Pennywise

I was with my friend Josh today as he pitched a really smart investor on his new company. The investor, as per the script, started picking holes in this and that. Mostly silent to that point, I interjected something to the effect: "this is a pretty cheap option on changing the world."

What is it with VCs?

Eliminate Advertising

I was rereading one of my favorite books last weekend, Reinventing the Bazaar: A Natural History of Markets, and came upon this:

Entire sectors of a modern economy are devoted to organizing transactions. The retail and wholesale trades and the advertising, insurance and finance industries exist not to manufacture things but to facilitate transacting... Innovating in any of these sectors means discovering a way to reduce the costs of transacting.

The point of marketing is to to spread information about products and services so that buyers can find sellers in a way that maximizes their welfare. Marketing has two goals: (1) match buyers and sellers as well as possible, and (2) do that as cheaply as possible.

A lot of the entrepreneurs I talk to are building things to help marketers find more customers, goal 1 above. It's interesting, although I'd love to see more of an emphasis on matching buyers and sellers more efficiently, rather than just trying to get peoples' attention.

But the blockbuster companies are the ones that make progress on goal 2. Innovating means discovering a way to reduce the costs of transacting. Someday, somebody will discover a way to do away with advertising altogether, reducing that particular cost of transacting to zero. That company will be bigger than Google.

[Addendum: More here.]

Away from witnesses

My favorite thing about this blog is that many of the readers are practitioners. People actually out making money by using marketing to sell products or generate leads.

I spend a lot of time daydreaming about the future, and one of my primary heuristics is a belief in progress, that things will become better, faster, more efficient. Others call it wishful thinking. But when I get out on a limb, the practitioners pull me back in (or, oftentimes, push me off.)

I spend a lot of time talking to very early stage companies, and they have world-changing ideas, but often don't really know what the world looks like in detail right now. And how could they? They aren't in business yet. So without feedback from the people who are actively engaged in actually doing the work, I would lose touch with what is feasible, practical, economical and as-yet-undone; things the "official" numbers and mainstream blogs obfuscate or simply don't understand. This is a trap I think a lot of investors--professional VCs more than angels--fall into.

At about the same time I posted on AdMob/GOOG, so did my friend Niki Scevak. Niki's POV is different than mine about the deal.

I think that for the smartphone ecosystem to succeed, there needs to be advertising to support mobile media. Since there needs to be advertising, somebody will find a way to make it work. But I don't know how--if I knew that, I'd be starting a company right now, not investing in other peoples' companies.

Niki looks at mobile advertising and says it's not going to work. There's no point, he says, because advertising supports commerce. Online advertising supports online commerce; mobile advertising will support mobile commerce. In supporting mobile advertising rather than commerce, GOOG has put the cart before the horse.

The interesting thing to me, in talking to people like Niki, is the tension between what is possible today and what I think the world will look like in three years. Getting from here to there is what makes this business exciting.

The fight is won or lost far away from witnesses--behind the lines, in the gym, and out there on the road, long before I dance under those lights. -- Muhammad Ali

AdMob, Google, Apple

Along with everyone else, I've been pondering the Google acquisition of AdMob. Some thoughts:

• Google needs to be in mobile hosted media; Apple's early move towards owning that space had the potential to sideline Google. Apple owned the customer. Thus Android and now AdMob.
  
• The mobile platform that is successful long-term will depend on the media available on it.
• The success of mobile based media relies to a large extent on the economics of advertising both on the devices and by tying the user of the device to their web presence*.
• The companies best positioned to improve these economics are Google and Apple. Among other reasons, because only they can tie online and mobile behavior of a large portion of mobile users through their control of the iPhone and Android app stores.

I think the upshot is that Apple needs to do something soon. As someone smarter than me said today, Apple has no advertising DNA. They either need to start hiring ad people**, and I hear nothing to that effect, or they need to buy something. Not necessarily an ad network, but something that gives them a means to extend the advertising ecosystem on the iPhone***.

But, PLEASE, don't take this news to mean that you should run out and start a mobile ad network. After the huge valuations put on web ad networks in 2007 (Doubleclick+Google, aQuantive+Microsoft, 24/7+WPP) there was a rush of company-starting and venture-funding that has, by and large, come to naught. By the time Google buys something, it is already too late to start a me-too competitor. Waaay too late. Build for three years from now, not for yesterday.

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* Both web retargeting based on mobile media usage and mobile targeting based on web usage will be extremely effective once they are available. The privacy implications of this are... interesting. But I'm not going to open myself to entirely valid accusations of hypocrisy by passing judgement. Others can do that more effectively.

** Meaning people who understand the new math and operations behind advertising. Not creative folk.

*** 16 C.F.R. 255: I have an investment in one, natch.

VC Investment Amounts

When I can't sleep, I play with data. It's like meditating.

