The arrival of web 2.0 has revived the network effects business model. Every where I look, web 2.0 companies are extending the existing model of 2 sided networks to re-integrating multiple part of the value chain. Take Zazzle for example, it’s a marketplace that extends the existing model of buyer-sellers by chunking out a previously vertically integrated seller responsibility of manufacturing into a separate role. I would not be surprised that in the future, once Zazzle is able to codify its manufacturing processes, that it enables third party or franchised “sub contractors” to be the manufacturing & logistic provider for its sellers/artists. (thus increasing its ROE and margins)

One of the major problems many “Network Effects” driven businesses face was the “empty chat room” issue. Like a chemical reaction, a certain amount of activation energy needs to exist in the value network in order for the virtuous adoption cycle to take place. How do you achieve that critical mass of users needed in order to attract more users and eventually create barriers to entry to dominate your market? There are several strategies employed by companies.

1 First to market by atleast 2 years. The classic example is of course eBay. What many people forget was that eBay was formed in 1995, at the time, the mere presence of a platform or venue was enough of a draw to end users given that there weren’t any alternatives. Word of mouth spread fast enough and conversion rate from visitor to user(buyer or seller) was high enough that the “empty chat room” problem occurred only for a small set of very early adopter. Driven by “newness & coolness” factors (it was actually one of the first commercial websites along with Yahoo!), traffic grew exponentially and trial sellers enabled Pierre to build an early lead that it never relinquished.

2. Luck. Everyone understand the concept of random walk and noise. So think of it this way. On the X-axis, time. On the Y-axis, # of SIMULTANEOUS users. With Z# of simultaneous users equaling to the critical mass required to build network effects. The company/site has some constant AVERAGE X# of simultaneous users, however, given noise and random chance, the actual # of simultaneous users fluctuates based on a normal distribution. Most of the time, the company is barely hanging on with that weekly average holding steady. BUT given time, the normal distribution WILL prove itself out (if the standard deviation is high enough to reach Z) by having X>Z simply by “luck.” At which point the business takes off and VC’s and founders become billionaires. Highly risky strategy and dependent on having a wide normal distribution of simultaneous user which is rarely the case anymore for todays’ websites. I sometimes call this strategy “build it and they will come.”

3. Blow it out. Raise a ton of money and spend it on acquiring a huge # of customers in a short amount of time – hoping to juice the marketplace through marketing and getting to Z# of users immediately. This was the strategies of many failed dot-coms and b2b marketplaces in the early 2000’s. Unfortunately when there is so much noise in the advertising channels it was really hard to make the message stick and for the ROI to justify both the cost of the campaign and the users acquired. Some worked (think Paypal’s pyramid scheme in its early days), most didn’t. VC’s don’t invest in startup that do this anymore, in most cases you better be at critical mass before raising series A.

4.Build “localized” network value. A variation of strategy 3, but focused on creating critical mass in one segment of the customer base via marketing and sales. Some examples include social networks, local trading/classifies, and superniche marketplaces. The whole point is that users place different value on having different type of users in the same marketplace based on their own preferences. Find a segment of the target market that values each other disproportionately higher than any other segments (you value your friends much more than random people) and concentrate on building critical mass in that segment before moving on to the next. Really an extension of Crossing the Chasm for network effects businesses.

5. Seed the marketplace. Find all your friends, recruit “mavens” and “influentials” (read the Tipping Point) and just beg them to sign up and use the product. Sometime companies will hire part-timers to act as initial users so that potential customer will perceive value when they first visit and convert to regular users. Its the equivalent of the age old strategy of opening a restaurant and hiring people to hang out/eat at there to give an impression of popularity.

5. Create “Point” product value. This last strategy is probably the least understood and could potentially be the most powerful and cheapest. Christina Jones of pcorder.com (a blast from the past!) explained it to me once when I was doing technically called consulting (but more like minimum wage internship) work for the company on their rebate strategy.

