The widening chasm between rich and poor may well threaten our democracy. Yet if that banker’s lament staggers your brain as it did mine, you’re on your way to seeing why America’s income gap is arguably less likely to spark a retro fight between proletarians and capitalists than a war between what I call the “lower upper class” and the ultrarich.

Perhaps its sour grapes (actually it definitely is). But this Forunes Article: Today’s lower upper class is seething about the ultrawealthy. rings so true to me.

The largest “sequential” income gap is no longer between the poor and the middle class . . . its between the rich and the ultra rich . . . no only that its the somewhat rich that has the will and the (comparable) resources to lead a revolution. Perhaps its even easier to remember that historically revolutions are most often enabled by the proletariat but LEAD by a coeterie of somewhat rich & up-and-coming men desperately attempting to overthrow the top .5% (of wealth and of power).

But the hopes and dreams of today’s educated class are based on the idea that market capitalism is a meritocracy. The unreachable success of the superrich shreds those dreams.

“I’ve seen it in my research,” says pollster Doug Schoen, who counsels Michael Bloomberg and Hillary Clinton, among others. “If you look at the lower part of the upper class or the upper part of the upper middle class, there’s a great deal of frustration. These are people who assumed that their hard work and conventional ’success’ would leave them with no worries. It’s the type of rumbling that could lead to political volatility.”

Political volatility? Perhaps not political volatility but a changing of guards . . . with republicans representing the ultra rich and privledged . . . democrats needs to recognized the power, spend, and will of the somewhat rich . . . its about time ?

If people no smarter or better than you are making ten or 50 or 100 million dollars in a single year while you’re working yourself ragged to earn a million or two - or, God forbid, $400,000 - then something must be wrong.

eeks. . . I guess I dont even qualify to be bitching . . . I better fall in line and join the labor party instead

Metcalfe’s Law (as it is common interpreted) is miss-leading. Even Bob Metcalfe himself recently re-iterated that the law can only be applied “locally” rather than “globally”. IE, the network effect is subject to a limited portion of the X-axis and not the entire curve. To put it in layman’s term, network effects derived from Metcalfe’s law do not last forever . . . in fact. . . it only applies only when the network is achieving scale. In his words:

As I wrote a decade ago, Metcalfe’s Law is a vision thing. It is applicable mostly to smaller networks approaching “critical mass.” And it is undone numerically by the difficulty in quantifying concepts like “connected” and “value.”

Not sure how I missed this post (Metcalfe’s Law Recurses Down the Long Tail of Social Networking) by Bob Metcalfe himself. But this is huge . . . even Bob admits that an entire generations of companies during the first bubble has crafted its strategy based on the vision of the world as V = N^2 rather than what he really meant -> V = A*N^2.

So, if V=A*N^2, it could be that A (for “affinity,” value per connection) is also a function of N and heads down after some network size, overwhelming N^2. Somebody should look at that and take another crack at my poor old law.

Of course the cost (C*N) of getting connected in a social network has been going down thanks to the proliferation of the Internet and its decreasing price. The value (A*N^2) of particular social networks has been growing with broadband and mobile Internet access. Emerging software tools expedite the viral growth and ease of communication among network members, also boosting the value of underlying connectivity.

In fact, A is not even a constant but another equation which has dependent variables N as well. There are HUGE HUGE (can I be more pedantic?) implications. Network effects did not kill the Techonology Diffusion Cycle (aka the S - Curve), in truth, it only describes locally the ramp up portion of the curve. In the end, the S-curve will win out and adoption will slow - with or without network effects. . .

Bob has essentially made 2 admissions

- the ramp is steeper than ever, that at the initial adoption phase, due to large decrease in cost of network connections in the last 5 years, network effects is as strong as there ever was

-However, as a network scales, opposing forces will come into play which cancels or reduces its increasing returns properties and flatten out adoption

What does this mean? Web 1.0 (and some web 2.0) giants are fucked as they finish climbing up the S curve and as network effects dissipates. Web 2.0 startups faces a much easier path to critical mass than ever before, thus it can mount a credible challenge against the incumbents.

