The Pressure on TV Networks, Ari Emmanuel and Cable Companies

Lots of recent discussion on TV and Hollywood. Ari Emmanuel accuses Google (again) of aiding and abetting pirates. Henry Blodget writes a nice piece on the changing TV viewing habits of consumers. Dan Frommer says those changing habits won’t really affect the MSOs and Networks anytime soon. And Jeremie Allaire seems to claim that Apple’s next move in TV will be to emulate TiVo’s (largely failed) box/cable-card strategy (but correctly points out the disruptive power of AirPlay). Oh, and Sean Parker launched version one of AirTime.

I wanted to add a few points to the discussion about the pressures on the TV industry. First, some basic observations:

TV programming is not homogenous

The uber-bright Hunter Walk provided me with a fascinating view into his opinion of the real tiers of TV programming. Out of the 4-5 hours of TV the average household watches each day, there are essentially three tiers:

  • Hour 1 (No Substitute) – This is the never-miss-an-episode, live-sports, must-see-TV that exists across many networks. The Sopranos, Mad Men, Yankees/Red Sox, French Open, Homeland, etc. When we watch TV, this is the first hour we watch. We watch this stuff live or DVR it and try never to miss it. We will pay for it any way we can and even endure roadblocks to watch it (like when networks won’t make it available on our preferred viewing device, or expire old episodes, etc.) While the networks believe 80% of their content fits this description, it is probably more like 20% of all shows currently on the air, at most.
  • Hours 2-3 (Nice to see) – This is stuff that we have an allegiance to, but are comfortable missing an episode and won’t really endure friction to see it. Many comedies fit this category, from 30 Rock to The Simpsons, as well as the countless procedural crime dramas like CSI, etc. The networks think all of this content is in the category above, but it really isn’t. And probably another 30% of all shows on the air fit this category.
  • Hours 4-5 (Filler) – This is the low-budget, mostly reality show programming that networks use to fill the time between their one or two hit shows. Think Kate Plus 8 or Let’s Make a Deal re-runs. The only time you watch this stuff is when you are couch-surfing. This is probably 50% of all programming on air.

When Ari insists that Facebook, Google, Twitter and everyone else in tech will have to “pay for Aaron Sorkin”, he is really talking about the “Hour 1″ category of programming. That stuff is really high-value and is not in a lot of danger of being disrupted any time soon (although the rising production costs and off-the-charts no-risk fees paid to talent are surely to be reconsidered in the future.) But as for the other two categories…

Our attention is shifting away from TV

All media operates in an attention economy. They compete for our attention against the backdrop of thousands of choices as to how we spend our time: email, video games, Facebook, Twitter, Flipboard, Instagram, etc. The latest numbers show those choices are finally catching up with TV; we are watching less of it, whether DVR’d or not. We aren’t watching less of that incredible No Substitute programming, but we are watching less of the 80% of the other stuff. And by the way, those big “hit” shows that Ari talks about have relatively small audiences. Only about 3 million people “tune in” for an episode of “Game of Thrones” and over the course of a week about 9 million people have seen it through various means. Same for Mad Men (3 million)Desperate Housewives (9 million) and The Good Wife (9 million). That’s a pretty small audience compared to, say, the 450 million on Facebook every day, the 800 million who watch YouTube videos every month, or the more than 100M people who watched the final episode of M*A*S*H. As TV and other entertainment choices proliferate, “hit” audience sizes have decreased. So, one of the immediate threats to network/cable television is that we are likely to watch less and less of the “Hours 2-5″ programming that fills so much of their programming grids. (The smart production companies know this and are already producing much lower-cost, quality programming for YouTube and other online-only outlets.) And where will that lead us?

The pressure will first come from the advertisers

If Nielsen didn’t lie and try to convince TV advertisers that the 50% of people with DVRs still watch commercials (hint: that is utterly ridiculous. We don’t watch any commercials anymore unless we watch a live sports event), I believe advertisers would appreciate that we aren’t seeing their commercials anymore. While the PC and mobile web still don’t offer nearly the great story-telling opportunities for advertisers as TV commercials do, it just doesn’t make sense to continue to buy very expensive TV media when no one sees your commercials. Certainly live sports TV CPMs will go up, but the rest has to fall as advertisers figure this out. And reports detailing that we are watching less TV has to start to sink in. Advertisers would love to try to buy only the hit stuff, but networks are good at bundling to force them to buy the filler programming too. But the whole bundle will start to feel more and more pressure.

