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Archive for October, 2010

Microsoft’s Extraordinary Quarter, Valuations, and “Who Owns the Cash?”

Posted by Bob Warfield on October 29, 2010

As usual, there is another fascinating discussion underway among the Enterprise Irregulars.  And again, as so often happens, there are related discussions.  In this case we have a discussion about whether there are any companies who’ve reached $100M in revenue with 100 employees, and one about Microsoft’s recent quarter, its cash position, relative valuations versus companies like Apple, and the idea that Microsoft’s cash belongs to shareholders.  It’s fascinating to watch these threads come together serendipitously, and then extract further meaning from the gestalt. 

Gordon Gecko at Teldar Paper

Shareholder Gordon Gecko

Let’s start with the $100M/100 employee thought.  Are there any such companies?  Perhaps, but they are certainly private and they are likely insanely profitable.  The profitability piece means there would be a tendency to spend the profits to reduce risk (and what won’t be said, make everyone’s life easier) and explore new growth possibilities.
 
I think it is very likely doable to build such a company, just that few are motivated to do it and would perceive such a model as very high risk.  I also think some of the technologies you need to do it may not have existed until recently.  The alternative to technology is an unfair market advantage as evidenced by gross levels of profitability.  Let’s talk about each.
 
Go through the laundry list of $100M businesses, and ask yourself what are the characteristics that drive headcount that have to be minimized:
 
–  Leveraged marketing and sales–no feet on the street.  So it’s marketing driven, whatever it is, and it’s either sold online or through a dealer channel that doesn’t rake too much off so you can transfer cost to the channel.  But supporting the channel can drive up heads, so you almost would need something they have no choice but to carry.  That leads to an idea that is both an unfairly strong brand and is also something of a monopoly.  Not sure what qualifies today, but back in the day DOS would have been a great example.  More on that in a second.
 
–  Customer Service:  Amazing how many heads this drives.  You need a product that either requires very little service or a Customer Service methodology that produces very little cost (Social CRM can reduce your costs to 1/3 of what they were, been there, done that). 
 
–  Product:  Platforms and on-prem drive spurious headcount.  At Callidus, we estimated we could get by with 40% fewer heads if we only had to support the current release on 1 platform and we would have no loss of innovation.  I will go further.  The optimal number of developers is a maximum of 10.  Any more than that and your team loses efficiency due to communication loss.  Give me 10, and I can build almost any single product you can imagine in 12-18 months or less.  Been there, done that.  Quattro Pro kept up with 10 developers against Lotus and MSFT teams of 100 or more.  However, they do have to be the RIGHT 10 developers.  I could write a long post on that, but will spare you here.  To get more than 10 working efficiently, you need a loosely coupled application suite, where each module has its own 10 and the communication requirements between them are modest.
 
–  Manufacturing and Fulfillment:  Clearly (well, maybe not, I guess I can imagine some cases, sort of) it will be hard to get there with physical goods.  You can outsource it all.  Could a Dell back in the day do $100M with 100 and all the right outsourcing?  Maybe, but we are speaking of software here.
 
The Internet and technologies like Social CRM make some of this possible.  The alternate model, which is a product with ridiculous margins and brand ubiquity to drive unbridled demand, has also existed.  Back in my Borland days, we used to envy MSFT having a $250-300K ratio of revenue per employee.  We knew that the profitability was very uneven and that the monopoly DOS franchise financed a lot of it.  I have no doubt that DOS could’ve been cut out and scaled to a $1M per employee business.  This is probably true of some Google businesses too.  But, these companies never do that.  They finance the future and they reduce risk by spending the profits today.

Now, one of my esteemed colleagues mentioned that it would be a terrible investment decision for a company with such margins not to embark on a plan of ambitious investment.  That is certainly the conventional wisdom, but the track record says otherwise.  The majority of M&A transactions started out with just such a thesis and wound up net destroying shareholder value.  I would venture to say this is probably also the case for large companies trying to start new businesses.  It is rare that they can get them up to the levels of performance of the core franchise, and hence they are dilutive.  This was certainly true for Oracle and its apps business relative to the DB business, for example.

It will be interesting to see whether today’s technologies and Internet allow some of the bootstrap players who’ve already gotten quite large to get there.  Their motivations as “lifestyle” companies (and I don’t say that like it’s a bad thing), might lead them not to care about this “invest to grow” imperative.  I’m speaking of companies like a SmugMug or a 37Signals.  I suspect their revenue/employee metrics are pretty close already even if the absolute revenue numbers are not.  You don’t have to read many interviews with the SmugMuggers to realize they’re in love with photography and their customers and are unlikely to move too far afield of that.

Now we see pretty clearly the link between the $100M/100 and the Microsoft quarter.  Both are examples of what I will call “unfair profitability.”  These are profits born not just of good ideas and good execution, but of some sort of lock-in effect that inhibits competition over long enough horizons to build such franchises even though the profits are so huge that competitors should be homing on it like heat seeking missiles.  Coincidentally (can there be so many discussion coincidences, or is there more at work in the Universe than we know?), there is a fabulous article by Jim Stogdill on this very issue of unfair profits called Points of Control = Rents.  Worth a read for a good discussion of who has unfair profits in our world today and how did they get them. 

We’re on the downslope now folks, so bear with me. 