The National Venture Capital Association recently released their latest venture investment numbers for the US. On their web site, they use the annoying iChart gadget. Annoying because as you scroll backwards and forwards in time, it adjusts the x axis, so I can't really compare amounts across time. Why would they do that? Are they mad? I'm going to send Edward Tufte to beat them over the head with Javanese railroad timetables.

Anyhoo, so I took their US regional data and charted it more congenially (click on the charts for larger versions. I graphed the three largest regions, Silicon Valley, New England and NY Metro. Here is total investment: I've heard a lot of talk recently about New York having a startup renaissance. My Boston VC friends have meanwhile been bemoaning how quiet Boston is, and living on the Acela to NYC. The data does not support this. New England may be a bit ghost-towny, but NY isn't taking off.

Let's look at number of deals:

Same. I mean, I don't have access to the NVCA database, just their publicly released data. If I did have access, I would do this analysis with early-stage internet companies; that may show a different story.

Average deal size:

This is interesting mainly because it shows average investment size to be about the same from region to region (although NY is noticeably more volatile, while Silicon Valley less so--probably because there are more deals.) I find this surprising, given the different character of industry in the three areas. I wonder if this is a product of the VC model, as opposed to actual business capital needs: the tail wagging the dog. This is anecdotally so, and certainly not a good or efficient thing if true.

The other interesting thought that came up was the big drop in investment Q1 and Q2 of this year and the slight pick-up in Q3. I thought this was happening, as I noted in Is the Time for Angels Passed? Here's the proof. There are many potential reasons for this, but the most obvious is that VCs invest when they see the economy getting better. Here's a graph of Total US VC Investment (left scale) and the S&P 500 (right scale):
Well, now. Aside from a bit of the euphoria in 2000, VC investment tracks pretty well. In fact, it looks like it may lag a quarter or two. Why is this? Leaving aside the canard that venture is uncorrelated, venture investment lifecycles are not the same as public company lifecycles. You might invest in IBM this year, expecting them to raise their dividend next year because of the improved economy. But you shouldn't invest in non-public companies that way. You should expect your venture investments to mature in three to five years (depending on the stage at which you invest.) Unless you really don't believe in the business cycle, the best time to invest is when the stock market is low. Venture investment should be counter-cyclical. Is this a case of a buy high, sell low mentality, or another structural failing of the VC model?

I can see the Empire State Building out my window. When they turn the lights out at 2am I know I'm going to be tired tomorrow.

Data consistency sidebar

I mentioned here that I would compare my post on online spending trends to Rob Leathern's and see why we came to different conclusions. The answer, unsurprisingly to anyone who's done any work with this type of industry data, is that we use different numbers.

I used TNS for ad spend data. Rob used both TNS and IAB numbers. TNS and the IAB have wildly different estimates for online ad spending. For example, US online spend in billions:

	2007	2008
TNS	$11.3	$11.8
IAB	$21.2	$23.5

TNS has consistently had smaller numbers for online spend than the IAB. I'm not going to pass judgement on whose numbers are better: I do not know. I merely noted the difference and decided that if I was going to compare online to other media, I would use spend numbers from a single source. This, I think, gives a better comparison, if not necessarily a better absolute number.

How to rake it in by screwing your customers

A long, long time ago I was at Prodigy when we decided to change from hourly pricing to a flat rate of $19.95 per month. Flat rate pricing was clearly preferred by our customers, and our competitors who were offering it were taking them away from us.

Problem was, when people are accessing the internet by dialing into 28.8k modems, more hours online meant more peak demand meant more modems needed, meant more expense.

As we evaluated the price change, I noticed that some of our formerly best customers would now become our worst customers. For instance, there was a bunch of die-hard group text-based RPG fans who spent 100+ hours online per month*. Paying by the hour they were great customers, but with a flat rate they were our worst. We had to ditch the RPG.

In fact, we had to ditch any content that people spent a lot of time with. It turned out that the people who liked the service the most, who spent the most time on it, were our worst customers. Our best customers were the people who never logged on but never got around to turning off the monthly bill.

I lost interest in this business model and moved on; businesses that do better as their customers do worse should not survive.

I was thinking about this today because of my friend Josh's excellent blog entry on the Google Mortgage thing and on retail banking in general.

Unlike most people's mental model of retail banking operations, banks do not make most of their money on the difference between the rates at which they lend versus the rate they offer for savings. American banks, quite distinctly from banks elsewhere in the world, make the bulk of their money from fees and charges. Invisible and often unavoidable consequences of little clauses in contracts that no one ever reads.

Banks' best customers are the ones who are getting screwed by the banks. Banks' worst customers are the ones who are probably pretty happy with their bank. This perverse incentive shouldn't persist, but it has. What's it going to take to change it?

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* This was a lot back then.