Don Dodge on The Next Big Thing

Tech bubbles, tides, and earthquakes - What you should know

Are we in a tech bubble? Yes. When will it burst? I have no idea, and neither does anyone else. Mike Arrington, founder of Techcrunch, has a great story today "We're In A Terrible Blubble". It is insightful and entertaining. My view is that tech bubbles are a little like tides in the ocean, and a lot like earthquakes in California. You know they are going to happen like the cycle of tides, but like earthquakes you just don't know when.

Rich valuations for market leaders do not constitute a bubble. Bubble valuations happen when investors extrapolate the current state of growth to infinity. Or, when they extrapolate the valuation of the market leader to a tiny startup. For example, if Groupon is worth $6B, then my Copypon.com is worth at least 1% or $60M. Sorry, but that is not the way it works. The market leader has huge market share, higher margins, and much higher vaulation than the 2nd, 3rd, or 4th place player. Typically the top four companies in any market own 95% of the market. Everyone else fights for the remaining 5% of the market and loses; boat loads of money.

However, it is true that valuations are getting super rich, even for the market leaders. Just four months ago I wrote this;

Is there a bubble in seed stage investing? Critics point to Twitter raising $200M at a $3.7B valuation, and Facebook being valued at $35 Billion, or Groupon at $6B valuation just 6 months after raising a $135M round at a $1.35B valuation as evidence of  a bubble. The Economist seems to think there is a bubble. Eye popping headlines, but the reality of seed stage investing is very different.

Twitter, Facebook, and Groupon are not seed stage investments. These are late rounds in companies with significant traction, user bases, and revenues. Are they overvalued? Maybe. But, the best properties always look too expensive. It is only years later that those high prices look pretty reasonable. Time will tell if that is the case here.

Today, just four months later, the valuation of Twitter is said to be over $7B, doubling in just four months. Facebook valuation is somewhere around $80B, again doubling in four months. These are private companies so the public doesn't know the revenues, profits, or growth rates of these companies. Public stock markets have huge supply and demand that establish real market values. Private secondary markets are thinly traded and highly volatile. Without real market data it is impossible to say if these are bubble dreams or justified valuations.

Bubbles, tides, and earthquakes - Markets always have up and down cycles. They are in constant motion like the tides in the ocean. As soon as one bubble bursts another starts to form somewhere else. Just like the tides. But, unlike the tides, bubbles don't build and pop in predictable cycles. They are more like earthquakes. We know one will happen eventually. We study seismic data to try to predict it. But the truth is no one knows when it will pop.

One major difference between the dot com bubble of 2000 and the current situation is who will be hurt when it bursts. Back in 2000 crazy companies with minimal revenue and zero profit were going IPO on the public stock markets. Inexperienced retail investors were spending their life savings buying up these stocks. They got slaughtered. Today these companies are private. Very experienced professional investors are buying positions. When the bubble bursts these guys will get hurt, but don't cry for them. Their net worth might drop from $100M to $90M, or from $1 Billion to $900 million. Wah, wah, wah. Nobody cares. Not even the investors losing the money. They are professionals and know it is part of the process.

So, there you have it. Don't worry about a tech bubble. Take advantage of it. Start a company and build it as fast as you can. In the end investors will make millions or maybe lose some. But you will have the experience of a lifetime. Go for it!

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Saying no to great ideas and customers

Focus is critically important to startups and large companies. Focus means saying no to some great ideas. Having lots of smart people and lots of money in the bank can make it hard to say no. I was mentoring a startup, helping them sort through where to focus and how to prioritize the opportunities. I told them to choose their customers carefully. Huh? That's right, choose your customers carefully, and choose what you build / productize even more carefully.

Great ideas come from customers, partners, and employees. Big customers can have very specific needs, and demand those features in your product. Sometimes those customer demands align with your vision, but when they don't...just say no. For a startup that needs all the revenue they can get, saying no to a big customer is very hard. But, saying yes to customer requests that take you away from your strategic vision can paint you into a corner that you never get out of. Once you have those features and those customers you can't just kill them...you are stuck. Your product will never again be the universal, adaptable platform you intended it to be.

Saying no to great ideas from super smart employees is even more difficult. Startups need to focus or they will fail. Big companies have the same problem. Read this Q&A with Apple CEO Steve Jobs from aBusinessWeek interview back in 2004. 