The dual revenue stream model of the cable networks provides lots of air cover against decreased ad revenue. The affiliate fees they get for carriage will sustain them for a while. Brand advertisers are looking elsewhere to find places to tell their stories and to reach their audience. And online, we can target viewers and assemble audiences with drastically better efficiency (and reliability) than on TV. Online video is becoming so performance-based, that advertisers now can pay only when someone has actually watched the commercial and not pressed the “skip this ad” button. If you really care about making sure someone sees your commercial, online is the only place to show it. And more and more, we just aren’t seeing the ad on TV anymore.

What’s This Mean?

  • Advertisers will begin to spend less on TV and that will be the canary in the coal mine that big changes are afoot
  • We will continue our shift away from viewing traditional TV and towards IP-delivered unbundled shows, some which will have migrated from traditional TV, but many that will be organic and native to internet programming (the made for YouTube stuff is a prime example here.)
  • Ari will continue to demand high prices for the “Hour 1″ shows created by his elite clients, but the audiences for those shows will grow smaller and smaller.
  • As a result, networks will begin to feel the pinch of decreased advertiser spending, and they will try to raise carriage prices to the MSOs more aggressively
  • MSOs will keep trying to push our bundled TV prices up higher as a result of this, pushing more and more of us away and into other IP-delivered options
  • Finally, I believe the as more of us watch IP-delivered programming, the lure of certainty that the audience you really care about is seeing your ads will prove appealing to more and more advertisers, and online video ad revenues will continue a dramatic ascent
  • And so the cycle will go

(Update: this report from Pivotal Research refutes all of Henry’s points…but bases all of its observations on data provided from a single and biased vendor: Nielsen – a panel-based research method that looks at activities of only 25,000 households – and has concluded, for one, that those of us with DVRs still watch ads. Go figure. Oh, they make their money from the TV industry.)

 

 

Why Should eBooks Cost $15?

Last week’s announcement by the Justice Department that they are suing Apple and several of the world’s biggest book publishers for conspiring to keep eBook prices high generated plenty of media coverage. One challenge in wading through this coverage is that most of it tends to be written by…journalists. And some journalists are also authors. And authors seem to have a soft spot for publishers who fight for higher prices. So, we get lots of coverage sympathetic to the plight of the poor book publishers. Amazon is evil, you see.

Absent from most of this coverage are two main questions: a) what is the right price for eBooks and who gets to set it, and b) why are eBooks not interoperable on different devices? These questions, in my mind, are far more interesting than the ongoing struggle of publishers to adapt to Amazon’s dominance in book retailing. In fact, the answers can significantly help legacy publishers stay competitive for the future and avoid extinction.

eBook Pricing

First, a conversation about 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. [By the way, as publishers continue to resist this market force, new "publisher" models are appearing and will replace the traditional functions of publishers with more digital-friendly models.]

Openness and Interoperability

Now, how do legacy book publishers fight back? Well, to begin, their biggest mistake prior to over-reaching on pricing was to insist retailers DRM their eBook titles. Just like in online music, this insistence on anti-copying protection (albeit with limited usefulness) not only creates inconveniences for consumers, it allows for dominant proprietary ecosystems to form (like Apple did with iPod/iTunes, where tracks bought from iTunes only played on iPods, Kindle books can only be read on Kindles.) Instead, publishers should have demanded the opposite. All eBooks should be sold in open, interoperable formats, so an eBook sold at Amazon could be read on a Nook, etc. This would have separated the reader market from the retail market and lessened Amazon’s eBook dominance. It may be too late for this change to work, but it is worth exploring. Incidentally, I predicted this in 2009 with this piece, “The Book Industry Is In Trouble, But Piracy Is Just A Symptom.”

