Web 2.0 Scalability Myth

Greg Linden’s eBay, scammers, and self-governance brings up a good point. Scaling infinitely is somewhat of a myth.

There was a time in my life, that I looked at eBay’s buisness model longingly (5 years ago before I joined) and thought that if one day we could just achieve critical mass, We would be PRINTING MONEY and I could just retire and watch the zero’s grow ... boy was I wrong...

Yes the margins are great, better than the traditional one-to-many business models. But it does bring up a whole slew of other unexpected issues that threatens to negate network effects ...

Here is a simple test that almost all company fails ... if value added for a company is truly networks effect driven the difference between its cost of capital and ROI should increase ALMOST exponentially and infinitely. Put it another way (without stupid finance speak) Gross Margins should not only increase infinitely but exponentially as well. There not one company on this earth that has done this yet ...

Even Google has seen its margins decrease and cash flow growth slow; further more, as much as people think Adsense/word is this self sustaining monster, there are thousands of cute/hot/buffed Stanford undergrads doing menial adwords tech support/filtering/placement etc ... . just for a chance to date Larry (ok low blow ... but mommy and daddy didnt mortage the house and get you into Stanford so you can attach one of the phone headsets to your head all day).

Myspace is just beginning to run into this issue as well. To police its community it hired a Chief Whatever Officer to safequard the community from ... itself ...

Digg, with the whole issue of selling ID, digging for money etc, will eventually discover that there are certain things algorithm cant solve for and people will be needed to handle the exception cases.

I guess the summary is that nature has a way of finding balance... no one organism or company can grow unchecked forever... eventually the very thing that made it successfull will created some sort of negative externality and brings balance back into the live sex chat world. (hmm isnt this in the pre-amble to Star War VI?)... eBay with trust, youTube with hardware costs, MySpace with sex, and Google with too many Stanford undergrads ...

If network effects can creat a platform which enables certain drivers to create value exponentially it can just as easily enable other drivers to destroy value exponentially.

Google is Growing Up

As much as everyone rags on Google for their shot gun approach to product development, Google is actually showing signs of growing up and building a much needed product development/maketing process & infrastructure. Business Week spend some time pointing out google’s questionable track record. John Battelle has also pointed out multiple times in the past that Google needs to do a better job of integrating product development, management, and marketing - or so he calls it “product marketing.”

Google circa 2000 approach - build it they will come ... cause we are google and you love us not being evil ... we in fact hate marketing

(I heard they let go an interim VP of Marketing back in the day for recommending a TV compaign)

Google circa 2003 approach - leverage the huge amount of search traffic to send traffic to new products ... but I still wont pick up a phone call or answer an email to market the damn thing cause you come to me... I’m google

Google Checkout 2006 approach -

1) code complete doesnt mean time to launch, infact build some business momentum first before launching

2) get some named accounts to proof value propsition as well as write some marketing case studies before opening up the kimono

3) leverage google traffic, userbase, strategy etc

4) oh ya, make sure the damn thing scales first

In fact, it looked to me that Google Checkout was incredibly well coordinated from PR, branding, business development, release, strategy, and general marketing perspective. I think a few things has contributed to this. From what I know, the Google Checkout team is not just bunch of 20 some odd year olds, it is actually one of the older (read more experienced) team at Google with people who learned product management/marketing at a diverse set of companies before landing at Google. Also, a friend told me that Google hired a jasminlive consultant who used to be an executive at eBay to revamp it Product Development Life Cycle and model it similar to eBay’s clockwork like process. (Ironic isnt it? that as eBay tries to losen up its processes, Google is doing the opposite). If Google checkout becomes successful, it will be held up at Google as a best practice example of how to manage the PDLC. All the more headaches for the rest of the valley... smart, innovative, risk seeking, AND process driven ... now they just have to work on that ego thing ...

Cash America Buys Online PayDay Loan Startup

Since almost no one covers the industry in the blogosphere, I might as well start for my own edification.

Today, Cash America International, a publically traded provider of payday advance loans, just acquired CashNetUSA for around $35M. I cant seem to find whether CashNetUSA is venture funded, which might explain that the $35M price tag. It is a good lump of cash for the owners/entrepreneurs, but as far as a VC investment is concerned, this is not exactly a homerun. What the acquisition does potentially signal is a turning point in the industry where bricks and mortar players are seeing some sort of inflection point in share shift towards upstarts in the industry trying to leverage technology to increase efficiency in either distribution or customer service.

The industry as a whole is known to be a little bit shady, but with hightened interest in the segment, competition is driving increased visibility and accountability. Sequoia has in fact made a series of bets in the underbanked sector. One of which in the payday loan space is called PayDay One. Another called Xoom for Money Transfer. And ofcourse Green Dot in financial services. Another VC firm that is also very active in the segment is Oak Investment Partners ... but in the later stages. Given how large the opportunity is, I’m surprised how many VC’s are chasing after the latest web 2.0 play but not really playing actively in this livejasmin industry... you invest in what you know I guess ... the old Buffet adage...

Learn more about Green Dot here at our Prepaid Visa web site.

Micro Rounds (<$1M) Could be a Double Edged Sword for Entrepreneurs

Vinod Kholsa is a legend for a reason, look at returns he has gotten on the fund he is running by himself. (via Infectious Greed)

I know rounds of <1$M in the seed phase is getting more and more popular especially for web 2.0 startups that launches via the Techcrunch method. (recently profiled by business 2.0 as a how to pull out... only if it was that easy I would be “independently wealthy” by now.) All things equal, I would not have raised $50M in 24 month at my last startup and settled for a more gradual $15M over 2 years. And probably a round of $1M or so for seed. All the reasons to do so has been blogged to death (less dilution, more discipline, smaller egos, more control etc.) But these is a negative side to all of this that no one is talking about... that is

1) Raising $1M versus $5M doesnt mean your pre-money stays the same. This is the screwed up part. For $5M you are probably giving up 35%-45% of your company. For $1M you are probably giving up 15%-25% for the company. The scale is not even close to linear. You have to make the choice whether that extra $4M is worth another 20% in dilution ...

