Meritocracy Consulting Blog

February 10, 2010

Microsoft, stop copying Apple! Your old strategy will work just fine.

Filed under: Apple, Microsoft, Tech — Scott @ 3:25 am

In many posts I point out the perils of vertical integration.  Yes, Apple has succeeded with a strategy of vertical integration, but correlation is not causation.  They have not succeeded because of vertical integration, they have succeeded in spite of it (so far).

In recent years, almost everything Apple has done has been genius…not necessarily complicated:

Apple’s computers are successful because they clearly found a niche of people that like design, aesthetics and being different…then they built on their success and actually grew this market…or rode the naturally growing trend of discerning consumers.

Apple’s ipod was successful because at it’s launch consumers had thousands of dollars of free/stolen music sitting on their computer.  This phenomenon created an unnatural majority of consumers who were willing to overpay for “the best” and even “fashionable” product that leveraged their existing music collection….then we got hooked.  Imagine if you found a briefcase of $1,000,000 in cash in your backyard.  Are you going to go ask for tax advice from H&R block, or are you going to pay $400/hr for advice from the top legal accountant in your area?

Apple’s iphone was successful because no competent software company took the mobile space seriously.

Apple’s ipad will be successful for the same reasons as the iphone.  Amazon has demonstrated that their is a growing new interest in display only media consumption, but like GPS device makers (who demonstrated the market for high quality mobile experiences), Amazon has created a 1 trick pony.  People want a multi-function platform.

On computers: In any space with public consumption (think sunglasses…not cereal), there will always be a luxury market.  If other people know what you buy, then at least some people will really care about how they are perceived for their purchases.  As prices drop or as the visibility grows, the base of luxury or fashion conscious consumers will also grow.  As prices dropped, people started buying more laptops and computers truly became “personal” (not shared by families).  Apple perfectly seized the opportunity to make people feel special…the reliability and beauty of their software were just differentiation points that further helped convince customers to pay a bit more.

On the ipod: Apple’s product was elegant.  Even excluding the ability to purchase music, itunes was leaps and bounds ahead of Windows media player and winamp.  The fact that people could purchase music legally through itunes just further added to the excitment and allowed retailers, journalists and the media to refer to the ipod/itunes combo as “the solution” to piracy.

On the iphone: Sorry Nokia, Sony, Palm and every other pre-iphone mobile OS maker, your software was terrible.  Apple was the first company to stop “trying to allow mobile phones to use the internet” and they actually figured out how to do it.  If anyone used a phone to try to access the internet BEFORE the iphone you know what I am talking about…your internet access was a party trick at best.  The app market, media integration and touch screen were all great features, but really Apple’s main differentiator was the fact that they made the mobile internet experience fun and possible.  Blackberry was leading the pack in a major way before the iphone.  They countered with an inferior touchscreen, when they should have leveraged their strengths and ONLY their strengths.  If they expanded the accessibility and quality of their apps, addressed the crappy browser, continuously stayed 3X over apple in video and picture quality (which Apple was not very aggressive with)…they would still be leading.  Only when they figured out how to advance touch should they have come out with a touch screen.  Apple pushed mobile forward, but they are not invincible.  Picasso said “good artists copy and great artists steal”, but artists that copy and produce something inferior may damage their reputation forever.

On the ipad: Simply put, Apple has a track record and lot’s of street cred.  They deserve it.  With that said, Bill Gates has been talking about tablet computing for 10 years.  After the ipod came out…and then the iphone…and then the Kindle…what is Microsoft waiting for?  Their existing tablet OS is not that bad, for the past 5 years they should have been developing more “tablet specific” UIs while working on pushing their partners to the exact specs of Apple’s ipad.  I think they feared they would cannibalize laptops and desktops.  I could write many separate posts about how short sighted it is for companies to fear cannibalization, but in short, if you have an idea for a product that consumers would like more than what you currently offer…if possible, do it, or someone else will.

Despite acknowledging Apple’s many successes, Microsoft should not follow Apple down the road of vertical integration. Ever heard the expression that “you should leave the dance with the person that brought you”?  This advice should have been applied by Microsoft the past 5 years and will prove critical to their ability to maintain their relevance going forward.