 

Q: Apple has long been an innovative place with lots of smart, passionate engineers. But it seemed to fall off the map in the years before you returned in 1997. What happened?
A: Let's start at the beginning. Both [Apple co-founder] Steve Wozniak and I -- and I think I can speak for Woz -- got our view of what a technology company should be while working for Hewlett-Packard (HPQ ) in the late 1960s and early 1970s. And the first rule over there was to build great products. Well, Apple invented the PC as we know it, and then it invented the graphical user interface as we know it eight years later [with the introduction of the Mac]. But then, the company had a decade in which it took a nap.

Q: What can we learn from Apple's struggle to innovate during the decade before you returned in 1997?
A: You need a very product-oriented culture, even in a technology company. Lots of companies have tons of great engineers and smart people. But ultimately, there needs to be some gravitational force that pulls it all together. Otherwise, you can get great pieces of technology all floating around the universe. But it doesn't add up to much. That's what was missing at Apple for a while. There were bits and pieces of interesting things floating around, but not that gravitational pull.

People always ask me why did Apple really fail for those years, and it's easy to blame it on certain people or personalities. Certainly, there was some of that. But there's a far more insightful way to think about it. Apple had a monopoly on the graphical user interface for almost 10 years. That's a long time. And how are monopolies lost? Think about it. Some very good product people invent some very good products, and the company achieves a monopoly.

But after that, the product people aren't the ones that drive the company forward anymore. It's the marketing guys or the ones who expand the business into Latin America or whatever. Because what's the point of focusing on making the product even better when the only company you can take business from is yourself?

So a different group of people start to move up. And who usually ends up running the show? The sales guy. John Akers at IBM (IBM ) is the consummate example. Then one day, the monopoly expires for whatever reason. But by then the best product people have left, or they're no longer listened to. And so the company goes through this tumultuous time, and it either survives or it doesn't.

Q: Is this common in the industry?
A: Look at Microsoft (MSFT ) -- who's running Microsoft?

Q: Steve Ballmer.
A: Right, the sales guy. Case closed. And that's what happened at Apple, as well.

Remember, this interview with Jobs was back in 2004. He is referring to the time at Apple when he was ousted and John Sculley (sales guy) took over Apple. Jobs says the same thing happened at IBM and Microsoft. 

My experience mentoring that startup, and the Jobs interview, crystallized for me the importance of product focus. Yes, it is good to have multiple features and even multiple products, but they must, as Jobs would say, "add up to something". Every new feature and new product should support the company vision. It should leverage what you are doing and create real synergy. If it doesn't...just say no.

Hard to say no - It is easy to say no when you don't have the people, or the cash required, to do the job. It is much harder to say no if you are a startup that needs every customer you can get, or a big company with lots of employees and plenty of cash. Focus or fail. Focus on building great products, or fail with too many features that "don't add up".

Remember the Peanut Butter Manifesto by Brad Garlinghouse, former VP at Yahoo? Here is an excerpt that captures the essence;

We lack a focused, cohesive vision for our company. 

We want to do everything and be everything -- to everyone. We've known this for years, talk about it incessantly, but do nothing to fundamentally address it. We are scared to be left out. We are reactive instead of charting an unwavering course. We are separated into silos that far too frequently don't talk to each other. And when we do talk, it isn't to collaborate on a clearly focused strategy, but rather to argue and fight about ownership, strategies and tactics.

Our inclination and proclivity to repeatedly hire leaders from outside the company results in disparate visions of what winning looks like -- rather than a leadership team rallying around a single cohesive strategy. 

I've heard our strategy described as spreading peanut butter across the myriad opportunities that continue to evolve in the online world. The result: a thin layer of investment spread across everything we do and thus we focus on nothing in particular.

Focus or Fail - It happens at startups, and it happens at big companies. It sounds easy, but it is much harder than you might imagine.

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Do Windows or Mac Operating Systems Matter?

Robert Scoble asks "Does anyone in Silicon Valley care about Windows anymore?" I think the bigger question is "Do Operating Systems Matter Anymore?" Of course every computer needs an operating system to work, but does anyone care which one? Increasingly users are spending more time with applications that run in the browser, and rarely interact with the operating system.

In the old days there were "killer apps" like VisiCalc or Lotus 123. The choice of app determined which operating system you purchased. Today most applications run in the browser so the underlying operating system is irrelevant to the end user. 

With hundreds of millions of Smartphones and Tablets flooding the market, and hundreds of thousands of apps, does anyone think about operating systems? Probably not. But that doesn't mean they aren't still wildly profitable.