Next up for discussion is the statement that the disparity in PE multiples between AAPL and MSFT is crazy given the margins of the two companies and the quarter MSFT just had.  My response is that the disparity in multiples is not crazy at all.  Take your Yahoo stock charts and overlay 5 year performance of MSFT and AAPL:

AAPL vs MSFT Share Price

There should be no doubt in your mind why AAPL gets a higher valuation.  In fact, the contrast is so stark you may wonder why AAPL doesn’t have an even bigger premium.

Inevitably, Warren Buffet’s name was invoked as was the question of whether one could invest in MSFT for the long haul.  In essence, was MSFT so undervalued as to be an ideal Buffet Tech Stock?  But if you’re familiar with Buffet’s investment thesis, MSFT is not really a Buffet business.  Value is not the only part of the Buffet/Graham equation.  Value is the insurance in case the rest of your thesis fails and there has to be has to be a rest of the thesis.  In particular, for Buffet, there has to be reason to believe earnings growth can go on forever at a rate that amounts to an interesting rate of return.  Industries with disruptive tendencies are not good bets because that growth is not reliable in the long haul.  Hence Buffet will declare self-deprecatingly that he won’t invest in tech because he doesn’t understand it.  What he means is he can’t predict when then disruptions will happen, and they happen often enough he can’t hold for a sufficiently long horizon to be interested.
Lastly, we get to the idea that companies have a responsibility to distribute excess cash because the cash belongs to shareholders.  The idea that the cash belongs to shareholders is also an interesting one.  It’s become something of a cliche, in the Gorden Gecko at Teldar Paper Shareholder meeting-esque sort of sense. 
 
If shareholders really owned the cash or even the company, they could call up and have the cash sent over.  Companies can trade below their cash value, and it isn’t even all that uncommon for them to do so.  If shareholders owned the cash, they would call up and have it sent over from one of those companies.  If you had a company that had delivered the kind of equity returns that Balmer’s Microsoft has (flat for so long that it has been called a “Value Trap” by one of our EI’s), I suspect you would also like to have a lot more cash sent over.  But you don’t own the company or the cash, so you don’t control the cash, despite it feeling good to claim otherwise.  What you own is a piece of paper that grants you certain shareholder rights.  That’s a steed of a different hue.  There are lots of people in the “That cash belongs to us” food chain that are much closer to being able to pick up the phone and have the cash sent over than the poor common shareholder.
 
Ask any VC what terms have to be in the deal for the preferred to be able to pick up the phone and have the cash sent over.  Entrepreneurs should make no mistake, it is possible for those guys to own the company and the cash.  In fact it is very likely for that to happen.  I have even personally seen a case where a firm picked up the phone, had the round they’d just put in sent back, and closed the doors.
 
Ask your banker what terms have to be in their note such that when those provisions are not met, they don’t even have to pick up the phone.  They can sweep the cash.  It was a big concern among startups that this was going to happen a lot very recently.
 
These people and many others are closer to “owning the cash” than common shareholders.
 
Common shareholders are not powerless, just almost powerless so that it takes ridiculous numbers of them working together to have a voice.  And even then, what can they really do?  They can jawbone about it.  They can sell their shares.  They can launch proxy fights, which the company will respond to with all sorts of machinery that is efficient at blocking hostile takeovers.  They can launch shareholder suits about failures of fiduciary responsibility.  Yada, yada.  There has to be an awful lot at stake to get enough of them mobilized to go through any of these processes with much chance of success.  Having too much cash on hand is not something that will rise to that occasion.  It’s not enough to mobilize the troops.  If nothing else, the processes are lengthy, the cash is liquid, and quarters are fragile.  If you want to get an envelope full of cash out of a car whose ownership is being contested, you don’t set fire to car to increase your chances.  There has to be some malfeasance, some sense that management is doing something really grossly unfair to the common and well outside their fiduciary responsibility.  We’ve all seen enough shenanigans to know that “grossly unfair” is a very high bar indeed.
 
In the end of the day, companies that can establish unfair points of control allow them to create artificial scarcity and milk the consumer.  Network effects are the most popular Lock-In 2.0 for the Web World, though they existed in the form of available apps and hardware platforms back in the DOS days, the CP/M days before that, and all throughout the mini and mainframe eras.  Today’s buying marketplace is only slightly more canny in their ability to see the garden wall being built and get upset with the gardener about it.  If they see it in time, they try to steer clear.  Open Source has become powerful for exactly that reason.  I love the Red Hat quote, “We love to turn a billion dollar business into a couple of hundred million dollar business.”
 
The prior software generation also had an “implementation rent.”  If you just spent $100M to get SAP live, even if the whole experience was terrible, and the end result only just tolerable, it will be a long long time before you consider undertaking anything remotely like that again.  Most careers won’t survive it.  I vividly remember asking a telco senior exec one time how she thought about the ROI of billing systems.  She laughed and told me there was no ROI.  Nobody thinks about that ROI.  They only think about whether their career can survive the process of replacing a billing system should they be unlucky enough that it comes up on their watch.  SaaS companies road into some of these situations with the idea they would be so much easier to install they would defeat the “implementation rent.”  Some of them are encountering the penalty for that largesse in the form of unreasonably high churn.  If it was easy to put it in, it is easy to take it out as well.
 
