The shift to intangibles

What are corporations made of? Well, mostly not buildings and machines and property and such anymore. Most of their value comes from brands, patents, ideas and other intangibles. Nothing is more telling than SnapChat’s recent fund raise from AliBaba at $15bn valuation.

intangibles

James E. Malackowski, chief executive officer of Ocean Tomo, the intriguingly named merchant bank that assembled this data, predicts that the tangibles/intangibles balance will shift back a bit in the next few years as various forces (higher labor prices in China, cool new manufacturing technologies, etc.) “fuel a return to tangible domestic investments.”

A stock market correction would bring down the intangibles percentage too — Ocean Tomo calculates intangible assets simply “by subtracting the tangible book value from the market capitalization of a given company or index,” so the rise in intangibles since the 1970s is in part just a reflection of rising stock market valuations. But that’s not all it is: the cyclically adjusted price-earnings ratio on the Standard & Poor’s 500 Index has risen about 2 1/2 times since 1975, while the intangibles increase has been almost fivefold.

So the modern corporation really is a different, much less bricky-and-mortary creature than its predecessors. In a speech in London earlier this month (it will eventually show up online here), Colin Mayer, a professor at and former dean of the Said Business School at the University of Oxford, cited the above data as evidence that we are on the cusp of a new corporate age. To illustrate, he recited an awkward yet informative knockoff of the seven ages of man from Shakespeare’s “As You Like It”:

At first the merchant trading company established by royal charter to undertake voyages of discovery and promote commerce around the world.

Then the public corporation created by Acts of Parliament to engage in major public works and the building of canals and railways.

Then with the freedom of incorporation in the 19th century, the private corporation — the seedbed of the industrial revolution and the manufacturing corporation.

Next comes the service firm and the rise of the financial institution.

The fifth age is the transnational corporation putting a girdle around the world and running rings around national governments.

Last scene of all that ends this strange eventful history is the mindful corporation — sans machines, sans man, sans money, sans everything.

Mayer’s prime example of this “mindful corporation” is WhatsApp, a company with no assets, no profits and very few employees that Facebook bought for $22 billion. “The mindful corporation is an extraordinarily efficient concept,” he quipped. He went on:

The fact that the corporation has become footloose and timeless could be a source of tremendous wellbeing that frees it from the political constraints and historical conventions to which we are currently subject.

The story doesn’t necessarily have a happy ending, though. Last year Mayer wrote a very interesting book called “Firm Commitment,” in which he argued that corporations had in the past succeeded and created economic value in large part by entering into commitments — with employees, customers, suppliers, shareholders and others — and that the modern ideology that corporations exist only to serve the interests of shareholders was endangering their ability to commit to anyone else.

As he summed up in his speech:

From entities with persistent ownership beholden to their nation states, corporations have transitioned into organizations with investors with no commitment to any particular nation or generation other than the present. The result is that the interests of the corporation have progressively diverged from those of the societies within which they operate.

The less tangible a corporation’s assets, the freer it is to escape commitment. This is apparent in corporate tax bills, as corporations where intellectual property plays the biggest role (technology and pharmaceutical companies, mainly) are most able to shift income from country to country to avoid taxation.

Another worry, mentioned by Mayer but expounded upon at length elsewhere (and with brevity on Bloomberg TV yesterday) by another former business school dean, Roger Martin of the University of Toronto’s Rotman School of Management, is that corporations where the value is mostly intangible tend to funnel income to the relatively small number of talented people who are credited with creating that intangible value, thus fueling a sharp rise in income inequality.

Mayer’s proposed remedy to these problems is what he calls the “trusted corporation,” companies built on the model of Bosch and Bertelsmann in Germany and Tata in India, owned not by footloose shareholders but by an industrial foundation. Short of that, he argues, corporations should be required to articulate a purpose beyond just maximizing return to shareholders, and directors should hold executives accountable for fulfilling that purpose.

This isn’t just academic noodling. Similar ideas are at the heart of the burgeoning B Corporation and NewCo movements, in which entrepreneurs commit to goals other than (just) making money. Something about the evolution of the corporation over the past few decades has begun to convince a lot of people that companies need a grounding in something other than shareholder return. And part of that something may be the fact that we can’t rely on buildings and machines and property to ground corporations anymore.

Mayer uses WhatsApp as his canonical example of a company with no assets and very few employees and yet a huge market cap (given its $22 billion purchase by Facebook), but just a short while before that Silicon Valley was all abuzz about Instagram for the same reason, albeit a lower price in relative terms.

Just wait until VR goes mainstream. The most valued bricks and mortar and real estate of today are digital. It’s a lot cheaper than the real thing, and a whole lot less regulated, too. Tech companies do love their degrees of freedom.

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Video of the week: Contagious Story telling

Why do some science stories spread, while others are easily forgotten? How do you properly utilize storytelling techniques when writing science stories in order to gain mainstream attention? Oscar award-winner, filmmaker, and screenwriter Scott Z. Burns revealed new answers to age-old questions of the craft and dives deep to reveal how he weaves fact with fiction together, and how he renders science information more manageable to appeal to a global audience, based on his vast experience and career as an award-winning Hollywood screenwriter.

Scott Z. Burns, is an Award-winning Producer/Screenwriter & mediaX Distinguished Visiting Scholar. His credits include: writer and producer of An Inconvenient Truth, the Academy Award-winning documentary, for which he received the Humanitas Prize and the Stanley Kramer Award from the Producers Guild of America.

Should startup marketplaces focus on transaction revenue?

Hand crafted goods marketplace Etsy recently filed for IPO and Erza Galston has a great analysis of it’s S1. Etsy is a powerful business with extraordinary network effects. Its customers are extremely loyal, and its committed sellers are earning significant income. But there are legitimate concerns: it is the quintessential case study on the challenge of low margin platforms. Additionally, it faces uphill challenges – a slowing growth curve and unclear product pipeline. Most importantly, the IPO comes at an inflection point as Etsy looks to expand from its niche focus to serving a much wider market.

Sizing up the space

To truly understand Etsy, it is important to size it up against a few other marketplace businesses: Homeaway, Shutterstock and GrubHub. Although they’re different, they’re all participants in some aspect of the freelancer/sharing/independent economy. They all aggregate wildly fragmented markets. They also all make a similar claim: that their platforms ultimately expand the total addressable market and earnings for their merchants, despite acting as a fee taking middleman.

To start, here are some high level stats to see how they stack up against Etsy. Note, Homeaway does not report the Gross Values transacted across its platform as much of its revenue comes from subscriptions. The following is to back out those numbers based on several assumptions.

Etsy1

Key takeaways

Growth is slowing. This isn’t a huge surprise. It of course becomes incrementally harder to grow at the same Y/Y percentage as scale increases. But it’s especially concerning that their growth slowed in the face of a marketing spend that more than doubled in 2014 from $18 million to $40 million (or, more accurately, increased by 40 percent on a percentage of revenue basis).

Seller services are paramount. Etsy’s gross margin has been increasing by a compounded 10 percent year/year for the past three years. Given that it has a consistent 3.5 percent commission and $0.20/listing fee, the obvious question is how that’s possible? Answer: Ancillary services, add-ons, and products all targeted at its power sellers. Etsy breaks out its revenue into two categories: Marketplace Revenue (3.5% + $0.20/listing) and Seller Services (everything else). At the end of the day, to buy into Etsy, you need to believe that this product-focused revenue will grow significantly and drive its valuation.