2) This is the part that I hate the most. Putting in less money means VC’s are taking less risk. This is not the case for entreprenuers. Quiting a job and relying on your wife’s salaries to feed the kids is extremely risky when you only have 12 months of burn in the company bank account. Put it another way, VC’s only have variable cost when they invest in the startup, entrepreneurs have a huge fixed cost they have to cover before the rewards are worthy. For each dollar a VC invests, there is an dollar he/she could lose. The entrepreneur, on the other hand, is not just betting with sweat equity but with his career, family, (and baby food?) VC’s can now dull out investments in smaller chunks pending milestones and market condition. (this is a huge risk mitigator for them)

The other positive externality for VC’s is that any entrepreneur that is doing this must be extremely committed/confident of his concept or financially independent w/ a succesfull startup under his/her belt. Which helps with positive self-selection.

3) The last point has to do with recruiting. How do you recruit employees when all you have is 1M bucks in the bank? Its really really hard to do so unless you give inflated titles and/or inflated equity (and perhaps that would not work either). And of course the equity comes out of the employee pool which dilutes the common share holders (founders) and not VC’s (remember, the pool is usually allocated BEFORE an investment so the dilution is to founder/employees not VC’s). In which case, the dilution you hoped to save by raising a little money might go down the drain.

Good news of course is that its easier to start and scale a company than ever. So easy, infact, that people can do it as a side gig until certain milestones are met and negotiation leverage returns to the entrepreneur not the VC.

EachNet Marries Tom.com?

The rumour starts again (this is not new news people!)... let’s remember the same rumor took place in March ... Tom.com Eats World. At the time the rumour was that Tom.com might buy both Sina & EachNet.

I”ll maintain the same position as I had before. Tom.com is one of the most “western” of the Chinese companies (its actually more “Hong Kongnese” than Chinese). eBay has done well in its partnership with Tom.com on Skype. The acquisition is more likely to be a partnership with equity in Tom.com’s favor. I would bet on this transaction to happen eventually but not in the next 6 month. And that eBay will NEVER exit China completely.

On a side note, the combination of Paypal and EachNet make A LOT of sense. PayPal and EachNet needs make a big bet on cross border trade. The only way to do that is to integrate the customer experience from search, settlement, to logistics. The ideal strategy is to attack Taobao through attacking its cash cow - Alibaba.com, a glorified but very profitable directory ... the same way Alibaba outflanked EachNet initially. Cross border e-commerce is a nut that has yet to be cracked. There is a reason lots of trading firms still thrives. Back in the B2B days, a whole slew of companies was funded to the tunes of $50M plus to duke it out in this market ... nothing worked ... but the opportunity is still there...

How to Find the Next Hot Job

Wouldnt it be nice to join Google in 00, eBay in 98, Yahoo in 95, Dell in 92, or even Myspace in 2003? Not having to deal with the startup risk while gaining all the upside is one of the best bets you can make in your career - monetarily but even more so, for career progression (everyone loves a winner). Joining a startup with only 10 people is way too risky if you dont have over 5% of the equity. Joining big company after the hypergrowth means that you are stuck in a Corolla while everyone else at work has a M5 at home (and a Prius at work). My advise is to be like a VC and do due diligence on the new prospect like they do. Investing in your career is actually a bigger bet than the $4-5M in investment the average VC’s make in any round. This is not as hard as seed stage investing cause you dont want to be betting on a idea. This is much more similar to late stage investing where the financials/metrics can tell 70% of the story.

Not trying to say its a fool proof (or even a good way ... time will tell) methodology or that its the only way... this is the process I came up with and went through as I hunted for my next adventure.

The key is to understand if COMPOUNDED growth can take place in the company and how close the company/startup is to reaching that stage. Geoffery Moore calls it the tornado, bankers call it hockey stick, VC’s call it traction, I just call it 100%+ growth year over year in REVENUE with a customer base over 500K. (law of small numbers can fool people into thinking the growth is large when its not sustainable).

1) First, I try to understand the buinses model well enough that I can identify the main levers that moves the business. The key is to have a water fall of metrics that starts at acquisition (or awareness) and all the way to revenue (profit is even better but too hard to measure in a startup cause you are sacrifising profitablility for growth)

Example here might be eBay in 1999

- new registration per month

- active customers per new registration

- # purchases per month per active customer

- average purchases per active customer

2) The basic requirement is that atleast one or two of these metrics has to ALREADY be growing at 15% - 30% year over year

3) Understand what needs to happen to make the other metrics grow 15% - 20% as well. Has anyone been trying to move these metrics? what tactics/programs/strategies has been tried? The answer I want to hear is actually that no one has been looking at it too carefully because the other metrics are already driving enough growth for the company. (And I think these needles can be moved)

4) #2 gives me proof of success, #3 shows me potential for even faster growth.

5) If EACH of these metrics can grow independently @ 20% a Year over Year, you have a blockbuster on your hand ...

No company can grow at 80-100% year over year without multiple underlying factors growing at a reasonable 20% a year. It is often not sustainable if only one metric is growing at an incredible rate while the rest is stagnating. (quick example, retail companies relying soley on store expansion to drive growth ... ie GAP in 2000)

So there you go, happy hunting ...