1. For new start-ups the decreasing cost to scale has created cheap and fast ways of gainning large amount of users and achieving critical mass. Look at how fast youTube grew in the last 18 month. Simply unbelievable. Even Google took 2-3 years before achieving traction. It wasnt just 24 month ago that Myspace was just a speck. . .

2. For giants like eBay, Yahoo, Google, and even Facebook and Myspace (today). . . the MARKETING FACT OF LIFE - SEGMENTATION has slowly reduced the value of network effects. By definition, network effects is a mass market play. It is in opposition to the concept of niche marketing, niche product, for niche segments - ie the better you can target your product or service to a particular niche the more likely he or her will chose your product over a competing generic solution. These giants cant no longer band-aide new site wide features and functionalities hoping to attract new segments to their website as USAGE TIME, SCREEN REAL-ESTATE, USABILITY limits the feature creep. This admission that network effects is no longer the dominant driver of their business - that segmentation is - is widely seen but rarely discussed . . .

- Facebook opening up to non-college students

Still fighting a good fight, refusing to give up on network effects eventhough the number are telling them that the growth is lowing. They might just stab themselves in the foot by refusing to segment their social networks.

- Myspace demo over 35

The value of each connection within network is decreasing for new users & existing users as demographics become more diverse.

- eBay launching eBay Express

Recognizing that there is a segment of cusotmer (new! now!) that will never “take” to the traditional ebay.com and that segment wants an entirely new shopping experience that having a new & BIN filter simply does not allow

- Google buying youTube

Trying to conitnue to depending on its userbase from google.com to build critical mass in its newly launched properties no longer works. It bought youtube to create another destination to funnel traffic to its set of services . . . it needs more than one network effects to drive it future growth . . .

The net effect is, ofcourse, that the world is getting flatter. That the ebb and flow of startups & incumbents will continue, competition will increase . . . and that nothing grows forever . . . (perhaps not such a new concept after all)

All it take is one week to ruin someone’s reputation on the web. Just another example of the divide between the technology blogosphere and the rest of the web (ala rocketboom vs. lonelygirl15 or digg vs. collegehumor) . . . Murry Gunty was a big deal for the technorati but rest of the web could care less . . . in this case, Aleksey Vayner has been THE news for the last week but I barely read a peep about him in my usual feeds by the pundits (you know who) of the valley . . .

Anyways, I wont delve into it too much but this Aleksey guys is a prototypical jackass found in 10% of the MBA population . . . even worse he *allegedly* falsified his resume to include founding an investment company, a charity, and even a book on the holocaust (how low can you get?)

IvyGate is widely credited as the lead blogger on the story

DealBreak has some juicy stuff as well.

Gawker really broke the story open.

And I think I just saw it on the yahoo homepage !!!!!

ReveNews speculates that ValueClick is planning to sell CJ and focus on its behavioral targeting business and perhaps build out an agency.

Who Might Buy CJ
Advertising.com, aquired by AOL in 2004, has been attempting to set up an affiliate network for years and has never managed to get traction for various reasons. If it buys CJ, then this gives them a huge footprint in the affiliate marketing space. Also, the CJ network should fit in nicely in properties that form Ad.com.

As for my other thought, first let me emphasis, this is all speculation and I have no inside information from anyone, so what I’m about to say is just some thinking aloud. Experian Interactive is building an online lead gen powerhouse, and CJ, with it’s strong anchor in lead gen, fits nicely in its portfolio of companies. And they get affiliate marketing, after all, LowerMyBills.com and ClassesUSA are just affiliates that set up a sale side and then grew into giants.

And I’m sure their would be many other suiters that would buy CJ too. It seems to me, ValueClick is at a crossroads when it comes to CJ; this will be interesting to watch.

