Altos Ventures Musings

They Can't Tell You How To Soar

Customers will always tell you they want better products and lower prices. They might even be able to articulate how much better certain products should be. But don’t expect them to be able to tell you how different those products could be. More importantly, don’t expect them to tell you how you should surprise and delight them.

This was an insight from a book called Different, Escaping the Competitive Herd written by Youngme Moon (I won't review the book but I'd recommend it for entrepreneurs and marketers fascinated by inconic brands such as Apple, Harley Davidson, IKEA and InNOut Burger). 

As Clayton Christensen explained in the Innovator's Dilemma, there is a predictable pattern in just about every product category. Innovation leads to products that improve to a point where customers are over-served (the web browser might be the latest category to reach this level).

From a vendor's perspective, the problem is that over-served customers become so skeptical about the differences between products and brands that differentiation is rendered meaningless. Most customers become not only bored but unhappy.

In category after category, over-served, bored and unhappy customers would love to discover something delightful, remarkable and refreshing. And marketers spend billions of dollars trying to rise above the competitive noise.

Ironically, intense competition only quickens the pace toward blandness and a herd mentality in markets. This trap is hard to escape. The herd phenomena is seen in self-organizing systems as disparate as ant colonies, bird flocks and stock markets. 

Paradoxically, the best way to stand out, might be to NOT focus on beating the competition. At the 1997 WWDC, before he rejoined Apple as CEO, Steve Jobs stated the following (32:43 of video):

"...the other thing I feel very, very, very strongly about is, it's incredibly stupid for Apple to get in a position where for Apple to win Microsoft has to lose. That's really dumb... Apple can win without having to have Microsoft lose."

Don't focus on being better. Don't fret over differentiation. Think Different. Be different. Transcend boundaries. Stand alone. Walk down a very lonely path. 

Something that every entrepreneur should keep in mind is what Jerry Garcia once said: 

"You do not merely want to be considered just the best of the best. You want to be considered the only ones who do what you do." 

What will you do? How will you be different? One place to start, is to be yourself. Be genuine.

To really, really soar, don't just be better, faster, cheaper. You can do better than that. And please, please, please, don't aspire to be "the Mint of XXX category" or "the AirBnB or YYY category" or the "Groupon of XYZ category."

Another Perspective on Yahoo!

Paul Graham published an essay about "the problems that hosed Yahoo" which got shared by many people via Twitter and Hacker News. Many people called it "customarily brilliant." 

I really enjoy Paul's writings but this one didn't sit well with me. I disagreed with key points and came away concerned that young entrepreneurs would learn the wrong lessons from history.

In the essay, Paul suggests that Yahoo failed due to two problems - 1) easy money and 2) ambivalence about being a technology company.

Money

Paul takes us back to 1998, when Yahoo was riding high, making money from big brand advertisers as well as over-funded, "fat startups" (a term popularized recently by Ben Horowitz). In Paul's words, Yahoo was "a de facto beneficiary of a pyramid scheme."

I agree that too much easy money, especially over-funding, can harm companies. Too much money can mask problems. That said, I don't think it had much to do with Yahoo's demise.

We can second guess how Yahoo could have re-invested profits but I would not fault them for pursuing it. They built a very successful company which beat every competitor of their era. 

Everyone benefited from the bubble. If Yahoo had not taken the money it may have been diverted to others and weakened its competitive position. You have to be in the game to even have a chance at riding the next wave. 

Maybe what Paul meant to say was that Yahoo management should have recognized that they were lucky or that their business model was not sustainable?

In hindsight, it's clear that Yahoo did not appreciate the potential for search and perhaps over-estimated the quality of their revenues. But, as Paul acknowledged, no one else, including Larry and Sergei, knew how big search was going to be, in 1998.

It's hard to predict the future and deceptively easy to come up with simplistic explanations in hindsight. Yahoo beat its competitors hands down and built a very profitable, growing business. I would not diss them for it.

Paul's second point was about culture and leadership.

Hackers 

Paul suggests that Yahoo was a technology company but either didn't know it or were ambivalent about it. He also seems to imply that if hackers had run the place Yahoo would have been fine (or at least would not have been hosed).

I disagree with both points.

Yahoo was never a technology company. They were a media company (albeit a "new media" company) from the day that Dave and Jerry started serving up pages from their trailer at Stanford.

When Mike Moritz invested in Yahoo, it was the emerging brand and traffic that impressed, not the technology. Unlike Google, there was no core technology from day one. Later on, Yahoo did develop many technologies - they had to in order to scale (Hadoop is one example).

Bill Gates would have also said that Yahoo was never a technology company. When Gates saw Google, he saw a company that reminded him of Microsoft. It was probably the only company that ever scared him. He never had that reaction to Yahoo.

The important thing is not to be like a Google or Facebook (or the early Microsoft). The important thing is to be yourself. Be authentic. Be genuine.

So maybe Paul's point is that Yahoo didn't know who they were. Perhaps, but I disagree that Yahoo had to be like a Google or Facebook because that is not who they were.

Pixar is a great media company. The fact that they were founded by technologists doesn't confuse them. They even sell rendering software to other companies, including competitors. It doesn't diminish their identity as a media company. 