In essence the strategy is to design products that has 2 components to its value proposition – point and network value. The point value is value proposition for the product independent of the # of people in the network. As a result, users are compelled to adopt the solution regardless of general adoption. Personal productivity software such as word, excel etc derive most of its value through its ability to allow its users to be more efficient, more accurate, and more productive. The hard part is to create coherent synergies between the two components that encourage the usage of the network component once the user begin using the point product. Intuit is doing this via Quicken (point value) + MyQuicken (network value) which includes Investing Center, Banking Center, Loans, Insurance etc. As another example, Trumba’s calendaring service could create more point value for its software if it is able to synchronize the various personal work/home/online calendars of a single person before relying on the ability of the service to publish to multiple users.

Of course, none of the strategies presented here are mutually exclusive, try it all if you have the time & money. But given limited resources some evaluation will need to be made on which combination will be the most effective. Also, I’m sure I’m missing some as well as this is based on my personal experiences and observations, so feel free to add more.

Good article in Knowledge@Wharton on Three Reasons Why Good Strategies Fail: Execution, Execution…

Buried within the article is an interesting nugget on two school of thought on key to execution success.

One school emphasizes people: Just put the right people in place and the right things will get done. However, within the people school, there are also divisions. Some experts insist that the right people are hired, not made. “The idea is you get A players, you pay them a lot of money, and you pay them for the performance they generate — irrespective of what may be happening in some other business or region,” Mankins says. Others within the people camp think that the key is to improve executive performance through training, and improve the average employee’s performance through the creation of a culture of accountability. For example, W. James McNerney, Jr., the chairman and CEO of 3M, argues that by improving the average performance of every individual by 15%, irrespective of what his or her role is, a company can achieve and sustain consistently superior performance.

A second school emphasizes process rather than people, Mankins says. Larry Bossidy, the CEO of Honeywell and co-author of Execution: The Discipline of Getting Things Done, is one of the leading proponents of this school. Hrebiniak is also a firm advocate of better processes. “If you have bad people, sure, you’re not going to do anything well. But how many organizations go out and hire bad people? They all hire good people. So something else must get in the way,” he argues. Mankins, however, believes both propositions have merit. “I don’t believe those two schools of thought are competing. I think they’re just two sides of the same coin,” he says.

From my perspective, most boards (public or private) tends to hire good poeple in order to implement good processes. At the highest level, the boards simply do not have time, energy, and sometimes the expertise to fix things themselves. Unfortunately, sometimes this baton is just handed down from level to level until nothing really changes except a game of musical chairs.

Ok. . . this is getting ridiculous. . . . (although I have to give them credit for being clever). . .

Today I got a snail mail from Internet Listing Service Corp looking suspiciously like a bill for an domain name I bought a few month back through Yahoo!. (even got that billing “blue” background with visa and mastercard logos)

Its asking me to give them my credit card to pay for

1. 1 Year - $35.00
2. 2 Year s- $60.00
3. 5 Years - $140.00

“Annual Website Search Engine Listing”

Now, I know these guys are trying to walk a fine line as to not get dragged into court. If I read the “bill” carefully, I can find out that I’m actually paying for a search engine registration service not domain registration service. (damn expensive xxx registration service at that). And there is a warning that “This is not a bill. This is a solicitation.”

So with that, they are hoping to get away with the scam, hoping that spouses, parents, or just some unsuspecting person will give them their credit card and pay off the “bill.” Once they charge my credit card, I’m not sure what other unscrupulous thing they plan to do with it. . .

Its the wild wild west out there . . .

We’ve heard so much (and too much) regarding the long-tail of content. . . books, blogs, podcasts, videos. .. but is there such as thing as a software long-tail? I would say so, but the harder question to answer is that “is there money to be made in the tail?” The deeper and more important question on the economics of the software long-tail is that

1) can money be made in creating a marketplace/aggregator for software (big head + long tail)?

2) can publishers of niche software (tail) make enough money through such a marketplace?

Apparently many people think so.

In the last few weeks, Vector Capital’s purchase of WinZip, Yahoo!’s acquisition of Konfabulator, and finally Salesforce.com’s announcement of Multiforce all points to one emergent thought that the software tail is where the money will be.