So if you are an investor, don’t predicate your success on ownership of the cash.  Rather, choose companies that have unfair points of control that allow them to be unfairly profitable in markets that are growing faster than the S&P 500.  Make sure those unfair points of control and that market growth can continue unimpeded for as far as the eye can see.  Beware disruption.  Does AAPL warrant a higher multiple than MSFT?
 
Yes, despite the current extraordinary MSFT quarter, it seems the market favors Steve  Jobs’ ability to create these unfair points of control in fast growing long tenure markets over the apparent failure of Microsoft to add any new ones and the evidence their old points of control and markets are at risk.

Posted in apple, business, saas, strategy | 1 Comment »

PaaS Strategy: Sell the Condiments, Not the Sandwiches

Posted by Bob Warfield on October 20, 2010

This is part two of a two-part series I’ve wanted to do about strategy for PaaS (Platform-as-a-Service) vendors.  The overall theme is that Platforms as a Service require too much commitment from customers.  They are Boil the Ocean answers to every problem under the sun.  That’s great, but it requires tremendous trust and commitment for customers to accept such solutions.  I want to explore alternate paths that have lower friction of adoption and still leave the door open in the long run for the full solution.  PaaS vendors need to offer a little dating before insisting on marriage and community property. 

In Part one of this PaaS Strategy series, I covered the idea of focusing on getting the customer’s data over before trying to get too much code.  We talked about Analytics, Integration with other Apps, Aggregation, and similar services as being valuable PaaS offerings that wouldn’t require the customer to rewrite their software from the ground up to start getting value from your PaaS.  Now I want to talk about the idea of starting to get some code to come over to the PaaS without having to have all of it.  My fundamental premise is to create a series of packages that can be adopted into the architecture of a product without forcing the product to be wholesale re-architected.  I use the term “packages” very deliberately.

Consider Ruby on Rails Gems as a typical packaging system.  A gem can be anything from a full blown RoR application to a library intended to be used as part of an application.  We’re more focused on the latter.  The SaaS/PaaS world has a pretty good handle on packaging applications in the form of App Stores, but it needs to take the next step.  A proper PaaS Store (we’re gonna need a better name!) would include not only apps built on the platform, but libraries usable by other apps and data too.  Harkening back to my part one article, data is valuable and the PaaS vendor should make it possible to share and monetize the data.  Companies like Hoovers and LinkedIn make it very clear that there is data that is valuable and would add value if you could link your data to that data.

What are other packages that a PaaS PackageStore might offer?

I am fond of saying that when you set out to write a piece of software, 70% of the code written adds no differentiated business advantage for your effort at all.  It’s just stuff you have to get done.  Stuff like your login and authentication subsystem.  You’re not really going to try to build a better login and authentication system, are you?  You just want it to work and follow the industry best practices.  A Login system is a pretty good example of a useful PaaS package for a variety of reasons:

-  It doesn’t have a lot of UI, and what UI it does have is pretty generic.  Packages with a lot of UI are problematic because they require a lot of customization to make them compatible with your product’s look and feel.  That’s not to say it can’t be done, just that it’s a nuisance.

-  It adds a lot of value and it has to be done right.  As a budding young company, I’d pay some vendor who can point to much larger companies who use their login package.  It would make my customers feel better to know this critical component was done well.

-  It involves a fair amount of work to get one done.  There is a fair amount of code and it has to be tested very carefully.

-  I can’t really add unique value with it, it just has to work, and everyone expects it to work the same way.

-  It is a divisible subsystem with a well-defined API and a pretty solid “bulkhead” interface.  What goes on the other side of the bulkhead is something my architecture can largely ignore.  It doesn’t have to spread its tendrils too far and wide through my system in order to add value.  Therefore, it doesn’t perturb my architecture, and if I had to, I could replace it pretty easily.

These are all great qualities for such a package.  What are some others?  Think about the Open Source libaries you’ve used for software in the past, because all of that is legitimate territory:

- Search:  Full text search as delivered by packages like Lucene is a valuable adjunct.

- Messaging:  Adobe and Amazon both have messaging services available.

- Mobile:  A variety of services could be envisioned for mobile ranging from making it easy to deal with voice delivered to and from telephones to SMS messages to full blown platforms that facilitate delivering transparent access to your SaaS app on a smartphone.

-  Billing:  There are companies like Zuora out there focused on exactly this area.  Billing and payment processing comes in all shapes and sizes, and many businesses need access to it.  You needn’t have full-blown Zuora to add value.

-  Attachments:  Many apps like to have a rich set of attachments.  There’s a whole series of problems that have to be solved to make that happen, and most of it adds no value at all to your solution.  Doing a great job of storing, searching, viewing, and editing attachments would be an ideal PaaS package.  There are loads of interesting special cases too.  Photos and Videos, for example.

I want to touch on an interesting point of competitive differentiation and selling.  Let’s pick one of these that has a lot of potential for richness like Photos.  Photos are a world unto themselves as you start adding facilities like resizing, cropping, and other image processing chores, not to mention face recognition.  There’s tons of functionality there that the average startup might never get to, but that their users might think was pretty neat.  After a while, the PaaS can set the bar for what’s expected when an app deals with photos.  They do this when their Photos package is plush enough and adopted widely enough, that people come to expect it’s features.  When it reaches the point where the features are expected, but a startup can’t begin to write them from scratch, the PaaS vendor wins big.  The PaaS customers can win big too, because in the early days, before that plushness becomes the norm, a good set of packages can really add depth to the application being built.

