Offline to Online: The Internet Inside

I recently tweeted about the acquisition of HauteLook by Nordstrom.  I think this is one example of many we will see in the coming years of large scale, “offline” incumbents buying their way into the future.

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]

A Reflection on Boomi

This was a long overdue post, but it’s been a busy year.  Fitting this comes as we head into Thanksgiving.  Our investment in Boomi came at an interesting time.  There were plenty of scars from the legacy integration 1.0 and EAI worlds.  Those companies were marked by significant services implementation relative to license sales to deal with unique customer environments.  That made integrations complex, costly and brittle.  Companies like Grand Central, Bowstreet, and others had all tried to ride the Web services, SOA, and interconnected enterprise wave in the early 2000s.  Most were way ahead of their time, leaving lots of dead companies on the road of venture capital.

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!

Zappos & Amazon – Happy News For All

I had been asked a few times over the last week about my thoughts on the Zappos transaction.  I think this is a great story for innovation and startups.  Zappos started in a space many believed you could not transact online: selling shoes without people trying them on… Of course, as the world has grown increasingly comfortable transacting on the Web, that changed pretty quickly and Zappos took off.   With their focus on customer service and company culture (can watch a video by Tony Hsieh on that here), they were able to build sustaining brand advantage.

Ultimately, I think Zappos could have gone public, but Amazon stepped in and paid over 20x+ reported EBITDA of Zappos.  That’s a serious multiple, healthier than the public markets now.  And of course, in an online business at this scale there are significant capex cost, so I’m sure if you looked at cash flow, you get an even bigger premium.  Zappos built a dominant brand in a category, and Amazon stepped up and paid a premium to get the company.  To me, that’s a textbook entrepreneurial story.  I think you will continue to find next generation e-retailing companies thrive, but with an innovative new spin.  Gilt just raised money at a reported $400MM valuation, and had multiple bidders competing to get in.  There are a whole generation of companies pushing the ‘mass customization’ or ‘personalization’ theme, and doing well.  It’s all about finding a novel approach, attacking it quickly, and building scale at a brand level before someone can catch up.

AlwaysOn Panel: “Big Media’s Digital Strategies: Where do Private Companies Fit?”

I moderated a panel this past week at the AlwaysOn OnMedia conference in NYC.  It was an opportunity to get behind what the “big media” folks are thinking in this economy, and how they interact with startups.  The panelists were Jessica Schell, SVP, NBC Universal; Walker Jacobs, SVP at Turner Digital; Vivek Shah, Group President Digital, Time; Jim Spanfeller, President, Forbes.com; and Sanjaya Krishna, Principal & US Digital Services Leader, KPMG.  Below are the most interesting takeaways I got from the session.  For the full panel, click here.

·         On the overall economy, as expected most of the panelists indicated it was tough going out there, and they were focused on partnerships that drove revenue.   In fact, given the pressures in the broader market, they were “more open than ever” to partner.   Some of the panelists highlighted their willingness to do deals in areas like content as evidence of that openness.

·         One of the key challenges they saw in unlocking more digital dollars was translating brand advertising into value online.  One of the more interesting ideas was from Vivek Shah, who said that while growth in performance based advertising in a recession is to be expected (as demonstrated by the most recent Google and Yahoo quarterly results), it is akin to harvesting crops.  It’s easy to pull in more food near term by harvesting more (search) but if you don’t plant any seeds (brand advertising), you may find yourself without crops in the future.

·         All the panelists want to find ways to drive additional lift and yield – the “optimization” problem has still not been solved.  Each were working with various contextual, behavioral, and other techniques to try and improve CPMs and deliver a more compelling story for this medium versus other areas of spend to advertisers.  There were a few areas of strength highlighted, including in QSRs (quick service restaurants) and entertainment, to go along the usual weak spots of finance and autos.

·         In defense of traditional media, the panelists pointed out that people turned first to CNN when news of the airplane landing in the Hudson River broke, not the blogosphere.   The panel expressed a need for better curation tools.

·         There was lots of discussion around the dearth or plethora of data online, and the need to make better sense of it all.  Data standardization continues to be a recurring theme.

·         Time Warner and NBCU both highlighted their investment arms (Time Warner Investments and Peacock Equity Fund) as one way to get introduced and a way for them to learn about startups, but quickly pointed out that the best way was to get a direct operational relationship.  An investment did not guarantee a deal, and a deal did not guarantee an investment.

·         In terms of mistakes startups make when engaging with big media, the panel offered the following advice:  1) don’t present a deal that assumes you’d capture the lion share of the economics out of the gate; 2) set expectations appropriately – start small and prove success rather than promising the moon; 3) focus on how to drive revenues in this environment; 4) know what items they are willing to outsource and what items they would never (such as the sales relationship).

