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Venrock 7

My partners and I are thrilled to continue collaborating with fantastic entrepreneurs to help build enduring, iconic and meaningful companies. Last week, we completed the fundraising of Venrock 7, a $450M fund focused on disruptive early-stage tech and multi-stage healthcare companies. For many VCs, the process of raising a new fund brings a helpful opportunity for self-reflection — a chance to take stock of the world, the disruptive technical forces likely to bring change and a candid assessment of one’s abilities to thrive in this environment. While we are always observing the world around us and making adjustments to our areas of focus and investment strategies, every four years or so, we too go through a rigorous process of prophesy and self-evaluation. Like an entrepreneur presenting their company to a VC, we pressure test our strategy with LPs during the process of raising a new fund. We came away with some exciting observations about both ourselves and the world. I am pleased our LPs share our view of our abilities and have entrusted us with the resources necessary to help build some great companies.

At Venrock, preeminent among all of our abilities is a belief in the importance of a performance-oriented and supportive culture — internally and with our entrepreneurs. We believe we will not excel as a partnership if we do not truly admire and respect each other. We are good at listening not just to the entrepreneurs with whom we meet, but to each other, distilling each other’s wisdom and foresight. And we work hard to preserve this culture internally. Each day, I feel my partners are behind me 100% and are rooting for my success, as am I for theirs. Equally important, however, is a focus on performance. We are in this business to make money for our LPs, and that can only be accomplished by investing in great companies and participating in their upside. In my almost six years at Venrock, I have never been more excited by the team surrounding me, our expertise, our intuition, but mostly our deep mutual respect and support for each other.

Areas of Excitement

There are plenty of important trends to discuss in tech. Here are just a few areas that really excite me:

New York

shutterstock_114734815New York continues its ascent and importance to the tech ecosystem. As a firm that has been in New York for decades, we have now made a deeper and even more meaningful commitment to investing in early-stage New York City tech companies. We are doubling down in New York with a larger team and have invested in some of the largest and most important tech companies here. Appnexus, Dstillery, Smartling, Dataminr and a few others not yet announced represent what we hope to find in our investments — hungry, passionate, and brilliant entrepreneurs bent on creating enduring and very large companies, sometimes creating new industries themselves. As a firm, we are confident some of the greatest tech companies of the coming decades will be founded in New York City and we hope to find them and invest in them early.

AdTech -> Marketing Cloud

funnelTraditional adtech is evolving into the SaaS marketing cloud. We continue to focus on the highest-value layers of the adtech and marketing services stack as consumer attention continues its migration away from traditional to online media. Ad-supported business models continue to dominate the internet, are performance-based and offer brands better control and measurement of their ad dollars. Our unwavering belief in the long-term primacy of ROI-driven advertising leads us to seek out the most innovative and best-performing ad products and the technologies underlying them, especially as ad formats and consumer media platforms change from desktop web to social mobile stream to app to OTT video and beyond. We focus on the emergence of best-in-class tools for marketers to help them take control of the entire marketing funnel, from prospecting to conversion to long-term customer relationship management.

Blockchain

opengraphThe emergence of the blockchain may be one of the most promising technical innovations of the last five years. We see the highly inefficient and expensive legacy payment and money transfer mechanisms being pressured by the far lower-cost methods made possible by blockchain-driven solutions. We are excited by innovations in addition to Bitcoin that can be built atop the blockchain, especially contracts, IP transfer solutions, voting solutions, ticketing, identity, and eventually distributed computing.

Video

shutterstock_129089885Readers of this blog know of my passion for the disruption of legacy media companies. I am particularly excited by the changes underway to the video ecosystem. The emergence of mobile as both a video creation and consumption device is sucking attention away from the traditional TV screen but also democratizing the creation of engaging video. I believe changes in the traditional TV value chain are well underway and I look forward to finding more companies catalyzing these changes.

And More

We continue to explore the intersections of technology with education, financial services, branded commerce, enterprise software and, of course, healthcare and healthcare IT. As always, we believe in the power of entrepreneurship to bring progress, efficiency and new capabilities to markets and are thrilled to have fresh resources to invest in great entrepreneurs embarking on exciting journeys.

