Rethinking the Tip Jar

I picked up some coffee the other day at Birch Coffee near our offices and encountered this tip jar (yes, I tipped for LOTR):

Tip Jars @ Birch

Aside from this being a creative way to ask for tips, I am willing to bet that this tactic is more effective than a standard tip jar.  Instead of asking explicitly for money, the staff here cleverly made tipping a game.  It was actually fun to tip the Brich folks, I got to simultaneously vote for my preference.  In it’s own way, this tip is about the tipper as well.

There are so many things in the world of business that are set up and executed without any creativity applied. This inspired me to try to rethink assumptions on monetization with some of our companies.

Creative Destruction

I’m reading The Master Switch by Tim Wu, which was recommended to me by Jerry Neumann (side note: Jerry recently produced an awesomely useful VC bot which tracks announced investments as they show up on vc sites).  If you’re interested in the technology industry, you should definitely read it.   It addresses some interesting themes that are essentially timeless:

Theme 1: Information Industry Power Tends to Centralize

In The Master Switch, Wu reviews the 20th century and effectively makes the case that every American information industry started out free and open, but eventually became restricted, with power centralizing around a monopoly or cartel.  This theme rings out as alarming while today’s debate over net neutrality plays out.  Right now we’re seeing a narrowing of the competitive field for data providers (AT&T / T-Mobile merger) while all of our data is simultaneously moving to the cloud, becoming more dependent on the network.  From here, it looks like the Internet may be heading down a similar path as its predecessors; time will tell.

Theme 2: Innovation Causes Creative Destruction 

A related, slightly less ominous theme that the book touches on is the concept of creative destruction.  Economist Joseph Schumpter gave us the modern definition of the term, which refers to the idea that, when  businesses reach a steady state of maturity and future growth is unlikely,  entrepreneurship often unleashes an innovation that destroys the old industry and restarts the growth process. This process can be painful in the short-term for an economy, but is widely considered to be long-term beneficial.

Creative destruction occurs in all business sectors and industries, but at a high frequency in the technology business.   Typically, an innovation on an existing technology is adopted by an early set of enthusiasts, then it hits the mainstream when its value becomes proven, replacing the previous generation technology in the process.  For a leader to survive a changing of the tides, it often must release a new product that cannibalizes its current cash cow.  Because leaders are usually focused on short-term earnings to keep the equity markets happy, they rarely make the change in time.  We recently witnessed this with RIMM, but (to Wu’s point) this has been happening since Western Union refused to see the telephone as a viable threat to its telegraph business in the early 1900’s.

Aside from the tech industry,  innovation is the eventual cause of creative destruction in most large, slow growth industries.  As Chris Dixon has observed,  the Internet has been the agent of disruption in a many industries and will likely disrupt many, many more in the coming years.  Music was the first to go, but now news, politics, commerce, advertising, marketing, film & television, human resource management, operations and finance have all been disrupted by Internet-based innovations.  Predicting which industries are next, and how creative destruction will manifest is where the biggest opportunities exist.

Melting Ice Cubes: New vs. Old Media

The media industry has a lot of melting ice cubes

I try to get involved in lots of conversations about the future of the media industry.  Having worked initially in the music industry (content creation)  and later in the emerging media business (content strategy),  I spend a lot of time thinking about were people spend their time accessing information and consuming content, and I’m lucky to live in New York, where there are a lot of really smart folks who think and talk about this a lot.

The media business is an interesting place right now,  there are a lot of new executions happening on content development, distribution and monetization and the big changes aren’t over by a long shot.  This innovation has created a lot of transitional friction.  This is not new news but worth continuing the discussion.

Changes in consumer behavior create a great deal of what’s referred to in the investing world as secular risk.  I take a class right now where someone mentioned newspapers and terrestrial radio, describing  the two industries as melting ice cubes because the value is melting away as customers move to other parts of the media universe.  I think that’s an apt description for what’s happening to a lot of businesses that used to make lots of money.  Because customers are migrating to new media sources and away from old media sources,  the value of these older models is….evaporating.   It happens fast:

Want to change the music industry?  Download your music for free.

Want to never walk into a bookstore again?   Stop buying books.