Here’s the essence of what I see — we have authors and publishers screaming that Amazon wants to sell their books at prices lower than the arbitrary costs the authors and publishers have set. But why must eBook prices be $15? What is so magical about that price? Will it maximize profit? I am skeptical that this price does optimize profit. I see how it attempts to protect a legacy cost structure that is out-of-whack with a digital goods market. Yes, Amazon is a relentless competitor. But they always seem to be on the side of lower prices. And as consumers, we love this about Amazon. But none of the articles I have read seem to mention that the winner in a lower-price eBook market is the person authors are all writing books for in the first place. The reader.

(Incidentally, I am completely unmoved by the argument that if Amazon forces traditional publishers to sell books at lower costs, then the publishers will go away and we won’t have books anymore. Hogwash. The publishers built for a printed books world may go away, but their digital native versions will replace them.)

Continuously Updated Awesomeness − The Spotify Play Button

I was completely psyched by Spotify’s announcement of their new play button to embed legal, licensed music into web pages. The web has needed this for far too long, and this is the missing step to enable Spotify to become the universal music platform on the web, allowing us to share songs with each other with the confidence that they will play. We still have the small problem that not everyone is a Spotify user, but that may take care of itself with this announcement.

I get a lot of requests for music recommendations. I maintain a Spotify playlist called “Continuously Updated Awesomeness” where I add my favorite new finds. I am happily embedding it below! Enjoy, and please subscribe…

Network Effects Are Magical


The following is a guest post by my partner Brian Ascher in our Palo Alto office. He blogs at VC Waves where this originally appeared. This set of thinking drives many of our investment decisions. If you are not one of these models, you should be.

Network Effects are magical.  They are the pixie dust that makes certain Information Technology businesses, especially on the Internet, into juggernauts.  They can be found in both consumer and enterprise companies.  Network Effects are special because they:

  1. Provide  logarithmic growth and value creation potential
  2. Erect barriers to entry to thwart would-be competitors
  3. Can create “Winner Take All” market opportunities

Network Effects are like a flywheel–the faster you spin it the more momentum you generate and enjoy.  But not all markets lend themselves to Network Effects.  They are not the same as Economies of Scale where “bigger is better.”  To be certain, Economies of Scale can give strong competitive advantage and defensibility to the first to get really big (or Minimum Efficient Scale as the economists call it.)  For example, SAP and Oracle benefit from having massive revenue bases which enable them to employ armies of engineers who develop rich feature sets and also to hire huge sales forces.  However large these companies are today, though, their growth rates, especially in their early years, were far more modest compared to those Network Effect companies whose growth resemble a curved ramp off of which they launched into the stratosphere.

There are four main types of Network Effects:

  1. Classic Networks, in which the value of a product or service increases exponentially with the number of others using it.  Communications networks like telephones, fax, Instant Messaging, texting, email, and Skype are all examples.  Metcalfe’s Law captured this as a simple equation where the Value of a network = N², where N is the number of nodes.  Typically, each node in a classic network is similar to each other and possesses both send and receive capabilities.  This will become clear juxtaposed against the other network effects below where there are different types of nodes.  Other examples of classic Networks are social networks (eg Facebook) and payments (eg PayPal).
  2. Marketplaces, where aggregations of buyers and sellers attract each other.  Lots of sellers means variety, competition, and price pressure, which all serve to attract more customers.  And because the customers flock, more sellers are enticed to participate in the marketplace.  eBay, stock exchanges, and advertising networks are all examples.  One nuance of marketplaces, however, is they differ in terms of the scale required for acceptable liquidity.  For example, ad networks can achieve sufficient reach and liquidity at relatively low levels which is why you see thousands of online ad networks, where they each exhibit network effects but not in a winner take all fashion.  Stock exchanges and payment networks require far greater scale for network effects to operate, which is why you see much greater concentration in these industries.
  3. Big Data Learning Loops:  “Big Data” is all the rage in techland, but just having gobs of data is not necessarily a Network Effect, nor any sort of competitive advantage per se.  What you really need is unique data and algorithms that process that data into insights which then lead to decisions and actions.  A flywheel effect comes when you get a critical mass of data that you mine for insights; pump that value back in to your product or service; which attracts more users which get you more data.  And so on.   Venrock portfolio company Inrix is a good example, where they mine GPS data points to derive automotive traffic flow data.  The more commercial fleets, mobile app users, and car companies they can get data from, the better their traffic analysis becomes, which gets them more users and hence more data.  They turn data into an accuracy advantage that earns them the right to get even more data.
  4. Platforms – are a very special and powerful form of network effects.  In Information Technology, a true “platform” is where other developers build technology and businesses on top of your technology and business because you offer them one or more of the following:
  • Lots of users/customers, and you represent a distribution opportunity for them
  • Compelling development tools, technology, and (sometimes) advantageous pricing
  • Monetization opportunities

