Five Years Too Late

December 22, 2009

Apple is a Bad Example

Filed under: Uncategorized — fiveyearstoolate @ 10:08 am

Eric Wiesen

Twice in the last 24 hours I’ve read interesting takes on a couple of key and timely issues around our space, but in both cases the author used Apple as an example that is presumed to be generalizable by the reader. I think this is going to be wrong more often than not. I’m not the biggest fan of argument by example to begin with – if you can only make your argument by putting another fact pattern next to it and saying “see, it’s like that!”, that tells me that you don’t truly understand the conceptual framework of the argument you’re making, and you rely on already-answered questions around analogous situations to make your point for you. But if you’re going to argue by example, pick an example that actually extends to cover situations your readers will likely encounter.

The first piece I read was a counterpoint to the often made argument that software companies should release as early as possible rather than try to develop a feature-complete, perfect product. While I generally agree with this premise (particularly for web-based b2c companies where iteration takes weeks if not days and can be pushed instantaneously), it was refreshing to hear the alternative point being made. Until, that is, they began to use Apple and the iPod as their game-set-match argument by example. Lost me there.

Why? Because Apple is different from other companies. Is that a hackneyed thing to say? Of course. But Apple has, in my view, a distinctive advantage over essentially everyone else in this area – an advantage that doesn’t fit at all well into any strategic framework you’d learn in business school. That advantage is Steve Jobs. Apple’s approach is (and always has been) the opposite of “ready, fire, aim”. They’ve always taken a long time to release product and always done it in a design-by-fiat way. But here’s what’s sort of funny:

  • Early 1980s: Apple II family, original Mac family. Great products, happy users, explosive growth.
  • 1985: Steve Jobs fired
  • Late 1980s: Kill the Apple II, later pre-PowerPC Macs expensive, niche, market share begins collapse.
  • Early 1990s: Market share continues to collapse, cedes essentially all markets but graphics and edu to WinTel. Newton = fail. Switch to PowerPC is a mess. Huge problems with endlessly delayed OS 8.
  • 1998: Steve Jobs re-hired.
  • Late 1990s: Original iMac released, company gains momentum and begins turnaround.
  • 1H 2000s: Apple begins Intel transition. Iterates quickly on iMac. Releases compelling laptops. Streamlines product offerings. Launches iPod in 2001.
  • 2H 2000s: Launches iPhone in 2007. Takes over music industry. Market share continues to grow. Company is worth more than Dell.

This is a long way of illustrating that Apple’s strategy has only worked when Steve Jobs was running the company. Whatever it is that he does differently than other executives has made this strategy work. So unless you have Steve working for your company, you probably shouldn’t look at Apple and try to do what they do. I think there is a cogent argument to be made that in some cases you can do more harm than good by releasing early and often, particularly in b2b contexts. But the success of the iPod shouldn’t be why you make that decision.

The second piece was a really interesting interview with Mike Moritz of Sequoia. Mr. Moritz is much smarter than I am and is a spectacularly successful VC, one of the best of all time. And I enjoyed the interview, so I don’t want to make this point more heavily than I should. But… he was talking about founders and the extent to which they do and don’t scale with companies’ growth. And the example (determined in part by the structure of the interview, which was around the updated version of The Little Kingdom) was Steve Jobs and Apple.

This is a challenging subject in the world of startups and venture capital. There are a handful of very high-profile founders who’ve taken companies from an idea to huge success. Everyone can name them: Steve Jobs, Michael Dell, Bill Gates, Larry Ellison, Jeff Bezos, Marc Andressen, etc… Most entrepreneurs (and the investors who back them) want to believe that they are the next name on this list. It’s a longer subject for another post (perhaps done collaboratively with a founder), but the reality is that some founders have the skills, orientation and INTEREST in running a large, operationally complex company and others don’t. In any event, I’m hesitant to apply the case of Steve Jobs, a unique individual and case with little generalizable value, to whatever situation a particular founder or investor might encounter.

The larger point is – arguments are the strongest when they are supported by internally consistent logic and don’t rely on external pattern-recognition exercises. But if argument by example is the way you want to go (either when trying to make a case to someone else or to make a decision for yourself), I’d think twice about relying on Apple as your example. Chances are, Apple is different.

