Fractals of Change

Invent, Baby, Invent

Tom Friedman says we ought to be chanting "Invent, Baby, Invent" rather than "Drill, Baby, Drill". Forget that this is a false dichotomy (or read this post), invention IS a good idea. I've spent most of my career inventing both technology and business models - successfully and unsuccessfully, have a handful of patents, better stuff I was too dumb to patent, and an interesting career and comfortable life to show for it so am all in favor of innovation. Unfortunately neither cheerleading nor government subsidies are very effective in stimulating invention.

Inventor invent because they can't help it – just like writers write even when no publishers'll publish. What matters to society is how many good inventions actually can be deployed. The deployment rate of invention has a lot to do with capital (and a lot to do with marketing – I've been lucky to have Mary to promote my inventions). Government capital, however, is usually harmful to the innovation process (some exceptions below). Let's take a look at energy which is what Tom Friedman is talking about.

Corny ethanol is the greatest achievement of the latest round of government-stoked energy innovation; it's a bipartisan boondoggle made inevitable by the position of Iowa in the primary calendar. It has succeeded in adding a great deal of ethanol to our fuel mix. It's dubious whether it's led to a significant reduction in either oil imports or CO2 emissions since so much energy is required to grow, transport, and process the corn and much of that energy comes from oil. It certainly has added to commodity inflation (I have no idea how much). The subsidies paid to ethanol producers tilt the scales AGAINST other less-favored forms of energy innovation. Private capital likes to bid with and not against government capital so bad choices made by government are followed and then encouraged by private capitalists who benefit from them. VCs who bet on corny ethanol and were rewarded with subsidies like to picture themselves as green – it's only become recently clear that this particular shade of green is the color of money.

The next round of private investment in solar and wind generating capacity is waiting breathlessly to see when and whether Congress gets around to passing some subsides and what those subsidies are for. If there weren't a prospect of subsidies, more of that private investment would have already been deployed. Moreover, without subsidies the capital gets deployed better because the return is determined by base economics and good execution, not whose lobbyists do the best job writing the rules for subsidy. Let's do a thought experiment: do you think Congress is hesitating on the next round of alternative energy subsidies because our representatives are diligently trying to understand the science and economics involved?  I didn't think so.

BTW, it's not that private investors are prescient or infallible. Most private investment in innovation is in dead ends. But, when the government isn't tipping the scales, private investment fans out across the landscape and the good stuff inevitably gets funded along with a lot of what turns out to be junk. Government as an investor concentrates on what'll pay the highest political dividend and, even worse, drags the private investment in the same direction and discourages diversity of investment.

Let's talk about cars. Both major Presidential candidates are in favor of $25 billion of subsidized loans to American car manufacturers; have you noticed that Michigan is a critical swing state? Is innovation, especially radical innovation likely to come from the major manufacturers? Of course not. Are innovators who aren't major manufacturers going to be able to raise the capital they need to bring their innovations to market; very difficult seeing that their competitors are getting these big gobs of taxpayer subsidy. The result of these loan guarantees will be to decrease the likelihood that America will turn the energy "crisis" to the energy "opportunity".

There is a role for government capital in enabling infrastructure – the power grid which creates a way for even yet-uninvented energy sources to distribute is, perhaps a good example. Keeping taxes low doesn't make inventers invent – they'll do that anyway – but it does help convince the investors the inventers need to invest. Taxing capital out of the private market and having government "invest" it is pretty much the worst way to encourage innovation.

Too Much Revenue, Not Enough Growth

Jeff Jarvis posted a comment on my post In Praise of Revenue:

"I'd also like to see you reprise your lesson (from the Union Square event some time ago) on extracting minimal value from the network you create so the network grows as large as possible and the value you've created and can extract in the end is greater than if you had tried to extract more value at the beginning. Did I get that right? I quote you to that effect all the time. Did it just the other day with a big publisher whose blog ad network is taking too high a cut. I told him to just cover his costs for the first year - or less - and he'd end up growing something bigger that would be more valuable to each member, thus bigger, thus more valuable to him. Eh?"

