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Physical products should be things people want first and platforms second

There has been much talk over the last couple of days about Facebook’s $2bn acquisition of virtual reality headset maker Occulus Rift, a lot of it suggesting reasons why they would pay so much for a consumer company that is yet to ship a consumer product. To my mind the best answer to that question is that virtual reality could become a platform as important as mobile and that Facebook wants to position itself well if that happens.

You could use a similar argument to explain Google’s recent $3.2bn acquisition of Nest, although this time the next ‘platform’ is the connected home.

I think these arguments are good explanations of why the acquisitions happened – i.e. why Facebook and Google specifically were interested and why the price tags were high – but not why the companies were successful. The success came because they created products with a real wow moment that people love and talk about with their friends (strictly speaking in the case of Occulus Rift products that people think they would love…). The acquisition interest came after that success.

Moreover, there are other hardware companies out there enjoying success because people love their products that aren’t platforms in the same way – e.g. GoPro, which is slated to IPO.

My point is that founders of hardware companies should think first about creating products people love (and a sustainable business) and second about being the next platform. I’m afraid we might see a wave of business plans from companies thinking platform first and product second.

Google slashes cloud prices

I love Amazon and AWS for the way they keep cutting their prices and for the way they support the startup ecosystem. As an example they offer Forward Partners companies, and the companies from many accelerator programmes $10,000 of AWS credits, effectively making it free to get started on their platform. For these reasons Amazon is the first choice for most startups.

However, Google just slashed its cloud prices and is not cheaper than Amazon for all but the heaviest users. Significantly cheaper in fact. Pricing for these products is complicated, but by the analysis of cloud management software company Rightscale Google is 30-60% cheaper for on-demand usage (i.e. light usage), 21-32% cheaper for 1 year heavy reserved instance pricing (i.e. moderate usage) and 3-19% more expensive for 3 year heavy reserved instance pricing (i.e. heavy usage).

Price decreases come regularly in this market and I’m sure Amazon will take action soon, otherwise startups will start turning to Google. I can watch this sort of price competition all day long, but it will be interesting to see how Google fairs playing the price game against Amazon. Historically they have been a high margin monopoly type business whilst Amazon has always been about low prices.

Explaining carried interest

‘Carried interest’ is the name given to the profit share schemes that investors in venture capital funds, typically called ‘LPs’, use to incentivise the partners at at the funds in which they invest. The partners are typically called the ‘Manager’, as their job is to manage the fund by making investments and managing the portfolio to maximise returns to LPs. We’re going through the process of explaining and awarding carry to the people in Forward Partners and I thought I’d share the explanation there.

Most Managers of venture capital funds in Europe get 20% of the profits on the entire fund once a minimum hurdle has been returned. If there is no hurdle then the maths are fairly simple. A good fund is one that returns 3x the investment made by LPs. We are aiming for a £30m fund, so in our case a 3x fund would mean we are returning £90m to our LPs with a profit of £60m. The carry pot would then be 20% of £60m, which is £12m, and that money would be shared amongst the staff and partners at the Manager according to a percentage split agreed when the fund was set up.

Similarly, if the fund returned £40m and there is no hurdle then the profit would be £10m, and the carry pot would be £2m.

If a high level understanding is sufficient for you then stop reading here. If you want to understand how hurdle rates apply to marginally profitable firms then read on.

Hurdle rates stipulate that the Manager delivers a minimum return before any carry gets paid out. That minimum return is expressed as an annual percentage increase called the hurdle rate. The table below shows the impact of a 5% hurdle in the examples above:

Screen Shot 2014-03-25 at 19.31.11

There are two things to understand here. Firstly, how the hurdle effects whether carry gets paid out, and then the secondly how the ‘cartch up’ effects the amount of carry in the pot.

  1. Line 6 shows the amount the fund would have to return to beat the hurdle and get into carry. You can see that the amount goes up each year as an extra year of the 5% hurdle compounds. Lines 7 and 8 show whether carry would pay out at all with a given level of profit in each year, illustrating the point that the hurdle only matters if a fund is marginally profitable. You can see that with a £10m profit carry will only pay out if the returns are realised by year five (which would be fast), whereas when a fund is tripled carry will payout regardless of how long it takes. Note that these calculations make the simplification that all investments are made on day one of the fund and all the returns come in one lump in the year indicated.
  2. Lines 10 and 11 show how the ‘catch up’ operates to get the Manager back to 20% of total profits after the hurdle has been reached. If the catch up is 100% then once the hurdle has been reached then all additional profits go into the carry pot until it has caught up to 20% of total profits. Most LPs want the catch up clause to be a little more favourable to them and stipulate that during the catch up phase 80% of additional profits go into the carry pot whilst the other 20% go to LPs. These catch up provisions only bite in situations where a fund is just into carry.

If you want to see the workings or play with the assumptions in the table above you can find the underlying spreadsheet here.

The final piece of the puzzle is vesting. Much like options in a startup carried interest schemes vest over time, typically five or seven years.

