What startups can learn from Nintendo

James Surowiecki has a great article in the New Yorker this week about the new Nintendo Wii system, titled "In Praise of Third Place."  What James really asks is if you are a distant third in a market, how do you compete with the big boys?  In this case, Nintendo is slugging it out with Sony and Microsoft and rather than going into hand-to-hand combat, Nintendo has changed the game and the stakes – forget about being the most powerful and fastest machine but how about focusing on being the easiest to use with a significant differentiating feature – motion sensors.  James goes on to say:

The point is that business is not a sporting event. Victory for one company doesn’t mean defeat for everyone else. Markets today are so big—the global video-game market is now close to thirty billion dollars—that companies can profit even when they’re not on top, as long as they aren’t desperately trying to get there. The key is to play to your strengths while recognizing your limitations. Nintendo knew that it could not compete with Microsoft and Sony in the quest to build the ultimate home-entertainment device. So it decided, with the Wii, to play a different game entirely.

I would argue that rather than title the article "In Praise of Third Place" that it should be titled "In Praise of First Place" because what Nintendo did was slice and dice the multi-billion dollar gaming market so that it could be first place in a submarket (which is quite huge) that Nintendo has defined, that plays to its strengths, and that it can win.  This is a big deal and quite smart.  Even though Nintendo is a large company fighting even larger ones, this is a strategy that any startup can use – change the stakes and be the best in your new category.  This does not mean to slice ad infinitum until you get a market so small that it is irrelevant, but the point is that going into "hand-to-hand" combat with those with much greater resources can be quite hazardous to your health.  Take a look at an excerpt from an earlier post I wrote about competing with the big boys

First, as a startup you have to get away from a feature/function battle because you will always lose against a big boy.  If a customer has already bought a product from an incumbent, they are more often than not willing to stay with that incumbent if they can deliver the extra feature/function soon enough in a good enough way. What I like startups to do is win with the product roadmap and vision.  Show the prospect how you solve their needs today better than the incumbent but more importantly why you are different and how your approach will solve their future needs.  If you can differentiate on this level, it gives you a much better chance to win. 

The future of television advertising (continued)

A little over 2 years ago, I wrote a post about the future of television advertising.  While I have always been bullish about broadband video advertising, I have never believed that the $60b television advertising industry would disappear overnight.  In fact, before the Internet dominates all advertising why couldn’t one bring the tools of the web to the television world making TV advertising more effective, targetable, and measurable – in effect changing it from a mass media to a more targeted dynamic one.  That is in effect what one of our portfolio companies, Visible World, has been working on during the last few years.  Visible World enables every ad to be as dynamic and diverse as the market and audience it captures as new data resources, analytics, tools, and platforms transform marketing.  With its simple-to-use tools, advertisers create, monitor, and deliver intelligent video spots that are edited automatically anywhere and any time they run to reflect the time, location, and context in which they appear.  All while delivering traditional reach within any media plan.  Think of what the web looked like in a static world versus today’s dynamically driven one where web pages are now assembled on the fly based on who you are and what you like.  Visible World is bringing the power of dynamic customization to television advertising.  It is especially nice when someone like Jonah Bloom, Executive Editor of Ad Age and a guy who really gets it, recognizes the power of our platform as evidenced by his AdAge column the other day.

Modifying TV spots
In an hour of omnipotence I’ve rebuilt and redistributed ads for some of the biggest companies in the country. Borrowing their existing creative I’ve modified a dozen commercials, turning each execution into hundreds of 30-second spots, each more targeted and relevant than the original. I’m confident that my work — if it were affecting the real world and not just Visible World’s demo system — would’ve multiplied the ROI on these ads by a geometric factor that would establish me as a genius within my organization, or at least ward off shareholder griping for another quarter….

Already six major marketers are using Visible World to manage and modify their ads in real-time. Another 12 are having dashboards built for them right now. This is a technology at a tipping point, and if you’re not prepared to take my word for it, maybe you can persuade the folks at Visible World to give you a turn as ruler of the ad world. It’s pretty heady stuff.