Microsoft (perhaps still the best software firm) decided to create an XBOX instead of leveraging their strengths (creating software, and presumably software games). While the XBOX is doing OK, the approach alienated many other companies who previously were diehard Microsoft supporters. While it is hard to imagine, what if Microsoft instead created a gaming OS and allowed other companies to create the hardware? Perhaps through a distributed network of peripheral and software creators, innovations such as the Wii remote, TIVO and boxee would have first emerged within the Windows gaming ecosystem. Instead, Microsoft’s media center is on life support, and lightweight hardware devices that stream media are gaining traction as an alternative to bloated and expensive windows home servers. Perhaps most importantly, if Microsoft were more focused on their core businesses they would have been able to jump in front of the curve on Gmail, Youtube and Google Docs while avoiding the Windows Vista disaster.  It is a tough position to criticize successful ventures (like XBOX), but it is my belief that a more focused and consistent approach by Microsoft would have positioned them much better for future success in their 5 largest (or most significant) divisions:

  1. Operating systems and server software
  2. Office software
  3. Mobile, tablets and embedded software (like gas pumps, home appliances, etc…)
  4. Search
  5. Advertising

Microsoft got distracted by the excitement around the ipod and now the iphone…their approach should have been that of the Android. Essentially, Google (with the Android) is giving away the mobile OS to further their strategic goals with items 3, 4 & 5 above, and possibly to give them a strategic beachhead on items 1 & 2 as well. Yes, Microsoft was out front with a mobile strategy, but they were trying to charge $10 for an average…non-innovative mobile OS. Really Microsoft? No internal leaders were able to recognize and galvanize the troops to realize that mobile, search and advertising are your 3 largest vulnerabilities and have been for the past 8 years? Instead, they released a buggy OS, attempted to build a proprietary software/hardware combo with the Zune and XBOX and now are playing catchup big time in all categories (except the operating system…which they lead, but now finally has real competition).

Bill George wrote that this past decade has essentially been lost for American businesses and he critiques the lack of leadership that one demonstrates when they apply (possibly misapply) Milton Friedman’s overemphasis on “shareholder” value.  Companies have focused on financial engineering, outsourcing and cost-cutting…over leadership.   Cost-cutting is great, but a smart, trained and motivated workforce can be re-tasked (rather than fired) if a company has innovation pipelined and a business strategy based on continuous improvement and innovation…essentially a sense of pride and desire to create a lasting and meaningful business.  In layman’s terms, Microsoft should not covet thy neighbors strategy…their problems are related to user experience and a lack of innovation. Any of Microsoft’s new closed systems are not going to solve those problems and instead it alienates all of their customers and partners who have been patient and supportive of their open and clunky (read ‘non-apple’) strategy for years. Those supporters are deteriorating…along with Microsoft’s ability to collect their toll on all computer users.

Some argue that it is not possible for Microsoft to fix their problems (i.e. buggy and non-innovative software) without moving toward closed and vertically integrated solutions.  I believe this conclusion is myopic and possibly delusional.   Microsoft knows that their “partnership strategy” got them where they are, they need to stick with it.  Does that mean change nothing?  Absolutely not.  Specifically, they need to take a close look at their faults and user complaints, reassure their hardware and reseller partners that success will be shared, outline a clear vision, and then copy just 1 thing from Apple…the ability to under-promise and over-deliver.

7 more examples of vertical integration gone wrong

Filed under: Uncategorized — Scott @ 2:24 am

If you have read any of my other posts, you would know that as a technology consultant and adviser to businesses, I don’t like vertical integration.

1) Apple’s refusal to work with Adobe (specifically Flash) despite Flash’s 99% market adoption and a huge existing investment by developers and companies. (Also, Apple’s focus on short-term wealth creation over long-term societal…and possibly shareholder value…through more open and extensible products/services).

2) Oracle’s belief that they can provide all IT to all companies (and now ditching their partners to also provide the hardware as well…after buying Sun). Additionally, it should be noted that Oracle picked up MySQL, the leading open source database in this acquisition…I have not heard many annoucements for Oracle’s plans to improve MySQL.