Jeff remembers quite accurately that I advocated optimizing for growth rather than revenue – in the extreme forgoing revenue. Jeff's advice to the publisher was right on. If you simply solve for maximizing revenue, you can end up with little growth – and little future revenue opportunity. Note, though, that Jeff did not advocate forgoing revenue; in fact, he did advise the publisher to cover costs, presumably so that growth can occur without needing to raise more capital or so that there will be a solid basis for raising capital when it can be put to good use.

The case Jeff presents of an ad network is particularly straight forward. It is difficult if not impossible to sell ads which will be seen by only a few number of people. The cost of selling the ads is too high to justify the effort; advertisers are not interested in taking the trouble to investigate a tiny potential market or put any creativity into reaching it. Other than in strictly local markets, there need to be millions upon millions of impressions AND data to do targeting with before advertisers are interested. So it is not practical for any but the very largest blogs to sell their own ad space – and even they usually don't. There is an opportunity for ad networks which aggregate advertisers and advertising on one side and an inventory of space ads can run on the other side. The network matches the ads to the blogs, typically collects from the advertiser, and pays the blogger. Google is the most successful example of an ad network but the ads it aggregates appear in many more places than just blogs. Federated Media, the ad network to which Fractals of Change belongs, is an example of a blog-based ad network.

If you're an ad network, the more page views you have to sell, the more and better the advertisers you can attract. The more advertisers and the higher the rate for page views you can achieve, the more bloggers you'll attract to make their page view inventory available through you. You obviously have to scratch to get started, need to have some credibility or an existing inventory of ads to start with, and are going to lose some money getting going. But now you've got traction: how much of the ad revenue should you share with the bloggers and how much should you keep? Your investors may be pushing for some return on their capital (profits); your compensation might even be tied to your margin on sales rather than just your gross sales. Nevertheless, charging more than you have to, even if you can for a while, is a mistake.

Charging too much stunts growth so you'll have fewer units to charge for in the future. Charging too much opens the door to competition.

The more that bloggers make from your ads, the more space for ads you'll have available as bloggers tell their friends which ad network to use. The more ad space you have, the more ads you'll get and – on the average – the more you'll be able to charge for ads because you'll have better opportunities to target and you'll have more advertisers interested. The more ads you get and the more you can charge for them, the more money bloggers in your network can make.  You want to keep this virtuous circle of growth going as long as you possibly can.

If you are extracting profits before you have to, you're forgoing future growth. In any sort of competitive market, profits attract competitors. Big profits attract lots of competitors. Would-be competitors can point to your profits and easily get funding. Funded competitors can undercut your rates and "steal" your bloggers. Whoops; the circle is now turning in the non-virtuous direction. If you're doing well but running at or close to breakeven, you've made it impossible for anybody to undercut you without running at a deficit which is hard to get funding for – at least in this market. The biggest danger to you is someone who finds a way to substantially cut costs or to deliver a better product. Obviously you've got to be vigilant about that and ought to lose some sleep over these possibilities – but keeping prices down keeps a plague of me-too competitors from cutting off your growth.

This logic goes well beyond ad networks, they just make a good example.

Craig's List has the successful strategy of forgoing revenue for MOST listings it runs and MOST markets that it's in. That strategy helped it attract a critical mass of listings and a critical mass of listings meant a critical mass of ad readers which attracted more ads etc. etc. If Craig now attempted to maximize revenue by charging for a substantially higher percentage of ads, a door would be cracked open for competition. There is no chance at current rates for a competitor to steal Craig's listings (and readers) by charging less. If and when Craig's List is bested, it'll really have to be by something which delivers a better way for listers and readers to communicate.

Unless you are a protected monopoly, high prices are a recipe for losing whatever lead in the market place you have. Low prices are the engine of growth.

The strategy Jeff suggested to the publisher and that I'm recommending here is to keep revenue as low as it can be and still fund growth. No revenue is a different strategy that I'll post more about.

Hold the PowerPoint; Launch the Site

PowerPoint presentations won’t get you into the meeting room of most venture capitalists even though you may need a presentation once you get there. Working software that they can look at before they look at you, on the other hand, seems a great way to start. That’s the result of a very unscientific survey that I sent only to my favorite VCs.