Disney is another example. Walt Disney Imagineering has been inventing cool new technologies for decades. They were the "new media" company of their generation. You don't have to fit someone else's mold. Be yourself. Be unique.

Another key point Paul seems to make is that "adult supervision" is bad. Implication seems to be that if hackers had run the place Yahoo may not have lost. Again, I disagree. 

There is good adult supervision and bad adult supervision.

Amazon is an interesting case study that, on the surface, defies hacker conventional wisdom. Even as they delve deeper into technology, Amazon's management is stacked with MBAs.

Even their most technical businesses, Amazon Web Services and Digital Media (including Kindle), are led by a Harvard MBA and a Stanford MBA, respectively. Even so, Amazon continues to attract and retain plenty of good hackers. In fact, momentum seems to be increasing in the hacker community. 

There is nothing inherently wrong with adult supervision or non-technical management per se.

That said, I do think people can get seduced by the belief that there is a mythical "world class" management team that can fix your company. On this front, I think Paul and I probably agree. Don't count on someone coming in from the outside to fix your company (or, in the case of Yahoo, your stock price). 

When the bubble crashed, Yahoo looked for a savior. In contrast, Amazon stuck with Jeff Bezos even though their stock took a similarly huge beating. Bezos likes to remind everyone how the pundits called them "Amazon dot toast."

Terry Semel knew little about Yahoo or the Internet when he took over in April, 2001. It quickly led to the mass exodus of the future leaders of Yahoo. The fallout we are witnessing now may still be the after shocks. 

To conclude, I'd like to share a great story about how Nike is still shaking up the shoe industry. When Phil Knight retired after almost 40 years as CEO, he decided to bring in fresh blood and passed over the leading internal candidate for CEO. 

Luckily, Nike had such a strong culture that it quickly rejected the outsider. The new CEO, from S.C. Johnson (the makers of Pledge, Windex and other cleaning products) lasted only 18 months. The new CEO is a home grown prodigy - a former shoe designer who was the internal CEO candidate in 2003. 

With 33,000 employees, there is plenty of "adult supervision." It just happens to be the right kind. 

What Did Bill Gates Worry About? Lean or Fat?

I found this from the transcript of a Charlie Rose interview with Ken Auletta, right after "Googled" was published. It is interesting to hear about what Bill Gates worried about back in 1998, near the all time peak of his power (and the peak of the fat startup era). 

CHARLIE ROSE: And are they on the cutting edge of exciting stuff or are there two more kids in a dormitory room at Stanford that are about ready to come up with something that’s going to blaze new trails? 

KEN AULETTA: Well, we don’t know that. That’s the great thing. I mean, I think I may have told the story when I was on your show, I tell in my book that Bill Gates in ‘98, when I asked him what he worried about, he didn’t say the obvious, which is "My competitors, Netscape, or Oracle or Apple." He said "I worry about someone in a garage inventing something that I haven’t thought of." 

(LAUGHTER)

That year there were two guys in a garage. 

CHARLIE ROSE: Sergey and Larry in a dorm, yes.

KEN AULETTA: Google has the same reason to worry. What is that new technology? One thing they are conscious of is social networking and that could pose a problem for search. 

 

Now, I should also point out that Mark Zuckerberg started Facebook in a dorm room while Kleiner Perkins and Benchmark funded Friendster and Sequoia funded Plaxo during the very early days of social networking.

I feel like a broken record but this is something I wrote in 2006 in Venture Lotto:

The most sought after deals are led by proven managers. Especially popular are entrepreneurs who have made money before - they get investors lining up like sheep.

Ironically, the people who end up creating the blockbusters are usually unproven managers. They emerge from the fringes, and start small, in niche or overlooked markets. They take time to learn and iterate and burn very little capital before turning profitable. They follow a slower, but lower-risk path. In our own portfolio, the companies which raised less funding not only performed far, far better but had much lower failure rates.

Entrepreneurs can't count on a portfolio. The best ones we know are much more risk-averse than conventional wisdom might suggest. They don't take foolish chances. They spend money as if it were their own. They observe, listen and adapt; but fundamentally, they strive to control their own destinies, which is best done by generating profits. They do need a little capital, but they want help and advice even more. 

Ben Horowitz Makes Compelling Case for Lean

Like many of you, I've been following a fascinating and important debate between Ben Horowitz and Fred Wilson over the past couple of days. To recap, it all started with this post: The Case for the Fat Startup.

Fred then responded with Being Fat is Not Healthy which has received a lot of comments worth reading, including some comments from Ben. 

Then earlier today, Ben responded with the best post of all The Revenge of the Fat Guy.

After reading through the posts, I've come to the conclusion that Ben and Fred actually agree on the fundamental points. In fact, the most important point was already made by Steve Blank last year in Lean Startups Aren't Cheap Startups.

Steve, a key figure in the lean startup movement, felt the need make the case that you cannot confuse lean with cheap. He concludes with the point that if you confuse the concepts "when you do find a repeatable and scalable sales model, you will starve your company for resources needed to scale."

The reason I love Ben's latest post is that he helps debunk some myths about Product-Market Fit, which, according Marc Andreessen, is "the only thing that matters" Along the way, he also makes a compelling case (though perhaps unintentionally) for staying lean. 

