BeyondVC

Selling to large enterprises costs big dollars no matter how frictionless your sale is

I have written a number of times about frictionless sales and how on-demand companies have a huge opportunity to reduce their sales and marketing costs and subsequently scale their business more efficiently. Here is an excerpt from a prior post:

Frictionless sales means reducing the pain for customers to adopt and use a service/product and consequently reducing the cost of sales and marketing to get a customer and generate revenue. As I mention in an earlier post, "The less friction you have in your sales and delivery model, the easier it is to scale. The easier it is to scale the faster and more efficiently you can grow." The lowest friction sale can be a user clicking on a web page and the content owner getting paid for it. The highest friction sale is spending lots of money on marketing and trade shows and having a large, direct sales force of expensive reps pounding the pavement for months trying to close a large deal with an enterprise customer. Follow that with a 3 month implementation process to get the customer happy. There are various grades of friction between these two extreme points like open source business models, software as a service, and reseller/OEM-type models as other forms of packaging and delivering a product/service. And of course, each of these models requires a different methodology and way of marketing and selling to a customer. Ultimately what you want is sales leverage where every $1 you spend on sales and marketing equals multiples of that in terms of revenue.

The perception that it is much easier to scale definitely holds true if you are selling to consumers, small businesses, and workgroups within large organizations. However, it seems that many public on-demand vendors are feeling the pressure to deliver growth and ultimately need to feed the revenue machine by going after larger customers. And what many companies are learning is that no matter how on-demand your software is, if you are selling to huge enterprises you are going to have to spend huge dollars in sales and marketing. Sales cycles are long no matter how you slice it and even if there is no massive hardware and software installation, many large companies want to have their service customized and integrated, even lightly, with other systems. in other words, many of these high flying on-demand vendors are starting to look more like the old software companies they are trying to replace. As per a Wall Street Journal article today, it seems that many of these public on-demand companies are finding out the hard way that no matter how frictionless your sales process is, the bigger the company you sell to, the more it is going to cost you.

There is nothing to install, so workers can start using online software without the aid of the tech department. That makes it easier for companies that sell online software to get into a business than their on-premises competitors.

Seizing on this, investors bought into online-software companies in a big way. During the first 10 months of 2007, shares of 15 online-software companies tracked by Thomas Weisel Partners increased in value 61%. Since then, however, these companies have lost about a third of their value.

Wall Street has realized that it isn’t enough to simply offer online software—you have to have a sales strategy that can make your offering a corporate standard. It is possible to get individuals, project teams or small businesses to buy online software through word-of-mouth marketing, but it is hard to make money from these groups—at least the kind of money necessary to become a billion-dollar company.

In order to get there, they can’t operate like an Internet start-up, letting their technology spread virally as end users hear about it. They need to sell to the same executives and information-technology professionals who made purchasing decisions before online software was an option. Businesses have a lot riding on the decision to use one product or another. And while having pockets of workers advocate for a particular piece of software is a plus, the execs who sign the big checks still want to see demos, vet the seller and do all the things they have always done when they buy software.

So if you are an on-demand vendor, either stick to your focus of scaling with SMBs and consumers which requires a completely different sales and marketing approach more rooted in traditional online budgets and telesales or be prepared to spend some real dollars if you truly want to go after the big guys.

M&A - it ain't over till it's over

The economy is clearly slowing down and the IPO market is nonexistent. As I have always said, this is the time to hunker down and tweak your business to get your model right. If you are interested in exiting today, M&A continues to be the only viable path along that front. Having been through a number of acquisitions and potential acquisitions through the years, one point I must remind you of is that any deal isn't over until its over. On the surface, this seems so obvious. And yes, once a term sheet is signed and a price and general terms are agreed to, you are in great shape. But recently, through discussions with other VCs and entrepreneurs, I am hearing about more situations where strategic buyers may significantly change the deal terms after more serious due diligence or even potentially walk away from a deal. This can be especially painful if you have spent a number of months meeting with the strategic and going through due diligence in lieu of running your business. Trust me, this happened to one of my portfolio companies last year and reasons cited can include we had a change of strategic priorities and or look at the economy, there is no way we can value you like we did when we started the deal.

