For the last few decades, retail companies expanded by driving greater and greater geographic footprint.  Stores were the only point for transacting product and even today represent the preponderance of sales.  “Same store” numbers helped to gauge the productivity of a store but top line most of the time was driven by number of new stores.  Stores had P&Ls they were responsible for, and this system has created an entrenched infrastructure and KPI bias where many retailers measure and optimize around in-store traffic, rather than driving the “most efficient transaction” regardless of where they occur.

I believe this model has to change.  Consumers have a myriad of choices on how and where to transact today.  Online ordering with the very liberal return policies have made it far easier to buy something, try it, and send back than potentially taking a few hours to physically go somewhere.  Buying has bifurcated into two buckets: routine transactions and inspired transactions.  Routine transactions are things that we know we need, don’t require a lot of thinking, get replenished on a regular or reasonably regular basis, etc.  We either know what we want (new jeans) or we’re indifferent across a broad enough range and need to solve a functional task (toothbrush).  Inspired transactions are things that I’m not sure about, that I’d love to learn to fall in love with, that I am trying to discover.  I want a new look instead of just jeans; I want to understand the philosophy of the brand that I am going to wear as I view it as an expression who I am.

I’d argue that the entire domain of routine transactions is designed to go online.  It’s far more efficient and the best use of a consumers time.  Educate me online and let me transact.  Don’t make me spend hours to do a chore.  The second category is where offline shines.  I walk into the Apple store to engage with product.  I’ll go into the Apple store to experience an iPad or the MacBook Air to see if I really care about how thin it is.  I’ll subconsciously feel how “smart” the brand is in servicing me and differentiating.  If I go to the showrooms on 5^th Avenue, it’s to feel the luxury and curation of what Cartier or Saks represents.  And it is about entertainment as much as anything else.

Heineken Lounge at an Airport - A Brand Experience

What does this all mean?  Well, I see huge reductions in the number of points of presence for many retailers (not including same-day consumables like coffee or food).  Retailers have to align with consumers, liberate their time and allow them to transact in whatever manner provides the greatest utility.  Retailers should be in the business of selling things wherever that most efficiently occurs.  My partner Larry told me about one innovative retailer that uses their physical store to crowd source and showcase new products only – as soon as something sells in meaningful volume (indicative of a repetitive buyer in a “routine transaction”), it is moved to the online store and that shelf space is freed for a new product to experience.

Over time, I see stores being “owned” by marketing and viewed as a brand expense instead of the revenue bearing, full P&L today.  Should I penalize the store if you came in, had a great experience, and then bought online for convenience?  Or more likely believe that it served its purpose?  Controversial, maybe.  But 10 years from now I think the retailers that survive the transition to digital will look at it more that way than how they do today.  I also wouldn’t be surprised if 10 years from now, we see a flagship Gilt store on 5^th Avenue and major cities around the world.  It sounds crazy now, but that might be the most “efficient” way on a blended marketing basis to create mass awareness (like TV today).

The bottom line is that the role of the stores has to change.  It cannot be about the purchase.  Too much of buying is moving online.  It has to be about experience, education, and inspired serendipity!

Lot18 is a next generation wine e-commerce company, initially leveraging a membership driven engagement model.  What excited us in October 2010 when we first seeded the company was how Lot18 took an incredibly complicated category, and created a beautiful site where wineries’ products were showcased to consumers.  Though it leverages a membership driven model, this is not about distressed goods or deep discounting as is commonly confused with the space.

Wine has a complex distribution chain of wholesalers and distributors before getting to the retail store.  Lot18 allows wineries to bypass that distribution, while protecting their brand and introducing them to a much broader audience.  Value gets passed directly to the end customer, enabling outstanding prices on great wines.  Frankly, as a “non-wine” person, I find the discovery and education that Lot18 offers to be far superior to any in store retail experience.  I can buy a great wine at a great price (because it’s direct) and know that it’s a wonderful product to bring out while having guests over, give as a housewarming gift, or enjoy on a special occasion.  For people who love wine, you’ll find product that has never been released from cellars, or offers from wineries that have 3 year long wait lists, and benefit from their Select service, which calls our top buyers with offers that could make anything in their cellars blush.