Amazon’s leadership principles

I’m a big admirer of Amazon as a company (and a holder of their stock). That admiration comes in large part from their relentless focus on good execution and their leadership principles are another good example. First I like that they are clear that everyone at Amazon is a leader – so the principles are for everyone. Secondly the list is a good one. There are fourteen items on it in total, and a lot of them are what you’d expect (e.g. think big, hire the best) but a four of them are maybe not widely understood/accepted:

  1. Invent and Simplify
    Leaders expect and require innovation and invention from their teams and always find ways to simplify. They are externally aware, look for new ideas from everywhere, and are not limited by “not invented here.” As we do new things, we accept that we may be misunderstood for long periods of time.
  2. Are Right, A Lot
    Leaders are right a lot. They have strong business judgment and good instincts.
  3. Dive Deep
    Leaders operate at all levels, stay connected to the details, and audit frequently. No task is beneath them.
  4. Have Backbone; Disagree and Commit
    Leaders are obligated to respectfully challenge decisions when they disagree, even when doing so is uncomfortable or exhausting. Leaders have conviction and are tenacious. They do not compromise for the sake of social cohesion. Once a decision is determined, they commit wholly. 

It’s particularly important to remember 2 and 4. Fast paced accurate execution is critical to startups’ success and that depends on good judgement, honest and open debate, and then commitment to decisions.

Improving checkout conversion

checkout abandonment

Think about the chart above for a moment. It’s showing that 50-80%+ of people who have got far enough through the purchase process to click on the checkout button then decide not to buy. That’s huge. Another way of looking at this data is to say that poor conversion of the checkout pages increase customer acquisition costs by 100-400%. Companies spend hours optimising their spend on Google and other channels for much smaller improvements than that.

The answer, of course, is to optimise the checkout page. Abandonment rates rarely get far below 50% but there is a lot that companies can do.

The primary reason people abandon checkouts is price. We are hardwired to prefer not losing something (our money) to gaining something (whatever we are buying) so optimisations that reduce the impact of price are very effective. Free shipping is perhaps the most well known of those, but other tricks like not using $ or £ signs and using neutral colours and smaller fonts for the price also make a difference.

Other useful tricks include:

  • not forcing customers to register
  • optimising the language on buttons (e.g.  Gumballs.com got a 20% improvement by changing ‘Proceed to checkout’ to ‘I’m ready to checkout’)
  • minimising the work for the user – smallest number of fields, pre-populate if possible
  • make forms smart – validating fields as the user progresses makes them much less confusing and if you can’t do that put the error messages next to the error
  • reassure prospects at every stage – e.g. with social proof and trustmarks

The message is clear – there’s huge value to be had from optimising the checkout page. As a final example one company reduced their checkout abandonment from 80% to 54% with the changes below.

checkoutimprovement

You can find these tips and others on 7 Proven Secrets of High Converting Checkouts. Thanks and kudos to author Joanna Wiebe.

The macro view and the micro view

The macro way of building looks at characteristics and trends in the broader marketThe private messaging space is blowing upAnonymous and/or ephemeral content is hugeThe free-to-play model is far more effective for monetization than a pay-to-play model.

The micro way of building looks at characteristics and trends of individualsMy little cousin and all her classmates are obsessed over how many positive counts their photos get. My friends love Airbnb because they get to stay in cheaper and more unique places than what traditional hotels offer. It’s so fun to guess which Secrets are from which of your friends.

Credit Julie Zhou

I love this for the way it identifies and labels two very different ways of thinking. Because they come from different perspectives and use different language the macro view and the micro view are often at odds, but they are both equally valid. Recognising that fact is the first step towards reconciliation, and reconciliation here has a big prize. If a product or company works at both macro and the micro levels then it will likely have both soul and be playing to a big trend – i.e. it will have better than usual odds of success.

Failure to reconcile happens all the time in the startup world when the micro view, often espoused by an entrepreneur, pitches an idea with reference to a group of users they know well to a holder of the macro view, often an investor, who can’t make the link to their macro view. To the entrepreneur it feels like the investor is trying to follow the herd and pigeon-hole their idea into a well understood trend and to the investor it feels like there is too much risk that the entrepreneurs reference group of users isn’t representative and the opportunity is too small.

The language of ‘macro’ and ‘micro’ view can help bridge that gap. Investors can say ‘that’s a compelling micro-view, but how does it link to the macro-view I have of trends in the market?’ and entrepreneurs can say ‘I get that XYZ is a big trend, but how is it manifested in new products, services or use cases?’.

We haven’t used this language before, but here at Forward Partners we are backing the macro-view that the eCommerce ecosystem broadly defined has a lot of opportunity and are in the process of fleshing out what that means at a micro-level. I think this macro-to-micro framework will help us do a better job.

Moving away from clicks and links to attention and quality

Tony Haile, CEO of analytics business Chartbeat has a great post up on Time with the provocative title What you think you know about the web is wrong. His point is that we have all been tracking clicks and links as a proxy for attention and intent, but attention and engagement are what really count. As a result publishers and advertisers often misunderstand their businesses and invest in clickbait and articles that people don’t read that don’t perform for advertisers.