Extraordinary network effects. One of my favorite metrics to analyze is marketing spend as a percentage of revenue. In this regard, Etsy is outright compelling. Historically it has spent 40-70 percent less on a percentage basis than their competitors, while realizing similar, if not greater, growth rates than other marketplaces. “Network effects” may be a buzz term, but Etsy is the paradigm. Eighty-seven percent of traffic is direct/organic while 78 percent of purchases are from repeat buyers. There’s a reason they can spend a whole lot less on marketing than the competition: Their powers sellers drive acquisition on their behalf.

Was 2014 an experiment? Etsy will need to credibly communicate to the market that its 2014 marketing efforts were experimental – being the first time its ever ramped marketing efforts so quickly and with a focus on building self-sustaining international markets. Its S1 suggests the increase was mostly buyer-side SEM acquisition in these foreign markets (and research suggests minimal traditional TV or radio advertising). But the results were disconcerting with CAC nearly doubling in 2014.

The strength of the network

When investing in marketplaces, one of the defining factors I look for is evidence that the platform is generating sustainable and beneficial economics on both sides. For example, at Zipments, many couriers are earning nearly double as independent workers on the platform than at their prior messenger agencies.

Another example: Bloomnation received the following e-mail from one of its florists:

I wanted to take a moment out of my day to thank you for allowing me to be part of Bloomnation. I spoke to you months ago. I was really hit hard and struggling in Jan-Feb. I was worried being a single mom and this was my 15th year in business. I work alone in order to take care of my son. I had no clue how internet sales worked. Your company has helped me get out of the red zone I was in and revitalize the energy of my shop, flow[ing] with orders. I really really appreciate your orders coming into my shop. In June I was able to put my son into school so I could focus on more business. You helped me fall back in love with my life and love of flowers. I feel so happy its like the feeling of how I first started back in 1999 when I was 19 in my garage on the beach.

The reason this supply-side effect matters so much is because of power law distribution: namely, power sellers will be the primary drivers of scale on your platform. While the long-tail of one-off sellers does provide product breadth and liquidity, power sellers will drive both volume and organic referrals to their own native product stores.

Consider how this has played out in the case of Etsy (note that Etsy defines a 2011 Active Seller/Customer to include all 2011 actives, including those acquired between 2005-2010, which self-selects for a large number of existing power users):

Etsy2

In its S1, Etsy offered a glimpse into its 2011 cohorts of both buyers and sellers. In this breakdown, we see that although only 32.3 percent of sellers who had sold an item in 2011 were still actively selling in 2014, those who remained on the platform had developed into serious power sellers – on average $13K per active seller from that cohort. And as power sellers become smarter and empowered by better tools, I expect their average earnings to continue increasing. This is one of the most fundamental signs of Etsy’s strength – the ability for its sellers to earn a living.

On the buyer side, we see an identical pattern of highly valuable repeat purchasing emerge:

Etsy3

A typical cohort (2012-2014), will see year/year attrition of 80-85 percent or so, but the business isn’t built on one-time buyers. The power buyers are coming back and purchasing 110 percent year over year. One of the fundamental questions the public markets need to ask is how many of these customers exist in the market and can Etsy find a way to reach them?

But overall, on a high level, Etsy has done an impressive job maximizing value for its sellers, especially as compared to its competitors.

Etsy4Etsy5
​The statistic to look at here is that in spite of active sellers increasing by 63 percent over the past two years, GMS per seller correspondingly increased by 32 percent in the same period. This is in contradistinction to a normal supply/demand curve – and is additional proof that Etsy’s buyers and sellers are among the most loyal and committed.

By comparison, Shutterstock’s active contributors, which also grew by 63 percent in the same period, only saw its earnings per seller increase by 19 percent. Impressive to be sure – but only half of Etsy’s growth.

As an aside, Homeaway would appear to have decelerating value to its property owners. But their business is heavily subscription based and free-to-post listings (implying lower quality properties) are what’s dragging down the averages.

Etsy12

Nevertheless, Etsy and Shutterstock are also effectively free to create profiles and sell goods – whether high quality or not. It’s something I’d consider if I were an investor in Homeaway.

Marketing – CAC and payback 

From a pure customer acquisition standpoint, none of these businesses break out CAC or LTV the way traditional e-commerce businesses do. That said, I’ve made some assumptions to get a rough model:

Etsy6

Above is the broken down CAC for buyers OR sellers, assuming the entire marketing spend be allocated to either side. The biggest assumption made in this exercise is defining “new customers” simply by taking the current period’s cumulative buyers (or sellers) and subtracting the prior period’s. That’s obviously a poor assumption because there was (a) attrition among actives and (b) reactivation of dormant accounts. But in assuming that (a) and (b) roughly cancel each other out, we can get a sense of Etsy’s marketing engine.

That said, in reality, Etsy has two customers – buyers and sellers. Its S1 notes “Marketing expenses increased $21.8 million, or 122.2 percent, to $39.7 million in 2014 compared to 2013, primarily as a result of an increase in search engine marketing from Google product listing ads” (implying mostly buyer focused acquisition). So here’s what it looks like if we assume 80 percent of expense on demand-side (buyers) and 20 percent supply-side (sellers).

Etsy7

Overall, CAC increased Q/Q across the board, both for buyers and sellers alike. While worrisome, it’s also expected at Etsy’s scale as there’s a general law of diminishing incremental returns. But here’s why that matters, and how Etsy stacks up versus GrubHub and Shutterstock:

Etsy8

  • The glaring metric is how small Etsy’s average spend per buyer and its corresponding Gross Margin per buyer. Etsy is truly only a business that works at scale – which they have – but it’s a clear red flag to other businesses attacking spaces with small order sizes, tiny margins and only medium frequency of purchase. Very few businesses like that will ultimately make it – Etsy did – but it’s the exception: it should be a warning to entrepreneurs.
  • The reason GM per customer matters is because customer acquisition is darn hard (and getting incrementally harder) and large order sizes, large margins, or high frequency provide a vital margin of error. Etsy stacks up better than its competitors on Payback period, but its expensive 2014 eroded its Payback advantage.
  • Most marketers will tell you that, at Etsy’s scale, targeting a Payback of anything under 12 months is good. And even with its small revenue/buyer, it’s still well below 12 months. But the gap is closing fast. Even with its strong network effects, I fundamentally do not believe its CAC can be reduced significantly, if at all. That leaves two options: 1) Improve gross margin to enhance revenue/buyer or 2) Stop investing as heavily in growth to realize the benefits of its highly profitable, power users.

It’s not all about that base

The common thread across all these marketplaces is the continual move away from a dependency on pure transactional revenue. Here’s how all four consider their revenue breakdown:

Etsy has six main revenue sources: 3.5 percent transaction commissions; $0.20 listing fees and seller services; promoted listings; direct checkout; shipping labels; and point of sale payments (like Square Reader).

Homeaway has three main revenue sources: subscription revenue from property owners for bundles of listings which comprises 77 percent of all revenues; 10 percent transaction commissions from pay-per-booking listings; and a variety of ancillary revenue sources such as national and local advertising, property management software solutions, insurance products, and tax preparation services.

GrubHub has two main revenue sources. It’s notoriously tight-lipped regarding its exact commission structure, but most estimates put its base commission to be relevant on listings about 10 percent and variable commission for preferred placement.

Shutterstock has four main revenue sources: subscription purchase packages; on-demand pricing where sellers receive 20-30 percent of the purchase price; license revenue from its video and music assets; and ancillary revenue from its online learning platform SkillFeed or cloud asset management software, WebDAM.

For each of these marketplaces (with the curious exception of Homeaway) base transactional fees are of diminishing incremental importance – with ancillary products and services driving much of the platform margin growth. This likely explains why, for example, Grubhub has been so focused on entering the delivery game: a significant gross margin boost.