Example include Operating Systems like Microsoft Windows, Apple App Store, and Amazon Web Services.

Each of these four types of network effects can be extremely powerful on their own.  Yet, even more power is derived when a business can harness multiple types of network effects in synergistic ways.  Google, Apple and Facebook do this for sure, but a less well known example is Venrock portfolio company AppNexus that operates a real-time online advertising exchange and technology platform.  The exchange aggregates advertisers, agencies, publishers and ad networks for marketplace liquidity, but also offers a hosting and technology platform for other AdTech companies and ad networks to augment their own businesses.  And the vast troves of data AppNexus processes every millisecond flows back into the system as optimized and targeted ad serving.

Network Effects are what you want fueling your business.  Sometimes you just need to get clever about discovering and harnessing them.

How to Negotiate Valuation With a VC

This post originally appear on NASDAQ on Tumblr.

So, you have received a term sheet from a VC to fund your financing round. But you aren’t comfortable with the valuation. So, how do you negotiate? Here are a few pointers:

1) The first is to understand the VC firm’s philosophy on price and term sheets. Some VCs are flexible on price but will introduce other terms to essentially manipulate the effective price (such as participating preferred, the size of the option pool, anti-dilution provisions, etc.)Other VCs, such as Venrock, prefer to deliver vanilla term sheets but have a clear agreement on price. In other words, because valuation is only one term in a term sheet, you first need to be clear what you are negotiating. Ask the VC what their views on price are.

2) The most effective way to negotiate price (and other terms in a term sheet) is to have a competing offer. Receiving multiple term sheets gives you a clearer signal on the market’s view of what your company is worth. You can most quickly move price by telling a VC, “I want to work with you and your firm, but our term sheet from this other firm is offering us a price of x.” The more term sheets you have, the more pressure you are able to place on all interested VCs.

3) Some caution is prudent here. In my view, it should never be your goal to maximize price. Picking the right partner and the right firm who truly understand your company and mission and have lots of experience building successful companies like yours is far more important than squeezing every last penny out of the market. Also, be careful what you wish for. The higher the price, the bigger expectation you are setting for your exit. Be reasonable about what you are most likely to accomplish and pick a partner worthy enough to join you on your entrepreneurial journey.

Wither the Giants? The Arrogance of Aging Incumbents

My friend and former colleague Greg Scholl sent me an article this week and a provocative quote jumped out of it. Here is the view of Irwin Gotlieb, CEO of one the largest global advertising agencies on the planet, as he shared his view on this year’s CES. Given last week’s SOPA/PIPA debate, I thought Mr. Gotlieb’s observations were worth elevating, as they effectively capture a way of thinking that ultimately undermines incumbent media companies and the businesses that serve them:

 

Much of what we saw at CES relates to things we’ll be seeing 24 months out. In my mind, it’s all good: we’ll be able to target better, we’ll be able to segment better. The ads will be delivered on screens that are sharper, look better, larger, which ultimately provides more effective communication. There’s one last element: in the role that we [media buyers] play, we have a responsibility to ensure that technology develops in a manner that doesn’t shake up the supply-and-demand equation of our business, doesn’t destroy the content amortization business, isn’t disruptive simply for the sake of being disruptive.