3) Mobile phone operators’ refusal to unlock phones, invest in customer service or improve the mobile data speeds (the US has some of the worst and slowest download speeds).  I would bet that mobile phone operators have more employees working on blocking illegal traffic and apps than they have researching ways to increase internet access speeds.

4) Amazon, Google, Microsoft, IBM and dozens of other companies all moving forward with proprietary cloud computing platforms.

5) Google buying every company under the sun and trying to compete in all markets…possibly doing so successfully because for the past 10 years Yahoo, AOL, Microsoft and a handful of other incumbents lacked leadership and vision in terms of the internet. (Not to forget the effect the post internet bubble had in terms of no available VC or IPO funding. Without 2nd and 3rd round VC funding, companies saw an exit to Google as a preferred alternative to trying to build a standalone great company).

6) Banks attempting to grow through use of complex financial instruments and leverage instead of improving the consumer experience.

7) Walmart moving into groceries, digital music, electronics, banking and generic drugs…instead of continuing to focus. My main gripe with retail is that all companies are focused on boxing out competition instead of trying to improve people’s lives by automating the process of shopping…is there a reason we still go to stores? Yes, the online experience is inferior.

If you disagree with any of these viewpoints, take a step back and look at the entire forest.  Still disagree? If so, I welcome comments, emails or even phone discussion from individuals looking to persuade me otherwise.

Don’t be fooled by Apple…stay focused!

Filed under: Startups, Tech — Scott @ 2:02 am

Apple is experiencing standout success as a company that tries to do it all…don’t be fooled, vertically integrated companies rarely succeed.

What are some up and coming companies that are doing well by staying focused?

  • Twitter – open to the point of ridicule…they are already competing nicely with Facebook and critiques should realize that their success should also be measured and credited in comparison to all of the less open competitors that did not even get off the ground
  • Wordpress – largest blogging platform…beating Google and other large players in this space
  • Tesla – if they successfully implement the software API that they have talked about (things like dashboards created by 3rd party companies, acceleration/speed limits on new drivers…lame, but of interest to parents, and even self driving cars…could emerge as viable new businesses)
  • Blippy – how have credit card companies, Amazon and paypal not realized this opportunity? Props to Amazon and ebay if they partner instead of competing with this company.
  • Bedrock - new advertising product, turning the controls of Google’s debatable ad monopoly on their head

While these companies are small, they each are great examples as they are solving a narrow set of challenges in a space with near limitless growth potential.  I look forward to watching them evolve, and HOPE that they stay independent.

February 5, 2010

Has Apple changed our view on vertical integration?

Filed under: Apple, Google, Microsoft, Uncategorized — Scott @ 4:35 pm

For it’s entire history, Apple has essentially stuck with the approach of vertical integration, increasingly controlling every aspect of the value chain. Recently, this model has been hugely successful, encouraging the company to broaden their control to include ownership of chip manufacturers, control over manufacturing, extremely strict software standards, a nearly closed ecosystem and proprietary retail stores.

Historically, vertical integration has been typically bad for companies, and definitely bad for consumers (think of how powerful companies have killed innovation and driven up prices):

  • Standard Oil – broken up as a result of anti-competitive practices and price controls achieved through their vertically integrated monopoly
  • AT&T – broken into baby bells, allowing Sprint and MCI to enter the market and drive down long distance prices
  • Current oil companies – controlling prices and discouraging alternative energy investment
  • Cable providers – local monopolies have contributed to the US having one of the slowest broadband speeds in the modern world…not to mention my $120/month cable bill
  • Apple – for years their vertical approach and refusal to just detach the OS from their hardware almost drove them out of business
  • Microsoft – leveraged their natural monopoly to arguably hurt software innovation for years and delay the potential of the internet
  • Mobile phone providers – through vertical integration they delayed the adoption of smartphones, stifled phone operating system innovation and continue to focus on customer lockin rather than on what customers really want…really fast mobile broadband and the freedom to use devices from any manufacturer

In a tandem post, I discuss how the business world has recently shunned conglomerates (once again), but is vertical integration something that finally works? I think that as more companies move toward vertical integration, they are charting a crash course that will eventually end with failure. This belief is entirely unpopular now as a result of tremendous success by Apple, Walmart and the vertically integrated oil companies, but I believe that we are reaching a point where weaknesses are visible in even the “shining examples” of vertical integration.

