Don Dodge on The Next Big Thing

VC investors make Silicon Valley the startup capitol of the world

Silicon Valley is the epicenter of the universe for technology startups. Why? They have some of the best technology universities in the world. Sand Hill Road is home to the largest venture capital firms. And, they have a pool of startup talent that is unrivaled anywhere. It is a powerful combination. Boston has those elements too. Great universities like MIT, Harvard, BC, BU, Northeastern. Top notch VCs like Polaris, Matrix, Globespan,  North Bridge, Highland, General Catalyst, and others. And startup talent from DEC, AltaVista, Lycos, Lotus, PTC, Akamai, Groove, and others.

Paul Graham asks “Can you buy a Silicon Valley?” and suggests that $1B invested in 1,000 startups could recreate the Silicon Valley magic. It is an interesting proposition. Even $50M invested in 50 startups would be enough to test the theory. I believe it takes the right blend of investors, entrepreneurs, big tech companies, universities, and a vibrant pool of existing startups, to attract more new startups. Can a city create the vibrant startup ecosystem by actively financing 50 or 100 startups? Maybe.

The Ycombinator experiment in Boston didn’t achieve the success it could have because the investor community, VCs and Angels, didn’t step up and invest in the 40 companies hatched there. Boston has a very active VC community that has raised over $10B in funds over the last 3 years. So, money wasn’t the problem. Maybe it was a mismatch on the types of companies Boston VCs know and understand.

Cities become famous for different things.If you think of insurance you think of Hartford. If you think of investment banks you think of New York, more specifically, Wall Street. If you think of advertising, it is Madison Avenue. Automobiles? It is Detroit. Films...it is Hollywood. Country music? Its Nashville. It is the natural order of all things that centers of excellence emerge and attract more talent.

All of these cities became the epicenter of their industries by historical serendipity. While other cities have some measure of all the elements necessary to support a particular industry, (universities, money, people, infrastructure) it is rare that any city can replicate the success of the dominant center. Success attracts success. The best and brightest people want to make it to the top where the competition is at the highest level. Employees are the same way...they want to work with well known successful people.

Sports stadium or startup center? Paul Graham points out that for the price of a football or baseball stadium a city could instead fund 500 startups with $1M each and create a startup ecosystem that could rival Silicon Valley and create more jobs than any other comparable investment. My post last week “Create 50,000 companies and 250,000 jobs for $1B” made a similar argument. These are real stimulus ideas. Government and the private sector need to work together to make it happen.

The Lost Decade 1997 – 2007 or Life outside the Tech bubble

Michael Mandel, Chief Economist at BusinessWeek gave a sobering and thought provoking presentation on the economy at the MTLC Annual Meeting. He explained the huge expansion of debt and plummeting savings rates in the US over the past 30 years that contributed to the current situation. Mandel also included 10 year snapshots of wage growth and stock market performance which illustrated ZERO real growth. A lost decade. We read the headlines but they don’t sink in until you see the data visually. It is stunning…a story best told by charts and graphs.

This chart shows the S&P 500 adjusted for inflation with 1997 being the base year. The stock market booms of 2000 and a smaller boom in 2007 are clearly visible. At the end of the 10 year period the S&P adjusted for inflation is significantly lower.

Life in the Tech bubble – The stock market performance does not match the explosion of innovation and technical advances we have seen in the same period. The Internet became real and usable for most people in this timeframe. Yahoo, Amazon, eBay, Google, and many other companies led the web ecommerce explosion. Every major company started selling products and services on the web. There was a similar innovation explosion in wireless technology and cell phone applications. Social applications exploded with MySpace, Facebook, YouTube, Flickr, Twitter, lots of blogging technologies, and hundreds of other innovations.

 

 

Comparisons to The Great Depression - Yet, all of this innovation in technology and growth of the web produced absolutely nothing in terms of real wage growth or stock market returns. In fact, this period, from a stock market perspective, was worse than The Great Depression of 1929. Again, take a look at this slide from Michael Mandel of BusinessWeek that compares 1997-2009 to 1927-1939. The comparison is stunning…and scary.