The company has grown more rapidly than anything we could have predicted.  It helps that it is led by serial entrepreneurs Kevin Fortuna and Philip James, who have built some very large businesses in their past (and have a few unique experiences to boot).  They have executed extremely well.

We’ve had a long standing thesis in E-commerce, from Stubhub to Shopify to Lot18 to AHAlife and many more.  Retail is changing faster than we can imagine.  We’re delighted to invest behind this team, and look forward to working with our new partners in NEA.

If you’d like to become a member of Lot18, simply click here to get an invitation.

Bamboom was started by Chet Kanojia, an entrepreneur I had the great fortune to invest in and get to know for many years at Navic Networks.  Navic was an outstanding company bought by Microsoft in 2008 in a very successful outcome.  They were one of the few positive, large exits in the interactive television space, and Chet’s leadership was a big part of that.  Chet’s last round of capital came just after the bubble burst in 2001, and he managed it brilliantly until our ultimate exit.  Joining Chet at Bamboom as CTO is Joe Lipowski.  Joe is a brilliant technologist and RF engineer we’ve known for a long time as well.  We backed the spin out of Celiant from Lucent, and Joe was the CTO at Celiant (acquired by Andrew for $470MM).  When Chet began to talk to us about his idea, it was a no-brainer to put the two together.  The team around these guys is equally talented and truly best in class.

The idea is quite simple yet technically complex and brilliant.  Bamboom wants to enable customers to experience broadcast TV, over the Internet, to any device, without all of the headaches associated with accessing it today.  They have combined brilliant RF engineering with wonderful software design to create an incredible consumer experience.  More details will emerge as we roll out of closed beta, but suffice to say it looks fantastic.  This is what a next generation television experience should look like.  Fully integrated, portable, native social integration, rich interactivity.  As consumers shift television consumption online, we will see new content, commerce and advertising opportunities that we can only begin to imagine.

We are delighted to partner with Chet and our co-investors on the journey!

I believe every business today is going to be rewritten for the web, or “Internet optimized” as I call it.  This is not about putting up a website or selling online.  This is much more fundamental.  The Internet affects literally every part of a business system and makes it much more cost efficient than their legacy comparable.  Let’s take a few examples:

• Marketing – Paid, organic, display, affiliate and other channels are far more precise and cost effective to pin point your audiences than any blunt mass-market tool of the past.  You are connected to all your customers, it’s just a matter of finding them (and vice versa).
• Product – In an Internet optimized business, the product is instrumented to see real metrics on how people are logging into your application, which functions people are accessing, what breaks and doesn’t, etc.  Each of those tell you in real time what features to focus on or not, develop or discard, etc.  Customers participate in the product development process.
• Development – Multi-tenancy, single instancing, and SaaS makes development easier and faster than the complex install matrix of the past. Cloud services like AWS, Rackspace, Engine Yard and others are fully variable infrastructure available to build upon.  AGILE and other development methodologies create output on regular basis.

Any “new” company is doing things efficiently across virtually all departments from the ground up (and includes areas not mentioned like sales, hiring, finance, and more).  At scale, they will have a fundamentally better cost model than any legacy player possibly could.  The legacy company still has those very expensive relationship based sales reps, or the high touch TV-driven ad model, or the “divine from above”/ “decide by committees” product model.  These are all points of friction that makes them hard to change, slow to adopt new business models, and not innovative.  It also leaves them at a fundamental economic disadvantage.

If you think about it, this concept is true for almost all businesses.  We see retail in the Nordstrom/Hautelook example.  The same is true in traditional advertising versus ad networks; console based gaming versus virtual goods businesses; large media publishers versus blog aggregators/publishing platforms; stock fit retail brands versus custom manufacturers; etc.  The Web is as deflationary across the internals of a business as anything else!  This wholesale rewiring is happening now, creating a unique moment in time and a littany of new companies looking to lead the pack.

The most likely way for offline players to evolve is to buy these Internet optimized businesses, incent those organizations to grow as rapidly as they can, retain the talent for as long as it possibly can, in the hopes they can eventually re-make their overall business by being led by example.  Those that do nothing will not survive, and there will be many;  those that think aggressively have a shot, and I think we’ll see much more of these partnerships with traditional brands and Internet optimized companies going forward.