An impetus for this post and a related post on the failure of conglomerates was Bill George’s article on how the past decade is a lost decade because of an absence of leadership. Bill pointed out some grim statistics and briefly touched on the need for businesses to strive for long-term value. Dead on, but a little vague…immediately I felt like I had something to add in terms of diagnosing this “lost decade”.  Simply put, its cause can be attributed to a return to vertical integration and overemphasis on scale (as was common in the 1800s, and most recently in the late 1960s and early 1970s).

It seems like this past decade was plagued by an overemphasis on blocking competitors instead of differentiating through innovation. While these techniques can be effective for optimizing profits in the short-term, it is not surprising that the US is now struggling to maintain its worldwide leadership and create jobs. When companies place too much emphasis on blocking competition (through vertical integration, local monopolies or other non-innovative techniques) they create a hostile environment where the entire industry fights amongst themselves rather than looking to the future. In the short-term, there certainly will be some winners…like Apple, but in the long-term everyone loses…hence a 10 year period with no real economic growth for the United States.

Not convinced that vertical integration is a second rate strategy?  Check out a detailed look at Microsoft’s trend toward vertical integration as well as 7 more examples of vertical integration gone wrong.

There are literally hundreds of examples to show us why a strategy of vertical integration will ultimately will be bad for most businesses and society. As far as the decade being “lost”, it is my belief that poor leadership results in management’s decision to focus on the “strategy de jour” which seems to be to provide a complete vertical experience that is slightly less expensive. In the short-term this gains market share, but is very unlikely to change the world, improve our lives or spawn the next “unknown” industry. In fact, it seems like a focus on breadth instead of depth actually results in much slower innovation. Would we have been better off if Zappos and Mint stayed independent and continued to innovate with retail and personal finance…I think so. Consumers would benefit more if Quicken and Amazon had viable competitors.  Do I blame those entrepreneurs for selling?  Maybe a little, but it would be nice if late stage VC firms could have provided some liquidity and encouraged them to build standalone businesses.

We’re already seeing a lot of failed efforts and disintegration, but perhaps led by Apple’s relatively recent success as a “total closed system”, I think we will have several more years before this mindset breaks down and true innovation is unleashed.  Do I know what will drive the next phase of growth? No, but if Microsoft had their way back in 1998, the internet would have been used only for allowing customers to download windows applications.

In another post, I advise companies to ignore Apple’s unlikely success and point out several companies that I hope stay focused on just what they are doing.

In summary, working with partners is scary and unpredictable.  The allure of boxing everyone out and doing everything yourself continues to grow as Apple and others find success with this strategy.  If as consumers we can see the benefit of “companies doing less well”, then we should trust history and expect focused companies to win out in the end.  Realistically, innovative companies will probably find a way to leverage partnerships and truly “open platform” strategies will prevail…I do trust markets.  The question, is how long will it take and at what cost to shareholder value and society at large.  Perhaps somehow we can wake up consumers to reward smaller, more focused companies…or MAYBE, the government can empower focused, open and highly innovative companies to thrive faster.

Ironically, if we all put down our iphones and support platforms like Android (and hopefully other new open platforms as they emerge), we’ll actually get better phones a few years down the road.

Have all my business efforts been a waste of time?

Filed under: Uncategorized — Scott @ 4:18 pm

Bill George writes that the last ten years (2000-2010) will historically represent a “lost decade” for business (same post, wsj). I’m 27 years old, so between internships, 2 startups and a lot of technology consulting, I’ve been active in the business world for about 10 years. Does that mean all of my efforts have been “lost” as well?  Upon personal introspection I have concluded that my personal efforts have been productive–likewise, there have been some standout large companies in this lost decade. As a whole, unfortunately I agree that this decade has been lost and our economy has dragged its feet…the question we are all asking now is why?