PaaS vendors that want to take advantage of this for their own marketing should focus on packages that deliver sizzle.  I can imagine a PaaS package vendor that totally focuses on sizzle.  They’ve got photos, video, maps, charts (bar charts to Gantt charts), calendars, Social Media integrations, mobile, messaging, all the stuff that when it appears in the demo, delivers tons of sizzle and conveys a slick User Experience. 

Before moving on, I want to briefly consider the opposite end of the spectrum from sizzle.  There’s a lot of really boring stuff that has to get done in an application too.  We’ve touched on login/authentication.  SaaS Operations is another area that I predict a PaaS could penetrate with good success.  Ops covers a whole lot of territory and the ops needs of SaaS can be quite a bit different than the ops needs of typical on-prem software.  For one thing, it needs to scale cheaply.  You can’t throw bodies at it.  For another, you have to diagnose and manage problems remotely.  One of the most common complaints at SaaS companies I’ve worked with is the customer saying performance is terrible.  Is it a problem with the servers?  Is it a problem in the Internet between your servers and the customer?  Is it a problem inside their firewall?  Or is it a problem on their particular machine?  Having a PaaS subsystem that instrumented every leg of the journey, and made it easy to diagnose and report all that would be another valuable, though not particularly sexy offering.

I hope I have shown that there is a lot of evolution left for the PaaS world.  It started out with boil the ocean solutions that demand an application be completely rewritten before it can gain advantage from the platform.  I believe the future is in what I’ll call “Incremental PaaS”.  This is PaaS that adds value without the rewrite.  It’s still a service, and you don’t have to touch code beyond the API’s to access the packages, but it adds value and simplifies the process of creating new Cloud Applications of all kinds.

Posted in cloud, platforms, saas, strategy | 8 Comments »

The 8 Flavors of Social

Posted by Bob Warfield on October 19, 2010

1.  Social built on email and message board traffic.  Perhaps Notes started this frolic, or was it IRC?  Both still soldier on quietly in their corners while forums won the day.  Xobni and others want to go back to the future.
 
2.  Social built on documents.  Wikis, in other words.  Blogs also get a run here somehow:  Social built on Dear Diary?
 
3.  Social built on people and activity streams:  Twitter et al in the purest sense.  Facebook too is all about “me”.  But we had SMS, we had Instant Messenger, and maybe blogs go here more than as documents.  We’ve had some of this for a long time.
 
4.  Social built on questions ala StackOverflow.
 
5  Social built on geolocation and the check-in.  This is closely tied to social reviewing.  Foursquare, Yelp, and all of that ilk go here.
 
6.  Social built on rich media: YouTube and the music social crowd.  Photo sharing social ala Flickr and Photobucket live here too.
 
7.  Social built on transactions in business software, e.g. Chatter?  BTW, Notes did some of this in its day.
8.  Social for business cards and the casual handshake.  LinkedIn.
Have I missed anything?  What’s next? 
We’ve barely scratched the surface of what people are interested in talking about.  Some of these are third and fourth generation while there are large areas never even touched.
Social Analytics?  What might that mean?  Social medicine?  Some of that trying to hatch out there.  Social buying and collecting?  Funny how eBay totally missed that boat, but Amazon is trying to go there.
Figure it out the next big social category and you’ve got tomorrow’s headlines.

Posted in user interface, Web 2.0 | Leave a Comment »

PaaS Strategy: Data not Code

Posted by Bob Warfield on October 12, 2010

This is part one of a two-part series I’ve wanted to do about strategy for PaaS (Platform-as-a-Service) vendors…

The PaaS market is a fascinating one.  Building SaaS and Cloud apps that really take advantage of the Cloud is non-trivial.  And, as I’m fond of saying, at least 70% of the software you build winds up adding no differential business advantage at all.  It’s just stuff you have to get done to finish a working software product.  If you could buy a solution to all of this, and focus all of your energies on the part of the software that does add competitive advantage, that would be good for all concerned, right?  Hence many PaaS offerings set out to do just that–save you 70% of your coding, make you radically more efficient, and let you focus on your business problem while they take care of Multitenancy, the Cloud, and whatever else they can.

It’s a great idea with just one great big problem–it requires an incredible commitment on the part of the customer just to get started.  Giving up control over 70% of your code is scary as heck.  I’ve written before about the need for PaaS vendors to act like Switzerland in order to be as non-threatening as possible.  After years of abuse at the hands of companies like Microsoft, everyone who writes software fears lock-in.  It gets worse too.  Have you ever tried to get developers to work on someone else’s code?  Their answer is universally the same.  No matter who wrote the code or how good it is, it could be done by the Senior Architect they most totally respect, the first time they look at the code and hear you want them to deal with it, their response is invariably, “This code is sh*t and we’re going to have to rewrite it.”  I’ve seen this over and over again.  Oddly, developers seem to hate to learn new things, but they most hate to learn new code.  They rebel at even simple things like trying to organize how they format their code.  Now PaaS vendors would like them to drop everything they know, learn a completely new framework and potentially even a new programming language.  Is it any wonder it’s an uphill battle?