Want to kill terrestrial radio?  Don’t turn it on.

Media and entertainment are risky because, often,  all it takes for you to become worth nothing is for your customer base to refrain from consuming your content.  When Napster dropped an A-Bomb on the business in 1999, the argument from a lot of music fans who gorged themselves on free music was that “the music industry had been ripping them off for years,  this was just a rebalancing”.  The party is now over and SoundScan just had its worst week in history; which is an unfortunate blemish on a great achievement for Amos Lee.

Some great things have been growing, new businesses like Sirius XM, Pandora and Last.FM for music….and digital books and tablets are incredible; but these innovations have largely come at the cost of traditional media businesses and  they haven’t found the type of profitability that is necessary for long-term sustainability.  This is potentially value destroying.

Some of these changing businesses were desperately in need of disruption; I think others are just going to get run over and it’s the downside to innovation.  I believe innovation is, net-net, an exciting proposition that allows for new players, new solutions and and overall better experience for consumers.  With that said, the transition can be tumultuous and sometimes things like albums and books get lost in the shuffle…and they were really great products and I’m going to miss them.  I do know one thing for sure, if content farms are the future,  then we’re all going to start missing the past.

Five Predictions for 2011

I started to write a retrospective on 2010, but  decided that we all lived through the year and there are some great photo essays that are much more interesting than my thoughts.  Instead,  I’m going to make  five predictions on tech, social and digital media trends in 2011.

1. Exponential growth in the U.S. smartphone market

Mobile is my current fascination, and the growth that we’ll see in 2011 in the U.S. market promises to make it the rest of the country’s fascination as well.  I wrote a post about this recently, and recognize that people have been predicting the year of mobile for a long time. But looking at the current environment makes it easy to see, from my perspective, that 2011 (or 2012 at the latest) will be the year that mobile will start to compete with the web for most relevant technological innovation (read Fred Wilson’s post to get the pro’s perspective) in the world.

Right now the early adoption is complete.  The iPhone skimmed the market for the high-end tech enthusiasts and the coastal hipsters.  The people who want the next thing have it, but they had to buy AT&T contracts in order to get it and, overall, the iPhone is an expensive investment when you start looking at the data plans.  Broader market penetration will happen with the growth of the Android platform; which will become the device- and service provider-agnostic operating system that will allow low-cost producers to offer smartphones to the price-sensitive consumer.   The increase in availability of these phones, I predict,  will actually lower the cost of data plans as well.  This is a  trend that is bound to continue as the fixed costs of building data delivery infrastructure is recouped and competition brings the supply of data networks up and the cost of the service down.

2. An increase in mobile gaming, but a decrease in pay-for-app models

Angry Birds was worth $20 million to EA, and for good reason.  Electronic Arts currently owns over half of the top 10 spots in the itunes App store and Angry Birds alone has sold over 6.5 million copies.  Mobile gaming is going to continue to grow, and it’s going to pull in a much broader audience in 2011 (see prediction #1).  With the growth of the category, however, I’m not confident that we will continue to see the pay model that currently exists in the itunes store , and I’m not entirely convinced that social currency will support the marketplace either.  I’ve been in the app marketplace for a while now and I’m surprised at how few apps have really embraced the ad-supported model that has driven the web economy for so many years now.  It’s possible that mobile advertising simply hasn’t developed enough to sell performance, but on a CPM level, I’m surprised that more advertisers aren’t clamoring to get into people’s smartphones.  If this changes with the broadening of the market, I think we’ll start to see more social gaming on mobile devices, and gaming publishers similar to Zynga and RockYou on mobile devices.

3. Continued adoption of web-based productivity apps by businesses

Google is going to take a few more swipes at Microsoft in 2011, and they will continue to pull share from the leader with the improvement of Google Apps for business and education.  Cloud-based apps just make sense for most people, who really don’t use much processing power to accomplish the majority of their tasks.  It’s also far easier to synchronize email, calendar, contacts and documents when they’re in the cloud.  Based on prediction #1 (above), it makes sense that more and more companies will move to the cloud for their business application needs because people are going to increase the number of screens that they use, and hence have a greater demand for easily synched solutions. Google Apps are the best cloud-based productivity applications in the market. Microsoft Live is a few years too late and a few features too underwhelming to be particularly useful.