 

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Without Aereo, How Will Traditional TV Be Disrupted?

After yesterday’s Supreme Court decision
against Aereo, will traditional TV be disrupted?

The First Phase of Disruption Already Started
There has been a major shift away from appointment TV to on-demand viewing, beginning with the DVR, followed by Netflix, and now partially fulfilled by hundreds of OTT on-demand apps, from HBOGO to Crunchyroll. The cable networks, of course, only make their programming available OTT if you authenticate with your cable log-in, preserving MVPD economics. So the only part of the TV ecosystem feeling pressure from this trend is commercial advertising, since, with a few exceptions, the majority of on-demand viewing is commercial free. But this shift to on-demand insures that our kids fully expect all video programming to be portable and on-demand.

Will there be a cheaper cable bundle?
With the end of Aereo, it is unlikely we will see bundled economics of cable TV programming disrupted by a tech company outsider. The only way to offer traditional TV programming over the internet will be to license it from its creators or distributors. Those content owners set rates in such a way as to preserve traditional cable bundle economics. Sure, Apple, Google or Amazon could become an MVPD, but they would be unlikely to offer a cheaper or smaller bundle.

There is real pressure on the bundle, however. Remember, cable TV is really a bundle of bundles. If an MVPD wants ESPN, they must also license and pay for ESPN2, ESPN3, ESPNNews, etc. These mini bundles force MVPDs to pay for more channels than they may otherwise want and in turn must charge consumers more. But they have little choice. Even if you wanted to assemble a smaller, less-expensive bundle of programming, it is made nearly impossible by the imposition of these mini-bundles. And the costs of these mini bundles have been rising, which has led Comcast to buy NBC, Comcast to buy Time-Warner Cable, and now AT&T to buy DirecTV, all as attempts to create leverage against rising mini-bundle costs. This upward price pressure is creating a real problem, since the number of cable subs is now falling in this country. Rising rates, falling subs.

It is unlikely tech companies will be able to meaningfully change these core economics. For this reason, I believe the core disruptive force acting on traditional TV is coming from outside of the TV ecosystem. It is coming in the form of alternate programming being consumed largely by the youngest demographics. I’m talking about YouTube, Twitch.TV and many smaller video companies stealing kids’ time away from the tube.

The Second Phase
YouTube, for many years, was scoffed at by the traditional TV content owners as lacking in quality. But my eleven year old today watches 90% of his video programming on YouTube. CaptainSparkles and Crazy Russian Hacker are true celebrities to him, as big as Kevin Spacey is to me. With more than 6 billion hours of video watched each month, YouTube today reaches more people than any cable network and, even among adults 18-34, they are bigger than any cable network. Their growth rate continues unabated and in short order, YouTube may one day be bigger than all of traditional TV. By buying Twitch, they cement themselves as the overwhelming largest platform for video game content, one of the two most popular content types among kids. And newer entrants like Livestream and YouNow are building engaged audiences with long tail programming.

This view that TV’s competition comes from the bottom is not a new one. (Hunter Walk and I discussed this in this post.) What is new is the widespread shift to mobile devices. As smartphones hit scale, we carry with us both a video creation and consumption device at all times. The real-time web collides with the mobile video web and a new genre of video programming emerges, somewhere between broadcast and messaging. These new personal video formats will steal even more video viewership away from TV, particularly among youth. So if younger kids grow up consuming video away from TV, and TV’s response is continued rising prices of bigger channel bundles, something has to break.

Image credit: Denys Prykhodov / Shutterstock.com

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Taking the Other Side in the Amazon/Hachette Debate

This post is likely to be unpopular.