Tony says that smart companies like Medium, Upworthy, and the Financial Times have figured this out and are starting to focus on engagement metrics to measure their own success and value their advertising products. The net result is higher quality content which consumers spend more time reading and which supports brand driven banner ad campaigns with quality creative with high recall rates. The insights here are that recall rates are a better measure of ad performance than click through rates, and that recall rates rise when the creative is good AND users dwell on a page long enough to notice it.

The article is packed full of supporting data, much of it culled from a 2 billion pageviews generated by 580,000 articles on 2000 sites. Here are a couple of highlights:

  • We don’t read what we click on so chasing pageviews is a mistake. 55% of the 2bn visits analysed spent less than 15s on the page. The most valuable customers are those that remember a site and come back. Publishers generating linkbait have to start again from scratch every time.
  • Native advertising only works when the content is great – and today most of it isn’t. On normal articles 71% of people scroll, but for native advertising the figure is 21%. The trick for publishers is to ensure that the native advertising offers an experience consistent with the rest of the site.

The web that Tony describes is an exciting one that I would love to see. Less clickbait and shallow articles and more quality content that holds attention combined with a shift towards higher ad quality creative designed to inspire and be remembered. Sounds great to me.

The perils of carrot and stick based management

This is a list of what Dan Pink, author of Drive: The surprising truth about what motivates us, calls the ‘seven deadly flaws of carrot and stick based motivation:

  • They can extinguish intrinsic motivation.
  • They can diminish performance.
  • They can crush creativity.
  • They can crowd out good behavior.
  • They can encourage cheating, shortcuts, and unethical behavior.
  • They can become addictive.
  • They can foster short-term thinking.

A couple of these are obvious, but many of them are counter-intuitive. A few years ago I would have rejected the notion that rewarding explicit behaviour (carrots) can diminish performance but in the case of creative work I have come to see that it is true, and I think similarly about the other ‘flaws’ listed. Most of the work we do in startups is of a creative nature one way or another so this is a very important point.

The takeaway is that the best performing teams will come to the managers who reject carrots and sticks and embrace the more complicated and tricky notion of motivating by giving their people autonomy, mastery, and purpose. If you are a manager, and this post resonates with you in any way I strongly suggest reading the book.

Balancing entrepreneurial drive and instinct with lean and other methodologies

On Tuesday night Michael Breidenbruecker, founder of Last.fm, RJDJ and all round nice guy gave a talk for around 50 of our friends and portfolio company staff (thanks again Michael). One of the interesting things about the Last.fm story is that success took a while to come. There were, I think, 2-3 years of little growth before market changes pushed music streaming into the mainstream, user numbers rocketed and the company was acquired by CBS for $280m.

In his new startup Michael is rigorously applying lean principles. These principles weren’t around when he founded Last.fm in 2002, so they built what they thought the industry needed and people would want. They quickly found a small group of passionate users which he says is what kept them going until the market turned, but looking back Michael thinks that if they applied lean principles they might have made some different decisions.

That observation prompted an interesting discussion about how to strike the right balance between entrepreneurial drive and instinct on the one hand and modern startup methodologies like ‘lean’ on the other. Someone from the audience made the good point that you sometimes see entrepreneurs over-focusing on doing everything by the ‘lean book’ and missing the big picture requirement of doing something meaningful.

I have three observations:

  • startups still need a great idea at their core – without that no amount of lean discipline will bring success, but once the great idea is there disciplined application of lean and other methodologies reduces the requirement for further moments of inspiration and/or luck down the line
  • it is easy to picture entrepreneurial drive and instinct as polar opposites to startup methodologies but that misses the point – they are in fact compliments – the methodologies help with the execution of the entrepreneurial ideas, in particular they make it quicker and cheaper to find out what works
  • for big and long-ranging decisions on issues like strategy, product quality, brand and market evolution it is often best to rely on instinct, but for shorter term and smaller impact matters like choosing between competing site designs and predicting customer behaviour methodologies and data are often more useful (see here for a good discussion of this point in the context of design)

As regular readers of this blog will know I’m a big fan of methodologies like lean, design thinking, and customer development. That’s because they increase the speed of learning, reduce the cost of failure and will ultimately increase the success rate of startups. My point here is that they are not a substitute for good old-fashioned entrepreneurial flair.

Looking for a Talent Manager to join Forward Partners

We’re hiring again! If you’re interested in joining us as a Talent Manager or knows somebody who might be then read on.

At Forward Partners we set out our stall to do much more for companies than just provide capital. I like to think of us as offering resources to entrepreneurs in four areas:

  • Help to make sure the product is aligned with customer needs
  • Help to make sure the product is of high quality (code, design, UX)
  • Help finding the first XXX customers
  • Help building a great team

All of this is in addition to strategic advice and access to our networks.

The Talent Manager will take the lead on the fourth item, helping our companies build a great team, and will also help with our own recruitment needs. The most common hires are co-founders, developers, marketers, and designers. Responsibilities will include helping companies build out a talent plan, building and maintaining a database of London’s best candidates, and managing recruitment processes. You can see more detail and apply on LinkedIn.

This is a great chance to play a key role in the success of Forward Partners and next wave of hot ecommerce companies and to learn the secrets of venture capital :).