The Unbundling of Scale

During the industrial age, economies of scale were a major source of competitive advantage. Many production processes exhibited decreasing unit costs over a very large range of output. Steel was a classic example which resulted in a few very large steel companies dominating the market (at least until the rise of mini mills which made steel from scrap).

The defensibility of scale in the information age is a lot less clear. Why? Because there are companies that are providing scale to others. Amazon AWS is a great example. No longer do you need your own data center to have servers anywhere in the world. Cloudflare is another which gives you a global edge network. Twilio connects you with carriers around the world. Sift gives you fraud detection and Firebase data synchronization.

I should be quick to point out that network effects (and the related supermodularity of information) may still give large players a big advantage but they should not count on traditional scale economies as being defensible by themselves. These will be available through service providers even to the smallest of startups.

It is also useful to think about how this has become possible if it was not possible during the industrial era. In the industrial processes many of the steps had to be tightly coupled. For instance you could not heat up the steel in one place and pour it into a shape in a different one. With information by contrast the cost of transfer and combination is extremely low and so we should expect to see a much finer slicing (something I wrote about nearly 6 years ago in a post titled “Feature vs Company”).

Posted: 30th July 2014Comments
Tags:  strategy scale unbundling competitive advantage

Writing Software Applications In-House

There is something very exciting going on in the world of software: a shift towards developing new application software in-house (as opposed to relying on third party offerings). For instance, at USV we have developed the linksharing on usv.com and our new analyst application process. Why does that make sense now? Because writing small applications has become so easy that it is today’s equivalent of writing an Excel macro.

Chris Dixon has a good post yesterday where he describes some of the trends that have made this possible, including on demand infrastructure, lots of API based services, open source libraries and scripting languages. I would add to that a database layer that makes it easy to deal with semi-structured data, such as MongoDB (we are investors).

As a result the tradeoff has shifted from using a complete third party application to building it yourself for many projects. What you gain is fine grained control over design, functionality and integration with other systems you are using. What you pay is having code that you need to maintain. So if you are going that route there is a real premium on keeping your code short and super readable.

I am fully aware that we have gone through phases like this before. For instance in the early days of the PC that’s how I first earned money — writing in house software for the personnel department of the local Siemens branch in my hometown.

Still it feels like this time the in house approach will be here to stay and if anything be extended to non-programmers through services such as IFTTT. One of the key drawbacks of the in-house move during the PC days was the fragmentation of data. That is largely eliminated today as the data resides in the cloud in any case.

In addition to the cost and complexity of in-house development having come down massively there is another crucial reason for the shift (which also makes me believe it will be longer lasting): software plus data is increasingly the key competitive differentiator.

PS Back to my posts on the economy tomorrow

Posted: 14th April 2014Comments
Tags:  software in-house strategy

Healthcare: Commerce Before Marketplace?

I am generally not a big fan of strategies that involve pursuing business A now in order to pursue B in the future. I tend to believe that you should go for B right away. For example, if you are planning to disrupt textbooks I would likely prefer a strategy that figures out how to peer produce those instead of one that first tries to make the renting and exchange of existing textbooks more efficient. Why? Because there are few businesses that have pulled off the “A now, B later” trick — most everyone simply gets stuck in business A. Netflix is one the few that pulled it off. They first shipped DVDs and now successfully stream (even Netflix they almost botched the transition).

Two possible justifications come to mind for the “A now, B later” strategy. The first is technological progress. When Netflix got started, streaming was not yet a truly viable option. The second one is behavior change. When Amazon first got going, buying online was enough of a change for people. It would have been too much to also ask them to do so in a marketplace and so Amazon chose the commerce format. Bezos smartly picked books where an online store had big advantages over a brick and mortar one.

This latter justification seems particularly relevant when looking at healthcare opportunities. After many years of content sites a la WebMD we are now seeing a great many startups that want to actually provide care. This ranges from medical Q&A sites all the way to telemedicine applications on mobile phones. Going to the computer or your phone for a consult rather than a flesh-and-blood doctor is a big behavior change. That suggests that an Amazon like strategy where you start with commerce and only introduce a marketplace later may be the winning model.

So what would a commerce model a la Amazon look like in healthcare? It would be a branded service that provides diagnosis, prescription and if necessary referral. The service would use some combination of texting, possibly video chats / image uploads, and use of existing lab networks (eg for blood analysis). The logical entry point would either be primary care in its entirety or a large specialty such as dermatology. I believe the right service could quickly grow large, especially if it can be priced in a way where insurance reimbursement becomes a secondary consideration. The subsequent marketplace would be for cases that require a specialist or treatment other than prescriptions.

I am curious to hear from others whether they buy this argument about a commerce model coming first or think we will go straight to a marketplace. Also, if you know of any startups pursuing the commerce model please let me know.

Posted: 3rd March 2014Comments
Tags:  healthcare strategy startups

Google Selling Motorola Mobility: Rejecting Vertical Integration

One of the many good things about blogging is that one can go back in time and look at one’s own thinking in a more objective way. Without putting it in writing it is all too easy to pretend, as history unfolds, that one had a great understanding way back. Our minds a terrific at rewriting our own thoughts — this tends to come out strongest when we talk about our career paths.