 

 

 

 

How did we get here? This crisis has been building for a long time. Savings rates have been declining for years. Debt has been exploding. GDP growth masked these problems, but when you look closer at GDP growth you see that it was fueled by massive borrowing. Basically, artificial growth. These charts, assembled by Charles Songhurst at Microsoft, tell the story. First, private debt to GDP from 1920 to 2009. Debt is now higher than any other time in history, including The Great Depression of 1929.

This chart shows how Mortgage Equity Withdrawals (borrowing against equity) has fueled GDP growth. If you subtract that debt out of the GDP growth you see a much lower real GDP growth, illustrated below by the red bars. GDP growth was actually negative in 2000 and 2001, and less than 1% most years since then.

 

Most economists predict that consumer spending will drop further, savings rates will increase, and a massive deleveraging (debt reduction) will take effect over the next few years. The federal government is responding with massive spending in the Stimulus Bill recently passed by congress. Healthcare, Energy, and Education will receive big chunks of the stimulus spending. Interestingly, these are sectors that are labor intensive, so job growth is expected to result. These are also sectors that do well in recessions. Everyone must buy healthcare, energy, and education no matter what the economy is doing.

Information Technology saves money and increases productivity – Innovation will lead us out of this recession. Those technologies that provide immediate cost savings will do best. Businesses are looking for ways to save money first. New technologies that enable entirely new approaches, new value, or new experiences will get businesses and consumers spending again.

The stock market is not likely to reward companies that cut jobs, retrench, and cut dividends. It will be seen as a sign of weakness. Strong companies that take a contrarian view and invest aggressively in new products and technologies will gain consumer confidence and win market share. Smart companies will recognize the opportunities and resist the temptation to retrench like everyone else. As Warren Buffett says “be greedy when others are fearful”.

You can read Michael Mandel’s blog and see his entire presentation at BusinessWeek.

Create 50,000 companies for $1B

Thomas Friedman of the New York Times today wrote “Startup the Risk Takers” where he suggests the US government should stimulate the economy by funding startups, not by bailing out GM and Chrysler.

“You want to spend $20 billion of taxpayer money creating jobs? Fine. Call up the top 20 venture capital firms in America, which are short of cash today because their partners — university endowments and pension funds — are tapped out, and make them this offer: The US Treasury will give you each up to $1 billion to fund the best venture capital ideas that have come your way. If they go bust, we all lose. If any of them turns out to be the next Microsoft or Intel, taxpayers will give you 20 percent of the investors’ upside and keep 80 percent for themselves.”

“GM has become a giant wealth- destruction machine — possibly the biggest in history — and it is time that it and Chrysler were put into bankruptcy so they can truly start over under new management with new labor agreements and new visions. When it comes to helping companies, precious public money should focus on start-ups, not bailouts.”

Friedman’s main point is this; invest in the future (startups), not the past (bailouts). Startups are the best opportunity to create new jobs in high growth industries, and do it fast. According to the SBA small businesses created 70% of all new jobs in 2007, and account for about 50% of all employment in the US economy. Small business is defined as 1-500 employees.

Fred Wilson of Union Square Ventures says “No Thanks”. Fred writes “The venture capital business, thankfully, does not need any more capital. It's got too much money in it, not too little. Just ask the limited partners who have been overfunding the venture capital business for the past 15-20 years what they think. You don't even need to ask them. They are taking money out of the sector because the returns have been weak.”

Government wants to create jobs, VCs want to create wealth – Do VC backed companies create jobs? Yes, but their primamry goal is to create wealth. VCs invest about $25 billion a year in over 3,500 companies. These companies grow fast and create jobs. But, VCs primarily fund technology companies with fewer employees and explosive growth potential. Most VCs only fund 2% – 5% of the companies they see, leaving 95% unfunded.

Service based companies create lots of jobs, but don’t get VC funding.- What about all the viable companies that don’t meet the 10X return potential that most VCs demand? Would a VC have funded Wal-Mart, McDonalds, Subway, or ServePro when they were small startups? No way. Service based companies don’t fit the VC model. But, a successful service company might have 5,000 employees, compared to a successful technology company with 500 employees. The government should focus its stimulus money on programs that create jobs. New approaches are needed, but some existing programs are listed below.

