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.

Media6˚ Solves a Very Big Problem

I am excited to announce that Media6Degrees has joined the Venrock portfolio. News is here and the press release here.

Social networking is consuming a larger amount of our time spent online. Social media sites attract more than 650M visitors a month and drove more than 2.1 trillion page views last year. A substantial amount of social media ad inventory has gone unsold and, despite lots of trying, few companies have figured out how to use the data gathered by our social media browsing and deliver relevant ads based on it. When search exploded, it created huge ad inventory that was highly monetizeable, since search expresses intent on which ads can be precisely targeted. The growth in social media has largely failed to create a meaningful platform for advertisers to help monetize this creation, especially on a measured ROI basis. With so much more advertising going performance-based (as I have written about before), this problem is ripe for a technological solution.

Enter Media6Degrees, an impressive NYC advertising technology company. They have mapped the social graph (so far on the order of 80MM people) and provide major brand marketers with a way to reach scalable, highly targeted audiences. They are a behavioral targeting ad network, and use their understanding of the social graph to target not just people within target segments, but the people connected to those people who display high degrees of homophily, the tendency of like-minded individuals to cluster with other people who strongly resemble them.

The company is doing fantastically well and the CEO and Founder, Joe Doran, is a true thought-leader in the social media/behavioral targeting space and the ad tech ecosystem in general. I am proud to be associated with this company and its team and am honored to join my fellow investors from Coriolis Ventures, Contour Ventures, and USVP.

The Ad Ecosystem: It’s All Going Towards Performance

ROI. Get used to it, Madison Avenue.

In the past 15 years, the hyper-growth of interactive media has presented the advertising world with some of its most pressing challenges; since it is so easy to measure performance online, advertisers would like to better measure the performance of non-interactive media (print, radio, outdoor, TV). Spurred on by John Wanamaker’s legendary quote, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half,” advertisers have been asking big media to justify $30 – $100 for much of the last five years. The pressures of the current economic conditions have only added to the urgency.

My view of the prices of media advertising in general is somewhat controversial. I believe the reason print and TV have been able to demand the rates they have is largely because there were so few ways to measure the efficacy of the buy; they are largely opaque non-performance-based media. We all know TV viewing rates are “measured” by a measly 5,000 Nielsen Peoplemeters and rates have been artificially boosted by the entire “Sweeps” concept and the Up-front sales process. When you look at the TiVo data, you get a more clear understanding of how poorly correlated the Nielsen viewing numbers really are with reality (when DVR usage is taken into the picture.)

Why talk about this now? Because online, every click is known. We know people try their best to ignore ads. The heatmaps of eyeball viewership online demonstrate that people try their best to avoid looking at banners. But we have also learned that search is the best indicator of intent and that when highly relevant (text) ads are shown, users click in great numbers. And when we combine intent with relevancy and interactivity, the real value of reaching a customer is known. Today, Google’s adwords market is the best indication of what a customer is worth. And it is nowhere near $100 CPM.

Why are online CPMs $5 – $20 for text and banner ads and TV is 5-10 times that? Because TV (and most traditional media) has been significantly over-priced for decades and online media is priced closer to the value to an advertiser of reaching a consumer. In addition, there is a growing supply and demand problem. What percentage of total available web inventory is unsold? 60%? 80%? That drives down prices. And even so-called premium inventory (Yahoo home page, nytimes.com) is sold at half that of TV CPMs.

So, where is this all going? Traditional media CPMs are coming down. And as those media become interactive and can be sold on a performance basis, their effective CPMs will fall dramatically as the true value of reaching a customer emerges.

This means the race is on for making all media as hyper-targeted, efficient, and as performance-based as it can become. One of my favorite digital media sectors is the advertising technology space. There are a plethora of companies focused on exactly this. By using every type of math around applied to every piece of data thrown off by our surfing behavior, we can make advertising more relevant and measure its efficacy. This satisfies the advertiser’s need to buy advertising on a performance basis and, in theory, makes advertising that much more relevant to the consumer. (I am skeptical that, aside from search marketing, we have yet seen any advertising actually appreciated by a consumer, but that is the subject for a different blog post…)

So, stay tuned for more thoughts on this space. I’d like to explore some specific sectors of ad tech like media buying, behavioral targeting and media exchanges.

Netflix got it right. Will the Studios follow?

In trying to legally consume digital movies, there are two models: the Netflix way and everyone else. Let’s start with the latter.