Ben's post should be a warning for entrepreneurs and VCs who put too much faith behind the magical product market fit concept. Here are some things to watch out for:

1. Product market fit is NOT a discrete, big bang event. If you are fortunate to find product market fit, you will most likely get there through lots of hard work "through partial fits, a few false alarms, and a big dollop of perseverance...there’s no formulaic answer."
2. It's NOT obvious when you have product-market fit. "It’s usually not black and white."
3. Once you achieve product-market fit, you can lose it.
4. Once you have product-market fit, you still have to "sweat the competition."

All of these points should serve as a warning for people with too much money to spend (or invest) and eager to step on the gas once product market fit is found. Given all of the uncertainties, it would be prudent to maintain some humility even if you believe that you've found product-market fit (you can also reach the opposite conclusion - even when in doubt, step on the gas - it's just not the path I'd recommend). 

Ben's last point is important to consider because, on the surface, it makes a case for the fat startup. Since "the best markets are usually the ones in which competition is fierce" you should invest aggressively to make sure you win the market."

I would ask, how much should you raise/invest? How about a billion dollars as Webvan did?

In any huge new market, there is no question competition will heat up. But even a billion dollars is nothing when you are talking about competing against the big guys. 

Rather than focusing on how much money to raise, how about focusing on producing profits and creating a sustainable business model?

When I look at competitors, the ones that scare me are the ones that have found ways to make money and scale at the same time. The "fat startups" that are burning through millions or tens of millions of dollars a month don't scare me.

Ben says that you can't win the market by saving your way there. I totally agree. But conversely, you can't win by spending your way there either. Even if you raise hundreds of millions. For every Loudcloud/Opsware, there are dozens of craters. As David Packard liked to say, "more companies die from indigestion than starvation."

There is no question that Ben is a great entrepreneur who knows first hand how difficult it is to build companies. He knows that it often takes more money and longer than you'd like. So it would make sense to raise more money than you think you need. If someone offers to invest boatloads of money in your company at a great price, you should consider taking it. I agree. But even Ben has said that it should not be your plan A.

If you are one of the very fortunate entrepreneurs who is able to get boatloads of funding at a great price, you should be careful to resist pressures to spend that capital from excited investors. You need to also do your best to resist your own temptations to pursue every great idea that you and your great team comes up with to win the market. A company growing on profits just tends to be much more disciplined than one growing based on boatloads funding.

Just as Ben agues that Twitter is the exception, not the rule, I'd say that Loudcloud/Opsware is the exception, not the rule.

Even Loudcloud/Opsware is not a very compelling case for the fat startup. They raised $346mm in 15 months and went public in March 2001. By September 2002, market cap had fallen to $28mm, which was less than cash on hand and about 8% of capital raised to date. That sounds like value destruction to me. If you were an investor or employee, you'd be pretty bummed right about then.

Then an amazing thing happened. From 2002 to 2007, the company raised no more capital and created tremendous value - great job Ben! They exit for $1.6B in September 2007! I would guess that there was a lot of great technology created in the prior 2 years that helped. But I would also guess that the thought of running out of cash was pretty scary when you are at a $28mm million market cap. If I were in their shoes, I would have been more determined than ever to get to profitability so that I would never have to raise more funding. 

To recap, during the first era (Loudcloud), hundreds of millions are raised and return almost nothing. During the second era (Opsware), if you bought stock, which was publicly available, so any of you could have participated - you did NOT have to be a famous entrepreneur or a hotshot VC to get a chance to invest - you would have made a spectacular return.

Ben Horowitz just reinforced my belief that "fat startup" is not only a bad idea but a dangerous one. Just as the lean startup concept can be harmful if people misunderstand the key points, the fat startup concept can also be harmful. In fact, it can be a LOT more harmful to the VC industry. Entrepreneurs will also suffer from excessive dilution, recaps and wasted lives pursuing bubbles and false dreams.

I'll end with a concept Warren Buffet has repeated over and over again - don't count on the kindness of strangers to save you. Make sure you have enough cash on hand. To me, that is not an argument for the fat startup, it's an argument for the lean startup.

Celebrity Investors, Board Members and Advisors

"The quality and quantity of the financial backing that HomeGrocer.com has received for this latest round of financing clearly indicates that we have a model that is both viable and sustainable." 

- Homegocer's CEO in 1999 Press Release announcing $100mm round 

Chris Dixon's blog post from today about how to select your angel investors talks about a common mistake entrepreneurs make - choosing an investor based on their "celebrity value (by "celebrity" I generally mean in the TechCrunch sense, not the People magazine sense)." 

The same is true for choosing VCs, board members and advisors. We've invested with plenty of famous VCs and board members who were extremely well connected to the CEOs and boards of companies such as Microsoft, Oracle, Cisco, Intel and many other Fortune 500 companies. 

In our experience, celebrity investors and board members do little to help entrepreneurs do what they need to get done. They offer little in the way of strategic or practical advice about hiring, firing, product development, closing deals and financing. Even worse, sometimes the advice can be out of touch with what is going on in the industry or company but due to their celebrity status, some off the cuff comments can carry too much weight. 

Perhaps the most value that celebrities bring to the table are connections (even Chris in his blog post applauded "connectors" who can "introduce you to key people when you need it"). In practice, however, most people with great connections guard their rolodexes. 