Microsoft annual revenues are over $62 Billion and growing. Apple is bigger than Microsoft, at $65 Billion and growing. Both are powerful companies making huge profits. Much of Microsoft's revenues and most of its profits come from Windows and Office. Apple has diversified significantly so that most of its revenues and profits come from iPods, iTunes, iPhones, and iPads.

Cost of hardware - Computing has always moved to smaller, faster, cheaper platforms. Starting with million dollar main frames in the IBM days, to hundred thousand dollar mini-computers in the DEC, SUN, Data General days. Thousand dollar personal computers were the next step in computing. And today, hundred dollar Smartphones and Tablets are the hot platform.

Software prices dropped too - It was common to pay hundreds of thousands of dollars for software on the old main frame computers. Software for Mini computers typically cost tens of thousands. PC software cost hundreds of dollars. Web based applications are a few dollars a month, or maybe free, funded by advertising dollars.

Economics of Computing - While the cost of hardware and software has dropped significantly with each platform transition, the number of users has multiplied ten fold, or more. So, the economics still work. Look at this chart from Morgan Stanley analyst Mary Meeker;

With the explosion of computing devices at such low prices do operating systems matter? Every device needs an operating system, but it has become a low cost, low margin commodity. Where is the future of computing?

Phone Computer – Your cell phone will become your primary computer, communicator, camera, and entertainment device, all in one. The exciting new applications run in the browser, with application code and data in the cloud. There will be docking stations everywhere with a screen and a keyboard. You simply pull out your phone, plug it into the docking station, and instantly all your applications and data are available to you. You can connect to the Internet via your cell phone service, WiFi hotspot, or wired connection.  Your phone will have enough storage so you can decide which applications and data are stored on your phone, and which will be in the cloud. Replication will work seamlessly in the background so that you always have a backup copy of your data in the cloud.

Cloud Computing – The explosion of reliable broadband bandwidth, virtualization technology, cheap storage, memory, and servers, has made Cloud Computing the obvious choice for the next decade. There are huge cost advantages versus on-premise servers. Why buy servers, hire IT admin to manage them, buy operating system licenses, application licenses, pay 20% maintenance fees every year, worry about security updates/breaches, hassle with asset management, etc., when you can just “pay as you go” with cloud computing resources? You can buy compute cycles from Amazon, or hosted applications like Gmail and Google Apps. Google also provides a cloud infrastructure with an integrated development environment to build scalable web applications. The Cloud provides lots of choices and cost advantages.

Browser as Web OS – The browser is becoming more important than the underlying Operating System. HTML5 puts many OS capabilities into the browser, especially off-line storage/use. Google is developing Chrome OS that is essentially a browser and operating system in one. The Chrome CR-48 Notebooks are now in beta test, and will likely be available to the public later in 2011.

The cell phone as your computer, the Cloud for applications and storage, and the Browser as your operating system. These are huge changes in computing. They are happening now. Ten years from now will people care about Windows or Mac operating systems? Not likely.

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Do tax rates effect startups and job growth?

Everyone wants a vibrant economy, innovation, and job growth. Do lower tax rates result in more startups and job growth? Do higher tax rates have the opposite effect? Tim Kane in the Huffington Post argues "Cutting Taxes Will Boost Entrepreneurship".

There are strong opinions on both sides of this issue, but very few facts. Most of the people arguing about it are politicians who have never started or managed a real business. In the USA, Democrats think big government spending, redistribution of wealth, and higher taxes on the "rich" are the right approach. Republicans believe less government spending, less reguation, and lower taxes stimulate job growth.

The problem is our society needs elements of both approaches, but neither one is completely correct. In the political compromise we get the worst of both worlds. Gigantic budget deficits, runaway spending, minimal job growth, "lower" taxes on the rich, reckless business risks by some capitalists, and an unstable economy.

The good news is that no one in the startup world listens to politicians. No entrepreneur decides to start a company based on promises from Democrats or Republicans. And, my belief is no one decides to NOT start a company because the tax rate is 35% versus 30%. Nice theory, but in practice the last thing an entrepreneur is thinking about is taxes. There are dozens of other more important concerns than taxes. Of course at some point taxes DO become onerous and would disuade an entrepreneur, but we are no where near that point today.

