Fred Wilson wrote two posts in 2010 that were very influential with the startup community.

The titles were:
Mobile First, Web Second
Mobile First, Web Second (continued)

If you’re in the minority that never read these posts – you should.

I know that they really impacted an entire cohort of startups because every company that was coming to pitch me businesses was (is) saying, “I’m a ‘mobile first’ company.”

Part of the beauty of blogging that in two sittings Fred was able to influence what was built over the next 12 months.

I loved the idea of “mobile first” but something always bothered me. Kind of like a law firm (or VC firm) with four partners but shortened to just two, people dropped off his second two words. People forgot that Fred also wrote “Web Second.”

So I’ve had to encourage an entire cohort of startups that I’ve met not to ignore the power of the web.

I’ve wanted to write a blog post called “Mobile Second” for a long time to make this point more forcefully. But it never quite sat right with me because that wasn’t my point. I’m not trying to argue that mobile should be an afterthought but rather that the web shouldn’t be either.

So I thought I’d try a different approach and reword Fred’s title and call it “Web Second, Mobile First.” Maybe people could shorten that to “Web Second” as a reminder to not give up on the power of the tethered web. The power of large screen real estate. The power of a keyboard.

Here’s my view:

I support a “mobile first” strategy for many (not all) companies

Fred’s post was right. The world is adopting smart phones and for many young people and many people in the developing world this will be one of their first computing devices.

Mobile has many attributes that are critical:

• The devices are individual, not shared
• They are location aware, which is important in personalizing the service offering
• They are more likely to be the “bottom end of the sales funnel” or in other words close to “point of purchase.” If I am looking at movies on my mobile phone there is a higher chance I’m out-and-about and ready to buy tickets. I have talked with people in the industry who tell me that mobile movie sites convert ticket sales much higher than desktop websites.
• They are limited in size. In some senses this might seem like a disadvantage. BUT … I’ve talked to a number of eCommerce sites that also report much higher conversion rates than standard web. The hypothesis is that the limited real estate forces less choice and therefore less distraction. This increases conversions of items shown to you.
• They are often one click away from buying. It’s not pleasant handing over 30% margin to Apple when you sell stuff through the App Store. But on the other hand if you have a product with a very high gross margin (software, virtual goods, etc.) then this is often more than made up by higher conversion rates versus asking somebody for a credit card.
• They occupy a lot of people’s leisure time. Therefore if your app is geared toward leisure activities (games, communications with friends, etc.) then mobile is awesome.

BUT (and this is a big but …)

I believe in integrated products. Thus I endorse Web Second.

I think many recent companies make the mistake of not investing enough in web products, if they invest anything at all. I mostly use Twitter on my mobile devices. But there are some things you just can’t do with mobile app. Most notably following many conversations at once the way can do with TweetDeck.

I love using Yelp’s mobile product. If I’m traveling in an area I don’t know well I love to set up a filter to say I want, “Chinese food, 3 stars within 2 miles” or if I’m walking it’s great to filter based on distance to where I’m at. But the killer feature for me is “open now.” I use this all the time. Where can I eat at 3pm nearby? Which restaurants in LA serve past 10.00pm (turns out not many on the Westside of LA, unfortunately).

You couldn’t have the same impact with your desktop Yelp.

BUT … try doing proper restaurant research on a mobile device. Try reading a bunch of reviews, checking 5 different restaurants to try and compare the differences. Try writing long reviews of a restaurant. That’s why Yelp is effective. They do both well.

So when I talk to the numerous photo sharing websites that I’ve met I always encourage them to think about all of the awesome Mobile Second features that they can build to supplement their product. Mobile is great for capturing images and quickly & easily sharing them. It’s great for quickly scrolling through photos. That’s why I love Instagram. It’s fun social entertainment that without words helps me feel connected to people that I’m close to or whom I want to follow.

But photo sharing sites ought to have web tools that allow me to create “collections” of photos – mine or otherwise. They ought to feel more like Pinterest (photo at the top of post) where discovery is awesome and integral to the service itself.

Mobile First photo sites ought to integrate with other services that might let me send postcards , create photo albums to print, create blog entries or other similar features. I know that many third-party apps are stepping in to do much of this … but that’s the point. It’s a hole that isn’t filled by the initial applications.

I also love Batch. I think it’s a beautifully designed product that is also tremendously useful and focused. It allows me to upload a bulk set of photos that I can then more easily share. But I’d love it 100x if it had a complementary web product that better let me organize my photos into batches, view other people’s full collections and integrate more seamlessly into my social sites.

I’ve been saying this “Web Second” privately for long enough to not feel like I’m just getting on the bandwagon of Pinterest’s success (just ask any team at a company in which I’ve invested). But Pinterest’s success really proves the point I’ve been making.
My wife (and it seems every woman in America) is now addicted to Pinterest. It’s the new magazine. I think it’s replacing time spent on TMZ. It’s graphical, beautiful, simple to consume and has a wonderful layout. But that product is the perfect example of perfectly suited for the web given the real estate available. What if Instagram had a beautiful collage of images like Pinterest. How awesome would that be?

Pinterest seems to have conquered the “normals” before it captured the attention of the tech elite. Perhaps that should be a lesson to us all to think more broadly than our echo chamber? To think about how the masses use computing devices in 2012?

I would love to see FourSquare double down on web development and market it harder to its user base. It seems that FourSquare’s strategy has appropriately broadened from “check ins” to “discovery” of great places to eat or visit. This is a product feature that is easier to consume AND to create on the web.

For example, everybody should easily be able to follow Holger’s top sushi spots in San Francisco. That’s a list I plan to work through. (by the way, Holger, Kaygetsu should be number one, other than ambiance )

FourSquare in the future? Web Second, Mobile First. I hope so.

I’m digging LinkedIn’s new mobile product. I use it more than the web version (although it certainly could use some performance improvements). But I would never want to do my recruiting search campaign on mobile. I need more real estate for that.

I recognize there is an issue with resource scarcity

Come on, Mark. We only have 5 engineers, how can we do all that?

I know. I get it. But once you’ve launched your iOS product and finished your Android roll out, you need to do a strong push on an integrated web product before you double down on your next generation of iOS features. MVP on mobile then hit web.

Try to think about how leveraging the web will do the following:

• Create a differentiated product versus your mobile-only competitors. Use that as a source of competition.
• Have the ability to enable “content creation” and “content curation” in a way that makes all of the mobile consumption by other users a better experience. If you have a fashion-sharing product, wouldn’t viewing collections of outfits on mobile devices be a richer experience if there were more content and deeper content because your web product enabled your power users to more easily create it?
• Conversely allow your mobile products to shine on the web. Using the fashion-sharing example, imagine turning your shared fashion photos into beautiful magazine-like collages that can be scrolled through, Pinterest style.
• Build features that make using native-phone apps pointless. Case in point: Text messaging. If you use the native device your messages get purged eventually on most devices. You also lose them if you lose your actual phone. Having a web product abstracts the text message from the device and makes it a truly cloud service. When consumers realize this – who in their right mind would keep their text messages locked on their mobile device?

Web also allows you to become a funnel for converting more users of your mobile app. Obviously.

Tablets Third

I’ve starting thinking more about tablets. They are clearly an important part of our future computing fabric. They are somewhere between web & mobile. I think starting as an extension if your mobile strategy makes sense due to resource scarcity. But as your business grows I think it warrants consideration of how your table product will differ. It’s clearly a larger real estate which makes increased features possible. The larger real estate also makes content discovery different.

Again, tablets are the new magazines in some ways. My wife loves to scan her iPad and look at Pinterests. While Pinterest is not yet a commerce platform, what if commerce companies created similar looking products rather than just their traditional catalogs? What if they made their products more interactive? Not as a replacement for the catalog but as an alternative way to interact with their products.

I know that Pinterest has been driving sales in the Suster household. Tania found this hilarious onesie for a dear friend who just accidentally had his fourth baby. They thought they were going to stop at two. Doh.

I don’t yet feel strongly enough about tablets to encourage entrepreneurs with whom I work to put too many resources against it with few exceptions. Tablets are huge video consumption devices. So anybody building “second screen” TV apps or even “primary screen” TV apps needs to think seriously about their tablet strategy independent of their mobile strategy.

Customer First, Experience Second!

Cookie Morenco made some astute observations in the comments section below that accurately reflect my true feels on this topic. It’s “Customer First, Experience Second.”

“I sometimes feel that we’re being forced into a Mobile First strategy by the developers rather than by what some customers want. 

I’m sensitive to this issue because I Ok’d my developers to have a Mobile First, Web Second strategy on a product where our analytics didn’t match consumers actions (in our case, less than 5% use mobile). 

Our developers wanted Mobile more than our customers did.”

This is so perfectly said I won’t add to it. Whenever I see mobile pitches I always start by wondering how normal users would want to use the product.

What’s Your View?

What do you guys think? Do you think Mobile First companies have taken the web seriously enough? What examples do you have of mobile products that would be greatly enhanced by a better web product?

Or do you think most mobile developers should concentrate their resources on being MEMO (Mobile Excellent but Mobile Only)?

I’ve got strong views on this topic. But I’ve love to hear yours to refine my thinking.

I know that “Mobile First” has become engrained in developers minds. And that’s a good thing.

I hope I can at least etch in a small number of developers minds the ending – or starting – of that sentence: Web Second.

Raising money is hard. And when you’re relatively new to the process it’s easy to be confused by the process. There is all sorts of advice on the Internet about how to raise capital. Of course much of it is conflicting.

I’ve raised money as a “hot company” and I’ve raised capital when no one would return my phone calls. I’ve raised in boom markets and when everybody thought the Internet was a fraud. I’ve raised seed rounds and A-D rounds. I raised money as an entrepreneur, like you, in 1999, 2000, 2001, 2003 and 2005 for two different companies.

And of course I’ve sat on the other side of the table: As a VC. I now observes the fund raising process as a profession. And I also now have to raise money myself, but this time from bigger institutions that our industry calls LPs (limited partners).

I’ve tried to make this advice as well-rounded and biased free as I can. This is not just the perspective of a VC although I can’t say I have zero VC bias. This is the fund raising perspective from both sides of the table.

Executive Summary
For those that want the answer without reading a long post – here it is. Fund raising (as is much of life) is a sale – pure and simple. The sooner you understand that the sooner you can plan your campaign.

As with any sales campaign you need to:

• Qualify your buyers early so you focus your scarce resources on people likely to buy your product
• Spend time researching your buyers and not just pitching them
• Call high. Partners make investment decisions.
• Meet in person. They’re not buying a book on Amazon or shoes on Zappos. They’re buying you. And that doesn’t work remotely.
• Build a relationship with your investors over time. “People buy from people they like, trust, respect and … believe.” (Zig Ziglar). Trust doesn’t come from one 45-minute Powerpoint pitch or 30-minute demo.
• Create scarcity. Three rules in sales: Why buy anything? Why buy me? Why buy now? If you haven’t read my post about that, you should. The hardest is the last: Why Buy Now. People avoid difficult decisions until they have to make them.