Create 50,000 startups for $1B - How about government funding for startup incubators similar to Ycombinator and TechStars. These startup mentorship programs are very successful in creating startups and driving innovation but they only cover 30 to 50 companies a year, investing about $20K in each one. Why not start 50,000 companies a year? It would only cost $1B, and could incubate the next Facebook, Google, or Microsoft…and millions of jobs. How many jobs will $1B invested in General Motors create? Government funding for VCs is probably not a good idea, but maybe a small amount of funding for startup incubators would create the jobs that VC backed companies won’t. $1B invested in 50,000 startups would conservatively create 250,000 jobs immediately. If just 2% of those startups became wildly successful they would create 3 million to 5 million jobs.

What can government do? Government should create incentives for investment.  It is probably best not to make the investments directly. There are already some good programs and incentives in place that have been forgotten or underfunded for too long. Pouring money into these programs is certain to stimulate investment, inspire innovation, and create jobs. Here are a few examples of programs that stimulate investment from the private sector.

SBIC – Small Business Investment Company A program managed by the SBA, SBICs are privately owned and managed investment funds, that use their own capital plus funds borrowed with an SBA guarantee to make equity and debt investments in qualifying small businesses. The U.S. Small Business Administration does not invest directly into small business through the SBIC Program. This program encourages private investment in startups and small businesses.

SBIR – Small Business Innovation Research Another SBA managed program, the SBIR encourages small business to explore their technological potential and provides the incentive to profit from its commercialization. SBIR targets the entrepreneurial sector because that is where most innovation and innovators thrive. By reserving a specific percentage of federal R&D funds for small business, SBIR protects the small business and enables it to compete on the same level as larger businesses. SBIR funds the critical startup and development stages and it encourages the commercialization of the technology, product, or service, which, in turn, stimulates the U.S. economy.

R&D Tax Credits – There a 20% R&D tax credit for “incremental” R&D spending, over and above what you spent the previous year. There are lots of restrictions on expenses that qualify. Unfortunately startups are limited to a 3% credit because they don’t have lots of prior years spending base. This program could be significantly enhanced by loosening the restrictions, which would in turn stimulate research investment.

Seed Capital Tax Credit – Maine has a 40% Seed Capital Tax Credit for startups, that can go as high as 60% for startups based in high unemployment areas. This is a good example of targeted support for private investment to create startups, jobs, and innovation. More states should adopt Seed Capital investment tax credits.

There are probably lots of other little known programs that support investment in startups. We need to publicize them and invest more in them. Please leave a comment and a link to your favorite program.

TechStars coming to Boston

TechStars, a startup mentorship program similar to Ycombinator, is opening a new office in Boston. TechCrunch speculates that the move is in response to Ycombinator closing their Cambridge office but the truth is Bill Warner, Shawn Broderick, and other Boston based mentors have been working on this for 6 months. I have been a mentor to TechStars in Boulder since its inception, and will take a larger role with the Boston based program.

Other Boston mentor supporters include Dan Bricklin (inventor of VisiCalc)  John Landry, (Serial entrepreneur)  Colin Angle, (co-founder of iRobot), Eran Egozy (co-founder of Harmonix, maker of Guitar Hero and Rock Band), Nabeel Hyatt (founder. Conduit Labs), Rich Levandov (Partner, Masthead Ventures and Avalon Ventures), Bijan Sabet (Partner at Spark Capital), and others.

TechStars is all about mentors helping first time entrepreneurs get started. Giving them the advice and mentorship they need to take an idea and build it into a startup. The list of entrepreneurs, VCs, and startup mentors is truly impressive. TechStars provides some seed funding that basically provides living expenses while the founders are developing their idea.

Typically at the end of the 3 month program the founders have built a functioning product/service, have worked out a business model, and have a rational business plan ready to pitch to Angel investors and VCs. In fact, at the end of each session TechStars holds an Investor Day attended by over 50 VCs and Angels. Many companies receive Series A funding at the end of the program.