·         I concluded asking the panel what company they would start knowing the problems they currently faced in their environments.   The answers:  a next generation data exchange, improving the mobile experience, new back office systems designed for the digital era, improving operational efficiencies.

It was a fun panel to moderate.  The panel cited numerous examples of startups they have successfully partnered with to drive mutual value, but it was clear there was a long way to go.  Those of us part of the startup ecosystem should take heart!

The Entrepreneur’s SEO – “Startup Exit Optimization”

I was chatting with a start-up CEO today, who had received some early inbound interest from a potential acquiror.  Without any discussion of price, he asked me innocently enough, “Should I think about it?” 

I started thinking about the positioning of the Company and the phase, and offered the following.  I think most start-ups go through several brief natural local maxima, to borrow a calculus term, over its life (3-6 month windows of time over a 5 -7 year life) .  Those maxima are periods where, on a risk adjusted basis, it may make sense to exit early.  The trick is to recognize whether you are there or not, so as to know whether you are value maximizing. 

To be clear, this is not a post advocating early exits.  Heck, as many other people have observed, as a venture investors generally try to swing as big as possible across a portfolio of companies.  As a maximizer of *company* value, however, you have to be cognizant enough to realize when you are on one of these plateaus, pick up your head to look around, and see if someone might be looking at you through binoculars from afar.   You’ll always have to be “bought not sold”, and many people move from valley to valley never getting to a peak, but if you do, recognize it, assess it, and make an informed decision. 

Generally, I’d say an acquisition is value maximizing if it occurs in one of three periods: the “concept” pop, the “growth” pop, and the “IPO” pop.  In the “concept” pop, a company is acquired primarily for its radical vision or strategy, with no correlation to financial metrics.  (This is not in the context of a bubble.)  Think of a Series A company that seems to have a laser sharp vision for a particular space that many other people haven’t begun to understand.   The Company usually has visionary management, early mindshare in a rapidly evolving but undefined/unstable space, and the early positioning (and PR!) to objectively call it a “thought leader”.   In a normalized market, it’s probably just getting to revenue.  The multiple is the highest at this stage b/c the denominator (revenues) is low; conversely the acquisition price is also the lowest because the acquiror has no reasonable financial grounds on which to pay the price.  They just know this could disrupt, transform, or catapult their business and want to be on the ground floor.  This is usually the $50-100MM exit. 

The next major hill is the “growth” one.  This would be a Company likely past its Series B, generating $10-20MM in revenues, has clear market leadership by virtue of tangible numbers like customers/partners/ASPs, and a fully built management team.  In this case, a Company has built hard technology that works, has perfected how its sales machine works, and now is adding fuel to the fire.  It’s probably growing at unsustainable longer term rates of 100-200%+ but can project wonderful visions of grandeur.  Competition exists from a raft of “me-too” startups, but also in the marketing from large vendors as well.  From an acquiror standpoint, you can start putting loose financial multiples to the Company and assessing sales channel synergies.  While the multiples begin to come down relative to the first hill, only a fool would give up what seems like a rocket ship, and so the absolute dollars go way up.  Exit values are usually in the $150-300MM range.

The last major hill is the “IPO” hill.  The IPO hill is the company that has not only done all of the above, but has managed to stave off ALL competitors, large and small, and built a truly defensible position.  The Company has not only done that, but also met the inter-steller, global galactic, worm-hole inducing bar to go public by filing its S-1!  An acquiror at this point would be capitulating that they will not beat the company at its game, and moves in to take it out before it goes public.  The multiples here have to come way down and likely tie to some notion of “accretive” (within 2 years) for the acquiror, but again the absolute number is much bigger.  The universe of buyers is also much smaller given the magnitude of the exit.  This is usually the $400MM+ purchase. 

Why look to an “exit check” at each of those hills?  Well, typically, those hill peaks are followed by valleys of varying depth and visibility.  Doing a little more wont change the exit outlook; in fact, it’s more likely to cause you to be “in discussions” while on some kind of a non-optimal slope.   And while there are always larger, more lucrative, adrenaline producing hills ahead, you have to be fully prepared with better equipment, maps, resources, and a better set of lungs, while finding enough sustenance and staving off nipping animals, before emerging on another peak again.  In start-up terms, that means making sure the product works, figuring out sales cycles, successfully deploying at customer expectations, rising above the noise of ever present competitive slideware, maintaining price points, expanding the available market, raising venture capital (aka, dilution!), hiring and retaining great people, building appropriate regulatory and compliance infrastructure, and so on.  All are manageable issues, but companies inevitably move downward from a plateau when getting into the weeds of execution.  The numbers bear out how many make it through to the next hill.   

[As an aside, it's why VCs love guys who have "done it before" - their lungs and maybe wallets are usually stronger to go the higher distances.]

How do you know you’re leaving one of these hills?  I’ll save for another day if there’s interest…