Every company is different so it’s hard to listen to advice from the uber-successful fund raisers. Their story will likely be very different from yours. Fund raising is bloody hard. It takes a lot of work. Don’t believe otherwise.

If you want to watch the video version summary of my advice on fund raising it’s here. It’s an hour and has tons of insights on the process. Tell a friend!

And now, the details …

1. Identify the right target investors
Every investor is different. I never suggest that entrepreneurs just randomly pitch VCs. Start by trying to narrowing the list of total prospective VCs. Create a spreadsheet or list them in a CRM. The total universe of VCs are what we call in sales “suspects” – otherwise known as “the top end of your funnel.” But focusing on too many is a mistake. You want to narrow the suspects into a group called “prospects.” These are people with whom there is a likely match for your product or service. This narrowing follows the three golden rules of sales: qualify, qualify, qualify.

Remember again that the three major steps to a sale are: Why buy anything? Why buy me? Why buy now? If you can solve these three major questions you’ll sell. The first step in the qualification is “why buy anything?”

In VC terms that means the key questions you need to answer are, is this investor:

• Geographically focused and have they invested in my geography before? (most Seed or A round deals will be done by an investor in your region so that should help you to focus. Other investors have national practices. Know which one you’re talking with)
• Right for my stage? (approaching an investor who normally does $20 million C rounds for your $2 million funding round is a waste).
• Focused on my industry? (I get approached about clean tech or biotech periodically – I don’t focus on these. You’re wasting your time with me).
• Already invested in one of my key competitors? VCs are unlikely to invest in direct competitors so you will normally be qualified out.
• Do they have money to invest? (look at how many deals the firm has done in the past 12 months. If it isn’t many (or any) that should tell you something. You can also find out when they raised their last fund. If it was more than 5 years ago you probably want to ask around a bit to see whether they’re still investing).

Also recognize that WITHIN a VC you have partners who focus on different areas. For example, if you’re looking to approach Kleiner Perkins it’s worth knowing that my friend Matt Murphy runs their iFund and therefore is the in-house expert on all things mobile. I’m sure there are many partners at KP that know the mobile space but if you’re a “mobile first” company you’d be well served by focusing on Matt. In Accel that’s Rich Wong. At GRP that’s largely me.

If you’re raising money in Financial Services I’ve never met a more knowledgeable investor than my partner, Brian McLoughlin. He’s focused on that sector (not exclusively but predominantly) and therefore has an amazing network at large financial services firms to help you with business development. He knows the history of all of the payment gateways, mobile payment platforms, credit offerings, remittance companies, etc. Others that are experts in this field include Matt Harris at Village Ventures and Jim Robinson at RRE. Approaching random VCs who aren’t experts in FS makes little sense.

In ad tech there’s Seth Levine at Foundry Group and both Dana Settle & Ian Sigalow at Greycroft.

And so on. Not trying to be comprehensive here – just making sure you know that partners & firms are often focused. Fred Wilson likes, “large networks of socially connected people” while Foundry lists its 5 key themes on its website. Do your homework.

I do the same. When raising money for GRP, I look at my suspect list and say, “Do they like VC versus buy-out funds? Have they invested in new VC relationships versus just doing investments in firms in which they have long-standing investments? Do they invest in funds that are $200-300 million versus $50 million or $500 million.” I use the same methodology I am advocating to you.

2. Determine how to get access to them
In the era of social networks, LinkedIn, Facebook messaging, Quora and email addresses that are easily guessable, it’s easy to think that maybe you should just approach a VC directly. They seem so reachable. Yet this approach in my mind is the equivalent of spam. I get many Tweets directed at me that say, “come check out my product.” Even if I wanted to be this accessible, I could never find enough time in the day to evaluate every single person who approached me. Neither can any VC. So they develop short-hand ways to qualify things better. The main way they qualify is to determine who introduced them and the veracity of the introduction.

As I like to say, in the era of social networks and transparency if you can’t figure out how to get introduced to a VC then hang up your cleats now. You’ll never make a great entrepreneur. I wrote a longer post on how to access VCs that you should read.

But the short answer is that the best intro is from a portfolio company of that VC or by other entrepreneurs whom that VC respects. So your journey to fund raising begins by strengthening your relationships with other entrepreneurs. You need to build genuine relationships with these portfolio startup founders as well as trust with them and the rest will follow. Earn the right to the intro. I often recommend that entrepreneurs try to focus on building relationships with younger companies that aren’t already “big time” because they’ll have more time and willingness to help.

Approaching Dennis Crowley to figure out how to get access to his earliest investor, Bryce Roberts? Not so much. And trust me, if you’re early stage you DO want to meet Bryce. He’s awesome for early-stage entrepreneurs.

3. Meet early
There is much controversy on this topic. I have laid out my philosophy in, “I Invest in Lines, Not Dots.” If you haven’t read that you should – it’s one of my most re-tweeted posts. There is the school of people who tell you that you should only meet with VCs when you’re ready to raise. Their arguments are:

a. Fund raising is too time consuming and meeting early is wasting time
b. The VC will get a bad impression of you and you should wait until you’re on your best footing to raise.

Both of these arguments are logical and thus many entrepreneurs buy them. They’re both flawed, though.

“Fund raising is too time consuming” … yes, fund raising takes time. If you save it all for some mythical 6-week period every 18 months where you hit up all the VCs at once – sure, it will consume much of those six weeks. But as I’ve argued before, you need to ABR (always be raising). By constantly taking focused VC meetings you’ll have relationships established for when you are ready to raise. As the CEO you have many tasks you need to do on a regular basis. Call it your functional pie chart. These include building products, recruiting, managing your finances, marketing, selling, getting feedback from customers and … fund raising.

It will be at least 5% of your week so if you work a 60-hour week (I know, I know, you work more) then you should dedicate 3 hours per week to fund raising. Maybe up to 6 hours.

Remember that if you’re meeting with targeted investors you’re meeting people who can challenge your thinking. You’re meeting with people who can help you with introductions. You’re meeting people who can give you market insights and information. REAL information. Not what you read in the press. And of course you’re meeting people who can give you money. It takes money to grow a business.

Most VC partners do 2-3 deals per year max (except for the higher volume shops). So the odds are never great for you. But VCs want to be helpful – even when they can’t invest. So they go out of their way to offer advice and introductions. The shortest path to meeting hard-to-meet entrepreneurs or senior executives at a big company is to have a VC who likes you, but isn’t yet ready to invest in your company, introduce you.

“VCs will get a bad impression of you” … also logical but slightly misleading. So let me be clear. DO NOT show up at a VC meeting unprepared. Do not “wing it” and see how the meeting goes. Know your plan in advance. Know what you’re going to discuss. Know how much information you’re going to give. Know that it is HUGELY important to make a good impression.

What I advocate is letting the VC know that, “you’re not yet fund raising but you’re building early relationships because you’re going to be fund raising in the near future and you want to start determining where there are good matches in the industry for your firm.” All VCs want early access. If they see you when you’ve already got your first term sheet and they’ve got 3 weeks to decide then by definition they have no relationship with you. So winning means they’re paying the highest price.

Sure, some people work this way. I think it’s a terrible way to work. When I get these inevitable emails or calls I respond the same way, “It’s a shame for me that I’m too late to your process. Why don’t we meet right after you raise your money so we can start a relationship early for your next round.” And I mean it.

Fab wrote a popular post on fund raising in which they advocated a very different approach to mine. Their approach worked for them because their business is super hot and on fire. I introduced one of my dearest friends and one of the most talented guys I have worked with, David Lapter, to the company and he became CFO. So I know how first-hand how awesome Fab is. And the CEO is experienced. If your business is totally killing it please follow Fab’s advice. It’s ideal for people who have VCs all chasing them.

For everybody else I would encourage you to meet early and often.

4. Press the flesh
It’s tempting to want to stay in your offices and fund raise via email or web conferencing. But fund raising is a contact sport. You’ve got to get out there and shake hands and kiss babies. If you’re in the Bay Area this may be easier. If you’re not you’re going to have to put in some miles and some time away from home. Raising money is a “direct sale” not a telephone sale. They are buying YOU. So interacting with you in person is paramount. Many VCs don’t like to tell people to travel to them. They may even suggest phone calls. This is part out of guilt of not wanting to make you travel and part because they know they can have shorter meetings on the phone – it’s harder to cut a meeting short if you have traveled.

Always do your important meetings in person. I can’t over state the importance of the human connection in being able to develop a relationship. If you have to travel tell the VC you’re already planning to be in town. They feel less obligation to you and therefore are more likely to say yes to an in-person meeting.

5. Avoid the two big “donuts” in the year
There are two times every year where raising VC from partnerships with more than two partners is exceedingly hard. July 15-Aug 31 and Thanksgiving to New Years. I’m not saying VCs are lazy. They are not. But they are highly likely to be in the age bracket of 35-55 and often have kids. That means that they take their holidays with their families and these are the big seasons.

Most VCs I know these days answer emails on vacation. Good or bad – it just is. But there is a different reason not to raise in those periods. In order to get a VC to agree to fund you, you need to get the entire partnership on board. And so while your VC partner may not be gone the entire month of August, you can bet that at any time at least a few of their partners will be gone.

And because all sales processes rely on momentum, you don’t want to have a process that has a “dead spot” in the middle of it. I call these “fund raising donuts.” Plan your timing accordingly. If you’re concerned about this issue I wrote a longer post on the topic.

6. Have a narrative / make it simple
Nobody will buy what they don’t understand. It’s your job to take the complexity of your company & industry and develop a “narrative” that helps investors better understand the context. It’s basically story telling. Don’t under-estimate the power of stories. When I was reading the Fab.com website I noticed that the CEO refers to Fab’s “one thing” as being design. By talking in this way, he can create a storyline that investors can say, “oh, Fab.com. They’re the place focused on design. They think design wins. They think there’s any underserved market for young urban professionals who care about quality design and don’t want to buy cookie-cutter, Idea furniture and accessories” (or whatever their pitch is).

Investors can agree or disagree but they know what they’re evaluating. As do journalists.

The best company pitches are those that have this narrative. Why does the world need another X? Or why are the market conditions ripe for a new entrant who does Y when Y hasn’t existed in the past 20 years? I spoke at length about the narrative here.

Trust me when I say that the narrative is vital to your business. It’s important in aligning internal strategy, communicating with others, talking with partner, recruiting and, yes, raising VC.

7. Create a sustained campaign
Many people equate a great pitch meeting with success. They then lament the fact that the process died shortly thereafter. All sales campaigns are processes that occur over time. It’s your job to find a continued way to stay on the radar screen of the VC.

You had your great meeting. If it felt great it probably was. But in the three weeks since your meeting that VC has seen 12 other companies, had 3 board (bored) meetings and had to deal with some enquiries from his own investors. So when you’re wondering what they’re thinking about – unfortunately it’s not likely you.

