Monthly Archives: August 2012

Do something that your competitors aren’t doing

Competition is inevitable. Any idea that gets significant traction will be imitated by your existing competitors or attract the interest of new entrants. If the nature of your idea doesn’t have sufficient barriers to entry, a rival with superior execution capabilities will likely outperform you in the long run. Building a team with superior execution skills is therefore a necessary condition to make your startup successful.

However, there are many instances when execution alone is not sufficient. For example, many marketplaces have significant network effects which give first entrants an important advantage. Once a marketplace has sufficient users, it becomes very difficult for a competitor to acquire users to a new marketplace where there are only a few buyers and sellers. The switching costs for existing users are simply too great and new users have an incentive to go to the platform where they will have the greatest number of buyers and sellers with whom they can transact.

Despite the crucial nature of execution, there is therefore a preceding step which entrepreneurs can use to differentiate their startup. In particular, you can build a product or service which is different from what the competition is offering. If you are imitating a competitor which is reasonably skilled at execution and are fortunate to be in a field where the first mover doesn’t have a significant advantage, you are likely to capture a similar fraction of the market at best. If you happen to be an imitator in a field where the first mover has a big leg up, the outcome will likely be much worse. But if you do something that your competitors are not doing, you have the chance to create a new market or to capture a much greater share of an existing market.

A case in point is Ginger.io, a big data startup which uses passive and active smartphone data to help physicians and hospitals monitor their patients. The key differentiator here is the passive data. Most competing healthcare startups rely on active input from patients to monitor the progress of their disease. This is costly for the patient in terms of time and effort as they often need to input their data multiple times a day. Patients may forget to record their data or be unwilling to disclose information if they feel like they aren’t making progress. The benefit of passive data is that it requires no patient input. By monitoring a patient’s smartphone usage behavior and changes from a baseline, including who they call or message, how long they talk for, and the time of day when they use their phone, Ginger.io is able to complement a patient’s active data with passive information to more accurately monitor the progression of their disease. Best of all, obtaining this information requires no effort from the patient. The information is then used to help physicians and hospitals produce better treatment outcomes in a shorter amount of time, which ultimately reduces healthcare costs.

As Ginger.io is experiencing, there are very real benefits to doing something that your competitors aren’t doing. You find it easier to acquire customers who are attracted by your novel approach which is a great improvement on the status quo. This cascades to other areas of your business. Current employees are more motivated because they are pursuing a cutting edge idea, and prospective employees are easier to hire because they want to be part of the innovation which you’re producing. It’s also easier to raise capital because investors see more defensibility in your idea. You’re no longer simply competing on execution, but also on product. For all these reasons, the next time someone tells you that it’s all about execution, remember that you’ll be much more likely to succeed if you’re executing in a different direction than your competition.

Why an introduction from a mutual friend is better than a cold call

This one’s going to be short and sweet. Today I spent some time reflecting on what differentiates the founders who I want to fund from the rest of the pack. In addition to the usual suspects like having a passion for what they’re doing, adopting a broad vision yet being able to convey it in simple terms, and having a deep understanding of the technical details of their business, there was one factor which I wasn’t expecting. I was more willing to fund those entrepreneurs who came to me through the introduction of a mutual friend than those who placed a cold call.

In today’s world of the internet and LinkedIn where it’s fairly easy to find a mutual contact, my gut instinct tells me that coming through the introduction of a mutual friend shouldn’t send a strong signal about the quality of the entrepreneur. Since I couldn’t pin down a rational reason for why I preferred founders who were introduced by a friend, I decided to perform a simple exercise to see if the preference for a common contact was unique to me or shared by others.

I pulled out a piece of paper and began writing down the 10 greatest successes of my career. These included accomplishments like starting a business, making a successful investment, and landing a job. I then evaluated how I had started on the path to success in each case. In particular, I was looking to discover whether the first step of the journey had been through the introduction of a friend or if I had initiated the contact through a cold call. To my surprise, my friends were responsible for originating 9 of the 10 successes. So not only do I react more favorably to an introduction, but it seems like the majority of everyone else does as well.