[Update 4/08 - Random House leads round of financing at Flat World Knowledge]

[Update: 4/25 - The Travel Channel announces $7.5MM investment in Oyster.com]

With this renaissance in e-tailing, we noticed most of the e-commerce platforms out there were significantly dated.  Many had not changed for over a decade, offered very little flexibility, and did not take advantage of the incredible advances in software we have seen in that period of time.  But we found one – Shopify – which we are extremely excited to announce as our latest investment. 

Shopify is a unique retail platform company that allows merchants to have an online store up and running in 20 minutes, but with a unique app store model that allows it to also service the highest end commerce providers.  There are some interesting applications on the platform today, but the goal is to rapidly build out the ecosystem so a retailer can find everything they need to run their business – online marketing, billing, inventory, logistics, supply chain, mobile, etc.  With this approach, we should satisfy any retailer from small to large with a consistent platform and a best of breed set of options.

Shopify was founded by Tobi Lutke several years ago as he and his friends wanted to launch their own snowboarding store.  They found most of the alternatives out there very kludgy.  Fortunately for the rest of us, they are renowned Ruby On Rails core contributors and developers, and so they decided to build their own store.  They opened the platform for others in 2006, and have surpassed $100MM in Gross Merchandise Value with over 10,000 active stores on the platform a few years later.  It’s a real business that is poised to power the next generation of retail.

We are excited to partner with Tobi, the Shopify team, Bessemer and Felicis on this investment.

We believed Boomi’s timing was different.  The emergence of cloud compute services and the growing maturation of SaaS was a stark change from the past.  Both were important backdrops to answer the question “what had changed”.  We’ve had a thesis on how the cloud would require the re-writing of various middleware services.  While the team had a long history in EAI, they decided to bet the farm on the cloud in 2007 and wrote an innovative forward looking platform from the ground up.  They launched in early 2008, and we invested in the summer 2008 on the backs of healthy customer activity.  The business wound up growing very rapidly 300%+ CAGR, continued to launch new innovation upon innovation, won major awards, struck some good strategic partnerships, and eventually got purchased by Dell in an outstanding result for us as investors and for the employees.  From the outside, it was how you’d script it.  But there were definitely things we learned along the way.  Below are a few of them:

•         SOA and Web services (WS) are foundational, not competitive with integration.  Many had a view that as a result of the maturation of Web services, integration was built in and no longer needed.  In fact, turns out WS were foundational to doing integration in a flexible, repeatable manner.  It allowed us to connect more easily to systems, but you still needed a platform to orchestrate, move, transmute, and connect these WS ports.  We believe we are finally, after a decade, scratching the surface on how SOA will empower and impact applications going forward.

•         It takes time to find your sweet spot in the pyramid.  Boomi launched with incredibly disruptive pricing, which led to a lot of customers quickly adopting.  Early on, it turns out many were very small businesses only looking to connect two low end applications, where the value of the platform was less obvious and there were simple alternatives in the “point to point” world.  The value of an integration platform grows non-linearly with the number of points connected.  We pivoted to focus on companies with slightly greater needs, where our platform value would be clear and our innovation led to high stickiness. It takes time to tease out who the *right* customers are for a new category product.  Once we understood that, it helped clarify decisions around product roadmap, hiring, sales model, etc.

•         Don’t be afraid to raise prices.  Related to above, low price, high quantity led to a lot of early customers, but it didn’t scale exactly the way we wanted or attract the best fit customers for our product.  But it led to a lot of buzz.  As we realized our best customers were a little further up the pyramid, we worried that increasing pricing would also mean losing the very small business segment and perhaps impact buzz.  We spent a lot of time thinking about the tradeoffs, but decided it was more important to align with our target customer.  We increased prices three times and the business didn’t skip a beat (in fact inflected upwards).  If you find your spot on the pyramid, align all parts of the business to it.

•         SaaS delivery model changed everything.  Unlike the legacy world, which was plagued by high services and one off implementations, true SaaS allowed us new functionality and velocity the market hadn’t seen before.  We could do exciting things like using multi-tenancy to figure out what most people do when connecting applications, and auto recommend process maps.  This eliminated 90% of the manual work in integration.  Our platform could be opened up, allowing people to build connections and make them available to the entire community.  We could get reasonably complex integrations done quickly and reliably.