Almost 10 years ago, the consensus was that there really isn’t big money to be made in creating applications for the Windows platform especially in consumer applications. (and also because NT hasn’t really made inroads beyond the work stations market). The general wisdom was that whatever you create/code Microsoft will eventually “embrace & extend” it to death if the market is big enough. . . (actually, mainly just give it away for free). Whatever is left, Symantec will scrap up as if Microsoft has an implicit understanding with Symantec to let it protect its flank in return for some market share. This was even more so after Office blew away wordstar, Ami Pro, wordperfect, Lotus 1-2-3 etc.

Of course the world changed when. . .

1. The internet arrived and brochure websites became web apps
2. Intuit Rebel Alliance was able to beat back Microsoft Evil Empire

Given more opportunity, and increased confidence . . . entrepreneurs and VC’s began to fund consumer plays (which eventuall let to e-commerce companies) more often resulting in the last consumer bubble and todays’ web 2.0.

This has been happening for quite some time now, but no VC really jumped into a market where they considered themselves part of the tail. They were still out trying to hit homeruns trying to find a market large enough (the head) for that multi-billion $ play.

But now, it seems like VC’s, entrepreneurs, and companies are getting more and more intrepid, willing to bet into any part of that long-tail meme.

Konfabultor was a collection of tail/niche applications waiting for a player with critical mass of users and more a broad portfolio of mass-appeal applications (& content) to acquire it and really unlock its value.

Vector is perhaps hoping the change in economics of the business (be it micro-payment, software subscription, increase distribution through aggregators) might enable to it finally monetize the WinZip user base.

Salesforce.com is making an even headier bet. That it wants to be the aggregator/marketplace of choice for hosted applications. By building a platform (which I hoped an open source version will one day appear) with basic services (authentication, hosting, application server, payment, provisioning etc), Salesforce.com hopes to be able to become what

eBay is to “stuff”
Netflix is to video
Napster/iTune is to music
xxx is to Podcast
blah blah is to blah (cause everything is a long tail  )

So lets celebrate sofware’s arrival at the long-tail party and wish them good luck.

I’m not even sure how to articulate this and I’ve been thinking about this on and off for almost 3days now. In the spirit of blogs, this is just going to be a rambling rant. So here goes. . .

Something is going on in the Internet industry that goes beyond the concept of “brand” make popular by David Aaker and other.

Google has built so much brand equity behind the whole concept of “don’t do evil” that its users have given it incredible leeway in the way it conduct business and release products. The web accelerator product, its adware guideline, and autolink that would have raised much more scrutiny if a company like DoubleClick did the same thing.

Claria on the other hand is trying as hard as it can to figure way to legitimize itself and find more above board business model – in order to find a way to find an exit despite huge revenue #’s. (I heard rumors of $100M +). If Claria tried any of Google’s tricks, all hell would break lose.

Microsoft has spent billions to create a gentler and kinder image. Passport failed for variety of reasons including lack of trust from the user base.

The eBay community has made a habit of voicing its displeasure on any changes (for better or for worse) to the website (many times rightly so).

Yahoo used to change its relevancy rank algorithm without much uproar but advertisers are now quite sensitive to transparency of its process. But comparatively, its users certainly have not demanded the kind of transparency that eBay’s has given even though the overlap between its advertisers and eBay’s sellers should be significant.

The overlap between the user bases of the various companies is intriguing. This is not about the brand preferences of different users segments; but that given the same person he or she has different expectation from different companies on the way they conduct their businesses.

I call this expectation - “implied customer contracts.” Brand is more about preference, value, and choice. Brand rarely illicit uproars unless something seriously goes wrong. “Implied customer contracts,” on the other hand, is much more. It limits (or opens up) the strategic options of the company whether it is a new product, a new acquisition (MSFT buying Claria), or new strategy. Customers seem to believe that there is an unspoken contract between them and the company on how the company is “allowed” to behave. Anything outside the implied customer contracts, huge displeasure is voiced as if a contract was breached. In many ways, customers are running the show more so than ever before.