If I was eBay, I would be looking at this very very carefully. I would use leaving CJ as a leveragee to give it negotiating power so it can acquire it cheaper than anyone else. Once eBay buys it, it no longer has to invest in its own affiliate technology to increase margins. Plus, if I was ebay, I’ll combine it with the contexual program its testing and take on adsense (starting with its huge base of affiliate marketers who 100% also uses adsense). Futhermore, it can turn its world class internet marketing team/technology into a profit center rather than a cost center . . . this is a bet that eBay NEEDS to make. and sounds like the ante is not that high either . . .

Core Marketplace + Express + Pay Per Call + Pay Per Acquisition + “Future Initiatives” are all viable bets around the advertising/marketing (or simply customer acquisition) industry . . . where Google hasnt gotten a strong head start.

Thought provoking conversation on Enterprise 2.0 by Jeff and his buddies (Sadagopan, Barry) + a retort by a VC at polaris. Surpisingly, the conversation helped me reconcile a part of my past with my current path. (original post )

First caveat is that I’m completely out of my depth when it comes to discussing SOA, master data management, customer data integration, and product information management (eh?). But I did dabbled my feet in the dot-com days in selling to enterprises (notice I didnt say enterprise software, small businesses is probably a better word) so perhaps I can share in literal terms about my experiences. In fact, Jeff was one of my board members, (I’m sure Jeff have already completely erased his association with our venture from memory ) .

We were a “B2B Marketplace” that allowed general contractors to find and manage subcontractors. Even in the beginning, we recognized that we were really a provider of web based application software to the industry, and that the “discovery/search” value proposition of the marketplace was minimal. In fact, at the time, there were so few “SaaS” (a term that appeared much later) examples, that hotmail was my main source of inspiration. We were blazing a trail but haphazardly, inconsistently, and perhaps even without a hint of self-awareness (for better and mostly for worse). We had some of the characteristics of so called “enterprise 2.0″ but because we lacked the self-awareness to created a coherent strategy & execution plan that would have become the ethos of enterprise 2.0/web 2.0. My failure was driven by naivite, inexperience, and in small part, the lack of precedence. . . . and that is the hardest part of enterprise 2.0 . . . having all the pieces wasnt enough, everything has to fit just right because there is no playbook . . . yet.

1) Direct enterprise selling sucks, is highly inefficient, and makes you do unnatural things in your product strategy in order to drive higher deal sizes. We vacilated between thinking that we were an enterprise productivity tool vs. enterprise software. Enterprise productivity tool should have been the right answer especially after spending time at eBay (its sellers are the SME sweet spot) . . that recognition changes everything you do from marketing to design . . . on one hand, we had a hotmail like viral acquisition strategy (self service, self signup, referals as expected functionality, and bottoms up adoption/sales cycle starting with the end user rather than the CFO) on the other hand, we also had a sales force focused on the enterprise RFP process. We couldnt reconcile freemium vs. value pricing . . . and we should have, by coming up with a revenue model focused either on services or scale rather than seats. This is how open source has thrived, and how salesforce.com scaled.

2) Large enterprise software vendors are not the future. There just has to be a way to grow our collective markets by appealing to millions of small business users and this isn’t going to come from SAP, Oracle, or IBM.
The million niches like construction are the future. . . its the gap between Intuit and SAP; the gap between accounting and ERP application that is the future. (both is usage & in segments)

3) The SOA-ification of big enterprise products has attacked a technical dimension, not an economic or business model one. In a somewhat bizarre turn of events, the historical strength of market leading business applications, the integrated suite approach, is being turned from an advantage into a liability.
Taking a productivity view of the product rather than an ROI, creates a whole different approach to development & design. Instead of focusing on ROI, inefficiencies, and risk managment of the enterprise, we could have focused on ease of use, adaptability, and integration at the end user interface level (rather than at the data level). Furthermore, click stream usage data becomes the overwhelming driver of development plan rather than feature/check box focused. It also focuses the company on serving its current customers rather than using product development to chase after deals which might not be in its sweetspot.