So what’s a poor PaaS vendor to do?  My answer is simple: quite focusing so much on code and change your attention to data.

Data is so much less threatening to the developers you hope to win over.  Sure, you’ve got to prove to them that you’ll take good care of their data, but if they were building software to run in the Cloud or be a SaaS app to start with, presumably they’ve come to grips with that and it’s a conversation you can get through.  Data is extremely advantageous for the PaaS vendor to have.  First, it leads to code coming over as your customers will inevitably want to do something with the data.  Second, there are strong network effects associated with the data (that will turn out to be a pun, sorry) due to latency.  Simply put, it is easier to access data in the same Cloud than in another Cloud.  So data will tend to accrete.  The more data that is in a Cloud, at least if its data that goes together, the more data will want to be in the same Cloud.  Data is also pretty frictionless to get into the Cloud.  Sure, there is latency if you move it around a lot, but loading it in and keeping it up to date is not so bad.  Those same developers that wanted to rebel over swallowing a bunch of foreign code have no problem at all getting on board with a project to move a bunch of data into a Cloud.

The next question to answer is, “Why should a customer put their data onto our PaaS in our Cloud?”

There are some good answers here too.  Customers will put their data in your Cloud in exchange for:

  • Analytics:  Reporting and Analytics is something every application needs to do that is pretty darned painful to keep building yourself every time.   There is a reason the BI companies stayed independent for so long even though the apps companies owned the data–it’s hard to write BI software!  And so many SaaS companies have lousy to middle of the pack reporting and analytics.  For some it is almost non-existant.  Almost nobody has much in their first release, but they nearly all reach a point where they have to invest in it because their customers demand it.  PaaS vendors should focus on this one up front.  It is extremely high value add, and gives a powerful reason for customers to move their data into your Cloud.  Make it easy for them to create their reporting and analytics data warehouse there.  You won’t be sorry.
  • Integration:  Next on the list of reasons to move data to your Cloud is you will solve an Integration problem for customers if they do so.  No software is an island these days.  It all has to integrate to something.  If you can facilitate that integration once the data is in your Cloud, everybody wins.  Note that this integration should inform your business development strategy too.  Look for partners to pull into your Cloud that add value through integration.  Identify key systems of record, and either get that system into your Cloud or get connectors to that system into your Cloud.  But don’t offer the connector without the Cloud.  Give the connector away in exchange for keeping data in your Cloud.  Don’t give away the cow, sell the milk.
  • Aggregation:  The subject of deriving benchmarks from aggregated data comes up constantly in reference to the Cloud.  The insights that can be gained from looking across many customers at the same data are tremendously valuable.  The PaaS vendor should facilitate this in two ways.  First, they can act as an aggregation clearing house.  It takes a particular kind of BI Warehouse to be efficient at aggregation.  It takes a particular kind of expertise as well, so there are services to be sold here that a lot of SaaS companies don’t seem to have.  Call this an offshoot of Analytics if you like, but in my experience it is rich enough to be a stand-alone offering in its own right.  Second, the PaaS vendor can augment the value of the data via aggregation of a different sort.  Take Salesforce.com’s purchase of Jigsaw.  Suddenly they have a lot of interesting data about any contact that you may have in any database for any reason.  If they let you connect that data to yours, it is a sort of aggregation that adds value.  For sales and marketing or supply chain-related software, there is a lot of opportunity in this sort of value added data linkup.  There is less opportunity for inwardly facing data, but it is still there (salary benchmarks, anyone?).
  • Other Value Added Services:  Let’s not stop with the Big 3.  There are lots of other Value Added Services you can bring to the table once customers are comfortable giving you a slice of their data.  Disaster Recovery is an obvious one.  But what about Disaster Recovery combined with Integration?  Not only are you helping to back up the customer’s immediate data, but you are backing up the data they may have entrusted to other Cloud Providers and SaaS applications.  What about services to help them manage their data in various ways?  Every SaaS vendor has to manage data in some form or fashion.  At the very least they need a plan to archive or dispose of it.  Perhaps your Cloud is the final destination in a hierarchical archiving scenario.   And while we’re talking backup, archiving, and disaster recovery, how about a simple service while your customer’s SaaS app is down during a maintenance period?  Can you provide them with a reduced-functionality front end and access to data so that their customers are never completely cut-off with no service waiting for the regularly scheduled maintenance (or the irregularly scheduled and unplanned-for outage) to end?  Of course you can, and it will make your customers happy because it makes their customers happier.

Okay, there’s a sampling of things PaaS vendors can do to win over the data of customers so they can earn the right to win over more and more code.  It offers a way to build a win-win relationship between the PaaS Vendor and customers so that trust can be built and a stronger relationship can unfold.  In the second installment, I’ll be writing about how PaaS vendors should manage that unfolding so the elephant can be eaten one bite at a time.

Related Articles

Have you noticed how many Analytics and Integration acquisitions IBM has been making in the last 12-18 months?  Fascinating basis for PaaS over there.

Posted in business, cloud, saas, strategy | 7 Comments »

Greylock + Angelgate Signal the Seed Funding Pendulum Has Reversed

Posted by Bob Warfield on October 5, 2010

Seed money. 

