Mar 2008
How developer platforms (should) drive marketplaces
Monday - March 24, 2008 Filed in: Strategy
| Venture
Capital
Marketplace rules.
Rule #1: Failed. Amazon limits the supplier participation to their premium strategy.
Rule #2: Failed. Limited suppliers means limited transactions are available
Rule #3: Failed. Amazon regulates the process of how a transaction takes place, conforming to Amazon pricing models
Rule #4: Failed. Once you book an order from a different supplier than Amazon, all bets are off with regards to transparency, shipping, returns etc
Rule #5: Failed. There is no way for new buyers to see who bought what at what price and equally for sellers who sold what.
Rule #6: Failed. User opinions are irrelevant if they are not borne out of a transaction.
Rule #7: Perhaps not relevant here.
Rule #8: Failed. Amazon is "competing" in the "marketplace" with its suppliers
Amazon will have a much harder time to sustain growth and meet Wall Street expectations, as a lot of growth through premium suppliers will become non-organic (or sell through revenues). Amazon has plenty of opportunity to migrate to a real marketplace without losing its footing, but it better hurry. In the meantime, Jeff, please call Amazon what it is: earth's premium selection.
Why Amazon is not a marketplace
Monday - March 17, 2008 Filed in: Strategy
| Venture
Capital
Real marketplaces are much more powerful than just a collection of stores. Amazon, for example is a Super Store not a marketplace today. EBay, FaceBook and YouTube represent more fundamental marketplace principles - and as a result - fascinating growth.
Marketplaces are a favorite topic these days, perhaps spawned by sky high valuations for social-media platforms such as FaceBook and Bebo. A social-media platform, you know, is nothing more than a marketplace in which personal attributes are traded (through the use of social applications).
Marketplaces are interesting because, if implemented successfully, provide massive user adoption and winner-takes-all leadership positions. Great traits for any investment portfolio. A marketplace is highly disruptive in a market where the premium opportunity, the Super Store model has been exhausted - or simply does not exist. Some markets, because of their highly fragmented nature, cannot be captured by high margin and proprietary access and a marketplace is the only way to leverage its total size.
I have written extensively about marketplace criteria in specific markets and its origination about 600 years back, so I won't cover that specifically here. But so many other markets are ripe for marketplace macro-economics delivered by technology. Virtually any market characterized by unique transactions between large amounts of sellers and buyers is a candidate for free-market principles. The life-cycle of proprietary markets is dramatically shortened by the Internet, a distribution medium that instantly removes artificial boundaries such as geographic location and limited access.
Here are 8 rules that make a marketplace succeed:
1/ Un-arbitrated participation
No seller or buyer should be banned from participating in the marketplace. A key fundamental of a marketplace is that it grows itself and that the quality of the buyer and seller is a reflection of the market, not controlled by the market. After-all, the purpose is to connect The Long Tail of supply with The Long Tail of demand.
2/ Un-arbitrated transactions
Apart from exchanges that are illegal by law, no transactions should be banned. People come to a marketplace to perform a unique transaction, one they could not act on in a premium market.
3/ Free pricing mechanisms
Pricing models and terms are defined either by the seller or buyer or by both. Not by the marketplace. Pricing models can include such transactions as sell, auction, reverse auction or subscription - or even a combination of those. Pricing, including free, is completely and independently determined by or between seller and buyer, predetermined or negotiated. The marketplace takes a simple transaction fee off of the transaction value.
4/ Predictable behavior
Marketplaces need to establish trust in order to survive and thrive. Pricing models and behavior of the marketplace need to be predictable and follow (not dictate) the goals of buyers and sellers. The marketplace should follow the needs of the market not the other way around.
5/ Transparency of transactions
Marketplaces rely on a vast new influx of sellers and buyers to grow to massive size. That means the marketplace must operate with a transparency that shows new buyers or sellers how to become successful as most of its users are greenfield participants.
6/ Meritocracy builds reputation
Trading favors and segmentation can be established but only based on mechanisms that are derived from real transactions, not plainly from user opinions. Opinions are useless if not supported by a proven reputation within the marketplace. Transactions based reputations provides long-lasting stickiness to the marketplace.
7/ Support for intermediaries
For existing markets moving from premium to a free-market, its existing intermediaries need to be able to continue to represent their sellers or buyers. A new technology marketplace should not want to disintermediate or alienate those agents.