For statistics and a broad stroke view, check out Bill’s article, its concise and a good intro to my posts here which dive into more detail and provide some specific reasons for the lost decade. I’ve broken my ideas into 2 separate posts, perhaps after another 30 years running companies and making billions, I will figure out how to be as succinct as Bill George. The best summary of his article is a regurgitation of the first paragraph where Bill writes,

“Consider the ugly facts:

  • In the past decade, the U.S. lost fully one-third of its manufacturing workforce.
  • Information technology jobs – the bright spot of job growth in the 1990s – were down 21%.
  • The only growing sectors – education (up 32%), health care (up 30%), and government (up 9%) – are all funded primarily with taxpayer dollars. As the U.S. continues to shift away from the private sector, government deficits mount.

I generally agree with Bill’s overall assessment that the decade suffered as a result of a lack of leadership, but where did our leaders go wrong? A key assertion of his article is that our economy experienced a net loss in non-taxpayer funded jobs, specifically pointing out that health care and education (both heavily funded by the government) were the only 2 major sectors that had a net increase in U.S. employment…oh yeah, we also saw a growth in government jobs. Other industries that we would have expected growth in–such as IT and communications– employ fewer people today than they did 10 years ago (in the United States). The above statistics are clearly grim, and surprising, but these numbers alone do not confirm for me that the decade was “lost”. Assuming these facts are accurate, I immediately wonder how the net growth in IT, communications and manufacturing related jobs would look if we took a global measurement. I would think (without researching) that the growth in jobs in countries like India, Vietnam, China, Brazil, etc… has more than offset the jobs that were lost in the US. Contrary to many protectionists, I don’t think the decade’s failure was related at all to our failure to protect jobs from going overseas (specifically manufacturing), but rather a failure of business leaders and our government to identify and create (or invest in) new rapidly growing industries.

My primary motivation for writing this article is the fact that Bill did not attribute the lack of value creation over the past decade to some failed philosophies that businesses continue support–vertical integration and a return to the belief that conglomerates can deliver value through diversification and management synergies. The late 1960s and early 1970s are infamous for the erroneous excitement over conglomeration. Not many non-business majors remember this period for the disastrous conglomerates that were formed…but the logic at the time proved to be horrible and it seems like every company except for GE disintegrated and returned to the belief that “focus” was ideal. Through incredible discipline GE has continued to do OK, but that is a post for another time.

Despite business schools teaching (to those who are awake) of the failed logic of conglomeration, in recent years we have had many self serving executives (and bankers) convince us that we were now much smarter and could avoid the issues that occurred “last time”.

We have recently, during the lost decade, seen many failed conglomerates. Ironically, every CEO studied the last time period where conglomerates failed…and most of the companies did not even get nearly as diverse as the prior generation before hitting debilitating competition from more focused companies:

Let’s reflect:

  • Banking – Apparently participating in retail banking, investment banking, financial services, insurance, private equity, hedge fund management, venture capital and creating complicated derivatives to tie everything together does not actually reduce the overall volatility or risk of the firm.
  • Auto Industry – GM and practically every other car company got involved with financing, while simultaneously growing their workforce by purchasing suppliers and trying to run many brands that have nothing to do with each other. Does it make sense for Rolex to be associated with Casio? Hint: the answer is no. Car companies thought they could successfully manage high end brands alongside low-end counterparts. The lack of brand clarity in the car industry dragged down the high end brands and prevented companies from focusing on their lower end models…causing both brands to suffer. Focused companies like Toyota and BMW did well while the American conglomerates (and Daimsler Chrysler) suffered.
  • Media Conglomerates: AOL/Time Warner is often called the worst merger ever. Yahoo, with Terry Semel in charge, thought “media” was critical to being an internet company. Shockingly, being good at the internet was actually the key to being an internet company. Google focused on technology, Yahoo diverted their attention to media…Yahoo struggled.
  • True Conglomerates: Tyco, WorldCom, Enron…not surprisingly these companies that grew for the sake of growing (possibly so that management could justify greater compensation) ultimately blew up when the executive’s created accounting fraud…enabled by how complex the companies had become.

So conglomerates do not work…

Being reminded of how the concepts of “corporate diversification” and “conglomeration” fail to create shareholder value seems to now resonate again within management teams. This idea for several years has become more mainstream, but please check out my post about vertical integration since that trend has not really been criticized much at all.