Even when an intro is made directly to the CEO of a BIG company, it will get passed down the organization (usually down several levels) to the real decision makers. If the company is well run, the CEO will let his/her people make the decisions. 

If you do choose to use high level connections to force a deal through you should be warned that such a deal can backfire. If you don't take the time to build real support with the right people in the organization, they can do many things on a day to day basis which can ultimately sabotage the deal down the road (and distract you from what you should have been doing in the first place). 

My advice to entrepreneurs is to build your own buzz, based on fundamentals (an excellent banker advised one of our companies to "build your own heat" - it was good advice). You have to deliver real value! 

Also, please, please, please focus on generating your own leads. No matter how big your board or how well connected your advisors are they will NEVER produce the quantity or quality of leads your own team (and sales/marketing engine) will produce for you if you are going to be successful building a real business. 

In my experience, the entrepreneurs who see the most value from celebrity investors/board members and "advisors" build nothing of real value themselves. On the flip side, the best entrepreneurs see little value from celebrities (in fact, they probably find them distracting, if not somewhat annoying). 

Ironically, celebrities begin to embrace entrepreneurs once they think they are going to be successful anyway - with or without them. As it turns out, most celebrities need you more than you need them.

As far as I'm concerned, the real stars are entrepreneurs who create something from nothing.

Disclosure: As Chris D. admitted, as a non-celebrity but hard working small investor, this post is almost entirely self serving.

Top 10 VCs on Facebook

We recently set up a "Page" on Facebook (we had to get 100+ fans before we could lock in the official URL www.facebook.com/altosventures).

Given that Facebook Pages is becoming a web within the web, I wondered how many other VCs had set up official Pages. As it turns not, not many. From browsing around, I came up with a list of the top 10 VC Facebook Pages. If I missed a VC firm that has a significant presence on Facebook Pages, please let me know. I'm curious to learn about how they are using Facebook to connect with entrepreneurs, LPs and others people in their networks.

Top 10 VCs on Facebook Pages (as of 8/28/09)

1. Accel Partners (1,407 fans)
2. Sequoia Capital (1,001 fans)
3. Union Square Ventures (947 fans)
4. Kleiner Perkins Caufield & Byers (383 fans)
5. First Round Capital (314 fans)
6. Altos Ventures (264 fans)
7. Greylock Partners (261 fans)
8. Draper Fisher Jurvetson (253 fans)
   
9. Benchmark Capital (153 fans)
10. Hummer Winblad (59 fans)

Then I decided to take a look at some random tech companies and brands to see how many fans they had. The results were surprising. Some very large companies/brands had no official presence at all (i.e. Apple). Some were definitely using Facebook in better ways than others (Stanford vs. Harvard is an interesting contrast). 

Notable brands and their Facebook Pages:

• Google (305K fans)
• Youtube (3.5M fans)
• Yahoo (84K fans)
• Microsoft (72K fans)
• Oracle (11K fans)
• Stanford (41K fans)
• Harvard (0K fans)
• Barack Obama (6.6M fans)

For comments on this or other blog posts going forward, please do so on the AltosVentures Facebook Page.

Twitter Envy

After what seemed like the biggest PR week ever for a start-up, I did a Google News search this morning on "Twitter" and found 1,612 news articles. It was more than twice the Google News results for Facebook, Google, Microsoft, Amazon, eBay and Yahoo! COMBINED.

Last month, Seth Godin wrote a blog post talking about the difference between PR and publicity. If great PR is the strategic crafting of a compelling story...just what is the Twitter story? Can there be a credible story without customers (not users) and how they make money?

Before you get Twitter envy and start doing dumb things (like Facebook did changing its homepage) be sure you understand what your true mission is as an entrepreneur.

An entrepreneur's mission is not to get publicity or to become famous. It is to build a company. Without revenues and profits, you cannot have a viable company.

There is no doubt that Twitter has innovative product people and great engineers to be able to handle scalability issues. But let's just see if they will still be around when their venture funding runs out and the hype dies down.

In the meantime, don't learn the wrong lessons from Twitter. Don't rush out to hire a new PR agency. I've seen plenty of companies get hyped, raise huge amounts of funding, and land speaking gigs and magazine covers all around the world. It doesn't mean they will make it. In fact, it might decrease their chances (don't confuse cause/effect).

Yes, they might get lucky and flip the company for a princely sum (as Youtube did). But I doubt they will build a successful business or a lasting company.

What is your definition of success? PR or publicity? Build your company or your reputation? Build to last or build to flip?

RIP Good Times? A Different Perspective

Rip Good Times A Different Perspective

View SlideShare presentation or Upload your own. (tags: venture capital)

I put this presentation together to encourage a group of entrepreneurs I was to speak to at a conference in Reno, NV last week.

It's funny how times change.

People who have been following our blogs over the past 2 years know that we've had a more pessimistic, contrarian view of the venture business, even as the number of VC investments, fund sizes, deal sizes and valuations had been going up.

Now, of course, the world is totally different. Whether or not you believed that we were in a Web 2.0 technology bubble, Sequoia declared that the good times were over and it's now time to hunker down and fight for survival. In their widely publicized "RIP Good Times" meeting, they extolled the virtues of cash conservation to all of their CEOs and told them that they had to change in order to survive.

Now, we are contrarians again.

