Some iPhone Gripes, Part 1

I love the iPhone. But it is a work in progress, let’s face it. I wanted to quickly list a bunch of my specific issues with iPhone in the hopes that someone at Apple is listening out there (crazy assumption, I know…). First post of several:

1. When connectivity is limited and I choose to read/delete email, must you pop up seven different dialog boxes in rapid succession telling me “can’t get mail” and “can’t delete message”? Is that really relevant? Can’t you just queue my requests and actions and re-submit them once connectivity is re-established? Blackberry has been doing that for more than a decade. They even clue me in that a task is queued with a clock icon next to an unsent message.
2. When I am on a call and you pop a calendar alert or a text message arrived, must you make me deal with the alert before you let me have access to the phone controls again? Why force me out of the context of the phone call? Why can’t I access things like “speaker” and “end call” before I have responded to a calendar alert or a new arriving text message.
3. Push email is not compatible with the battery capacity you have chosen. Turning on push (for exchange servers) will kill the battery within 3-4 hours, rendering this feature completely unusable. Either fix it or warn users more prominently about this.
4. Why must I enter my iTunes account password every time before downloading free apps?
5. It takes 4-5 steps to delete a calendar event. Really? That’s the best UI you can come up with?
6. New calendar events: can’t I please click the hour on which I want the new event scheduled before clicking the “+” button to create a new event? The interface for setting the time is so tedious, I should be able to tell you when I want the event schedule by a simply gesture.

How to Monetize Social Networks

As comScore and others have reported, we are spending far more time on social networking sites than on any other sites or web activities today. From eMarketer today:

Time spent on social networking sites is increasing steadily, taking users’ attention away from sites such as portals. According to comScore, the top 20% of social network users visit networking sites 2.4 times per day, on average, and spend 31 minutes on them—twice as long as the same users spend with e-mail or instant messaging. And that, in turn, means more time with ads.

The problem is, this inventory is sub-optimal for display and text advertising. The same article discussed the challenges of low CPM inventory. Users are too engaged in social communications and games to click away on ads. Also, when we are reading about friends, we are not demonstrating intent like we do in a search query, so ad targeting is harder.

The truth is that we do demonstrate intent, authority and endorsement while on social networks. We demonstrate who our closest friends are, we share links to goods and services we like, we click on links shared to us by friends we trust. We throw off all sorts of useful data for ad targeting. But social networking site inventory is not the inventory on which to display such targeted ads.

The solution here is to use social networking data and re-target existing customers, prospects, and friends of prospects. This allows highly relevant ads to be delivered to customers on inventory less likely to be interrupting task-based or conversational behavior. Media6Degrees, a Venrock portfolio company, is doing exactly this. And they are not dependent on a single social network, but instead have amassed a meta view of our connections on the web. They are building custom audiences for brands that are highly scaleable. The 50 or so advertisers who have used them have seen dramatic results. There are others working on the same problem. 33Across and Lotome are focused on a similar problem. And I wouldn’t be surprised to see Facebook launch social ads on an AdSense-type distributed platform in the future.

The Book Industry is in Trouble. But Piracy is Just a Symptom.

Randall Stross has an article in the NYT this morning suggesting that the book industry may soon get “Napsterized” — suffer the disastrous fate of the music industry, all because of piracy. This article performs revisionist history on the explicit actions of the music industry underlying its decline. Piracy has been a convenient culprit for media industries as their distribution shifts to digital, but it is not the only cause of their problems. It is largely a symptom of traditional market issues.

In the physical goods world, media companies maintain a monopoly over the distribution of their content. They control who can sell it, they price it at whatever level they deem appropriate and they determine if and when a consumer can buy it (think release windows). As all media goes digital, this monopoly quickly melts away. The content owner cannot control distribution (it’s too easy to copy a digital good) and as such they cannot control availability. When this control erodes, pricing pressure follows as consumers have a choice between buying and stealing.

The music industry, after the emergence of MP3 encoding in 1996, did not internalize this fundamental change. They believed they could maintain their monopoly on distribution by suing consumers who engaged in piracy, controlling release windows and limiting licenses to only a few digital outlets at the same prices of the physical goods. Consumers inherently knew that the digital good should be less expensive than the physical one (there are no hard good costs, after all) and demanded widespread access to digital downloads. It took the music industry seven long years until they broadly licensed Apple in 2003 with their full catalogs. In that time, consumers found the alternative — Napster, Gnutella and Bit Torrent. By the time iTunes took off, it was too late.

