transactions that would otherwise have burdensome costs and usability barriers.

That may sound a little abstract, so I’ll offer up this fanciful example:  I go to visit Pandora for music, and Facebook and Pandora immediately know it’s me.  They know what kind of music I like, and they know what kind of music my friends like, so they are able to recommend some really great music for me.  Right there I have already participated in a content transaction:  I have offered my valuable tastes and contact information to Facebook, who handed that info over to Pandora – you have to think that Facebook gets paid for that.

And Pandora was glad to pay, because I really like that music they recommended.  In fact, I liked it so much that now I’m going to sign up for a Pandora subscription.  I’m about to reach for my credit card when I realize, hey, I can pay for this with Facebook credits!  Oh, I see I’m a few credits short.  No problem, I’m going to go this this Facebook game, SheepWorld, and rack up the extra FB credits I need – then back to Pandora to pay.

A bunch of little transactions happened in that scenario, and none of them actually involved me pulling out my wallet.  In fact, it seemed like fun, it didn’t seem like I was paying at all.  I was able to participate in a new economy because I’m a Facebook user, and now I’m getting used to paying for premium content.  And when the New York Times puts up its paywall, I’m not going to care so much because I’ll be paying with Facebook, which separates the media consumption experience from the payment experience.

Sound a little farfetched?  Could be.  But there was a time when I couldn’t imagine paying for TV.  Both free broadcast and paid cable television still bring in a lot of money, but cable is a much better business.  If Facebook enables new revenue opportunities on the Web for content creators, they will enrich themselves and enrich others even more.  I won’t like it, just as I didn’t like it when I started paying for TV.  It would be the end of the Web as we know it.

burn this

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Newspapers are dying, as any media observer could tell you.  But I don’t get the strident call to “burn the boats,” as Cortés supposedly did when he conquered Mexico for Spain. Never mind that the legend never happened, this advice doesn’t make sense in light of the beliefs of the people saying it.

Boat-burning advocate Marc Andreessen understands disruptive innovation as well as anyone.  At the very core of the startup culture that Marc helped create is a belief that small companies in the aggregate have a huge advantage over incumbents for bringing disruptive innovations to market.  A big company can’t become a small startup simply by destroying its current revenue model and firing all its employees – that would only result in a burned out shell, not a new startup.  A new startup can only be formed by innovators coming together to form a new company.  I realize there are exceptions to these statements, but they are very few and far between.  So “burning the boats” is statistically likely to be an exceptionally bad strategy for newspaper companies.

Tech writer Erick Schonfeld says it’s hard to watch the newspaper industry die slowly, noting that it could take decades for the newspaper industry to dwindle from $30 billion dollars a year down to nothing.  But Erick’s been covering startups for over 15 years, he’s seen successful startups kill the dinosaurs time and time again.  Like all of us in the startup world, he celebrates the success of startups against incumbents.  I don’t get the lamentation here – is it because the bedside deathwatch is comprised of relatives of the victim?  Who is burning the boats supposed to help, the dying incumbents or the anguished observers?

Given that the startups are going to beat the incumbents anyway, there’s nothing wrong with newspapers dying slowly.  Twenty years of slow death isn’t preventing innovation – all the innovators are outside the incumbents anyway.  But inside the incumbents are real people, hundreds of thousands of people who depend on their dying jobs to feed their families, many of whom aren’t going to succeed on the other side of the disruption.  Is there something wrong with letting those people eke out another twenty years of dead-end jobs?

This isn’t soft-hearted humanitarianism.  My heart’s hard enough to admire a capitalist system that sometimes causes individual misfortune.  But my point here is that the slow death of newspapers is an example of capitalism working correctly.  Big-footed incumbents are supposed to lose to startups.  Large companies are supposed to cling to their dying revenue streams while nimble competitors bring innovation to market.

