A Microsoft Ass Whooping

by mbmccall

Two key theme we discuss often here are: the importance of simplicity and transparency with customers and beware of strategics. Well…

Microsoft recently launched the Zune player. It is a massacre. You have probably seen the (uniformly horrible) reviews. It could be one of the quickest tube shots (or bloodiest) in the history of consumer electronics. Surprisingly enough, this is the same team that successfully launched the XBox and has put Sony in its current bind. Why the issue?

There are two culprits: Microsoft is trying to be too cute and they are also dancing too close to the devil.

Respect Your Installed Base:
In order to grab exclusive control over the player and content, they have sold all of their Windows Media Player partners downstream (Rhapsody, Yahoo, etc). The Zune will not accept their music and you can’t buy Windows Media content at the store (sorry Samsung and all). So, trying to be cute and stealing a page from Apple’s book, they have ended up throwing away one of their few assets…an installed user base.

Minimalism and Common Sense:
In order to throw in all their function (like WiFi sharing), they have made a clunky, brown music player. It is much larger than the iPod and looks more like an Archos. It’s like Windows vs Mac all over again.

Make Purchase Simple and Eliminate Friction:
Microsoft has hired a few too many consumer consultants on the design of their music store. The complexity of buying music is amazing. They are getting too cute for their own good. You have to buy in $5 chunks which forces buyers to give Microsoft float. You don’t buy with dollars, but with points since consumers tend to spend more money when they redeem points versus dollars (think of your average kids fair). You also redeem 79 points for a song which is designed to make you think it is less than the $0.99 Apple songs. In other words, they try to game you at every corner. The result is a convoluted solution with lots of friction points.

In contrast, the Apple store has one click purchase, stores your credit card, charges you $0.99 and you can buy whatever quantity you want. It is so simple, I find myself buying way to many songs since I just look them up and then click buy.

Give the Devil the Heisman:
I have danced with the record labels and they will pile constraints on you until they make your business model unworkable. Strategics don’t think rationally in fast moving markets and, like a drowning man, will take you down with them often.

Many of Microsoft’s woes are driven by restrictions thrust upon them by the labels including, I am certain, much of the idiotic DRM scheme. I saw, first hand, an investment (Dataplay) bury $180m in the ground because of DRM restrictions demanded by the labels.

As one of my favorite CEO’s, Tim Stultz says "Ask for forgiveness, not permission."

I own Macs everywhere, am drowning in iPods and enjoy our XBox 360. Thank goodness for Microsoft that Apple hasn’t come into console gaming…

What Sequoia Expects from Entrepreneurs

by mbmccall

Entrepreneurs are always trying to figure out what it takes to get funded by the brand name venture groups. VCRatings recently wrote a post using Sequoia’s website criteria for what they look for in a start-up. While these seem fairly straight forward, I thought it would be helpful to expand on some points. Historically, the elements that are the hardest and most intangible are:

1) Team DNA: this is one of those "you’ll know it when you see it". However, if the VC knows more about your space or business model than you or you come across as naive due to your claims, it is not a good start. The tech world grows more Darwinistic each day and those with the best street smarts win (not always the brightest). "A’s" attract "A’s".  Compare your team (honestly) and yourself to your highest profile competitors and determine how you stack up along the lines of creativity, tenacity, execution, public persona and such. Also, do the same against the "best in class".

2) Think Differently: VC’s get lots of pitches on any given area. It is those teams that can think about a problem or solution from a different angle, especially one that makes it more defendable, that stand out. It makes a VC want to hear more about how the team views the problem. Teams that can approach a problem from a different angle are advantaged since other competitors will be biased towards their own way of thinking (which may be flawed or too traditional/cookie cutter). This gives the team a head start and on-going advantage if they have the better mousetrap regarding approach.

3) Agility and Frugality: Iterate quickly and see what the customer wants. Keep it simple. While you’re at it, don’t spend a lot. Money doesn’t solve problems but usually causes defocus. Mike Cassidy (of Direct Hit and Xfire fame) believes in keeping everything to a minimum when launching to force focus and discipline. Think small and fast.