The book industry, with all this learning behind it, is making similar (but not identical) mistakes. They have licensed some of their catalog to a few eBook retailers. But there are still millions of titles not available for legitimate download. In addition, they have tried to hold pricing for the eBook at the same level as the physical book. Jeff Bezos knows consumers expect to pay less. So he subsidizes the price of eBooks in order to get the price to about $10 a book. When free is a few clicks away, convenience rules. The publishers should flood the market with their entire catalogs and price them at dramatically low prices. There should be hundreds of places to buy them online. They should make it painfully easy to buy an eBook, even risking the cannibalization of their physical books. They need to make the legitimate good superior to the pirated one.

The digital future for all media companies is likely a smaller market with inferior economics than the monopoly physical one they enjoyed for decades. To survive in this new world will require lower cost structures. But the result of not embracing this future are clear: just ask the music industry.

The Impact of Social Media on the Enterprise

For decades, companies have been defining the channels their customers must use to contact them. Social media challenges the long-held notion that companies control the conversation. “We are available by phone weekdays from 9am until 4pm Eastern Standard Time” is quickly becoming a thing of the past. “We will attempt to answer the emails we receive within 48 hours, but times vary based on incoming volume” will be no more.

In a world where any customer can, in seconds, tweet or post to Facebook a pithy product review or share an experience they had with a brand, companies are forced to entirely rethink how they interact with their customers. Step one, probably the hardest step, is realizing they are no longer in control. The power of social media has empowered the consumer to reach literally hundreds or thousands of people in seconds. And because we know a consumer’s closest friends are three to five times more likely to share the same preferences for products and brands, this newfound power is not to be underestimated.

Sure companies have Facebook pages and Twitter accounts. Yes, a few thousand companies are already searching Twitter for mentions and engaging customers. This is but a start. The real transformation happens when the companies let go of the conversation and instead work to nurture it. The brands who offer tools to their customers to increase the amount of conversation and encourage their customers to discuss the pros and cons of their products will be the winners who emerge from this disruptive time.

Companies like Get Satisfaction and UserVoice offer tools that change the balance of power between a company and its customers. Get Satisfaction has a fantastic manifesto, or “Company-Customer Pact” (http://getsatisfaction.com/ccpact), which defines a new relationship between a brand and its customers, encouraging public dialog, warts and all, but expecting productive discussion in return for the company’s helpful engagement.

While product forums from companies like Jive Software have been around for many years, I believe public conversations about brands will now be distributed in nature, spread across the web into thousands of tiny corners. The challenge for companies is figuring out how to manage this. A conversation could start with a tweet, be directed to a help forum, be responded to in email, updated in a blog post, and then broadcast on Facebook. How will this be tracked, measured and monitored? This market is ripe with opportunity for both brands and software platforms built to nurture the distributed web-wide conversation. And brands who are seen supporting a public dialog will engender more respect from their customers than those who turn a blind eye to it, or worse, try to shut it down. Ultimately, companies become more customer-centric from this disruption. I am sure United Airlines wishes they had just paid for the passenger’s guitar they broke now that the music video he recorded chronicling the ordeal spread virally and has been viewed more than five million times!

The company/customer relationship is but one relationship forever changed by social media. Similar transformations are happening between companies and their employees and companies and their vendors. New companies and tools will emerge to address these situations. At Venrock, we are looking for the entrepreneurs that are pioneering this space and embracing this opportunity. I would appreciate your point of view.

(This post appeared on Fast Company.)

Ignoring Market Signals

I am fascinated by the Hollywood studios’ war with Redbox. Today’s NYT has a nice overview and my friend Rich Greenfield at Pali Capital has been covering this for some time (registration required). Most of the attention is falling on two issues: (1) Hollywood hates the one dollar per day price point, and (2) also hates that Redbox breaks their windowing strategy by offering new releases as rentals immediately as the DVD hits the market.

Redbox’s CEO, Mitch Lowe, knows he has stumbled on a model to which millions of consumers are responding. There will be more than 22,000 Redbox kiosks by December in places like supermarkets and Wal-Mart stores. Their volume is sufficient to scare the studios. The studios’ fears? Cannibalization of DVD sales. Their argument? DVD sales are down 13.5 percent for the first half of 2009 over last year and some titles are selling 25 percent fewer copies than expected while rental income is up 8% (NYT, Digital Entertainment Group).

