Business models

Introducing the Curve

By | Business models | One Comment

The Curve is a new concept and book from my friend Nicholas Lovell that describes how to make money in a world when everything is trending to free. Nicholas has been helping the games industry adapt to ‘free’ for a while with freemium strategies where most users to play for free whilst super fans spend lots of money on in-game purchases. Now he’s bringing the concept to other industries.

Check out this promo video, and if you like it go buy the book. It’s good.


Proven value-add characteristics for physical products

By | Business models, Venture Capital | No Comments

Alan Patrick just wrote a post about London’s prospects as a centre for manufacturing. Along the way he wrote about the characteristics that are proven to add value to physical products:

  • Short Lead Times/Available now
  • High Design Input to create differentiation
  • Fast change/Fashion – make things that are hard for long lead time supply chains to replicate quickly
  • Design unique capability into a product

I love a framework, and this is a good one for thinking about the potential for physical products companies. This is a hot area right now, but it’s nascent, and that means there is little to go on when we make investment decisions and advise companies. Making sure that one or two of these characteristics are present and get stronger as the company develops is a good way to go.

And if you’re wondering, Alan thinks that London could be a centre for the manufacture of high value products, but we have cost disadvantages to overcome and would benefit if our schools taught our kids the right things, and if engineers were accorded the same status in society that they enjoy in most other OECD countries.

Opportunities in ecommerce

By | Business models, Ecommerce | No Comments

There’s a good post on Business of Fashion this morning which identifies four ecommerce models that are working in fashion:

  1. Social curation (which they helpfully define as ‘product discovery and connecting people to inspiration’)
  2. Collaborative consumption
  3. Vertically integrated ecommerce
  4. Online market places

These models work in all areas of ecommerce and not just fashion, and I expect we will be making investments in all of them. That said, it is social curation and vertically integrated ecommerce which have me most intrigued. Beyond cheap commodities finding stuff on the web can and will be made easier and more pleasurable and the Maker Movement has the potential to spawn many interesting companies that sell direct. Collaborative consumption also has legs, but I suspect the low hanging fruit has been picked and other areas may be await new technology development before they become feasible. Market places can make for great consumer experiences and great investments, but the concept has been around for a while now and the white space for new ideas is diminishing.

At least that’s how I see it. I’d be interested in your thoughts.

Stakeholder value vs shareholder value

By | Business models, Innovation, Startup general interest | 2 Comments

Yesterday I wrote some early thoughts on progressive business. I finished the post by wondering whether we are seeing the start of a trend towards doing business in a better way and how far those changes can go.

The change to progressive business is multi-faceted and whilst we can see that if something is to happen, the direction is towards authentic customer value driven organisations which truly value their employees and part of that is a shift to focusing on broad stakeholder value rather than shareholder value.

I started my working life as a management consultant in the mid 1990s and I clearly remember my first manager convincing me that the purpose of companies is to maximise value for their shareholders. Prior to that I had a fuzzy view that companies should have a responsibility to employees and society as well as shareholders. The killer arguments for me were that it was the shareholders who owned the company and as it was their property it should maximise value like they wanted it to, and that the companies who had pursued a simple shareholder value maxim over the previous 10-20 years had outperformed the rest. Besides, when shareholders do well, employees and other stakeholders generally do well to.

What’s interesting now is that those to killer arguments may no longer hold true. It could be that from c1970-2000 a simple focus on shareholder value was the best strategy, but that something broader is required now. This is how the argument runs (largely taken from an article on Forbes by Steve Denning):

  • prior to around 1970 companies were focused on multiple stakeholders resulting in confused priorities and poor decision making
  • a simple unifying focus on shareholder value allowed management to galvanise workforces and improve results
  • but that focus has now distorted business and the improved performance has now come to an end, as evidenced by poor stock market performance over the last ten years

Examples of distortions that come from focus on shareholder value are short term focus on the share price, excessive pay in the C-Suite, and and de-motivated employees. Read the Denning article for more details.