If it does alter the supply-and-demand equation, it needs to do so positively, not negatively. When you have the share of the deal volume that we do, you can’t just be passive about it. You have to try and influence it. The technologies and devices that begin to get manifested at a trade show like this needs to be guided, so that it all works out in the best interests of our clients.

Irwin Gotlieb, Global CEO, GroupM, originally appeared at TVExchanger.

We have a responsibility to ensure that technology develops in a manner that doesn’t shake up the supply-and-demand equation of our business.

A bold statement and, it seems, a common mindset for many incumbent business giants in their respective industries; a mistaken belief that they can somehow coax disrupting forces (be they new companies, or larger macro consumer trends) into conforming to their legacy business models and cost structures. As we have seen countless times, the actions of incumbents, when faced with technology disruption, often is to turn to litigation, legislation or other non-market strategies (i.e., anti-trust investigations, artificial price barriers) in an attempt to delay or block the challenging technology or companies. This perhaps work as a delaying tactic in the short term (Rio MP3 player case, Napster, book publishing agency pricing model with Amazon) but fails in the long term.

Mr. Gotlieb’s apparent belief that he and other advertising agency leaders can “ensure that technology develops in a manner that doesn’t shake up the supply-and-demand equation of our business” is futile in the long run but perhaps more pernicious is the implicit arrogance of thinking the market force of the web can be channeled into their bank accounts by sheer force of will. Of the many problems with this way of thinking, paramount is the ability to rationalize away making the hard choices and decisive actions to ensure the Group M’s of the world play a vital role in the new economy as they have done in the legacy one. (Cue Scotty from Star Trek…) “You cannot change the laws of physics.” For Group M and other incumbents, it’s almost difficult to fathom, given how entrenched and advantaged they are, that they could drop the ball. But, many will, as history has shown over and over again in times of market transformation.

Technology forces which bring greater efficiency and transparency to markets simply don’t care about privilege, access, and rolodexes. They disrupt predecessor markets because of structural problems like price opaqueness and false scarcity that no longer “work” in the new market. Look at Google: their entire approach to advertising is to ultimately remove the middle man just as increasingly, the media buying side of traditional agencies is the inefficient middle man, marketing up the cost of media to provide their services. Google is now selling $40B of media every year, the majority of it without a middle man (or at least with different sort of middle man … and in any case, getting far lower margins than traditional media bought by agencies.)

We watched as the music industry delayed their demise by suing Rio, Napster, and literally hundreds of others, delaying adoption of new business models not based on scarcity. We listen to Jeff Bewkes decry Netflix as the Albanian Army as he feverishly works to reduce their influence with his content. We observe the movie industry fight with everything they have to protect the windowing strategy and defend limited access to content instead of move towards open and immediate paid access to their movies. (Fantastic post on this from Rich Greenfield here, “Innovate Don’t Legislate”.)

And, as a microcosm of this larger conversation, we watched, over a very short period of time in the SOPA/PIPA debate, as the web demonstrated the disruptive advantages of network effects and scale, as over a period of weeks, legislation that appeared all but ratified was shuttered, up to and including an implied Presidential veto. Heady stuff. Granted, if we extend the metaphor and use SOPA/PIPA as a microscope, there are extremes on both sides, and it will be messy and require compromise if the big media incumbents and new technology disruptors are to learn how to co-exist. For big media companies and the service businesses that cater to them, this means recognizing the practical realities of changed business models – probably mostly that their cost of production needs to drop dramatically and they need fundamentally to re-think distribution and customer relationship management to remain profitable and relevant. On the tech side, it means recognizing that progress requires some level of institutional engagement and political compromise – because like it or not, this is the way our system of government works and how laws get written. This won’t be easy or natural, as it’s anathema to the culture of how new media tech and the startups that encompass it conceptualize and operate in our worlds. Facing reality and then demonstrating a bit more collaboration and compromise, however, would go a long way and be better for the customer, who, like our democracy, these industries ultimately serve. Because it’s the customer who is in the driver’s seat, and increasingly, they know it.