While I can offer you no protection from this happening to you, all I can say is to be prepared and skeptical, be willing to walk away, and make sure that you both do enough diligence and meet with the right decision makers before you sign any term sheet and embark on the extended process. Once the term sheet is signed, run like hell to get the deal closed because the longer a deal lingers the more opportunity there is for it not to happen. Keep the hammer down and always have next steps and a defined timetable. In addition, to the extent that the strategic acquirer has made other aquisitions in the past, I would try to leverage your personal network to reach out to some of the VCs or entrepreneurs involved to get a flavor for how the strategic will run their due diligence process and what doozies or surprises the strategic throw at you. Before you start spending your money from the acquisition, remember there is a lot that can change and that probably will change so keep that in the back of your mind as you go through the process.

What do I see in venture through 2010???

The Jordan Edmiston Group recently asked me and a few other VCs a few pointed questions about the future for circulation in their July Client Briefing. As an aside, I worked with JEGI two years ago and they did a fantastic job helping us sell Moreover Technologies to Verisign. They understand the media and online world, are well connected, and work diligently to get the job done. Anyway, here are the questions and my response:

Even though there is uncertainty in the credit markets, a stalled IPO market, and few billion-dollar plus M&A transactions, the investment activity level and appetite for quality businesses in the middle-market continues to be vibrant. Venture Capital firms continue to invest in companies that are providing answers to key disruptive market forces and are exiting those investments via M&A. The Jordan, Edmiston Group, Inc. (JEGI) solicited a handful of key VC executives for their responses to the following questions:

1. What are the key market forces you believe will impact your venture activities through 2010?
2. How do you envision capitalizing on or responding to these market forces?
3. How is the environment changing for deal exits (e.g., IPO vs. M&A)?

(My answer is pretty consistent with what I have been blogging about during the last few years. Here is an excerpt from the briefing and if you are interested in reading more and some of the other VCs responses, you can get it here)

We are continuing to move to a broadband connected world, where everything that we do on a device increasingly lives in the cloud. Our business applications, our music, our videos, pictures, and messaging will be easily accessible from any device, any time, and anywhere. We will continue to see new cloud-based applications and services, and data-driven services will play a larger role in this new world. There will be some great opportunities to invest in companies that take existing data and run algorithms over these streams of data to deliver better and more targeted advertising, personalized recommendations and search, and better overall services for end-users.

One of the next phases of growth and large revenue opportunities will be driven by what is captured every time you click on a page and move from site to site. How companies use this data to improve a user’s online experience is the next game changer. What I love about these kinds of opportunities is that algorithms scale, have high gross margins, and are highly defensible. With our computing world living in the cloud, there will be a whole new generation of mobile applications that leverage the increased computing power and faster broadband speeds that are offered today.

Mobile carrier voice revenue is declining, and data revenue is the next huge growth area for carriers. However, data revenue cannot increase without applications that drive usage. Obviously, there are concerns about carriers’ “walled gardens”, but I see a future where carriers increasingly provide open access to allow innovative apps to drive data growth. In addition, as mobile devices become better, cheaper and faster, we will see an increase in the number of users accessing the web from their wireless devices, as often as they do from their home PCs.

Capitalizing on Disruptive Market Forces
Dawntreader Ventures will capitalize on these disruptions by investing in the entire food chain, from infrastructure layer to the apps and services that touch the end-user. This includes investments in companies like Greenplum, which is powering the back-end data warehousing for a number of high profile Internet companies for targeted advertising; and Peer39, which provides semantic advertising solutions by using natural language processing and machine learning. This technology enables the company to go beyond keywords to understand page meaning and sentiment, to deliver the most effective display and text advertising to end-users.