I’ve long thought that an analogy with a pendulum is the best way to understand change in many walks of life is. Change always starts with a move away from an undesirable state of affairs, but then usually swings too far and has to come back towards a desired equilibrium position, which it will usually overshoot, and so on. Changes in direction are generally facillitated by a shift in thinking or ideology and are painful for practitioners who face the choice of changing their heartfelt convictions or losing relevance. In this case the pendulum swung from companies having bad decision making and results because they had too many overlapping objectives to poor results because the focus on a single objective of shareholder value is too narrow, and might now swing back to a broader set of objectives. Or at least so the argument goes.

It isn’t just Denning who is saying this stuff either. In 2009 Jack Welch called maximising shareholder value ‘the dumbest idea in the world’ and CEOs of companies like Unilever, Amazon, Google and Facebook have adopted policies and in some case shareholder structures which are designed to deliver long term value creation in a broad sense and ignore the vagaries of the stock market.

The changing dynamics of consumer internet investing

By | Business models, Consumer Internet, Venture Capital | 5 Comments

Fred Wilson wrote yesterday about changes in the consumer web and their implications for startups. Frist he observed that the large platforms (Google, Facebook, Amazon, MSFT, Twitter, etc) are ‘starting to suck up a lot of the oxygen’ making it ‘harder than ever to build a large audience from a standing start’. Secondly, he notes that the move from ‘desktop/web to mobile/app’ makes it more expensive to build a large user base, principally because of the need to develop for multiple platforms.

These changes are altering the dynamics of investing in consumer web companies. Historically the best of these businesses have been highly capital efficient and able to grow very fast on the back of the strength of their product and without dependence on a third party. This made consumer internet a very exciting investment category – this Pinterest case study shows why. Going forward the risk reward profile will be different. Higher development costs and dependence on the large platforms push the risk up and at the same time the chances of hitting a Facebook size winner have fallen (it is hard to see any of the large platforms allowing that to happen).

This doesn’t mean that the opportunities in consumer web are over. It does mean that going all out to build a huge audience without building in a solid business model from day one has become a riskier bet where success is largely predicated on one of the platform players acquiring the company. For me the sweet spot has now shifted to businesses that are able to able to extract a high ARPU from a focused community. Often times that will mean the companies are ‘close to the transaction’ or ecommerce related. These businesses can be capital efficient in spite of mobile development costs because they are able to generate meaningful revenues fairly early on and they can have great operational leverage which combined with high ARPUs allows them to generate significant profits from audiences in the tens of millions.

Lyst and MoviePilot are good examples of businesses from our portfolio that fit into this category.

Disintermediation–an old story playing out now

By | Amazon, Business models | 8 Comments

Disintermediation is one of the oldest stories of the internet. From the 1990s onward people have been making the obvious case that the internet is a revolutionary communications platform that can remove the middleman and his cut from all sorts of transactions leaving the parties on both side of the deal to share the spoils.

It’s an old story but one that hasn’t really played out in many consumer industries. We’ve seen Betfair cut the middleman out of sports bets for a reasonable chunk of the football and horseracing gambling market in the UK but I can’t think of another large business that has disintermediated a consumer market. Many large internet companies have succeeded because they have replaced an incumbent with a more efficient business model – Netflix, Lovefilm, Skype and Amazon spring to mind – but they aren’t true disintermediation plays.

The most obvious candidates for disintermediation are media publishing businesses. Despite all the disruption and heartache in the music, book, and TV/film industries this hasn’t really happened yet. I’m a big fan of Spotify, but they have slotted in alongside the record labels rather than replacing them. Similarly in the book industry Amazon has replaced a lot of physical book stores but they still get most of their books from traditional publishers. In TV and film we still get most of our content from traditional broadcasters, satellite and cable companies.

Traditional publishers in the music, book and TV/film industry have provided three types of service to artists:

  • finance
  • access to distribution (i.e. gatekeeper)
  • logistics and admin (e.g. studio space, editing, physical production of media)

These traditional publishers are pretty much all still in business, but they are all suffering mightily. On the one hand the shift to digital media and distribution has hit their revenues and profits and on the other hand cheap web services offer artists an increasingly viable alternative to the logistics and admin services they provide.

They are left clinging to access to distribution and finance as their raison d’etre, but recent advances in crowdfunding and the rise of global distribution companies like Amazon and Spotify are undermining these last residues of value add and may mean that the timing is finally right for a true disintermediation player to take them out of the market.