What got me into this was looking at presentations entrepreneur friends were crafting for the dual use of getting an initial meeting and presenting at said meeting. After a while I realized that no one presentation can possibly be good for both standalone use and personal presentation. Standalone presentations are suspect to begin with; they have to be incredibly wordy to introduce a new idea and words don’t make good slides. On the other hand, presentations you deliver in person need to be very sparse with good graphics to SHOW what your words TELL: the shape of your projected hockey stick; the commanding lead you’ve built in the marketplace; the beauty of your website (but why not just show the site?).  If all the detail is on your slides, people won’t be listening to you.

So I said make the best presentation you can to deliver personally; DON’T email it; DON’T compromise by making it standalone. Then I began to wonder whether VCs REQUIRE a PowerPoint in advance. Haven’t pitched VCs myself for a while and things change so thought I’d better ask:

“As a VC, what do you expect to see from an entrepreneur whom you don’t know or have a casual introduction to before scheduling time to listen to a pitch?

“A one-pager? A complete pp? A classic business plan or a casual one?

 

“What’s the pre-pitch norm? what do you get? What do you want?”

Fred Wilson of Union Square Ventures answered:

“A working web site I can play with and engage with others on

“I am dead serious bout that

“Nothing else matters to me at the start of the discussion.”

That’s actually great news for us nerds. Wouldn’t you rather code up some cool AJAX and php than make a PowerPoint presentation? In the old days you needed serious money to get a website hosted but that’s simply not true anymore, especially at small scale.

Rob Shurtleff of Divergent Ventures is looking for the highlights:

“What I think is most useful is a very carefully crafted one page email overview. This should be more then an outline, but focus on the top level “why is this deal interesting” points.  Problem being solved, results to date, team, target raise.  Include links so the reader can dig if they are interested.

“I am looking to see if it pattern matches on prior deals, http://www.shurtleff.org/2008/venture-pattern-matching/. My buddies at Foundry look for deals that fit their theme, http://www.feld.com/blog/archives/2008/03/glue_our_sticky.html.  The bar for getting a meeting from a cold email is pretty high, most meetings come from our networks.  It is completely worth the time investment to try and figure out a personal connection with a partner or associate.

“We get a steady stream of unsolicited physical and email inbound pitches, the most annoying come with an NDA…   Almost all have more information then I want to read through…”

Making a good one-pager can be harder that a whole deck of slides – but it’s much more important. BTW, it should be a well-laid out graphic one-pager chock fill of information but NO mouse print allowed. Don’t miss Rob’s point on how much better it is to have an intro –even a distant one – than not.

Speaking of Foundry Group and Brad Feld,  he not only answered me in email but immediately posted the question and his answer on Ask The VC. You can follow the link there to see all of it but here’s an excerpt:

“While everyone is a little different, I'm pretty simple.  Optimally, I'd like something to play around with (e.g. a simple web site or software demo / prototype.) ….I have no interest in seeing a business plan or a financial model for an early stage company pre first pitch.”

Good luck.

Raising Money in Tough Times

The best time to SUCCEED in raising money is when money is hard to get - like now, for example. When capital is easy to get, your competitors (who are, of course, much less deserving) will have plenty of capital, too. Dumb spending or pricing by them may “force” you to do the same. In the end, easy capital may not give you any advantage at all and you pay for it with part of your company.

Capital is a coward; the sound of popping bubbles sends it burrowing under the mattress for safety. Your tech startup is not in any way related to the sub-prime housing market or to the imploding debt of leveraged buyouts. Nevertheless, if you go out for money now, you are searching for a spooked commodity. You may just be wasting your time. But, if you get the money, it puts you at a huge advantage to unfunded competitors. BTW, your competitors include everyone else jockeying for attention in the new product and service marketplace whether they compete directly with you or not.

There is a fundamental difference in what scared investors look at compared to greedy, bold investors.

Greedy, bold investors (which is what you have while bubbles inflate) don’t worry much about fundamentals; they are too busy making sure they get seats at the table – any table. That strategy actually works at the beginning of bubbles (and Ponzi schemes); those who get in AND OUT early get rich – they really do: that’s what attracts everyone else. Obviously this happens not only in high tech but also in residential real estate and tulip bulbs: it’s a fundamental part of the economic cycle.