Tim Kane argues lower taxes would be better, but introducing a flat tax might be the best compromise;

"Over the last couple of years, I've been conducting economic experiments to see if progressive taxes affected entrepreneurial behavior, and early (unpublished) results confirm the empirical studies, with a surprising twist: Making taxes more progressive (that is, raising tax rates on the rich while lowering them for everyone else) lowers the incentive for people to take risks that might make them rich. But the surprise was that higher flat-rate taxes had no effect on entrepreneurial behavior."

"The facts point to a solution sure to please no one. Taxing the rich will hurt the economy, but raising taxes on everyone won't. The implication is that Congress could adopt a flat tax with a relative high rate and actually enhance job creation while helping to balance the budget."

Personally, I have never met an entrepreneur that said "I would start a company if only the tax rates were lower". The barriers to starting a company are much more fundamental. Things like local zoning laws that don't allow you to start a company out of your house or garage. Or, government regulations like OSHA, reporting requirements like 401B, legal issues like patents and trademarks, and other frustrating government issues.

Federal, state, and local governments are NOT here to help you start or grow a business. They create all kinds of rules and regulations designed to protect citizens, assuming that "business" is always to blame. This quote from Tim Kane's article sums it up;

"Democrats historically look out for workers, while Republicans tend to look out for corporations. The problem is, entrepreneurs are neither and/or both at once."

There is no "business" versus "labor" in startups or small busnesses. They are all just people trying to build a better future. Entrepreneurs who work their butts off to earn $250K are not rich, and shouldn't be penalized with higher taxes. They work hard for every penny.

Tax rates should not be used as economic policy or social policy. Taxes should be a way to fund government requirements, not a social policy to redistribute wealth to those that aren't as successful. 

If politicians want to stimulate the economy and job growth the best thing they can do is stop spending money they don't have, and leave entrepreneurs alone to do what they do best. The federal budget deficit is a real problem now. It has been growing for 30 years, but the last few years have been unbelievable and unsustainable. Take a look at this chart if you dare. 

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Startup founders can have their cake and eat it too

Back in the day Venture Capitalists were  king makers. They decided who got funded, facilitated strategic partnerships, and brokered M&A transactions for their portfolio companies. The world has changed...a lot. Evelyn Rusli wrote an insightful story for the New York Times about how startup founders are more in control now. Angel Investors are willing to invest more at higher valuations, and Private Equity investors are willing to invest huge sums at later stages and allow founders to cash in some of their stock. VCs are left in the middle with much less power.

Now startup founders can "have their cake and eat it too". They can get the funding they need to start or expand their company, AND maintain ownership control, AND take some money off the table by cashing in some of their stock before an exit. This is a big change.

Traditional Venture Capital (VC) investors would invest $1M to $3M in a Series A and take 40% to 60% of the company. More importantly, they would take Board seats, and sometimes control the company. Sometimes the BOD would replace the founders with seasoned executives, and later take on additional rounds of financing that would dilute the founders ownership to minimal levels. The VCs had all the power. Not anymore. From Evelyn Rusli's the New York Times story;

“For the next-generation opportunities around the Internet and social networks, I believe the biggest opportunities will be driven by young founders who maintain their C.E.O. positions,” said Jim Breyer, an early investor in Facebook and a partner at Accel Partners.

Angel Investors, "Super Angels" and some forward thinking VCs like Founders Fund and Accel Partners changed all that. Angels are typically wealthy entrepreneurs that have started and sold several companies. They are founders themselves and identify with the startup founders. Ron Conway, Mike Maples, Aydin Senkut, Jeff Clavier, Paul Graham, Brad Feld, Dave McClure, Paige Craig, and lots of former employees of PayPal, Google, Facebook, etc. are very active Angel investors. Often they can invest enough to cover what would have been a traditional VC Series A round.

Later stage investors like Yuri Milner (DST), Founders Fund, and Andreessen Horowitz are willing to invest from $50M to hundreds of millions in private companies at very high valuations. In the past only an IPO could support such high valuations. Not anymore. Now later stage investors are investing at billion dollar valuations and allowing founders to cash out some of their stock. In the NYT story, Andrew Mason, founder of Groupon says;

“By taking money off the table, you’re expunging a big source of risk, allowing you to focus on the interests of the company you’re building instead of your own,” said Andrew Mason, the 30-year-old founder and chief executive of Groupon. He said he was able to sell some of his shares in D.S.T. Global’s initial Groupon investment, a $135 million round last April.