In Etsy’s case, the growth of non-transactional revenue is their strongest growth driver. So much so that they explicitly highlight the growth in their S1:

Etsy9

Etsy’s Seller Services revenue has nearly doubled from 25 percent to 45 percent of total revenues in the last two years and now includes a full 450bps of Etsy’s gross sales volume. Vitally, the hyper growth in these new categories is offsetting a tangible decrease in Etsy’s core marketplace gross margin – down 8 percent over the past two years – most likely from discounting to new customers which has a contra-revenue (and thereby margin-contracting) effect.

These Seller Services are doubly important because Etsy also covers credit card processing fees on marketplace transactions, cutting its marketplace GM from 5.65 percent to an effective 3.5-4 percent. With that in mind, the question investors should be asking is how expensive are these supplementary services to build and operate and can they continue to grow nearly 100 percent year over year?

Etsy10

Although 2014 revenue grew by 57 percent, overall expenses grew by 68 percent. The silver lining is that if you remove marketing expense from the calculation, annual expenses grew only 51 percent.

Investors should be pushing Etsy to break out these expenses more clearly. Last year was one of learning on the marketing side for Etsy, and we can expect performance and spend to stabilize in 2015. If that assumption is correct and if the expenses requisite to support seller services continue to mature, Etsy will have a healthy balance sheet – although, at the expense of hyper growth.

Isn’t crafting trendy?

Both GrubHub and Shutterstock go to great lengths to define the breadth of their space – $70 billion and $16 billion, respectively – with Shutterstock even commissioning a research report on the study. The home vacation rental market is massive, easily bursting into the hundred-plus-billion mark. But Etsy makes no mention of its market size – no comparison to arts and crafts supplies (a $30 billion annual segment). It’s a curiosity that reflects Etsy’s possible Achilles heel – that the market simply isn’t that big. It really feels intentionally omitted:

Etsy sellers offer goods in dozens of online retail categories, including jewelry, stationery, clothing, home goods, craft supplies and vintage items. Euromonitor, a consumer market research company, estimated that the global online retail market was $695 billion in 2013, up from $280 billion in 2008, representing a compound annual growth rate, or CAGR, of 19.9%. This growth is expected to continue, with the global online retail market becoming a significantly larger portion of the total retail market, reaching $1.5 trillion by 2018, implying a 16.6% CAGR from 2013.

With GrubHub at 2 percent market penetration and Shutterstock at (estimated) 2.5 percent if Etsy is nearing 10 percent of its addressable market, for example, that would certainly explain why its growth is slowing while GrubHub is accelerating in spite of identical gross sales.

While, in principle, the market for jewelry, home goods and craft goods is outright massive, Etsy’s strict guidelines around hand-crafted, artisanal products is certainly limiting. This concern that led to its major revision of seller guidelines 16 months ago as well as its launch of Etsy Wholesale just 9 months ago. Even so, the success of outsourced vendors has yet to be validated – and casts real concern around their total addressable market.

Running through this market size exercise would make me extremely wary as an early-stage investor of the myriad niche or vertical specific marketplaces targeting smaller markets. I’d go so far as to say that any space without a minimum of $5 billion in annual transaction volume is a non-starter.

The bet

If Etsy were to hit the public markets today at a $2 billion valuation (WSJ says $1.7 billion) here’s how it would compare to its peers:

Etsy11

On both a revenue and EBITDA basis, Etsy believes it deserves a premium to more mature, slower growing marketplaces, which is fair. But unlike GrubHub, its growth is decelerating – quickly – even in spite of its focused efforts to leverage high-volume whole sellers and point-of-sale.

The bet on Etsy is:

  1. The market is ultimately larger than we currently estimate, especially internationally. Because GMS growth is decelerating by 15-30 percent annually, you need to either believe that macro trends cause consumers to increasingly favor hand-made artisanal goods, or that they’re able to appeal to the non-handmade, non-artisanal yet “still boutique” buyer and seller.
  2. Etsy can continue to acquire and cultivate power users via low-cost marketing through the power of its community and network effects.
  3. They can continue to build and launch high quality ancillary products that an overwhelming percentage of their active sellers are willing to pay for (between 18-36 percent of all active Etsy sellers currently subscribe to each of their Seller Services) – thereby enhancing their overall Gross Margin.
  4. It’s able to build product and sustain community quality while simultaneously stabilizing (or contracting) overhead expenses.
  5. Their community and brand values render them not susceptible to even more niche/verticalized platforms such as Minted or Dawanda stealing ever precious market share.

Conclusion

Startup marketplaces should take note and think about how they can build non-transactional revenues in the future. There are two main reasons:

  • Non-transactional revenues enables more aggressive pricing for transactions which will grow the market and make it more difficult for competitors
  • Seller and buyer services increase switching costs making it more difficult for new entrants (again) and increasing life time value

In the early days – at least the first year or two – the focus should be on driving transactions, which are the lifeblood of any marketplace. After that non-transactional revenues should become part of the focus, particularly if there are any questions over the size of the opportunity.

Looking back: How we got to where we are?

After my last post reviewing our future, I got to thinking about how we got where we are and how innovation has worked so far. I believe that reflection is critical for progress and improved decision making. The following video explains my belief in brief.

In line with that thought, I really enjoyed Steven Johnson’s How We Got To Now. This book stood out because 1) the anecdotes were entertaining and relevant, and 2) it got the process of innovation right.

I’ll just pick one story here that I liked. Frederic Tudor was a Boston entrepreneur in the early 1800s who had the clever idea to ship ice from New England to the Caribbean:

The history of global trade had clearly demonstrated that vast fortunes could be made by transporting a commodity that was ubiquitous in one environment to a place where it was scarce. To the young Tudor, ice seemed to fit the equation perfectly: nearly worthless in Boston, ice would be priceless in Havana.

Not only was the ice almost free, but so was the shipping:

His New England base gave him one crucial advantage, beyond the ice itself. Unlike the U.S. South, with its sugar plantations and cotton fields, the northeastern states were largely devoid of natural resources that could be sold elsewhere. This meant that ships tended to leave Boston harbor empty, heading off for the West Indies to fill their hulls with valuable cargo before returning to the wealthy markets of the eastern seaboard. Paying a crew to sail a ship with no cargo was effectively burning money. Any cargo was better than nothing, which meant that Tudor could negotiate cheaper rates for himself by loading his ice onto what would have otherwise been an empty ship, and thereby avoiding the need to buy and maintain his own vessels.

He invested his life savings and years building his startup. Everyone thought he was crazy. The local paper wrote a snarky article about him: “No joke. A vessel has cleared at the Custom House for Martinique with a cargo of ice. We hope this will not prove a slippery speculation.” He even spent two years in prison when he went into debt (this was before one of the greatest legal inventions of all time- limited liability). He finally got his ice delivered but failed to predict one thing:

Despite a number of weather-related delays, the ice survived the journey in remarkably good shape. The problem proved to be one that Tudor had never contemplated. The residents of Martinique had no interest in his exotic frozen bounty. They simply had no idea what to do with it.

We take it for granted in the modern world that an ordinary day will involve exposure to a wide range of temperatures. We enjoy piping hot coffee in the morning and ice cream for dessert at the end of the day. Those of us who live in climates with hot summers expect to bounce back and forth between air-conditioned offices and brutal humidity where winter rules, we bundle up and venture out into the frigid streets, and turn up the thermostat when we return home. But the overwhelming majority of humans living in equatorial climes in 1800 would have literally never once experienced anything cold. The idea of frozen water would have been as fanciful to the residents of Martinique as an iPhone.

