Is Consumer Software all Social Media?
I used to hear people talk about consumer software and social media interchangeably. I always used to think of these people as luddites or not in the loop somehow. I believed that this mistake was largely because social media is viral, is where people communicate, and is noisy. After all, consumer software is surely far more than new media. But lately I’ve been trying to understand what it is, with the intention of better understanding our thesis about collaboration, innovation, and web-powered value creation. As part of this exercise, I took some time to look at big U.S.-based acquisitions over the last dozen years. Here are some statistics I found which are interesting*:
I decided to categorize the start-ups by “News”, “Communication Tools”, “Photo/Video”, “Music”, and “Other”. Based on this categorization, the lion’s share of acquisitions have been communication tools (8) and photo/video sites (8). There have been 4 news sites, 1 music site, and the rest have been ‘Other’. In the last fifteen years, 2/3 of the consumer software acquisitions have been “Social media”, by one definition or another, totaling over $20B**. Even today, Reddit, Tumblr, Quora, and Twitter demand a lot of our attention. It’s worth considering the fact that those people who use consumer software and social media interchangeably aren’t crazy or wrong.
At least, not yet.
This article describes which start-up companies today are most popular to developers on AngelList, which is fast becoming a powerful resource for the early-stage funding, research, and recruiting. The companies are: Quora, Pocket, Path, Pulse, ClassDojo, Instameet, Ark, Rally, Locu, Clever, 42Floors, Kaggle, Ouya, Skillshare, WikiHow. Of these fifteen, 6 are “social media”, 3 are education, 2 are productivity, 1 is hardware, 1 is recruiting, 1 is non-profit fundraising.***
It makes me wonder if the next 15 years will resemble the previous, or if we’ve finally reached the point where the best businesses are not simply social media, but innovating on the rest of the web. I was frankly surprised by how many social media acquisitions there were in consumer, as compared to other categories. Now this list does not include eBay, Amazon, Google, Facebook, LinkedIn, Groupon, or Zynga, all of whom are now public companies, representing a greater diversity of industries. Perhaps software is finally eating the world, after all.
Is Facebook a consumer company?
What defines a consumer company, anyway? My working definition was a company which had you and me, individuals, as their customers. Samsung is a consumer company. I buy phones, washing machines, flat screens. Unilever is a consumer company. I buy ice cream, shampoo, and tea. Microsoft is a consumer company. I buy word processing, operating systems, and video game consoles. These companies are made or broken by how many products they can sell me.
What do I buy on Facebook? Yes, Zynga sells me (well, *somebody*) all sorts of digital goods within their games. And yes, Facebook does sell credits on the side. But 85% of their revenue comes from advertising. They sell advertising to companies: their customers are enterprises. Are these ad-revenue digital platforms really consumer companies? We are their product, not their customer, after all.
Jesse Jackson playing basketball with Marvin Gaye.
Crowdfunding Under The Best Investment Terms
The cheapest possible investment a company can get: customers paying more for the product than it cost to build the product. This throws off the cash to grow, keeps equity intact, and avoids accrual of interest. Happiness is positive cash flow. How do we apply that to equity crowdfunding, the new wave of private financing marketplaces. Today, people who are concerned about equity crowdfunding point to two major problems:
- If your equity crowdfunding platform is aimed at high-growth startups who are meant to return multiples, you run a very serious risk of losing everybody’s money all the time. Venture investing is a hard business that doesn’t return well, even for professionals. There’s no evidence that the crowd will invest any more wisely. Plenty of people believe that they won’t.
- If your equity crowdfunding platform features lifestyle business, what’s the payout, or return on investment? Just administering the dividends alone might cost more than the actual profit margins. Bars and coffee shops don’t make enough money to pay lots of people out. And if they do, if it’s only a dollar a month over 20 years, I don’t know if I’m that excited, as an investor.
One interesting feature that has emerged from Kickstarter getting to scale is this phenomenon of “pre-sales” for gadgets. In this model, the business start-up costs are paid for by customers waiting for their product, thereby charging future customers for current costs, but transparently and (more) ethically.** What about pre-sales for beers, or coffees? What if I raised a quarter million dollars of start-up capital for a restaurant by giving every ‘investor’ a free meal, or free set of meals, assuming an appropriate markup for COGS and operations? I’m giving my investors a return that they care about, I’m guaranteeing a certain amount of customers from day one, and I’m raising start-up capital without giving up any equity or paying any interest. Does the math work? What do you think?
** There’s still a risk that the company wont fill the orders and go under. Kickstarter gadget projects are feeling the burn here. But there’s always risk in investing, and this is a more easily mitigated risk than most, given the stage.
What We Can Learn from Airlines About Product-Market Fit
The airline industry is a useful case study on product / market fit. There are infinite features airlines can provide, and there are as wide a range of plane travelers as one could imagine. Virgin America, Spirit Airlines, and Southwest are three good examples.