4. Fragmented social networks

Facebook is now the place where you have the most connections that have the highest variance in value (mom, girlfriend, junior high-school acquaintance).  Facebook is now sort of a mashed up wall of brands, bands, friends, frenemies, places and games.  While Facebook continues to do a amazing job at delivering a platform that can be customized and controlled by its users,  I believe 2011 will be the year that people start signing up for smaller communities and networks that are relevant to a particular passion or activity.  Path is trying to fill this gap with a social network that only allows you to share photos with 50 people , and is filling in a void for hipsters and the visually curious to filter their photos with lo-fi effects.  These communities are built on top of the Facebook platform, but a different a slightly different value proposition and will start to syphon off some user attention.

I believe that music isn’t getting a fair shake in Facebook and that money is being left on the table in that space.   We’re going to be releasing a product in 2011 that will try to fill in some of the holes that Facebook misses in the music business and I’m looking forward to seeing entrepreneurs take on similar strategies.

5. Flat adoption of mobile coupons, despite the inevitable heavyweight user war.

Mobile coupons seem to be the trend that just won’t stick…yet.  I believe it’s going to take a little more time than people are hoping for consumers to start really using mobile coupon offers.  Media agencies are starting to experiment with QR codes and companies like Foursquare continue to make the push for location-based discounts (although I’ve struggled to  find a relevant advertisement in my experiences with the platform thus far).  Facebook PlacesHotpot and  Google Places are also diving into this space head first.  While Google, Facebook and Foursquare will trade punches like heavyweights in a royal rumble this year, I suspect that users will be decidedly absent from the fight.  2012 will be the year of mobile coupons, 2011 will still be the year of the Groupon.

The Mis-Application of Innovation

With all of the recent discussion about civil charges being brought by the SEC against Goldman Sachs, I got into a discussion with some friends about innovation, technology development and its abuse by people who either don’t understand the technology they are using, know but do not care about the risks involved, or knowingly behave unethically in an effort to leverage short-term gains.  After reading a blog post by Bill Taylor on the subject, I thought I’d chime in from a technology standpoint (although Bill does a much better job than I do at explaining my own thoughts on the subject–  you should definitely read his post).

Bill points out two blatant misuses of recent innovations developed by really smart people and abused by the financial services industry:  collateralized debt obligations and micro-lending.  These are both somewhat complicated technologies, and I think it’s safe to say that the U.S. housing market collapse was pretty clear evidence that the technology was egregiously abused.  The micro-lending conversation is perhaps a bit more ambiguous (it could be posited that the rejection of certain micro-lending offers are a natural piece of the economic puzzle, and will soon drive rates back down).  My position in the conversation my friends and I were having , which I still maintain, is that blaming technology is pointless and mis-guided.

People innovate.  It’s a natural thing for humans to do and should never be discouraged.   The idea that the innovation is the culprit is a dangerous position to take when situations like this arise because innovation is absolutely a net positive endeavor. Technological gains are part of what has made the U.S. economy surge in the past century, and it will unquestionably be the source of our economic growth in the future.  We live longer, happier lives as a result of technological innovation.

I think problems start to arise because of a lack of transparency and asymmetric information problems.   As Americans, we consume too much health care, we take out lousy mortgages and loans and we tend to make foolish financial decisions  as consumers.  American consumerism is generally an impulsive phenomenon–   or, we know we’re making bad decisions, but everyone around us is making them to so we fall in line with the behavior.  The solution to bad decision-making is more education and greater transparency. The solution is not to halt efforts to innovate from fear that innovation will be abused.

Peer Lending Gets Another Boost

According to TechCrunch, peer lending site the Lending Club, secured $24.5 million in Series C financing, led by Foundation Capital and joined by existing investors including Morgenthaler Ventures, Norwest Venture Partners and Canaan Partners.

Peer lending companies like Lending Club and Prosper are sites that connect lenders and borrowers in a transparent, social network style environment.  While certainly not risk free investments,  I believe these sites allow for a free-market solution to small-to-medium sized loans in an efficient way.  Through this direct approach,  these sites have the ability to eliminate layers of cost and bureaucracy that surround loans which, in theory, allows for lower rates for borrowers and higher returns for lenders.