In conclusion, I believe for our economy to grow and for jobs to be created:

  1. consumers need to embrace companies that are focused and not trying to over diversify
  2. investors and private equity groups should verbally and financially support smaller focused companies
  3. venture capitalists and the government should encourage and support smaller and medium sized businesses that are competing through innovation (as opposed to scale)
  4. executives and leaders should recognize a lack of focus as the cause of our troubles, and
  5. everyone should start actively thinking about and discussing the lack of innovation that is occuring through companies that are placing too much emphasis on vertical integration

December 14, 2009

How Amazon web services caused a bankruptcy

Filed under: Startups, Tech — Scott @ 1:09 am

The business covered here is fictional, but I would not be surprised if several real companies have experienced this seemingly paradoxical problem.  Can too much access to scalable hardware on demand be dangerous? (see my previous post on how on demand computing creates good and bad leverage)

Let’s take a look:

A company spends $5 (using CPC ads) to acquire a customer that generates $60/yr in revenue, but requires $50/yr in on-demand computing expenses (using something like Amazon Web Services…AWS).

In case 1: The company acquires 100,000 customers, generating an operating  profit of $500,000 in year 1, and $1 million in year 2. Yay for leverage! Assuming this startup has 5 people, the management expenses might be $500k/year, so the company breaks even in year 1 and earns $500k profit in year 2…this company is sustainable or can easily raise more money.

In case 2: The company also acquires 100,000 customers, starts charging $60/yr, but in month 6 an external factor drives the price point down to $40/year (let’s say, Google entered the space). In this second case, the company would lose $250k in the first 6 months (because of the 1-time customer acquisition cost), and then start losing massive amounts of money (because the service is no longer profitable).  Their balance sheet is clean (no debt), but the fact that the company has to service their acquired customers means that they are essentially locked into a long-term liability…without the cash to cover it.  Of course the service could be turned off, but if that happens, consider the startup dead.  As a customer, would you try other products if a new company just “turned off” a product that you were using?  I don’t think so!  Assuming they do the right thing and keep the service running…now this startup needs to either try to get bought or raise more money…anyone want to invest in a company without a profitable user base burning through $120,000/month in cash?

Here is the financial summary of case 2:

Month 0: -$500k in customer acquisition costs

Months 1-6: $3 million in revenue - $2.5 million in computing expenses - $250k in salaries (and related expenses)

Total cash flow (months 0-6): -$250k

Months 7-12: $2 million in revenue - $2.5 million in computing expenses - $250k in salaries (and related expenses)

Total cash flow (months 7-12): -$750k

In year 1, this company has burned through $1 million, and now has a monthly burn rate of $125,000.  Even IF the employees were willing to work for free to get the company back on track, they couldn’t.  They now need $83,333 every month just to pay their on-demand computing services.  Setbacks like loss of pricing power occur ALL THE TIME, a good entrepreneur can react, find a new strategy and build on prior successes…but not if they are saddled in “off the balance sheet” debt!

In case 2, it seems easy enough to not view their on-demand service as true “leverage”, but in case 2 the company pushed itself to the limit, and got hammered by downward pricing on their product.  Perhaps in a situation where traditional hardware was purchased and deployed, the company would have grown more slowly while focusing on customers with a higher profit margin (to increase the ROI on the computing assets that they purchased).   Imagine if they spent $500k right off the bat on servers and pre-paid hosting.  This company would then have a VERY low burn rate when times got tough…giving them substantial negotiating power when raising new capital.  Of course, there is a HUGE assumption that the company would be able to adapt and find a new revenue stream, but iteration and responding to competitive forces is part of what entrepreneurs and startups are really expected to do.

At least startups should UNDERSTAND how on-demand computing and subscription services impacts their risk/reward profile

Companies using on-demand services should regularly build models to understand how leveraged they truly are.  I studied corporate finance, and to me it seems like choosing to use on-demand services requires looking at a lot of the same “pros” and “cons” that a company would consider when looking at debt vs. equity financing…not surprisingly in our economy that has mastered the concept of boom & bust, I haven’t seen much coverage of the “cons”.

On demand computing can increase a company’s risk!