But frightened investors (which is what you have when bubbles pop) are worried not only about the fundamentals of the company but also all the external things you, the entrepreneur, don’t control. What if your market implodes through no fault of yours? What if the time comes to raise your next round and, even though you’ve met and exceeded all your objectives, ALL the money in the world is in hiding? Oh, dear.

So, if you’ve decided to raise money now (or have no choice), you have to address these fears. Here’s a few suggestions:

1. present a plan of reasonably achievable singles and doubles, not home runs. Remember you’re selling against fear, not to greed.
2. present a plan which is a believable projection of what you (either as a company or as principals) have already achieved.
3. instead of the automatic assumption that another round of financing’ll be available at a reasonable price when you need it, have a Plan B which includes going forward with NO additional financing.
4. consider making Plan B above your Plan A. If the market opens up and the company has done as well as you think it will, you can always change your mind.
5. show the investors how the addition of their money to your already excellent company will create a virtually unassailable position vs. potential competitors.

There is money out there; it’s just hiding. There are venture funds which have commitments for funds they’d dearly like to put to work. Credit is cheap for the most credit worthy (which doesn’t usually include startups), because credit is unavailable for everyone else and banks have to put their money somewhere. The terms you’ll get now are not as good as the terms you can get when there’s more money than ideas; but the money may be worth much more if you get it.

Good luck.

See a related post by my friend VC Rob Shurtleff on the perils of Bridges to Nowhere - on the perils of funding rounds that are too small to cross a chasm with.

Outside Chair

Longtime friend Rob Shurtleff, now a VC among many other endeavors, has started blogging. I take some of the credit for that which is only fair since he gets all the credit for my having gone to Microsoft a million years ago. Rob has interesting things to say: he recently posted that a board of directors should evaluate the CEO and give her or him feedback after each board meeting.

“…who should deliver the review? In my experience this is best done by the Chairman/women of the board, aka the Chair. In my experience the Chair can provide a key mentoring and organizing role that makes a CEO’s job easier.”

Implicit in Rob’s recommendation is that there IS a Chair of the Board separate from the CEO. Thinking back on having been both CEO and Chairman of my own startups, I think I would have done better with a separate Chair once the companies took in outside money even though I probably would have fiercely resisted the suggestion that I not hold both roles at the time.

A separate Chair makes reviews possible; everyone needs to be reviewed.

By necessity, a CEO provides most of the content of a board meeting; that’s a good reason why he or she should NOT also be moderating the meeting. A good Chair can assure that there’s a good agenda for meetings; that materials are distributed beforehand; and that time is left for important discussions. Moderation of a meeting is best done by someone who is NOT doing most of the talking.

A separate Chair provides an instant (if not long term) successor or replacement for the CEO in case of emergency.

A non-executive Chair can be more effective in getting other Board members to fulfill Board responsibilities and NOT try to manage the company than the CEO can. If the CEO is also Chair, she or he is effectively managing the Board which is oxymoronic although common.

The non-profit boards I’m on now and the Vermont Telecommunications Authority of which Mary is Chair have separate Chairs and CEOs. They function well this way, I think. The tension between CEO and Chairman is largely constructive. Here I think the private sector has something to learn from the public sector.

Obviously doesn’t make sense to have separate CEO and Chair when you’re a one person band and also the janitor, plumber, and receptionist. But the roles should split at the time you expect to have Board with real fiduciary responsibility which is presumably when there’s money in the venture besides your own. At that point you’ll have a better Board and a better company if you’re not the Chair (unless you want to be the Chair and have someone else be the CEO – that can work although founder/Chairs deserve a post of their own).

Rob’s post was in response to a post by Seth Levine on CEO reviews with lots of how-to in it.

VCs Follow Entrepreneurs

Both Brad Feld and Fred Wilson have recent posts on their blogs about the availability of a Google CSE for the Venture Capital Network of blogs.  It’s a good idea.  Not to boast but this capability has been available for My Way, The Entrepreneur’s Network since last November.  To use it you either go to the top of the left sidebar of Fractals of Change (you can do it by clicking the “search blog” link at the bottom of each post if you read the blog with a feedreader or in email) or you go to the custom landing page for My Way.

Of course entrepreneurs have to be over-achievers so we also have a little more functionality in OUR search: not only can you use it to search all the blogs in My Way, you can also choose to use it to search blogs which My Way bloggers think are a good extension to the topics covered in My Way.  Just use the radio buttons to decide which kind of search you want.