Investors in those large companies have already “priced in” slow death – the stock price reflects the conventional wisdom that these companies will slowly go out of business.  The stock price for public newspaper companies most certainly does not price in a “burn the boats” strategy, which would result in irresponsible destruction of shareholder value, as well as damaging all those jobs and lives.

This is actually a place where brutal capitalism and soft-hearted compassion have common ground.  Newspapers are dying and no one is going to do anything about it.  For the love of humanity and capitalism, just let ’em die a slow death.

twitAARRR

~ ginsu ~ Leave a comment

People are talking about a report that Twitter has a low proportion of “active” users.  I saw a similar debate rage a few years ago around the definition of users of Second Life.

Amusingly (and presumptuously), today’s report claims to define “True Twitter users” as active.  They say that a True Twitter User has at least 10 followers, follows at least 10 people, and has tweeted at least 10 times.

Why should we accept this definition?  Analyses like this often come from a position of functional ignorance.  I believe that only the company can have a “Truly” meaningful definition of “active” users, and there are often good reasons that the company shouldn’t waste time debating this definition with external observers.

This is especially true when a company has an evolving revenue model.  In those cases, “active” is only meaningful in the context of a business model cycle that some people call “Startup Metrics For Pirates” because of the acronym AARRR:  Acquisition, Activation, Retention, Referral and Revenue.  “Active” is the second “A” here, and what matters in the definition is that customer acquisition efforts lead to active users, who participate in activity that they want to repeat and tell their friends about, which ultimately results in the company getting paid.

So if Twitter had zero customer acquisition costs, and tweeting was both addictive and viral (obviously, none of these things are strictly true), then the only definition of “active” that would matter is “user who tweets once.”  Or, if Twitter charged only users with 100K followers, and only users who had 100 followers in the first month ever get to 100K followers in their lifetime (again, not true), then the active user definition might be “user with 100 followers in first month.”  My dumb revenue models here are not the point; the point is that “active” only has meaning in context, and only the company understands that context, especially in a pre-revenue company.

Twitter, rather famously, has not publicly settled on its revenue model.  Undoubtedly they have dozens of ideas, and so they have many dozens of potential definitions of “active” – and they’re not obliged to share any of those ideas with you or me.  They don’t need to waste time with ignorant and disinterested people (myself included):  it’s no use picking over these definitions with people who are not deeply invested in the business (as employee or investor), and who therefore lack the information and commitment required to contribute productively to the discussion.

chinese menu of startup blogs

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Last summer I mentioned some of the best startup blogs for entrepreneurs.  Since then, there’s been a notable proliferation of great startup blogging, so I wanted to note my current approach to keeping up with all the useful content.

I call this the Chinese Menu approach (“Pick one from Column A, one from Column B . . .”): Group blogs together by thematic category, and then read only one blog in each category. Every once in a while, I’ll change up the one that I pick in each category, so I don’t get sick of the same meal time after time.

Column A:  General Startup News

 Column B:  Venture Capital
Column C:  Startup Advisors

 Column D:  Coaches
Column E:  Founders (currently starting new business)

I add and drop blogs from categories all the time, and some blogs could be in multiple categories.  But the key is to just read one in each category.  This approach works well for me.  Switching up the meal selection once in a while helps keep me open to different perspectives.  I never miss anything truly essential, as great posts tend to be cross-linked extensively, or come to me by other means.  Incidentally, the same approach works ok for Twitter (though it’s not ideal).

mistakes were made

~ ginsu ~ 3 Comments

Compare and contrast –

In the startup world, failure is a badge of honor.  An honest postmortem of mistakes made along the way is greatly appreciated by the community.  For example:

The comments on each of those posts are overwhelmingly sympathetic, admiring and supportive.  Celebrating failure in context is a distinguishing aspect of our business culture versus many other countries.

In contrast, when the President of the US admits mistakes, the national and international coverage seems to imply that the admission itself its newsworthy and perhaps unwise.  Comments are largely vitriolic and incoherent.