There is a saying that entrepreneurs should create “painkillers not vitamins”. This is bad advice. Painkillers are not very interesting businesses. Lots of people create painkillers, and they either work or they don’t, and nothing more is generated as a result. The really interesting companies create vitamins. You don’t know you want ice until you figure out what to do with it. Once you do, you discover all sorts of things you couldn’t imagine before, which in turn create new opportunities for invention and entrepreneurship.

The stories in the book ultimately argue for public policies that support networked innovation:

[T]here are social and political implications to these kinds of stories. We know that one key driver of progress and standards of living is technological innovation. If we think that innovation comes from a lone genius inventing a new technology from scratch, that model naturally steers us toward certain policy decisions, like stronger patent protection. But if we think that innovation comes out of collaborative networks, then we want to support different policies and organizational forms.

People who understand how innovation really works tend to support open standards, lenient immigration policies, well-funded university research, employee stock options, and significant restrictions of patents.

Is the future already here?

Spending my teenage years revelling in classic SciFi such as Star Trek TNG, I believed that future was as much about technological advancement as it is about social development. The issues of women empowerment and equal rights to all, irrespective of sex, race, creed or orientation was engrained very strongly in those shows. Now the question is: “Is the future already here?”.

Technological advancement

I recently stubled across this tweetstorm from Noah Smith which kind of got me think about the technological convergence.

 1/Far-future sci-fi is coming to an end.

2/This is because of technology. Tech is starting to change the basic parameters of the human experience – emotion, communication, etc.

3/We’re starting to realize how little our lives resemble those of our ancestors – and how much less our descendants’ will resemble ours.

4/All the far-future sci-fi now is posthuman/transhuman stuff. You read a Hannu Rajaniemi book and you think “These people aren’t like us.”

5/Or you read a Charles Stross book, and you think “These people *are* kind of like us…but how does that make sense??”

6/Far-future sci-fi was always about how technology changes a ton but humanity stays the same. Now we know that just doesn’t happen.

7/Maybe in the early 20th century, when tech advances mostly augmented our physical abilities, far-future people acting like us made sense.

8/But nowadays, IT and biotech advances are changing our societies and our minds, not just letting us move faster and life heavier things.

9/On the plus side, near-future SF, like Ramez Naam’s “Nexus” or Margaret Atwood’s “Oryx and Crake”, is getting more mind-blowing.

10/And what near-future sci-fi used to be – Neuromancer, Snow Crash, etc. – is now just called “real stuff happening in the news”.

11/I’ll miss the dreams of spaceships and aliens. But living in the sci-fi future is even more fun than reading it! (end)

I wonder if VR will inspire a growth spurt in near-feature sci-fi movies just because it is more cinematic and compelling on screen than most of today’s technology in which the primary action consists of a programmer typing on a keyboard.

Steven Spielberg is set to direct the movie adaptation of Ready Player One next, and I see it as a natural spiritual successor to Minority Report, which contained a lot of ideas from futurists that Spielberg gathered for a brainstorm session prior to production. Minority Report felt like medium-term sci-fi when it came out, and it’s already clear that many of its predictions were off. From a technological point of view, if not a social one, Ready Player One reads like very-near-term sci-fi.

Given the momentum of VR now, it’s time to mine this fertile ground for more high concept movies that explore the norms after mass adoption of the technology. Given the incredible price pressure on VFX shops in Hollywood, many of which are closing up or suffering margin compression, a spurt of movies featuring a lot of VR scenarios would be a welcome supply of work, too.

Euguene Wei could not contain his excitement when he said: “I realized the other day that I will watch, in my lifetime, a VR movie about VR technology. I’m excited. No spoilers please.”

Should we throw caution into the wind?

Tadhg Kelly makes an interesting point when he notes: “It always sounds a bit New Age, but most socio-marketing thinking about all things digital tends to conclude that everything is going atomic. You might call it tribalism, niches, the Long Tail or anything like that, but all spring from the same source: given choices the market takes choices. Given the opportunity to branch away from the slopstream of controlled markets, that’s what the market tends to do. By this we generally mean that digital rewards efficiency, like a better taxi service, a better shopping service, a better way to get everything you’ve ever wanted delivered to your door.

But we also tend to equate atomization to rewarding niches and say that going digital represents some fundamental disruption of monocultural user taste. Now you can satisfy your urge to listen to obscure Cuban Jazz because it’s out there somewhere, and by extrapolation so can everyone. This is sort of true but not as true as some would wish. The Cuban Jazz may indeed be out there (on Spotify or Pandora perhaps) but most of it remains unlistened-to. Users may have all the choices, but still tend to favor number 1 over number 11,111. This may be for social reasons (not wanting to be left out) or simple laziness (not wanting to go digging through multiple pages just to find the thing you want) but it’s fact.”

Long tail? Really?

Indeed as the digital realm has evolved it has often led to mono-networks, like the App Store, Netflix, Amazon, Google, Steam or Facebook. In theory the App Store is democratized in favor of many developers. In practice it’s top heavy. Same for Netflix, same for YouTube, same for trending posts on social networks. It’s easier to go with the default search engine that everyone says is good rather than strike out and find out what DuckDuckGo is. (And if anything this seems to be even more the case in Asia where some truly colossal companies pretty much are the Internet for end users). The long tail may exist, but it’s not as fat as was hoped.

Digital rewards some disaggregation and divergence, but both often simply to form new aggregation and convergence points. The determining factor of the degree of monoculturation seems to be whether the target audience is technically literate or not, and often the assumption that the audience will grow more so over time is unfounded. Digital divergence is also pretty bad at surfacing new ideas. In every instance of a new platform (such as Periscope, say) it automatically gets put to old uses (selfies, cats, etc.). The niches that the digital realm surfaces are often driven by a sense of cause, but that cause often pre-exists its digital kick.

So this is why sometimes the new doesn’t work. And sometimes why it does. This is why sometimes the revamped old doesn’t work. And sometimes why it does. Digital stuff seems to follow the adage that it’s better to tell new stories in an old way or old stories in a new way. But not new in a new way or old in an old. New media is best for retelling old tales while old media is best for telling new tales. Kickstarter for re-vamping old tech obsessions, television for Game of Thrones.

VR isn’t some scrappy startup scene like the Homebrew Computer Club. It’s a playground of febrile corporate vision projects of the kind that struggle to express what their market, product, purpose or business plan really is. Maybe VR seems awesome in demo, but nobody nowhere knows what it’s supposed to be for. This means VR needs a tribe to sustain it for the 1, 2, 4, 8 or 16 years it’ll take to become a thing. And so the question is whether the VR tribe is large enough. And if not, whether those outside the tribe can really be convinced to strap on the goggles. There are no direct analogies to answer that question, but plenty of negative pointers. One example is the general shape of the peripherals (fancy joysticks etc) business. If VR follows the peripheral-market model it’ll convert maybe 1 in 10 of existing users on platforms to its cause, that probably equates to a too-small audience. Another example is the user-repellence issue. VR, much like 3DTV and movies, makes a non-zero amount of users feel nauseous when they try it. That’s kind of a turn-off, and its solutions are increasingly amusing.

Tadhg signs off saying: “This is why I’m tending to be wary of both VR and smartwatches, and any claim that either represents the future. They may represent either end of a spectrum, but they represent extremes. Much as Google Glass represented an extreme or 3DTV represented an extreme they’ll have their devotees. But I have a hard time seeing either as anything other than a niche business – and each a niche business with structural issues. Rather than this being a year of tiny screens or giant eye-wrapping immersion, maybe this is a year when we’ll look at what we already have and figure out what more they can do. Maybe this is a time to tell new stories in old ways.”

