The Best Blog Posts on Venture Capital

Sorry, but I couldn’t help providing these pointers.

I’ve been thinking for a while about writing some posts explaining venture capital. While I have a lot of friends who are serial entrepreneurs and venture capitalists, one of the my realizations in the brief time I spent in the industry was how poorly understood it is by 99% of people.

Well, it looks like Marc Andreesen beat me to it.  His posts contain roughly 90% of what I was going to say.

He has three of them:

Marc describes his experience with venture capital as follows:

My experience with venture capital includes: being the cofounder of two VC-backed startups that later went public (Kleiner Perkins-backed Netscape and Benchmark-backed Opsware); cofounder of a third startup that hasn’t raised professional venture capital (Ning); participant as angel investor or board member or friend to dozens of entrepreneurs who have raised venture capital; and an investor (limited partner) in a significant number of venture funds, ranging from some of the best performing funds ever (1995 vintage) to some of the worst performing funds ever (1999). And all of this over a time period ranging from the recovery of the early 90’s bust to the late 90’s boom to the early 00’s bust to the late 00’s whatever you want to call it.

Normally, I’d be skeptical, but as I read his posts further, I found myself really appreciating the perceptiveness of his comments.

For example, here is a brief passage from the first post:

Within that structure, they generally operate according to the baseball model (quoting some guy):

“Out of ten swings at the bat, you get maybe seven strikeouts, two base hits, and if you are lucky, one home run. The base hits and the home runs pay for all the strikeouts.”

They don’t get seven strikeouts because they’re stupid; they get seven strikeouts because most startups fail, most startups have always failed, and most startups will always fail.

So logically their investment selection strategy has to be, and is, to require a credible potential of a 10x gain within 4 to 6 years on any individual investment — so that the winners will pay for the losers and in the timeframe that their investors expect.

All early stage venture capitalists will repeat the above analogy to you, but personally I found that in 2001-2002, very few venture capitalists internalized what that analogy really means. What it means is that you need to take a certain number of “swings” every year, just to make sure your odds of connecting with a winner pan out. In 2001-2002, too many venture capitalists sat on the sidelines, debating whether $4M should buy them 50% or 60% of a Series A company, instead of making sure that they kept investing. After all, any contrarian investor will tell you, you force yourself to put money in when times look grim.

I also really appreciated this quote from Marc’s second article:

Why we should be thankful that we live in a world in which VCs exist, even if they yell at us during board meetings, assuming they’ll fund our companies at all:

Imagine living in a world in which professional venture capital didn’t exist.

There’s no question that fewer new high-potential companies would be funded, fewer new technologies would be brought to market, and fewer medical cures would be invented.

We should not only be thankful that we live in a world in which VCs exist, we should hope that VCs succeed and flourish for decades and centuries to come, because the companies they fund can do so much good in the world — and as we have seen, a lot of the financial gains that result flow into the coffers of nonprofit institutions that themselves do huge good in the world.

Remember, professional venture capital has only existed in its modern form for about the last 40 years. In that time the world has seen its most amazing flowering of technological and medical progress, ever. That is not a coincidence.

This is what made me passionate about venture capital when I was in the industry, and it’s why I will likely return to it in some form again. There is an extremely important role to play for venture capitalists to play in getting money from large, conservative institutions effectively into the hands of risky entrepreneurs who are building the new technologies and businesses of tomorrow. You won’t get there with government funding or small business loans.

My favorite part of Marc’s series, however, is in his third article, when he discusses the current paradox of venture capital, one that has surprised me personally. The question is this:

If venture capital in the past 7-8 years has had such horrible risk-adjusted returns compared to the public markets, why hasn’t the amount invested in venture capital funds decreased dramatically?

The answer is asset allocation.

I remember my Private Equity class at Harvard, where Dave Swensen, of Yale Endowment fame, came to speak. Venture capital has become an asset class that every multi-billion-dollar institution feels like it needs in its portfolio. This is because after 25 years of modern venture capital, it because a proven fact in the 1990s that over the long term, venture capital has returned almost 2x the public market return, with low correlation to the public stock market. That may not sound like much to you, but that’s music to a money-manager’s ears.

This predictably led a significant number of institutions to shift massively into alternative investments and venture capital in the late 90’s, just in time to get hammered by the crash of 2000-2002.