Perhaps it’s Pollyanna, but if so, my chips go on technology. Big media has the most to lose because after decades of the game being rigged in their favor, increasingly, it’s the opposite. Of course it is difficult and painful for media incumbents to embrace digital markets considering these markets ultimately are smaller and have less attractive economics. That’s presumably why big media executives are so well compensated – if it was easy, anyone could do it. The alternative, however, is to be disrupted by new entrants which don’t have any allegiance to aging business models and who could care less how out of whack someone else’s cost structure is. Coming back to Mr. Gotlieb’s view, I offer these thoughts. First, incumbents won’t be able to meaningfully guide the technology juggernaut of more efficient advertising mechanisms, so it’s perhaps better for them to focus their energies and advantages towards thoughtful reinvention. New technologies are bringing actual measurable performance and more efficient means of buying to a large share of advertisers. The challenge for incumbents is to adapt their enterprise to embrace this chaos and profit from it. The good news is, it’s doable. However, to think they can bluster their way out of this disruption is a fool’s errand.

This work is licensed under a Creative Commons Attribution 3.0 Unported License.

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As Big Media Goes Digital, Markets Shrink

Lots of debate, lately, about Big Media and their bumpy transitions from analog incumbents to digital providers. Over the past few weeks we have had debates around the proposed PIPA and SOPA legislation, Rupert Murdoch (that bastion of new media savvy) railing against Google as a “pirate” and @fredwilson chiming in on the predictable monopoly actions of his cable company, Time Warner Cable in their dispute with MSG Networks. Yesterday Fred posted his views on the weaknesses of Big Media extending their scarcity business models to the internet.

My long-time opposition to scarcity models for digital media content online is well established on this blog and before that at Apple, N2K and eMusic. One thing Fred mentioned inspired me to revisit this subject, and that is market size. Fred says,

But the studios themselves are likely to do better in a direct distribution model where they reach a broader market at lower effective prices to the end customer. This is what happens in digital distribution. Prices come down, markets expand, customers see lower prices and broader availability. Producers do better. Everyone else does worse.

A bunch of things happen when analog media markets go digital. First, prices come down. The cost of distributing digital content is far less than physical goods that used to carry that content (printed books, plastic CDs and DVDs, etc.). Consumers understand that and expect prices to fall. The music industry hated selling songs for $0.99 when CDs used to sell for $18. But almost no one bought tracks for $3.49 when digital music was first sold online. At $0.99, consumers bought a lot. Next, bundles break. Consumers expect to pay to hear or watch only the songs or episodes they want. TV shows sold as 22 episodes on a DVD for $49 will fail when you can watch any episode for $0.99. Consumers don’t like bundles when they have a cheaper alternative. And then competition increases. Because the old guard doesn’t have monopoly distribution anymore, lots of alternatives enter the market. Consumers get more choice. These are all good things.

But finally, and this is where my view diverges with Fred’s, markets shrink. I used to posit that when content is offered widely online with few restrictions, more of it will be sold. But because prices fall, bundles break, and competition increases, I think the legacy content owners end up with smaller markets. They may reach more people, but in many cases they will ultimately make less money per title.

This is not necessarily a bad thing. Since it costs almost nothing to distribute it digitally and the cost of online marketing is far less than on traditional media, content creators can still have great businesses and make lots of money. But the main reason, I think, so many legacy content companies resist the new digital markets and their new business models, is because their businesses will shrink. And that means significantly changing your cost structure. Fewer private jets and executive dining rooms with 4-star chefs (remind me to tell you about my lunch at News Corp a few months back…)

Because the new economics are scary, the incumbents resist it. But the startups embrace it. And this is why we do what we do. As digital media entrepreneurs, we are not working to preserve a legacy business model, we are hoping to create new ones.

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Got Klout?

Marissa and I are pleased to discuss our latest investment (and our first one as a team). We are excited to join with fellow firms Kleiner Perkins and IVP in investing in the internet’s standard for measuring influence, Klout. As the internet moves from pages to people, Joe Fernandez‘s vision of the need for “Pagerank for People” is spot on. Klout’s algorithms score the actual influence of people as they share on the social web. They attempt to measure your influence by observing interactions on the social web. As we all work to build and manage our online identity and profile, Klout helps measure our reach and topics of influence.