Sequoia_criteria

Google Cocaine

by mbmccall

The paid search revenue model is very addictive. New companies are launching everyday, leveraging online paid search engines to drive revenue. This obviates the need for bag carrier or other uncertain, high cost sales models. With cheap, commoditized infrastructure, any Joe and their dog can get into the online game. There has also emerged an enormous lead gen industry of players who simply arbitrage between what buyers (Lending Tree, etc) are willing to pay for a lead and what the intermediary has to pay through search, affiliate, etc to get the lead. Several years ago, you could drive a truck through this margin. In fact, while I could never talk anyone into it, I wanted to set up a hedge fund/trading firm targetted solely at profiting from the online efficiencies. Adteractive has built out a massively profitable business doing this for companies and pocketing the differential. It is rumored that after only 3 years, they were doing over $100m in revenue and dropping tens of million in cash flow.

The beauty and the curse of efficient markets is that everyone else has seen this and jumped into the market. Like hedge funds with stocks, one and two man operations are targetting every niche of the web, seeking out arbitrage opportunities. As a result, search has become perhaps the most expensive online acquisition channel, followed by affiliate marketing. Marketing emails to house files are by far the most profitable and efficient channel.

There are economies of scale to search as well. The larger you get and the more you do it, the more efficient you become. To begin with, Google and crew are continually tweaking their models, resulting in dramatic changes in results. You have to stay on top of these changes, especially for organic. On the paid side, companies grow more efficient through experience. They optimize price vs. word vs. position. This allows the bigger to get bigger at the expense of the smaller players. Niche players can do very well in their core areas (these are usually Affiliates who then resell their traffic on an affiliate basis).

However, the days of wine and roses is drawing to a close for the average mom & pop. As more and more of their competitors come online, two things drive the competition. How big the margin on their product(s) are (e.g. how much money do they have to work with) and their conversion rates. People wanting to win the search game need to enter with a margin advantage which gives them more room to bid. More importantly, conversion determines, often, the eventual winner. If we both spend $10 for traffic but you convert twice a well as I do, then you are making twice what I am on that traffic and can bid more aggressively. This creates a virtuous cycle. Landing pages, page layout, web experience as well as branding drive conversion on the sites. Again, more experienced players know best how to optimize their user experience and drive up conversions.

Interestingly enough, during recessions, search becomes much more attractive as rates fall through the floor. We will see what will happen during the next one (many say next year). During these periods, a well run operation can dramatically build up business by taking advantage of lower ad rates.

Like any market, the search market grows more efficient with each day. People begin to look far and wide for new arbitrage opportunities. As our economy continues to heat up and as Web 2.0 players flood onto the scene, this will eventually become an infeasible channel for many players. If you play this game, realize the key levers in the model and act accordingly. In particular, if you are in the lead gen world, move your model, if possible, from pure arbitrage to a more vertical model where you differentiate yourself on different elements. Some players are moving all the way back to owning product and look more like traditional web businesses. They can then leverage the profits of the business to continue feeding their search crack addition.

Good luck…

VC Return Myth

by mbmccall

I often see in the press that a company was acquired for $x million (say $200m) after having taken $y million in investment (say $20m). They often then go on to say that this led to a 10x return on investment.  This is wrong unfortunately (for us VC’s). The final return depends on what valuation the money came in at. If the VC’s owned all the business, then it is 10x. However, if they came in at a $280m valuation, they made 1x their money if it was preferred stock and about 1.6x if it was participating preferred. On several occasions, I have seen articles written about exits in our network where I know that investors made 3x their money. The articles put the return at a significantly higher level.

An example of this is the YouTube acquisition. Some speculate that the initial $3.5m in Sequoia money went in at a  $15M valuation which would give them roughly a 20% stake and that the second $8m tranche went in closer to $200m in value. I don’t know the right numbers, but if this is correct, then Sequoia would end up with about 23% of the company when the dust settled or about a $380m payout. This would result in a 33x return on their money. Not bad for a year and half’s work. That said, I have also seen some articles or posts talking about 100+x money.