If I want to watch a movie online (streamed or downloaded), I can go to Amazon OnDemand, iTunes, XBox Live, Vudu, and Sony’s PS3 platform. These are all generally the same: the selection varies from about 5,000 movies to 30,000 titles. I can download or view a DRM-restricted 24-hour rental (the download sits on my hard drive for 30 days but once I start playing it I have 24 hours before it “expires” and becomes unplayable) for $2.99 – $5.99. Or I can purchase a DRM-protected movie for $12.99 – $16.99. The DRM protections render the movies completely non-portable (I cannot take them with me, unless bought from Apple and used on an iPod). While that is not consumer friendly, the 24 hour expiration window is pure customer cruelty. Note to studios: why not just make the rental simply play once within, say, 30 days. Why must I finish watching in 24 hours? Just silly, really, and clearly meant to penalize those of us who have kids and/or work hard and have limited windows at night to watch TV. Can’t finish in 24 hours, TOO BAD! Buy it for $15, dude!

Or, you can join Netflix and come over to the good life. For $8.99 a month, you get one DVD sent to your home at a time, chosen from more than 100,000 movies. You get a fantastic queue system which allows you to essentially pre-order a rental as soon as you hear about a movie (long before it is even released on DVD). And now you can, at any time, as often as you like, stream more than 20,000 movies to your computer or TV (using a $99 Roku box). I am living in luxury folks. I can watch each movie as many times as I like, and take as long as I want to watch it. This is a company that understands and indeed caters to consumers’ needs.

I know the studios hate the model. Studio execs have told me they would be “out of business” if every service worked this way. But the adoption of the other models is paulty compared to Netflix’s. They have more than 10M subs and are growing like a weed. They are best positioned to migrate consumers into the digital movie world, because they can satisfy our need for vast selection with their physical/digital hybrid model. And they make the restrictions appear invisible. (True, no portability. But with WiFi on a plane, we’re getting there.)

Once again, I think the way to navigate the digital world is to remember that the consumer is in control. To win, you must satisfy them, not penalize them. (Last week’s studio idea: remove the bonus features from DVDs that are used as rentals in order to make people buy more full-featured DVDs. Um, good thinking.) It’s just too easy to steal, so better to offer me something superior to the stolen good.

Why Mint Matters: A Message to Entrepreneurs About Products

This is a column that really doesn’t need to be written. Or at least, shouldn’t need to be. Most entrepreners already understand this concept pretty clearly. But some do not, and for those of you thinking about taking the plunge into startup-land, there is an important message here: it’s all about the product. Take it from Aaron Patzer.

VCs spend a lot of time boiling down the characteristics of successful companies into their simple essence. I think I speak for most when I say it is usually: team, market, product. (Feel free to disagree, fellow VCs.) As an entrepreneur, I always thought most about those three subjects as well. Going back to my Apple days, however, I learned a valuable lesson that I did not always practice as an entrepreneur, and Aaron Patzer, the CEO and founder of Mint reminds me of why it is critical: the product must be absolutely stellar. Not good, not “okay for now”, but, to steal from SJ, insanely great. Have you used Mint.com?

Mint.com is the leader of several startups focused on personal financial management. It’s an audacious notion, since Quicken’s Intuit and, to a lesser extent, Microsoft’s Money, are so dominant. But Aaron recognized weakness in the market leaders: the products have become overly complex, have not adapted to the lifestyles and needs of today’s digital consumers, and perhaps most importantly, their innovation has been non-existent for almost a decade. But that realization is not the only thing driving his success. It’s because his product is amazing.

Aaron has both EE and CSE degrees from Duke and Princeton. Engineers often make great CEOs. But he is also the chief product visionary for the company. And he doesn’t just discuss what he’d like to see in the product — he designs things himself. He showed me the specs he creates in Photoshop. They are more than just wireframes. They looked like completely designed pages to me. You can see his attention to detail in the product. Although it is missing key features to completely overtake Quicken, it is light-years ahead in its usefulness and intuitiveness (pun intended). Mint demonstrates both a better understanding of the customer and a much better product than Intuit has delivered. And it’s paying off. Since launching in September 2007 and winning the TechCrunch 40, Mint has about 1M users and has probably developed an insurmountable lead over its new-startup competition.

The incumbents are taking notice. As if scripted perfectly by the Mint PR team themselves, Intuit’s lawyers actually sent Mint a letter two weeks ago flabbergasted by Mint’s claims of growth. Quicken has been caught completely flat-footed — their Quicken Online product is a weak, uninspired, water-downed version of Mint itself and their forthcoming version of Quicken for Mac, while claiming to be a complete re-write, still misses the mark completely (why must my entire financial life reside on one computer all the time and not online? Why must Quicken insist on charging banks in order to support Quicken when Mint supports more than 7500 financial institutions in the US, virtually every one that matters, and, with Mint’s iPhone app and email alert system, Mint is built for those of us who live our busy lives online and through multiple devices and presents us with beautiful budgeting and investment analysis — just the stuff that matters.)