Think about it this way. Let’s say you have a product in which the CMO of a company is your buyer. You wouldn’t imagine they’re sitting around 3 weeks after your meeting daydreaming about you. They’re under pressure to do tons of stuff. You were a priority when they agreed to meet you but since then they’ve been putting out other fires. If you start to think of VCs as a person who might buy your product like this CMO then you can plan your sales campaign accordingly.

Some relevant posts to help you on this topic:
I met a VC, what happens next?
How do you build long-term relationships with VCs

But the summary for you is:
- get an intro
- create materials for your first partner meeting. This is a demo + a high-level deck
- create materials that would be used in a follow-up meeting. This includes stuff like detailed financial plans, product roadmaps, etc.
- prepare a list of reference clients and a reference list of people they could call to ask about you

Then make sure to send out VERY high-level summary emails to update key investors on your company progress. Ask for 30-minute update meetings from time-to-time. Stick to your time slot unless they say they want longer.

Investors back companies where they see traction. What better way to show traction than to meet a VC early, baseline your performance and then update them on your positive achievements?

8. Lobby
If it were a sales campaign to a CMO you would naturally think about having customer references. You’d even probably go as far as to ask your best customers if they wouldn’t mind proactively reaching out to your prospects to subtly tell them how great you are. I call it “marketing heroes” and I wrote about it here.

So why would raising venture capital be any different. If the best intros to VCs come through qualified referrals from people they trust, then it follows that the best way to keep VCs interested in you is to have similar people tell them how great you are. So determine the VCs you want to influence, identify who influences them, figure out how you’re going to get these people loving your product, your company and you.

And then ask for their help in reminding the VC how great you are. And remember my golden rule, “you don’t ask, you don’t get.” Nobody proactively bugs a VC to tell them how great you are. You have to ask for it.

Will the VC know you asked them? Who cares. Any great VC will know that’s how the world works and if that’s how you influence them it’s probably the tool you use to influence journalists, customers, prospective employees and corporate suitors for M&A one day.

The only people you don’t need to lobby are people whom you don’t want to invest.

9. Recognize that fund raising is a part of your ongoing duties
As I’ve said before, ABR. Always be fund raising. It’s just a part of your ongoing activities as a founder. Sure, you might not like it. It might not seem “core” to your business success. It is. Building a business is not about only building a product and seeing if customers like it. You can’t just do those things in business that you enjoy. Make fund raising a habit. Don’t only engage every 18 months.

10. Test interest
One of the best sales coaches I ever worked with used to talk to me about “testing prospects.” What he meant was that since your scarcest resource as a manager or sales rep is your time you need to qualify better. Most people are afraid of asking the tough questions because they prefer to imagine that you might be a buyer than to know that you’re 100% not. I prefer the latter. I once did a project with Carly Fiorina when she was president at Lucent. Her quote that always stuck with me was,

“I’d rather get a firm no then a muddy yes.”

So true. At least you can move on and focus your time on energy on people who might say yes.

So how do you test a VC?

It’s actually OK to say something at the end of your meeting such as, “I know that you’re not likely to give me a strong indication at this meeting, but I’d love to know if this is the sort of opportunity you could imagine doing if I was able to persuade you over time or would I be best off focusing my attention on other VCs?”

Said politely and I promise you people will appreciate it.

Similarly, it’s OK to email a non-responsive VC by saying, “I’ve email you a couple of times and left a voicemail. I know we all get busy. I just wanted to confirm whether you were super busy or whether this was a sign that maybe I’m not a good fit for your firm? If that’s the situation – I’d understand. But if so I’d love to know so that I can focus my limited time on other VCs. (if you are still open, I’d love the chance for a 30-minute meeting to give you a status update. I think you’ll be impressed.)

Other ways of testing a VC?
- if they show interest and have spent time with you, why not ask if you can set up a customer call for them so they can hear directly what they think of your product? Willingness = they are engaged. Not willing either equals, “not now” or “not ever.” Better that you know. A firm no is better than a muddy yes.
- how about setting them up to use your product? (if it’s possible). Then you have a reason to check in every couple of weeks, “I noticed you didn’t yet get a chance to log in to the product. Would you mind if I had a senior training rep call you for 30-minutes to give you a quick demo to get you up to speed?

There are a million ways to test. And a million more to drive engagement. I’d say <5% of people ever do. These are people who are more likely to raise VC. People who manage processes make more sales. As I articulated here.

11. Take appropriate risks
I always encourage people to take risks in sales and fund raising is no different. Remember those three rules of sales?

• why buy anything?
• why buy me?
• why buy now?

Well if the “why buy anything” is testing whether you’re even compatible with a VC, the “why buy me” has got to be extreme differentiation. VCs see companies all the time. They all start to sound the same. Be bold. Make your positioning strong. Stand out. It may turn off some VCs but for others it may be a positive.

I’ll give you an example from my own fund raising.

Conventional wisdom says that you can only build big businesses in Silicon Valley so as a VC you need to be there. But of course that’s horse puckey.  Some of the biggest wins of the past 5 years were built outside of the Valley. GroupOn, Living Social, AdMeld, Gilt Group, Demand Media, ShoeDazzle, Tumblr, FourSquare, etc. And the great monetization engines of the Internet were built in LA – Overture (AdWords) & Applied Semantics (AdSense).

But many VCs outside of Silicon Valley are afraid to raise against this conventional wisdom so they say, “yeah, I’m in the Valley all the time. And I went to Stanford so my network is there.”

We went the opposite way. Our biggest returns were outside Silicon Valley: Overture (LA), CitySearch (LA), BillMeLater (Baltimore), Ulta (Chicago), Envestnet (Chicago), HDI (Las Vegas), PF Changs (Arizona), TrueCar (LA).
So I argued with my partners we should stand firm. Our fund has always made money mostly outside the Valley. So my standard pitch is:

“If you’re looking for another Sand Hill Road firm we’re not for you. There’s 80 firms there – have your pick. But if you’re looking for something differentiated in your portfolio I think we’d be a great fit. We’re the largest fund in Southern California.

We were found to be the 5th most consistently performing fund in the country over the past 20 years by Prequin. Our 2000 fund is the single best fund of its vintage. Our 2008 fund looks spectacular.

We have followed this strategy for 15 years. And now it’s even easier to build a big business outside of the Valley. Our next fund will follow the same strategy. We invest in the Bay Area but more than 50% of it will be outside of Silicon Valley.”

So if I take a pool of investors I might turn off 8 with this positioning. But they were never going to be convinced anyways once they did due diligence and realized we’re not a SV-focused fund. And with these hard positioning I might get 3/20 into the “yes column” because they understand the “why buy me” better. Take risks.

12. Understand the important of marketing
Nobody thinks they are influenced by marketing. Everybody is. Even if it’s subconscious. We tend to be more excited about things that we read in the press and/or articles being forwarded to us by our peers. It’s human nature. So make sure you have a solid PR strategy.

I have two articles on the topic:
1. Understanding PR & Crisis Management
2. How to Work with PR Firms

Make sure good PR is underpinning your fund raising efforts. The articles about you create great collateral that you can email out in your VC update emails and they create collateral for your contacts to mail to your VC prospects on your behalf. And PR also has a way of generating inbound funding opportunities.

And trust me if they’re thinking about investing in you and an investor Googles you and gets “bagel” – so, too, will you.

13. Create urgency
The final rule of why buy anything, why by me is … why buy NOW! It’s the hardest rule of sales. Why should I buy a new TV when my current one works well? I know I want one but I can always buy it next year. In fact, there will be a newer, fancier model. Same with a new car. Same with an investment. Why invest now when I can see how your company develops? Or see the next company that rolls through.

The only way to get VCs to move is to make sure subtly that they feel a deal is or may become competitive. Life works the way it did in high school. A guy has three options to ask to the prom. He waits as long as possible. Why ask a girl today when I can decide tomorrow? Then the rumor mill starts and he hears his rival is going to ask one of his top picks today. Guaranteed that he’ll ask her before lunch.

Maybe life shouldn’t work this way. It does. You need to create a sense of competition.

That is best done through back channeling, where possible. I know some VCs will tell you this isn’t necessary or a good idea. They are probably “book smart” VCs who don’t even understand themselves the psychology of buying.

Conclusion
Fund raising is hard business. And perhaps it should be. Too many competitors getting funded leads to incrementalism and me-too competitors. There are some wildly successful companies out there that also become hot. It’s hard to take advice from them because the process one goes through when you’re the belle of the ball is different than when you’re having to sneak your way into the party.

I once had an LP tell me that when Sequoia fund raises they place the first call and say “we’re closing in 6 weeks – you need to decide quickly if you want an allocation.” I don’t know if that’s true, but it wouldn’t surprise me. When you’ve had the consistent success of Sequoia (or similar) over so many decades I guess you earn that right.

But when I fund raise I’ll be right out there with you.

• Plotting out where I think I have a strong fit between my prospects & my product
• Shaking hands and kissing babies
• Following through with email, phone call, follow-on meetings and lobbying
• Always pushing forward but never taking things for granted
• Always raising, even when I’m not.
• And praying like hell there’s no “Black Swan” event like the Greeks defaulting on their debt, the Italians pulling out of the Euro, a Lehman-like bankruptcy or a devastating terror attack that screws up fund raising timing for everybody. Damn you, Black Swans!

Like you I’d want to get it done as early as I could. Never taking a day for granted. Knowing that “time is the enemy of all deals.”

And then waking up one day many months later and seeing whether all of the hard fund-raising effort paid off.

ABR.

** post script **
Yes, I’m sure there were many typos. No, I’m not stupid. My grammar is generally quite good. But I hope you enjoyed the content enough to forgive my lack of time for editing. And anyways, you’re still reading, aren’t you? thanks for your understanding

Image courtesy of Fotolia

Over the holiday I became aware of a new tech blog that aims to have deep insights into the next generation of technology, which they call The Hypernet.

Why should you care?

Well, it is established by some of the industries more successful investors – Mike Maples and Roger McNamee.

My favorite post was this one (image above) in which they talked about their 10 hypothesis for technology investing.

It maps to a lot of my own views so I was interested to learn more. If you click through to Roger & Mike’s blog you’ll see that this blog post then links to a detailed presentation on the topic.

The ones I focus on the most are 2-7 and 10.

Hope you enjoy it. And I hope they keep up their early momentum.

Occasionally on this blog I break away from industry commentary and write more broadly. The first day of 2012 seems the perfect day to do so.

One of the most important articles I read during the entire year was David Brook’s op-ed article on “The Haimish Line.”

In it Brooks talks about his recent trip to Africa with his 12-year-old son. They stayed in some nice camps with showers & swimming pools and in some very basic camps without electricity or running water.

At the simpler camps his family interacted with all of the other guests – there was a certain bond – a warmth. At the nicer camps they had more luxury, comfort and space.