Digging a bit deeper for why we may prefer introductions rather than cold calls, I’ve concluded that it must be an evolutionary inheritance. As mentioned earlier, it’s not challenging to find a mutual contact to make an introduction in the world of the internet and LinkedIn. So, with the exception of a glowing introduction from a very trusted friend, an average introduction in today’s world shouldn’t carry too much weight. However, it remains very difficult for today’s rational brain to overcome thousands of years of evolution. There’s a reason why all the languages I speak have a variation of the expression “don’t talk to strangers”. We are evolutionarily wired to place greater trust in those we know directly, and knowing them through a mutual friend is the next best thing.

So whether you’re an entrepreneur looking to increase your chances of getting funded, or someone simply looking to experience greater success in their career, my advice is simple. After you’ve identified someone you want to meet, have a mutual friend make the introduction.

Rocket’s departure doesn’t change the strong long-term fundamentals of Turkey’s internet sector

Rocket Internet, the internet business cloning company led by the Samwer brothers from Berlin, recently decided to close its 400 person operation in Turkey. Rocket’s Turkish presence was concentrated in e-commerce where it targeted the clothing, jewellery, sports apparel, and homeware verticals. Since Rocket is a knowledgeable and respected actor in the global internet industry, their actions have caused entrepreneurs and investors alike to express skepticism about the potential of the Turkish internet sector. These concerns are misplaced because Rocket’s exit is not reflective of the underlying performance of the Turkish internet sector. Rather, it is the consequence of the incompatibility between Rocket’s strategy of flipping businesses and the long-term commitment necessary to succeed in Turkey.

Rocket is notorious for its short-term focus. The company readily acknowledges that it is not interested in making the costly long-term investments necessary to come up with new business ideas or creative ways to improve an existing model. Instead, it relentlessly focuses on copycat execution to outperform its competitors in the short-term. Its goal is to identify an attractive profit opportunity, ramp up fast, and exit fast. This is the model that brought it success with Alando, which it sold to EBay for $54M only 6 months after launch in 1999, and CityDeal, which it exited to Groupon for a valuation in the triple digit millions 5 months after starting in 2010.

Given these successes, Rocket tried to replicate the same model in Turkey. It was attracted by the country’s emerging internet industry and effectively purchased the option to explore flipping opportunities by entering the country in February of this year. Rocket then went on a hiring spree to rapidly grow its team to 400 people. Despite this large team, Rocket Turkey’s senior leadership was not Turkish. The lack of homegrown leadership in an e-commerce market with unique local characteristics like low customer loyalty is a clear indication of a short-term focus. 

Rocket didn’t want to invest in developing local senior leadership because its goal was to evaluate the value of its option in the next 5 to 6 months, just as it had done with Alando and CityDeal. If it had skyrocketed in value, it would exercise the option by exiting to a strategic buyer. If it looked like Rocket would need to hold the option for a significantly longer period of time for it to realize its value, it would redirect its finite resources to other short-term opportunities. A 2-3 year perspective is simply not part of Rocket’s DNA, and for good reason. The Samwer brothers don’t see the need to adopt a long-term philosophy since they already have a secret sauce which mints money in the short-term.

Rocket’s departure from Turkey is not a statement about the long-term fundamentals of the country’s internet sector. Rather, it is a reflection of the misalignment between Rocket’s short-term strategy and the long-term investment necessary to succeed in the Turkish market. In fact, however short it may have been, Rocket’s stay in Turkey has been a blessing for the country’s internet industry. 400 people may be unemployed now, but they are equipped with the experience and confidence to launch internet businesses of their own or to contribute to the growth of existing businesses with a long-term orientation. By learning from their employer’s activities, Rocket employees can apply their new skills to build sustainable companies which thrive in Turkey’s growing internet sector.

Istanbul’s potential as a regional hub for tech startups

I’ve spent the last two months immersed in the tech startup scene of Istanbul, Turkey. During this time I’ve had the great fortune to meet hundreds of entrepreneurs and investors in my attempt to understand Istanbul’s potential as a tech startup hub. I’ve spoken with college entrepreneurs who came up with a business idea in their dorm room the night before, as well as the founders of Turkey’s leading e-commerce sites. On the investor side, I’ve met with the figures behind incubator programs, early stage funds, and late stage firms. As the result of this deep immersion, I’ve realized just how far Istanbul’s tech startup scene has come since I first visited the city back in 2008. What’s more, the city has an even brighter future. Istanbul is a very strong candidate to become a vibrant hub for tech startups emerging from not only Turkey but also the Middle East and Eastern Europe.