•         SIs say they love SaaS but it’s hard to break economic incentives.  We worked with a number of larger SIs who individually loved what Boomi was doing, but collectively found it difficult to leverage the product.  It broke the model of “billable hours”.  “Easier to configure” made for efficiency, but not more revenue.  Some newer more progressive SIs, like WDCi out of Austrailia were great, but bigger shops found it hard to change.

•         Indirect channels are hard to predictably scale early on.  In addition to SIs, we also worked with dozens of ISVs who were go to market partners for the Company.  We began to see success but that came after years of effort.  Mark Suster has a great perspective that fits our case pretty well.  No one could care about our success as much as us, nor did it matter that much for others versus us.

•         Conviction is important.  When we first invested in Boomi, we planned to split the round with a co-investor and introduced the Company to a few shops.  Most folks could not get there, so we decided to write the entire check.  After the market collapse in 2008, we told the guys to just focus on the business and be smart with cash, which they did a great job of.  There was constant inbound poking given the profile, but mostly off and on distracting conversations.  We decided to write an additional check so the team could focus entirely on the business.  And it was ever so rewarded!

Looking forward, we’re always sad to see a market defining company go.  The team did an outstanding job and I’d work with them in a heartbeat.  We are glad to have been a part of it.  We think there continues to be a huge opportunity in cloud infrastructure software.  The strategic interest in Boomi underscored that.  Dell has a fantastic opportunity to own one of the cornerstone building blocks for public or private cloud offerings, and exploit that as a real differentiator versus others out there.  Meanwhile, we’ll go back and look for the next great company to back!

• FOX withholding rights to content from Cablevision is a great (but not unique) example in the content arena.  After getting killed in the advertising and market meltdown of 2008, many of the content producers now want to be a part of that lovely predictable subscription revenue stream.  After a game of chicken, FOX got its deal.  The recent Netflix deals are a great example from the opposite end of the spectrum.
• Online e-tailers versus brick and mortar retailers. The explosive growth of companies like Gilt Groupe, Bonobos, J. Hilburn, ModCloth and others are great examples of people choosing to either design directly to a captive audience base or bypassing the traditional fulfillment hubs.  Reducing or eliminating distribution at large retailers who require their markups allows much better pricing as margin savings can be passed on and therefore value to end customers.
• American Airlines in its recent dispute with Orbitz as they push AA Direct Connect instead of going through traditional GDS systems.  Initially, the aggregators and online pricing engines had better deals than airlines did at their own sites.  Quickly, the airlines moved to low price guarantees for their own sites.  And now this is the first salvo stepping into the traditional supplier link setup.

A number of people wind up benefitting from this trend.  Many companies have grown on the backs of helping brands and retailers find those customers online.  Fulfillment and logistics for physical items winds up being far more important, as the idea of buying and sending back gets ingrained in the psyche.   As we continue down the path, however, we’ll continue to see increasing pressure on people who solely sit in the middle.

3Par is a classic example of why many private companies go “on file” (meaning, file their S-1) to drive an M&A process.  If you are a unique company with technology and sufficient scale to go public, that should be a pretty desirable asset.  But many times you need to create a compelling event to get buyers to take a process seriously.  By filing an S-1, you are telling a broad audience that you intend to go public.  Once public, there are a whole new set of fiduciaries the Company becomes obligated to and new set of disclosure obligations.  For example, in 3Par, all bidding happened formally and publicly.  Dell had no ability to lock the deal up and drive it to a close.  Their foresight and brilliance tipped others into action.  We saw the same with EMC, when they swooped in on DataDomain and took them away from NetApp. 

If either of these companies chose to buy 3Par when it went public in November 2007, they would have saved over $1.8B!  There are many companies on file today that don’t really want to be public.  It’ll be interesting to see if these recent public battles spark others into action sooner.

First was the announcement of the World Economic Forum’s 2011 Technology Pioneers. Thirty-one companies received awards out of a global pool, thirteen specifically in the areas of Information Technology/New Media (where we focus).  Of the thirteen, three companies are from NYC (Knewton, SecondMarket, and foursquare), two are from the FirstMark portfolio (Knewton, SecondMarket)!   The Wall Street Journal had nice coverage here.  Each company represents a distinct sector – financial services, education, and new media – where NYC has specific depth and expertise.