Our companies did not need Sequoia to tell them cash is king. They had been operating that way for years. In fact, more than a third of all of our companies are on track to be profitable this quarter. Many have been maintaining profitability while growing for many years.

The reason that we feel like we are contrarians again is that we have not seen such a good environment for building companies in years. Entrepreneurs are more focused on getting to profitability and building companies based on solid fundamentals. Before, we felt like lonely voices in the VC world, which seems to be filled with people working toward billion dollar exits for money losing companies.

Over this entire year, we've noticed a trend. Some of our companies started seeing a steady flow of high quality resumes from competitors. I think it's now about to turn into a flood! It will be much easier to hire great people who are more hungry and realistic about compensation and how long it will take to build shareholder value.  

For entrepreneurs in it for the long haul, this downturn just bought them more time. Impatient VCs won't be hounding them to take more risk, to grow faster, to get more aggressive. Remember, as an entrepreneur, you have one company. You don't have a portfolio of companies. You can't afford to play venture lotto.

Remember what we said back in 2006 about Foxes and Hedgehogs in Silicon Valley?

"Foxes are great at raising capital - they thrive in bubble markets. Hedgehogs would rather bootstrap - they do far better during the inevitable crashes."

For all you hedgehogs out there, this is your time to shine!

Ousting the Founder

I was shocked to learn this week that Diane Greene, the co-founder and CEO of VMWare was ousted. I was not alone. Except for senior management (who found out very late, the night before) the employees of VMWare read about it, just like I did on Tuesday morning.

I guess $1.3B in revenues, $14B market cap, 50% growth rate and market dominance was not good enough for the board/EMC. One slight miss in one quarter and BANG! You're out. Perhaps the board believed industry pundits and worried about competition from Microsoft. So they brought in a "heavy hitter"...former Microsoft exec Paul Maritz as CEO.

I'd guess that the more likely reason was that Diane Green was a difficult person to deal with. There is no doubt that she was a controversial CEO. It was her way or the highway and she churned through senior execs (especially in sales and marketing). She never gave much respect to the folks at EMC either (who owned the vast majority of the stock - and controlled the board).

Some other hard-headed, "controversial" founder/CEOs that come to mind are Bill Gates, Larry Ellison, and Steve Jobs. These founders may be difficult to deal with but I'd rather go with them than take my chances with a new hired gun CEO.

Over the years, we've observed that it's difficult, if not impossible, to match the passion and commitment that founders bring to their companies. It's not just a job for them. It's deeply personal. The difference in commitment is akin to the differences you might observe between missionaries and mercenaries (or hedgehogs versus foxes).

Look, I have nothing against Paul. I'm sure he's a very smart, capable and hard working guy. But this whole situation reminded me of the time Steve Jobs was ousted from Apple more than 20 years ago.

As co-founder and CEO, Diane Green built one of the all time great successes in Silicon Valley. Very, very few companies ever reach $1B in revenues. Even fewer in the technology industry. Even fewer in the software industry. And even fewer ever exceed $10B in market cap.

Why the hell would you fire her?? No, don't tell me...I've heard all the reasons. VCs oust founders all the time. I've been in plenty of board level discussions around this topic!

It's almost a rite of passage in Silicon Valley. As a founder, you start a company, get VCs to fund you, recruit a "world class" management team...and eventually, find your replacement (or get ousted).

What people seem to miss, however, is that just about every great company ever created - in technology as well as low-tech, was built by a founder (or a CEO who happened to join the company very early in its growth phase) and a team of dedicated people who grew with their companies.

I don't believe in "world class" management in the generic sense. "World class" in what??

What I believe in is people who learn on the job and become - over time - the best at what they do. Along the way, they make plenty of mistakes. But that's part of the learning (and perhaps the luck of it - because the mistakes happen to be not fatal for the survivors).

Think about it. Some examples of great companies led by founders for decades are GE, UPS, FedEx, Wal-Mart, Southwest Airlines, HP, Intel, SAP, SAS, Apple, Oracle, Microsoft, Adobe, Sun, Dell, Qualcomm, Broadcom, Nvidia, Dolby, Amazon.com, Salesforce.com, etc.

There are some great companies where the original founder(s) did not grow the company but the CEO who grew the business to $1B+ in revenues joined very early on in the life of the company (typically below $10mm in sales): IBM, McDonald's, Starbucks, Veritas, Cisco and Google are examples.

It'll be interesting to see what happens. Even a founder hanging on to the bitter end won't save some companies (i.e. Wang, DEC). But I'd rather take my chances with the founder who built a $1B business from scratch than go with someone new.

The average tenure of the CEOs in our three largest companies is 9 years. They learned on the job. None of them had been CEO before we started working with them. None had much experience in their industry - the market did not exist, and the technology and business models had not yet been invented. But they are guys who took us this far (average sales of nearly $90mm this year) and we will gladly stick with them as long as they still want the job.

I'd rather take my chances with the people who built the business and grew their companies than the "professionals" - the hired guns - the mercenaries - coming in, after the fact, to "fix" things or to "take it to the next level."

We tell all of our companies this - if you want to build the leader in your industry, you have to have the world's leading experts in your field working for you. But do NOT expect to find them outside of your company. Someone senior from the outside won't come in to show you the way. They won't save you.