In every other mass media, measurement provides a benefit to the advertisers who subsidize that media. Large companies have emerged based on, frankly, less than perfect measurements systems. In TV and radio, panel-based inference measurement somehow have passed as a legitimate way for advertisers to make decisions on where to spend billions in advertising. These incumbent measurement firms became standards for measurement within their domains. Klout has the benefit of being able to measure actual data, not inferred data. They aim to score the entire social web. They currently have scored more than 300 million users and are scoring and re-scoring a mind-boggling amount every day. With more than one billion people on the social web today, they are by no means complete. Nor are their algorithms perfected. Just as Google changes their PageRank algorithms hundreds of times a year, Klout will evolve their data science as the social web changes to provide the most accurate influence scoring on the web.

Klout has the distinction of being one of the few companies whose monetization plans actually benefit its users. Using Klout to identify influencers in particular topics, brands offer new products or special “Klout Perks” to you in the hope that you will like them and share your point of view with friends and followers. This relationship, unlike interrupt-driven advertising, benefits both parties. Klout has worked with more than 100 brands like Starbucks, Audi, Spotify and Microsoft and has hundreds more lined up to do the same. Joe speaks infectuously about his plans for taking Klout to “the real world”. He imagines restaurants knowing your Klout score when you call to reserve a table, airlines printing your Klout score on your boarding pass, and of course call centers knowing your Klout score when you call to complain. Already hotels are using your Klout score when you check in to decide upgrade policies.

Aside from this exciting vision and stellar progress, two other themes draw us to Klout. One, we hold a passion around seeing the relationship between a brand and a customers changed. We believe that the social web requires brands to respect us more. To take our point of view more seriously. To adopt policies consistent with good service and fair treatment. No human should have to sit on a plane for seven hours on the tarmac, of course. But also, utility companies should be held accountable for poor service, cable companies should be held accountable when we stay home from work for a day and the repair crew never shows up. Banks should be called out for imposing hidden fees in the dark of the night. And finally, our governments and elected officials should hear from more of us more often. In this age of declining influence of traditional media, Klout enables our individual voices to be more influencial with instutions who hold power. That is exciting to us.

And finally, Klout supports our view that we are shifting from an attention economy to a data economy. The last ten years of digital media on the web have been built on attention. Those web properties that amassed our attention (generally by stealing our eyeballs away from traditional media) and reached scale have been rewarded with great businesses. Yahoo! got our attention with email. Google got our attention with great search. Facebook gets our attention with photo sharing. We believe the next ten years will be built around data, and in particular, social data. We have invested in M6D for its leadership in social ad targeting. We invested in Singly for its leadership in building a social data locker and app platform. And now we are investors in Klout for its leadership in social influence measurement. We salute Joe and his team for amazing progress so far, and are pleased to be along for the ride.

“Great” is Tough to Pick out of the “Good” Crowd

The following is a guest post by my partner, Bryan Roberts. (@brobertsvc) He is one of those legendary VCs who, at about my same age, has invested in many of the most spectacular healthcare companies created over the past decade. He has been the highest-ranking healthcare investor on the Forbes Midas List since 2008. He is wise beyond his years and a great mentor to me. I found this post quite inspiring and wanted to share it widely.

The oldest adage in start-up’s, for entrepreneurs and VC’s alike, is “the key to success is the quality of the people.”  Markets and innovative approaches are important, but my experience supports this notion unequivocally. I have had the good fortune to be involved from an early stage with several billion dollar companies, and most found success after a material pivot from their original approach – Athenahealth, Ironwood Pharmaceuticals and Sirna Therapeutics to name a few.  “I invest in people” is the start-up ecosystem’s version of motherhood and apple pie, but how do you identify “Great” prospectively?

Whether explicitly or not, everyone has their own answer to this question, and based on the success rates, those answers by and large stink. I don’t have a Magic 8 Ball on the topic, but two things make this the issue I wrestle with most: (1) the often-unpredicted success or failure of “nobodies” or “sure things” respectively, and (2) the outsized rewards for locating great, juxtaposed with the probability of abject failure when settling for good. The A+ entrepreneurs with whom I have partnered have come in unusual packages – simply put, there has been no central casting: a biology post-doc who thought about opening a microbrewery B&B; a large animal veterinarian who went to business school in his late 30’s; an x EMT who was also nephew to the President among others.  The best VC’s seem to show the same diversity of background.