Exit Strategy

Unfortunately, the market for IPOs is currently “dead”, but it may reopen in 2009. M&A continues to be strong for the right companies that fit a strategic hole in an acquirer’s portfolio. In the end, I continue to tell my portfolio companies that if you focus on what you can control (growing and managing your business), then the external factors (exit strategy) will take care of themselves. However, if you try to force the issue and shop your company, that shows a sign of weakness and more often than not will result in a fire sale. Companies are bought and not sold. For strong, well managed companies, opportunities will always present themselves, as long as you can avoid making desperate decisions.

To read some other VC responses and to get an update on the state of Interactive M&A, I suggest getting the JEGI briefing here.

Data wars heating up - Microsoft buys DATAllegro

As I have written in previous posts, what you do with data will be one of the next battlegrounds on the web. Knowing that they had some limitations with SQL Server, Microsoft announced its acquisition of DATAllegro (full disclosure: my fund is an investor in competitor Greenplum) to enter the data warehousing market. Enterprise volumes across the board are ramping up quickly and this clearly gives Microsoft an opportunity to capture that market. Being an investor in Greenplum, I always like to see healthy exits of competitors as many believe it will trigger further consolidation. When a competitor is acquired, the first reaction from many is often asking themselves why it wasn't them and fear about competing with a juggernaut, but my perspective is quite different as it usually opens new opportunities. As I have written before, many acquisitions fail and companies are usually so distracted for the first 6-12 months trying to integrate operationally and technically, that this gives others in the market a nice window to continue executing on their business plan. So I tip my hat to DATAllegro and look forward to an exciting 12-18 months ahead as the data wars are clearly heating up now.

Your reputation matters - how to handle reference calls

The world that we live in trades on reputation. What that means is that eventually whether you are raising capital or landing new customers, your references will matter. If you are an entrepreneur, a VC will want to do some deep reference checks on you and also on any major customers or partners. If you are trying to land that big customer, naturally the sales propsect will ask to speak with other customers to get a better understanding of the technology and your service. How you handle and manage these reference calls is crucial to moving to the next step in a funding round or to closing a sale. I have seen some entrepreneurs take the nonchalant approach, feeling quite secure in their relationships, and freely passing on contact information for their personal references and partners/customers. Many times these calls will turn out just fine but there is still a big chance that they might not turn out as planned.

In my opinion, the best way to deal with reference calls is to carefully manage the process. First, I would identify the 4 or 5 best references (customers/partners/personal) and have a call with them to make sure they are willing and have the right attitude and to pre-screen them with questions to make sure they convey the right information to the interested party. Secondly, I would make sure that you don't inundate your references with too many calls as they may tire of helping you after awhile. Finally, I would also set expectations and be quite clear with the VC or potential customer about what to expect from the call. For example, I was talking to a CEO yesterday, and he mentioned that our strategic partner would take a call from a VC but that the partner was not the most effusive individual and would clearly state the facts but nothing more. Well, if that is your only reference for that partner, make sure you convey this to the interested party to set expectations (see my earlier post about that).

As a side note, a couple of my portfolio companies gave pretty big discounts to their first customers but also made sure that as part of the deal they would serve as lead references for other prospective customers and for VCs. The discounts got the customers to take the leap of faith to buy the portfolio companies' products and also got them quite excited to freely promote our technology to others. The point is that you should always think about your reputation, who will be your best reference, and then to cultivate them to really make sure that they can help you grow your business.

Raising capital and meeting expectations

What I like to tell portfolio companies is that on average it will take 6 months to raise capital with some cycles being shorter and some being longer. Given that, it is imperative for a company to start thinking about its next round well ahead of time and the milestones it needs to hit to have the right momentum to get potential investors excited. One area that I would like to caution entrepreneurs is being too aggressive on the milestones and revenue forecast, particularly in the near term.