In short, I don’t believe that television advertising will go away but that it must be reinvented quickly and that advertisers must embrace rather than fear new technology.  And as we move into the future, rather than focus on broadband vs. television (digital vs. analog), I also see a world where both sides can work with each other to effectively deliver better results for advertisers.  As video becomes increasingly more fragmented and viewed on various systems and devices (television, VOD, broadband, gaming systems, cable, mobile, iPods), it will be imperative for advertisers to have an easy way to manage and optimize their video advertising campaigns wherever the audience is.  In addition, the more progressive advertisers will try to figure out how to marry online ad optimization with the offline world.  For example, let’s say you are an advertiser and your online ad for a specific mortgage product for ARMs is getting more clicks in a certain geography versus one for fixed rate mortgages.  Using that data from the Internet, wouldn’t it be great if you could change your television commercial so that the next airing has an updated offer for ARMs instead of for fixed rates?  That is just one example of how Visible World can bring the two worlds closer together, using data from your Internet campaigns to enhance and optimize your media spend on television.  And of course, without the Visible World technology, it would be hard to do this in a near real-time, automated, and cost-effective manner.  There are so many more ways that Visible World can make a television commercial more relevant and effective.  As Jonah goes on to say:

These are fairly obvious ways of using the technology, but as smart creatives start to get comfortable with this tool, we’re going to see way-more-ingenious applications. The ads could even become responsive to the programming. Think the Geico gecko opening his sales patter by commenting on the score in the game, perhaps — sort of entertainment being integrated into the ads, rather than the other way ’round.

Advertisers are starting to get it so keep an eye out for this idea of "advertising responsive to programming" during the next couple of weeks.

Yahoo’s manifesto for change

If you are a big company getting your butt kicked, it seems like the thing to do is issue a memo.  Bill Gates did it after Microsoft lost out on the first wave of the Internet.  Ray Ozzie wrote one for Microsoft about the importance of software as a service last year (see an earlier blog post).  The most recent memo is from Brad Garlinghouse of Yahoo (see WSJ Article – annoying that it is password protected) who wrote a "call to arms" for Yahoo to stop doing everything and to focus on a few things and to do them well.  According to Brad, "we want to do everything and be everything — to everyone" which means they are investing in too many areas and are spread way to thin.  Brad goes on to outline a number of basic issues that can and will kill any business, small or large (see memo here):

1. We lack clarity of ownership and accountability
2. We lack decisiveness

Rather than just outline the issues, Brad recommends some much needed solutions:

1. Focus the vision
2. Restore accountability and clarity of ownership
3. Execute a radical reorganization (blow up the matrix where there is no clear owner and kill redundancies and overlap)

This is all just basic Business 101, but sometimes if you grow too quickly and don’t take a step back and strategize about what’s important, you can get lost pretty quickly.  Whatever happened to the whole media group in LA with Lloyd Braun?  How about all of the turf wars between the tech team in Sunnyvale with the media guys in LA?  As an example, whenever one of my portfolio companies wanted to do something with Yahoo we were always never sure of who the real owner of the decision was and consequently it made it incredibly frustrating to work with them.  When there is no overarching vision and when there is overlap in terms of responsibility, you can imagine how much time executives can spend fighting amongst each other rather than focusing their aim on the competition.  And inevitably this leads to slow movement, bureaucracy, and an exodus of top talent.  While outlining a vision can sound hokey, it is important for every employee to not only know, but live, eat, and breathe the company mission.  It sounds like Yahoo’s mission to be the "most essential global Internet service for consumers and businesses" lacks clarity for the executives.  While I do use and love a number of Yahoo services, I always use Google for my searches.  I am sure all of these basic changes and suggestions, if taken up by Yahoo, will help them execute in a more streamlined and efficient manner, but at the end of the day it is going to be tough to outsearch Google in terms of technology and monetization (2x the monetization rate per search for Google vs. Yahoo).  Assuming Yahoo does narrow its focus, I can’t wait to see what ultimately will be the top 3 priorities for the company.

Is the bar lower for a tech IPO?

I am not sure if you saw the news, but Salary.com recently filed for an IPO to raise up to $50 million. On the book is Thomas Weisel Partners, William Blair, Needham, Pacific Crest, and Wachovia. According to the S-1 filing:

Salary.com is a leading provider of on-demand compensation management solutions. Our comprehensive on-demand software applications are integrated with our proprietary data sets to automate the essential elements of our customers’ compensation management processes….