Many reporters dig deeper to get to the real numbers. However, when you see an article about a big exit, don’t always assume that it resulted in a big win for the investors. We have been known to over-price our deals on occasion (more so these days) and this obviously impacts the return multiple.

Tree Whacking

by mbmccall

Chicago was hit by its first hard snow of the winter. American cancelled a lot of its flights from midnight through noon today and the roads are an icy mess (though starting to shape up). Our dog is in second heaven, jumping through the snow and as we shovel the walkways, thinks we are throwing him something and keeps digging into the tossed piles for his prize. The upside of all of this is that everywhere has a beautiful, white blanket which should last for a couple of days.

However, the dark side of this is that we have about 150 feet of Arbor Vitaes which bend over in the snow. If not addressed, it freezes there and permanently harms them. So, I get to go out and whack both sides of the hedges with a broom. I end up covered in snow, soaking wet and suffering a near heart attack from the significant activity over about an hour and a half.

I gave up snow blowing since our driveway is too long and gladly pay $50 for a plow to come through. As I whacked away, I wondered if there wasn’t an invention that could save me from by anguish on the bushes. I could see it selling on Midnight infomercial with the wood chippers, Alpaca’s and Ab Loungers. Email or comment with any suggestions!

Sunday I will go back to a more traditional post about "Google Cocaine" (credit to Sridhar Murthy at our company, TicketsNow, for this).

Chance Encounter

by mbmccall

"Chance favors the prepared mind" — Louis Pasteur

My love/hate relationship with the Economist continues here on this post. I love to read the Economist as it is, in my opinion, one of the best written (if not the best written) magazine in circulation. Because of the breadth of international topics and the density of its articles, it take me quite a while to hammer through it. I hate how they stack up as I try to find time to get to them, but well worth the effort… So, here is a second post from the most recent issue.

In the Economist article "The Universal Diarist",  it talks about the formation of and on-going success of Six Apart. (Quiz: what is the origin of the name…and it is not Kevin Bacon). Since I blog on their platform and have looked at using most of their offerings, I am quite familiar with the firm. I am debating using their most recent offering, Vox, for more personal applications. Mena Trott uses Vox to chronicle her life with uploads of video and photos (including cell phone shots) from her day to day life for descendants. I digress here.

What I find most interesting in this article is how "accidentally" they came across their business. At 23, Mena started posting personal observation about childhood, pets and such on her site Dollarshort. In one post (about her husband), she surprisingly began to receive a variety of comments from a broad array of people, giving her advice or expressing emotion about her situation (buying a banjo of all things). She was surprised by the breadth of readers and about their willingness to dive into dialog with complete strangers. The light bulb went off in her head…the era of mass media was being replaced by "intimate media" in the web 2.0 world.

Like Alexander Fleming’s accidental discovery of Penicillin, Mena stumbled upon the core idea for Six Apart by chance. The same can be said of Pierre Omidyar in the founding of eBay (wanted to create a site for his girl friend to buy and sell her Pez collectibles). Chance plays a key role in the creation and success of businesses. However, being tuned into and on the lookout for opportunities in the noise is also a key ingredient. For every issue or problem or set-back, you also have a potential opportunity for a solution. However, our normal reaction is to bemoan our situation and struggle through it. It is rare that we tune into where there may be opportunity. This needs to be reprogrammed into our daily living in a very systematic manner whether it be personal encounters or business setbacks.

Bill Miller, one of the most talented investors of our era, recommends a book on chance called Fooled by Randomness: The Hidden Role of Chance in Life and Markets by Nassim Nicholas Taleb. Worth the read for those into this kind of work.