Sometimes a bit of each is in order. But what he noticed was much more happiness & many more memories were derived at the poorer camps where you interacted with people. He defined the difference between being at the two camps as “crossing an invisible haimish line,”

“[Haimish is] a Yiddish word that suggests warmth, domesticity and unpretentious conviviality”

I like that. He goes on to say,

“We live in a highly individualistic culture. When we’re shopping for a vacation we’re primarily thinking about Where. The travel companies offer brochures showing private beaches and phenomenal sights.

But when you come back from vacation, you primarily treasure the memories of Who — the people you met from faraway places, and the lives you came in contact with.”

So true.

And so I framed much of my life since reading the article in Haimish terms. Was I on the right side? What things made me happy? What luxuries were false comforts?

The more I reflected on what makes my truly happy the more I realized that I was happiest on the right side of the Haimish line even when it’s sometimes easier to sneak back over the the reclusive luxury side.

The great irony is that the more success you have in life the more likely you are to be pulled on to the wrong side of the Haimish line. You can fly first class and not talk to fellow passengers. You can stay in super exclusive hotels. You can have big offices and lavish houses.

Yet none of these things lead to the great feelings you get being amongst people of all walks and backgrounds. It is this reminder that helps me form my internal compass and not hide behind a fortress.

It’s why I still randomly meet up with people I’ve met on Twitter or this blog. It’s why I still go to after-conference parties and hang out until the end of the night with whomever wants to chat. It’s why I can still be caught playing beer (and tequila) pong at 4am at the Local Response offices.

And why I still made it to breakfast at 8.30am with Christina Cacioppo the next morning (although I’m not sure she found me too Haimish of a conversationalist that day ).

If you get a chance after you’re done with this post then please be sure to read Brook’s Haimish op-ed.

Examples in My Life & Work

SxSW
2011 was the first year I went to SxSW. I wrote about my experience in this post and why I enjoyed this event more than most. If you haven’t been and are considering it I highly recommend reading that post.

But summarizing what I liked most about SxSW? It lives on the right side of the Haimish line. Almost all of the people at SxSW are from out of town. They have very little “other business” in Austin as they would when the come to NYC, SF or LA. So many people just “hang out.”

The event seems to be more focused on 6pm – 3am than it does to people sitting and watching panels. I had so many casual meet-ups with random people that I wanted to spend quality time with, like Naval Ravikant and Farb Nivi. Like Steve Blank, Dave McClure, Dennis Crowley, Evan Cohen, Gary Vaynerchuk, John Price, Angelo Sotira and many, many more.

All of these people were publicly accessible and talking with just about anybody.

One of the biggest pleasures for me was just meeting all of the random people at food trucks at 2am like Joshua Cook from Gunderson Dettmer where we chatted over chicken-fried waffles served with syrup and hot sauce. Nom nom nom. Or riding a crazy party bus and sitting next to Aaron Batalion the co-founder & CTO of Living Social. Randomly.

Office Space
I always love visiting companies because you can tell so much about the character of the company by spending time in their offices. You get a feel for the company “vibe.” Do they all get along? Do they have a strong sense of culture? Do they seem to have fun?

Having a great work environment is tremendously important in attracting & retaining great employees and in getting teams to work well together. Teams that hang out together work more productively in difficult situations.

You find some offices where the CEO or senior team have cordoned themselves off. It’s an obvious temptation. As a founder you end up having to deal with a lot of sensitive information & discussions. You probably also value the concentration you can get from a bit more quiet and solitude. Cordon yourself off and you get dragged into a lot fewer problem-solving sessions for other people.

But doing so has many drawbacks. And I usually recommend against it.

One of my big disappointments at GRP has been our office space in Los Angeles. When you walk in it feels like a lawyer’s office.  Like we take ourselves a bit too seriously. I can’t really change it because we had a super long lease. But that expires soon and I hope to get back to the right side of the Haimish line. We’ll see.

TechStars Interactions
I refuse to go to demo days. Not just TechStars but any demo day, really.

Why? Well, I get nothing out of seeing how well a bunch of people can pitch their businesses on stage. You don’t get to know companies that way. It’s very artificial and contrived.

Yet I love TechStars. So I promised the guys that I would come and hang out with companies well before their demo days. Dave Tisch was kind enough to organize sessions for me in NY (little did I know in advance they would be filming it for a reality TV show on Bloomberg where I was cast as Simon Cowell )

I came and hung out with companies and got to know many 1-on-1. Some I still speak with.

And Nicole Glaros organized a full day and evening for me in Boulder. I did individual sessions with every single company. And then we busted out the ping pong table. And as anybody who was there will attest I summarily defeated every TechStars company handily.

They were lulled into a false sense of security by my gray hair

It wasn’t until David Cohen turned up that I got knocked off my mantle. And went home with bruised ribs from diving. I was too sheepish to tell my wife it was a ping pong injury. Creek.

Entrepreneur Dinners
One of my favorite things to do is to organize entrepreneur dinners when I travel. I usually ask somebody local who knows the local scene to invite out 10-15 local entrepreneurs who might be interested to meet up and I agree to pick up the tab.

What I love is that I don’t pre pick the companies. I don’t try to optimize for who might be a great investment opportunity or somebody that I really “should know.” In stead of just calling up buddies who live in the area or inviting out the most senior person in town that I know, I opt for random interactions.

Why?

The Haimish factor. I find no better way to get a feeling for local communities than to sit with a group of early-stage entrepreneurs and talking about the local scene. What is working, what isn’t? What are their projects? What is the local funding environment like?

I profiled one of these interactions from when I last visited Seattle.

Sure, it would probably be “easier” to just grab a friend and have a quiet dinner at a local posh restaurant. I like to do that sometimes, too.

But I prefer the crowd.

The Subway
I lived in London for nearly a decade. For the first few years I took the Underground everywhere. Over time as I became more senior at Andersen Consulting I had more resources to take taxis everywhere. For a few years I found myself constantly in taxis.

It was certainly more private. I probably caught less colds. But it was colder. After I started my first company I find myself back on the Underground. I love that feeling of being amongst random people. I love the people watching. I love imagining what all of their lives are like. What they do. Where they live. Who they are.

When I’m in New York City I almost always find myself taking the subway where possible. I feel more connected. I feel more at one with the city. I feel more Haimish.

Camp in Sequoia National Park
Every year I go with my family to a camp in the mountains of Sequoia National Park – it has become a family tradition.

The kids get to go hiking, water skiing, kayaking, sing camp fire songs, roast marshmallows, do a skit in front of a group, do archery, swim in a lake, make tie-dye t-shirts and even shoot rifles.

Mostly they get very dirty. Hang out with new friends. Spend lots of time with my wife & me. And we eat every meal together.

The accommodations are fine – certainly not The Four Seasons. Tania & I each do activities that we don’t get enough time to do during the year like mountain biking, rock climbing, water skiing and sunset hikes with spectacular views. And we also shot rifles! For suburban kids turned city-slickers I have to admit it’s a lot of fun.

The camp attracts people from many different backgrounds from NorCal and SoCal (there’s no easy airports so people don’t seem to come from out of state). But almost nobody asks what other people “do.” It barely comes up until late in the week.

We eat at tables together. We hike together. We sing silly songs together. We see each other every morning looking like a Mack Truck ran us over. Everybody talks. Everybody lets their hair down (and certainly doesn’t wash it).

It’s one of our highlights every year. And it’s very Haimish.

Launchpad LA
A few years ago I started a mentorship organization in Los Angeles called Launchpad LA now run by the uber talented Sam Teller.

As I alluded to in my post on our recent program in which we now invest $50,000 per company and have shared office space, Bill Gross (the founder of Idealab) was instrumental in convincing me to keep Launchpad LA running despite an over-abundance of local LA accelerators. He said:

“I think that the more initiatives, the better … I think it’s the many initiatives and variety that make Silicon Valley, Silicon Valley and that we need to do more of that here.”

But one of the other major drivers that I discussed with all of the people with whom I sought counsel in the decision was The Haimish Factor.

Having been involved with 23 companies that had been through Launchpad LA in its first couple of years, I felt very close to these founders. I count most of them as personal friends. We hung out a lot together a dinners and educational events.

And as I said to my close friend Adam Lilling who helps run Launchpad LA

“I’d much rather sit in Launchpad’s offices and get to know 10 companies intimately than to constantly sit in a conference room in an artificial situation being constantly pitched by entrepreneurs where my job is to mostly say, ‘no.’

Getting to know a handful of entrepreneurs better and helping them with their daily problems does a much better job of keeping me connected to what issues modern companies are facing than debating the merits of pitch decks in 45-minute sessions.

In my job, I obviously need to do both. But I can tell you which is more clearly on the right side of the Haimish line. So in 2012 you’ll see me a lot more often at the Launchpad LA offices. And on the road out meeting you. Speaking at events. Holding dinners. Getting rides from random people (a habit I picked up from Brad Feld). Occasionally inviting anybody available in the next 30 minutes to come have breakfast with me.

Happy 2012 to all of you.

My wish for you all is – when your January program to “get back into shape” fades into normal life, try for your second goal.  Remember the Haimish line.

Find ways to always put yourself amongst people where you’re an equal and where your status is less important than your ability to talk, engage, challenge, compete and laugh with others.

Some Fun Extra Reading

If you have some extra time and want to read some of the other posts I’ve done that stray outside of the tech boundaries I’ve compiled a small list of my favorite ones below (in no particular order):

1. Focus on “The Dopeness” (Life is 10% how you make it, 90% how you take it)
2. Whose Life are you Going to Change? (my tribute to Cory Van Wolvelaere & challenge to readers)
3. Don’t Take the Littles Things for Granted (on spouses, children & friendships)
4. Leadership, Teams, Success & Happiness (Tiger Moms & the true definition of success)
5. Don’t Lose Twice (know when it’s time to be gracious)
6. Read, Travel, Experience, Live (avoiding monoculture as a way to become a broader thinker)

There are certain topics that even some of the best journalists can’t fully grok. One of them is profitability.

I find it amusing when a journalist writes an article about a prominent startup (either privately held or preparing for an IPO) and decries that, “They’re not even profitable!”

I mention journalists here because they perpetuate the myth that focusing on profits is ALWAYS the right answer and then I hear many entrepreneurs (and certainly many “normals”) repeating the same mantra.

There is a healthy tension between profits & growth. To grow faster businesses need resources in today’s financial period to fund growth that may not come for 6 months to a year. The most obvious way to explain this is with sales people.

If you hire 6 sales reps in January at $120,000 / year salary then you’ve taken on an extra $60,000 per month in costs yet these sales people might not close new business for 4-6 months. So your Q1 results will be $180,000 less profitable than if you hadn’t hired them.

I know this seems obvious but I promise you that even smart people forget this when talking about profitability.

Hiring more people isn’t always the right answer. You have to understand whether they’re likely to yield revenue growth in the near term OR whether you have access to cheap enough capital to fund your losses until your investments pay off.

Exec Summary:

Most companies (98+%) in the world (even tech startups) should be very profit focused.

Being profitable allows you degrees of freedom you don’t have when you rely upon other people’s money.

