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Explaining the Snapchat valuation

19 Nov

There was a lot of buzz this past week about reports that Snapchat turned down a $3b all-cash offer from Facebook and a subsequent $4b counter-offer from Google.  It’s admittedly an extremely rich valuation for a young company with no revenue.  But I think there’s some nuance to note:

  • I think the investor psychology and math here is important.  VCs are more worried about missing out on the next Facebook/Twitter/Workday/etc. than they are in investing in the next MySpace/Bebo/etc.  For say a $500m fund, the cost of not being in one of the 2-3 huge outcomes that drive investor $ returns every year is higher than the cost of writing a say $30m investment to $0.  Investors, moreover, are probably more keenly aware than ever of the power law dynamics at play in tech investing (see here and here)
  • There’s been some handwringing over how Snapchat will monetize.  I wouldn’t be so worried about this.  Consumer internet companies don’t fail because they can’t monetize.  It seems unlikely that you’re going to have a highly engaged audience of hundreds of millions of users and not enough opportunities to make money.  Consumer internet companies are adept at finding ways to monetize with ads and advertisers are keen to experiment with new potential ROI.  The common early refrain on Facebook, Twitter, Instagram, etc. was that “they didn’t make enough money.”  That, of course, turned out not to be true.  There is a risk though that it doesn’t monetize as well or as quickly as its current backers hope (see Tumblr as an example).
  • Part of the challenge for Snapchat is that it’s grown its user base so quickly so fast.  The company is less than three years old and the rocket ship took off less than 18 months ago.  It hasn’t had an opportunity to explore monetization.
  • The concern of Snapchat’s team and investors should be around the product and making sure its audience stays engaged.  It’s captured the teen and 20-something audience, which is also probably the most fickle set of users.  I think the concern is whether these users move on to some other app over time.  But I think it’s reasonable to bet otherwise as the network effects in a business like this are incredibly powerful.
  • There have been some rumors that Snapchat is going to be raising another large round of funding, much of it going into secondary purchases of founder shares.  I’d be a bit concerned about this.  The founders already took $10m each off the table in the last round.  If the rationale for pre-exit founder liquidity is to give founders the ability to go for big wins, I’m not sure how another large secondary cash out makes sense, especially given that the company isn’t monetizing.  It’s one thing to sell down your stake as a founder when you’re a later stage, EBITDA-generating company.  But I don’t see how it aligns investor, founder, and employee interests at this stage.

How Do You Make SaaS Defensible?

4 Oct

I’ve been thinking about SaaS and what makes it defensible.  SaaS is an extremely broad term.  Evernote, Linkedin’s recruiter product is SaaS, Basecamp, Salesforce, etc. are all SaaS and are all very different.  But I think many of these products share a common challenge.  If someone comes up with a new SaaS product and it starts to gain market traction, these products can be and often are copied.

Let’s look at the HR software market as one example.  HR and the associated “Human Capital Management” software space is a massive segment with billions of dollars of annual spend by companies large and small.  Any company small to large in size has some potential need for HR software.  Inside the HR software suite, there are lots and lots of different types of products.  Applicant tracking software for recruiting.  Performance review and tracking software.  Time sheet management.  Org design tools.  Benefits administration software.  Employee on boarding and off boarding software.  Etc etc.

Many times these components are bundled together into a single suite of SaaS products, which is what you find from the bigger players like Taleo (now part of Oracle), SuccessFactors (now part of SAP), SilkRoad, Workday, and others.  Other times they are separate point solutions.  For instance, there are literally dozens of providers of point solutions for Applicant Tracking (ATS).  Why?  Because it’s fairly easy for even a single good developer to copy the design and functionality of existing ATS products in order to put together their own serviceable SaaS offering.