Mint is not complete. And if any other company shipped it, I may not use it until more features appeared (most noticeably, bill pay and reporting). But because the product is so fantastic, it drew me (and one million others) in. And Aaron will get there.

So, the lesson here is clear: you need an absolutely killer product. Pulling a team together who understand that need and know how to get there is important. But as the founder or founding team, make an honest assesssment of your strengths of producing a world-class product. One of the founders must have this ability, and it might just be best if it is you.

Note: Venrock nor I have an investment in Mint. I just really like the company.

NBC: Please watch our shows on Hulu (only sometimes)

File this in the, “Um, you’re kidding, right?” department.

Yesterday, NBC, one of the owners of Hulu, demanded that Hulu force Boxee to stop letting its 200K+ users watch Hulu programming through Boxee. Boxee, in case you haven’t tried it yet, is a wonderfully simply interface for browsing media on the net in a “lean back” experience. It is directed at those of us who have attached our computers to a nice TV screen and would rather watch Hulu, YouTube, and all the other free content on the web on a nice big screen, ads and all. Boxee is an internet browser at its core. It is not licensing content, selling you downloads, or directing you to stolen shows. It is making watching web-delivered video easier to find and watch. It is helping Hulu. Last week it sent Hulu more than 100,000 viewers.

NBC, who licenses thousands of shows to Hulu, in their wisdom, is getting scared. They are hearing about all these 20-somethings who are cutting their cable bill and foregoing the $80 a month to instead watch their faviorite shows online. They aren’t stealing the shows through torrent sites, mind you, they are watching them legally through the means that NBC is providing. The problem is that NBC makes an overwhelming amount of their profits through subscriber fees paid to them by the MSOs. The ad revenue they get from putting ads in Hulu are the digital pennies I refer to here.

While I understand the digital transition is challenging for big media, doing things half-hearted won’t help. If you want to beat piracy, you have to embrace the methods consumers demand. Boxee has done what AppleTV and all the other digital media adapters have not done which is to put a pleasant interface on the browsing of web-delivered entertainment. And they have 200K+ of the most savvy internet video viewers as their customers. What do you think those customers will do now? Throw away Boxee just to watch NBC’s shows? Nope. One of two things: watch non-NBC programming, or worse, steal NBC’s shows. Either result is a loser for NBC.

Tip o’ the hat to Dave Mandelbrot for a bit of prodding to post.

Memo to Studios: Break the windows

Brad Stone and Brian Stelter have a piece in this morning’s NYT about the rising toll of piracy, or digital theft, on the TV and movie studios. We have heard this story before.

On the day last July when “The Dark Knight” arrived in theaters, Warner Brothers was ready with an ambitious antipiracy campaign that involved months of planning and steps to monitor each physical copy of the film. The campaign failed miserably. By the end of the year, illegal copies of the Batman movie had been downloaded more than seven million times around the world, according to the media measurement firm BigChampagne, turning it into a visible symbol of Hollywood’s helplessness against the growing problem of online video piracy.

Like their music industry brethern before them, the Studios are referring to these downloaders as “pirates” and “thieves” instead of what they really are…customers who cannot buy the product they want. I am not suggesting that all seven million downloads of Batman could have been sold, but certainly a great many of those people wanted to see the movie in their home as it was released. The problem was, they couldn’t.

The movie industry has used a windowing release strategy for years which basically skims profit from various demand groups of customers; those who want to see a movie on release weekend can go pay $10 to see it then. If you would rather see it free, no problem — you just need to wait about 18 months until it hits ad-supported TV. This has been fantastically successful and makes all sorts of sense. Except for now. In the digital entertainment economy, customers are in control. They won’t wait for entertainment product to hit a particular window. Customers expect to be able to watch what they want, when they want it, at a reasonable price and in a convenient format. This is the lesson of MP3 music. And customers are about to teach it to the studios.

It’s time for the studios to break the windowing strategy. There are challenges with this: they will certainly cannibalize sales of early window-ed product like theatrical releases and DVDs. But by doing so they will avoid forcing digital customers to seek out pirated copies in order to satisfy the demand for the movie. For the Dark Knight, Warner Brothers spent more than $100M generating demand around the theatrical release of the film. Only a certain number of recipients of that advertising intended to see the film in a theatre. The rest of us might have been interested in seeing it too that same weekend, but in our home, or on our iPod while traveling. Those options were not available to us. So seven million people went out and stole the film. Why not sell it to them too?