In many ways, the first investment in your company is the most important.  Once you have investors, it becomes exponentially easier to get more investors, at least if you don’t screw it up. 

Once upon a time, a slideshow and a team could raise quite a lot of seed money.  It hasn’t even been so very long ago.  I’ve been involved in 5 startups that all came into being that way.  There was no need for bootstrapping, and the products built by those companies were too expensive to develop as bootstraps anyway.  Somewhere along the way, fairly recently, something changed.  VC Funds had terrible returns for too long, perhaps.  And suddenly, it was darned near impossible to get seed money.  A team and a slide show were not enough.  You needed to bootstrap a product.  You needed to have customers for investors to talk to.  You needed something nebulous called “traction”.  Traction was a moving target that depended on what was fashionable, what inspired the investors, and how charismatic the founders were.

This period made things hard for entrepreneurs.  Yes, there has been much rejoicing about how much more cheaply products can be built and marketed.  And yes, some can.  But in many ways, the kinds of products we started building involved lowering our sights to what was possible without a decent seed round.  I’ve written about this for quite some time.  I’ve even published numbers that show how VC returns have gone down in almost direct proportion to seed funding drying up.  Silicon Valley ain’t what it used to be as Dan Lyons says in his Newsweek article on Facebook.  While I will almost certainly go see the Facebook movie, I’m already emotionally prepared that it may be depressing.  The Valley doesn’t see itself this way, but I wonder if The Social Network doesn’t have an awful lot in common with Wall Street: Money Never Sleeps?  Both movies depict a world where schemers get uber-rich without creating anything of much real value by traditional standards.  Gordon Gecko constantly refers to getting in on the “Next Bubble” and implies you’re a sap if you’re out for anything with more meaning to it.  Is our modern world of investing in one Social startup after the next, many of which are building features moreso than products or companies, any less vapid than the Wall Street Gecko occupies?

A very smart friend tells me the VC’s are well aware of all this, but they’re also well aware that their returns ultimately depend on whether the tide is coming in or going out.  And, they’ve been sitting on a beach with the tide going out for about 10 years now.  Hence they’ve been shy about seeds.  They sound like momentum investors to me, when described that way.  The problem is that a momentum investor looks for periods of unfair valuation and rides that wave (tide metaphor again).  However, such periods are often relatively short-lived.  In an era where it takes 5 years, 7 years, maybe 10 years to build a startup to a stage where it can IPO or get bought at VC return-worthy valuations, how do you predict the tide well enough to seed the right deals in time to catch the window of opportunity?  The answer is simple: you can’t.

Then a funny thing happened: the entrepreneurial ecosystem evolved.  Angels came onto the scene and stepped in where traditional VC’s had left off by doing seed rounds again.  Sure, it wasn’t a lot of money at first, and it would be darned hard to build a company like Peoplesoft or Autodesk with it, but it was a step.  Then we started hearing a lot about bootstrappers who focused on opportunities that required so little capital they did away with VC’s altogether.  And some of them made fortunes.  I’ve never seen any numbers, but it’s hard to believe they’ve done all that much more poorly than founders at traditional startups lately.  This created a real danger for VC’s, who must have started to wonder whether they could be cut out of the loop altogether.  After all, despite much protesting, its pretty hard to tell the difference between a Super Angel and a VC.  Maybe that’s what Angelgate really brought out into the open, that these investors are all pros who are scrapping hard at a tough job, and that if they take their eye off the ball and forget its all about the entrepreneur, that’s a bad thing for their business.

Recently I read that Greylock is staking ex-PayPal and LinkedIn founder Reid Hoffman to do seed funding with $20M.  I think that’s great news, and a good move on Greylock’s part (always a savvy firm).  What the entrepreneurial ecosystem needs is this healthy competition and more seed money.  Maybe it means the seed funding pendulum has reversed.  I hope so, because after reversal it still takes time to come up to full speed.  VC is a business that depends on Darwinian search to find opportunities and a portfolio effect to mitigate the risk of failed opportunities.  What that means is you place a lot of bets as well as you can, but knowing that most will be bad bets.  You depend on a few to be insanely great, and on the diversified portfolio of these investments to protect you from the risk.  With each successive round you double down where traction verifies the earlier bets were good.  If there isn’t seed money, there isn’t enough feedstock of initial deals to drive the process of Financial Selection (bit of a play on Natural Selection, it is seldom very natural in this world!).  Too little diversity is bad for any ecosystem.  Funds with more seeds cast a wider net, not to mention creating relationships with entrepreneurs that will want to have them in subsequent doubling down rounds.

Now comes the next challenge–with competition, as with evolution, there is always another challenge.  As more seed money becomes available, you will have to broaden and diversify your investments.  If everyone is investing in location-aware social networks, you want one of these in your portfolio, but you want to find other areas that aren’t so crowded.  You’ll have to try more contrarian investing to avoid having your portfolio become too highly correlated both internally and across the spectrum of what VC’s are investing in.

That’s the beautiful thing about a market–it forces its players to constantly evolve.

Related Articles

Michael Arrington says, “Something tells me the venture capitalists are just about done having their lunch eaten by the ‘super angel’ crowd.”