Now, I think that failure can be overrated as an indicator of future success.  But I firmly believe that the openness to failure in business is one of the things that makes this country truly great.  It’s ironic and sad that this cultural gem does not extend into our political arena.

UPDATE 4 Oct 2010: Here’s a great list of the 25 best startup postmortems.

the price they paid

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Cue the background music [link to a streaming music play].

Watching the gyrating reports on the price paid for Apple’s purchase of music streaming service LaLa reminds me that acquisition prices are widely misreported and often misunderstood even when correctly reported.  Some people only want to know one number – the price paid – without caring about the many other numbers that are relevant to understanding who got what:  the company’s cash on hand, outstanding debt, financing history, and other numbers relevant to the capitalization of the company.

Even the best reporting often misses one important element of the analysis:  newly issued options (or other equity) shortly before the deal.  I like to call this the “options icing” – and it’s a very important concept for understanding what really happened.  For company founders, management and especially employees, it can mean the difference between a happy and tragic outcome for their startup.  The “icing” is both icing on the cake for employees, and also a good way to ice a bad cap table.

The options icing doesn’t come into play very often, but it is more common when the acquiror is a large, sophisticated tech company that historically rewards employees with equity incentive.  This kind of acquiror understands that the future success of the acquired product is less about the technology and more about the personnel continuing to prosper in the big company environment.

Let me make up an example.  A big company has got a problem if the market value of a 50-person company they want to acquire is only $20 million, while the investors have already put in $35 million into the company.  Typically, the investors have to be paid back first before anyone else gets paid, which means that employees would get nothing, which means that the big company would spend $20 million and get a bunch of seriously disgruntled employees, who will probably leave the company pretty soon after the deal. Even if the investors agree to restructure their liquidation preference, say by half, you still have very little left over:  $17.5 million to investors, $2.5 million for employees.  Let’s say that 1/2 of the employee stake is owned by 2 founders, and then you’re down to only $1.25 million for 48 other employees.  Nobody is happy with that outcome.

Here’s where the options icing comes in.  The company could issue a huge pool of options to employees who would be critical to carrying the product forward (in any scenario, whether acquired or not).  Say they issue $10 million worth of new options.  The magic here is that a smart acquiror will be willing to pay for some or all of those new options.  Even though the company is still only worth $20 million, the acquiror could be happy to pay $30 million if the options are issued to the right folks with the right terms.

The “right terms” include typical vesting terms, so the employees receiving options are incented to do great work for the acquiror.  From the employee’s perspective, this is fair because it is a whole lot better than the stick in the eye they would have been getting under the $20 million scenario.  From the acquiror’s perspective, this is a good deal because rather than flushing $20 million down the toilet, they are making a rational $20 million purchase, with a nice $10 million compensation package that addresses the compensation disadvantage that big companies face in competing with startups.

One of the key reasons that people work in startups is that you can really move the needle for the company’s value.  In financial terms, if you are part of a startup that creates, say, $100 million in value, then it’s a pretty neat feeling to have made nothing into $100 million, and you can get rewarded handsomely for that.  But if you are in a big company that is worth $100 billion, nobody will really notice, or even be able to tell, that you added $100 million in value – it certainly won’t make much of a difference in the stock price.  And that creates a compensation disadvantage for big companies that are trying to motivate their employees with equity grants.

But in the scenario above, the big company can pay for $10 million in stock grants to motivate a relatively small number of employees to execute on a product they clearly understand.  If these employees can turn that $20 million business into a $100 million business, they will be rewarded for it in a manner comparable to their rewards if they had remained an independent company.  That kind of compensation is generally not possible to award in a big company other than in this scenario because of internal “fairness” issues.