Think about it. If you can go outside and hire a CEO or other very senior executives to come in to YOUR company and tell you what to do and how to do it - better than you - then you've created nothing special. There is no secret sauce and you have NO CHANCE of building a truly great company.

We like to tell all of our companies this - the world's leading experts in your business will be the people you develop. The young people you hire today will be your future leaders. Five to ten years from now, they will BE the world's leading experts in your business. You will have to figure it out - together - along the way.

Don't count on those mythical "world class" managers to come in to save the day. Not only are there no guarantees, I believe they will end up hurting your chances of building a special, lasting company. If you do try to hire them anyway...good luck. What I will guarantee is this - they will negotiate HARD for a nice severance package.

The Future of Software

According to Mark Benioff, the founder of Salesforce.com, the future of software is no software. It's a catchy slogan (Salesforce.com's phone number is 1-800-NO-SOFTWARE) but sticking to such a statement might make Benioff a modern day Henry Ford (who once declared that customers can have any color as long as it is black).

Most of us have already experienced the future of software - and it looks like iTunes, not Salesforce.com (who doesn't have an iPod these days?). But before explaining, let's do a quick review of how we got here.

As the technology industry evolved, it has served wider and wider audiences. Decades ago, it was engineers making products for each other - like HP's engineers making products for the guy sitting at the next bench. The next wave was driven by businesses, culminating in Y2K (even Netscape, the company which helped kick-start the whole Internet revolution, made most of its money from businesses). In the latest wave, consumers are driving the tech industry. When Benioff started Salesforce.com, his inspiration was Amazon.com and eBay not Oracle or SAP.

However, over the past few years, we've seen hackers and entrepreneurs pushing exciting new frontiers and the more I think about it, the software industry will be taking its cues from iTunes, not Salesforce.com.

As Yogi Berra says, it's deja vu all over again. At first, we started with big servers connected to dumb terminals, then we had client-server computing, and then web based computing (i.e. back to thin clients). Now it's back to fatter clients (again).

How fat?

Well, it depends on the application. Hackers are just too creative to be tied down with the "no software" model. Clever hackers working on Google Maps blew away Mapquest using AJAX which makes supporting different browsers and operating systems a whole lot more complicated. But the increased trouble is worth it, from a user's perspective.

However, this is just the first step. We have been seeing an incredible array of new plug-ins, widgets, toobars, and applications which require new downloads and installations. The real developers are back - over-paid script editors can step aside. Companies with talented developers will have serious competitive advantages over Web 2.0 companies that are long on hype but short on technology.

With broadband, multi-megabyte pieces of software can be easily downloaded, installed, and updated and, if done right, they will drive faster adoption and more stickiness. For example, in Korea, PandoraTV (one of our portfolio companies) started by providing a YouTube-like video service. They are now also connecting to proprietary client software on PCs as well as cell phones to millions of users. They are quickly moving up the traffic rankings and were named company of the year (the founder was also named entrepreneur of the year by the Korean tech press).

But wait, there's more - much more!

The real inspiration for this article was not "more software" vs. "no software", but new business models being developed by clever entrepreneurs. It's the combination of hacker creativity AND business model innovation which will revolutionize the software industry.

In the past, high prices for software were required to cover sales and distribution costs. It was like the old door-to-door salesmen selling encyclopedias. (High margins for encyclopedias were needed to cover sales costs, not the marginal costs of updating and printing encyclopedias - which, like software, is relatively low).

Salesforce.com's on-demand, recurring revenue model is better than the outdated perpetual, per-CPU licensing models of SAP and Oracle. However, most SaaS (software-as-a-service) companies are still stuck with per-user or per-seat licensing models which are bound to get blown away by new, more innovative (and disruptive) business models.

To explain the second half of the new software revolution (the business model revolution), let's go back to the iTunes example.

iTunes is free.

The concept of free software is nothing new to proponents of open source software - but the new software revolution has little to do with it. We will see hundreds of new "free" software companies that do not participate in the open source community. The way that Apple makes money from iTunes is through the use of its software and the ecosystem built around it. To date, Apple has sold over 2 billion songs. Not bad considering you can still download those songs from P2P networks for free. They've also sold 50mm TV shows and, within the first few months of launch, they sold over a million movies even though only 100 movies were available. iPods are great (the 100 millionth unit will be sold this year) but what gets customers hooked is the software.

Pulling another example out of Asia, there are dozens of game developers that make millions (sometimes hundreds of millions) of dollars giving away free Internet games. What they charge for are "virtual goods" sold to millions of addicted users. Virtual goods include virtual clothing, music or game elements (such as an upgraded car in a racing game) which help improve game play or one's chances of beating competition.

Buy the song, not the album.

The biggest winners will figure out how to make money through smaller and smaller increments of value. Google's model of charging pennies per click is a good example. The bottom line is pricing must be low (i.e. not vulnerable to disruption) and it must be more directly aligned with value. A great example is Vertical Response, a bootstrapped and profitable email marketing software company, which charges based on the number of emails sent. An enterprise can have an unlimited number of users - the price is the same. Their model is more rational - and highly disruptive to companies selling software the old way.

Content is king.