Posted in business, strategy, venture | 3 Comments »

A Pair of Killer Pricing Articles for Startups

Posted by Bob Warfield on October 4, 2010

Must reads for any startup are Jeff Nolan’s “The Myth of Freemium and Related Pricing Topics” and VC Seth Levine’s “Pricing models, the freemium myth and why you may not be charging enough for your product.”

I’ve written about my own experience with Freemiums and price changes at Helpstream.

Some high points from these two gentlemen as well as my own experiences:

-  Think of Freemiums and Low Prices as Marketing.  Like any other Marketing program, there needs to be a discernible ROI.  You can’t lose money on every unit and make it up in volume.   Ultimately, your sales and marketing costs have to wind up being a small part of the revenue you receive from each customer.  Don’t mis-state that ratio by failing to include the unnaturally low price (or no price in the case of a freemium) you are charging.

-  I agree totally with Jeff Nolan who says it is just as hard to lower as to raise prices.  Seth is in the conventional (easier to lower) camp, but customers feel cheated if you slam the price down.  They think you’ve been overcharging and wonder if they were suckers to trust you.  OTOH, my experience raising prices has been much better.  Customers understand that an early stage startup can’t charge as much as a later stage.  One of my mentors calls it “Earning the right to charge your product’s true value.”  That’s a good way to think about it.

-  As Jeff and Seth allude to, pricing works better when it is aligned with value.  The more value you recieve, the more you should pay.  The exception is for large up-front transactions, which are often discounted. 

-  In addition to aligning price with value, think about how to align it with expense.  If you’ve succeeded in aligning all three–price, value, and cost of delivery, it’s unlikely anyone will game your pricing and it will be much easier to understand and accept.

-  Simple is always better.  Love the examples of Heroku and Base Camp that are given.  Keep in mind that not everyone in your organization is necessarily aligned with the desire to keep it simple.  Complexity gives Sales room to manuever and add their value through negotiation.  You have to think about whether it is better for your business to undergo that friction (i.e. how often does Sales negotiate to the better) or is it better to be transparent and easy for customers.  When in doubt, err on the side of the customer.

-  Unbundling and tiering needs to be aligned in such a way that every customer doesn’t need the separate line item.  If everyone needs it, you’ve needlessly complicated things.  If the great majority need it, you’ve needlessly complicated things.  If less than half need it, you may be on to something.

- It’s a beautiful thing to outflank the competition with a qualitatively different pricing model.  Qualitative means your pricing isn’t just cheaper, but it works differently.  Keep in mind the admonition about aligning price, value, and expenses before attempting this.  I’ll give as an example Helpstream’s pricing for a SaaS Social CRM product.  Every player in that market except Helpstream wanted to charge for their customer’s customers.  We only charged for our customer’s employees who were on the system.  We told our customer’s we couldn’t see penalizing them for successfully building communities of their own customers and they loved it.  We were able to do this because we could deliver the service for about 5 cents a year per customer’s customer.  It took some unique architecture to pull that off, but it was a powerful competitive weapon.

-  I disagree with Seth Levine about cutting the trial period from 30 days to 14 days.  That really depends on the product and customers.  Get a good sense of how long it should take them to evaluate your product, get all the ducks in a row on their side to make a purchase, and then use that figure, whatever it turns out to be.  Getting all the players in an org to agree on a Social CRM system in 14 days was never going to happen for Helpstream. 

Be sure to check the links at the top.  Lots more good material in all 4 blog posts!

Bootstrappa’s Resources

Links to the Bootstrappa’s Paradise blog series as well as other useful resources for Bootstrappers.

Posted in business, strategy, venture | Leave a Comment »

Half of VMWare’s Customer Base Should’ve Bought SaaS

Posted by Bob Warfield on October 4, 2010

According to Network World (which got its data from a VMWare customer survey), half of VMWare’s customer base is using the product to virtualize Microsoft Exchange.

Why in the world didn’t these customers buy a SaaS mail product?  For all the hassle of managing Exchange servers in your own data center, it’s just not worth it.  The savings could have been tremendous and a lot could’ve been offloaded.  Anyone who has used a product like Google’s G-Mail knows the spam filtering is 10x better than what anyone can afford with individual Exchange servers too.

Come to that, why isn’t Microsoft migrating Exchange customers into its own Cloud as fast as it can?

‘Nuff said.

Posted in business, cloud, data center, saas | 1 Comment »

Who is Your Chief Content Officer?

Posted by Bob Warfield on October 2, 2010

Who do you see when you look around the table at your fresh young startup?

The usual suspects are likely all there.

A set of executives that likely includes a CEO, a VP of Engineering or Products, a VP of Marketing and / or a VP of Sales (not all startups have both, but most have at least one).  Gotta have some software developers to build it.  There is someone charged with the product vision.  It could be one of the Execs or perhaps a Product Manager.

At the very early stage, that almost everyone you really need.  QA, operations, Tech Support, more sales people, help for marketing, and all the rest can come later.

One thing that shouldn’t come later is content.  When you look around that table, who is your Chief Content Officer?  Who is responsible for making content happen, and just as importantly early on, who will write the majority of your content while everyone else is busy with other things?