Virgin America has consistent WiFi, plays nightclub music and has sexy mood lighting. Anecdotally, the tech community reports on experiences flying Virgin America far more than other airlines. Customers love it. In fact, Virgin America has won more awards since their founding than any American airline. But TIME magazine recently reported that
since 2007, Virgin America has posted a net loss of $671 million and an operating loss of $446 million.
Nobody likes Spirit Airlines. They are cheap. They nickel-and-dime at every possible turn, and offer a stripped down version of travel that feels a little bit like a Chinatown bus in the air. Their flights are consistently the cheapest at face value, but they offer very little personality, or charm, and hide fees down to charging for water on their flights. They are the anti-Virgin America. And they are killing it. According to Wall Street Journal, they are
pound for pound, the most profitable airline in the U.S.
All bags fly free on Southwest. Unlike Delta or United, Southwest prefers point-to-point flights, so you don’t have to connect in Charlotte, or Atlanta, to get where you want to go. Southwest does not have WiFi, and they have first-come first-served seating, like a bus or train. Their goal seems to be less about maximizing profits, like Spirit. They don’t want to coddle their customers, like Virgin. They seem to care most about what the customers want - cheapest possible travel. And in an industry that has been losing money for a half century, Southwest has been profitable for 39 consecutive years.
I went to the corporate websites of these three airlines to try and learn a bit more about why each of them has chosen the path that they’ve chosen. I found “About Us” pages that could not have been more different, and even surprising.
On Virgin, unsurprisingly, they list their amenities and awards:
On Spirit, they describe their “ultra low fares” and “fee-based” optional upgrades:
But on Southwest, they describe a mission and set of values:
Each of these airlines is winning in a big way against its competitors because of how they have built their feature set. Nobody can touch Virgin’s experience. Spirit’s profits are the envy of the whole industry. Southwest has a no-nonsense transparent experience. But I’m struck by how the airlines think of themselves, and that’s where I think the real lesson lies. If you are looking to build a business to last you a long time, you need to do more than listen to your customers, or to your shareholders, like Virgin and Spirit. You need a mission that makes sense, and the discipline to build your business outward from it.
Financing the Ed-tech revolution
I met two companies this week who are working on solutions in a space that I had only considered in passing until I spoke to them. Per U.S. household, there is currently more student loan debt than credit card debt. We’re talking, ballpark, one trillion dollars. And that number doesn’t seem to be going down any time soon. The cost of college has risen 1,000% since they started keeping a record of the figure in 1978. For some context, since 1978 the cost of food and healthcare have risen 200% and 600% respectively. Education costs are blowing up. Recession-driven state budget cuts are sending public education costs through the roof. For-profit universities are greedy bastards, and private universities have always been expensive.
And it’s not like the market is not trying to solve this problem. In the United States alone, $100 billion of grants and scholarships were distributed last year from 20 million sources. And the government is trying its best to support the markets, and their efforts are (to my understanding) impotent. The Obama Administration approved a $40 billion increase in education spending to address this crisis. The landmark result of this legislation raises the limit of a Pell Grant by… wait for it… $400. By 2020, they expect another 820,000 students to receive the $6000 promised by the grant. It’s an earnest (and expensive) effort which I applaud, but it’s not gonna do much. One thing’s clear: this market needs technology.
Thanks to Learnsprout and Clever, there are now API’s across school information systems - which are the fragmented data management tools that all schools nationwide use - so innovators can build apps that use attendance, grades, and all other individual, school, and district data to improve outcomes in K12 education. These APIs should power innovation in higher-education financing as well. It should be easier for schools to discover scholarships and grants for their top performers, it should be easier for those performers to apply for the optimal number of scholarships (which is probably many more than the average student applies for), and grant-makers should take advantage of this unprecedented access to school data. Crowdfinance can grow the pool of capital accessible to our students by inviting the community to participate. Consumer web/mobile applications can simplify the process of tracking and repaying loans for students. The numbers in this market are absolutely massive. There’s money to be made, and a lot of good to be done. While we talk about MOOCs, other forms of vocational training, and re-education, we should consider innovating on college financing. Some folks are already doing what I’ve mentioned above. Let’s see more!
Monetizing Internet city-states
Taxation is the source of revenue for city-states. It happened in Roman times, it happened in Egyptian times, it happens today. Why, then, do so many online communities insist on letting outside institutions buy real estate on their local billboards as the main form of revenue? Facebook and Twitter didn’t have to be advertising companies. They had a critical mass of loyal citizens who ostensibly would be willing to pay for services the same way Americans pay for police, public school, and roads. They could have been online city-states. I like what 4Chan and Reddit are doing, to this effect. I bet the latter communities last longer than we expect them to, because they are treating the citizens of their communities as constituents, rather than product.