The beauty of all of this is that it is one of the few situations in this rotten ol’ world that deal dynamics favor the rank-and-file employees.  Most corporate dynamics, especially in big deals, have a tendency to screw the little guy.  But in order for this situation to be a good outcome for everybody, the rank-and-file employees have to be rewarded in a fair manner.  Coming back to my example above, the options icing can be win-win-win all around:  The investors can get a little tip for agreeing to the restructuring and the new equity; let’s say they get $18 million, just a bit more than they would have made otherwise.  That leaves $12 million for the employees – say the two founders take $3 million, more than twice as much as they would have made under the $20 million deal.  The other employees get $9 million, more than 7 times as they would have made.  The acquiror paid $10 million more, but as described above, this is money that really makes sense to spend, and it’s more like incentive compensation than it is acquisition consideration.

And this deal gets reported as a $30 million price paid.  But really from the right perspective it should be regarded as a $20 million deal.  Now, I am not saying that anything like this is what happened in the Apple-LaLa deal – actually the discrepancy in the reported numbers is too large to be explained by options icing alone.

privacy matters

~ ginsu ~ 3 Comments

What is going on with Facebook’s constant gyrations about privacy policy?  Does anyone really care?

A little while ago I suggested that online privacy concerns are best addressed by free market solutions, not governmental regulation.  I’ve discussed the topic with quite a few entrepreneurs, investors and professional marketers, and the overwhelming view in that group is that regular consumers just don’t care about online privacy.  “They” say:

  • privacy is too complicated a topic for consumers to understand
  • no one reads privacy policies
  • consumers can be distracted from privacy concerns with the offer of just about any shiny object

Much of that might be true – but I also took the time to talk to a bunch of “regular” consumers.  And these things are definitely true:

  • consumers know that their privacy is being compromised by many online services
  • consumers do not like being taken for granted
  • consumers will avoid services that abuse their information, and will seek services that use their information properly

These two sets of “truths” are not mutually inconsistent.  To me, they add up to:   Online services can gain a competitive advantage by giving consumers the most sensible default choices along with the right advanced options for privacy – make it simple, but make it right.  I think Facebook believes this, and that’s why they keep tinkering with their policies.  They understand that a lot of their initial attraction was a result of making different privacy assumptions than more open services like FriendFeed and Twitter.  They know that even if no one ever reads their privacy policy, if they make the wrong choices about privacy, they will lose users.  As they saturate their available audience, they have to figure out how to strike the right balance among their different demographic bases, all the while competing with the advantages that more open services have.

These are extremely nuanced choices, but getting them right makes the barrier to competitive threat all the more defensible.  And these are product choices; this is something that many I’ve talked to misunderstand:  people think that this privacy stuff is just legal mumbo jumbo or regulatory mishmash.  That’s plain wrong – laws and regulations are just the cart behind the horse.  In a social product where community is paramount, policy choices are product choices.

google killer

~ ginsu ~ 3 Comments

By my own admission, I’ve become a complete hack, for using the term [blank]-killer.  A lot of people are asking whether News Corp would really block its content from Google’s index, and make a deal with Microsoft for exclusive search access.  And if they did, and others followed, would this represent a serious threat to Google?

The tech-über-alles crowd would have you believe that “de-indexing” from Google would be suicide for any publisher.  The assertion there is that Google drives the majority of web traffic, so if you’re not findable through Google, you might as well not be on the Internet.

But that assertion flies in the face of another observation from the technoscenti – social media like Facebook and Twitter are becoming increasingly important as traffic drivers (though this importance may be overhyped).  We may be heading towards a future where the links are shared through social media are more valuable than search links.

More importantly, and against the prevailing wisdom in some circles, content still matters.  People use media services because of the content on it.  Other factors are important too:  the features must be complete, the UI has to be easy, the price has to be right, yadda yadda yadda.  But would any of those other factors make up for terrible content?  No, content is, if no longer king, still the jewel in the crown.