In April of 2012, I wrote “Why Should eBooks Cost $15” in response to the news that the Justice Department was suing Apple over price collusion with the book publishers. In it, I discussed eBook pricing…

Readers of this blog are familiar with my many discussions on digital good pricing and price elasticity. There’s “Weighing In On the Amazon/Macmillan Pricing Debate” where I detail that the market can tell you your optimal (i.e., highest profit producing) price for digital goods. Each incremental digital good has no additional cost. The marginal cost of distributing it is zero. So you really want to maximize total profit by finding the price that produces the most number of copies sold. In these markets, you make a mistake when you set your price by looking at your legacy costs (which were designed for a physical goods market in pre-digital times). Digital markets produce much lower profit per item, since digital markets tend to have lower prices for goods. (See “As Big Media Goes Digital, Markets Shrink“.) In all the discussions about why book publishers demand that eBooks should be $15 and not $10, they say it is because they cannot afford to sell books at $10. That is, they cannot cover their legacy cost models on that number. Right. Which is why you must rebuild your cost structure for a digital goods industry with far lower prices. You start by paying your top execs much less than millions of dollars a year. Then you move your offices out of fancy midtown office buildings. Why should eBooks cost $15? Amazon is far more of an expert on optimal book pricing. They have far more data than publishers, since they experiment with pricing hundreds of thousands of times a day across millions of titles. Amazon can tell you the exact price for a title that will produce the most number of copies sold. Amazon is pretty sure that number is closer to $10 than to $15. Yes, they want to sell more Kindles. And they believe that lower eBook prices mean more eBooks sold which means more demand for Kindle. The negative coverage of Amazon is centered on them selling eBooks below cost in order to reach the $10 price point. But that is a function of publishers setting the cost higher than $10. If the profit-maximizing price for an eBook is $10, then publishers must adapt to set a wholesale price lower than that, even if it means your legacy cost structure doesn’t allow it. And that’s the rub.

Now, more than two years later, we find ourselves having the same discussion. The Amazon/Hachette dispute (most of the journalists covering it have been sympathetic with Hachette) is largely over the retail price Amazon believes it should charge for eBooks. Hachette wants this price higher, Amazon wants it lower. Hachette seems to want to try to keep eBooks priced about the same as physical books. But why should it? eBooks have no marginal costs, and consumers therefore expect the pricing to be lower. Amazon agrees.

While the hardball tactics Amazon has used to force Hachette to lower prices have, somewhat uncharacteristically, inconvenienced Amazon’s customers, I believe their larger point is the right one. Many legacy industries who’s models were built in the analog world have trouble adapting to the lower prices of digital markets. (See the music industry.) Amazon’s pricing data likely shows they will sell more eBooks at lower prices. They want Hachette to price eBooks lower. In this new world, more copies can be sold, for lower retail prices, but with no physical costs. The profit might well be close to the same amount, or it may even be less per unit. But adapting to the increased competition for consumers’ attention/spend and the inevitable price erosion of digital goods compared to their physical peers requires prices to fall. Amazon is attempting to force the publishers’ hands.

Most of the emotion around this debate has centered on the effects of Amazon’s tactics on authors. I understand how a dominant retailer can hurt sales by temporarily refusing to stock titles or make them hard to buy. But the long term effects of Amazon fighting for lower eBook prices is likely to make the eBook industry healthier in the long-term. For that, authors should be supportive.

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The FCC Decides to Eviscerate the Neutral Internet

Like many in the tech community, I was both shocked and dismayed at the FCC’s sudden about face on the basic principles of net neutrality.

“The principle that all Internet content should be treated equally as it flows through cables and pipes to consumers looks all but dead.” – The New York Times

FCC, in a Shift, Backs Fast Lanes for Web Traffic

If the FCC’s proposed rule-making goes forward, this will be the beginning of the end of the open and non-discriminated internet. This proposal so obviously favors large companies with deep pockets at the expense of new entrants and startups. An internet where all content is treated equally and routed without preference has served to create a culture of massive innovation and has witnessed trillions of dollars of wealth creation and millions of new jobs. Allowing giants to buy preferred access to end users will automatically diminish the quality of service of non-payers. On the internet, we know speed and responsiveness are necessary to deliver high-quality user experiences and to delight customers. This proposal would make it far more difficult for non-payers to deliver those types of experiences so essential for success. The FCC should immediately re-write their proposed rule-making and eliminate any notion of favorable treatment to any content or payer.