Here’s the interesting part: that hammering — by people who, say, only started investing in venture funds in 1999 — has not resulted in a significant pullback on the part of institutional investors from venture capital.

Instead, venture capital has become an apparently permanent asset class of many large institutional investors — and increasingly, smaller institutional investors.

One element that I do believe Marc missed here is the behavioral finance aspect of why institutions still put billions into venture capital. You see, on average, venture capital has done poorly the last 7-8 years. But there have been some great funds that have performed spectacularly (Google, anyone?) Like hedge funds, many institutions have money managers that believe that the venture capital funds that they have picked will be the few that outperform. (Of course, most of the best venture funds turn away money regularly, but that’s another story.)  Thus, everyone believes that they will be “above average”, even though that’s not possible.

In any case, definitely read Marc’s articles. Bookmark them. Read them and think about them the next time you read some press about venture capital. They are keepers.  I just wish I had written them first.

Top Ten VC Lies

Too good to pass up… from Paul Kedrosky’s blog tonight.

The Top 10 VC Lies…

10. We’re all on the same side here.
9. A lower Series A valuation is good for you too.
8. We’re not funding XXXX companies anymore.
7. I liked it. Really. But we just don’t have the bandwidth right now.
6. We don’t do deals we can’t drive to.
5. Come back when you have a lead investor.
4. Absolutely, we know top people at Google and Yahoo well.
3. Absolutely, we know people at Sequoia and KP well.
2. We love your CEO.
1. I liked it, but I couldn’t get it past my asshole partners.

Enjoy.

Sonofusion: Could the Key to Fusion Lie in Bubbles?

This week’s Science Times in the Tuesday, Feb 27, 2007 edition of the New York Times was just phenomenal. So many things worth writing about!

I’m just going to write one tonight, but I had to give a shout out to their cover story, and one of the coolest technologies I had the chance to investigate years ago, sonoluminescent fusion.

New York Times: Practical Fusion, or Just a Bubble

The basic concept behind sonofusion, also known as bubble fusion, is to take advantage of a unique behavior of liquids when exposed to sound waves. The sound waves can create spontaneous bubbles in the liquid, which then collapse with such force that they actually generate light. This behavior is called sonoluminescence. Here’s the innovative idea: if you use heavy water, which features radioactive forms of hydrogen, it may be possible to actually use sonoluminescence to actually create temperatures high enough to create fusion. And with fusion comes a 50-year dream of using the ultimate form of clean energy, not for weaponry, but for commercial and personal use.

When I was in venture capital, I specialized in software companies, not experimental physics. When you work for a top-tier firm, you get hundreds of unsolicited business plans submitted to you, by email, on a weekly basis. In most cases, an unsolicited submission is the worst possible way to connect with investors.

However, one day I got an email with a business plan for a company in Grass Valley, CA called Impulse Devices. It wasn’t every day I got a plan for a new energy company (this was 2002, and the recent boom in clean energy companies hadn’t begun yet.) Imagine my surprise to find the founders with credible backgrounds, and published material in peer reviewed journals.

Over the course of a few months, I took a few calls with the company, both to better understand the technology and the potential opportunity. It wasn’t a good fit for the firm I worked for, but I was nonetheless curious.

I don’t know if they’ll be able to deliver the addition orders of magnitude improvement in energy generation to generate viable fusion where other approaches have failed. The NY Times piece has a nice summary of current fusion efforts, which, while successful, currently take in more energy than they produce.

Mainstream science is pursuing fusion along two paths. One is the tokamak design, trapping the charged atoms within a doughnut-shape magnetic field. An international collaboration will build the latest, largest such reactor in southern France in coming years. The $10 billion international project, called ITER, could begin operating around 2016 and is intended to demonstrate that all the scientific and technological challenges have finally been tamed. Commercial tokamak reactors could perhaps follow in 10 years.

The other mainstream approach is blasting a pellet of fuel with lasers, creating conditions hot and dense enough for fusion. The National Ignition Facility at Lawrence Livermore National Laboratory in California is to start testing that idea around 2010. The cost of the center, with 192 lasers, has soared to several billion dollars. Harnessing that approach will also take decades.