Are we there yet?

On a technological level, I am convinced that we are slowly but steadily moving on the right path. On a social level, I am a bit concerned, especially given the rising tide of discriminatory legislation – recent developments in Indiana with its Religious Freedom Act. However, it is heart-warming to see technology leaders such as Tim Cook, Mark Benioff and Fred Wilson speak out on the issue.

It is my humble hope that we move beyond these issues and delve into the real mysteries of the universe. I will leave with Captain Picard’s signature phrase

Make it so

Platforms or Pseudo-platforms

Recently, Twitter curtailed Meerkat’s access to its graph. There was a lot of buzz about why and whether Twitter should just compete on its own merits with its recent acquisition Periscope. Twitter was not the only platform to do so. Look at the following example from a recent Apple acquisition featured on Wired.

Travis Jeffery is a software developer who’s been using a database system called FoundationDB for a project at his startup. Earlier this week, he noticed that the software had been pulled from the web. He soon received a terse email confirming that the software had been taken down intentionally, but little else. “We have made the decision to evolve our company mission,” it read. “And as of today, we will no longer offer downloads.”

Hours later, TechCrunch reported that FoundationDB had been acquired by Apple. Neither company has responded to our request for confirmation, and FoundationDB hasn’t updated its Twitter account since Monday. The only public acknowledgement the company has made of any changes came is a notice posted to the company’s support site featuring the same text that Jeffery received by email. He still hasn’t heard anything else from the company.

FoundationDB’s apparent shutdown won’t ruin Jeffery or his company. Other FoundationDB users might not be so lucky, however, if support for the technology really is being tanked. Sure, they can still use the copies of FoundationDB they’ve already downloaded and installed. But there won’t be a company providing support, updating the database to work with newer operating systems, or providing security patches.

It’s yet another a cautionary tale about putting too much faith in unproven companies offering proprietary platforms that could go away at any time—especially when a behemoth like Apple swoops in to buy it up. Often, such acquisitions are purely to hire new talent or integrate a startup’s technology into a new or existing product. In FoundationDB’s case, it’s unlikely that Apple wants to get into the business of selling enterprise database software.

That leaves companies that depended on that platform out of luck. And when startups suffer, so does innovation.

No Foundation

Like other NoSQL databases, FoundationDB offered a way to build databases that spanned hundreds or thousands of different servers, often housed in geographically distant data centers. That’s fine for many applications, such as messaging. It’s not a big deal if the occasional message accidentally gets delivered twice, especially if it’s only apparent for less than a second. But for other applications, such as financial systems, any discrepancy is a huge problem. You just can’t debit a customers bank account twice for the same transaction. FoundationDB promised a way to provide scalability without sacrificing performance — a truly rare combination of features.

It’s not clear why Apple would have acquired the company, but there are several possibilities. It might want to use FoundationDB’s technology to power its own web infrastructure, which ranges from iCloud to the AppStore to its mobile advertising service. Or it could just be acquiring the company in order to have its employees build new infrastructure for Apple to use internally. Or, perhaps, it’s both.

Had FoundationDB been open source, the community could have picked up where the parent company left off.

In the meantime, nothing is certain for FoundationDB’s existing customers. It’s conceivable that it could become part of the company’s developer tool offerings, or be open sourced at a later date. But in all likelihood the project is dead.

We’ve seen a number of similar situations in recent years. For example, cloud storage company Nirvanix which provided storage services for IBM’s cloud service, shut down in 2013, giving customers just two weeks to migrate their data.

Open Source’s Saving Grace

Former FoundationDB users will now have to choose between either continuing to use a piece of software that won’t be supported and won’t receive any security updates, and migrating to a new database. That won’t necessarily be easy since there are so few databases that work like FoundationDB. Had FoundationDB been open source, the community could have picked up where the parent company left off. There are examples of this happening elsewhere.

For example, a company called Couchio (later called CouchOne) was founded in 2009 to provide support for the open source database Apache CouchDB. In 2011, the company merged with Membase, another open source database company. The new company called itself Couchbase, and set to work created a new database that combined elements of both projects. A few months later, Couchbase announced that it would stop contributing to the original CouchDB project altogether.

Had CouchDB been a proprietary product, that would have been the end of it. Developers and companies who used CouchDB to power their software would have no choice but to either use an unsupported piece of software or migrate to the new Couchbase database. But since CouchDB was open source, other developers were able to continue its development.

There’s no guarantee that FoundationDB ever would have had the level of community involvement to make that happen, but by developing its product as a primarily closed-source system, it never even had the chance to build an outside community of developers to maintain it.

Regardless, Apple and FoundationDB could have handled the acquisition with more grace. Even though Jeffery’s company wasn’t using FoundationDB for anything critical, having to replace the system is still a pain. “We’re excited for them, and as users of Apple products, we look forward to seeing how Apple makes use of their technology and talent,” Jeffery says. “That said, we would have appreciated some more notice.”

Jeffery might not be bitter, but any users who were more invested in FoundationDB are probably feeling less forgiving right about now.

Platforms and Pseudo-platforms

Some have termed what happened to Meerkat and Travis Jefferey “platform risk,” and it is, but one must be willfully naive to consider ad-monetized social graphs like Facebook and Twitter to be ‘platforms’. I would rather consider them as ‘pseudo-platforms’

Amazon Web Services (AWS) is a ‘platform’. That is, you can count on it even if you use it to compete with its parent company Amazon. Netflix still uses AWS in their tech stack even as Amazon Instant Video is spending over a billion dollars on content to battle it out with Netflix in the video streaming space, to name one example, and I’ve yet to hear of any company of any size getting bounced from AWS because they were competitive to Amazon. You could even start a retail company and use AWS. It’s a utility like the power company.

The reasons why lie in both Amazon’s business model and philosophy. AWS isn’t free. This is crucial because Amazon makes money off of its AWS customers regardless of what business they’re in. As for AWS’s philosophy, you can call it altruistic or just pragmatic or both, but if Amazon wants to compete with a company that uses AWS, Amazon will try to beat them in the marketplace. If they can’t, they still get a bite of that competitor’s income through AWS fees. It’s a win either way, and considering AWS is a fast-growing platform that’s a critical piece of the world’s technology stack, it’s more than a minor one.

Compare this to free tech platforms offered by companies like Facebook and Twitter that make money off of ads targeted at their social graphs. If a company like Meerkat comes along and piggybacks off the Twitter graph to explosive growth and captures a unique graph, in this case around live video-casting, Twitter doesn’t make any money. On the contrary, since the network effects of graph-based products tend to lead to “winner takes all” lock-in, Twitter just ends up having armed a formidable competitor that it might have to spend a lot to buy or compete with later. It’s a no-win situation.

Facebook has similar ambivalence as a platform. Anyone familiar with the tech space in recent years can name more than one company that rode the Facebook graph and News Feed to explosive growth only to plummet off a cliff when Facebook turned a knob behind the scenes or just cut off access.

None of this should be surprising unless you’re some “don’t be evil” idealist. Take a more pragmatic view of tech and put yourself in Twitter and Facebook’s shoes. Would they want developers to build off of their platforms?  The most ideal developers on their platforms would be apps and services that publish lots of great content into Facebook’s News Feed and Twitter’s Timeline such that users spent more time in either service seeing ads.