Sometimes I (and plenty of others) feel like Mark Zuckerberg and Dick Costolo are farmers and we are the crop. Yishan Wong and moot have an opportunity to be governors, or mayors. And when it comes to how they administer their sites and deal with community conflict, the differences are clear. Zuck and Dick’s constituents are clearly advertisers (though there is a tension there.) I don’t agree with everything that happens on Reddit or 4Chan communities - in fact I’m uncomfortable about most of it - but I think they operate with an unusual form of integrity. Unlike governments, which can go into debt, and even sometimes bankruptcy, companies need revenue or else they don’t exist. But online advertising revenue doesn’t seem to be easier to scale than online tax revenue. Ask any Wall Street analyst. The latter just feels like the more sensible system - the one likelier to last.
On English: the word “pursuit”
Let’s take a moment with the word pursuit. Its most famous application will serve as an interesting case study for its use, and for our understanding of it.
The goal of government, so famously wrought by the framers of the United States in the Declaration of Independence, is to protect the “unalienable rights” of Life, Liberty, and pursuit of Happiness. This trio of rights serves as the standard upon which political theorists plant their flags. And pursuit of happiness is the most interesting, and largely the least clear. How does one ‘pursue’ happiness? One definition in the Oxford English Dictionary describes a pursuit as “an activity of a specified kind, especially a recreational or sporting one.” In this case, pursuit of happiness is little more than a way of describing the activity of happiness. Cool. But the static version of pursuit may not be the one intended with the “pursuit of happiness”. After all, we tend to think of the pursuit of happiness in terms of the chase for it. The other definitions and etymology of the word affirm that instinct. The Middle English definition of pursue is to “follow with enmity.” In fact, the Anglo-Norman French pursuer comes from the Latin prosequi, which is also the root for prosecute. Is happiness the rabbit, and us the fox? Why did we decide on the pursuit of happiness? Why not the search, or the discovery? Why not exploration, or even the enjoyment? I wonder if hunting for happiness limits the other two goals. If I were to discover happiness, would that not give me life and liberty? The framers of the United States Constitution and Bill of Rights are often hailed as visionary beyond what they may even have understood. But I admit: I think about hunting, or car-chases, as I consider the word pursuit. Is happiness something we should be chasing with hostility?
I’m going to commit to the pursuit of happiness as the activity, rather than the chase. Gratitude, patience, prayer, song. That’s more like it.
Optimizing for partner, optimizing for price.
Application infrastructure is making everything cheaper to build
Lately, application infrastructure has made it easier than ever to launch a prototype on the internet. Browser-based IDEs are in a race to develop tools that make programming fast, easy, and faster and easier. Guilds, to borrow Dave McClure’s term, of entrepreneurs are gathering in hubs like Techstars, YCombinator, and 500 Startups to draw support from their fellow classmates, share brand value, and supplement their own skills with the institutional wisdom of the crowd. As the obstacles to getting an application out the door have been overcome, one by one, the world of web and mobile products has trended towards the entrepreneur in a big way. Venture capital has noticed, and is adjusting accordingly, if belatedly, as I’ve noted in the past.
Entrepreneurs are banding together, driving valuation prices up
But I’ve noticed another trend has followed these. I’d like to call it the “collective bargaining agreement” of seed investing. At the last major entrepreneur-guild Demo Day, it was amazing to see how the prices had substantially risen from the one before it. But that wasn’t entirely surprising. After all, the early stage valuations for mobile and web apps, even given recent public tech stock volatility, has steadily risen over the last half decade. What surprised me, though, was how these entrepreneurs went about closing their deals. Almost the majority of them approached the negotiation with a price in their minds, and the conversation hinged around whether or not that was a price the investor could meet. These prices were non-negotiable more often than not.
When fundraising, an entrepreneur can optimize for price, or optimize for partners
Some entrepreneurs want to optimize for price above all. The difference between a $6M cap and a $12M cap (or a $20M cap) is psychologically and materially important to them. They believe they can get to revenue quickly. They continue optimizing for the highest possible valuation whenever possible. This is one extreme. Other entrepreneurs want to optimize for partners above all. They have a wish list of 5-6 investors or firms who they think are strategic, a cultural fit, or they just want brand association with, and are willing to meet those investors at the valuation where they are most comfortable. Investors want to get the most of a company for the least amount of money, so these entrepreneurs tend to get their valuations pushed down. This is the other extreme.
What we can learn
There is an optimal point in this curve for each entrepreneur out there, but the unionizing of the entrepreneurial side has pushed the conversation hard towards the former. This means that smaller funds, or those whose mission and mandate is to be more price sensitive, are increasingly disqualified from the collective bargaining agreement type of seed investing. Entrepreneurs in these guilds should be careful about this trend, as short-term price optimization is attractive, but not always the best path, when there are really good partners out there. Investors should be wise to this evolving reality, and should communicate their expectations clearly and aggressively, as technology hastens the pace of seed investment dealmaking.