Note to blogger nerds: We entrepreneurs believe in groovy stuff like open source. Maybe you want to create an option of searching not just your blog or website but some other relevant collections of websites. If that’s the case, you are welcome to the snippet of HTML  I put in the template for my sidebar to implement this feature. The trick was to use a table of radio buttons where the value associated with each radio button is the ID of a different Google CSE. You’ll want to put the IDs of your own CSEs in, of course.  Also note that this code is slightly TypePad specific but I don’t think you’ll have any problem modifying it for whatever blog platform you use.

Full disclosure:  I have copied innumerable features from Fred’s and Brad’s blogs. That’s why I’m delighted to have been ahead of them in this case (not that entrepreneurs and VCs are competitive, of course).

For Web 2.0 Success - Think Local, Act Local

Ever since washingtonpost.com reported the drastic downsizing of Backfence, a company which runs a collection of sites focused on specific towns, there’s been blogosphere speculation about the viability of a local strategy.  Given Chris Anderson’s great formulation “our interest in a subject is in inverse proportion to its distance (geographic, emotional or otherwise) from us”, shouldn’t a local strategy be a shoo-in?  Given that it’s much easier to reach a critical mass of buzz in a local market than a national one, shouldn’t local be the way many Web 2.0 startups get traction?

Maybe.

Quoted in the washingtonpost.com article Vin Crosbie, managing partner of Digital Deliverance, a Connecticut media consulting firm says “realistically, it's going to take close to 10 years for the business models to be there and for there to be enough advertisers willing to give money to hyperlocal start-ups.  Backfence's problem is that it was too early.”

Is Vin right?  Is it just too early?  I don’t think so.

If your plan is to start a local site or two, get great local penetration, and then roll out clones covering every other berg in the country, fuhgetaboutit.  That has been close to what the Backfence model was.

Local content has to be intensely local and local people need to be intimately involved with the production of that content.  You can’t create local sites from Silicon Valley or Silicon Alley or suburban Washington, DC.  They have to be created locally.  Just like local newspapers.  Sure, local newspapers get rolled up into conglomerates (and often lose much of what made them good in the process); but conglomerates don’t drop local newspapers into communities like fast food franchises and expect them to work; they buy existing local properties.

Some of the futures great local sites will spring from existing newspapers: in  New Orleans Pulitzer winner nola.com, founded from The Times Picayune (but run separately), is a great example of that.  Some will come from local radio and TV stations.  Others’ll get their chance to succeed either because there is no competent local media or the local media has decided to take an ostrich approach to the web.

The local web sites have advantages over their traditional media predecessors: they are accessible to homies whether the homies happen to be home at the moment or not, they don’t have a legacy of replicating national and international coverage which they need to shed, and they don’t need to own expensive physical plant like printing presses and broadcast towers.

A critically important advantage local web sites can have is linking people together much more intensely than letters to the editor, the society page, and personal ads ever did.  Stowe Boyd is dead on when he criticizes Backfence: “they opted to roll out a journalistic user experience just about as social as the local paper sitting in a puddle of water in your driveway.”   

I think Stowe is wrong, though, when he says: “it's not about getting the right angle on issues that people are passionate about, like crime or whatever.”  People ARE passionate about what they’re passionate about.  Successful local sites will be GREAT at local coverage AND they’ll have a powerful social element and support Google mashups and the other things Stowe recommends.  They need both; they can accomplish both.

Moreover, the social aspect’ll be part of the reporting and vice versa.  That’s what citizen media is all about.  Blogs and wikis and other neat stuff built into successful local sites will make the content not only social but better than it would be with a strict separation of “we” and “media”.

The disadvantages that local sites face are real, too:  they have to build an audience; since startup costs are low, they’ll face plenty of competition for attention and advertising (just as the original local newspapers did); they need to build a local advertising sales force and train local advertisers on using the web.

Starting a local web site is probably NOT suitable for national VCs to invest in.  The exit may not come until the industry “matures” and someone starts consolidating the successful local sites.  That may be ten years. It’ll also take patience and local, local, local focus to make a local site succeed.  If the founders are looking over their shoulder thinking “how do I replicate this model in a thousand other places so I can get fabulously rich”, they’ll probably fail to meet the local need.