Still Not Easy - Plentiful capital, and low cost of startup resources like Open Source software, cheap hosting, and pay as you go services, has made it fast and cheap to start a company. That doesn't mean it is easy. Far from it. It may be easier to start a company, but it is much harder to be discovered and gain traction with users and customers. There is a lot of competition for user attention.

There is another disruption happening in Press, PR, and startup promotion. The traditional PR agencies are of diminishing importance. The press editors don't have the king maker power they once had. The old line startup conferences can't charge the high prices they once did. Social media, blogs, Twitter, and Facebook are changing the way startups market to their customers. Techcrunch Disrupt, Ycombinator, Launch Conference, and TechStars provide a grand stage for startups to strut their stuff for little or no cost. That is disruptive.

All these changes have put more power in the hands of the startup founder. That is a good thing.

Subscribe - To get an automatic feed of all future posts subscribe here, or to receive them via email go here and enter your email address in the box in the right column. You can also follow me on Twitter @dondodge

Startup founders can have their cake and eat it too

Back in the day Venture Capitalists were king makers. They decided who got funded, facilitated strategic partnerships, and brokered M&A transactions for their portfolio companies. The world has changed...a lot. Evelyn Rusli wrote an insightful story for the New York Times about how startup founders are more in control now. Angel Investors are willing to invest more at higher valuations, and Private Equity investors are willing to invest huge sums at later stages and allow founders to cash in some of their stock. VCs are left in the middle with much less power.

Now startup founders can "have their cake and eat it too". They can get the funding they need to start or expand their company, AND maintain ownership control, AND take some money off the table by cashing in some of their stock before an exit. This is a big change.

Traditional Venture Capital (VC) investors would invest $1M to $3M in a Series A and take 40% to 60% of the company. More importantly, they would take Board seats, and sometimes control the company. Sometimes the BOD would replace the founders with seasoned executives, and later take on additional rounds of financing that would dilute the founders ownership to minimal levels. The VCs had all the power. Not anymore. From Evelyn Rusli's the New York Times story;

“For the next-generation opportunities around the Internet and social networks, I believe the biggest opportunities will be driven by young founders who maintain their C.E.O. positions,” said Jim Breyer, an early investor in Facebook and a partner at Accel Partners.

Angel Investors, "Super Angels" and some forward thinking VCs like Founders Fund and Accel Partners changed all that. Angels are typically wealthy entrepreneurs that have started and sold several companies. They are founders themselves and identify with the startup founders. Ron Conway, Mike Maples, Aydin Senkut, Jeff Clavier, Paul Graham, Brad Feld, Dave McClure, Paige Craig, and lots of former employees of PayPal, Google, Facebook, etc. are very active Angel investors. Often they can invest enough to cover what would have been a traditional VC Series A round.

Later stage investors like Yuri Milner (DST), Founders Fund, and Andreessen Horowitz are willing to invest from $50M to hundreds of millions in private companies at very high valuations. In the past only an IPO could support such high valuations. Not anymore. Now later stage investors are investing at billion dollar valuations and allowing founders to cash out some of their stock. In the NYT story, Andrew Mason, founder of Groupon says;

“By taking money off the table, you’re expunging a big source of risk, allowing you to focus on the interests of the company you’re building instead of your own,” said Andrew Mason, the 30-year-old founder and chief executive of Groupon. He said he was able to sell some of his shares in D.S.T. Global’s initial Groupon investment, a $135 million round last April.

Still Not Easy - Plentiful capital, and low cost of startup resources like Open Source software, cheap hosting, and pay as you go services, has made it fast and cheap to start a company. That doesn't mean it is easy. Far from it. It may be easier to start a company, but it is much harder to be discovered and gain traction with users and customers. There is a lot of competition for user attention.

There is another disruption happening in Press, PR, and startup promotion. The traditional PR agencies are of diminishing importance. The press editors don't have the king maker power they once had. The old line startup conferences can't charge the high prices they once did. Social media, blogs, Twitter, and Facebook are changing the way startups market to their customers. Techcrunch Disrupt, Ycombinator, Launch Conference, and TechStars provide a grand stage for startups to strut their stuff for little or no cost. That is disruptive.

All these changes have put more power in the hands of the startup founder. That is a good thing.

Subscribe - To get an automatic feed of all future posts subscribe here, or to receive them via email go here and enter your email address in the box in the right column. You can also follow me on Twitter @dondodge