The worst kind of developer would be one that used either the News Feed or Timeline just as a captive notification stream to build their own competitive social graph. Meerkat is guilty of at least one part of that. Meerkat leaves random links in Twitter that take users out of Twitter’s timeline to some other app to experience content, and Meerkat’s stale links just sit in Twitter timelines like branding debris or worse, as spam.

For all its press these past few weeks, Meerkat’s graph is relatively shallow. However, the potential for being first to get traction as another near real-time medium of note was rising with every live broadcast notification from another tech influencer. As Twitter knows better than anyone, it’s not necessarily how many users you convert in the beginning of your journey to create a high-value graph, it’s who you convert, and Meerkat had captured the imagination of some real luminaries. Furthermore, Meerkat is actually more real-time than Twitter, which lays claim to being the best publicly available real-time social network.

Notifications are the most valuable communication channel of the modern age given the ubiquity of smartphones, and Facebook and Twitter are among the most valuable information streams to tap into given their large user bases and extensive graphs. Email is no longer the summit of the communication hierarchy, and both Facebook and Twitter want to avoid the spam issue that polluted email’s waterfalls.

This conflict of interest is why I refer to Facebook and Twitter as pseudo-platforms. Unless they change their business model, any developer trying to build some other graph off of Facebook or Twitter should have a second strategy in place in case of explosive growth because access won’t persist.

Even before Facebook and Twitter, this type of platform risk from ad-supported businesses lay in wait to trap unsuspecting companies. Google search engine traffic is one of the more well-known ones. Google’s PageRank algorithm is, for the most part, a black box, and I’ve encountered many a company that fell on hard times or went out of business after Google tweaked PageRank behind the scenes and turned off the bulk of a their organic traffic overnight. As Google enters more and more businesses, that platform risk only escalates.

Alternative platforms do exist, even if they’re not perfect, and that matters because AWS, as developer friendly as it is, doesn’t offer a useful graph for companies looking for viral growth.

The most important such platform to date might be Apple’s contact book. It’s certainly one of the largest graphs in the world, and Apple doesn’t rely on advertising to those users for income. The App Store is not completely open, but it’s reasonably so, and once you’re approved as an app it’s rare that Apple would pull the rug out from underneath you the way Facebook and Twitter have.

Phone numbers were the previous generation’s most accessible and widespread key for identity and the social graph, and Apple’s iOS and Google’s Android operating systems and the rise of the smartphone suddenly opened a gateway to that graph. Many messaging apps bootstrapped alternative or parallel social graphs just that way. I doubt the telcos were looking that many moves ahead on the chess board, and even if they had, I’m not sure they would have had much recourse even if they had wanted to prevent it from happening.

Meerkat is a very specific situation though, and the reason I still think of Twitter and Facebook as valuable platforms, is that both developers and Twitter and Facebook can benefit from lots of other more symbiotic relationships with each other. These relationships are possible specifically because of the nature of Twitter and Facebook primary ad unit.

Both companies could do a better job of clarifying the nuance of just what types of relationships qualify. This would head off more developer frustration and prevent them from just writing off those two platforms entirely, as many already have. Given how many developers have been burned in the past, distrust is high, but I believe a lack of clear and predictable rules makes up more of the platform risk here than is necessary.

P.S: Adapted from Eugene Wei‘s post on Platform risk

Android as it stands now

However much Apple wanted to go ‘nuclear’ on it, Android is here to stay and will probably power the majority of smartphones in the near future. The key role Android will certainly play in wearable computing only adds to its considerable market power.

The Android juggernaut has a lot to do with Google’s innovative approach to licensing and their early commitment to open source. Open source distribution overcame the objections of the handset manufacturers and mobile operators who worried about OS lock-in, where Google might extract the highest-margin revenue from customers those operators and handset folks thought were theirs.

Android’s promise was that if a mobile operator felt threatened, they could compile their own non-Google Android from source, and run their own app store and cloud services. In practice, despite enormous investment by Samsung and others to offer alternative services, Android’s rise has been Google’s rise. Except, of course, in China, a market I’ll come back to discuss in a moment.

A lot is happening on top of the Android operating system: apps. Because, like Microsoft Windows and Apple OSX/iOS, Google both enables and competes with app developers who support its operating system, creating a fundamental tension in the market.

Some time back, Bill Gurley wrote about the brilliance of Google’s “less-than-free” Android distribution strategy. It played out more or less as Bill imagined it would, including the centrality of Google Maps. He saw Android as a defensive “moat” around Google’s search business. This was a logical assumption at the time, but the reality turned out to be a lot more complicated. The mobile eco-system we have in 2015 is dominated by apps not the browser-centric mobile web, as some anticipated. And that is a crucial difference.

The primacy of apps has three interesting implications for search, and ultimately for Android itself. First, the rise of messaging and social media apps has made traditional search less relevant — you find your content curated in your Twitter feed or on Snapchat, not via a search box. Second, a lot of high-value (read: monetizable) search has moved out of the browser into vertical apps. You look for restaurants in Yelp or OpenTable, you start your shopping search in Amazon, you look for car service in Uber. Third, the most lucrative “search” in mobile has turned out to be app installs which are largely driven from inside other apps rather than from search engine advertising that Google dominates (installs are a cornerstone of Facebook’s mobile revenue, for example). Mobile app companies have created considerable value riding this shift from search-driven discovery to app-driven discovery.

Google’s response has been to elevate its own apps and services — the Google Mobile Suite — to the central business position in Android, to de-emphasize the Android Open Source Project where the core OS resides, and to create leverage into 3rd party apps through an API that insinuates Google’s content and services, such as Map or Wallet calls, into 3rd party commerce flows. Google has doubled down on Gmail (and by extension the Google+ identity system), cloud storage through Drive, Google’s office productivity apps (Docs, Sheets, etc.), the Play store, Wallet, and most importantly Maps, which may be the most valuable and organically mobile search platform.

As late as 2013, at the Mobile World Congress in Barcelona, Google’s Andy Rubin was saying: “[O]pen is good … Competition is good. We built Android because there was no open operating system.” But as any carrier or handset manufacturer can tell you, Google has recently linked their attractive Android licensing to guaranteed distribution and placement of the Google Mobile Suite, and has started tightening compatibility certifications, ostensibly to “protect” customers. This is very troubling to carriers and handset manufacturers looking to create value through software, and very troubling for app companies competing with Google, particularly as Google has started increasing the “tax” for API access to things like Maps.

Everywhere, that is, except China. Politics, protectionism, and the threat of uncensored search have kept Google largely out of the Chinese market. Open Android, not Google Android, is the dominant smartphone OS in the country, with multiple variants compiled from Android open source distributions. Last December, the Chinese mobile company Xiaomi, whose phones run an Android variant (rumored to be a heavily modified version of Cyanogen’s CM9), became the most valuable private company in the world.

China’s mobile market is an interesting case study, because it has developed without the looming market power of Google (and, while China is a healthy iOS market, Apple doesn’t have the same hold on Chinese app developers that it has in the West). In China, the value in the Android eco-system extends broadly to 3rd party messaging (Tencent’s Weixin) and 3rd party e-commerce (Alibaba’s Taobao) without a commensurate platform tax. These Chinese mobile/internet providers have become incredibly powerful, valuable companies.

With mobile clearly the world’s most important commercial battlefield, and with four out of every five smartphones worldwide running Android, the role of an independent, truly open Android is of significant importance to every constituency in the mobile eco-system — from carriers to handset manufacturers, from app developers to end users.