However, in order to succeed, local sites can’t invent every aspect of their existence any more than each local newspaper invented the printing press.  More on the national opportunity to help local sites succeed:

Web 2.0 – The Global Opportunities in Local

Two New Must Read VC Blogs for Entrepreneurs

Short form:

Ask the VC by Brad Feld.

VCInJerusalem by Jacob Ner-David.

Long form:

If you’re an entrepreneur or wannabe entrepreneur, you gotta read blogs by VCs; it’s not an option.  Obviously, if you’re in the lucky position of evaluating VC offers, knowing what they say and how they think is a big help.  If you’re negotiating, knowledge is strength.   If you’re getting ready to pitch VCs, blogs can help you decide whom you want to pitch and to understand their hot buttons when you make the pitch.

If you’re deciding whether or not to try to raise VC money – and that’s a big, big decision – reading VC blogs tells you what you’re getting yourself into.  If you are starting up and NOT raising VC money now, you still want to know how VCs think because raising some later is one of your options and, to preserve this option, you gotta structure the company’s progress so that you will be able to show VCs the kind of metrics they are interested in.

Even if you’re NEVER (and you should never says “never”) gonna raise VC money, you gotta read VC blogs.  Why?  Not only because VCs are funding your competitors but also because the smart VCs are thinking about the business environment all the time and their POV will challenge your POV.  We all know that having our POV challenged is good for our ROI (return on intelligence).

I assume you already read A VC by Fred Wilson.  Everyone does and it’s well worth the time but it’s hardly new so it’s not the subject of today’s post.

Brad Feld, a managing director at Mobius Venture Capital, always had plenty of good startup advice in his old blog, Feld Thoughts, which is still running and still fun to read.  Last year’s series on termsheets in that blog remains a must read.  But he is now concentrating his VC thinking in Ask the VC.  You really can and should ask questions there and get answers.  Brad is also the coordinator for Venture Capital, a spliced feed of many VC blogs.  It’s a much bigger companion to My Way, the spliced feed of entrepreneur blogs I coordinate.

Some people, not always with kind intent, say Israelis are like Americans only more so. The energy level there makes it hard for me to get any sleep on a short trip. Much of the technology which made Web 1.0 possible (especially but not limited to VoIP technology) and much of the technology for Web 2.0 comes from Israel.  So do lots of NASDAQ listed companies and fine entrepreneurs.

I first met Jacob Ner David, the managing partner of Jerusalem Capital, when he was co-founder of Delta Three, a competitor of ITXC which Mary I founded a little later.  I’ve liked and respected him since those days and followed his career through more startups and into Venture Capitaldom with interest.  There is just enough distance and difference between Israel and the US to make Jacob’s keen view of the shared high tech industry in VCInJerusalem piquantly different from that of US-based VCs.  He also still remembers what it was like to be an entrepreneur.

In an embarrassing coincidence, I just discovered that Jacob quoted Fractals of Change in his post today. 

Full Disclosure: I am an investor in and advisor to Jerusalem Capital.  Also have directly and indirectly co-invested with Mobius.  Turns out that reading VC blogs helps in making as well as obtaining VC investments.

Answers to some questions you may not want to ask Brad about VCs are in the posts below:

VC Primer from an Entrepreneur’s POV – Source of Funds

VC Primer from an Entrepreneur’s POV – The Funds

VC Primer from an Entrepreneur’s POV – What About Angels?

MyBlogLog – Shoestring Web 2.0 Success Story

Social networking company MyBlogLog just sold itself to Yahoo for a reported price of just over ten million dollars.  Since MyBlogLog was a five employee virtual company operated on a shoestring with no VC or angel funding, it is a counter-example to my assertion that Web 2.0 startups need to raise more money now than they used to and usually must spend marketing dollars to rise above the clutter.  They are a viral success story; no marketing dollars.  And, even though this kind of success is now harder to achieve amidst the clutter of companies launching cheaply, it’s certainly a story worth understanding.

According to Om Malik, who was having dinner with MyBlogLog Chairman [CEO] Scott Rafer when the deal closed, the company was founded in 2005 by Eric Marcoullier and Todd Samson as a traffic measurement tool for bloggers.