8/ Non-compete
The marketplace cannot itself participate in the marketplace by providing its own transactions or even participate in - or act on behalf of - transactions between sellers and buyers. Apart from the fact that the business models don't jive, a marketplace cannot be trusted when it simultaneously participates and facilitates an impartial exchange.
So, a simple method to determine whether a marketplace has massive market potential is to hold it up against the rules provided here. These rules are macro-economic principles that dictate how markets behave and grow, the technology implementation must support those principles to have a chance of making it big. It's a free world after all.
Marketplace rules: look, don't touch
Sunday - March 16, 2008 Filed in: Strategy
| Venture
Capital
Over the last 10 years I've also
been closely involved with early stage
technology funding (advising VC firms and
Angels) and have invested personal time and
money in early stage ventures. That has given me
a unique perspective of the challenges between
entrepreneurs and investors.
I've written about my Top 10 fundraising lessons for entrepreneurs, and dare to follow up with my Top 10 investment strategies that may be useful to investors and entrepreneurs, here:
1) Invest in the founders, but be wary if the company consists of technologists only. The ones that come in without an operating plan clearly do not understand what you as an investor are looking for. Get a real operator in early.
2) Invest in the business, don't invest in technology. The statistics prove it: ninety-nine out of a hundred of the most innovative technologies never turn into successful businesses. Especially investors (both VC and Angels) that made their money in the hay-days of technology have a tendency to underfund the business side, providing a weak foundation for any technology to succeed.
3) Don't invest in an early stage company with more than one product or service. Let the company become the King-of-One, rather than the King-of-None. Multiple products or services require more money to support successfully and dramatically dilutes the focus of the company. Multiple products or services also "invite" a larger group of competitors, making it hard for customers to perceive true differentiation and unknowingly, slows down adoption.
4) Don't invest in an early stage company with more than one business model. Keep it simple. Multiple revenue models sound good, but usually don't yield the projected outcome. The company should make all of its money in advertising or in subscriptions, not in both. Dilution of focus is costly and provides yet another reason for failure.
5) Don't invest in companies that rely heavily on partner support early on. This is the typical David and Goliath phenomenon. Partners sell once the company does in overwhelming numbers. The company should always have direct control of its own business model first, before they allow any partner to reduce its margins.
6) Invest money or time, don't do both. I very much relate to Carl Icahn in an interview with Dan Primack (on PEhub) with regards to CEOs responsibility to make the numbers work, and not to rely on investors to "add value". The CEO is in the driver seat, take him out if he doesn't produce.
7) Look for fundamental changes in customer experience. The Ultimate Driving Experience is what sets BMW apart, not just the timing in their engines. Customer experience is much more than a pretty user interface, it is an overall experience that spawns disruptive purchasing.
8) Watch how professional the team operates pre-funding as an indication of their interaction post-funding and with customers. Real professionals do everything with a purpose and I have mastered the art of detecting them. So well that I can tell from a visit to a trade-show floor whether a company is going places.
9) Don't categorize investment allocations based on past investments or trends. Every company is unique and requires an amount of money unique to their assets: people, timing, market and ecosystem. If you don't think you have a unique scenario, you probably don't have a valuable investment opportunity.
10) Invest with passion but don't fall in love with the company. Investing is the ultimate flirting game, but it is usually a bad idea to get really involved. Your asset value is the selection and performance of all the companies in your fund. Stick with what you do best.
From an investment perspective I see many "sub-optimizations" but not a lot of real great innovations these days. I do blame the current investment model for that sometimes. We, in Silicon Valley, have too many technology investors using the same rearview-mirror investment criteria. Although I have a lot of admiration for Apple, it is a bad sign when we need to leave real innovation in the hands of large companies like theirs.
The landscape for investors is about to change dramatically, no longer can they just continue to invest in proprietary technology silos at single digit valuations. They'll soon need to broaden their experience ("in search of the Economist VC") to understand the macro-economic impact of marketplaces, platforms and the impact of technology to other industries.
A wonderful long road for technology innovation and investing still lies ahead.
I've written about my Top 10 fundraising lessons for entrepreneurs, and dare to follow up with my Top 10 investment strategies that may be useful to investors and entrepreneurs, here:
1) Invest in the founders, but be wary if the company consists of technologists only. The ones that come in without an operating plan clearly do not understand what you as an investor are looking for. Get a real operator in early.
2) Invest in the business, don't invest in technology. The statistics prove it: ninety-nine out of a hundred of the most innovative technologies never turn into successful businesses. Especially investors (both VC and Angels) that made their money in the hay-days of technology have a tendency to underfund the business side, providing a weak foundation for any technology to succeed.