However unlikely it is that a maverick approach like sonofusion will be the one to succeed where others have failed, there was a great quote in the article I wanted to spotlight:

“It’s really a shame the Department of Energy has such a narrowly focused program,” said Eric J. Lerner, president and sole employee of Lawrenceville Plasma Physics in New Jersey, another alternative fusion company. Mr. Lerner has received NASA financing to explore whether his dense fusion focus might be good to propel spacecraft, but nothing from the Energy Department.

The department is spending $300 million on fusion research this year, and President Bush has asked for an increase to $428 million for next year’s budget. Almost all the increase would go to ITER.

The department supports research for many approaches, said Thomas Vanek, the department’s acting director for fusion energy sciences, but that has to fit within tight budgets. “Since the mid-’90s, it has been a tough environment for fusion energy.”

Some fusion scientists argue that fundamental physics makes these alternative approaches unlikely to pay off. Some agree that financing some high-risk, high-payoff research could be worthwhile.

“I personally think there should be more of these smaller ideas funded,” said L. John Perkins, a physicist at Lawrence Livermore. “Ninety-nine might fail, but one might pay off.”

This is the problem with large, centralized-planning-based approaches to big science, and the reason why private capital markets can be so much more effective at generating innovation.

The big dollars, whether they are from large corporations or from governments will always go to the most practical, the most developed, and the most accepted approaches. The idea of funding 100 ideas, knowing that 90% will fail is not something that seems prudent to stewards of public capital. This is what the venture capital industry, however, enables in the aggregate, and society benefits heavily from that 1 in 100 approach that actually does change the world.

I am so excited now for space exploration, because for the first time, the great giant shackles of centralized government planning for the industry are being broken. Vanity contests and start-up capital are generating more innovation in spacecraft and related technology than the entirety of the post-Apollo space program. That same approach is breathing incredible new life into technologies around clean energy.

So, just in case sonofusion ends up being the miracle that brings practical fusion to the world, just maybe you read about it here first. If not, let’s all hope that another 99 ideas as out-of-the-box as this one get funded.

Cisco buys Reactivity for $135 Million

Super quick post this morning, but I’ll flesh this out later today.

However, I had to say a big Congratulations to the entire Reactivity team, and in particular, the close friends of mine who are founders. John Lilly, Brian Roddy, Bryan Rollins & Mike Hanson, a very special congratulations. Mike & Brian, I think this means your going to be working for Cisco for a while. 🙂

Here is the official press release from the Reactivity website.

Reactivity was in the XML Gateway market, which means that they made a secure, fast box that would allow the routing of XML messages. For modern distributed development, which involves exchanging messages in the XML format, a new level of security and management software is needed.

I feel very close to Reactivity, even though officially I was never an employee. The company was founded while I was roommates with John Lilly, and I even attended one of the earliest (if not the earliest) classic Silicon Valley lunches where the model was sketched out on a napkin. The idea was to build a technology business around the very best people coming out of top schools – people who wanted to start their own companies, but hadn’t found the right mix of people or ideas to get going.

Reactivity’s original mail server was my old PowerMac 8500, and I believe my old color laser printer went into the company as well. Later in life, as a venture capitalist, I was able to consult and help advise structuring during their Series B. I always felt good when I could be helpful to my friends and to the company.

Reactivity went through several generations. It began as a stand-alone product consultant and innovation factory, incubating people and startups. They were the hot place to work in the late 1990s for smart, savvy Stanford & MIT engineers and entrepreneurs. Zaplet came out of the company, as did Raplix (which became CenterRun). They became VC backed, getting funding from Peter Fenton and Mitch Kapoor at Accel. In the downturn, the company re-started with a focus on product, and their new product and platform was born.

A special congratulations to the team again. What a great way to start a day. I’m going to have an extra spring in my step all through the week.

Update:  Some nice words from John Lilly, on his personal blog, about the acquisition and about this post.  Funny.  I forgot the laser printer was called the 800 lb. Gorilla.  It was an Apple Color Laserwriter 16/600.  It was HUGE and LOUD.  Funny.

Isilon & IronPort: A Tale of Two Startups

Two of the startups that I had a chance to work with when I was in venture capital had big news lately, and I thought I’d write up a quick post of congratulations.

Isilon Systems (Ticker: ISLN) went public on December 15th, just sneaking in before the new year. They raised $108 million in their offering, and they are trading well above their offering price. Their market cap, as of Friday, January 8th, was $1.5 Billion.