One example where I am reasonably happy with my own analysis is acquisition of Motorola Mobility by Google. I wrote that:

Apple is vertically integrated and Microsoft controls Nokia (without having had to buy it).  Between that and having filed or acquired a lot of patents, these two pose formidable threats to Android.  Buying Motorola lets Google fight both of these threats in one go.

and predicted that

… Google will only retain parts of Motorola - the patents and the hardware design capabilities, but close down or sell off much if not all actual manufacturing and handset distribution

Yesterday, Google announced the sale of Motorola Mobility to Lenovo. They retained the patent portfolio. I don’t know if they also retained any hardware design capabilities but they just acquired more of those with Nest.

Overall this re-enforces my view that Google very smartly understands that software is eating the world and is not pursuing the same deep vertical integration strategy as Apple. Recent purchases of robotics companies do not contradict this view as that hardware in that space is far behind on the commoditization curve.

PS I am sure that I have made quite a few predictions on Continuations that went the other way (and by all means please point this out to me). I am not focused necessarily on the outcome itself but more on the thinking about the event.

Posted: 30th January 2014Comments
Tags:  google motorola vertical integration strategy

Adding Value: The Big Picture (Advice from VCs)

Vinod Khosla said yesterday at Techcrunch Disrupt that one of the hardest things for entrepreneurs is to figure out whose advice to trust on what topic. That is spot on because as an entrepreneur you will get advice from just about everyone all the time (including random people you have just met for the very first time who don’t know squat about your product or company). Unfortunately that terrific quote will get buried because of a bunch of other things Vinod said right then, such that a lot of VCs add negative value, that he doesn’t go to board meetings much anymore (because other VCs just talk) and that entrepreneurs should pretty much ignore what most VCs say (because they haven’t done enough themselves).

I am not going to argue that we VCs always know what we talk about as we clearly don’t. But unlike Vinod I don’t believe that you have to have done a lot of big things yourself in order to be able to give good advice. It also helps if you have observed a lot of things. The role of an advisor is different from the one of the entrepreneur. There have been many great investors who never built a large company themselves. Just as there have been many great coaches who never excelled at the game they were coaching. Or the best editors aren’t successful writers themselves.

Why is this? There are many reasons but the primary one is being able to see the big picture. The number one problem as an entrepreneur is to get enough distance from the business to be able to see the big picture. You are in it every day. And that narrows your view. Just like it does for the players on the field. This is true for all of us all the time. Stepping outside of your context and analyzing your own situation from “above” is really, really hard. And that’s where a good VC will help you. He or she will help you see the one or two things that are really holding back the company (among the million things competing for your attention).

You still have to determine whether you should trust a particular person on the big picture or not. There are unfortunately very few signals for this and success of companies is an incredibly noisy signal. Therefore my recommendation is: call your fellow entrepreneurs and get their feedback on the quality of advice they have received. 

Posted: 12th September 2013Comments
Tags:  vc advice strategy

Listening Too Much / Too Little

It’s been a while since I have written a post in my Scylla and Charybdis series. As a quick refresher, the basic premise of the series is that startups are hard because on pretty much anything you can do too much or too little and the path to success thus requires navigating a narrow straight with deadly obstacles on both sides.

Today’s post is about listening. As an entrepreneur you can do too much or too little listening. How can you do too much listening you may ask? Well, by listening here I don’t mean the time spent having sound waves hit your ears but rather how much you change what you are doing based on feedback. It is very easy to make too many changes and to make them too quickly. As an entrepreneur almost everyone you meet will have an opinion on your startup and what you absolutely should be doing. That will range from someone insisting that you must have a specific feature to wholesale changes in strategy. Of course much of the advice you will receive will be contradictory to each other. And so if you listen too much you will be jerking your company around and building a bloated product.

On the other hand you can also listen too little. We all suffer from confirmation bias and it is easy to ignore feedback that doesn’t fit with our own view of the world. That’s particularly true for entrepreneurs who often don’t realize how hard it is for one of their employees to disagree with them. Feedback from board members is also easily ignored by young entrepreneurs (what do the “old folks” know about the new ways of the world and/or the view that only other entrepreneurs have valid opinions and not investors). Finally, the feedback that’s most ignored is that of the customer — far too few entrepreneurs spend time observing customers first hand (thankfully my friend Mark Hurst has a book forthcoming that addresses this point). It is by listening too little that entrepreneurs wind up running out of money or falling badly behind the competition.

Let me give a sailing analogy to illustrate the challenge. The ideal entrepreneur is like a sailboat captain who has a strong sense of the proper course to steer so as to not be buffeted by every piece of new information and yet capable of listening enough to understand when the ship has gone off course or the wind has changed to make a new course better.

Posted: 8th August 2013Comments
Tags:  scylla and charybdis strategy startups entrepreneurs

In Praise of Internet Exceptionalism

I have been meaning to write about “internet exceptionalism” since I read a post titled “It Always Comes Down to Math" but various political and economic events intervened. The key quote summarizing the post is "but at the end of the day, regardless of what business you’re in, everything comes down to the same math problem. Revenue minus expenses must equal a positive number." That is of course not much of an insight although it would have been useful to add something like "from some point forward" (and businesses differ a lot in when that point happens and how much capital is consumed before then). But instead, the author felt compelled to add the following: "Anyone who tells you business works in some other way or the rules are different on the Internet or any other claim of exceptionalism is an idiot."