While I do not believe that peer-to-peer lending will ever replace traditional loans, credit cards and big banks,  it’s inspiring to see a new asset class emerge that, one day, could compete with Wall Street, or at least influence the price of this amount of money.  When you consider the scalability of this model (assuming transparent information on borrowers remains available) and the extremely high APRs that credit cards can charge for small amounts of money, this outlet could potentially  become a real resource for consumers trying to lower their interest expense, or make small investments in their businesses.  If these sites reach their potential, they will become a natural anchor to credit card rates.   Additionally, with annualized returns over 9.5%, it’s not impossible for places like the Lending Club to pull in a large investment pool from a large group of small investors looking to diversify from the market and avoid paying management fees.

According to their blog, the Lending Club has issued a little over $100 million in loans since it’s inception and currently controls about 75% of the peer lending industry.  This is an extremely small piece of the lending pie,  but I’m hopeful that this industry wil continue to grow.  The real challenges that peer lending sites face is (again) one of network effects.  As a market making site, it’s important that borrowers and lenders can connect with similar risk profiles (lenders that are willing to accept risk for higher returns, and borrowers who are willing to pay higher rates with relatively low default risk).  I plan to open a (very) small account this month to get an idea of the lending process  and I’ll post again on this topic soon.

On another note,  the Lending Club website is a great example of what a startup site should look like.  The value proposition for lenders and borrowers is clear & upfront; there’s very little potential for anyone visiting the site for the first time to be confused.

Locking on Strategy: Apple & Twitter

I’ve been trying to identify a trend I’ve seen this week in my RSS feeds, told through the story of Apple changing rules on iPhone application analytics (Venture Beat), the much-discussed HTML5 vs. Adobe battle (I like this Scobleizer read which discusses it)  and  Twitter developing 3rd party applications for mobile applications and acquiring Tweetie (I downloaded the Twitter application for Blackberry yesterday and it’s excellent). It seems that the biggest innovators in technology are integrating and consolidating their channels.

It’s been interesting watching these companies shift strategies and jockey for space.  Apple has always kept a somewhat closed shop.  The recent exclusion of Adobe Flash from the iPad was a bold move on Apple’s part, but not entirely surprising considering the company’s history of being a vertically integrated firm that does not like becoming dependent on channel partners.

Watching Twitter and Facebook move around has been the more interesting story.  For the past year, Facebook has been redesigning it’s user experience to mimic Twitter’s model.  Status updates and tweets are a very similar now, and this is most likely the result of these platforms focusing exclusively on gaining advantage through network effects.   Twitter and Facebook have been dependent on content and users first, revenue second.   Now that they have both gained massive user bases and rapid adoption growth; the focus is turning towards revenue generation.

Facebook generated over $500 million in 2009 revenue, which came thorough display and performance-based advertising.   Let’s assume that Twitter is moving into third party applications in order to serve up mobile ads; is it enough to match the revenue levels that Facebook has generated?  The picture gets cloudier when you consider  the fact that Facebook made the majority of their ad revenue through 3rd party application advertisiers like Zynga.  The platform has already chalked up some revenue by licensing their search results to Bing & Google, and I believe there is more revenue down this path in the form  of brands looking for in-depth market research along the lines of what BuzzMetrics offers.

Another route is the sponsored tweet.  I’m not a huge fan of this model as a user or as a marketer–  I just think earned media should stay earned and buying people’s twitter feeds doesn’t seem like a scalable, sustainable model to me.  The fact is that Twitter is an unbelievably useful, intriguing and transformative technology. While I’m not certain what their revenue model is going to ultimately be, I imagine it will be a combination of the revenue models that we’re seeing now (some search, some mobile ads, some sponsored tweets). Regardless what their ultimate revenue solution is,  the platform is undeniably here to stay.

UPDATE: Twitter announced it’s model for rolling out sponsored tweets yesterday , and will discuss them in greater detail ad the AdAge Digital Conference, here in New York, next week.    I’m looking forward to seeing how these perform.  Clearly, opening a channel for  more mobile advertising is a big opportunity.