IronPort Systems was acquired on January 2nd by Cisco Systems (Ticker: CSCO) for the bargain price of $830 million.

For me, these two liquidity events provide me with incredible validation, as these were two of my favorite startups that I was able to see at Series A funding during my limited time in venture capital. I can’t take any credit for their success, but I do think that these companies had a lot in common, and recent events give us a chance to reflect on what led these two start-ups to go the distance, when so many others fail.

  • Great, technical founders. There are a lot of different types of entrepreneurs, but I’ll admit that I have a bias towards experienced and deep technical founders. Sujal Patel fit the profile, exactly. As an engineer, Sujal had solved some of RealNetworks most complex back-end operational challenges. That experience gave him the insight for a new type of solution, a type of virtualized storage optimized for media. His experience gave him the insight to a real customer need, and his deep technical knowledge gave him the ability to spot a solution not on the market. Scott Weiss & Scott Banister also exemplified the profile. As early pioneers for Hotmail (Weiss) & Listbot (Banister), these two knew the email businsess well. They were also technically deep enough to see the potential for an optimized server for outbound email services. These are the type of founders that you want to see and fund, when possible.
  • Leveraging new technology to solve customer needs. Despite the mythology about startups in the press, most successful technology startups do not invent some radically new technology or application that no one has ever heard of. However, they do tend to take today’s technical innovation, and apply it to a real customer need that can now be uniquely addressed in a way that wasn’t possible before. Open source operating systems had become big news in the late 1990s, and into 2001&2. However, both of these companies were technically based on the idea that an open source operating system can allow a very small team to add incredible value by optimizing just a portion of a modern operating system for a specific application. Isilon optimized their threading & file system for virtualized storage for high intensity media use – high bandwidth, long reads, lots of simultaneous sessions. IronPort optimized their threading & file system around Sendmail.

    Like most innovations, this insight was not unique to these two companies – Tivo, for example, had done the same thing, and you could even argue that Cisco had gotten its start optimizing an OS for routers. However, it was still relatively early days for this type of platform, and open source operating systems gave entrepreneurs the ability to create incredibly robust, high-end vertical platforms with amazing speed and low cost.

    The perfect “next step” usually has to be technically robust enough to be reliable for customers, but new enough that the entire market hasn’t already adopted it. It’s not surprising to me that both of these companies had latched onto this next step.

  • Learn & adapt based on customer feedback. If you read the websites for Isilon Systems or IronPort Systems, you’ll see that these two businesses have evolved significantly since those Series A rounds in 2001 & 2002. It’s trite to say that the technology market moves quickly, and that startups have to move quickly as well. The real issue, however, is that no matter how insightful the founder, and no matter how breathtaking the technology, the difference between a great pitch and a great business is a relentless dedication to learn & adapt. If you are smart, and you have a strong technology in a space with an underserved need, you will have opportunities to win. But they are hidden, and good teams know how to listen, move, and take action based on incomplete information.
  • Tough funding environment. For people who haven’t worked in financial markets, this reason can seem counter-intuitive. How can a tough funding environment make a company more likely to succeed? Success is about the team, the technology, the product, and getting there first? Right?

    Wrong. Well, at least, it’s not completely right. Tough funding markets force entrepreneurs to think harder about potential opportunity. They force investors to focus more on true differentiation and economic potential. And they prevent the funding of 100s of copycat ideas in the same area, which can destroy the economics of a previously viable area through over-supply.

    I believe I was extremely fortunate to be in venture capital in 2001 & 2002, extremely tough markets. Believe me, there is just as much BS in a tough venture environment as a strong one – it’s just a different flavor of BS. The reality is that, when times are tough, and everyone thinks that its better to not be doing deals, you need to have the strength, fortitude and intellect to make some investments. Isilon & IronPort are examples of deals worth making in 2001 & 2002, when conventional wisdom said it was OK to not be making investments.

  • Limited access.
    “I would not join any club that would have someone like me for a member.” — Groucho Marx

    Early stage venture capital is a branch of private equity, which has become a household term these days due to the large amount of money involved and the high returns of the funds. However, it’s important to remember that private equity has higher returns than public equity for only one reason – it’s private! Limited access to information, to the investment, to the people, to something. Otherwise, our good friend the efficient market would have reduced rates of return already to something that risk-adjusted wouldn’t look so special.