Well, not only is that a bit of a strong statement in general but I also happen to think it is false other than with regard to the most basic premise that any business in order to be sustainable must eventually make a profit. Beyond that I think it is deeply flawed and I want to give just one example to illustrate my point. In bricks and mortar retail customers who come to the store and do *not* buy contribute meaningful expense, including time spent by sales people, physical space needed, cost for re-shelving items examines, breakage, etc. Also, in bricks and mortar retail the people who can access your store are inherently limited to people living in (or visiting) the geography of the store. If you combine both of these factors you will quickly understand why it is important to be obsessed with how many people who enter the store buy something and how much they buy: your top line is limited and non-buying visitors are costly.

Now contrast that with selling online. The entire country or potentially the entire world can be your customer. And someone visiting your online store but not buying will tend to result only in negligible cost (unless you invest heavily in realtime online consultation). So now what should you obsess about? Top line growth suddenly becomes hugely important. Unless your are huge already, if you are not at least doubling year over year you are likely to have a problem. Sure, you need conversion rate (if nobody buys you don’t have a business), but generally obsessing about conversion rate if top line growth is lagging is wrong. Why? The difference between growing 2% month over month and 7% is the difference between growing 27% per year and more than doubling! Try doing that with you conversion rate.

So yes — eventually you have to make more money than you spend but how you get there is often the exact opposite on the Internet from what it was in the physical world. It is therefore critically important to understand those differences if you want to succeed. Or put differently: Internet exceptionalism is a requirement not a flaw.

Posted: 13th June 2013Comments
Tags:  strategy startups exceptionalism

Reminder: Net Native Means Previously Impossible

At the height of the re-engineering craze there was one fantastic HBR article titled “Re-engineering Work: Don’t Automate, Obliterate.” In light of the changes in the labor market the choice of “obliterate” may now seem unfortunate, but the basic point of the article was spot on: don’t implement your existing processes in technology, come up with entirely new ones that simply weren’t possible before.

Much the same applies to building net native businesses. It is not about building a smoother version of what already exists in the market. That is a transient advantage as existing companies (in banking, insurance, healthcare, etc) adopt technology. If you want to build something big and lasting you have use the internet/mobile to do something that simply was not possible before (at least not at any meaningful scale).

Posted: 24th May 2013Comments
Tags:  startups strategy

Google Glass: Dangerous Adoption Strategy

I am quite optimistic about the long term potential of augmented reality. But I question whether now is the right time for a top down adoption strategy with a polished consumer product. It seems to me that we are at the hacker and early adopter stage instead.

By going with an immediate mass market strategy and embracing celebrities I think Google is taking a very big gamble. Let’s keep in mind that the iPhone was far from the first smart phone. A lot of software and application tinkering had happened on Blackberries and other predecessors most of which had niche use cases.

I often find myself saying to entrepreneurs that you “can’t push on a string.” It may be a tired cliche but it seems highly relevant for consumer products. If people aren’t ready for it, no amount of hype or spending will make the product stick. The people who are ready now are the hackers and tinkerers. So why not embrace them instead?

Posted: 18th April 2013Comments
Tags:  google glass strategy

Want a Good Deal? Have a Credible Alternative

First time entrepreneurs often ask me what they should do to maximize their chances of raising venture capital. To which I invariably answer: “Not need it.” Why? Because raising capital or selling your company is all about having a credible alternative. If you have a credible alternative you will arrive at a good deal — if you don’t, then bad things will happen. This is true for raising capital and it is true for exits. In both cases the best credible alternative is not needing the capital and not needing to sell. What about having multiple possible investors or buyers bidding each other up? By all means do, but having the ability to get that kind of multiple bidder process going depends crucially on the real alternative of not needing the transaction at all. And as it turns out when you have a credible alternative you don’t even need multiple bidders.

That’s why people who don’t want to quit their day job until they raise money rarely succeed in doing so. They are signaling that they have no alternative to raising the money. The investors feel that whether or not this startup happens depends on them. Who would want to invest in that? Instead investors need to feel that this startup will happen with or without them. The train is leaving the station. It’s also why having a burn rate so high that your existing investor(s) can’t easily fund you for another 15-18 months is dangerous. New investors conclude that the company doesn’t have an alternative and often won’t invest at all (rather than propose a low price). This also explains the expression that you want your company to be bought, not sold. Selling means you have no alternative. Being bought means you decide whether or not you like a deal.

So always keep having an alternative in mind. It applies incredibly broadly. Not just to deals with investors but also to hiring, suppliers, etc. If you have a sole supplier and your contract comes up you may find yourself on the wrong end of the deal. Or a customer who accounts for a large fraction of your revenues (or profits, or network). And so on.

Posted: 24th January 2013Comments
Tags:  fundraising exits strategy negotiations

Older posts