Confusing Traction With Value
The recent distressed exit of iLike reminds us of the need to build real value in our startups if we hope to create lasting companies and wealth. I have seen cycles that last about 18 months or so in which traction gets substituted for value. Yes, we’ll sometimes see exits with big numbers attached to them during the peaks of these cycles. But only those companies that have built real value will sustain valuations during lean years and create long-term successful companies.
If we look over the past fifteen years of webtime, we see a few categories emerge where real value was created:
- Efficiency/Cost Reduction (DoubleClick, RedHat, PayPal, Craigslist)
- Monetizeable audience (Yahoo!, Google, AOL)
- Repeat customer commerce (Amazon, eBay, Netflix)
- Solve a pain point (Checkpoint, Postini)
- Create new markets (EA, Google)
The aberrations occur when traction looks like value. When Slide was funded at a $500M pre-money valuation, that was an example of traction being confused for value. Sure people posted their pictures using a Slide widget 150M times, but there was no value created. Slide did not have a real relationship with those customers and it was a stretch to believe that an ad model would occur on top of those photo widgets. Similarly, iLike may have had its application installed by 50M users, but those “customers” were simply indicating a band or two that they liked. This is not valuable data and the audience was never monetized in any meaningful way. Another aberration was around CBS’s purchase of Last.FM for $280M. Last.FM had lots of users using its free service (something like 15M). But supporting those users was expensive (bandwidth, music rights) and the users weren’t paying. CBS viewed it at the time as a play for audience, and that makes sense. But at that price, a more successful ad model would need to emerge to overcome the content and bandwidth costs. As soon as the ad market hiccuped, that price looked exorbitant and indeed now traffic has declined and its business model unproven.
It bears noting that traction often precedes value. As VCs, we often look for early traction when vetting companies. But we also need to believe, and so should entrepreneurs, that the traction will result in an asset being created which has value. In Twitter’s case, the value of the collective shared links, I believe, will prove to be enormously valuable. In addition, creating a platform where consumers willingly subscribe to brands or information sources also has value.
I think we have returned to a time where eyeballs don’t necessarily equate to value, and rightfully so.
Traction is like friction, usually just a good way to waste energy. It’s always about content in the end, not packaging. Like with porn: would you actually buy DVDs if the whole thing was a big ad with no, um, payoff?
Peace.
@vinylart
(found you through @chartreuseb)
As you understand, most of the music industry has already been exploited. How many times can internet companies go to the well?
There just isn’t enough meat on the bones to support valuations.
But hey, you had a good run!
No doubt that irrational exuberance extends even to early stage investing, this is another good example. The last points regarding Twitter are the more interesting points. The value of the collective Twitter URLs are not as valuable as one might think, for two main reasons:
a) Limited Active User Base. Yes, they have off the charts user growth, but the number of users with engagement is small. Those generating 5+ tweets/day is supposedly in the hundreds of thousands. Of those active users how many are sharing URLs, that number is even smaller. Many of these have proven to be bots or highly commercial. In fact social bookmarking sites like Delicious or xMarks have a larger active user base generating URLs.
b) Lacks Content Diversity: A significant percentage of these URLs are duplicates (retweets that included an URL). While this does provide a popularity signal they tend to be retweets of news stories of the day. So, if you are building a news aggregation service that signal can be incredibly powerful, but as a broader discovery and search engine the data is not there.
Hi Ariel,
Thanks for your comments. From my information, Twitter link sharing is much more prevalent than you suggest. More than 50% of all tweets now contain links and the number of active user (ie, publishers) is an order of magnitude more than you suggest. But Twitter is in its very early stages. We will see over time. Stay tuned.
With a certain disclaimer that I have some dear friends back in London who work for Last.FM, I think there is an important distinction between their value and that of, as in this example, iLike.
Last.FM, though I wouldn’t put a monetary value on it, has data. Yes, they attempted to move streaming and on demand music playback front an centre for a while, but throughout those experiments they were a service built on user data from sources not exclusively connected to licensing encumbered listening. The business model doesn’t follow automatically from that, and interacting with the music industry has inherent instabilities, but if all the music streaming went away tomorrow, Last.FM would still have genuinely interesting data they could use to offer a standalone service. £280 million worth of data? I couldn’t say. But they’re not a rush job and they have value to a very good number of users.
iLike seemed to be based only on streaming and endorsements of artists. They data they could gather seemed shallow, and ultimately less useful. They didn’t build any depth, and as you very rightly say, traction in MySpace embeds and Facebook app installs does not make value.
Good points, Ben. Thanks for the comments. I do agree that Last.FM has a much richer data set. The issue for me is it is all around musical preferences, and in a massively declining market of music sales, that data is getting less and less valuable over time.
Isn’t investing is about selling the horse before the horse is dead? After all, a sucker is born every minute, and if VCs can find someone who can buy stuff for gigabucks, stick in it the bottom drawer and forget about it (and forgive, yes) – why not to take advantage? PayPal, YouTube, Vonage, AOL – all these writeoffs together are less than 1% of Obama stimulus and less than 10% of Lehman losses. There are so many deep pockets, they won’t notice a fortune or two is gone missing.
Yuri, I don’t agree with your point of view. VC investing is not about a greater fool theory. Trillions of dollars in wealth and millions and millions of jobs have been created from VC investments, not to mention life-altering products and services.
My comment on the same post on Business Insider –
These distressed exits are a good thing because they discourage another frothy of internet bubble. Folks developing or investing in ideas around Hug Tosses or Gifting Virtual Cold Beers (huh?) for FB or god forbid for iPhone or the Android- thankfully will be forced to think and maybe they will avoid the Pets.com sock puppet like fiasco.
At the core of all these ideas is the notion that advertising is the only revenue model. So, we are all caught up in a vicious bubble era like explosion in ad networks, viral but meaningless app publishers, ‘twit and twat – tis and tat”
NO more bubbles, please.
There is a good alternative to advertising – social commerce. People will pay for real value and get for Free or near free things that are meaningless. There is an article regarding the Free Internet on NPR.org and an accompanying radio story which will be aired tomorrow morning. Featured customer = Teachstreet. Read Voottoo’s reaction to that story in which we discuss Free vs. Fee based services. http://tinyurl.com/npr-teachstreet
Everyone is quick to jump to a conclusion about a company being successful People want that next big thing and will get ahead of themselves trying to find it.
Nice post!
I agree with your conclusions! There is a difference between creating value for customers/users and monetizing that value. Never mind the value you create, which may be spectacular, you may make very little money from it without a good business model.
“This is not valuable data and the audience was never monetized in any meaningful way.” This is perhaps easy to say in retrospect, -in many cases business models evolve over time just as it did for Google.
From Business Week, Dec 7, 2000:
“LIMITED BUSINESS. But how will Google ever make money? There’s the rub. The company’s adamant refusal to use banner or other graphical ads eliminates what is the most lucrative income stream for rival search engines. Although Google does have other revenue sources, such as licensing and text-based advertisements, the privately held company’s business remains limited compared with its competitors’.”
//Anders
TBMDB