In a modern web-based startup, content is King.  You can’t do without it.  Content trumps SEO and Links for marketing.  Content lets you start building a following before you even have a product.  Content will be your most powerful marketing tool when you’re ready to start selling.  Content can be a powerful differentiator against competitors, and it is content even more than product that will establish you as the Thought Leaders in your market.  Even if you’re a company focused on direct selling rather than selling on the web, you still need to arm your sales people with good content.

I’m not sure I’ve ever seen a startup stop and think about the idea of a “Chief Content Officer?”  Forget about actually giving someone the title, though that might be an important symbol.  Very few think about the job itself and getting the work done.

That’s a shame because it really is critically important.  Not only is content a potent marketing tool, but it’s also a potent feedback tool.  Most followers are lurkers.  Quite a few will respond to your content.  Very very few will step up unasked. 

Figure out who your Chief Content Officer will be and getting going on producing some content!

Bootstrappa’s Resources

Links to the Bootstrappa’s Paradise blog series as well as other useful resources for Bootstrappers.

Posted in bootstrapping, business, Marketing | 3 Comments »

HP and the Magnificent Madness of Big Company Shuffles

Posted by Bob Warfield on October 2, 2010

Ah, the Big Company Shuffle.  Just when an industry gets to be too boring, one of the waltzing elephants stumbles.  Will it fall?  Did it break a leg?  Or will it just shake it off and keep going?

Larry Ellison is “speechless”, but of course, not really.  Insiders are either depressed and hate the Board or happy and fired up, depending on who you talk to.  My colleagues among the Enterprise Irregulars are sharply split and opinions range from not saying anything if you have nothing good to say, to applauding the potent polymath team HP now possesses at the top (sorry, needed to get those P’s in for impact!).  There is talk of software being the “glue” (good thing it isn’t the foundation as it’s only 3% of HPQ’s revenues) and rewriting of legacies.  There is talk of this new CEO’s abrasive style.  That one worries me a bit.  The HP’ers I’ve known have been sensitive to this, and both Hurd and Carly Fiorina had problems with the rank and file not liking them.  It isn’t clear that Apotheker sets out to be a well-liked leader.  OTOH, a lot of the folks that like Leo for the job have experience seeing him in action, so maybe his style isn’t such a problem.  I’m from the school that thinks CEO’s need to be tough, but fair, and hopefully right.  Zoli Erdos, who is also an ex-SAP’er is less complimentary, but characteristically funny:

HP’s troops have never been more demoralized, and Leo has a lot of experienced with demoralized troops.  Not so much leading them out, but in … oh, well.

Dennis Howlett likes Apotheker for the job, and raises an important variable I haven’t heard so much from others: Self-Awareness.  When people understand their foibles they can change.  I’ve seen it happen, even for powerful leaders with big egos.  Perhaps most especially for them.  They say you mostly learn from your mistakes, if you will listen to them.  Certainly Leo Apotheker has a breadth of experience from which to draw on.  If he has some strategies to shore up his weaknesses, he could be a real surprise.

Some predict fascinating new combinations through acquisitions–they could buy SAP, “No, that’s old news, they could buy Salesforce.”  Never mind that the market cap of HP is distressingly close to SAP’s–$92B versus $60B, and you add a 30% premium and suddenly you have a merger of equals, or that new CEO Leo was more or less fired from SAP, or the way the German company is structured and who will therefore have a say so.  Heck, never mind that HP’s market cap is pretty distressingly close to Salesforces (trading at about $15B or 1/6 of HP’s for 1/10 of the revenue of HP) or that Leo was no friend of SAP’s ByD SaaS offering by all accounts.

And while we’re on this market cap fascination, think about what it takes before Larry Ellison can swoop in and create the World’s Largest Computer Company by acquiring HP.  He has to be chortling every time his stock goes up and HP’s goes down.  “Thank you Leo for bringing me that much closer!”  The question will be, with ORCL at $137B and HP at $92B, exactly how big does the gap between the two have to get, and how disillusioned do shareholders have to be, before it becomes a foregone conclusion?  Right now, he has a gap that’s closing in on 50%.  Larry’s goal will have to be avoiding a merger of “equals” after he pays whatever premium is necessary to get the deal closed.  He needs to play for differential performance between the two companies–ORCL up, HP down.  It would be fascinating to do some deep analysis on potential market moves that would accomplish this.  For example, does ORCL own a business they could discount like crazy to take profits out of the market that would disproportionately harm HP’s profitability? 

This is a move where timing is everything and the pressure is on.  If Leo stumbles, Larry will be there to catch him on the tip of his Samurai sword.  If Leo soars, Larry will have missed the opportunity to put the crowing achievement on his career.  At least for a while.  And he’s not getting any younger.  For HP, we’re off to a bad start with that stock price drop the first day of trading.  If it continues, Apotheker may need to contact Carol Bartz about joining her club.  He has to immediately galvanize the troops on some mission that is inspiring, empowering, and successful.  Does he have the reputation for doing that?  This is not a caretaker job, it’s a ship that’s hit an iceberg and is taking on water.  Bold steps will have to be taken, and quickly.

Yep, the elephants are dancing.  Because someone knows someone else, or once said something, or has a reputation for, here’s what could happen…

Are you getting a sense of the maelstrom?  It is truly a magnificent madness.  What a piece of work is the tech business!

Posted in business | 2 Comments »

 
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