• You may have leverage when you DO need to fund raise. (There are many investors who are not looking to build enormous businesses who value the fact that you can run a business profitably)
• It allows you many more exit opportunities. While Google and Facebook will buy “acquihires” (at least as of Dec 2011), many acquirers hate the idea of buying companies that aren’t profitable. When they look at buying your company they often think in terms of “how long will it take until I earn back the profits to pay for my acquisition price?” If you’re not profitable you’re purely a cost center to them.
• Being profitable certainly makes your company more sustainable in difficult times.

The characteristics of somebody who should NOT focus on profitability include those who:

• Have or perceive that they have the opportunity to build an immensely scalable businesses. Internet scale.
• Have easy access to capital by investors who are committed to building businesses at Interent scale

As I like to say,

“If you’re really on to an enormous idea then other people in the market are going to spot that and want to compete with you.

If you have a market lead then raising capital and making investments now will help you as others enter the market.

If you don’t, somebody else WILL!”

The Details

I have had this discussion with many a first-time entrepreneur. They have have raised $2-3 million, built a product that has some amount of market traction and got to annualized revenues of around $1 million.

At this level, as a founder you feel SO CLOSE to profitability that many say, “I’m going to keep my costs really low this year to try and hit profitability. I don’t want to be beholden to investors.”

My response is often, “That’s fine. What’s your objective? Are you looking to potentially sell the company in the next year or two? Do you plan to run this as a smaller business but maintain healthy profits? Do you imagine eventually raising VC and trying to build a faster growing company?”

Because of the circles I run in I tend to meet many people who eventually do want to build large companies and therefore do want to eventually raise VC and “go big.” But they want to do it with leverage.

I often point out that investors at this stage care way more about growth than profits so be careful not to shoot yourself in the foot. I certainly understand the desire to be in control, which is what you are when you earn a profit. Just be careful that it doesn’t come at the expense of investments in growth.

The likely response of a VC to your company that raised $3 million and now is profitably doing $1.5 million in revenue three years later is, “So effing what?” Harsh, but reality.

If you had huge customer growth but just didn’t focus on revenue that’s a different story. If you spent the 3 years perfecting some hugely differentiated technology IP that may also be different. But if you simply went more slowly to show you could earn a profit you may need to look for alternative funding sources to fuel your future growth.

Understanding Profits

No discussion about profitability can sensibly happen without covering the basics first so please forgive the 101 nature of these charts.

Simplifying:

Revenue -
Cost of Goods Sold (COGS) =
Gross Profit (also called Gross Margin or sometimes “Net Revenue”)

- Operating Costs
= Profit

When I look at an income statement (also called a profit & loss statement) I start by focusing on the revenue line.  One thing that should matter to all people trying to understand the performance of a company is whether they have revenue growth.

I always remind this to journalists who ask me about public stocks. If you had two companies each with $100 million in “earnings” (profits) they might have vastly different prospects for the future. One company might be growing its revenue at 50% per year and the other might be growing at 5% per year.

And assuming they both had the same net profit margins (profit / revenue) then the former company would be much better off at the end of the year.

So while the simplest way that people often evaluate stocks is by P/E ratios (price-to-earnings), one also needs to look at other metrics such as the PEG (price-to-earnings-growth). [of course there are MUCH more sophisticated financial tools than either of these, but PEG is a short-hand many people use]

Investors value growth.

The value of a company is the expected value of all future cashflows discounted back to today’s dollar (because as you know a dollar next year is worth less than a dollar today) and a company that is growing more quickly is more likely to yield better overall profits in the future.

So for a start when you want to evaluate companies you want to evaluate “growth.” Looking at earnings alone across two companies won’t tell you the picture of the different prospects.

And when you’re looking at even earlier-stage companies (as VCs do) you might be even more focused on customer growth than revenue growth.

The Nature of your Revenue Matters

When I do evaluate companies that already have revenue, I actually want to understand the revenue line in more detail. What makes up revenue? Is it one product line or multiple? Do 20% of the customers make 80% of the revenue or do the top 3 customers represent 80% of the revenue.

This is called “revenue concentration” and the more concentrated your revenue the higher the risk that your revenue could decline in the future.

I also try to understand things like how you’re pricing your product, how your competitors price and what your pricing expectations will be in the future. Fast early growth in a market is often eroded when competition gets fierce and prices are forced down due to competition.

Revenue is Not Revenue is Not Revenue
But it’s not as simple as just looking at revenue in dollar terms. For example, look at the following graph. You’ll notice that although both companies have the same revenue every year, Company 1 has MUCH higher gross margins than Company 2 because the cost of sales (COGS) is much lower.

“COGS” represents the amount that each sale costs you. For example, if you sell your product through a third-party reseller who charges 30% of any sale then your COGS will be 30% of revenue (assuming no other costs of sales).

The example chart is not actually atypical. The first company represents a normal software company that sells its products directly (either via sales staff or directly off of the internet). Many software companies have 85-90% gross margins, which is why it has historically been a very attractive industry.

Company 2 might represent an “ad mediation company” where the company gets paid by ad networks for running ads on publisher websites and the company in turn must pay the publisher 85% of the revenue it collects. This is not atypical for “middle men” who often take 15-30% of the value of the sale

This could also be a travel website who gets paid a bounty for selling airline travel.

Companies like to have high numbers in their revenue column but this can be quite misleading. After all, if you sell $500 million of United Airline tickets that isn’t really YOUR revenue. Your revenue is the $75 million you got paid in booking fees.

It could be an eCommerce website or “flash sale” where they are booking revenue from customers but then having to pay out a high percentage of the sale to the clothing manufacturer. Many eCommerce companies are in fact, middle men. Gross margins can range from 15-40%.

I know you’re shaking your head and thinking, “duh” but I promise you that even some of the most sophisticated people I know get off track on this issue of “gross revenue” versus “net revenue.” I saw this first hand with the growth of the “flash sale” category.

People kept saying,

“Company X is already doing $100 million in revenue! Wow! Amazing growth!”

Um, no,

“Company X is doing $100 million in gross revenue but is only at 12% margins which means the majority of the value is in the goods.

Many of these companies weren’t even taking physical possession of the goods in the early days. So they are really doing $12 million in “revenue.”

That in and of itself is an achievement. But it’s very different than $100 million in two years.”

Shouldn’t All Companies Want to Be Profitable?

Not necessarily.

Let’s consider the following two software companies, both of which have 66% gross margins.

Both companies look the exact same after one year. They both raised angel / seed money of $1.5 million to fund operations in their first year of operations. Both companies lost $1 million in their first year.

Gross margins at 66% is fine (they’re selling through a reseller who takes a 33% margin) but their sales aren’t yet large enough to cover the costs of their IT development team + management + marketing + office costs, etc. In many Internet startups 80% of the operating costs will be people.

So which company is better run?

The answer is that you have no way of knowing. A naive journalist might lament the fact that Company A is “not profitable” or is being a typical Internet startup and not worried about costs. After all, they doubled their operating costs when they weren’t even profitable.

What did they actually do? They raised $5 million in venture capital to fund growth. They used the money to hire a bigger tech team so they could roll out their second product line. They hired a marketing team to promote their products more broadly.

They hired a biz dev team to work on deals where their product could be embedded in other people’s products as a way to increase customer demand. They got a bigger office space so their employees would feel comfortable and they could improve employee retention.

If there was strong market demand for their product then this investment might pay off handsomely.

Let’s look at years 3-5 of the two companies.

Even though Company B initially looked prudent, it turns out that the investment that Company A made in people led to a higher annual growth rate. At the end of year 5 Company A has earned $14 million in cumulative profits (gains – investment years) while Company B has made $5 million.

Company A is now doing $47 million in annual revenue which Company B is doing $12 so years 6-10 appear rosier for Company A as well.

I know which company I’d rather have invested in. Growth matters.

But let’s consider an even more aggressive scenario. Let’s call it the “super high growth” Internet company. You know, the kind that unknowing commentators would be quick to lambast as being wasteful because they’re not profitable.

The company would have had to raise at least $35 million in venture capital to have funded operations like this. More likely they raised $50 million or more. Note that they likely raised this in 2-3 tranches, not all up front or all at once.

Crazy? Stupid? Should they have slowed down operating costs in order to “make a profit.”

Again, it depends. If the growth is as spectacular as it is here and IF they have access to cheap capital then they’d be crazy not to have raised the VC and instead stayed unprofitable.

This is the trade-off between profits & growth. You can drive profits up by not investing today’s dollars in tomorrow’s growth.

The next time a journalist wants to slam Amazon for not being more profitable I wish they’d understand this. Amazon is continuing to grow at such a rapid pace that of course it should take some of today’s profits and reinvest them in growth.

If there is a company that can’t grow fast enough then they should do other things with their profits, like return it to shareholders.

A Final Note on Profitability vs. Being Cashflow Positive

More 101, but experience tells me this is worthwhile to many. Many investors care much more about cashflows than income statements.

It’s worth noting just for those that aren’t familiar with the difference between an Income Statement and a Cashflow statement that being “profitable” is not the same as being “cashflow positive.”

You can be profitable while losing money.

Huh? I thought profitable meant you were making money?

Income statements are designed according to accounting standards that are designed to “match revenues & costs in the period for which they should be attributed.”

Quick examples:

1. An ad network (the middleman) might sell $500,000 in ads. It might agree to pay the publisher who runs those ads in 14 days. The advertiser who bought the ads might pay the ad network in 60 days.

So for this money I might show that I’m profitable on my income statement but I might actually have paid out $500,000 that I didn’t receive yet (negative cashflow)

2. I might have sold a $1.2 million contract over two years. I therefore might be “booking” $50,000 per month in revenue on my income statement. But the customer may be paying me quarterly in arrears (at the end of the quarter). So for the first two months of every quarter I’m showing revenue on my income statement that I don’t yet have in cashflow.

3. The same is true obviously on the cost side. I might have bought $450,000 in equipment that I amortize over the three years that I expect this equipment to be useful. So every year I show costs of $150,000 but I really spent the money up front.

A year ago I invested, along with Dana Settle at Greycroft Partners, in a startup company called Maker Studios.

What excited me was that they had an immensely talented team that understood how to produce & distribute low-cost videos, initially via YouTube. It was founded by Danny Zappin, Lisa Donovan & Ben Donovan (along with several creative talent like Shaycarl, KassemG and others).

They know this model of YouTube production & distribution better than anybody else that I’ve met in my 5 years in Los Angeles.

And anybody who follows this blog knows that I believe television disruption has already begun and it is more likely to resemble Internet content than streaming long-form content to our living rooms.

As I talked about this model with several friends in Silicon Valley I always heard the same refrain, “we don’t invest in content business – they are ‘hits driven’.”

I had to laugh a bit at at the irony of this. For one, the consumer-driven startup world has become immensely hits driven. You need star power of entrepreneurs surrounded by star power angels & VCs who in turn get tons of press from adoring journalists who are insiders amongst this crowd of tech cognoscenti.

And this is at the same time that content has become more predictable. Sure, you need to start with talent. But when you produce on Internet you can test your content in the same way that Silicon Valley firms test early versions of their software.