The Piano Man

The Price of Music

Will the recorded music industry ever grow again? Since 1999, the industry has been in rapid decline as CDs became unbundled into downloaded singles. The digital download market never came close to the size of the physical music market. Now we are in the midst of another format transition, this time from downloaded singles to streaming. The question many people ask, like the thoughtful Marc Geiger, is how big will the streaming market be? I think the answer lies not in consumers’ appetite for streaming songs but in the price services charge consumers for streaming.

Recorded Music Industry Sales

At the 1999 peak of the recorded music market about $40 billion of recorded music was sold. How much did the average consumer spend per year on recorded music? Hundreds of dollars? Nope. According to IFPI at the time, across the total 18-and-over population (both across many countries or individually within one), the average amount spent came to $28 per consumer. But that includes people who did not buy any music that year. If we look at just the consumers who bought music, they spent $64 on average that year. And that was at a time when one had to buy a bundle of 12 songs in the form of a CD in order to get access to just one or two. What has happened since?

Once the bundle broke, the average spending per consumer decreased. This is predictable, since bundles artificially raise the amount of total dollars a consumer spends. The chart below shows the average spending per capita in various countries according to IFPI (note UK Pounds):

ifpi

Another study by NPD Group in 2011 found similar spending, about $55 per music buyer per year on all forms of recorded music (they note that this spending is slightly higher among P2P music service users.)

npd2

But the one retailer on the planet who would really know what consumer are willing to spend on recorded digital music today is Apple. They are the largest music retailer in the world. Their data is very consistent, about $12 per iTunes account per quarter is spent on music, or about $48 per year. Note that this figure declines year by year as iTunes users are confronted with many more choices on which to spend their disposable income like apps and videos. Also note that total disposable spending, on average, is decreasing per account as iTunes gets bigger and bigger. As a service becomes truly mass market, it reaches fewer and fewer consumers willing to spend as much as previous consumers.

apple

So, the data tells us that consumers are willing to spend somewhere around $45 – $65 per year on music and that the larger a service gets, the lower in that range the number becomes. And these numbers have remained consistent regardless of music format, from CD to download.

Curiously, the on-demand subscription music services like Spotify, Deezer, Rdio and Beats Music are all priced the same at more than twice consumer spending on music. They largely land at $120 per year (although Beats has a family member option for AT&T users at $15 per month.) This is because the three major record labels, as part of their music licenses, have mandated a minimum price these services must charge. While it may seem strange that suppliers can dictate to retailers the price they must charge end users for their service, this is common practice in digital music. The services are not able to charge a price they believe will result in maximum adoption by consumers. The data shows that $120 per year is far beyond what the overwhelming majority of consumers will pay for music and instead shows that a price closer to $48 per year is likely much closer to a sweet spot to attract a large number of subscribers.

For this reason, I believe the market size for these services is limited to a subset of music buyers, which in turn is a subset of the population. This means that there will be fewer subscribers to these services than there are purchasers of digital downloads unless one of two things happen:

(a) consumers decide to spend more than two times their historical spend on recorded music or

(b) major record labels allow the price of subscription music services to fall to $3 – $4 per month

I think the former is highly unlikely given the overwhelming number of choices competing for consumers’ disposable income combined with the amount of free music available from YouTube, VEVO, Pandora and many others. The data shows consumer spending per category decreases in the face of many disparate entertainment choices. The latter is the big question. My experience with the major labels when I was CEO of eMusic was that they largely did not believe that music was an elastic good. They were unwilling to lower unit economics, especially for hit music, to see if more people would buy. Our experience at eMusic taught us that music *is* in fact elastic and that lower prices lead to increased sales. If the major labels want to see the recorded music business grow again, I believe the price of music must fall.

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An Emerging New Model for TV? Crunchyroll.

As the viewer trend data make clear, legacy TV is undergoing a dramatic transformation, led by the many alternative ways of watching video. Cable subs are in decline, network TV viewership has tanked, and now even cable TV viewership is eroding. We frequently discuss the new streaming providers (YouTube, Netflix, Amazon, Hulu) and the on-demand show/movie retailers (iTunes, Amazon, Vudu), but a new model is emerging and worth discussing — the over-the-top (OTT) TV network. Our recently-exited investment in Crunchyroll provides a prime example.