5) New big killer apps that are not going to be built for today’s enterprise. Most of the enterprise software market today is about finding gaps and filling them, linking products in new ways, and leveraging more value out of IT investments that have already been made. The consumer side of business may offer better opportunities.
Adobe calls a similar segment, “prosumers” . . . having all the characteristic of a consumer (usage & decision making) but with a profit motive as well. Small business owners evaluate sofware (webapps) like consumers and even pays like consumers, thus scaling sales is more important than chasing elephants. (eBay retrenched from its elephant strategy in 2003 if you read the press release carefully enough)

Lastly, I believe AJAX will have a much larger impact in the enterprise than in the consumer market. Consumers were anchored to the experiences of web 1.0 which made web 2.0 dynamism a refreshing improvement. On the enterprise side, end users are used to the interactivity and responsiveness of desktop applications already. As a result, some of the lack of adotion for webapps in the 1.0 (or dot com) days could be attributed to usability concerns. Ajax finally allows SaaS to compete on the same interactivity level as client/server applications. Web 1.0 simply did not have the RELATIVE impact on the enterprise world as it did for the consumer. I think Enterprise 2.0 could potentially be the step wise improvement of consumer web 1.0 and 2.0 combined for the enterprise world.

The quality of a blog is reflected and supported by the quality of comments. VentureBeat (Matt Marshall) has by far the best blog in the industry (judged by the comments) because of the reader he attracts as active contributors to the community. Intead of the usual - “Great post, I love to kiss your ass” comments, there is actually a lot of knowledge/experience shared on almost any post.

Today’s post on Visto was thought provoking not only because of the post itself but because of the comments. Given that only 1/10 venture funded startups achieve liquidity, it is more likely than not that an entrepreneur will encounter a “down round” and/or “carve outs” during his time than an IPO. Thus the information on this thread is more important than learning how to price an IPO or put together a roadshow. Instead of learning from experiences, comments like these can save lots of heart aches down the road.

Here are the cast of characters . ..

JB - sounds like a ex-VC returning from the dark side

Sometimes these “pay to play” financings are forced (coerced) by investors that smell an opportunity to increase their ownership stake and restructure clauses and preferences in favor of those that can continue to pony up money, money that they insist they have and on unconscionable terms. Management, typically new and hired guns, is unsurprisingly compliant. Why? They get what is called “carve outs” which is a guaranteed minimum payout (for the CEO and his favored executives), before any other common shareholder (or for that matter, prior investor) gets a penny.

So with carve-outs, restructures, etc. what hope can the common shareholder have? In the absence of a multi-hundred million dollar acquisition or IPO, the answer is: zilch, nada, zippo. Better for them to try their luck elsewhere. To Martin’s point about .5% or 1% or for that matter, 10%, I ask: does it matter when there is little left after the VCs take their cut (and liq prefs) and the execs their carve-outs which leaves (if anything) a measly amount to be split amongst the common shareholders.

Brian McConnell , a entrepreneur holding “perhaps” worthless common stock due to a (regrettable?) exit to Visto

Visto is a special case, and is likely to be Exhibit A for everything that is bad about venture backed private companies, from bloated and mediocre management, to insider deals that wipe out other shareholders. . . .

I am quite sure the average employee, who knew nothing about venture financing, was completely clueless about the actual value of his/her options, etc. It might as well have been a random number.

This is why I think private companies should be required to publish their financials, at least internally, with the same criminal penalties for fraud and misrepresentation. At present, common shareholders and employees are often treated as second class shareholders, with little or no access to accurate information, and little recourse if they wake up to discover that their shares are worthless.

A “Concerned LPs” (a frequent commenter) who should just step into principle investing

There is simply no way founders can structure a deal to protect against carve-outs and other malpractices which are typically engineered by VCs and compliant (new) management (brought in to wipe out everyone else).

