Musings on low cost start-ups and the importance of customer service

Venture capital money

I’ve been wondering lately if the current practice of building web2.0 companies with little capital can last.  Obviously it will benefit me as a VC if companies need more money, so all of this may just be wishful thinking, but here goes….

Best practice for financing web2.0 style companies has been (for a while now) to:

  • Have an original idea for a new product
  • Quickly launch a rudimentary service
  • Capture feedback as traffic grows to improve the service so creating a virtuous circle (note the winner-takes-all nature of this)
  • Find a way to monetise

It is usually only at the third stage of this that money on the venture capital scale is required and companies need less money overall.  I have commented on this previously in Venture Capital Model Changing But Not BrokenYou Gotta Go With Traffic, and You Can Only Go With Traffic.

The companies that have been successful with this model are those that have combined a great idea with marketing flair – there are many examples. Google, Flickr, Delicious and Digg all fit this model.

I am now wondering if this might change soon.  Recently I have been reading a lot about the importance of customer service as a differentiator – Brad puts in this context on the Union Squares blog and JP recently wrote the following:

As we move towards realms where more and more things get commoditised, and more quickly at that, it is reasonable to assume that the only aspect of a service offer that differentiates one firm from another is the quality of the customer experience.

If this is true it is bad news for venture capital.  Customer service and the customer experience are of course important to get right, but they are more about perspiration than inspiration – and inspiration is where the big money is at.  You wanna be investing in companies that have revolutionary products – like the ones I listed earlier.

So I was wondering if it was right that customer service is where the game is at now.

Then I was thinking back to some of the posts I made before I went on holiday (and yes, thanks, it was a good one…).  A key conclusion was that there is a long way to go in innovation.  Another was that social networks might start to look more like virtual worlds, or to put it another way virtual worlds might become the next social nets.  That says to me that it will remain possible to make money out of inspiration.

To take the thought a stage further, it might be that the next generation of web services will be inherently more complex and will therefore need venture capital investment prior to launch (in addition to angel money).  Examples of this might be social networks with virtual world style functionality and a return to client side development being important.

  • Most of the 2.0 companies are not innovative.

    Take for example MySpace. It really is not hard to build. It is simple a database that records a page layout, some info on the person and relation to another person. There is nothing really innovative about their product.

    Google was different. It came along with an innovative product (page rank) that did an existing function better. And it was not easy to copy. Most of web 2 companies are not innovative and they are very, very easy to copy. How many calendering companies etc do you need?

    I can’t think of a really innovative web service company around at the moment. What we have is lots of features masquerading as a company.

    The developments such as EC2 and S3 will help lower the capital cost of scale and reliability. I think the biggest costs will come down to labour and most likely marketing. Done wisely, I think there is every chance of low cost companies sticking around as long as they are innovative. The moment they simply become a me-too then their costs will rise as they have to devote more money to labour and marketing costs.

  • Most of the 2.0 companies are not innovative.

    Take for example MySpace. It really is not hard to build. It is simple a database that records a page layout, some info on the person and relation to another person. There is nothing really innovative about their product.

    Google was different. It came along with an innovative product (page rank) that did an existing function better. And it was not easy to copy. Most of web 2 companies are not innovative and they are very, very easy to copy. How many calendering companies etc do you need?

    I can’t think of a really innovative web service company around at the moment. What we have is lots of features masquerading as a company.

    The developments such as EC2 and S3 will help lower the capital cost of scale and reliability. I think the biggest costs will come down to labour and most likely marketing. Done wisely, I think there is every chance of low cost companies sticking around as long as they are innovative. The moment they simply become a me-too then their costs will rise as they have to devote more money to labour and marketing costs.

  • nic

    Thanks for the comment Simon.

    I agree that most of the web2.0 companies are not innovative. I think the successful ones have been though. However, the innovations have been of the “I could have thought of that” type rather than clever algorithms, which is why there are so many clones. Thankfully scale matters and there is a real first mover advantage which make it possible for companies like MySpace to be winners.

    I wonder if the innovation will start to move away from good ideas to good software/better algorithms. This would imply that the basic ideas have been had and that it will be about implementation going forward???

  • nic

    Thanks for the comment Simon.

    I agree that most of the web2.0 companies are not innovative. I think the successful ones have been though. However, the innovations have been of the “I could have thought of that” type rather than clever algorithms, which is why there are so many clones. Thankfully scale matters and there is a real first mover advantage which make it possible for companies like MySpace to be winners.

    I wonder if the innovation will start to move away from good ideas to good software/better algorithms. This would imply that the basic ideas have been had and that it will be about implementation going forward???

  • Quite possibly.

    In fact, Google is probably an excellent example of the good software/better algorithms model. The basic company was the same as Yahoo, Alta Vista et al. They simply came along with a better algorithm. It does need to be more revolutionary than evolution improvement.

    There is something to the idea of implementation being the driver of new web companies. In many ways what is changing is not what we do but how we do it. I wonder whether we will see the rise of new Googles and Yahoos in the purely internet arena. Was this simply the rise of the enterprises that reflect the new technology just new enterprises arose during the switch from gas to electricity? If this is true it means that we are unlikely to ever see the same rapid company growth in web companies again. Which does not bode well for web companies that have had lots of money poured into them.

    Internet and Web companies are entering a maturing industry. I treminds me of the late 80’s early 90’s desktop market.

    The area that is open and ripe for change is the web services/internet that interfaces directly to the physical world. Areas where the internet hasn’t really changed the way we do things. The example that comes to mind is mass customisation of products. Think Squid Labs (http://www.squid-labs.com/) in everyone’s garage.

  • Quite possibly.

    In fact, Google is probably an excellent example of the good software/better algorithms model. The basic company was the same as Yahoo, Alta Vista et al. They simply came along with a better algorithm. It does need to be more revolutionary than evolution improvement.

    There is something to the idea of implementation being the driver of new web companies. In many ways what is changing is not what we do but how we do it. I wonder whether we will see the rise of new Googles and Yahoos in the purely internet arena. Was this simply the rise of the enterprises that reflect the new technology just new enterprises arose during the switch from gas to electricity? If this is true it means that we are unlikely to ever see the same rapid company growth in web companies again. Which does not bode well for web companies that have had lots of money poured into them.

    Internet and Web companies are entering a maturing industry. I treminds me of the late 80’s early 90’s desktop market.

    The area that is open and ripe for change is the web services/internet that interfaces directly to the physical world. Areas where the internet hasn’t really changed the way we do things. The example that comes to mind is mass customisation of products. Think Squid Labs (http://www.squid-labs.com/) in everyone’s garage.

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  • The computer games industry provides a good case study here. Games like Jet Set Willy on the ZX Spectrum were programmed by a single individual and until relatively recently small development shops could successful compete.

    Now the cost of games production has risen massively and budgets for games have grown, pushing out the small dev teams in favour of big budget development, backed by multinational publishers.

    Probably what will happen in web 2.0 is the same as with Hollywood – you’ll get polarisation between heavy-duty social nets/ virtual worlds which require massive capital and light-weight, indie web productions based on low cost production techniques.

  • The computer games industry provides a good case study here. Games like Jet Set Willy on the ZX Spectrum were programmed by a single individual and until relatively recently small development shops could successful compete.

    Now the cost of games production has risen massively and budgets for games have grown, pushing out the small dev teams in favour of big budget development, backed by multinational publishers.

    Probably what will happen in web 2.0 is the same as with Hollywood – you’ll get polarisation between heavy-duty social nets/ virtual worlds which require massive capital and light-weight, indie web productions based on low cost production techniques.

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