December 15, 2009

Binary Pricing

Filed under: Uncategorized — fiveyearstoolate @ 11:09 am

Eric Wiesen

Stuart Ellman

When I (Stuart) just started in business, I worked with cash flowing entities, both buying them and selling them. Pricing methodology for these businesses was well-established and easily-understood: Project out the cash flows of the business, discount those cash flows at the appropriate discount rate and arrive at a present-value number. All I needed was Brealey and Myers Principles of Corporate Finance and my HP 12-C.

When I started in venture capital, I realized that the extreme variations in cash flows (and the highly speculative nature of them) prohibited DCFs from being useful. Comparables were the way to go.

  1. See how publicly traded comparables were doing,
  2. See how other similar venture deals were priced,
  3. Look at how similar companies were being acquired,
  4. Find out how other VC firms would value this company, and finally
  5. See how low the insiders were willing to take until they did it inside (in effect, find the market clearing price).

The problem most VCs eventually discover is that for the big winners (like Ciena, Priceline, Cerent, WebMD and Google, most of which I looked at at one time or another), it actually doesn’t matter how seemingly overpriced the deal is. These winners created fantastic returns almost irrespective of what you paid. The primary reasons? Traction and momentum. The problem was, it usually took until a Series C or at least Series B was completed until investors could see the traction. Series A funded the idea, Series B built the product and beta tested it, and Series C rode the momentum.

An oft-cited (but poorly understood) dramatic shift in the world of technology, particularly internet technology, is the enormous decrease in the cost of starting a company, building a product and distributing it via social or viral channels. Cloud infrastructure compounds this compression in terms of capital and time to market and reduces the fixed cost associated with getting a product launched. All of this rolls up to allow a company to generate traction with only Series A money and sometimes just the seed money.

The consequence of this is that for consumer-facing companies (and even some that address businesses, particularly SMBs) pricing is now binary. If a deal has early traction, (like Foursquare), VCs will kill to get into the deal and price it up as it looks to be a future winner. It doesn’t have a hockey stick projection, it is following the hockey stick upwards. On the other hand, if a deal is forecasting great traction (and all deals do) but doesn’t yet have it, there is no floor to the price. It is worth barely more than a person and an idea. Why? Because if it doesn’t cost much to generate the traction, if the product is great, why fund it until you know? From the VCs perspective, pay up for the ones with traction, wait on the ones that could get traction unless you are getting a rock bottom price.

This is rational because risk is in the traction and the momentum. Companies will come in and tell us at RRE that we should look at deals like Facebook or Twitter as comparables because their great idea WILL have momentum like that. What they don’t want to hear is that, UNTIL they have the momentum, they are worth very little. Why? Because if it doesn’t cost very much to get to market and there aren’t any real technical barriers to entry, then what does a tractionless startup actually HAVE? Unless the team is amazing or the product is actually quite technically distinctive (e.g. Dropbox), it’s hard to perceive a ton of enterprise value in a consumer-facing web service with no uptake. It’s also rational because the companies with runaway momentum are the ones that acquirers pay big money to pick up. Look at AdMob relative to other mobile ad plays. Where was the distinctiveness – runaway growth.

In my view, the best possible deals from a pricing perspective are deals like the one we just did with Justin Shaffer called Hot Potato. We funded Justin at a seed round price because we believed in Justin and thought that traction would occur. But the price reflected the lack of traction (and even a launched product) at that point. Fortunately, Justin realized this was the right price and took in the capital from ourselves, Josh Kopelman and many great Angels, and now has a company with real traction. And the next round will reflect the traction improvement. The critical point here is that Justin knew what his company was worth. He did not look at others with traction and demand a price discounted from those lofty levels. He waited until he actually had the traction to be able to demand such a price. He played it smart and VCs know that and want to fund him.

One piece of advice for entrepreneurs: everyone forecasts huge upside. Right now, either you have the growth and traction or you have excuses why you do not. If you do not, and you want to get funded, you are going to end up with a low price, if funding comes at all. One piece of advice for venture capitalists: there are no bargain prices on companies with great momentum. Any entrepreneur who is smart enough to call a few VCs and has the traction is going to get term sheets with lofty valuations. If that entrepreneur takes your bargain price, you have to ask yourself why. Pricing is no longer linear, it is binary. Welcome to 2010.

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