TFP & Emerging Technologies

I have a macro  economics  mid-term tomorrow,  so my head is filled with international trade, emerging market growth, labor markets and so on.  Tonight I’ve gotten to thinking about the Cobb-Douglas production function, and how it applies to the things that I’m interested in: new technology.

The Cobb-Douglas production function says a lot more than I care to in this post,  but the basic equation states the following:

GDP is a function of A (Total Factor Productivity or TFP),  K (The Capital Stock), and H (Human Capital).  The little alpha takes depreciation of the capital stock into account.  So, economists start here and get into a lot more depth in analyzing how certain markets grow.

The letter “A” is the intriguing factor here.  A is total factor productivity (TFP) and it basically represents two things:

  • How easily markets can clear (generally a lack of government intervention), and
  • Technology

These two things makes labor more efficient and productive.  Without technology, economies have a difficult time growing.   This got me thinking about that VC world and investments in new technology.  Total factor productivity measures how effective technology is at helping labor become more efficient.   There have been a number of transformative technologies that have made our lives easier, that have made us more productive of transformed the way that we do one thing.  These technologies are exciting to me.  Google’s search technology is a big, obvious example.  Microsoft Windows.  The personal computer.

I read this post today from  PE Hub about venture capital returns being  below market returns,  and got to thinking about “A” in the Cobb-Douglas function.  Technologies that we invest in need to address a need and generate value for a large marketplace.  My understanding is that there’s always a focus on market size when it comes to venture capital;  the economics of the business model simply dictate that market potential be somewhere in the billion dollar plus range.   My hope tis that, in the process of vetting new investments and sizing up market size, that investors are thinking about the value that these products provide to the end-user, in the long-term and applying their knowledge of fundamental economics in their decision-making process.

I’m sure a lot of projects look like Google before the rubber hits the road.  I think that the venture capital industry provides important value to the marketplace and the global economy; I hope to see it investing and growing TFP-positive companies.

The Startup Visa and David Ricardo

I’ve been reading Fred Wilson’s numerous posts on the startup visa andthought I’d chime in with some context that’s currently relevant to me.  I fully share Fred’s views on this topic,  and I think it’s important to discuss the relevance this has on the future growth of our economy.

I’m currently taking a global markets class at Stern where we’re reviewing and analyzing Ricardo’s theory of comparative advantage. This is an economic theory that’s often used to support globalization, because it generally lowers the cost of goods for all consumers.   I’m not going to get into the theory on this post, because the information on the theory is well written in Wikipedia (above link).  I do want to mention it in the context of the startup visa, because I think this theory and the current startup visa debate tied together.

Remember when NAFTA was under debate and everyone was talking about that giant vacuum sucking manufacturing jobs into Mexico? Well, that didn’t happen.  What did happen is that some manufacturing business went south of the border (where labor was less expensive), and other industries in the U.S., like corn  production, thrived in the new marketplace.  Additionally, goods became less expensive for both Mexicans and Americans.

I mention this because I believe globalization is inevitable.  I also believe it’s a generally good thing for the world, but only if our country is strategic in its approach to maintaining competitive advantages in industries that are important and relevant.  Allowing entrepreneurs into our country to start new businesses is good for everyone and it doesn’t threaten anyone.  It’s only a net-positive benefit to GDP to have new value-generating firms in our country;  I simply do not understand the counter argument.

I heard David Rose speak last month about angel investing.  He told a story about a group of Stanford MBAs who were pitching him a website that would allow angels to bid and compete on investing in startup ideas.  David’s problem with the product was that, in all of his years investing in startups, he had never once competed to invest in an idea.   It’s easy to understand why.  The likelihood of a startup succeeding is so low that it’s not logical to invest one as an angel because the economics are simply too daunting.  In a market where good ideas are in short supply, and success in startups is a (qualified) numbers game, why would we create legislation to block the flow of new ideas in our country?
Considering our increasing dependence on service businesses for U.S.  GDP growth, and considering the fact that we are a mature country and not generating new jobs outside of the new business environment,  we are taking huge risks every time we turn an entrepreneur away.