The case that is most pertinent is Alantec vs Mayfield (and other VCs) of the mid 1990s. The company was doing ok but not great; VCs engineered a crisis with compliant management to oust the founders and under pretext of financial necessities, recapped the company on terms highly preferential to the “new” investors (all of whom were already investors; no new investor stepped in knowing they were treading on thin ice). Company later flipped at a great profit to those “new” investors. Lawsuit filed by founders and the VCs lost in trial and had to pay up to the founders and common shareholders who were left out earlier. Since then the VCs have not attempted to go the legal path and simply settle (Nishan, Epinions, Rapt, …)

Yann who sounds like he has a degree in economics . . .

Very good thread of discussion! This is an agency problem seen in many asset classes that can only be addressed by transparency and close watch to conflicts of interests.

When you have bloated seriesA valuations, cyclical markets, general uncertainty of a technology or market, even a sound business will have up and downs. Google struggled along for a while before finding the right business formula. So in general, the concept of value going up and down is normal, and common shareholders should not be penalized for that.

If management is forced to be open and explicit about the terms and financial consequences, they will tread carefully. The need to be fair to employees and other common will force management to be fair in these.

So let’s push for transparency and accountability.

Ty Pike who offers some preventive medicine for all involved . ..

c) stay away from venture firms and partners with little operational experience, esp as entrepreneurs. If they haven’t started companies they are unlikely to empathize with entrepreneurs and employees. This worsens if the partner has a financial background.
d) Watch out for “stories” explaining why new money is needed, new management is brought in, etc. Ask if the new managers have the same clauses as all other common shareholders or if some animals are more equal than others. Watch for scapegoating of the previous team (or founders), as it is a timeworn tactic to disguise the greed of those new on board.

I was going to title this post Marketplace 2.0 (you know like software 2.0, enterprise 2.0) but I realized I dont want to create another empty bandwagon Anyways, last week, oDesk raised a good chunk of cash from an investor that knows more than anyone about building marketplace businesses - Benchmark. Which reminded me of one of the most important things I learned in the 2000 B2B craze.

As much as most people think that the value created by market places are from counter party discovery (aka search), capturing that value rest solely on providing transactional settlement services.

eBay.com is the exception rather than the rule. For consumer goods, the search cost of finding a business is high and the switching cost low. Thus EVERYTIME you want to buy a laptop, you will try to find someone to give you the lowest price. Thus eBay was able to build a gigantic business focusing solely on “discovery” as its main business. However, in the long run, when Google has taken over the world’s entire need for search, I would venture to guess that in 5 years, Paypal will generate over 2x the revenue of eBay’s Marketplace business. Note that Paypal is an example of a settlement service (financial one).

During the B2B days, eBay’s success on its business model let many to believe that if one created a marketplace and help business x find business y (or person x and person y) one can charge 10% for helping to broker that transaction. Oh boy, were we (I) wrong.

For most other businesses (non-consumer goods) counter party discovery is a commodity. It is also part of the transactional value chain that is hardest to capture. In most transactions, relationships matter much more (finding a plumber, contractor, house, supplier of PCB’s, or babysitter). The switching cost to of changing vendors/customer are very high. In that environment, once the introduction is made, the relationship between buyer/seller is taken “offline” - there is no longer a need for the marketplace going forward (for the completion of the initial transaction AS WELL AS the next transaction) . . . UNLESS you can add value through settlement services.

The marketplace (the discovery portion) is actually NOT the core competency of the marketplace business, it is just another way for the venture to hedge and reduce spending on Google. The marketplace acts as a FEEDER into the settlement services provided by the marketplace. As does Google. . .

Google has create the biggest “suckout” in the history of business by rendering metcalfe’s law irrelevant.

In such a world, oDesk has created the model for the next generation of online marketplace ventures. While others are still stuck in the 1.0 world competing with Google on search/discovery, oDesk has instead focused on how to lower friction and increase trust for the ENTIRE value chain. It has created a platform for relationship management that does not in anyway pigeon hole the value of the marketplace to fulfilling the initial need for finding a counter party. It has inserted itself between the buyer and seller permenantly. And that, is the brilliance of oDesk.