Filed under: Startups, Tech — Scott @ 12:59 am

Recently, I met with Kent Goldman from First Round capital at an office hours event in Santa Monica.  Kent as been on the entrepreneur and investor side of a lot of really great internet deals.  Additionally, I have heard nothing but good things about their firm and want to commend their VERY entrepreneur friendly networking event that they hosted.  Kent and I spoke about many interesting ideas (some mine, some general tech stuff), and as I wrote my thank you email, I came across an interesting post of his about a concept he is calling Capital Alchemy, or how to convert traditionally fixed costs into variable costs.

I encourage everyone to check out his original post, but essentially he highlights the growing trend of leveraging on-demand services and on-demand computing to grow your company with less capital.  By no means is his post meant to be an exhaustive resource, but he does point out the benefits of this new trend.  For investors, there really are few downsides, but for entrepreneurs and business owners, I wanted to discuss some potentially negative aspects of variable priced “subscription services” or the increasing reliance on “pay as you go” services as you try to grow your business.

When fixed costs turn into variable costs, the obvious benefits are flexibility and the ability to grow with less capital. The standing argument (not just from Kent) goes that any cost that can be turned into a variable cost…should be.  I mostly agree, but as with all subscription services, this strategy creates de-facto “off the balance sheet” leverage…a lot of it.

If this strategy creates “off the balance sheet” leverage, who is at risk?

With debt, someone must secure it (or at least they are supposed to), typically with cash, business equity or traditional assets (like a building, servers, etc…).  On-demand or “pay-as-you-go” computing creates hidden leverage that is essentially secured by the business owner’s personal equity in their business…and unknowingly the customers assume an unknown risk (that the service is more likely to be shut down unexpectedly).   For businesses that do nothing but grow, leverage is great, but the volatility of startups increases substantially as a result of this new strategy (capital alchemy).  Even though the mythical entrepreneur loves risk and volatility, I’ve found that most actual entrepreneurs are extremely risk-averse.  Because there is so much business risk in a startup that entrepreneurs must tolerate, financial risk (namely debt) is something entrepreneurs are usually not too excited about.

In addition to on-demand computing being very similar to debt financing…there is a misconception that on-demand computing does not have a price premium. On-demand computing is similar to using a credit card or factoring your receivables.  For people without money or access to less expensive debt,  sometimes those “financing techniques” are the only options…for each you pay a hefty premium.  As the size of the startup grows, on-demand computing becomes increasingly expensive (since cheaper alternatives start to emerge…like building and managing a small server cluster), PLUS there is the hidden leverage factor that I will demonstrate in a follow up post (read how amazon web services caused a bankruptcy).

My primary point is that startups should UNDERSTAND how on-demand computing and subscription services impact their risk/reward profile

Companies using on-demand services should regularly build models to understand how leveraged they truly are.  I studied corporate finance, and to me it seems like choosing to use on-demand services requires looking at a lot of the same “pros” and “cons” that a company would consider when looking at debt vs. equity financing…not surprisingly in our economy that has mastered the concept of boom & bust, I haven’t seen much coverage of the “cons”.

December 3, 2009

New ad solution? A breath of fresh air for publishers?

Filed under: Google, Startups, Tech — Scott @ 11:10 am

A new advertising product launched called Bedrock, from the founders of GumGum.  Bedrock allows publishers to literally create any ad on their site (image, text or flash), and link it to any keyword.

The secret sauce, which surely will evolve over time, figures out the quality of the link, the value to the advertiser, and the competitiveness for the keyword…and of course pays the publisher per click.  All reporting is done in “real-time”, which I particularly find pretty cool.

For months I have been experimenting with this new product before it had a name, over at a free forum hosting site that I consult for, http://www.invisionplus.net, and it’s a lot of fun to have such freedom.  In some cases its effectiveness is on par with other options, but the real potential I think will come from newly invented concepts…hopefully some of the ideas we are working on go live soon!

As a publisher across dozens of large websites, I look forward to using this ad solution, and wish them best of luck in taking on the big guys!

What do you guys think about this as either an advertiser or publisher?

November 23, 2009

Have Google and Microsoft gone M.A.D?