What baffles me is that the studios still think they are in control. The only reason this model exists, like Netflix, is because of the first sale doctrine. This section of copyright law makes it permissible for anyone who buys a copyrighted work to resell it. Therefore the studios can’t stop a wholesaler or retailer, to whom they have sold a DVD, from selling it to Redbox. And they can’t stop Redbox (or Netflix) from renting DVDs, even though they hate the practice. In the digital world, there is no first sale doctrine, and that’s why your choices of which movies to rent or buy online are terribly restricted and unreasonably priced. The studios set the terms, and no unapproved and unlicensed model can emerge.

Redbox, and Netflix before them, have found models that consumers love. They are based on low price points and high consumer convenience. Time and again we know consumers respond to these models. Consumers don’t respect windows and profit skimming (even though these are intelligent business models). In the digital world, consumers have too much choice to adhere to restrictions imposed by copyright owners. Why buy DVDs when you can download any number of the 65,000 apps in the iPhone app store? Why pay for a digital rental that expires in 24 hours when you can watch six simultaneous channels of the U.S. Open on DirecTV for no extra charge?

We now live in an attention economy. The studios haven’t yet learned that they are dramatically competing for our attention, not just our wallets. To be successful, they must look for market signals, and man is this a big one: consumers will rent more DVDs when you price them low, put them at locations where they already are, and offer the newest releases. The alternative? We’ll just do other things. That is, until the transition to the digital world is complete. Then most of these models will go away if the studios have their way. Then, like the music industry, piracy becomes a better choice and a superior good (no restrictions, low-price).

I have talked before about the need to read market signals. Note to studios: here is a big one. You should be excited, not scared.

Venrock: Shaping The Future, 40 Years of Innovation

I am very lucky to be a VC at a prestigious firm link Venrock with such a celebrated history. This year, Venrock turns 40. To commemorate that, we created a book detailing 40 Venrock entrepreneurs and the companies they built. It’s an inspiring read and motivates me to want to work with the highest caliber entrepreneurs and together create such meaningful companies who have, quite literally, shaped the future. Have a look, and please let me know your thoughts.

You can see the book in full-screen mode if you click the button.

Venrock: Shaping the Future, 40 Years of Innovation

For a paper copy, or more info, go here.

Confusing Traction With Value

The recent distressed exit of iLike reminds us of the need to build real value in our startups if we hope to create lasting companies and wealth. I have seen cycles that last about 18 months or so in which traction gets substituted for value. Yes, we’ll sometimes see exits with big numbers attached to them during the peaks of these cycles. But only those companies that have built real value will sustain valuations during lean years and create long-term successful companies.

If we look over the past fifteen years of webtime, we see a few categories emerge where real value was created:

• Efficiency/Cost Reduction (DoubleClick, RedHat, PayPal, Craigslist)
• Monetizeable audience (Yahoo!, Google, AOL)
• Repeat customer commerce (Amazon, eBay, Netflix)
• Solve a pain point (Checkpoint, Postini)
• Create new markets (EA, Google)

The aberrations occur when traction looks like value. When Slide was funded at a $500M pre-money valuation, that was an example of traction being confused for value. Sure people posted their pictures using a Slide widget 150M times, but there was no value created. Slide did not have a real relationship with those customers and it was a stretch to believe that an ad model would occur on top of those photo widgets. Similarly, iLike may have had its application installed by 50M users, but those “customers” were simply indicating a band or two that they liked. This is not valuable data and the audience was never monetized in any meaningful way. Another aberration was around CBS’s purchase of Last.FM for $280M. Last.FM had lots of users using its free service (something like 15M). But supporting those users was expensive (bandwidth, music rights) and the users weren’t paying. CBS viewed it at the time as a play for audience, and that makes sense. But at that price, a more successful ad model would need to emerge to overcome the content and bandwidth costs. As soon as the ad market hiccuped, that price looked exorbitant and indeed now traffic has declined and its business model unproven.

It bears noting that traction often precedes value. As VCs, we often look for early traction when vetting companies. But we also need to believe, and so should entrepreneurs, that the traction will result in an asset being created which has value. In Twitter’s case, the value of the collective shared links, I believe, will prove to be enormously valuable. In addition, creating a platform where consumers willingly subscribe to brands or information sources also has value.

I think we have returned to a time where eyeballs don’t necessarily equate to value, and rightfully so.

A New Music Model? Perhaps. But not for VCs.