3) Don't invest in an early stage company with more than one product or service. Let the company become the King-of-One, rather than the King-of-None. Multiple products or services require more money to support successfully and dramatically dilutes the focus of the company. Multiple products or services also "invite" a larger group of competitors, making it hard for customers to perceive true differentiation and unknowingly, slows down adoption.
4) Don't invest in an early stage company with more than one business model. Keep it simple. Multiple revenue models sound good, but usually don't yield the projected outcome. The company should make all of its money in advertising or in subscriptions, not in both. Dilution of focus is costly and provides yet another reason for failure.
5) Don't invest in companies that rely heavily on partner support early on. This is the typical David and Goliath phenomenon. Partners sell once the company does in overwhelming numbers. The company should always have direct control of its own business model first, before they allow any partner to reduce its margins.
6) Invest money or time, don't do both. I very much relate to Carl Icahn in an interview with Dan Primack (on PEhub) with regards to CEOs responsibility to make the numbers work, and not to rely on investors to "add value". The CEO is in the driver seat, take him out if he doesn't produce.
7) Look for fundamental changes in customer experience. The Ultimate Driving Experience is what sets BMW apart, not just the timing in their engines. Customer experience is much more than a pretty user interface, it is an overall experience that spawns disruptive purchasing.
8) Watch how professional the team operates pre-funding as an indication of their interaction post-funding and with customers. Real professionals do everything with a purpose and I have mastered the art of detecting them. So well that I can tell from a visit to a trade-show floor whether a company is going places.
9) Don't categorize investment allocations based on past investments or trends. Every company is unique and requires an amount of money unique to their assets: people, timing, market and ecosystem. If you don't think you have a unique scenario, you probably don't have a valuable investment opportunity.
10) Invest with passion but don't fall in love with the company. Investing is the ultimate flirting game, but it is usually a bad idea to get really involved. Your asset value is the selection and performance of all the companies in your fund. Stick with what you do best.
From an investment perspective I see many "sub-optimizations" but not a lot of real great innovations these days. I do blame the current investment model for that sometimes. We, in Silicon Valley, have too many technology investors using the same rearview-mirror investment criteria. Although I have a lot of admiration for Apple, it is a bad sign when we need to leave real innovation in the hands of large companies like theirs.
The landscape for investors is about to change dramatically, no longer can they just continue to invest in proprietary technology silos at single digit valuations. They'll soon need to broaden their experience ("in search of the Economist VC") to understand the macro-economic impact of marketplaces, platforms and the impact of technology to other industries.
A wonderful long road for technology innovation and investing still lies ahead.
10 Investment lessons learned over 10 years
I visited the entrepreneurs week
at Stanford this week where many MBAs were
walking around with new business ideas. Since we
raised a fair amount of money ourselves
in the last 10 years we've been focused on
startups, I wanted to give some advice that may
be helpful to any first time entrepreneur:
1) Define the end goal of the company in a newly defined market
The determination of pre-money valuation, even for the first round, should be based on the disruptiveness of the company when it grows up. The goal is to find the investor that understands the path to that goal, not an assessment of the current value of the company. The starting valuation then becomes a reverse calculation from that goal.
2) Don't set a valuation, but have one in mind
The valuation is usually suggested by the investor, but ofcourse, you don't have to take it. Ask your potential investor to value the company after you give them the pitch, the outcome of that tells you whether the investor really understands your unique proposition. If it is too low, it may be because the clarity of your pitch. If not: walk away.
3) Have an operating plan ready
An operating plan defines how you turn technology into a business, without it there is simply too much room for debate and depreciation. Show investors you know how to run the business. The more you do the easier it is to cement your use-of-proceeds.
4) Find an investor you truly like
Every entrepreneur deserves to be treated with respect. Waste no time talking to deep pockets with awful personalities, but don't be afraid to get some straight talk. Check TheFunded.com for war stories and ask around. Later, when business gets tough bad guys usually get a lot worse.
5) Define business disruptiveness
Building technology is one thing, but yielding a disruptive business value is even more relevant. The latter is defined by macro-economics, not just a more clever way to improve existing technology.
6) Take passion over domain expertise any-day
Find a lead investor that has passion for the business problem you are about to solve. An investor that claims to have domain expertise is usually the one that doesn't understand disruption within or across that domain.