When I first visited Istanbul in 2008, I could count the number of angel investors and venture capital funds on the fingers of one hand. 4 years later, there are local funds specializing in incubation, seed, and early stage investing, as well as later stage international funds who have established a local presence. There are also a large number of international funds scrutinizing the market from abroad and patiently waiting for the right moment to enter. Investor interest in the local market has exploded after the success of ventures like Gitti Gidiyor in e-commerce, Trendyol and Markafoni in private shopping, Peak Games in social gaming, Yemek Sepeti in online food ordering, and Cicek Sepeti in online flower shopping. The near double digit growth rate of the Turkish economy, young demographics, rising internet and smartphone penetration rates, and high social media engagement levels suggest that Istanbul has an even brighter future as a regional technology hub.

However, for Istanbul to realize its full potential within Turkey and as a launching board to the Middle East and Eastern Europe, entrepreneurs, investors, and the government need to continue innovating and collaborating. Successful entrepreneurs need to help grow the next generation of founders by serving as angel investors and mentors. Investors need to adopt a true partnership mindset with the founders which they back so that they can create value together. The Turkish legal system needs to accomodate new investment instruments like convertible debt which facilitate early stage investing.

Fortunately for Istanbul, it is still in the very early stages of a long journey. The seeds of Silicon Valley were planted when Bill Hewlett and Dave Packard founded Hewlett-Packard in a Palo Alto garage in 1939. The term Silicon Valley was not coined until 1971, and did not enter everyday language until the 1980s. Similar to Silicon Valley, it will likely take 30 to 40 years for Istanbul to achieve its full potential as a regional technology hub. All the right ingredients are in place and the trajectory has been set. Just like the boats advancing with the wind behind their backs on the Bosphorus, Istanbul is sailing in the right direction.

An early stage startup shouldn’t have an exit strategy

I was recently speaking with an entrepreneur who successfully raised a seed round, developed a fully functional product, and is currently looking for follow-on funding. His mastery of the problem which his team is solving, their customer segmentation, and their growth plan, was excellent. In addition to having a deep understanding of the technical details, he conveyed his vision for the company with enthusiasm and simplicity. I’m convinced that he’ll be able to raise the round he’s looking for and will have a decent shot at making the startup successful.

However there was one moment in our conversation that left me with a bitter sweet taste. Towards the end of our discussion, the entrepreneur said that there were several exit opportunities which he would be looking to pursue in the next 2 to 3 years. While a discussion of exit opportunities may be appropriate for a company that already has a stable recurring revenue stream, as in the case of a later stage startup or a private equity investment, I find such discussions misplaced for early stage startups. Unfortunately, such discussions have recently become all too common. Since startups are all the rage these days, many people who instrinsically don’t care about technology, innovation, or customer service are entering the industry with the goal of making a quick buck. Talking about exit strategies before scaling is a natural reflection of this trend.

An early stage startup is, by definition, young. When you’re young, you have a lot of room to grow. And the only way that you’re going to achieve your true growth potential is by having a laser focus on that growth. If you choose to focus on exit opportunities instead, you’ll lose on two fronts. First, you’ll sacrifice valuable time which you could be allocating towards building a product that offers your customers an ever improving experience. Second, you’ll miss the chance to build something truly revolutionary. Instead of building the best thing you can, you’ll build what you think will be bought. Imposing this constraint may make you more likely to achieve an average outcome, but it will come at the expense of pursuing a remarkable outcome.

Building for an exit also sends a strong signal about the motivation of the entrepreneur. An exit allows the entrepreneur to exchange their shares for cash. At this stage it’s useful to distinguish between complete and partial exits. A complete exit is one where an existing shareholder sells all of their ownership interest in a company. This is in contrast to a partial exit, where a shareholder sells a fraction of their shares. A partial exit can be valuable to reward an entrepreneur for years of hard work at subsistence-level salaries while ensuring that they retain sufficient equity ownership to continue investing all their energy into the startup’s growth.