You can get feedback from your audience and adjust based on their feedback. You can get subscribers who receive every version of your content that you release. You can monetize via Google Ad Sales before you have enough revenue to build your own sales team.

Sound familiar?

Maker Studios is the ultimate “lean startup.”

And then you can build email lists and market video content to your fans in the same way Gilt Groupe markets its clothes to its end consumers, making it an insanely scalable business.

In the era of the Internet video is not a one-way medium. Content producers can have direct relationships with end viewers that serve as feedback loops & direct marketing vehicles.

And nobody knows how to do this better on the Internet than Maker Studios. They are now the largest independent network who produce in-house videos and distribute them.

Maker Studios is dedicated to working with “talent” in the same way that Silicon Valley is dedicated to working with engineers. Our talent includes writers, directors, actors, singers, post-production professionals, costume designers, lighting professionals, sound mixers, show runners and so on.

This kind of business will not easily be replicated in Silicon Valley precisely because the skills are different.

We are now attracting serious management talent, having recently brought in the venerable Courtney Holt as the COO. And I’m excited to say that we’ve poached a major technologist from Silicon Valley who will move down to Los Angeles join as CTO in January. More on this soon.

But I really couldn’t do an overview of Maker Studios justice. I’ll leave that to Carson Daly who interviews Danny, Lise & Ben for Last Call in this great piece that describes what they do and why I’m privileged to watch them continue to build out their vision.

And if you happen to be “talent” (including tech engineers!) make sure to reach out to team Maker. There isn’t a more talent-friendly Internet video network out there.

I’m often asked by people what investment areas interest me.

It’s true that I have a functional focus on three areas: Performance-based marketing, digital television and mobile computing. I try to invest in things that I know and that I believe I might have better knowledge and relationships than the masses of VCs.

I have other areas of interest & competence such as cloud computing and document management given my background.

It’s also true that I’m mostly founder driven, where the founding team & my personal relationship with them leads to a strong mutual working relationship. If that bond isn’t there or if it feels like I’m in a bidding process for the highest price, I might as well be Wells Fargo.

But one theme in pervasive in all my thinking about investing in Internet-based companies: Deflationary economics.

And it’s something I think you ought to consider when building your Internet businesses.

Here’s what I mean

When you think about the great achievement of the Internet in aiding content, commerce & communication they include:

• Large scales of connected people & information never seen before in humanity
• Unprecedented transparency of information
• Open standards that make it easier to plug into other products & services, creating a global bazaar
• Socially connected individuals and platforms that enable faster roll-outs of successful products
• Payment ready consumers (Amazon, iTunes, PayPal) and businesses (Google AdWords, Square)

So which types of businesses become super successful given this environment?

Ones that offer amazing value (low relative margins) at high volumes that makes it nearly impossible for high-cost incumbents to compete. That’s what I mean by deflationary economics.

It is a classic case of the Innovator’s Dilemma in practice.  If you’re a startup and you haven’t read my summary of Clay Christensen’s seminal work please do.

It’s the single most influential piece of work in determining my investment philosophy and how I think about markets.  In a recent panel discussion I participated in with Fred Wilson he said the same.

Why Deflationary Business Win

In the simplest form, new startups have a product that is INFERIOR to that offered by the competition but at a dramatically lower price with the seller opting for a very thin margin on their product.

Initially their only customers are people who can get by on the reduced functionality or perhaps don’t have the money to spend on the expensive product.

Often it turns out that the market is greatly expanded by having a lower price point new entrant. And over time the new entrant attracts enough business that, as depicted in the graph above, the quality of the product slowly increases over time.

The new entrant keeps margins low but suddenly has a lot of profits due to large volumes of business.

How does the incumbent respond? Not by dropping price & quality – they don’t have an advantage there. Instead they spend more money trying to innovate on product quality and call attention to the weaknesses of the new entrants product quality.

Often major customers defect en masse to the new entrant as they realize that the huge price premium is not justified by the product differentials.

That is what Clay Christenson defined in his book as “The Innovator’s Dilemma.”

And this approach to looking at startup industries is what I call “deflationary economics.”

How it May Apply to Your Business?

When I’m asked about all of the mistakes I made at my first startup (I made them all) I often tell people that the single biggest mistake that I made was charging too much for my products.

We knew how to sell – we had clients paying $1 million / year. We knew there was value in what we provided. In order to grow we hired successful and expensive sales people who in turn were able to (and incentivized to) sell projects at higher margins and close big deals.

This was a mistake.

We grew really fast for a few years. But eventually low-cost new entrants came into the market offering most of our features at 10% the costs. We still won large customers but over time it became harder to compete.

Had I taken the lower-margin approach I really think I’d be sitting atop a $1 billion+ company today.

So when you start your company think carefully about whom your target customer is. If you’re trying to be a value-based product or trying to scale to a large market size you may want to think about deflationary economics.

• Does your product dramatically reduce costs in an industry with large incumbents and fat margins?
• Can you provide a narrowly focused product to a niche of that market who will be attracted to dramatically lower costs?
• As your business grows can you find ways to continually lower your costs by whatever means?

I would also think about how you use scale to your advantage to keep margins low.

• Are you offering a product where the supply costs will continue to drop precipitously? (think Amazon’s Storage costs)
• Are there alternative ways to monetize your product where incumbent are not? (think virtual goods of Zynga, ad supported models, freemium models)
• Are there ways to offer super low margins on your product knowing that you will overlay other product offers to the same customers later that will improve your margins?

Most of the Internet’s Greatest Successes Have Been Deflationary

Craigslist – Think about what Craigslist achieved. It’s remarkable. They took an industry that had charged people large sums of money (the classified industry) and made it almost entirely free. How do existing incumbents compete with that?

Craigslist is kind of an anomaly in that it’s founder seems to run it in a non-traditional style and with some objectives other than the pure profit motive. But by providing free listings he build critical mass (volume) so charging small amounts for certain types of listing (i.e. recruiting) he could build a very profitable business.

Craigslist is everybody’s favorite business to say, “I’m going to disrupt them” but somehow nobody has really been able to. Given their terrible UI I’m sure it will eventually happen. But beating free is hard, as is creating a two-sided market (chicken & egg problem).

Amazon – Amazon is the ultimate deflationary business. Everybody knows the story well. They launched as an online book seller.

They had huge scale advantages because they could offer a much wider book selection since they didn’t need to be limited to the physical floor space of a physical retailer.

They had huge cost advantages because they didn’t need to pay for retail space or all of the retail workers. They even

had a government break because they didn’t need to charge taxes and thus consumers got an even better price.

But Amazon didn’t try to build a hugely profitable business. Does that sound dumb? I always see naïve journalists comment negatively on businesses that are “not profitable.” Sometimes it’s good to not focus on profitability & sometimes it’s bad.

There is a tension between profitability & growth. The more you want the latter the more investments you make in people and infrastructure now to pay for faster growth that expense of short-term profitability.

It doesn’t work for every business. But if you are growing uber fast, building for scale and have access to capital to fund your growth then it’s always the smart play.

So instead of maximizing price they kept cutting costs.  Innovator’s Dilemma. How do physical retailers compete with that? Especially when Amazon will offer free shipping for its best customers.

And Amazon wasn’t content with just being books, they wanted to be THE Internet retailer. Walmart in the cloud. This generation’s Sears Catalog. So they kept cutting costs of everything they offered.

And then they decided they wanted to be the Internet retailer of computing services so they created Amazon Web Services

(AWS). And they made it so cheap that everybody gravitated towards them. They had a scale advantage and were driving deflationary economics (in other words, massively driving down the costs of goods & services).

I was at Salesforce.com when Amazon was super aggressive on that storage pricing. I met with our network experts to figure out whether we could launch a competing service. The assessment of our best experts was that we couldn’t. Their view was that Amazon was taking a loss on providing Internet storage.

I have not inside data on that but I’ll be they were right. I’ll bet that Amazon’s view was to start with a loss leader because they knew that storage costs could come down and that they could add more service on top of their storage product and ultimately provide a profitable bundle of IT services to their customers.

In other words, storage might have been a “loss leader.” In any event, they had such scale advantages in providing this Internet infrastructure that to this day nobody in the industry has come close to matching them.

In my estimation this is one of the biggest strategic mistakes Google has made in not competing more aggressively with AWS. The Cloud is the future at Amazon has an enormous lead. As far as I know, the revenue in AWS is not publicly broken out but the last rumor I heard was that it had crossed $1 billion per year.

Google – They have led the deflationary pressure on advertising, bringing whole industries into chaos. This has particularly hurt the print media businesses that can no longer charge enough to pay for editorial, printing & distribution.

They are bringing deflationary economics to word processing, spreadsheets and office automation. They are bringing deflationary economics to local advertising.

I guess I would describe Google as the ultimate scale & deflationary business.

Skype – As with many deflationary businesses, Skype started by giving away its product for free. Free phone calls anywhere in the world is as deflationary as it gets.

Telecommunication companies are still charging people for phone calls when the costs to them of providing the calls is infinitesimally small. Data transfer is what costs telecom companies money these days.

Ultimately when Skype had 10’s of millions of users it rolled out products that made money. They started with “Skype Out” which was placing a call from a Skype line to somebody on a normal telephone. They charge for this call, but they charge at rates that are an order of magnitude cheaper than a telco.

Expect this industry to be whiplashed by deflationary economics in the next 5-10 years. It’s no wonder they’re pushing so hard to be become our Internet supplier and our TV suppliers. Unfortunately for them neither of these businesses will escape the deflationary maelstrom either.

TextPlus – Speaking of telecom disruption, a new breed of mobile telco is emerging that are riding the deflationary wave. It’s the reason I invested in TextPlus. At 25 million downloads & 10 million monthly active users we’re achieving a scale that makes it a very attractive opportunity.

We started offering free text messaging at a time when most telcos are still charging $240 / year for unlimited-texting plans. In many parts of America that’s a lot of money for families to be absorbing for something that costs the telcos almost zero. That’s one reason a free texting app has been so popular.

But beyond that TextPlus now offers free phone calls to other TextPlus users and out-of-app calls are a fraction of the normal costs by mobile providers.

Expect a deflationary revolution in the global telecom market – at a minimum for voice services. And with 6 billion global handsets you can imagine what an immense market this will be.

LinkedIn – Lots of people talk about LinkedIn as a social network. What interests me is the deflationary impact that LinkedIn and other recruiting websites have had on the recruiting market.

Think of the principles I described about Internet economics of Craigslist: huge scale, many parts of the service are free and monetize the narrow features where businesses are willing to pay – and at hugely deflationary prices to their normal recruiting fees.

Zynga – Deflationary. In the offline world people were buying consoles and then paying for game titles separately – many in the $29-49 price range per game. Along comes an immensely scaled business that offers games for free.

I know, it isn’t offering the same quality of games so I’m not arguing that the entire game console business goes away over night. But it is hard to argue longer-term against the deflationary pressures that Zynga brings.