If Bing is able to be the exclusive search partner for the right content, Google is dead.  Of course, what’s “right” can vary quite a lot from person to person.  For me, it’s as simple as two publications:  If the New York Times and Wikipedia are de-indexed from Google, I’m going to stop using Google in favor of the search engine that has those two.  I might think it’s unfair, I might think it’s a triumph of soulless MBAs over tech heroes, I might think it’s the desperate grasping of dying empires.  But I want the content I want, and those principles aren’t enough to prevent me from switching.

Bing doesn’t have to make deals with every content provider, just a dozen or so critical ones that will cause another 40% market share gain (they’re at 10% now).  Sure it’ll be expensive to acquire the best content, but Microsoft’s got more cash than Google.  Once it’s 50/50, it’s anybody’s ballgame but the advantage goes to the one who has the content.

I’m pretty sure that Google is not going to sit back and smugly assume that Murdoch’s gambit will fail.  They’re going to get involved, they’re going to try to start locking down their own partnerships.  If I were them, I’d start with Wikipedia, one of the most important search result destinations on the web – it’s in the top five results of just about any search you do.  Sure, they’re a non-profit, but non-profits need money too.

new york state of mind

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There’s nothing like New York City – this has been said so many times in so many ways that it hardly bears repeating.  But the compulsion to declare love for New York is like the compulsion for love itself:  it doesn’t matter that countless generations have found this magic and proclaimed their discoveries to the world, each person still engages in a distinct journey for a song of one’s own heart.

I was born in New Jersey, grew up about 45 minutes outside of the city, and went to school and started my career in NYC.  I’ve been out in the San Francisco bay area for over a decade now, and I’m firmly rooted here with family and career, but the thought of going back to The City (the one and only “The City” – pretenders begone!) still occasionally buzzes in my head like a bee in a speeding car.  However, on a trip back to New York last week, I realized that one of the things that prevented me from moving back is my own very New York attitude.

Over the past few months, a few New York based technoscenti have carried a conversation about NYC as a startup environment.  Chris Dixon said conditions are ripe for a new NYC tech revival, Fred Wilson and Charlie O’Donnell agreed but noted that NYC has been a strong tech scene for years, and Dixon and Wilson came together to agree again that the NYC startup sector is special.  All this caused me to reflect on why I left the city that I love to pursue a tech career in Silicon Valley, and why I’d do it again.

It all goes back to why I went to NYC in the first place.  I was learning the law, I wanted to be a dealmaking lawyer.  And while there’s law and lawyers all over the world, the pinnacle of the practice is in New York.  Routine transactions in New York would be considered fantastically complicated almost anywhere else, and complex transactions in New York are so far above other places that they can’t be considered the same category of endeavor at all.  So if I was going to be a lawyer, I had to try to do it in the belly of the beast.

And it was a great time, but after a few years I realized I wanted to be more connected to the creation of something from nothing, rather than the financial engineering of something into vast amounts of money.  That meant working in startups, because startups aren’t about money but about value creation (a distinction often lost on New Yorkers).  So I shifted the path of my journey, but I retained that New York attitude of wanting to play on the biggest possible stage, and in the startup world, that meant going to Silicon Valley.

There are other great startup scenes in the world, and New York is certainly a special startup environment.  But if you’re a stage actor, you don’t go to New York dreaming of playing Off Broadway; you dream of your name in lights on the Great White Way.  Because I grew up as a New York dreamer, dreaming of a startup career meant leaving New York for the biggest and baddest startup scene in the world.

It’s all a bit ironic, and I’m not saying this “big stage” attitude is right.  In fact, it’s almost certainly not a healthy way to live.  A healthier attitude would be less entranced with the size of the stage, and more focused on the production and your role within it.  I think that’s the attitude held by Chris, Fred and Charlie, and I really look forward to seeing those guys continue the public conversation (and private work) about making New York into one of the great startup locales in the world.  For those interested, Elie Seidman is another good new voice in the thread, and of course Joel Spolsky is a longtime stalwart for software engineering in NYC (or anywhere).