Second was the announcement that TechStars is coming to NYC.  TechStars is the second accelerator program to launch in the Big Apple, and we believe this is a continuing sign of the growing depth of the NYC market.  We are enthusiastic supporters (and investors), and look forward to working closely with the inaugural class.

Both events underscore what we have been advocating for a long time.  NYC is an incredible place to start a company and one of the most exciting venture markets.  As technology investing has shifted from infrastructure buildout to leveraging the Web as a platform, so value creation has shifted from plumbing to “Internet-optimized” businesses combing the best of technology 2.0 with deep vertical expertise/talent to disrupt large incumbents.  We expect this to be a major trend for the next 5 – 10 years and NYC to benefit disproportionately from it.

First, let’s talk a little bit about data center and storage history.  Storage many years ago used to be housed with the CPUs.  The large vendors shipped computers with high end processors, packed with disk drives and called them servers.  As data storage grew faster than compute, the industry began to decouple storage from the compute, giving birth to companies like EMC. 

EMC and Hitachi Data Systems operated in the high end enterprise segment with very large storage arrays designed for high performance, availability, and reliability.  Because of how critical and difficult storage is, very few of the server makers chose to wade into the market.  In fact, most compute players would regularly OEM product from the specialized storage makers.  This led to a very happy symbiotic market with clean lines where everyone knew their place, and each of these vendors in fact OEM’d one another’s products.  For example, Sun and HP each resold HDS’s products.  Dell resold EMC’s products.  Brocade was built almost entirely on a channel model.  

A couple of moves really changed this panacea.  First, EMC got a hold of VMware and virtualization subsequently became the hottest trend in the data center.  This pulled EMC into the server side of the market and led them to rapidly expand beyond storage into systems management, software, and other layers of IT spend.  Second, Cisco announced they would be entering the high end server market.  This clarified their growing ambitions from dominating the router market into the compute part of the IT spend. Cisco announced a JV with VMware and EMC to complete their product vision late last year. Third, Dell bought Equallogic and HP bought LeftHand Networks, both signaling a movement towards owning IP for storage (albeit the mid market).  Dell had been partnered with EMC going back to 2001 and was a meaningful channel for EMC’s mid range products.  Very quickly everyone got a wake up call that their place in the stack was not secure.

So what’s happening now?  Every major data center platform vendor sees two major trends going on.  First is the rise of the dynamic, agile data center within enterprises.  This requires being able to spin up resources – compute, network, and storage – automatically in response to business demands.  Second is the eventual move of the data center to private and public cloud offerings.  In this model, the vendor no longer sells equipment to the enterprise, but assembles and runs all the parts as either a dedicated or shared service.    

In order to fulfill this vision, you need all parts of the stack working together seamlessly.  This is where 3Par comes in.  3Par was born during the great storage gold rush of the early 2000s.  Bringing their product to market took over $200MM in venture capital, including some recaps along the way.  They were one of many startups that were funded to build flexible, modular, high end systems, but one of the few to survive.  An enterprise’s lifeblood is storage and they would not trust startups lightly.  This required high burn to build the technology, and then high burn on the sales side to succeed in market.  To 3Par’s credit, they managed to get public and raise sufficient capital to sustain themselves to critical mass and profitability.  And now they benefit from scarcity value.

Looking at the landscape, 3Par is the only real alternative to EMC and Hitachi in terms of high end storage.  EMC has its own ambitions for data center dominance, while HDS is part of a much larger conglomerate.  If you believe you need to own storage and server, both to fulfill the vision above and to avoid partnering with a competitor, than 3Par is the only place to get this type of deep high end storage technology.  Given HP and Dell have a much larger sales channel than 3Par, these guys can immediately double, triple or quadruple sales from 3Par products overnight once it is part of their catalogue.  Both reasons afford the premium we are seeing.

Going forward I’d expect to see more data center consolidation.  There are some major battles brewing as companies compete to own the enterprise! Network Appliance has long been rumored as a fit for Cisco.  Plenty of other combinations make sense as well.  It’s clear to me, though, that the march is towards creating end to end solutions and masking complexity.  Should be a fun next few years to watch!