Android taxonomies

For reference, and, perhaps, discussion: ‘Android’ means lots of different things, and there’s a lot of confusion about forks, Xiaomi, China and AOSP, as well as ‘the next billion’. So this is how Ben Evans thinks about this. First, there are actually (at least) six types of ‘Android’ in the market today

  1. ‘Stock’ Android, as seen on Google’s Nexus devices, complete with Google services (but with tiny unit sales)
  2. ‘Modified’ Android, as seen on phones from Samsung, Sony, LG etc, complete with Google services – generally, these are modifications that no-one especially likes, but which Google explicitly allows
  3. ‘AOSP’ or open Android, as seen in China – essentially these phones are the same as number 2, but with no Google services and apps from the Chinese portals embedded instead. Hence Samsung, Sony etc sell their phones in China without Google services, but few other changes
  4. (or perhaps 3.1) ‘Modified’ Android as seen on Xiaomi phones and those of its followers, which people actually seek out, and which comes without Google services in China and with them elsewhere
  5. ROMs and third-party implementations of Android that are available for any handset, such as both Xiaomi’s MIUI and Cyanogen (an a16z portfolio company), which may or may not have Google services included or accessible. Again, these contain optimisations and improvements that make people seek them out
  6. Forked Android, such as the Kindle Fire phone: Android heavily modified to produce a different experience, and Google refuses to allow Google services to run on them (other than plain old web search, AKA POWS). Note that Xiaomi and Cyanogen are not forks.

The first two or perhaps three I would describe as ‘closed’ Android and the second three are ‘open’ Android, certainly from the perspective of device manufacturers. The first two (actually just number 2) have over a billion users outside China (as of the numbers given at IO last summer). Versions 3 and 4 have a further 400-500m users, almost all in China, and there are perhaps 50m users of 5 ( a very rough estimate) both inside and outside China, partly overlapping with the others. Six – well, ask Amazon.

In parallel, it’s worth breaking down Android users in a similar way:

  1. ROM users (very roughly, perhaps 50m people)
  2. People who like to install the kinds of apps that do things Apple doesn’t allow on iOS and Google does allow on Android (note that Apple now allows rather more things and Google does not, oddly, allow gambling apps)
  3. People with a personal preference for Android, who none-the-less do not actually install ROMs or do many things that are blocked on iOS (the difference between this and 2 is a grey area, obviously)
  4. People who don’t actually care very much one way or the other between Android and iOS, and (for example) got a good deal, preferred the handset design or (especially) the larger screen size that used only to be available on Android, and indeed might switch back and forth between iOS and Android
  5. People who can’t afford iPhones or other high-end phones and so got Android as the cheaper option.
  6. People who actually don’t care about smartphones at all, and so just bought a ‘cheap phone’ (or just a  phone with a good camera, say), and happened to get an Android since it’s taken over most of the mid range and low-end, and who don’t do much with the ecosystem
  7. People in emerging markets who really can’t afford anything other than a $50 or $100 Android phone but are enthusiastically taking advantage of everything it can do.
  8. As above, but have a relatively expensive data plan, limited 3G coverage and, often, limited access to power to charge their phone (this one is is where the ‘next billion’ will sit)

Some of these categories (but obviously not all) also apply to iOS, of course, but selling phones only at $600 for the latest model creates a more uniform customer base.

Layered across both of these is huge geographic variation. The must-have phone for teenagers in San Francisco and Jakarta is very different. But the underlying point about both lists is that tech and mobile have grown far past the point that there is really a single market for anything. When you connect everybody you get, well, everybody, and they’re not all like you.

P.S: Ben Evans and Mitch Lasky have great posts on the Android ecosystem from different view points

Fred Wilson looks back on the evolution of Investing and Entrepreneurship

Mark Suster (of Upfront Ventures) sits down Fred Wilson (of Union State Ventures) and takes him down memory lane to gather his experiences in the world of venture capital over the past 3 decades. Fred is amazingly candid and honest in this video and gives a great perspective on the evolution of the startup ecosystem over the years but more importantly insights into the real life of venture capitalists.

Best of Startup L. Jackson

Who is Startup L. Jackson? Is it some kind of a super-advanced AI bot that Elon Musk has been warning us about? Or is it some world class venture capitalist with a profound sense of humour. Either ways, it is a refreshingly new take on the startup ecosystem.

Raise enough that if things go well you can get to the A

How much money should you raise? Startup L. Jackson uses an “enough to get to real” standard because he is very focused on the need for delivering metrics at an A round. Josh Kopelman recently argued: “You should target 18 to 24 months of runway post Series Seed. The best time to raise follow-on capital is when you don’t need it, and 2 years of runway gives you the best chance to land in that situation.” Mark Suster has given advice on this, and Fred Wilson has a view you can see in a video here that argues in part that ‘less can be more’. Fred Wilson seems more focused on the amount raised by the startup when he said  “I just think if you’re forced to figure out how to get from here to here on a million bucks, if you’re good, you’ll figure out how to do it.

When a startup is raising a seed round they are often able to get away with selling a dream because if they are audacious enough in attacking a massive market what they plan to do can’t be captured in a spreadsheet. Chris Dixon makes that point when he points out: “If you are arguing market size with a VC using a spreadsheet, you’ve already lost the debate.” That is why at the seed stage the best pitch is a great narrative. The story/dream must be audacious and compelling and take place in a massive market with just the right team. Don Valentine also lays it out saying “The art of storytelling is incredibly important. Learning to tell a story is critically important because that’s how the money works. The money flows as a function of the story.

Startup Jackson points out that Founders should keep in mind that venture capital is a cyclical industry, as pointed out many times by Bill Gurley. Doug Leone has also discussed dilution when he says: “Be incredibly, ruthlessly selfish with your equity.

The hard part about raising money as a founder is raising enough capital so that you can focus on the business, have a margin of safety and enjoy significant optionality but still have the discipline to focus on aspects of the business that are genuinely important instead of four different things that are insanely distracting. Bill Gurley makes that clear when he says: “We like to say that ‘more startups die of indigestion than starvation.” If you raise too much money you can end up solving things with money instead of with innovation and great company culture. Keith Rabois also makes that point: “Many entrepreneurs are raising more money than they need and it can cause derivative consequences down the road that are not healthy.

Most startup outcomes are binary. Optimizing for the size of your slice is almost never a good idea if the pie is big. Raise enough to bake a big pie

The data undeniably shows that financial success in venture capital reflects a power law. John Doerr makes it saying: “The key insight is that actual [VC] returns are incredibly skewed. The more a VC understands this skew pattern, the better the VC. Bad VCs tend to think the dashed line is flat, i.e. that all companies are created equal, and some just fail, spin wheels, or grow. In reality you get a power law distribution”. Peter Thiel basically says that if you end up with a Unicorn result (a big pie), everyone gets rich. A venture capitalist or a founder getting a very high share of a 0% return is neither helpful or wise.

The worst possible thing you can do to your business is raise just enough money to throw up mediocre metrics right around the next round, especially with a high valuation you can’t back off of

Broken cap tables are a huge problem as Fred Wilson has noted, Jim Breyer discussed, and Sam Altman states simply: “don’t forget the prime directive of fundraising strategy: set things up so that you never do a down round. The badness of a down round is difficult to overstate; in fact, the threat of that is the best reason not to take a super high price when you’re offered one.  If you raise at such a price, everything has to go perfectly in order for your next round to be an up one.” Metrics referred to by Startup L Jackson above will be discussed more below, including the Five Horsemen (CAC, WACC, ARPU, COGs and churn) and their friend customer lifetime value.