In addition to our on-demand enterprise software offerings, we also provide a series of applications through our website, which allows us to deliver salary management comparison and analysis tools to individuals and small businesses on a cost-effective, real-time basis…

We offer our solutions principally on an annual or multi-year subscription basis. Our direct sales group markets and sells our solutions primarily using the telephone and web-based demonstrations. From the introduction of our solutions in 2000 through September 30, 2006, our enterprise subscriber base has grown to approximately 1,500 companies who spend from $2,000 to more than $100,000 annually, including companies such as Wal-Mart, Home Depot, Procter & Gamble, Merrill Lynch, UPS and Cisco Systems. We also sell to both individual consumers and smaller businesses through our Salary.com website.

From April 2001 through June 30, 2006, we achieved 21 consecutive quarters of revenue growth. During the years ended March 31, 2004, 2005 and 2006, we achieved positive operating cash flows of $0.3 million, $0.9 million and $1.8 million, respectively, and used $0.7 million of cash in the three months ended June 30, 2006. During these periods, we have consistently incurred operating losses, including $0.8 million for 2004, $1.9 million for 2005, $3.0 million for 2006 and $0.8 million for the three months ended June 30, 2006. As of June 30, 2006, we had an accumulated deficit of $21.8 million.

I would usually put IPO filings in the nonevent category but as I dug deeper into the company and financial performance, it did raise some interesting questions for me.  First and foremost, the traditional rule of thumb that most investment bankers have quoted me in the last couple of years was that in order to go public a company needs to have an annual run-rate of $40-50mm of revenue and a couple quarters of profitability.  While the Salary.com numbers are strong (read the S-1 here), they are not close to those metrics.  In fact, during the last 3 fiscal years for the company, it did $6.4mm, $10mm, and then $15mm in revenue.  The trailing twelve month number is closer to $20mm in revenue.  While slightly cash flow positive, the company is not GAAP profitable.  So the natural question for me is to ask whether or not the barrier for a private company to go public is much lower today and whether or not this will signal an ongoing trend in the future.  This is obviously relevant for a number of reasons.  Outside of a few outliers, most of the returns generated for VCs have been from M&A transactions.  If the IPO markets open up again, it would give investors and entrepreneurs another option to create value.  Using a back of the napkin analysis, most companies sell about 20% of their stock to the public, so one could assume that Salary.com is valued at around $200mm pre-money implying a 10x multiple on trailing twelve month revenue.  I must say that sounds quite appealing.  Anyway, we should all watch this company as it goes through its paces because if it does well, it could open the door for plenty of other companies like it.  There must clearly be an appetite from the institutional money managers who are looking for more upside from rapidly growing small cap companies.  By the way, one other interesting point about Salary.com is that is an on-demand application play with some web-based advertising thrown into the mix.  It is also mostly a subscription-based business which means it has a highly predictable revenue stream which is great for forecasting future performance.  Finally, the company only raised $5mm of VC dollars so it is highly capital efficient.  If you read from the S-1 above, most of the sales are generated through the telephone or through web-based demos, all of the traits for a nice frictionless sale and great business model.

The state of consumer security

I had the pleasure, and I mean pleasure, of recently rebuilding two of my home PCs running Windows XP because of performance degradation and other issues.  I ended up doing a clean wipe of the hard drives and reinstalling Windows XP from scratch.  Once I got the machines up and running with broadband connection, I recognized that I was completely naked on the web with no protection.  As you may or may not know, I have invested and am on the board of 2 security technology companies which sell into the SMB and enterprise markets (see Deepnines and netForensics).  Therefore, I clearly understand the need to lock down your systems and protect yourself against spyware, viruses, and other malicious attacks.  Of course, there is always a tradeoff between security and performance.  In the past, I have been an avid user of best of breed software on my PC – ZoneAlarm Pro for firewall, Norton Antivirus, and Webroot SpySweeper for Spyware.  One, this is not cheap, and two, and it becomes a headache to manage and keep track of after awhile, especially if you have more than one machine in the house where you have to set up rules for each separate PC.  For example, as you can see from a recent post, a new software release from Webroot killed one of my machines.  Despite the management overhead, what this best-of-breed approach offers me is diversified protection and real-time scanning.  What good is having virus protection if you are already infected and the virus scan detects and removes it after you are already infected?  There is a huge difference between prevention and remediation. 