Down on the Street

by mbmccall

"No longer can America take for granted its global superiority as a market for capital"
— the Economist

In a recent November 25th article "Down on the Street", the Economist lays out a very compelling analysis and overview of the mess our domestic financial markets are in. As discussed often in this blog, if we don’t address many of the issues plaguing our financial system as it relates to emerging businesses, we will lose our pole position in the global financial world. In fact, for the first time, Europe’s share of the worldwide corporate-debt issuance market surpassed the US. Furthermore, the AIM & LSE have passed the US in terms of % share of worldwide IPO proceeds with Hong Kong nearly dead-even with us. As recently as 2004, the US share was 5-10x that of Europe and Asia.

Some factors are to be expected such as capital and companies electing to stay local versus meeting in the US. However, many factors are self-inflicted wounds ranging from SOX to shareholder litigation abuse to balkanized regulatory oversight to inadequate shareholder rights. My favorite example is where China Life was hit by a shareholder suit within days of its US IPO. While things are heading in the right direction with SOX review, tort reform and the prosecution of the leaches at Milberg, Weiss.

The article is a good read for those interested in this topic and have any desire to ever go public on our soil…

Kessler’s Media 2.Uh-Oh

by mbmccall

Andy Kessler recently posted a series of posts about his view on the future of media and web. In "Media 2.Uh-Oh", he consolidates the six different posts into one piece. In it, he describes how the media model of old, owning the pipe, has been broken by the wave of new Web 2.0 technologies and the resulting battlefield requires a new set of strategies. In the past, large fortunes were made by controlling the pipe to the end consumer, whether this be phone, cable, newspaper, magazine or cellular. However, today, there is no dedicated end to end pipe. The newspapers have experienced this, video & cable are starting down this path and cellular will enjoy this once dual mode phones hit enmass.

Factors driving this even further are the "layering" of application architectures (web services & AJAX), P2P and low/zero marginal cost internet distribution. He goes into a series of recommendations around establishing virtual pipes (many would call some "networks") and "Going Wide". It is a good read. Enjoy.

The Billionaire Next Door

by mbmccall

I am sorry to say this is about Warren and not me. I have to admit that, while a wild-eyed VC, I am also a closet Buffett fan (aren’t we all…). Whitney Tilson posted Warren’s recent CNBC special on YouTube.

I’ve posted the CNBC special from last night on "Warren Buffett: The
Billionaire Next Door" to youtube at the following five links (youtube only
allows a max of 10-minute videos to be posted):

On a side note, my father-in-law was one of two traders in the US that Buffett would put trades through because of the volume he managed for Salomon Smith Barney. When our kids were born, we sent pictures of them, usually around age 7 months, with an accompanying letter from them explaining that they had just bought one share of Berkshire and were value investors. My son’s photo was with a rubber duck in his mouth looking up. In all cases, Warren responded with a personal letter within about three days as he tries to answer many of the letters he receives. In my son’s case, Warren mentioned that "Many of our long-time shareholders have asked me when you were going to join the fold — and your earlier hesitancy had caused them to become a bit shaky. Your purchase will calm them down…" My son is now older and this is one of his treasured possessions. Warren is a pretty amazing guy.

Failure Is The Best Medicine

by mbmccall

I have received a number of emails about my Paul Saffo post yesterday. Here is another link to his original Newsweek article on the Entrepreneurial "Cycle of Life" (analogy for you Disney fans).

The Silicon Valley of today is built less atop the spires of earlier triumphs than upon the rubble of earlier debacles

The dot-com collapse may have been a disaster for Wall Street, but here in Silicon Valley, it was a blessing. It was the welcome end to an abnormal condition that very nearly destroyed the area in an overabundance of success. You see, the secret to the valley’s astounding multiple-decade boom is failure. Failure is what fuels and renews this place. Failure is the foundation for innovation. (click here for the rest)

As I have often written in this blog, with failure comes lessons and opportunities (God closes one door, he opens another [or a window]). In fact, it is often necessary to experience the failure to be ready for the success. It changes your perspective, your knowledge, the industry structure, customer behavior, etc. Too often, entrepreneurs either a) are not able to hold on long enough to realize the eventual win or b) fail to see the lessons or new opportunities but rather see just failure.

 

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