    Whenever you see what you think is a great deal, you have to play Groucho. You have to ask, “Why am I uniquely getting this opportunity?” With Isilon & IronPort, we had concrete answers.

    I’ve seen too many eager, young, aggressive venture capitalists who don’t seem to realize that for good teams and concepts, there are ample sources of capital out there. The selection of an investor is a hiring decision, and there needs to be a good reason why the founding team needs you. Money isn’t the answer.

It’s interesting to me, personally, that I saw both of these deals thanks to our Seattle office, now closed. I actually worked the internal diligence and analysis of IronPort Systems, and was extremely positive one team and the company. Although Atlas passed on the Series A, Scott Weiss was someone I reached out to when I left venture capital, because I was that impressed with the company.

The current early stage venture environment is clearly over-heated at this point – too much money still chasing too few real economic opportunities. Still, great companies are started and built in the worst of times, and great companies are also started and built in the best of times. As long as technology continues to turn things that were previously expensive and complex into things that are now cheap and simple, there will be opportunities for entrepreneurs to solve today’s customer problems in whole new ways.

I’ll write about what some of my takeaways were about how to be a great venture capitalist another day. Today, I just want to say a hearty congratulations to the Isilon & IronPort teams, whereever you are. You deserve every bit of it.

VC Lifestyle Myths (in Retrospect)

A great post this week from Susan Wu at Charles River Ventures on the myths surrounding the legendary lifestyle of Silicon Valley venture capitalists:

Susan Wu: VC Lifestyle Myths

I was reading along, waiting for something to resonate, when I saw this screenshot:

Ah yes, it is all coming back to me now. The VC Lifestyle.

Now, let me be upfront about something here. I love venture capital. Honestly, I do. The idea of job where you are striving to know as much as possible about technology, people, strategy, and building businesses is definitely in my sweet spot. Not only that, but I continue to be amazed at the almost accidental set of circumstances that gave birth to the modern venture capital industry in Silicon Valley, and the amazing value that has been generated because of it.

All of that being said, the reality is that the VC lifestyle is not as glamourous as you might think, and definitely has elements to be desired. Susan captures a few key elements that definitely resonated with my memories of being an Associate at a large, early-stage venture fund:

  • Tyranny of Outlook. Meetings, meetings, and more meetings. Easily 6-8 a day, mostly pitch meetings with entrepreneurs & executive teams. The day is blocked off weeks in advance, and as a result, you are constantly moving things around as things come up, meetings go over, and you are trying to meet with just one more person.
  • Miles wide, but inches deep. It’s hard to imagine being lonely when you are meeting literally 20 new people everyday, and your rolodex grows to the thousands. But a vast majority of your contacts are people you meet once. Many others you might talk to once or twice a year. Even fellow venture capitalists and entrepreneurs that you are close too might touch base on a weekly basis. The reality is that the only people you truly see every day are those in your office, and our office was small. At it’s largest, we had two partners, an associate (me), an analyst, two executive assistants, and a receptionist. That’s not a lot of people.
  • Coopetition. Without getting into the nuanced politics of venture capital, it can be draining at times. As a young person in the industry, you are at once trying to build a reputation for yourself and carve out a niche, but at the same time you need the support and assistance of others around you. In the long term, you are judged on your own success, but in the short term, you are judged on your support of the senior partner(s) you are working with.

When I think about my life at eBay, it’s amazing at how much my experience in venture capital has helped me.

First of all, my Outlook calendar still looks like that. 🙂 Maybe that has more to do with growth, drive & Silicon Valley than venture capital itself.

Second, I truly love the number of people I get to work with at eBay. Love it. Not only have I met literally thousands of great people at eBay & PayPal over the past four years, but there are hundreds of people that I now know fairly well. Leading large project initiatives and new businesses at a larger company may be more constrained in some ways than leading a startup, but the counter-balance is the number of people you get to know and work with.

Third, my orientation towards senior executives has shifted. Before venture capital, there was some degree of awe that I felt around CEOs & executives of large technology companies. While I still respect their achievements, I found that venture capital gave me more grounding around the fact that these are, in fact, just people. At eBay, this has allowed me to be more comfortable, in general, around meetings with our senior staff. I still see to this day so many bright people, with excellent ideas, get tripped up the moment they have to succinctly and convincingly present an opportunity to a senior executive.