So of course, with an eye on simplifying my life, I decided to download and install Windows OneCare on one machine.  It was easy to download, offered diversified protection against threats, and also allowed me to add multiple machines.  However, one drawback, which did not really seem to be highlighted anywhere was that there was no real-time scanning and protection for incoming email.  That in my mind is a huge flaw.  How can Microsoft give everyone the perception that they are locked down with this new service when it does not scan your PC in real time for threats antivirus threats in your email?  I can see a whole army of consumers feeling secure but still having tons of issues without the real-time functionality. 

Anyway, this post is not about Windows or any one specific product, but the fact that I have to download and install security software on multiple machines and have to set them up and manage them.  As you know I am all about simplicity and reducing friction in usage, so why not have one simple box that does it all for the consumer – cable/dsl modem, router, wireless LAN, with best of breed security software loaded into the device?  Zarouterpressfinal3jg Just like the enterprise security market went from packaged software installation to set and forget appliances, why can’t I have the same functionality in the consumer market?  As we all know, hardware is a commodity and prices have fallen dramatically.  And just like enterprises, I want defense-in-depth for my house which means building in security at the edge before it can even get to my machines.  With best-of-breed security functionality built into the router, I can set security policies once for my whole house and not have to install and manage client software for every machine.  I also get my CPU cycles back on my PCs as they can be a drain for the machines.  The good news is that forward thinking companies like Checkpoint ZoneAlarm are starting to go after this market and recently announced just such a device for the consumer market.  If you look at this graph you can see why having comprehensive security at the edge is needed.  Malware gets blocked at the edge before it can do damage to your PCs.  In my mind the state of consumer Internet security is that we are still in the dark ages but it is getting better.

Consumers want instant gratification

Greg Linden has a great post summarizing a talk that Marissa Mayer of Google gave at the recent Web 2.0 conference.  I encourage you to read it because Marissa talks about how Google ran a user test where users wanted more search results.  Surprisingly, traffic and revenue dropped by 20% and what Marissa discovered was that load times for less searches was .4 seconds and load times with more searches was .9 seconds.  Despite the fact that users really wanted more results, in the end, according to Marissa and Greg, speed matters. 

This makes total sense.  In the broadband world we live in today, the Internet is about instant gratification.  I could argue that one of the reasons YouTube exploded on to the scene (besides the fact that it had every copyrighted video out there on its site) is because of its use of Flash – no download and instant gratification right in the web browser.  It sounds simple but it is true.  There are many vectors that you can optimize with respect to consumer experience but take it from Marissa and Greg that in the end, users want instant gratification.  In my mind what instant gratification really means is speed and ease of use.  It has to load fast and it has to be easy.  This is about reducing friction for users to experience your service and reducing the friction for you to generate revenue.  Remember no matter how many extra bells and whistles you add, don’t forget that speed and ease of use really matters.

CBS going early

As I wrote early last year, my perspective is that one must go early, go late, or go home to make money in the venture market.  Given that we at Dawntreader have always been early, that is where we will continue to focus.  What is interesting is that on the heels of the new seed funding plan that Charles River Ventures recently announced, CBS just brought in an Allen & Co deal maker to head up its Interactive division with an eye on going early as well.  As Quincy Smith, new CBS head, said in a Reuters interview, "I’m looking for the next YouTube, only a year earlier, when they were 1/32nd of their size, without building out stuff that we would find duplicative like sales force. The core engineering team is always important."  Of course, what he is also saying is that he also does not want to pay exorbitant prices for companies that he could have found earlier. 

While CBS has certainly put some dollars and focus behind this "going early" effort, it is not lost on a number of media companies that I have met with in New York recently.  All of them are looking to invest and buy startups before they get too big.  As you all know, commoditization means it is extremely cheap to get a web business started and build an audience.  Since the inflection points for startups occur much sooner and on much less capital, missing that first round means you have to pay up to get involved.  Paying up means it significantly increases the bar for success and the risk of your investment or acquisition failing.  According to the PaidContent post today, "On the making deals side, it sounds like he’s in sync with Moonves, who has said the company won’t be making major digital acquisitions."  All of this is to say that Rupert Murdoch made a ballsy bet when he bought MySpace and paid the price that he did – no one else moved as quickly or as emphatically. 