I now focus on these attributes:

  1. Great talent finds a way to win… and is relentlessly driven to do so with a real sense of urgency.  They follow through and complete the task – starting is easy, finishing takes real will.  It is not that they think out of the box, there simply is no box.  They view ambiguity as opportunity, not risk. When things get uncertain is when they really perk up and start to pay attention because that is when real change is possible.  Most of all, they exceed expectations. They bend the space-time continuum in some fashion and their accomplishments are extra ordinary.
  2. Experience is overrated. By and large, the world is changed by the young and the hungry. Experience can be enabling or constraining, but it is not even close to the silver bullet many believe it to be.  If you are seeking a VP marketing or head of sales at a 100+ person company, absolutely look at a resume.  But to find someone with the passion and uniqueness to actually create an early stage venture, you have to spend the time: watch them and see what they do, talk to them and see what they think, ask around and see how respected they are.
  3. Balance exploring/driving with learning/listening. Great people have a very clear grasp of the their vision, while understanding that the world has a lot to teach them. They are humble students of the game, but very confident in their abilities, and never “do what they are told.” They don’t avoid conflict and will always bet on themselves rather than shy away from risk.  They ask questions and argue on facts, balancing their gut with innumerable data streams to get to what they believe is the right answer.
  4. Great people are magnetic. They are not only smart and driven, they attract resources when all the data suggests they should not – whether capital, people or partners – and thereby become larger than just their singular efforts.

While potentially controversial today, I have come to believe that great entrepreneurs and great VC’s are two sides of the same coin.  Both embody these characteristics.  They are maniacally focused on changing the way we live with innovations others thought were not possible. They are passionate about building a great company and put the company before themselves.  No great VC takes solace in having a portfolio when an individual company struggles – like entrepreneurs, this is deeply personal and about so much more than just money.  Their roles are complementary, like looking down opposite ends a telescope, but those different perspectives to a problem can be extraordinarily synergistic.  Great future entrepreneurs can look like great young VC’s, and vice versa – three of my recent investments are stellar companies started by these “crossover” folks.

All venture firms are simultaneously never, and always, looking for team additions.  I believe this is a direct result of how elusive it is to identify those who will be not only smart, passionate, personable and high integrity, but also successful in this ever-changing, ambiguous entrepreneurial world where what worked last time is no recipe for future wins – and more likely charts a path to mediocrity.   In fact, my own difficulties in finding conviction around potential team additions for our firm is what spurred putting these thoughts on paper.

Fighting Disruptive Business Models Through Legislation

While there are countless examples of emerging technologies disrupting incumbent industries, there are very few examples of new industries beating the old through legislation. Generally, Washington influence and power is amassed over many years as nascent companies and industries grow. Few industries have the power and influence of the copyright industry. Coincidentally, very few industries are under as much business pressure thanks to tech disruption than the content industry. The two are mixing in poisonous ways.

In 1996, I had a front row seat through my friend Nicholas Butterworth and his involvement with DiMA as the Copyright industry forcefully negotiated dramatic changes to copyright law for the digital era. Most importantly, the DMCA included a hard-fought safe harbor protection for online companies providing them protection from infringement claims if they dutifully followed certain procedures. This has served our online community well.

Despite this, the copyright industry, still not comfortable with navigating the transition from analog to digital, is agressively attempting to force new changes to copyright law that would unquestionably cause lots of collateral damage to the internet and to internet companies with digital native business models (which are, coincidentally, a threat to traditional media companies). The Stop Online Piracy Act (H.R. 3261), introduced in the House in late October (which includes the most controversial parts of the Senate’s PROTECT IP Act (S. 968)), would be bad for internet companies, for internet expression, and for the future of copyright law. Right now, the digital innovation community is the likely engine of economic growth. This is not the time to hand out business model protection to traditional media companies.

More information here and here.

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