My take is that they wouldn’t have been able to build the social networking part if they hadn’t first succeeded in being useful as a tool for gathering user behavior statistics on blogs. I installed MyBlogLog on Fractals of Change because I wanted to know where my visitors are coming from, what pages they visit, and where they go when they leave.  Also saw their service functioning on a couple of other blogs and liked the way a thingy pops up when you hover over a link which says how many times that link has been followed today.

Even if social networking had been their goal, there was no network to begin with so there was no network value to us early adopters.  That’s why it was critical that they offer us better information about out readers and give the readers themselves information about what outbound links are hot on the site.  Very much like del.icio.us (also acquired by Yahoo) first offering value as a way to tag web pages so you can find them again and having network effect kick in later when enough people were using it to tag so that the aggregate tags were useful to each new user.

When I posted that Web 2.0 startups now need to raise more money and do marketing, Scott Rafer posted this comment:

“We brought a social network into public beta this summer and did fine with no budget. Marketing is critical; but for a social site, no-budget social marketing is the only kind that builds lasting value.

“VC funding of social sites is best spent on product management and scaling. Except in very odd circumstances, VCs shouldn't invest unless the site already has early adopter traction and growth. VC-derived marketing budgets at launch don't help if the service isn't addictive. And if the service is addictive, spending marketing money at launch will not contribute to your success. You'll spend it on the wrong things as your users' passions will surprise you -- always.”

Thought you might want to know more about their success so I emailed Scott and we had an exchange which he gave me permission to post:

TE: How important would you say your ability to gain a critical mass of members by supplying bloggers with statistics was to your eventual success in building network?  Do you think someone starting today could duplicate your trajectory or is there too much noise and/or not enough space left uncovered in social networking to provide the opportunity?

SR: The founders had 14k bloggers registered in the system when i met them in Feb 2006, versus the 50k we have as of today. That early base was critical because our success was a one-two punch. We were the leading reporting tool among a certain segment of bloggers and then parlayed that into a social app. I don't think it could have been done in one step. The basic issue is that a marketing budget would have been useless or worse at each of the reporting launch in march 2005 and the community launch in july 2006. The management distraction it would have engendered might have been fatal.

TE: I know that MyBlogLog was NOT VC funded which is an interesting point in itself. Is there any public information (or information you care to make public) either abut how it was funded or what the burn was up to the point where it progressed from analytics to social networking and from then to acquisition?

SR: The company was an on-spec project of a profitable, 10yo web apps shop in Orlando called cloudspace. They put in a couple hundred grand of in-kind coding over two years, I put in $24k to supplement server rental when traffic started popping (half in September and half of it after signing the Y! term sheet), and the Pro accounts (around $20k over time) paid for the rest. They have a variety of software libraries which leveraged everyone's time nicely, and their existing hosting relationship helped a lot. It's so pedestrian that it's certainly not confidential.

Founder Eric blogged: “Special thanks go out (what is this, the freakin' Oscars) to a couple of key people: Josh Kopelman for originally asking why the heck social networks were stuck on a single site, Fred Wilson and Brad Feld for becoming true believers and Andy Baio for inspiring me to create a link blog about this time two years ago, without which I never would have asked Todd to figure out how to track my links.”

Nice story and happy ending.  If you’re about to launch a Web 2.0 company, here are the lessons from this one:

1. You’ve gotta offer something besides social networking to your first subscribers since you won’t have any network worth thinking about until you attract a bunch of subscribers.
2. Your funding’s gotta match your strategy.  Here an eighteen month low profile attack could work because there was no impatient money AND because having no outside investors meant that an acquisition for “just” $10 million gave everyone a good payout.  Apparently, had the buyout not happened, the company would have raised a venture round.  They would have been in a good position to do so because there were no earlier outside investors AND because they had already established value.
3. Great product is essential.. Don’t really mean this to be number three in importance.  If it didn’t work, if it didn’t offer data we bloggers wanted, if it were hard to install, if it were ugly – MyBlogLog would’ve failed.
4. Good contacts are important.  Don’t know how influential VC bloggers Fred Wilson and Brad Feld got hooked on MyBlogLog initially for their blogs (they’re not investors in this, obviously) but their use of it and evangelism attracted others including me.
5. Viral marketing has to start somewhere.  See #4 above.
6. Great programming is getting more and more expensive.  They had a good way to get the code they needed inexpensively.
7. You CAN succeed without formal marketing.
8. That was then and this is now (don’t want to be a wet blanket but…).  Starting in 2007 is not the same as starting in 2005.  There’s more competition for attention and the great programming you need is even more expensive.  There’ll still be shoestring success stories but the odds are much worse than they were.