The existential threat to early-stage startups is almost always lack of demand. There’ll be infinite VC to fix tech if you clear that hurdle

Ann Winblad agrees when she says: “‘The market bats last’ means ‘Have you figured out: are there customers out there?’ ‘Do the dogs have their head in the dish? Are the customers buying?‘”

Getting to product/market fit and proving that “dogs are actually eating the dog food” is essential. If you want to know even more about how product/market fit fits into building a business Paul Graham lays it out here: “You need three things to create a successful startup: to start with good people, to make something customers actually want, and to spend as little money as possible.” Too many people forget that you need to solve a real customer problem. Without that, the business is toast (not even the artisanal variety). Reid Hoffman describes the other key element here: “If your technology is a little better or you execute a little better, you’re screwed. Marginal improvements are rarely decisive.

“Most successful startups are overnight success. That night is usually somewhere between day 1000 and day 3500.”

“If you’re competing on price, it better be the case that the incumbent’s cost structure doesn’t allow them to do the same.”

“BigCo may be late to market, but if there’s not a winner by the time they show up, it’ll probably be them. Go faster.”

As Rich Barton points out: “Ideas are cheap. Execution is dear.” Relentless perseverance is a requirement for any founder. Reid Hoffman asks: “Where’s the contrarian thinking that, if they turn out to be right, could be really, really big? Consensus indicates it’s probably not a total break-out project. If your thinking isn’t truly contrarian, there’s a dog pile of competitors thinking the same thing, and that will limit your total success.”

Ann Winblad has said: “We invest in markets. If the opportunity is not large, then the business, independent of the people or the technology, will fail. Because of this issue of intense competition and capital efficiency, opportunities always get smaller as soon as you fund the company.”  If you can’t get to $100 million in revenue the math does not work for the venture capitalist since the failure rate is so high, says Bill Gurley.

Can we start referring to the obligatory five year revenue forecast slide as uniporn?

Michael Mortiz could not make this point more simply: “Five-year plans aren’t worth the ink cartridge they’re printed with.” Good venture capitalists mentally giggle when see hockey stick shaped distribution curves based on unrealistic assumptions that don’t map to reality. Chris Dixon has talked about this saying: “If you can’t make the case that you’re addressing a possible billion dollar market, you’ll have difficulty getting VCs to invest.” Bill Gurley makes the point as well: “If your idea is not something that can generate $100 million in revenue, you may not want to take venture capital.

You can iterate your way out of stupid ideas, but you can’t iterate your way out of stupid

Heidi Roizen has said: “Things outside of your control will happen. You need to lean into this fact.” One great way to deal with uncertainty is to have optionality. Warren Buffett treats cash as a call option with no expiration date or strike price. Warren Buffett also says that “cash combined with courage in a crisis is priceless.” Vinod Khosla describes the situations faced by most founders: “Bad times come for every startup – I haven’t seen a single startup that hasn’t gone through a bad time. Entrepreneurship can be very depressing. If you really believe in your product, you stick with it.

Effectiveness is knowing 10 things will kill your startup this year and being able to block out all but the one that will kill it this month

Jim Barksdale made a very intersting point when he said “The main thing is to keep the main thing, the main thing.” Bill Gates said once: “Being a visionary is trivial. Being a CEO is hard. All you have to do to be a visionary is to give the old ‘MIPS to the moon’ speech — everything will be everywhere, everything will be converged.  Everybody knows that.  Which is different from being the CEO of a company and seeing where the profits are.

Once you’ve completed this exercise you can go to investors and say ‘We see our Series A happening in X months, when we hit Y metrics. We believe we need Z dollars to hire A-C, grow with D strategy.’ This turns out to be a great way to figure out if investors are smart. Good ones will help you build a better plan and you’ll be better for it. Bad ones will have poor feedback or just ask you where to send the check

Chris Sacca points out: “Good investors are in the service business. There are angels who have 75 companies and don’t call any of them ever.” Keith Rabois reiterates: “Early stage, almost every successful entrepreneur I know doesn’t care as much about the economic terms as much as who they are going to work with.” There is a huge difference between an amateur and a professional seed stage investor.

 Viral is not a product. Beware those selling it

Acquiring customers at a low customer acquisition cost (CAC) is great. What is not to like about organic growth where customers are obtained in a cost effective way? Mark Andreessen has made this point: “Many entrepreneurs who build great products simply don’t have a good distribution strategy. Even worse is when they insist that they don’t need one, or call no distribution strategy a ‘viral marketing strategy’ … a16z is a sucker for people who have sales and marketing figured out.”  Reid Hoffman adds: “What a lot of people fail to realize is that without great distribution, the product dies.

The startup that treats their investors like a bank and only calls when they run out of cash is missing opportunities

As Rich Barton points out: “Get the highest octane fuel in the tank [when choosing a venture capitalist].” Keith Rabois again weighs in: “If you have the option, raise money from one lead investor who has the right skill set, background, and temperament to help you.” As far back as when Arthur Rock was more active: “We spent a lot of time with our companies… [sometimes] if you divide up the number of companies they’re invested in by the number of partners, you find that the partners haven’t got ten minutes for any one company.

The Benchmark Capital partners have talked about how founders can do due diligence on a venture capitalist in this video. Founders that don’t work at and devote sufficient time to this due diligence process are, well, bonkers given it is a business relationship that can last more than 10 years.

Predicting failure is easy. You can have no clue, a startup can be brilliant, & you’re still probably right. Let’s see you pick winners

Most startups fail, as both Marc Andreessen and Fred Wilson have pointed out.  Getting actively involved as a venture capitalist in the small number of big winners is hard, which is why the distribution of success among venture capitalists is a power law, not just inside their portfolios. Mike Mortiz says: “[Venture capital] is a business that’s always had the investment returns concentrated in very few hands.”

Chris Sacca puts this post to bed: “As investors, VCs are wrong more often, than we are right. As a VC, I’m wrong most of the time, so whenever any of the VCs tell you about the rules etc. it’s really, because we’re wrong all the time. You should expect me to be wrong most of the time. When I’m right, I’m really really right. That’s what you should expect from a VC.

Key people covered in the article (I strongly advise following their phenomenal work)

  1. Chris Dixon
  2. Don Valentine
  3. Josh Kopelman
  4. Mark Suster
  5. Fred Wilson
  6. Bill Gurley
  7. Doug Leone
  8. Keith Rabois
  9. John Doerr
  10. Peter Thiel
  11. Jim Breyer
  12. Sam Altman
  13. Ann Winblad
  14. Paul Graham
  15. Reid Hoffman
  16. Rich Barton
  17. Michael Mortiz
  18. Heidi Roizen
  19. Jim Barksdale
  20. Chris Sacca
  21. Mark Andreessen
  22. Vinod Khosla

P.S. This article is adapted from Tren Griffin‘s post on the same topic

Video of the week: Virtual reality explained through optical illusions

Facebook has been making waves over the last couple of days with a series of interesting anouncements over the last couple of days at the F8 Developer Conference in San Francisco. Michael Abrash, the chief scientist for Facebook’s Oculus, took the stage during day two of the to blow everyone’s mind with some trippy optical illusions.

These pills aren’t blue and red, they’re the same shade of gray

As we all learned when “The Dress” took over the Internet in February, our eyes can play some serious tricks on us.

The blue tiles on the left and the yellow tiles on the right are really the same shade of gray, too

During the keynote, Abrash highlighted some interesting illusions to explain how we can trick our eyes into thinking what we’re seeing is reality. And according to Abrash, these perceptions, and the assumptions our brain makes about them, are what make virtual reality work.

The lines on this checkerboard stay straight the whole time

P.S.: Gif source: Mashable

I strongly recommend reading Ben Thompson’s detailed article explaining the possible impact of the F8 announcements in his post ‘The Facebook Reckoning’.