Breaking the window model is probably impossible in Hollywood. It is so tightly ingrained in the culture of its distribution system. But digital consumers have new expectations, and they are in control. Content owners must adapt to the reality that they must now win over customers and ask them to buy their products, but they must first make sure they are selling the products in the formats and at the time the customers expect.

Why Good Boards Matter

As a several-time entrepreneur, I understand how heads-down and focused the CEO and management team must be in order to execute well. Running a startup, no matter the size, requires intense focus. You are forced to filter out lots of non-essential information and minimize distractions. You become a complete expert on your sub-market, attend every meaningful conference, network with companies relevant to your business, and read absolutely everything having to do with your sector. Quickly, however, the trappings of focus pair down your peripheral vision. Innovations in other categories go unnoticed. Valuations and business models in other sectors become unfamiliar. You now have startup blinders on. Welcome.

There is nothing wrong with this, of course. We all go through it. The question is how best to deal with it (and whether you should).

You should deal with it. A great CEO is both a visionary and a synthesizer. To make good output, you need good input. Your staff and management team will have great ideas and perspectives, but they too will begin to develop startup blinders. The longer you work together, the more group-think becomes a real risk. This is where a great Board of Director and/or Board of Advisors can help.

If you have raised money from other people who make it their job to be hyper-aware of everything happening, you can take advantage of their perspective. You can look forward to board meetings and informal discussions with your directors not just as a a chance to vet your ideas, but to hear about the things you are missing. You want to best understand what is working elsewhere and how you can incorporate successful models into your planning.

Great VCs spend lots of time looking around. In the last four months, I have been deep diving into many sectors I knew little about owing to the fact that I had been deeply heads down in digital music for the past five years. Advertising technology, mobile applications, real-time web, social media, digital video, etc. There is some super valuable learning coming from these sectors that I wish I better understood at eMusic. One of the reasons I missed some of this stuff was that we didn’t have a board filled with valuable outside expertise. We were not surrounded by successful entrepreneurs, VCs, or business leaders who had fresh and relevant experience and who could impart to us their observations from other sectors.

So, as you look to raise money and assemble a board, think about not just what style of people you want to have around you, but how diversified a perspective you want them to have. You really want to have a few people in your orbit whose entire day is filled with making sure they know everything going on around you. You want them to challenge you with their learnings and make sure you are incorporating successful models into your planning. It takes some pressure off of the CEO and management team, allows them to focus, and offers them a chance to depend on the broader insights a competent board can bring.

What are TV Studios/Networks thinking?

I love TiVo. We all do. I have three of the older models. I use DirecTV so I can’t use the newer ones. As a result, I missed something amazing that has been happening on these devices.

Last week I visited a friend who has a few Series 3 Tivos. They are all networked. On these newer devices, TiVo saves you the trouble of needing to set each different TiVo to record the same shows. If you are in the living room and want to watch something recorded on the bedroom unit, no problem! You can access your recorded shows from any networked TiVo in the house. Brilliant, right?

Wrong. More than half of the shows my friend had recorded in one room were not able to be played back in another. Why? “This show cannot be played due to copyright restrictions.”

That’s right. It appears as if certain studios are instructing TiVo not to let their shows be shared from one device to another. Now of all the places to exert control over user behavior, why this one? There is no risk of piracy here. A consumer, in his own home, time-shifted TV in his bedroom. This network feature only lets you move shows around from one device in the home to another in the same home (on the same subnet). How does this impact the Studios? It allows me to watch the show where I want it. What is gained by inconveniencing the consumer?

Last week, before getting on a plane, I spent 25 minutes on the iTunes store looking for some TV shows or movies to add to my iPod. I keep my list of must-see movies in my Netflix queue. Of course, due to DRM issues, I can’t watch my Netflix “watch now” movies (which I am paying $18 a month for) on my iPod. Apple’s store had two out of the 43 movies in my queue. Neither were available for rent. I could buy them for $14 each. No thanks. Much easier just to Torrent something quickly.

Once again, the big media companies fail to grasp that the consumer is in control here. If they don’t make it reasonably easy for me to spend my money (and sell me their media at a fair price), I just won’t. Or worse, it makes piracy more compelling. It’s just plain easier to steal a TV show or a movie today online and get it on your portable device. Well, to be fair, iTunes/iPod is very easy, but at $14 a movie, no thanks. Some are available for rent, but not enough. And with iTunes rental, once I start the movie, it blows up after 24 hours. So much for falling asleep in the middle of watching one. Granted, streaming video online is getting better, but I was going on a plane. Streaming was not an option for me.

And why stop me from doing something completely legal (time/place shifting of my recorded TV show) in my own house? There isn’t even a compelling business reason to do so! It’s just anti-consumer for the sake of it. Here we go again.