Crunchyroll is the largest provider of Japanese anime online. They license scores of hit and long tail anime shows from Japanese media companies for streaming throughout the world ex-Japan. They offer a free ad-supported viewing option and attract millions of unique monthly viewers. They also offer a paid commercial-free offering at seven dollars per month which makes available a deeper selection of shows. They are available on the web for PC streaming, and have an app available on every mobile and connected TV platform available (iOS, Android, Roku, AppleTV, PS3, Xbox, etc.).

Crunchyroll has amassed hundreds of thousands of paying subscribers and is profitable with net margins many internet and legacy media companies would envy.

While they don’t benefit from the incredibly rich we-will-pay-you-a-fee-even-if-no-one-watches-your-network affiliate fee model of legacy cable TV, they enjoy a more accountable dual advertising/consumer subscription model. While most of us would consider this content niche, their total active actual viewers are considerably larger than most cable networks on your cable grid. Perhaps most impressively, like most technology companies, they are highly efficient, employing fewer than fifty employees.

This model benefits from many of the advantages of the web. An embedding/link-sharing culture helps Crunchy, as everything viewable can be shared and discussed throughout the web. The product is highly mobile and feeds our preference for snackable media consumption on phones and tablets. Non-subscribers get easy access and a thorough chance to experience the content without paying. And the team is staffed by fantastic technologists who rapidly adopt and optimize the service for every new platform that emerges. The team has already started expanding their successful model to new content verticals.

Their success, I think, points the way for niche programmers to deliver great video services directly accountable to their viewers and advertisers alike, and not polluted by the MVPD indirect affiliate fee model nor the antiquated Nielsen people viewer/sweeps model.

For these reasons, Peter Chernin’s The Chernin Group is the new owner of this impressive company and team. I look forward to watching the continued success of Kun, Brandon, James, Brady and the whole team. Without much fanfare, they have pioneered a way forward for much of the video programming world. We are honored to have been investors since 2007 and to have watched you succeed.

Will the Internet Unbundle Higher Education Too?

I was fortunate enough to be asked to deliver the keynote address at this year’s Sustainable Scholarship Conference, put on by ITHAKA. Here, I attempt to review how the internet has disrupted bundled industries and consider the question of whether it will unbundle higher education too.

ITHAKA is a not-for-profit  that helps the academic community use digital technologies to preserve the scholarly record and to advance research and teaching in sustainable ways. They run the popular JSTOR service, a growing digital library of more than 2,000 academic journals, nearly 20,000 books, and two million primary source objects provided to colleges, universities and scholarly communities. I serve as a trustee of ITHAKA.

My slides from the presentation are here:


Thank you to Kevin Guthrie, ITHAKA’s CEO, for the invitation to speak and for the overly-generous introduction!

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Why AdTech is Back (It Never Left)

One of the most valuable characteristics of venture investing is that sectors go in and out of favor. Certain sectors, no matter the investment climate, have perennial long-term value. At least, that is my view. And I hold that view strongly about the AdTech sector.

More than 60% of the enterprise value created by internet companies comes from companies whose business model is primarily the selling of ads. Since the internet is both a communications medium and a transactions platform, I believe it will always create massive value through advertising. The internet, unlike most traditional media, is inherently a performance-oriented medium and it delivers on the promise to make advertising and marketing more accountable and more efficient. Underlying the delivery of better ad performance, in a world filled with big, quantifiable data, is an ever-increasing slate of sophisticated technology operating on massive datasets in real time. If you advertise on the internet, and eventually, every brand and service in the world will, you need exposure to these technologies or you will underperform your competitors. The AdTech sector, fundamentally, is the delivery of these advanced advertising technologies to all advertisers.