However a discussion about exit strategies refers to complete, not partial exits. As a result such discussions suggest that the entrepreneur will no longer have any ownership in the startup after they exit. When such discussions take place in the context of an early stage startup, they serve as a strong indication that the entrepreneur’s primary motivation is that of financial gain. While this is a fair motivating factor, I do not want to invest in an entrepreneur that places it at the top of their goals. The best entrepreneurs are those whose primary motivation is non-financial. Instead, they seek to deliver a vision greater than themselves and have an unwavering belief that they are the best person to do so. When a resolute entrepreneur seeks to deliver a vision they believe in, the exit strategy takes care of itself.

Opportunities for social gaming companies in mobile and real-money gaming

With over 70M daily active users, Zynga is the global leader of the social gaming industry. Zynga has nearly 6 times as many daily active users as its nearest follower King.com. As a result of its size, Zynga’s financial performance serves as a bellwether for the performance of other social gaming companies. This is why the poor results which Zynga recently announced for the first half of 2012 had an adverse impact extending well beyond the company. Industry analysts who were painting pictures of sunshine and happiness until now have reversed their stance to one of doom and gloom.

However, instead of having a short term memory, we need to remember that the social gaming industry has developed over the last 5 years. It is therefore very unlikely to disappear overnight. In fact the industry faces two big tailwinds in the form of mobile and real-money gaming. Properly pursued, these opportunities will ensure that the industry not only maintains its growth but, more importantly, achieves sustainable profitability.

The first big opportunity for social gaming companies to increase profitability is the transition from browser based games, including those on Facebook, to mobile. In comparison to browser based games, mobile games allow companies to tailor their games based on the user’s location. This not only gives companies the opportunity to improve the gaming experience for users but also makes it possible for advertisers to offer users more targeted location-based ads. This leads to higher click through rates and greater ad revenues from mobile games than from browser based ones.

Mobile games also have greater user engagement than their browser based counterparts because people don’t sit in front of their PC all day but almost always have their smartphone accessible. The ease of performing repeated interactions is a very attractive feature of mobile games.

The combination of an improved location-based gaming experience, more targeted advertising opportunities, and greater user engagement leads to significantly higher monthly average revenue per user (ARPU) for mobile games. Whereas different sources quote monthly ARPU figures ranging from $0.22 to $0.32 for browser based games, these can be as high as $10 to $12 for mobile games. This includes $8 from virtual goods and $2 to $4 from advertising depending on the smartphone operating system.

Social gaming companies have a second big opportunity in real-money gaming. Since social gaming companies largely offer freemium games, they have so far relied on two sources of income: virtual goods and advertising. The flow of cash has been an exclusively one way street with money going from gamers to the company. With the introduction of real-money gaming where users are rewarded for outperforming their peers, gamers will for the first time have the opportunity to earn more than what they pay to play and progress in a game. Since they will only be able to acquire this carrot if they beat other gamers, they will increase their spending on the virtual goods which increase their probability of winning. This is in addition to the upfront payment that can be required to take part in a real-money game. Another way they can increase their chance of winning is by spending more time playing the game, and this will make gamers more attractive targets for advertisers.

There will be legal limits to real-money gaming in those countries that prohibit online gambling. However, there are enough countries where the model can be tested and proven before showing those governments that do prohibit the activity that the stakes involved for most social games are much lower than for traditional casino games. Once the distinction between real-money social gaming and gambling has been established, companies will increase their income from virtual goods and advertising while also having the opportunity to add a new revenue stream in the form of an upfront pay-to-play fee.

As humans we like to play games and compete with each other. This will not easily go away. Social gaming companies addressing these intrinsic motivations have entered a rough patch not because of their poor fundamentals but because extreme hype had simply gotten ahead of great fundamentals. By continuing to meet these intrinsic motivations while innovating in mobile and real-money gaming, social gaming companies will soon refocus attention on their great fundamentals.

Investing based on domain knowledge and personal fit

The number of startup pitches that a venture capitalist receives is too high to understand the idea and team behind each startup in utmost detail. Since a venture capitalist has a fixed amount of time to allocate among potential investment opportunities, it’s necessary that we prioritize our time among startups. Although each investor will have a slightly different take on the attributes which they use to decide which startups are worth understanding in greater detail, there are two initial filters which most of us rely on. These are our domain knowledge and our personal fit with the startup team.