Y Combinator growth benchmark

By | Business models, Startup general interest | 2 Comments

Back in September Y Combinator founder Paul Graham wrote an essay about growth. The central point of his essay is that startups are all about growth and that is the one thing they measure at Y Combinator. According to Paul most startups should look at revenue growth, but active users is a good proxy for companies that aren’t charging their customers (yet).

Because the Y Combinator program is short (3 months) they measure growth weekly. Here are the benchmarks:

A good growth rate during YC is 5-7% a week. If you can hit 10% a week you’re doing exceptionally well. If you can only manage 1%, it’s a sign you haven’t yet figured out what you’re doing.

Paul goes on to point out that growth is exponential and that small differences in the weekly percentage growth rate have a surprisingly big impact on where a company ends up after a year or two:

A company that grows at 1% a week will grow 1.7x a year, whereas a company that grows at 5% a week will grow 12.6x. A company making $1000 a month (a typical number early in YC) and growing at 1% a week will 4 years later be making $7900 a month, which is less than a good programmer makes in salary in Silicon Valley. A startup that grows at 5% a week will in 4 years be making $25 million a month.

I share the view that growth is critical, and that without very high growth rates early on a business will never grow big. Growth is the main driver of value in our companies and it is what makes them exciting to IPO investors and acquirers. I disagree that growth should be the sole focus though. In practice most businesses are cash constrained and have to optimise the trade off between investing in growth and running out of cash – so they focus on growth AND operational efficiency. The unknown variable here of course is the ability to raise more money, and there may be a difference between what Paul is saying and what I’m saying purely because Y Combinator companies growing at 5% per week are always able to raise capital and therefore can focus on growth knowing that if they hit their growth target they will never run out of capital.

Most companies aren’t so lucky. They need to maximise for growth whilst either getting to profitability within their existing resources or maximise for increase in valuation at the next round by thinking of the milestones they can hit before running out of cash. Many of those milestones will be growth oriented, but they often centre on hitting round numbers – e.g. $10k or $100k per month in revenues or 1m active users. Hitting these milestones takes time and growing faster but running out of cash before they are reached may not be the best strategy.

(Paul arguably covers this point when he says that entrepreneurs should look forward to make sure that growth can be maintained, and stopping growing because cash has run out would definitely be a failure to look forward. I wanted to make it more explicit.)

Finally there is sustainable growth and unsustainable growth. That may not matter much when companies are just getting going in Y Combinator but it is critical as a business grows. The classic case of unsustainable growth is where each customer costs more to acquire than his or her life time value. It is mostly ecommerce companies I’ve seen suffering from this problem. To maximise growth in the early days they spend a lot of money on marketing and sometimes lower prices to attract users. Impressive revenue growth follows, but losses rise at an equally rapid rate, and the company has to raise more money to keep growing. To show that the company will make profits in the end management produce models that assume metrics like gross margin, customer repeat rates, and customer acquisition costs will improve going forward. Sometimes investors are convinced. Sometimes not. The standout example of this sort of thinking recently was Groupon which convinced investors at its IPO that their customers were very loyal and that they could at any point become profitable by halting spend to acquire new customers. Many potential investors chose to stay on the side lines because they didn’t believe the assumption about customer loyalty and feared the company was structurally unprofitable and growing unsustainably.

Musings on the iPhone5, market maturity and open systems

By | Apple, Business models, Mobile | 2 Comments

I like open systems. Always have, and probably always will. It’s partly because open-ness begets more innovation, partly because open systems are easier for startups, and partly because I don’t like the way companies that dominate closed systems bully the other participants. The last two points are illustrated well by Apple’s recent ejection of the iKamasutra app from the app store – an app that had been in the app store for 3-4 years, and had grossed millions of dollars and 9 million downloads.

On this score at least the last couple of years haven’t been kind to me. Apple’s closed ecosystem remains very strong, Android has done well, but has itself become quite a closed system (although at least you can add unapproved apps to your phone, if you can find them), Amazon has made great strides with it’s own closed ecosystem, and most recently HTML5 has been found wanting in comparison with native apps.

One of the side theories in Clayton Christensen’s Innovator’s Dilemma is that in periods of rapid product evolution then integrated supply chains dominate, but as the product evolution slows down the interfaces between different elements of the product can standardise allowing specialist firms in each area to come to the fore. He gave the PC as an example – in the beginning everything was made by companies like IBM, but over time it made more sense for them to buy more and more components from third parties – e.g. disk drives, graphics processors, RAM chips.