Let me explain. Like any other VC, I love to invest in companies going after big markets with huge revenue potential. That being said, I also like to see plans grounded in reality as well. Rather than get me excited, showing a revenue ramp from $1mm to $17mm to $65mm will actually do the opposite for me, raising more questions and concerns than general excitement. Along those lines, it is also imperative that when you share your plans with investors that you are pretty confident that you will realize your milestones or hit your numbers in the next 6 months as investors like to see if you can deliver on your promises. One cardinal sin is being overly optimistic in the near term and falling flat on your face in the due diligence process. It is much better to position yourself in a way that you can meet and exceed expectations during the due diligence process than the other way around. When this happens the rest of your forecasts become more believable.

The next generation web - scaling and data mining matters (continued)

I had some interesting meetings yesterday and as I reflected on them this morning, one common theme emerged which is that the next generation of the web will be built on data mining and extracting intelligence from the reams of data web services collect on a daily basis. This reminds me of a post I made in March of 2006 titled "The Next Generation Web - scaling and data mining will matter" where I mention:

I truly believe the next battleground will be based on scaling the back end and more importantly mining all of that clickstream data to offer a better service to users. Those that can do it cheaply and effectively will win. The tools are getting more sophisticated, the data sizes are growing exponentially, and companies don't want to break the bank nor wait for Godot to deliver results.

My first meeting was with a well known research analyst covering Internet stocks. While we discussed the usual topics such as how the Internet was taking share from traditional advertising budgets and how the top brand advertisers have not really embraced the web yet, our most lively discussion centered around next generation advertising technology which all centered around increasingly complex forms of data analysis. To that end, I mentioned one of the fund's portfolio companies, Peer39, which is using natural language processing and machine learning to create highly precise matching of commercial offers and user generated content. As you might guess, the secret sauce is the algorithms that the company has created.

Later in the day I had lunch with a friend who we had funded years ago. What was interesting to hear was how many of the future product lines that we discussed a few years ago were finally starting to emerge as real revenue drivers for the business today. Years ago the company's first data center cost around $20mm and the latest one which has orders of magniture more customers cost only $3mm. Clearly, any data-driven opportunities a few years ago were cost prohibitive in the first place and too early for the customer to understand in the second place. That was the case because many businesses were just worried about not getting Amazoned and today they are all on the web thinking about how to drive better results. That is why our discussion led to a massive data warehousing project his company was working on to take all of that data across his huge customer base and to help them better monetize their sites.

What I love about these kinds of opportunities is that algorithms scale, have high gross margins, and are proprietary and defensible. The next generation web is not about what you click and see but what is happening behind the scenes every time you click on a page and move from site to site.

Old school content has value...again

Every day it seems we are reading about the power of social networking to transform the Internet and how we communicate online and also consume and discover new content. While that is true and clearly changing the consumption habits of online users, today seems like a flashback to the old school Internet days where traditional content was king. First IAC announced the acquisition of Lexico Corp which owns dictionary.com, thesaurus.com, and reference.com and then CBS announced the acquisition of CNET. With $400+ million of revenue in 2007, it seems like a good buy for CBS at a little over 4x trailing revenue. So looking at the fact that people are recognizing that social networks are not as easy to monetize as previously thought and the understanding that old school content can still be monetized, I wonder what other old school content companies may be in play in the future (can anyone say the Knot.com or the thestreet.com - full disclosure, i bought shares of these companies for my own account during the last couple of months). Given the weakening ad spending environment and the fact that many of these small public Internet companies reported lower guidance for the rest of 2008, it is clear that now is a good time for strategics to buy and expand their uniques and ad inventory. As I have always said, when it comes to the web, scale matters! Also see Silicon Alley Insider for some comments from the CBS conference call regarding scale and the value of premium content:

CNET's been very disappointing for past few years. What are your strategy for improving CNET revenue growth, margins?

CFO: We think that they have the asssets to do that, they've revamped a number of the sites. Combining with us is good because there's very little overlap with our advertisers (auto, pharma, etc), but CNET audience demo very attractive to our advertisers. And then they reach advertisers (electronics, etc) that we don't. Other efficiencies: One public co instead of two. Combining some ad platforms, etc.

Given MSFT/YHOO, other consolidation, does this make you big enough on the Web?