Web 2.0 – Greater Initial Investments Required was the first post in this series.  Next was Changing Ingredients for Web 2.0 Success – Continued with Reader Help.

Yahoo.licio.us is about how del.icio.us created value.

Changing Ingredients for Web 2.0 Success – Continued with Reader Help

More money, I posted, is needed for web 2.0 success now that everyone knows you can start a web 2.0 company on a shoestring. Readers of Fractals of Change have added useful breath and depth to the discussion both in the comments on that post and on their own blogs.

Brian Oberkirch blogs that there are other uses for more money than just PR (I should have been more clear about this. He’s certainly right). “The thing startups have to spend capital on is this: time. Nuance and pitch-perfect user experience are going to sort winners from losers. That takes time, community engagement, trial and error, a team.”  He cites slow-build successes like FeedBurner, WordPress, and 30Boxes who have built great value slowly rather than hurried to an early exit.

ESPECIALLY, if you’re gonna end up spending money on PR, you wanna get the product right before you start trumpeting it. Stowe Boyd picks up on this very well:  “Companies that squander their first launch with less than the "social tipping point" -- the minimum level of social features that will engender viral uptake -- will simply fall from view. There's too much innovation, too many apps, too many releases, too much to waste people's time with a half-baked product. Get it right, or you will disappear into the dustbin of failed promise.”

Stowe also laments the number of me-too products and suggests moving into the “white space” of unmet needs.

History can teach the wrong lessons because each novelty is a novelty only once. You can’t be a “me-too” novelty.  When del.icio.us first launched it had an almost impenetrable UI.  People took the trouble to learn to use it because it was an incredibly useful clipping service; enough people used it so that it benefited from the network effect of being an aggregator of many people’s clippings.  The rest is history - but DON’T try to repeat it.  One, as Stowe points out, there are already enough clipping and general purpose “also liked” services; two, since you’re going to pay dearly one way or the other to get attention, you don’t want to squander the one and only time people link from TechCrunch to your product with an unsatisfactory experience.

Reader crunchback comments:  “Raising "enough money" as you say, is key. Sometimes the right amount is $0. None, nada... …For most Web 2 entrepreneurs, the path to riches is bootstrapping or lightly funding a business that has a real revenue model out of the gate. It ain't as cool as telling all your buddies about how you closed a round that makes you worth $30m on paper. But the paper's worthless and for most Web 2.0 VC investments will stay that way….”

Seems like a contradiction to the thesis that you need MORE money to succeed but it isn’t. If you raise too much money too soon, you will be under great pressure from investors to produce results. This can lead to premature release of products, shoddy execution, or simply selling out too soon. On the other hand, if you can use just a little money to get to the point where you demonstrate great potential (revenue’s not a bad benchmark nor is it the only one), then you can raise the larger sums you’ll need later at a better multiple. Very much why Fred Wilson talks about smaller initial investments by his fund leading to larger investments later.

Come to think of it, the Web 1.0 bubble was an example of too much money way too soon.  Nothing compares with the pressure and expectations of being a public company. (OK, I’ll stop whining.)

Reader Rick Burnes comments:  “A lot of what you're saying is based on the idea that TechCrunch, A VC and Boing Boing are the blogs you have to get mentioned on in order to succeed. That's not necessarily true. Many current startups focus on verticals where these blogs are irrelevant and the bloggers that do matter have far less Web 2.0 noise to deal with.”

Excellent point.  It’s much easier to get to a critical mass of attention in a segment of the market than the whole market. If you’re introducing a vertical market product, you want attention which is focused on and credible to prospects in that market – not the general market. Even if you have a broad market product, you may well want to start by getting to a critical mass of attention in a subset of the market – then emerge from your beachhead both with more funding and a core of users.