How did this happen? Certainly, the Internet is an exciting medium and technology that elicit incredible emotional response. But more so, many of these technologies effect our quality of life more deeply than anything else we’ve seen in the consumer business previously. We spend more just as much time now on the web as we do watching TV (more so if you count work hours). Furthermore, the interaction is active versus passive. The quality of our web interaction and its effect on our sense of “normalcy” is deeply ingrained into our routines. Any change to our web experience seems to elicit the same response as if our favorite route to work is suddenly closed. Certainly not “material” but deeply unsatisfying and worth bitching about.

Companies need to be exceeding aware of the action it is taking today and how that action and future actions will accumulate to create customer expectations that might be a strategic weakness or strength later on down the road. Careful planning and communication is needed to really create a coherent “implied customer contract” that allows for flexibility and goodwill from its customers. It is much harder now for incumbents to change the way their customers expect them to behave. Like real contracts, I believe this “implied customer contract” could eventually become a liability. For many ‘net giants this expectation could become their Achilles heels. Clayton M. Christensen concept of “innovator’s dilemma” could become more acute than ever.

Here is the News.com blog which says Gilder says so.

Eh. . . quite a contrast to the dead blog sentiment of yesterday . . .

Gilder argues that TV is dying and will be followed by Hollywood. . .

In an apparent hidden reference to the long-tail, he argues choice will enable blogs or (video blogs? or I think he meant to say “peer-produced content”) to overtake TV/Hollywood. . .

As much as I think the Long Tail is an valid economic framework. . . lets not forget two more proven and probably more important theories/forces . ..

Economies of Scale & Economies of Scope

Yes, the internet will drain dollars away from TV and Movies. . . through a variety of means . . . blogs, TIVO, streaming video, bit-torrent. . . etc. . . basically we only have so much time a day and we are spending more on the ‘net. . . no arguments here. . . everyone agrees . . I would not even ague with people that think the market will shrink by over 50%.

BUT TV & movies will not die because Economies of Scale and Scope. The entertainment industry business model relies heavily on economies of scale and scope. To create a truly profitable content requries huge capital investments in order to create contents that are “scalable” and with mass appeal. Those investments in technology, marketing, distribution, brand (of actor/actress), and production are so large that no “blogger” or individual content producer can hope to ever match.

Those invesments and the value it creates for consumers creates economies of scale and scope for the TV & Movie industry. Certainly these advantages are reduced with the internet but I’m not expecting the JibJab guys to produce Toy Story IV anytime soon.

BTW: notice the flame in the comment section of the Gilder article. . .

Here are some other with similar sentiments. here, here and here

My first systematic exposure to the venture world was in a class back in my college days at Stanford. I vivdly remembered the very first thing Professor Kosnik said on the first day of class was dont let your startup become the “LIVING DEAD.” Your time is your most valuable commodity. Dont let your startup drain the the most productive time of your career. Succeed or fail decidedly. Move on, get up, do it again if you have to. Just dont let it linger. You only live so long and have so many shots at changing the world.

Today, Fred Wilson in his popular “VC Cliche of the Week” series talks of non-exits from the VC perspective which is almost as painful. (Opportunity cost is lower for VC’s since they can invest/particiapte in 5-10 companies at a time)

In the simplest case, the patient dies. That’s usually good for everyone involved. The company didn’t get customers, revenues, and build a business.

But it’s rarely that simple. Some companies get customers, revenues, create value, but don’t get cash flow positive. They end up on life support and nobody wants to pull the plug for good reason. This is by far the most common cause of deal fatigue.

So whats does this have to do with blogs? Well… later on in the day I read two more posts reference through threadwatch about the future of blogs . . . both decidedly negative. . .

Future of RSS is Not Blogs by Sharon Housley

When will blogging peak? by Jeremy Z

With that, I have to say based on my tiny sample size, many of the blogs I used to love to read are now part of the “Living Dead” While certainly popular once upon a time or atleast launched with some fanfare - today they are dying slowly with infrequent updates losing subscribers.

So I say this to these bloggers, treat your blog like a startup - dont let your labor of love become labor of lame. Update more frequently or shut it down completely. Other options include join something like AlwaysOn where you can contribute to a community instead or opening up your blogs to more contributors to keep it fresh. In the end, no one likes the living dead.