Applications for TechStars is now open. Apply by March 21, 2009. Check out the TechStars site for more information and links to startups from prior TechStars sessions.

30 most important innovations from last 30 years

PBS’ Nightly Business Report today published a list of the 30 most important innovations of the last 30 years. The list will be made public on Nightly Business Report tonight on most PBS stations. The list is presented in “count down” fashion and includes many of the innovations that today seem normal but were truly revolutionary when they were brought to market. The top 4 choices are obvious and essential parts of our everyday life; the Internet, PCs, cell phones, and email. I would be lost without any one of them.

Here are the complete results:

1. Internet WWW
2. PC/Laptop computers
3. Mobile phones
4. Email
5. DNA testing and sequencing/Human genome mapping
6. Magnetic resonance imaging (MRI) 
7. Microprocessors
8. Fiber optics
9. Office software (Spreadsheets, word processors)  
10. Non-invasive laser/robotic surgery (laparoscopy)
11. Open source software and services (e.g., Linux, Wikipedia)
12. Light emitting diodes (first real devices in 1960s; in products in mid-70s) 
13. Liquid Crystal Displays
14. GPS Systems
15. Online shopping/ecommerce/auctions (e.g., eBay)
16. Media file compression (e.g., jpeg, mpeg, mp3) 
17. Microfinance 
18. Photovoltaic Solar Energy
19. Large scale wind turbines
20. Social networking via internet
21. Graphic user interface (GUI)
22. Digital photography/videography
23. RFID and applications (e.g. EZpass)
24. Genetically modified plants
25. Bio fuels
26. Bar codes and scanners
27. ATMs
28. Stents
29. SRAM flash memory
30. Anti retroviral treatment for AIDS

To compile this list, thousands of nominees were submitted by Nightly Business Report viewers.  The finalists were then judged according to seven different criteria determined by senior Wharton School faculty who served as judges:

1.  Did it have a direct and/or material effect on quality of life?

2.  Did it address a compelling need?  Did it solve a compelling problem?

3.  Was it a fresh, new breakthrough?   Was there a "WOW" factor?

4.  Did it change the way business is conducted?

5.  Did it increase the efficiency of how resources are used?

6.  Did it spark an ongoing stream of new innovations on top of the original innovation?

7.  Did it lead to the creation of a vast, new industry?

What do you think? Do you have any additions to the list? Would you have a different priority order? Imagine what the list will look like 30 years from now. There are a lot of entrepreneurs out there working on The Next Big Thing for the next decade.

Pitch your idea to the San Francisco Chronicle

Deborah Gage at the San Francisco Chronicle is doing her part to help startups get exposure and maybe some VC funding. The program is called “What’s Your Pitch?” You can submit your business idea to the Chronicle where it will be reviewed by a panel of VCs. The winners will be published in the Chronicle along with VC reactions and suggestions.

Money to fund startups is as scarce as it's been in years. But we all know that successful businesses often are forged during tough economic times. With this in mind, The Chronicle is giving entrepreneurs a chance to pitch their startup idea in the newspaper (and they can be based anywhere, not just San Francisco). The winners will get great exposure, along with suggestions from some venture capitalists who will review the ideas.

Please send your "elevator pitch" -- your idea, the benefit of your idea and why you deserve to get funding -- in 300 words or less, to dgage@sfchronicle.com ASAP. Include your contact information and, if you have one, a picture of yourself or your product.

The best and strongest ideas will be picked and published in the Business section of the San Francisco Chronicle on February 24. Move fast, get noticed, and get started! Good luck!

Presence, status, and alerts the secret sauce of social networks

Facebook announced they are opening up their status API to other applications. AllFacebook says “Say Goodbye To Twitter” because in essence that is what Twitter is…a status update service. Fred Wilson says not so fast, Twitter is much more. Fred says Twitter’s public versus Facebook’s private model, and Twitter’s one way follow versus Facebook’s reciprocal dual approve model will make a big difference.