This logic suggests that as products become more mature then their ecosystems should become more open. The fact that hardware, software and key web services have remained integrated on mobile has made me wonder whether the pace of change is now so fast that products no longer mature in the way the PC did.

I’m now wondering if I simply wasn’t allowing long enough for smartphones to mature.

Unless the first thing you do when you turn your computer on is read this blog (hello mum!) you will by now have seen details of the new iPhone5. The headline is that the improvements are incremental rather than revolutionary. Compared with the 4S the iPhone5 has a 9mm taller screen, is 20% ligher, 18% thinner, the processor is twice as fast, has three microphones instead of one, and a slightly better camera. There is nothing new. Techrunch thinks “It’s not as earth-shatteringly different than the iPhone 4S, to be sure.” and Adam Leach, analyst at Ovum, wrote that the incremental nature of the upgrade shows “how mature the product is”.

If Leach is right that the iPhone is mature then the next version will simply be another incremental improvement, and smartphones from Samsung and others will similarly move forward in steps rather than leaps. This will create time and space for standardisation of the interfaces with app stores, media players and the like, which would enable third parties to play in these spaces, ushering in a period of greater open-ness in the ecosystem. That would be good for iKamasutra and other startups, and good for the consumer to. As evidence for this conclusion I would cite the fact that iTunes, the App Store, and Google Play aren’t shining examples of great software development, and that app discovery is little better than you would get from a printed catalogue.

Amazon’s gadget as a service strategy

By | Amazon, Apple, Business models, Google | One Comment

As you’ve probably seen Amazon announced a slew of new devices yesterday, no smartphone, but their four new Kindles have been well received in the blogoshpere, particularly the Kindle Paperwhite and the new Kindle HD, both of which have got me excited.

Perhaps most interesting though is that once again Amazon is playing the price and volume game – they aim to win against Apple and Google by leveraging their scale to offer cheaper prices. The strategy to achieve this is to bundle hardware with content as a service. This slide from Bezos’ presentation says it all. (See ZDNet for more on this.)

Use our services

Also interesting is that Bezos announced a $50 4G data plan and chose to play up the total cost of owning a KindleFire HD with total cost of owning an iPad. The combined cost of data and hardware for the KindleFire HD comes in $410 cheaper in the first year than for the 32GB iPad.

This news evidences the continuation of a couple of big trends that we’ve talked about before:

  • Amazon, Google and Apple are converging on the same business model to compete across the consumer tech value chain from devices through services to content.
  • These same companies are increasingly control access to consumers. They are the new gatekeepers, and digital media startups will increasingly have to play nice with them. I don’t see this as good news.

Musings on freemium

By | Business models | 2 Comments

I’ve been meaning to write a post on freemium since reading Alan Patrick’s When freemium fails, and doesn’t last week.

The point of Alan’s post is to say that whilst having a freemium business model works for some companies it is not as widely applicable as everyone (including me) thought a couple of years back. I think he’s largely right. The basic problem is illustrated by the story of Chargify (from WSJ):

for some, the "freemium" strategy is turning out to be a costly trap, leaving them with higher operating costs and thousands of freeloaders. That’s what happened to Chargify LLC, a provider of billing-management software to small businesses, which used the freemium business model when it started out in 2009. The Needham, Mass., company gave away its software to merchants that billed fewer than 50 customers a month. If a merchant wanted to bill more than 50 customers monthly, then the business owner would have to start paying $49 a month.

Most Chargify users never became paying customers. Within a year, the company was on the path to bankruptcy. Chargify eventually put up a paywall for all users. Last month the 12-employee company became profitable, with more than 900 paying customers. The starter plan is $65 a month.

Alan quotes David Cohen, founder of Techstars, as saying that due to low conversion from free to paid (typically 1-2%) freemium only makes sense for businesses that can reach millions of users. Otherwise they won’t get enough paying customers. This was Chargify’s problem.

For those that can’t reach millions that leaves two choices. Get everyone to pay or find another source of income – e.g. advertising, selling related products, or do something with the data. Of these, getting everyone to pay is at once the hardest model to execute and the easiest model to scale.