In the old days, maybe software was more product oriented. For example, tools, operating systems, Word or Excel didn't include knowledge or content - users supplied it. Then as applications became more sophisticated they possessed embedded knowledge or "domain expertise" (examples include QuickBooks, SAP, or Salesforce.com). iTunes takes it a step further.

In the future, software's value may be so linked to content (and data), that it won't be clear which is more valuable - the software or the content? Going forward, software companies will look more like content companies and content companies will have to develop more software (or partner with software companies) to monetize their proprietary content more effectively. iTunes and Google are good examples. So is Xignite, one of our portfolio companies, which provides tools and Web services that stream financial data into applications and websites (they were also bootstrapped and profitable without VC funding).

Xignite doesn't just provide tools for developers. They offer content from their own databases as well as serve as a conduit (and new distribution channel) for a growing list of content partners. You can think of them as a next generation Bloomberg. However, unlike Bloomberg, most of their customers are not from the financial services industry (which is yet another sign of disruption - new users who could not or would not pay for Bloomberg terminals are becoming customers).

Another example from our portfolio is DemandTec, an on-demand software company which analyzes POS (point of sale) data from retailers and makes recommendations on pricing and promotions of products. They combine knowledge gleaned from transactions with market research data (from partners like Nielson) to provide unique insights. They also connect networks of retailers (like Safeway) and manufacturers (like P&G) to solve cross-organizational issues like the thorny out-of-stock problem on retail shelves (DemandTec's massive server farms analyze over $250 billion dollars of transactions from thousands of stores per year on behalf of their customers).

Get better faster.

The next generation of software connects developers directly with customers (not just through PCs but through all sorts of devices and gadgets). There will be no such thing as shelf-ware. If the software doesn't deliver value, software and service providers won't get paid (based on new pricing models). If new software does deliver value, it will be used and usage data will prove to be very valuable to developers. They can do market research everyday or every hour. Doing A/B testing is common practice at companies like Amazon.com and Google. Software companies that follow their lead will get better faster than their competition.

Over time, the usage data itself can become killer content. One of our companies, Instill, started by enabling restaurants to buy supplies online. Now they also make millions of dollars selling market research data (about the food services vertical) to manufacturers such as Coca-Cola. Likewise, if Apple stays alert, they should be able to monetize the data collected from the iTunes network.

I do have to give some credit to Mark Benioff in that he is experimenting with new business models (i.e. they have a 10% revenue sharing program on App Exchange). But Salesforce.com's problem is that they are addicted to a core-business model which is vulnerable to disruption. Most software models are subject to disruption because marginal costs are essentially zero. (I have already seen some start-ups switch away from Salesforce.com to cheaper alternatives). That is why examples like iTunes, Google, and the other companies I've mentioned (that demonstrate new ways of monetizing software) are so interesting.

Ironically, Salesforce.com is a victim of its own success. They can't change their core business model because their whopping $4.5 billion dollar market cap depends on it. This is the trap (and treadmill) that Netscape fell into after their hot, hot, hot IPO. They grew spectacularly (faster to $100 million than any software company since Lotus, which grew faster than even Microsoft). But they were hooked to a business model vulnerable to disruption (when Microsoft decided to give away browsers). If Netscape had been a bit more patient and kept their burn rate under control, rather than ramping up a loser model, they might have been able to figure out other ways to monetize - they could have been a Yahoo or Google (a decade ago, Netscape had more traffic than any website on the planet).

For entrepreneurs as well as venture capitalists, this is all great news. We don't have to be addicted to old business models. We can experiment and try new ones and we can afford to not only survive but thrive on much smaller revenue streams (if we keep burn rates low!). The Salesforce.coms of the world will have a very hard time switching models just as the companies before them found it difficult to switch away from their entrenched business models and practices.

In summary, as we evaluate new software investments, our firm looks for the following characteristics:

1. Easy to use (the bar is getting set much higher, must deliver compelling user experience, not fancy unused features. Solve real problems - duh!)
2. Easy to try (if download is required, should be easy to install and update)
3. Easy to buy (transparent pricing, terms and conditions. No hassle purchase - self-service option, no negotiation necessary)
4. Business model innovation (monetization in smaller increments, through actual use and value. No shelf-ware!)
5. The melding of software, content, and service (usage data can also be very valuable)
6. Increasing efficiencies and value through network effects (scale leading to snowballing competitive advantages)

Lessons from Korea

The following article written by Brendon Kim, one of my partners at Altos Ventures, was published by the Software Development Forum in August. I thought I'd post it here also.

Korean Petri Dish

Take 16 million households composed of 47.5 million people and give 75% of them broadband Internet access – access that is at times 20X faster and much cheaper than what we find in the United States – and interesting things will happen. South Korea has often been described as a Petri dish for developments in the Internet.

Over the past few years, the partners at Altos Ventures have spent a great deal of time thinking about, visiting and building relationships in Korea. We have observed that, indeed, interesting things are happening. Many of the most successful Internet companies in Korea have pioneered new behaviors and new business models and while not always directly applicable, there are lessons for Silicon Valley.