Brad Stone has a nice article in today’s NYT about Polyphonic, a new model for funding music artists and bands. The venture is exciting, largely because of the people involved. Terry McBride, in my opinion, is probably the most innovative businessperson in the music business and has a track record to demonstrate it. In the article, Brad Stone quotes me as casting doubt on the appropriateness of this model for venture investors. To demonstrate why, we need to make a bunch of assumptions, but I will make those assumptions as reasonable as possible:

The Polyphonic model, according to the article, will take $20M and invest $300K chunks into bands. Let’s assume that is structured as an advance against a 50/50 split on all revenue the band produces (publishing, touring, merch, recorded music sales and other licensing.) After fees to operate the business (let’s say $2M over three years), on average, Polyphonic would make 20 investments (i.e., fund 20 bands) a year over three years, or 60 bands. This assumes Polyphonic does not provide any follow-on funding to the bands. That is, on $300K, the bands must pay themselves, pay for marketing activities, tour support, record an album, seek distribution, and generally fund their infrastructure. (While possible, this is thin.)

How much revenue can a band produce? Let’s break that down. Out of the 105,575 new releases in 2008, just 1,515 sold more than 1000 units. Polyphonic likely expects these 60 acts to perform as a portfolio. Some will bomb, some will do well, and a few will do really well. (VCs manage investments this way too.) Putting some numbers around that, let’s assume 10% sell meaningless amounts, 50% do okay (under 20,000 units), 35% sell well (45,000 units) and 5% do exceptionally well (more than 100K units). Let’s say one is a huge breakout and sells 1M units. And let’s assume a 1x multiple on the sales revenue for merch, publishing, touring and other income (ie, doubling).

As the chart below shows (at $7 royalty a record ($10 ASP – 30% retail margin) and assuming the band can double its recorded music revenues through touring, publishing, merch, etc.), the total to an entity like Polyphonic would be just under $27M on a $20M investment, or about a 35% cash on cash return. Might beat the S&P over three years, but probably not.

You can see where the sensitivities are: if the major breakout hit sells 2M units, the the take is more like $46M. If you assume no breakout hits, but all 60 acts sell 45,000 units, the return is about $28M. If you assume every band can triple its revenues beyond its recorded music sales, the you can produce about $46M on $20M, which is pretty decent.

The other challenge with this model is that the funder owns nothing more than a cash flow interest in the band. The article discusses that the artist still own their masters and all rights. I applaud that construct as I think that is the right new model with the right incentives. However, it means the multiple applied to a company like Polyphonic, which is building no long-term equity value, is less than that paid on a company building longer-term equity value. In other words, it is hard to sell a company like Polyphonic for a big multiple.

VC economics, however, look very different. If a VC took $20M into 10 deals at $2M each (let’s say each investment buys 25% of the company) and just one companies is sold for $200M, assuming all other deals fail (unlikely), the VC has produced $50M on $20M. If two companies are sold for $200M, the VC has produced $100M on $20M. (This analysis is greatly simplified just to illustrate the point.)

Let me be clear: I really like what Polyphonic is doing and am hugely supportive of their model and direction. I want alternative models like this to exist, I want artists to prosper, and I want artists to be in control of their own destiny, surrounded by smart people who understand how to market in the new digital world. I just don’t think these models can produce a venture return. There are plenty of other sources of capital for these models, and I am excited to see them get funded and take off. Hats off to Terry McBride and the team at Polyphonic.

Got a Ph.D. in Behavioral Psychology, Comp Sci and Statistics? We’re hiring!

My friend and fellow VC Raj Kapoor at Mayfield Fund has an insightful post about monetizing social networks. He believes social networks’ value is in the data, not in the inventory and I completely agree. In fact, this realization is the basis for our investment in Media 6 Degrees, who, so far, is the only company who has figured out how to do exactly this.

As Raj mentions, a new economy is developing around targeting data. As advertisers demand more performance out of the media they buy, the need for more precise targeting in the display space emerges. Data companies like Blue Kai and Exelate can sell you very specific audience based on a host of particular targeting criteria. Often times, the more precise your targeting, the smaller the audience you can reach. Media 6 figured out that social data is the key to both precise targeting and audience expansion. It is helpful to be able to target people who are interested in your product. It is better if you can also target their closest friends who are most likely to be interested in the same product based on the concept of homophily.

Today, the social nets have a treasure trove of data about their users and can put that to good use both in the service of advertisers and in making advertising more relevant for the end-user. It’s important to note that doing so in a way that actually produces great ROI for the advertiser is pretty hard. Media 6’s data scientists have been at it for years. It’s a new field (or at least a new application of a well-understood concept) and I look forward to seeing years of innovation in this space. It is fun to see interactive advertising technologists now spending lots of time with social scientists and behavioral psychologists.