Maker Studios – Network television costs $50,000 – 100,000 per minute to produce. Reality shows can be cheaper, with the lowest-end costing $6,000 – 8,000 per minute.

Maker Studios is an Internet producer of content relying on deflationary economics. It produces shows for $500 – 1,000 per minute. It’s no surprise that it has now become one of the most viewed networks of video programming in the world, achieving 500 million video views per month having only raised $3 million in venture capital.

Maker Studios produces shows like =3 by Ray William Johnson (NSFW), one of the most subscribed to shows on YouTube. Many episodes are garnering 8-12 million views while its network competitor (and equally brilliant show) Tosh.O is getting 3 million views.

Other shows like Epic Rap Battles of History (my personal favorite – if you get addicted we’ve produced about 15 or so now. The best ones have been watched more than 35 million times) and Animonsters are delivering huge audiences and significant revenues.

I know that the networks, studios & cable companies don’t yet see this business as a threat. My experience in looking at deflationary businesses says that they should pay attention to it. Deflationary economics tend to eat at the core of traditional offline businesses.

Of course I could go on and on including businesses like AirBnB, DropBox, Box.net, Yammer and so on. All deflationary. But by now you more than got the point.

So What Do I Look for In My Investments?

Exactly what I’ve outlined.

• Teams that care about keeping costs low.
• Teams that want to drive waste out of the system.
• Teams that have a “lean” mentality.
• Teams that are comfortable with transparency of pricing & costs and don’t mind competing in that environment.
• Teams who aspire to build really big businesses and believe in deflationary economics.

Fred Wilson recently posted a great video on his blog with the CEO of Forrester Research, George Colony. The money slide is the graphic below.

The chart shows three scarce resources and their improvements over time. The top line is available storage (S), the middle line represents processing power (following Moore’s law) or (P) and the bottom line is the Network (N).

In it he asserts that the web is dying and in its ashes will see the rise of the “App Internet.” The App Internet is different than the HTML Internet (aka The Web, WWW and in the mobile arena “The Mobile Internet” or short-hand HTML5) because the “presentation layer” and “client side” functionality are defined by applications that run on your mobile device and connect into the open Internet back-end to exchange information with other web services.

He’s right about this. But only temporarily in my view. And while the App Internet is currently more powerful than the Mobile Internet it has fundamental flaws. It isn’t open in either its standards or in the way that applications are marketed and distributed. I will cover this in my post.

Colony’s presentation is intriguing (and worth a watch if you have a few minutes) because I love to see when informed people make arguments that are different than you ordinarily hear (and different from my own views). In the end, my bet is that George’s bets will largely prove wrong. This blog post lays out my case. If anybody from Forrester reads this I hope they won’t see it as an attack on George’s presentation, which I found enlightening, well argued and interesting. My views are just a data point in the debate.

In the end, Seth Godin’s comments on Fred’s blog post said it best:

“His black swan is showing.

The problem with just about every prediction made by industry firms like Forrester (all the way back to 1985 when these firms said that the Commodore 64 was going to change the world–until the VCR interrupted to become the next big thing) is that they are based on sophisticated analysis of what’s in the rear-view mirror. 

A tough way to drive.

The trends are legit, but we have no idea what unexpected breakthrough in human interaction is going to change everything.”

In other words, nobody can really assert authoritatively what the future of tech or the Internet will hold. I have some educated guesses.

George’s Arguments

1. The web is dying and will be replaced by “the App Internet.” He says that since storage & processing are growing at a much more rapid rate than the network we’ll be at a point where not having apps on devices will greatly under utilize the power of the devices in our hands. In other words, our mobile devices are all powerful and the network that they connect into sucks.

2. Social networking is peaking. He cites that we have reaching a saturation of social networking in which nearly everybody is already using social networks (85+% in most developed countries and in urban environments in the developing world) and the amount of time dedicated to social activities already exceeds many other important tasks such as exercise and is even approaching the same amount of time we dedicate to child care. He argues for a world he calls POSO (post social) in which we will only use social applications which drastically cut down our time involvement and/or increase our productivity.

3. Social media will be pervasive in the enterprise and is primarily driving by customer interactions. He shows data that the overwhelming majority of major enterprise in the US is currently adopting or looking to adopt social networking technology. When asked what their objectives are they cite some form of “improving customer communications” by a long margin.

A (Very) Brief (and Selective) History in Computing
To understand my perspective you have to rewind to the late 80′s / early 90′s in business computing. As a software developer I wrote code on what was called a “dumb terminal” because it literally had no processing capability. It is the opposite of the world that Colony describes. The local computer had no processing capability, the network did its job and the central computer was the master.

We wrote programs that existed solely on a centralized computer (a mainframe), all of our data was stored centrally and all processing was centralized. When we wanted to compile our programs (turning human programming language into an executable file that the computer can read) we had to submit them to the mainframe and wait for them to be processed in sequence along with everybody else’s code.

In busy times compiling a program could take more than an hour, so we obviously didn’t submit often and if our program had errors and was unable to compile it was devastating. Things got so bad on one project that we ended up doing split shifts with teams of people programming from 8pm-6am and the next team arriving at 8am.

Throughout the 90′s the PC became much more popular in corporate environments, so companies began to replace dumb terminals with PCs. We ran software on the PCs called “terminal emulation” that allowed us to act like a dumb terminal to interact with mainframes and to act like a PC (with word processing, spreadsheets, etc. the rest of the time.

In this era the computing model known as “client / server computing” was popularized. What this model said was that since we now had really powerful processing on our desktops we should split the computing responsibilities between the PC (the client) and the mainframe (the server). Initially the computer did basic functions like “screen validation” (making sure that you didn’t enter non-sensical data into fields, for example) and could take over functions like compiling your software code so you could check for errors before submitting it to the mainframe.

Over time the PCs began to do more and more. They took over the “presentation layer” of computing. As a society we got used to the windows metaphor of computing. So suddenly we had “drop down” boxes that gave us multiple choice selection of data, we had dialog boxes that would prompt us with “Are you sure you want to proceed? Y/N.” This initially took on what was called “thin clients” because the server did most of the work.

The more the processors on our PC improved, the more we expected our PCs to do and everybody gushed about this new era where we had much better user interfaces and we had way more individual device power. Centralized computing was giving way to smart, distributed devices.

Sound familiar?

It was wonderful. For 5 minutes. Then the unintended consequences started cropping up.

• How much data was acceptable to sit on local devices? Few had considered what happened in a world in which the data was distributed. Suddenly you had security risks, confidentiality problems, privacy concerns (think about your medical records being distributed), etc.
• What happened when you submitted a processing request to a central server (think, I’d like to transfer money from my bank to yours) but the transaction didn’t complete? You could be in a situation where your local computer had assumed the money was transferred and it wasn’t. We had to develop whole frameworks of “middleware” to deal with this problem. We had to come up with “two phase commits” and “rollbacks” and other data tricks to keep our devices in sync.
• We started to realize that that most expensive part of computing was actually manpower. Manpower to develop all of these applications, manpower to maintain them, and manpower to deal with all of these devices, which added great complexity to our IT environments. For example, on any software upgrade for a typical client/server enterprise package it would take up to 50% of the overall development budgets to deal with testing the software in heterogenous environments.

So having powerful devices with decentralized computing is not always a panacea.

Enter the World Wide Web (WWW).

As George appropriately describes in his video, the Internet and the Web are two different, but related things. The Internet represents what you might think of as “plumbing.” It defines how data gets moved around on networks, how files get located, how files get transfered between devices, how packets of data get sent via routers, etc. The WWW is the presentation layer. It’s central standard was HTML (hyper text markup language) that described how we would show data on computer screens.

When web browsers (the programs that can read and interpret HTML) were popularized they were “dumb.” It was literally like returning to the old days of computing. On the Web almost all of the processing was centralized and your browser was your input / output device. As an example of how dumb they were (for those that don’t remember) whenever you changed one field in a browser-designed program the entire screen had to refresh. It was a terrible user experience.

But for software developers like my company the web was a blessing. We were able to crank out software code at a much greater pace than was ever possible for. We designed our code and tested it in a Firefox browser and once we had working code we then had to figure out how to make the clunky Internet Explorer work. But the heterogenous environment was practically eliminated. We didn’t have to worry about which computer you were on. we didn’t have to support 3 database types, worry about network configurations, etc.

We flirted for a brief period with building some client-side applications (mostly for offline use) but abandoned those efforts when we realized how much overhead it took to maintain – especially as we release new versions of our code and had to always keep the local, offline software in sync with our releases.

We adopted an ethos that all of our development would be web only and that eventually browsers would become more powerful and make the user experience much better. And that’s what happened. A series of standards emerged known as “AJAX” (asynchronous javascript and xml) that gave the web-based designer much more control over the browser. Suddenly you could update small portions of the browser without refreshing the whole screen.

AJAX was one of the major drivers of the “dot com renaissance” that became known as Web 2.0. As people realized streamlining client-side development really matters to cost-effectively build software, new tool sets emerged to streamline the process. Libraries like jQuery have emerged that lower the effort to build front-end code.

Web & Social Change the Landscape of the Web

Prior to the popularization of smart phones and Facebook we were in a pretty good place on the Web. The one big concern many people had was how to constrain the total dominance of Google. Every startup (every company, really) was beholden to the traffic god that was Google search. One change in Google’s algorithm and whole businesses could be wiped out as chronicled in this excellent book by John Battelle called The Search.

The growth of social networking (er, the growth of Facebook) along with the growth of the iPhone have changed the landscape dramatically.

In this chart from Silicon Alley Insider you can see the first major trend to affect the open Web – the growth of Facebook. And Facebook’s popularity has only increased in the past year.

Why does the rise of Facebook affect the web? Because it isn’t a part of the open WWW. Facebook exists behind a walled garden. You need to log in to use it. Content or software developers who want to build products that work in Facebook have got to develop inside of Facebook’s framework rather than working on open, Internet standards.

Brands, celebrities and even individuals like you who produce information inside this walled garden are subject to the rules & conditions set upon you by a private company – Facebook. This isn’t a case against Facebook, it’s just a statement of fact.

As more people consume Facebook pages, less people are consuming open Web pages.

I wrote about this previously here and spoke about it on YouTube with Howard Lindzon here & here. (if you’re not that familiar with the topic it’s worth a 20-minute watch)

Is the App Emerging as the Winner?
The App Internet had a clear advantage in the past few years. Why? Because the mobile devices had a series of new features for which mobile browsers were not optimized. Examples include the camera, GPS, the accelerometer and the small screen sizes.

And importantly when developing games that require high-end graphics to handle game play you need to make use of the iPhone’s PowerVR GPU (graphics processing unit).

So Apps were inherently more powerful than browser-based applications.

It also had two other huge advantages.

1. Apple had a mechanism for charging users for apps and because most people already had an iTunes account it was simply 1-click to purchase an item. This meant that small teams could create games and make real revenue whereas on the Web this was much harder because you either had to build (or license) your own billing infrastructure, convince consumers to get out their credit cards (which they don’t like to do) or you had to sell enough advertising to make it worth offering your product.