Les: We just tripled our digital platform. Are there possibilities to do tuck-ins? But right now, we have taken a major leap forward. We are very happy with the cards we're holding now.

CFO: We're now a top 10 Internet company. Could we be a top 5 over time? Sure. But would be through growth, not acquisition.

Les: Remember! Premium content!

Open vs. closed networks and Facebook chat

As you know, I have always been a believer in open standards (see my post from January 2006). Being a market leader, it is quite easy for Facebook to create their own standard similar to how every other instant messaging network was started. And to that end, Facebook started down that path. But just today, it announced that it was extending its chat and opening up its service by offering XMPP/Jabber support. Assuming there are no restrictions, this is a huge win for openness. Maybe one day Skype and MySpace and others will adopt the same strategy and move us to a world where we can IM anyone from any network and have one IM identity rather be forced to live in a world that was similar to the dark ages of email where Prodigy, Compuserve, and AOL users could only communicate with users on the same network. Once Facebook starts with chat, maybe when and if it ever offers VOIP, it would leverage the open SIP standard as well. Rest assured that the development team at portfolio company Gizmo5 is digging into the details of the Facebook annoucement and in short order can offer seamless connectivity to Facebook chat from your mobile phone. From the day Gizmo5 was started, it was built to live in a world of open standards leveraging the SIP protocol for VOIP and Jabber/XMPP for IM and Presence. As you might imagine, the smaller networks who needed users were the ones to adopt open standards first. Slowly but surely, larger and larger networks have adopted these standard starting with Google Chat in 2006 and now Facebook with its dominant market share in social networking. It seems as if the floodgates are opening and this is quite exciting. As I mentioned in my post from 2006:

Whatever happens it will be interesting to see if true open standards will triumph over closed and proprietary and how long that will take. At the end of the day consumers don't care about protocols, they just want it all to work seamlessly and easily, and they do not want to be on their own island for communications. What I want is one identity or phone number that works on any IM network, VOIP network, or even integrates with my PSTN and cell phone identity?

Nokia-an Internet company???

As I have mentioned before, Nokia is one of the few handset manufacturers to get it (See my post from 2/07 on this). Nokia understands that hardware margins are eroding and like in many technology businesses the value is in the software and monthly service revenue. In addition, as time goes by, more and more people will be using their phones and data services to get information and communicate with friends. Therefore it is no surprise that Nokia announced yesterday that it wants to be more like an Internet company and less like a manufacturing company.

Our new structure is helping Nokia to be more integrated as we focus more attention on developing new businesses around Internet services. Over time, it will allow us to be faster and more agile in bringing out new products and services, in serving our operator customers better, and in meeting our customers' needs in different parts of the world.

Our goal is to act less like a traditional manufacturer, and more like an Internet company.

The other piece that Nokia gets is that if they don't start offering services on their devices, Google, Microsoft, and Yahoo will. The delicate dance that Nokia is playing is how to fend off the traditional Internet guys while also adding value to its carrier partners. Despite the fact that Nokia is one of the few companies that sells a significant number of phones direct to the consumer, carriers still matter. To that end, it will be interesting to see how VOIP plays into this delicate balance. For more on this, take a look at Michael Robertson's latest blog post (full disclosure-Dawntreader is an investor in GIzmo5 and I am on the board) on the world's smallest dual mode wifi phone. Yes, dual mode wifi means the phone can make VOIP calls over wifi networks. As MIchael says:

"This is not Nokia's first wifi phone, but it is significant for several reasons:

It has a street price of $200-300 (vs $400-900 for previous phones)

Power utilization has improved so it can do ~3 hrs VoIP calls and ~4 days WLAN standby (historically wifi phones have had awful battery life) It's Nokia's first s40 wifi phone (the majority of Nokia's phones are built with s40 parts so it will be very easy to create many more wifi models)

From my perspective, what is great is that the price point is falling quickly for dual-mode handsets, the battery usage/life is getting better, and manufacturers like Nokia are willing to offer innovative services on them through partners like Gizmo5. 2008 will surely shape up to be an interesting year in the wireless industry.