I’m quite happy with my move back to an operational role in 2003, and I’m extremely happy with the opportunities I’ve been given to help design, launch, and build brand new sites & businesses at eBay.

But some day I’ll likely go back to venture capital. Maybe. Right time, right place, right people. But not yet.

(BTW, If you aren’t reading Susan Wu’s blog, it’s worth bookmarking. I have a special place in my heart for any venture capitalist who actually play World of Warcraft, and can actually comment intelligently on technical issues.)

Riya tries again as Like.com

I read a lot of news today about Riya trying to reinvent itself as Like.com today. Of all the coverage, Don Dodge’s summary resonated with me the most.

Riya tries again as Like.com

I think Don uses Riya to summarize of the key takeaways I had from my own experience in venture capital:

The lesson for entrepreneurs is don’t have preconceived notions about how your product/service will be used. Test with lots of different customers to discover where they see value. Remember, it is not about the technology…it is about the problem it solves.

Personally, while I find Riya’s technology truly exciting in its potential, this new direction feels a bit too manufactured, a bit too orchestrated and timely. It rings of smart people figuring out strategy behind closed doors, rather than a true customer-driven request or need.

Metadata tagging of blogs and pictures is hot right now, but tagging of video is just getting started. Is it that hard to believe that in a few years, when studios build the digital versions of their properties for distribution (either BD/HD DVD and/or download versions) that they will tag them with the appropriate commercial content? Wouldn’t it be easier for software on the web or on your TV box to just then link to appropriate interesting items (like boots, dresses, cars, other product placements) to a rev-share storefront for the studio? And wouldn’t the owners of that content want to control that linkage – charge for it, since it’s their property (the movie, the show, the shot) that’s driving the demand?

This is hot technology and it’s incredibly generalized, but in many cases we tend to look for the ultimate solution when a very simple, manual process can hit the business need 80/20. So I’m still not sure this is a business vs. a cool demo.

BTW If you haven’t tried it out, go see the Like.com Alpha site.

Remember the $1M Homepage? MMMZR takes Ponzi to Web 2.0

Seeing this type of site just makes you so angry that people could make money this way.

MMMZR homepage

The founder blog is here.

I guess I’m just kicking myself for not doing it first. The Ponzi scheme is a historically proven model for allocating money and gaining traction. Like the $1 Million homepage, I guess this business is a 100% based on his ability to generate press and therefore traffic to his single page.

Well, now I’m helping out… sigh.

eBay Reputation, Shipping Prices & Ending Times

A big thank you to one of the great product managers at eBay, Rebecca Nathenson, for forwarding me this German study on eBay economics. (I would link to her blog, but she is hiding it from me…)

The Effect of Reputation on Selling Prices in Auctions (PDF)
by Oliver Gürtler & Christian Grund

As I mentioned in my previous post about starting prices, I have a strong interest in academic studies on the economics of eBay, the largest online marketplace globally. I am convinced that our level of understanding of the economics of marketplaces like eBay are still in their infancy.

As someone who has been selling on eBay since 1998, this study covers three topics that are easily familiar: reputation, shipping prices, and ending times. The study is from May 2006, and it is based on the eBay Germany site, but their is no reason to believe that they are country specific.

The first piece of the study looks at the effect of feedback on final selling prices on eBay. They confirm the obvious – reputation does impact final selling price positively. What’s interesting here is that it seems that the overall number of negatives did not have a measurable effect on final selling price. However, the percentage of negatives did. This result verifies anecdotal experience from many eBay buyers and sellers who will tell you that the “percent positive” is their primary measure of eBay reputation, once feedback scores rise beyond an initial threshold.

The second interesting tidbit from this study is their study of shipping prices. Once again, it confirms the obvious – higher shipping prices lower final sale prices. However, the interesting tidbit here is the fact that one dollar of increased shipping led to less than one dollar in reduced final sales price. This means that sellers may be better off charging a fair cost for shipping & handling, rather than assuming that if they offer low shipping that the cost will be made up in the auction price.

When I first started selling computer components in bulk, I experimented with different combinations of price and shipping cost. In one experiment, I took the exact same listing & description, and set different prices for the item & shipping, but left the total the same. They ranged from $15.99 with free shipping all the way to $0.99 with $15 shipping.