What VCs Look For and How to Pitch

As I complete my first six months as a venture capitalist, I feel compelled to share with entrepreneurs the many insights I have gleaned from sitting around the partnership table and gaining a deeper understanding of the economics of venture. This is a continuation of my earlier post on the subject.

Not all firms are the same. Fund size, fund tenure (how far into the current fund is the firm?), firm’s track record, partner’s areas of interest and the firm’s areas of focus all affect the types of deals a fund wants to do and their expectations for returns. It is essential to understand this matrix before deciding to pitch a firm. Here are some tidbits:

Why we say “no”
At Venrock, each active partner will probably look at between 200 and 1000 deals a year and will invest in, at most two or three. As a firm, we are seeing thousands of deals a year and funding, on average, about 12 to 18 . With the realities of that ratio, VCs are highly selective. Getting a “yes” is as much about finding the right fit into the matrix I describe above as it is about having great prospects as a company. It’s also important to note that a “no” is often not an indictment on the quality of your idea but more a statement about fit, timing, scale, stage and return prospects.

The new importance of traction
As the costs of creating IT/digital media statups has fallen dramatically, the expectations for early progress have increased. Series A deals used to be two guys and ten slides, but now the expectation is that you will have a core team, a product in the market, at least as a beta, and are showing some customer adoption. VCs are prepared to take plenty of risk, but make sure you know the size/stage preferences of the firm you are pitching. At Venrock, we focus largely on Series A deals, meaning first institutional money in and also have a seed program called The Quarry.

What does it mean to “knock down risk gates”?
VCs view the long path to success as a series of milestones. Achieving each milestone decreases risk. When you approach a VC, it may be helpful to think about the milestones, or “risk gates” you have already achieved. Things like assemble a team, design the architecture, get the code into alpha or beta, incorporate early customer feedback, sign a distribution partnership or two, bring in early revenue are all examples of milestones you may have identified or accomplished by the time you meet with a VC. Here’s a good example of the different languages spoken by entrepreneurs and VCs. An entrepreneur came in and during a pitch said he was just “weeks away” from signing a huge revenue-producing deal with a major customer. He clearly thought that was a validating piece of market feedback. But that made all of us think, “why would he possibly come out for funding now since signing that deal completely changes the prospects of the company?” In other words, if he was so close to knocking down a risk gate, then knock it down before seeking funding.

It’s about the team first and the market second
The quality of the team is more highly correlated to success than any other factor. Knowing that, we bet on a team. VCs look very carefully at the strengths and capabilities of the founder and the key management. For that reason, it goes without saying that you should be highly selective in assembling your early team and you should make their capabilities and background clearly known in your pitch. If you bring any colleagues along, make sure to let them speak. We look at the market second. If it’s really big and ripe for disruption, we get excited. If it’s small and getting smaller, it is likely uninteresting.

Understand the expectations for how big you can be
Depending on the size of the fund, most VCs are looking to fund companies that can get big. Typically this means a company capable of achieving at least $50 million in revenue within five years. This is not a hard and fast rule, but the notion of finding companies with big potential is what VC is all about. If your company, no matter how exciting, will likely reach $5 million in revenue in five or six years, seeking venture capital may not be your best funding source. Again, this isn’t a statement of the worthiness of your idea, but more a reality of the economics of venture capital and the returns LPs expect from VCs. Of course there are exceptions and some VCs use a different rule to measure impact. For example, plenty of companies have been funded which demonstrate substantial consumer traction without a revenue model (iMeem and Twitter are but two). But in any case, VC is about making a bet that a company can be big.

Find the right partner
Each firm is a collection of partners, each with their own point of view, track record, background, and areas of focus. Venrock works hard to incorporate the feedback of all of our partners on our deals. But given our relative strengths, it makes sense for you to target the partner most focused on the market segment of your company.

We are beholden to our LPs
Remember, at the end of the day, VCs are managing money for a bunch of sophisticated investors. Those investors have expectations about the range of returns their investment will produce. Venture investing is extremely high risk and for that, high returns are ultimately expected. To meet this goal, many firms have developed thought patterns about what types of companies and entrepreneurs are likely to make that happen. In Venrock’s case, in forty years, we have invested in more than 430 companies. Of those, 124 have IPO’d and 126 have M&A’d. With that many deals under our belt, you can see how we would have a perspective about how to invest. It’s not necessarily the right one, and it is certainly not the only one, but your job is to find a firm that is looking to do the type of deal you are presenting.