Foundations of today’s Social Networks - Instant Messaging was the first widely used application to expose “presence”, meaning if you are online or off, and “status” meaning if you are away, busy, in a meeting, etc. Groove Networks used “alerts” to advise you when something changed, and “read/unread” to let you know about new information or changes to old information. Social Networks like Facebook and LinkedIn took these simple “social gestures”; presence, status, and alerts, and combined them with a friend network model to create an entirely new communication platform.

Fred Wilson is a VC investor in Twitter, a brilliant strategist, and a good friend. His blog post this morning, which I encourage you to read, makes some powerful observations, more eloquently than I could. Here are a few nuggets;

It seems to me, and I am certainly influenced as an active user of and investor in Twitter, that status has emerged as the ultimate social gesture. If you look at traditional social nets, Facebook, MySpace, Bebo, etc, etc, they offer many social activities; writing on walls, posting and tagging photos, sharing videos, listening to music, playing games, etc.

But as Joshua Schachter explained to me a few years ago now, reduction of services to the simplest user experiences is a powerful generator of focused activity. And that's what is going on at Facebook and across the social networking sector right now. Status is universal. Not everyone takes photos or videos, or plays games. But everyone has a status and it changes. It's also quick and easy to post a status message. And it's massively conversational (something we didn't quite realize until Twitter users invented the @reply).

Lessons for Enterprise Software developers from the social network innovators? There are many. In businesses and large enterprises email is the core communication and collaboration tool. Your email contact list is the business equivalent of your social network.Why not apply these social network features (presence, status, alerts, friends network, introductions, photos, etc) to business applications like email and instant messaging? Microsoft Outlook already has presence. Office Communicator (IM) already has presence and status. It isn’t a huge leap to add other social network features that could transform email and IM into “business networks”.

The difference between FREE and 1 cent?

Walter Isaacson, former editor of Time Magazine, wrote “How To Save Your Newspaper” where he suggests a new system of micropayments to pay for any type of digital content on the web. Newspapers are dying, suffering from rising costs, reduced advertising budgets, and free content on the Internet. Micropayments (less than a dollar) have been tried many times in the past by companies like CyberCash, PepperCoin, DigiCash, and others. None have gained much traction, and making money from such systems is challenging at best. PayPal is useful for larger transactions but the overhead costs make it impractical for micropayments.

So what is the difference between free and a penny? Friction…inertia…hassles. Most people would be happy to pay five cents or even 50 cents to read an article in Time Magazine or the New York Times, or to get access to other useful content like pictures, video, audio recordings, etc. The problem is not the cost, it is the friction in getting it done. For micropayments to work they must be simple, fast, and universally accepted, with the click of a button. Oh, and if everyone paid just a penny to view content it would translate to a $10 CPM rate, which is double or triple what most web content commands. Think about that for a minute.

Mr. Isaacson explains how newspapers and magazines got into this mess;

The easy Internet ad dollars of the late 1990s enticed newspapers and magazines to put all of their content, plus a whole lot of blogs and whistles, onto their websites for free. But the bulk of the ad dollars has ended up flowing to groups that did not actually create much content but instead piggybacked on it: search engines, portals and some aggregators.

Another group that benefits from free journalism is Internet service providers. They get to charge customers $20 to $30 a month for access to the Web's trove of free content and services. As a result, it is not in their interest to facilitate easy ways for media creators to charge for their content. Thus we have a world in which phone companies have accustomed kids to paying up to 20 cents when they send a text message but it seems technologically and psychologically impossible to get people to pay 10 cents for a magazine, newspaper or newscast.

Unwittingly, Mr. Isaacson also illustrates why micropayments have not worked, and why the web advertising model is a challenge in many cases. There are too many players looking to take a piece of the transaction. In the web advertising world that $3 CPM (1,000 impressions) gets split between the host web site, the ad serving network, an ad targeting service, the ad agency, and sometimes other intermediaries. At the end of the day the overhead costs associated with managing all the players percentages translates to fractions of a cent per impression.