The result – the best selling item, measured in page views and conversion rate, was the $9.99 price with $6.00 shipping.

My theory at the time was that two human factors were occurring here. First, people see exorbitant shipping as dishonest. As a result, the listings with ultra high shipping looked dishonest, and it resulted in a lower purchase rate. At the same time, although buyers love free shipping, they were confronted with sticker shock from the high $15.99 price. Clearly, gas stations know what they are doing when they price gasoline to the 9/10 of a cent.

In their words:

The results with respect to the other variables indicate that postage affects sales revenue negatively, which was expected. However, an increase of postage in the amount of 1 € does decrease the price only by the amount of 5 per cent on average, which means by about 60 Cent at an averaged price of 12 €… In our case, however, it seems to be beneficial for sellers to segregate the total revenue into the two dimensions postage and selling price, because potential buyers concentrate on the main price during auctions and neglect the amount of the postage.

The last interesting insight from this research is their investigation of the effect of duration and ending time on the final selling price.  Interestingly, there is a surprise here, which they dub the eBay Evening Fallacy.  They claim that auctions that end in the evening perform worse than auctions that end earlier.  As an interesting side note, they also found no evidence that duration impacts the final selling price.

What’s interesting about this insight is that it doesn’t really explain why this fallacy exists.  One possibility is that historically, evening ending times did perform better than earlier times.  However, as this became known, supply overwhelmed demand as everyone piled onto the same popular times.

I think actually this is a nice place to end this review, because in the end, while fascinating, the last insight is a warning.  eBay is a dynamic marketplace, and as information flows through the market, the profitability of different strategies may change over time.  Everyone knows they vary by country, by category, and by season.  They also can vary based on what everyone else is doing.

In finance, there is a theory of efficient markets that posits that public information flows nearly instantaneously through the stock market.  As a result, all returns are merely compensation for risk. Part of the attraction of private equity is the fact that it operates in a world, by definition, of more limited information and more limited access.  That’s what yields those wonderful returns that Venture Capital has seen over time.

It’s interesting to think of eBay in that light.  Strategies are always evolving, as information is communicated about how to succeed on eBay.   Are proprietary access to inventory, or proprietary strategies the keys to outperformance?  Efficient market theory has a risk-free return built into its model.  Does eBay have the equivalent of a risk-free return, and if so, what is it?

That’s why I love research like this.  It goes beyond the anecdotal and makes you think.

Sequoia backs PopSugar for $5M

I’m finding the trend of venture backing for blog networks really fascinating.  Looks like Sequoia has jumped in with $5M for PopSugar out of San Francisco.

Techcrunch has some coverage here.

I’m guessing that the venture backing is a bet that this is a disruptive way to build a new media outfit with a fundamentally lower cost structure, but with all the revenue upside.  Media has always been profitable – witness the longevity and economics of newspapers – so this theory isn’t completely outlandish.

VentureBeat has coverage here.  Interesting deal for Mike Moritz.

Are Web 2.0 Social Networking Sites Exponential?

Jason Steinhorn sent me a link to this fairly interesting blog post on the growth dynamics of social networking sites.

The mathematics of Web 2.0: Why don’t ALL social networking sites experience phenomenal growth?

The article looks at two interesting questions:

  1. Do social networking sites show N^2 growth (ala Metcalfe’s Law), or do they show 2^N growth (exponential)
  2. Why do some social networking sites show far more rapid growth than others.

I need to think about this a bit more.  My initial reaction was no, these sites are showing N^2 growth (which is huge), and the author is getting confused about the fact that trees don’t grow to the sky, and not all sites are going to fulfill their algorithmic destiny.

However, on further consideration, the growth of groups is really the key.  Since groups can continue to form, and can “repeat” membership fairly aggressively, you might be seeing more of a combinatorics equation, like the one in his article.   A study of the growth of groups might be the real key here – I’m not sure these sites really support full combinatorics, which is what you’d need to see 2^N behavior.

If you are wondering why this matters, let’s try a mathematical explanation.  These equations define the “growth characteristics” of certain types of models.

N^2 (N Squared) tends to get you numbers like:

1, 4, 9, 16, 25, 36, 49, 64, 81, 100

Pretty good.  1 to 100 in just 10 steps.