In my previous posts on the evolution of online advertising, I painted a picture, like so many observers of the space, of a world where all impressions are traded on exchanges. That inevitable transition is happening at light speed now. More than 17% of display impressions on the web are traded on exchanges and the forecasts are bullish on this trend. In that world, online advertising looks much more like trading stocks than the buying of ads over lunch meetings. In 2008, we believed that significant value would be built in this exchange layer. It was this thesis that supported our Series B investment in AppNexus. That company continues its incredible run and is one of the largest global ad exchanges in the universe. We believe AppNexus will remain one of the most important companies on the internet.

While a huge amount of buying has moved to the exchanges, the level of sophistication of many advertisers taking advantage of these RTB platforms is still rudimentary. It turns out, just like outperforming the stock market year in and year out, it’s hard to do it well. The amount of data available to buyers is enormous. The number of parameters available in tuning and targeting your audience is almost limitless. And, most importantly, there are always better data scientists down the road doing a better job than you can at building proprietary targeting models. For all of these reasons, in our opinion, the second-most valuable layer in AdTech is the data-driven ad network layer. (Not to be confused with the inventory driven ad networks.) Data-driven ad networks employ either large proprietary data sets or proprietary targeting models on top of very large data sets. The sophistication of the data scientists within these companies delivers a sustainable performance advantage over their less well-equipped peers. Two examples of these companies in our portfolio are Dstillery (formerly Media6Degrees) and Bizo. Both Rocket Fuel and Criteo are two additional companies in the space. Rocket Fuel’s recent IPO fetched it a market cap of more than $1.7B and Criteo is now over $2B. Many are asking themselves, “Why?”

[As an aside, Zach Coelius, the CEO of Triggit, points out that these companies should no longer be called ad networks because they no longer amass large amounts of inventory. They are instead more accurately "algorithmic media buying" companies or "data-driven targeting" companies...not really sure, but they aren't traditional ad networks.] 

The reason these companies are so valuable is that buyers on the exchanges are dominated by performance-oriented marketers today. Their dollars seek the best performance. The data-driven ad network layer is increasingly a case of the haves and have-nots. The better you perform relative to your peers, the more ad dollars you receive. These four companies significantly out-perform their peers, and their incredible revenue growth (and enviable media margins) indicate this.

The reason these companies have bright long-term futures is that this layer is increasingly necessary, hard to replicate, and experiences tremendous network effects. In the early days of AdTech, some believed the traditional media buyers would be able to build their own technology stacks and deliver better performance and value than independent companies in the market. This has not turned out to be true. The best performance can be found elsewhere, largely within technology companies, and so that is where the dollars are flowing. This presents enormous long-term challenges for the incumbent media buyers and will continue to pressure them to flow more and more of their client’s dollars to the better performing AdTech companies.

I believe this layer will eventually see tens of billions of dollars of media buying flowing through it. Of course, the exchange layer benefits from all of this too. For these reasons, there will be additional public AdTech companies which will fetch multi-billion dollar valuations coming to market. AdTech is back. Except it never left.

 

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Venturescape: This Year’s NVCA Annual Meeting

I’m going to Venturescape, the NVCA Annual Meeting May 14 and 15 in San Francisco and you should too. I haven’t been to one in many years, but this year is different.

The NVCA is the National Venture Capital Association. It’s much more than just a trade organization, and this year’s annual meeting demonstrates that.

My friend Jason Mendelson from Foundry Group is on the NVCA Board of Directors and he is running Venturescape. That being said, if the meeting was going to suck I wouldn’t go. But it looks quite good.

I’m excited about the agenda, as this is the best lineup I’ve seen at one of these events. Included in the mix are:

  • Dick Costolo, Twitter CEO
  • General Colin Powell
  • Ginni Rometty, IBM CEO
  • Anne Wojcicki, 23andMe CEO

There is also the world’s largest VC Office Hours. And for the first time, “fun” is part of the meeting in the form of NVCA Live! — a great concert featuring Pat Monahan from Train and Legitimate Front, a band in which I’m staring as the drummer and main groove man.

If you are a VC, I hope to see you there. If you are an entrepreneur, ask your VC funders for tickets to NVCA Live!, as that is open to everyone, although tickets are only purchasable by NVCA members.

If you are coming, especially to NVCA Live!, let me know. See you there.

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