Micropayment systems would also have many parties looking to take a fraction of each transaction. The host web site, the content provider, the micropayment technology provider, the bank clearing house, the company that signed up the end user, etc. When the transaction is only pennies to begin with, the “supply chain” can’t sustain itself.

Another quote from Mr. Isaacson; "The key for attracting online revenue, I think, is coming up with an iTunes-easy, quick micropayment method. We need something like digital coins or an E-Z Pass digital wallet – a one-click system that will permit impulse purchases of a newspaper, magazine, article, blog, application, or video for a penny, nickel, dime, or whatever the creator chooses to charge."

Freemium model – Many companies use the Freemium model, meaning the base service is free, but you pay premiums for added services, capacity, or convenience. This model works because people value the free service, make it a part of their routine, and are willing to pay a premium for added services. Usually just 3% to 5% of all users upgrade to paid services but the scale is such that it can be a profitable business.

Consumers are willing to pay for content. But, the price must be reasonable, and the payment system must be simple and frictionless. The technology is available to do it. The problem is the players in the “value chain” need to adjust their expectations on their percentage of the revenue. Micropayments may be a perfect opportunity for an open source solution funded and supported by the largest players in the web community. The world would be a better place for everyone on the web if we had a universal micropayment system.

Microsoft MSN, Windows Mobile, Xbox in the news

Techmeme has become my morning newspaper for all things tech. This morning Microsoft MSN was the top headline with a Kara Swisher story about WonderWall, a new celebrity news site. WonderWall is produced by Berman Braun Interactive. The story includes a quote “ We are investing more than ever in content,” said MSN GM Rob Bennett. “With Wonderwall, we are creating an offering to attract and retain new audiences, using content that is already at the core of MSN.”

Mary-Jo Foley at ZDnet has a story “Windows Mobile: What’s coming when” Windows Mobile v7.0 is the next release and Mary-Jo speculates on what features might be in the release and when it might happen. Mobile World Congress is coming up in a couple weeks so lots of rumors and pre-announcements are surfacing.

Another TechMeme headline story on Microsoft’s Xbox “Netflix movie downloads are a success on Xbox 360” VentureBeat writer Dean Takahashi says “Microsoft said today that more than a million Xbox 360 users have downloaded the Netflix application via Xbox Live since the alliance was launched in November. In less than three months, Xbox Live gold members (who pay $50 a year) have watched more than 1.5 billion minutes of movies and TV shows.” And “People who subscribe to Netflix can watch movies for free on the Xbox 360 on the living room TV, provided the Xbox 360 is hooked up to the Internet. Netflix has 9.4 million subscribers while Microsoft has more than 17 million Xbox Live subscribers. In addition to Netflix, Xbox 360 owners can download as many as 17,000 videos from other services on Xbox Live.”

Where does video conferencing fit?

AT&T introduced a video phone over 40 years ago. PictureTel, a video conferencing company started in 1984…25 years ago. Today MSN Messenger, AIM, Yahoo Messenger, Google Talk, Skype, and a bunch of startups including Seesmic, ooVoo and SightSpeed offer video conferencing/chat.

David Pogue at the New York Times wrote “Video Chats Overcome Clunkiness” describing how the new version of Skype is actually pretty good for video chat. High quality sound and video, fast transmission, and useful added features.

A poor start - In the past video conferencing was expensive, unreliable, poor quality, and required special equipment and high speed connections. Only the most dedicated souls would use it. Today most of those problems are solved and prices have come down to where basic services are free. So why isn’t everyone using it?

Where does it fit? Your first important meeting with someone needs to be in person. You need to establish a relationship, get a feel for their personality, body language, voice intonation, etc. Once you establish a relationship a simple telephone call works well. When you know them well nothing beats email for thorough, documented, communication. Where along that continuum does video fit in?

On Line Learning – The one obvious area for video conferencing is distance learning, where seeing the subject is important. Another area is product demonstrations, but even here screen sharing programs like Live Meeting work much better.

Are you using video conferencing/chat? What are the best uses of real time video? What are your favorite products or services? What will it take for video to take off? Will a poor economy and travel restrictions cause more people to use video conferencing services?