We have also observed that most of the better Korean startups share some common characteristics – characteristics we like to see in U.S. companies. NHN Corp. is testament to the notion that local knowledge will beat global expertise. NHN runs Naver.com the leading search engine and portal in Korea. Google and Yahoo may dominate in the United States, but they are mere also-rans in Korea. Naver relies on the familiar advertising revenue model, posting $228 million in online ads last year, almost 40% of the market. What are not so familiar are the results of a search on Naver. In addition to the standard list of links to websites, Naver posts links to other types of documents such as blogs, maps, dictionary entries and books. All well and good, but the most distinctive feature and arguably the reason why Naver is more popular than any other search engine is Naver’s pioneering use of user-generated content – truly local knowledge. Naver encourages users to post answers to queries from other users. Responses are rated by other users and catalogued. Responders are also ranked and given stature in the community. Ask a question about anything, say raising a puppy, and often, the most complete and popular answer comes from another user. Other engines have started to offer this feature, but Naver has such a commanding lead in the number of user entries, that it is difficult, if not impossible, for others to catch up.

Years before young Internet users in the United States were creating profiles in Myspace, Koreans in their teens and twenties were posting homepages in Cyworld. By some estimates one out of four Koreans or 90% of all Koreans in their twenties have a Cyworld homepage. When meeting for the first time, it is not uncommon for people to exchange Cyworld addresses rather than email addresses or phone numbers. The community has developed its own culture and customs. For example, ignoring comments from visitors to your home page is considered extremely rude and you can be pilloried for it. This encourages people to be very active participants in the community.

Cyworld’s revenue model is also pioneering. Basic services are free, but the site generated close to $200 million in revenues in 2005. A large portion of revenues comes from the sale of dotori (acorns), Cyworld’s virtual currency. Users spend dotori to buy virtual objects to decorate their homepage “room” and accessorize their avatars, one upping each other. Rooms might be enhanced with a digital TV or couch or flowers. Avatars might be dressed in the latest fashions or jewelry – all for a few dotori, which eventually add up to a lot of real money. Members are known to spend hundreds of dollars a month on these digital items and countless stories have been told of teens that have been punished by their parents for going too far.

The items selling business model generates revenues (and profits) for the Korean online gaming company, Nexon. Nexon posted well over $200 million selling digital avatars and accessories last year. Among other games, Nexon developed Kart Rider, an online hit in which players race each other in cartoon graphics gocarts. The company claims that nearly one out of four Koreans have played the game and that over 200,000 players are racing at any given time. Races have even been broadcast on cable. With the support of real world sponsors, some have made Kart riding their profession. Nexon does not rely on any subscription revenues; Kart Rider is free to play. Instead, the game charges you for items – accessories, such as missiles to take your opponent out of a race, balloons that lift your kart out of a missile’s way, smoke bombs that cloud your opponents’ vision, goggles that help you see through smoke and performance enhancements to make your cart perform better. The game is simple to play and just minutes a race, so it is easy to get hooked. Every time you lose to a better equipped player, the more you want to level the field or gain advantage and the more you want to reach into your wallet.

Pandora.tv is Korea’s leading video destination on the Web. (Pandora is an Altos Ventures portfolio company.) The company was established months before YouTube in the US. Early on, Pandora’s founder, Peter Kim, saw that some of the most popular sites in Korea revolve around self expression. Cyworld was an obvious case in point and to some extent, so was Naver. So, unlike many other video sites, Pandora was designed to be more about self expression and less about video sharing (although you can certainly do that too). Pandora is mainly organized around channels that members make their own with a collection of videos that expresses their characters or interests. The site posted 300 million page views in June, doubling page views in just three months.

Pandora focused on generating revenues from the start and experimented early with several business models. Pandora derives revenues from a number of sources: pre-roll advertising, where an ad is played before a requested video; consumer subscriptions, where users pay for higher bandwidth; content distribution fees; and “brand channel” sales, where businesses buy a channel for commercial use. Brand channel customers include major corporations such as Reuters, small businesses, churches, schools and even politicians. At the time of our investment, Pandora was already at cashflow breakeven with minimal outside funding.

NHN, Cyworld, Nexon and Pandora innovated in varied ways but they shared some similar characteristics when first starting up. Based on our observations, many of the better Korean companies also share these qualities. At Altos we look for these same characteristics in U.S. companies.

• The company is capital efficient. The venture industry in Korea is not as well developed as that in the US and early stage venture capital is scarce. As a result, most entrepreneurs are forced to bootstrap, looking for revenues early and keeping costs low. Capital efficiency is built into the DNA of the company and the team.
• The company continually experiments and tinkers with the business. Koreans are said to have a cultural bias towards action and learning by experience over data collection. Companies innovate over time by experimenting, learning and implementing the learning.
• The entrepreneur is extremely focused and single-minded, much like a hedgehog. For a country of 47.5 million people, the startup community is surprisingly small and reputation is everything. The entrepreneurs we like have a reputation for being thoroughly committed, headsdown, execution-oriented and interested in creating an enduring business with a solid business model.

In the last several years, Korea has emerged as an innovator in semiconductor manufacturing, wireless, consumer electronics and the Internet. The country is not about to stop here. Korea is in the midst of a major five year government sponsored technology program, the 8-3-9 Initiative, designed to keep Korea on the cutting edge of technologies such as IPv6, 3G/4G wireless, wireless broadband, mobile broadcasting, RFID and digital television. Korea is enjoying its recent role as innovator and Petri dish and we would benefit by keeping an eye on the growing developments there.