In theory it sounds great – spread around a number of smaller bets instead of making a bet-the-farm acquisition like a Facebook. And  I am sure that CBS will see a ton of great entrepreneurs, but the question is whether or not CBS, a traditional media company, can identify the right companies and add significant value to drive them to success.  Early stage investing is not easy and neither is acquiring a couple of entrepreneurs working out of someone’s apartment.  Success for CBS will come down to execution as it will really be competing with technology companies like Google and Yahoo (take a look at a discussion we had at Kinnernet in April about this topic) who have a better pedigree and track record of buying pre-venture-backed companies and making them successful.  If you throw in the inevitable friction that will be created between the new and old media side of CBS, it will be interesting to see how this strategy evolves.  Regardless, more capital and more exit opportunities is great for entrepreneurs.

Utility computing for the web and startups

There is a great BusinessWeek article outlining Amazon’s ambition to be a utility for web businesses.  This reminds me of a conversation I had last month with a founder and former CTO of one our of our prior portfolio companies who said his goal was to have a highly successful SAAS play with 1 operations guy instead of 20.  When I asked him how he would do it, he quite simply said Amazon – Amazon EC2 (Elastic Compute Cloud) and Amazon S3 for storage.  Sure, I had heard about this before when Amazon launched it during the summer, but what really got me thinking was that here was a guy who had been there and done it – scaled a SAAS business to incredible numbers and he had been playing around with Amazon’s infrastructure and was willing to offload a majority of his new startup’s business on the Amazon infrastructure.  When we talk about the commoditization of technology and how cheap it is to launch a new business on the web, we think open source and commodity servers. Now think about being able to launch a new web-based business and only paying for what you use.  If it takes you awhile to scale you don’t have to burn alot of capital upfront and only pay for minimal usage.  If you are hugely successful, then you don’t get caught with your pants down because you have the opportunity to quickly load a few more virtualized images on the Amazon EC2 infrastructure and pay more for that usage – bandwidth, storage, and compute time.  Think about it –  the upfront cost of starting a new web-based business if you went the Amazon route (when it is ready for primetime) has been driven down another order of magnitude as you can get started with little to no capital expenditures. The numbers are pretty incredible too – $0.15c per GB per month for storage or $150 per terabyte per month, $0.20c per GB for bandwidth, and the use of a pretty standard server (1.7Ghz x86 processor, 1.75GB of RAM, 160GB of local disk, and 250Mb/s of network bandwidth) for $0.10c per hour or $72 per server per month.  Not too bad when you think that you can scale up or scale down pretty easily.  It will be interesting to see how many startups look to use the Amazon infrastructure after it gets more publicized at the Web 2.0 conference.  As a startup, your job is to allocate your scarce resources as efficiently as possible – time and money.  If you can stretch either of these and give your company more of an opportunity to hit critical milestones or get better product out the door, then it is a huge win for you to spend your dollars on making that happen, rather than on capital equipment.

When competitors are acquired…Socialtext and Jotspot

In an earlier post titled "When Competitors are acquired" I discussed that rather than sulk and wish it were you who was bought, smart companies will go out and capitalize on the opportunity as their competition is temporarily distracted and inwardly focused on creating synergies.  Rather than comment on the whys of the Google Jotspot deal, I would rather point out what smart competitors like Ross Mayfield of Socialtext are doing to capitalize on the deal.  As mentioned in his blog post:

Socialtext, the first wiki company, announced today a free hosted wiki program for JotSpot customers following that company’s acquisition by Google. Socialtext will migrate JotSpot wiki content and provide one year of Socialtext Professional hosted wiki service to any JotSpot customer who signs up by the end of November 2006. While most JotSpot customers are small-to-midsized businesses, this offer is extended to deployments of any size.

Who knows whether or not Ross’ program will be ultimately successful but I certainly applaud his efforts for being aggressive and moving quickly on the deal.  For what it is worth, I have used both services in the past and while Socialtext was certainly more powerful and flexible, I found Jotspot incredibly easy to use.  As i have mentioned repeatedly, reducing the barrier or friction to usage is incredibly important on the web and can be a make or break issue for your business.  As Ross says, while Socialtext (higher end) and Jotspot (lower end) are clearly going after different segments of the market, it seems that Jotspot’s vision to go after the lower end and help the power user with an incredibly easy to use service won the day for Google, as it continues to expand its efforts to take on portions of Microsoft’s business.