2. Apple had a store. For early game developers this made it easier for your application to be found on the limited “shelves” in the iPhone App Store. Now that there are MANY more apps out there – this isn’t such an easy game. But in the early days the App Store was very appealing to new entrants.

Round 1 clearly goes to the App Internet.

Will the App Metaphor Hold for Mobile?
This is where my disagreement with many starts. I think the allure of Round 1 has convinced people that in mobile, apps are better. I’m not so sure.

1. Workarounds are developed. The surest sign of a market inefficiency is when solutions emerge to help developers get around the bottlenecks of platform development. This is what is happening in mobile. Developers are now able to build apps in native languages such as Javascript or HTML5 that can run in multiple platforms.

There are companies that develop “wrappers” that in essence handle all of the functionality needed to control each individual device that “abstracts” the programmer from having to build in device specific code. Some of the companies that do this include PhoneGap, Appcelerator, Strobe and RhoMobile.

2. Browsers will catch up. Just as in the first round of the web when everybody complained that web browsers weren’t powerful enough to build applications on, many of us believed that open systems would win. Eventually standards will emerge that will make it easier to build natively into browsers. Effectively either the wrapper developers become browsers or the browsers build wrappers or the two groups merge.

Also note that AJAX finally took off when Google open-sourced a bunch of its internally built AJAX frameworks. I wouldn’t be surprised if big innovations from Facebook and others in the mobile web eventually see there way into open-source mobile initiatives.

3. The costs of multi-platform development are too expensive. The costs for developers to build for multiple platforms is too great, the gatekeepers are too powerful and the outcomes ultimately limit innovation as happens in any system when a few players are a choke hold on distribution.

If you want to do a deeper dive on why I believe this is bad overall for the system despite the short-term allure of iPhone’s beautiful products please see my post “App is Crap, why Apple is bad for your health.” And before Fanboys slam me, please note that I own 3 Mac laptops, 2 iPads, 5 iPod devices & Apple TV. I love the products. That doesn’t mean I think it’s great for our future as an industry to have a close distribution system.

4. Distribution becomes a stranglehold. Fred Wilson talks about this in his “mobile gatekeepers” post. The early allure of empty shelves in the App Store is making way to the over-crowded shelve (currently tallied at more than 500,000 SKUs). This leads to all sorts of games by developers to get into the rankings, most of which favor companies with more cash.

Also, whenever we see distribution strangleholds we tend to see slower innovation and more resistance by the distributor to change. Think about the following examples:

• mobile phone companies who controlled our crappy phones prior to the iPhone breaking that hegemony
• cable & satellite companies who have controlled our paid TV through set-top boxes that make it impossible for innovation on the TV set
• radio stations that controlled the music we listened to until music could achieve wider distribution on the Internet

Choke points are never good for innovation.

5. Data, data, data. Just as when we first went from mainframe computing to client-server computing we forgot that data leakage and data management across multiple devices is a big issue. The App Internet creates the potential for many more data issues. That doesn’t mean they can’t be solved, but it’s not as easy as saying, “powerful apps on our mobile devices is the best answer.” More power, more distribution = more data problems.

6. TCO. There is an acronym we use in computing called TCO or Total Cost of Ownership. It is often used in ROI calculation on projects to estimate a build vs. buy decision. Often people who build apps internally at their company calculate only the costs of the initial build rather than the total costs of maintenance of the project. Maintenance often greatly exceeds the development costs when you consider both human costs of maintenance plus the loss of productivity of not having an app that innovates as fast as the market solutions do.

I think there’s a TCO argument to be made against the proliferation of the App Internet. The more companies build their own apps, the more maintenance work they’ll need to do, the more employees they’ll need to maintain their apps and the further the innovation drain. I know this is a harder concept to quantify and intellectualize but I’ve seen it first hand in 20 years of working with large corporation on “legacy” IT projects. The App Internet opens the door to many more legacy apps.

This argument never features into any young developers mind because it takes years to see the decaying effect of legacy infrastructure in corporations (plus, many app developers prefer the sexy world of consumer apps).

To be clear … I think that the App Internet won’t disappear overnight. I also think certain apps will always be more effective built natively. But the same is true of today’s non-mobile computing. Still, most apps need not exist. Long live the Mobile Web.

And What about Colony’s Assertions about Social?
I’m going to save that for a future post. Coming soon.

Postscript:

“If I had more time, I would have written a shorter letter.”

Marcus T Cicero

Sorry for the uber long post. Given more time I could make it concise. And I’d have fewer typos. But I valued getting my ideas out there. If you think there are any inaccuracies I’d be glad to meet you in the comments section and I’ll gladly amend any mistakes (rather than differences of opinion)

I am a big believer in VC pitches that the bio slide should come up front. Actually, I think the advice in this post applies to any sales meeting also.

The short answer is that by knowing the key members of the management team the VC firm can quickly identify strengths on your time and know whether you have some competitive advantage in your chose field relative to other people with whom you will compete.

This is especially important since I believe that 70% of the decision of many VCs are based on the potential of the management team in one way, shape or form. I know it’s incredibly important to me in my investment decisions.

I wanted to write a quick post on a pet peeve that I have when teams present “who they are” whether in a bio slide or just in the up front introductions.

What occasionally happens is the CEO introduces his team giving a brief overview of who everybody is. I hate this. I want to hear everybody speak – to get to know the team. What purpose could there be to having the CEO talk on behalf of everybody?

You might say, “it’s streamlined, we don’t want the intro to take too long.” That’s an excuse. If you really believe that then just have your team practice their personal intro’s and tell them the time budget they have to hit.

Why is it a pet peeve?

For starters I think that if you bring people to the meeting with you they should all have a role in the presentation. No “bag carriers.” If they already have a limited role relative to the CEO then why would you kill an obvious place where they actually CAN be heard (but by the way, I think best practice is to assign pages to key execs in advance and know who will do which pages).

The second reason I don’t like it is that it is usually a sign of a domineering CEO, which I never like. Great CEOs can attract and retain great talent. This appears to be the case with Dave Morin who is apparently doing a great job at retaining his key talent in difficult times. When I see a CEO who takes 90% of the minutes of a meeting I assume that as a leader that person probably doesn’t listen to others opinions as much as they should. Either that or he/she don’t trust his/her colleagues.

I’ve run into the problem myself. We traveled the country last year meeting with people who invest in VC funds to get to know them better. Occasionally one of my partners would intro me because I’m the newest parter at the fund (at just under 5 years, they have been at GRP Partners 8-15 years). I would always jump in early into their intro and politely break in to introduce myself.

I don’t like being framed by others.

Let me introduce myself!

Let your team introduce themselves.

Image courtesy of Fotolia

A few weeks ago I was reading a blog post by MG Siegler that really struck a chord. The title was “The Jerk,” which is a reference to both the Steve Martin film but more precisely to Robert Scoble’s interpretation of Steve Jobs having just read his biography.

The gist of MG’s argument is that he’d rather work with people who are openly critical of his ideas if it helps him to perform better than to have a bunch of “yes men” around who just say what a great job he’s doing. I agree with that mentality. And the problem is that most people are “yes men” because it’s easier.

It’s far easier to tell somebody, “that looks great” than to defend why you don’t agree. To critique requires you to have your own point-of-view, to be able to articulate it and to be able to debate the merits of your point-of-view relative to the the other persons.

I have written about this topic in regards in different ways before and if you haven’t read them I think they’re probably both worth a glance:

1. Don’t be a Grin Fucker
2. Don’t Sweep Feedback Under the Rug

When I sent out a Tweet with MG’s article I got a number of messages back saying the equivalent of “you don’t need to be a jerk to make a point. In today’s economy it is counter productive because the best employees have options.”

I agree with that sentiment (my motto is that life is too short to work with dicks) but I think it misses the point.

The broader message in my mind is one of being honest & direct with your feedback (= hard) versus giving people a free pass when you know something isn’t high quality (= easy).

I recently was reviewing a press release for a company in which I’m an investor. The CEO sent around his draft release to the entire investor base for comments. I would describe the responses at “atta boys” ranging from “awesome!” to “we’re so excited to work with you.”

My response?

I told him that I thought the press release was crap (I think my words, exactly).  It was overly intellectual, had too many competing ideas, didn’t have enough catch phrases that would be picked up in the press, emphasized some facts that made us look smaller than we were, was too long and had terrible quotes.

I then asked for editing rights to his Google Doc and I rewrote a version of it. I then walked him through the logic of why I changed what I did. Of course I can’t write every press release for the company nor would I want to. I wanted to lead by example, make my points and then I hoped that the founder would think about how to do this himself the next time.

I promised him that if he liked his version better he could run with it and I wouldn’t complain. But that I was certain that my version was better for reasons a, b, c, d, e.

It was nearly 2am. Sure, it would have been ONE HELL OF A LOT EASIER to say, “well done! good luck!” but I cared more about the outcome and the lesson.

VC Pitches
I face this issue several times a week. I get presentations from aspiring entrepreneurs. Having been an entrepreneur for near-on a decade and having pitched in 100 VC meetings I hated getting no feedback. “Thanks, we’ll call ya” or “We really like you but need to see a bit more traction.”

So I swore when I got into the industry to provide real feedback, in real-time in my meetings.

I’m not always right. I say so.

I don’t live the business every day – you, do.

So if you have conviction and think I’m wrong – fine. I view my job is to be your sparring partner. To make sure you’ve thought methodically about your business. To pick hole’s in your approach. To try and save you wasted energy, help you avoid bad decisions and to make you that much better in your next VC meeting.

I try to do it constructively and with a smile on my face. But I can’t always be that. Sometimes I just serve it up directly. On a bad day I’m sure it can come off as condescending but I try my best not to make it so.

If I tell somebody that I am “absolutely certain this won’t work” (based on my judgment) I’m sure it doesn’t feel very nice. I usually try my best to offer constructive views on what they might do differently. But if my honest assessment is that they need a new CEO, need a better designed product, or similar – I will say so.

I subscribe to the philosophy that 70% of the people will respect me for my directness if I’m not a dick. They might not like the message at the time but later they may value the insights. 30% will likely just think I’m a dick. That’s OK.

I always believed that the job of a startup founder is to be Respected, Not Loved. And the same holds true for VCs. [if you never read that post, I think you'd enjoy it]

So if it takes 30% of the people to not like me in order to deliver some value to the 70% I’m willing to make that trade off.

It’s the harder path, trust me. You get argued with. You have to defend your point-of-view. It takes longer. You frustrate some people.

In Summary
I don’t believe in yelling at people. It’s counter productive. Don’t be a dick for dick’s sake. I’ve seen plenty of that in my career. But don’t give people a free pass on feedback. Take the harder track. Have a point-of-view. State it. Defend it. Push your colleagues (or your boss!) to produce higher quality work by challenging assumptions.

Image courtesy of Fotolia.com