Filed under: Bing, Google, Microsoft, Tech — Scott @ 11:57 am

For years people have speculated that Google and Microsoft would ultimately faceoff in a death match.

Microsoft has not been taken very seriously in search until recently as they are rumored to be discussing an exclusive deal with News Corp that would leave Google on the sidelines, unable to index name brand websites like the Wall Street Journal.   It’s my belief that this deal will lead to an arms race of exclusive content deals, forcing Google to give back some of their profits each year in the form of payouts to news content providers and presumably content providers of all shapes and sizes.

Additionally, TechCrunch just posted an article explaining how Google’s OS strategy is designed to hit Microsoft where it hurts.  For the past 1-2 years Google has finally admitted publicly that a cash rich Microsoft can ultimately make life difficult for them.  Even if it takes Microsoft dozens of iterations and huge acquisitions, they are likely to eventually be there to keep Google honest in search and with their other products…hopfully.  I think when people look back, the year 2009 will represent a turning point when competition between Google and Microsoft became very direct and aggressive.

With Google diving into operating systems and online hosted office applications, and Microsoft continuing to make acquisitions, deals and improvements in the search space, it looks like each company is now directly pointing a figurative nuclear arsenal at each other, essentially saying, “I will do whatever it takes to hurt your core profit centers…unless you back off”.   Does M.A.D. or Mutually Assured Destruction work between two companies, like it did during the coldwar?

Microsoft through cashback deals has shown a willingness to pay users to search.  If they go through with the exclusive content deals, they would be paying websites to hide their content from Google.  What’s next, paying advertisers to stop advertising?  For Google’s sake, not even Microsoft has that much money.

Of course, Google is not taking these encroachments lying down, in the next year they will have a free competitor to the majority of Microsof’t’s current and future sources of revenue, including a free traditional OS (Chrome OS), a free mobile phone OS (Android), free hosted exchange alternative (Gmail for organizations + Google apps), free sharepoint alternatives (Google Sites), free speech recognition and somewhat advanced calling features (Google Talk) and last but not least free website hosting (App Engine) as an alternative to all of Microsoft’s expensive server solutions.

As a consumer, I hope they keep it up, and I also hope that they try to differentiate a little on factors other than price, such as “who can provide the greatest privacy”, or “who can create the most extensible platforms”.  Is that wishful thinking on my part?

Since the newest addition to the Microsoft nuclear arsenal is the rumored exclusive content licensing deal with News Corp, I should point out that I think the potential Microsoft Bing and News Corp deal would be a total disaster for Microsoft and News Corp, but at least it represents some creative thinking and a willingness to take risks.

Instead of buying news, Bing will be buying failure!

Filed under: Bing, Google, Microsoft, Tech — Scott @ 11:26 am

Much discussion has now broken out about a potential exclusive news deal between News Corp and Microsoft’s Bing.  I actually wrote this article last week, in response to Jason Calacanis’ post where he and others became really excited bout an evil plot to dismantle Google.

I 100% disagree with anyone who thinks that this deal is good for either Bing or News Corp.  Anything along these lines on the part of Microsoft or News Corp would be short sighted and practically suicidal. News sites have taken a beating because they did not embrace technology once, essentially sitting by watching Craigslist, online media and bloggers undermine/make irrelevant their cash cows.  With the profitable aspects of a news organizations already mastered by OTHER companies online (classifieds by Craigslist, advertising by adsense, Business news by a wide range of sites, etc…), the last thing a news company should do is provide a new financial incentive for someone to replace (through incentivized innovation)…the actual news production.  By trying to exclude content from Google, the financial incentives would start to build for Google to compete with them…one way or another.  Currently, the value add for showing news search results is just to keep the visitor loyally using Google…anyone who posts truly objective news, knows how poorly news stories convert with Google adsense.

Suppose this not-so-genius deal gets done, it is prudent to consider both how Google will respond in the short-term and in the  long term.  I also outline how Google would now have a strong incentive to invest in next generation tools that could replace old fashioned news organizations entirely….in a post titled: Do we really want Google motivated to take on news?

There has to be a better alternative for everyone than going down the road of exclusive search engine partnerships.  I plan to post some details on what these alternatives could be…in the meantime, I welcome your feedback and thoughts.

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