The first filter is designed to ensure that I only look at ideas in domains where I believe I have a strong edge in understanding the idea’s future potential. For example, I will be willing to go into a lot of depth to understand the idea behind a startup which uses positive and negative incentives to promote better human behaviors. As the result of my natural inclination and years of training, I tend to think in terms of the underlying motivating factors behind our actions, and how we can generate more of the desired actions by changing these factors. I’m therefore confident that, after having gone to great lengths to understand such a startup, my evaluation of its potential will be among the most accurate in the industry.

On the other hand, it’s very unlikely that I’ll spend a lot of time trying to understand a startup producing a novel medical device. I have no medical training and no exposure to such devices beyond what I’ve experienced as a hospital patient. Since I have no edge in evaluating the future impact of new medical devices, even if I spent many days researching a medical device startup my knowledge of its potential would be very limited compared to that of experienced practitioners. As a result, the investment decision that I make would be less informed and more prone to error.

So a startup needs to be playing in a domain where I have sufficient knowledge for it to attract my attention. Assuming that this is the case, the next filter I apply is that of personal fit with the team. Since a venture capitalist’s role is primarily one of providing support, not day-to-day execution, I need to fully trust each of the core team members’ ability and motivation to run the show. Passing this filter is more difficult than it sounds because it takes several interactions to build trust but only one to break it. After this trust has been established, some startups will ask for help on a weekly basis, while others will do so once a quarter. I don’t have a preference for either approach. This is because I’ve already made the investment decision knowing that the entrepreneurs are fully responsible for the business’ success or failure. Even if I were not there, I trust that the entrepreneurs will bring the best out of the startup.

The importance of doing the right thing

I was recently speaking with a successful entrepreneur selling enterprise software. During our discussion he mentioned that he hadn’t predicted the very fast growth that his company experienced over the last year. Digging a bit deeper, it emerged that the company had a substantially different product a year ago. As a result of speaking to existing and potential customers, and getting input from their mentors, the startup then pivoted to a significantly different product. The technical requirements of creating the new product were similar to what the company was originally working on, however the new product addressed an unmet customer need. On the other hand, the company’s original product was simply one of many options that customers could choose from in a crowded space.

This startup was fortunate to discover the right product on which to focus its limited resources early in the game. Unfortunately, there are many more startups that dedicate substantial time to developing a product which fails in the marketplace. There may not be enough customer demand, there may be too many competitors offering an undifferentiated product, or the technical challenges may simply be too great to overcome. Whatever the reason, this lack of success is often possible to predict before the startup dedicates 4 employees and 6 months of work to a problem. It’s not enough to simply dive into an idea and work hard in a direction that hasn’t been premeditated. Before doing things right, startups need to make sure they’re doing the right thing. With a bit of foresight and planning, you can save thousands of employee hours, and significantly increase the chances of your startup being successful.

If you’re an entrepeneur deciding which product to prioritize right now, or you’re new to the game and are thinking about starting a business, what steps can you take to make sure that you do the right thing? A key element is to have a clear vision for how your product responds to an unmet customer need. Is there an actual problem that your product will solve differently than competition, and how can you build and market your product to maximize the value that it gives customers? Being different from competition is key here because if you do the same thing as your competitors who have a head start you’ll at best capture a part of their pie. What you want to be doing is making new pies that your customers want to try.

The best way to make a new pie is to have the right ingredients. Just like a cook will find it easier to make an apple pie if they have apples, most successful entrepreneurs already have a natural inclination or experience in the industry that they’re serving. If you’ve been selling real estate for several years, you’ll likely be better informed about the needs of real estate agents and better able to design a product which meets these needs. If you haven’t been selling real estate, you should at least enjoy browsing homes on Zillow.

Doing the right thing is an often overlooked stage of a startup’s life. With the recent emphasis on execution as the defining factor of a successful startup, it’s easy to forget that execution will only help you win if you’re executing in the right direction. You want to be swimming downstream, not upstream. By thinking about what customer need you’re meeting, how you will serve customers differently and better than competition, and how your background and abilities are aligned with what you’re trying to do, you can position the current on your side.