2^N (2 to the N) tends to get you numbers like:

2, 4, 8, 16, 32, 64, 128, 256, 512, 1024

1024 in just 10 steps.  Much more powerful growth, and the difference gets more and more staggering as the model grows.

This is why, by the way, compound interest is your friend.  Exponential growth is your savings doubling regularly, over some period of time.

Of course, this article has me thinking… Metcalfe’s Law is about computer networks.  But why wouldn’t computer networks actually show exponential growth?  After all, I can belong to multiple networks – my ISP’s network, my home LAN, my workplace LAN (VPN)… is there some element of this growth in the networking business as well?  Is that why wireless networking has been so powerful?  The overlay of these “networking groups”?

There’s something interesting here… but it’s just too late tonight for me to figure it out…

Behavioral Finance, Product Design and Entrepreneurship

Now that I’m entering my fourth week maintaining this blog, I’ve decided to come back to the subject of why I really believe that these three topics are intertwined.   These three topics are the reason that I named this blog Psychohistory, and these three topics seem to completely dominate my education and professional career.

The reason for this belief is crystalizing, and it’s remarkably simple:
I truly believe that incredible opportunity lies at the intersection of the irrational (human emotion) with the rational (finance, technology, business).

Behavioral Finance offers us the opportunity to design financial systems based on the basic insight that the way that human beings relate to money involves far more emotion than intellect.  To understand economics, you must understand your very human economic actor.

Product Design is based on the premise that deeply understanding the ways that people interact with technology can lead to profoundly more useful (and desirable) designs and products.  To understand product design, you must understand your very human customer.

Entrepreneurship offers us the opportunity to build companies by figuring out how to replicate the economic miracle of creating billions of dollars in new value by unlocking the very human emotions of inspiration, motivation, cooperation, and self-determination.  To understand entrepreneurship, you must understand your very human entrepreneur.

Like all good elevator pitches, I probably need to reduce this in complexity by an order of magnitude before I’ll be happy with it.  But I’m excited about this insight, and more importantly, I’m already seeing incredible leverage from it in my industry, where everyone is talking about the intersection of technology, commerce, and community.

Scott Kleper & SpotDJ

A good friend of mine just updated his personal blog for the first time in months recently, and I thought this was as good a time as any to introduce the very cool startup that he’s been working on.

The company is called SpotDJ, and his blog post about it is here.

Scott has been a good friend ever since I met him through the CS 198 Section Leader program at Stanford, where he was one of the first section leaders I hired.  Scott was one of those great student developers who didn’t just take Computer Science classes – he really wrote code.  Shareware, mostly, for the Mac.  Even then, Scott always shipped.

Scott had the misfortune of having an internship at Apple Computer in probably the most depressing time possible – in the Advanced Technology Group, in 1997, right as the entire group was disbanded.  Since then, he’s done some pretty interesting things – working for several companies and even co-authoring a book.

Doing a startup is something that is very easy to talk about in Silicon Valley, but make no mistake about the fortitude it takes to really quit a good paying job and go out on your own.  Scott is doing it right now, and SpotDJ is evolving into something really interesting.

I love the idea that instead of bidding on keywords (Google/Yahoo), you might actually target content/advertising based on a song.  If they can crack some  success measure like cost-per-click (cost per listen?) and some demand measure like click-through (selection? rating?), it’s a very interesting way to target content/advertising in an environment where keywords aren’t the way people navigate.

In any case, check out the company, and kudos to Scott.

Blogs I Read: Don Dodge

In the spirit of hilighting some of the best blogs that I read and given Google’s product announcement today for “Applications for Your Domain“, I’d like to point you to this humorous press release on Don Dodge’s blog today:

Don Dodge on The Next Big Thing: Google Announces New 24X0 Support Service for Business Users

I find Don’s blog particularly interesting because he:

  • Posts regularly
  • Provides insight from his unique experiences at AltaVista, Napster, and now Microsoft
  • Provides a rare intersection of the “modern” Microsoft point-of-view on Web 2.0 and related technologies and products, with an outsider flavor
  • Seems to genuinely understand the professional Venture Capital viewpoint on key technology trends (based on my experience as an Associate Partner in a multi-billion dollar early stage firm)

A worthy addition to anyone’s RSS feed…