7) Don't get squeezed
Investors like to put investments into past investment categories and make an assessment of how much it costs to build your business. Don't let them stray too much from what is in your operating plan, if you do you will get punished for it later, both on the execution side as well as in excessive dilution.
8) Know the investment allocation
Usually a little harder to do with angels but VCs should have a total investment amount allocated to the business. Ask them for the total allocation upfront, so you know when you need to go shopping somewhere else. Also, don't be afraid to ask who else needs to sign off on this deal within the VC firm, in most cases it is a very democratic process internally with a primary sponsor. After your first meeting you should get in front of a General Partner, talking terms.
9) Control your own eco-system
Investors like to wiggle around and determine how much money should go into R&D, Sales, Marketing, Business development, Support and G&A. Too much money in marketing is usually an indication the product or service lacks real viral adoption and that should be avoided. If the balance of this eco-system is not guarded heavily by the entrepreneurs the result is an excessive bleeding and further dilution in subsequent rounds.
10) Balance your board
A board without a balance of technical and business expertise can really bring a company down when the going gets tough. The technical board members will spend too much time validating deep technology progress without real affinity for the bottom-line. On the flip side a demand for too early revenues can have disastrous effects on product or service readiness and customer experience. Keep them both in check.
Be honest and transparent, too much talk without real interaction with a prospective investor is a bad sign. Paint a realistic risk-management picture, in which you describe both the pluses and minuses, not unlike the way a VC sells their risks in a Private Placement Memorandum (PPM) to its limited partners. Feel free to e-mail us if you need help.
1) Define the end goal of the company in a newly defined market
The determination of pre-money valuation, even for the first round, should be based on the disruptiveness of the company when it grows up. The goal is to find the investor that understands the path to that goal, not an assessment of the current value of the company. The starting valuation then becomes a reverse calculation from that goal.
2) Don't set a valuation, but have one in mind
The valuation is usually suggested by the investor, but ofcourse, you don't have to take it. Ask your potential investor to value the company after you give them the pitch, the outcome of that tells you whether the investor really understands your unique proposition. If it is too low, it may be because the clarity of your pitch. If not: walk away.
3) Have an operating plan ready
An operating plan defines how you turn technology into a business, without it there is simply too much room for debate and depreciation. Show investors you know how to run the business. The more you do the easier it is to cement your use-of-proceeds.
4) Find an investor you truly like
Every entrepreneur deserves to be treated with respect. Waste no time talking to deep pockets with awful personalities, but don't be afraid to get some straight talk. Check TheFunded.com for war stories and ask around. Later, when business gets tough bad guys usually get a lot worse.
5) Define business disruptiveness
Building technology is one thing, but yielding a disruptive business value is even more relevant. The latter is defined by macro-economics, not just a more clever way to improve existing technology.
6) Take passion over domain expertise any-day
Find a lead investor that has passion for the business problem you are about to solve. An investor that claims to have domain expertise is usually the one that doesn't understand disruption within or across that domain.
7) Don't get squeezed
Investors like to put investments into past investment categories and make an assessment of how much it costs to build your business. Don't let them stray too much from what is in your operating plan, if you do you will get punished for it later, both on the execution side as well as in excessive dilution.
8) Know the investment allocation
Usually a little harder to do with angels but VCs should have a total investment amount allocated to the business. Ask them for the total allocation upfront, so you know when you need to go shopping somewhere else. Also, don't be afraid to ask who else needs to sign off on this deal within the VC firm, in most cases it is a very democratic process internally with a primary sponsor. After your first meeting you should get in front of a General Partner, talking terms.
9) Control your own eco-system
Investors like to wiggle around and determine how much money should go into R&D, Sales, Marketing, Business development, Support and G&A. Too much money in marketing is usually an indication the product or service lacks real viral adoption and that should be avoided. If the balance of this eco-system is not guarded heavily by the entrepreneurs the result is an excessive bleeding and further dilution in subsequent rounds.
10) Balance your board
A board without a balance of technical and business expertise can really bring a company down when the going gets tough. The technical board members will spend too much time validating deep technology progress without real affinity for the bottom-line. On the flip side a demand for too early revenues can have disastrous effects on product or service readiness and customer experience. Keep them both in check.
Be honest and transparent, too much talk without real interaction with a prospective investor is a bad sign. Paint a realistic risk-management picture, in which you describe both the pluses and minuses, not unlike the way a VC sells their risks in a Private Placement Memorandum (PPM) to its limited partners. Feel free to e-mail us if you need help.