On a controversial note here are my dead blog walking candidates. . .

VentureBlog - Got so famous it was on NYT (or is it WSJ), the first blogs on the venture industry. . . now updated once a month. . . I used to love reading it once or twice a week.. . . now its like losing touch with a close friend. . . very sad

Ray Ozzie - wow last post 2004. Ozzie’s got a lot of street cred, please dont be so selfish and share some wisdom with us. Dont be a part of the bandwagon and disappear after a half hearted effort.

NW Venture Voice - one post a month. . . hard to get the “voice” of the firm this way

Bnoopy -JotSpot must be taking a lot time .. . although for every post still get a lot of comments. . . Joe Kraus must have lots of friends

VCBall - again another VC with a once a month blog. . . cant help but think these guys are just trying to gain some blog-cred but not putting real effort into it

The New Normal - started with a bang, now its ….. dead? maybe not? is it a blog for PR purposes when Roger launched Elevation or for his new book?

Seeing Both Sides - this is just a warning dont give up yet. . . losing a little bit of momentum

BUT in the end, like Dave Cowan says, Who Has Time for This. . . we all got to feed our kids somehow. I aint got an extra hour or two a day. . . maybe I’ll end up like these guys eventually. . . a living dead blog. . . so feel free to flame me then too

The problem with “waterfall” product development processes is not the process itself. Its the people. The process relies too much on informationation transfer in huge chunks that gets larger and more complex as the process moves down the chain. Unless you have a fully motivated and very detail oriented team, something WILL get lost in the translation. More simply put, people hate to read and ends up just skimming the PRD, scope, ERD, and whatever 80 page document you put infront of them.

Well, Sasha over at Yahoo! has a little “plug-in” called Collaboration Sessions that attempts to get everyone on the team to think in the same framework regarding the product to be developed that helps (but not completely) make the traditional process more effective.

BTW, Boxes & Arrows is my blog find of the week. Seems to have lots of Yahoo! people blogging so gives alittle insight into the nature of the beast over at Mathilda & First. Will have spent Saturday morning catching up on all the old articles.

Base on statistics below, from PE Week Wire, as bad as it seems, its probably still easier to raise a round of money for a new VC fund than to raise seed/series A for a startup.

In light of Tejas Ventures folding after being unable to secure enough LP commitments for its debut fund, I looked at some data about recent first-time fund-raising activity. Getting the first one done is never easy (most fail), but first-time VCs are faring particularly badly right now when compared to their first-time LBO peers.

According to data from Thomson Venture Economics, the percentage of first-time VC funds getting raised compared to overall VC funds getting raised goes as follows:

2000: 34.27%
2001: 33%
2002: 28.4%
2003: 31.3%
2004: 26.84%
2005: 16.67%
Compare this to first-time LBO funds as a percentage of all LBO funds getting raised:

2000: 21.47%
2001: 25.3%
2002: 36%
2003: 28.57%
2004: 21.15%
2005: 21.05%

Web is abuzz with the Myspace Acquisition (SiliconBeat,SearchViews,Marc)

What percernt of MySpace’s pageviews is from non-monetizable content? Ie “models”, “adult entertainment professionals” and “others”? While positioned carefully as a “music” affinity destination, a large percent of MySpace’s traffic seems a little “sketchy” to me. Dont have anything quantitative, but go ahead and surf around, its certainly not a PG-13 kid of place (much less PG). Quite a stiff price to pay for the offline equivalent of Broadway & Columbus in SF. (ie kinda hip, kinda seedy, lots of traffic).

For the bankers out there. . . 12% premium seem kinda low doesnt it? Compared to Shopping.com of 20% premium. I would guess that the drop in premium is a potential sign that sellers are eager to sell and KNOWS their stock is over valued. When insiders sell, the bubble might be just around the corner. The question I have is how the VC’s plan to liquidate their MySpace stocks? Murdoch didnt buy Intermix just to spinout MySpace for an IPO.

EDIT: Bill Burnham just answered my liquidation issue. Great analysis, scary smart deal structuring by both firms which should scare any entrepreneur sitting the table across from either of these firms.