The result may not be as feature rich or stable as more established products, but can be enough to gain some market share, albeit often small.  When you have a large enough market, there’s enough spend to support several large players offering  variations on essentially the same SaaS product.  And that same large market can support a very long tail of smaller copycats.  The latter may not be large, VC-supportable growth companies, but they can be very nice, profitable enterprises for their owners.

Another example of this is in the customer service management software space.  Zendesk created a “next gen” SaaS product for customer service agents to better manage customer service tickets through multiple channels (email, phone, social media, etc.) from anywhere.  Freshdesk, an India-based company, started in 2010.  While I’m not a user and I haven’t looked at either company in detail, best as I can tell there is limited differentiation between the two companies.  And there is a whole host of smaller companies with similar general product offerings.  Google it.

Like the HR and ATS examples above, the customer service management space is very large.  It can support more than one large player and long-tail of smaller providers who compete with the bigger guys through cheaper pricing, a specific vertical focus, or simply taking a tiny bit of market share in a very large market.  Often times it’s the latter and customers and some portion of customers just don’t know better that there’s a potentially better, more established product out there.

I could go through other examples with similar characteristics.  CRM, accounting software, social media management for marketers, email marketing, you name it.

An important point to make here is that these typically aren’t winner-take-all situations.  These usually aren’t marketplace businesses where there’s a network effect where increase scale creates a bigger and bigger moat around your business until the point where it makes no sense for either side of the marketplace to use any service but yours.  So how do you differentiate yourself?

A few ideas:

  1. Scale allows you to invest in a better product, and there’s not better business advantage than a better product.  I think the real benefit to scale is the ability to create a better product.  When you have more dollars to invest and you can attract better tech talent, you can build a better product.  More stability, more core features, more integrations, etc.  The more this happens, the harder it is for someone to simply copy what you’re doing.  It’s also hard to engineer for scale, so being able to create an awesome, reliable product that works at scale (think Evernote, Dropbox, etc.) is an advantage in and of itself.
  2. Try to create platforms, which in turn generate network effects.  Salesforce’s Force.com is a great example of this.  Salesforce essentially has thousands of developers doing R&D for free on their platform.  Salesforce can’t possibly think of every potential feature or customer need, and they don’t have to.  Others can experiment and do this for them.  This is very hard for competitors to replicate.
  3. Similarly, creating some type of network and then placing a SaaS service on top creates defensibility.  Linkedin is a cardinal example of this.  The core software tools Linkedin provides to recruiters aren’t anything special in and of themselves.  But they are incredibly powerful and proprietary given the network they’re built on top of.
  4. Having a unique angle and/or world class capability in Sales & Marketing is huge.  Selling to large, enterprise grade customers requires sophisticated sales teams and strategy.  Building this isn’t easy or quick, nor is it the realm of “copycats.”  Similarly, for people selling into consumers or SMBs, creating a great online marketing capability, perhaps supplemented with some inside sales, is tough.  It requires talent, full-time effort, the ability to experiment with multiple channels, etc.   If you can build this, you’ve created a big moat for yourself in terms of sales and distribution.

If you can nail 2 out of 4 of these, I think you’re on your way to building a SaaS business with a chance to occupy market share at the head of your market rather than the tail.  What other concepts would people add to this list?

The Third Wave Opportunity on Mobile

19 Aug

There’s really two sets of major players on mobile.  The first is historically desktop-focused companies where their pageviews started on the desktop and are now shifting rapidly to mobile as the share of time spent by users switches from the desktop to smartphones and tablets.  This includes services like Groupon, Google Maps, Yelp, Dropbox, Facebook, Twitter, eBay, Fab, Digg, Huffington Post, Gmail, Linkedin, Amazon, Skype, Salesforce, Kayak, TripAdvisor, and a whole host of others.  The second group is companies who started on mobile and don’t make sense without it.  Evernote, Uber, Prezi, WhatsApp, most mobile games, Roambi in the enterprise, and others are in this category.   

What’s interesting is that in terms of pure reach, the traditional desktop companies are really dominating.  The first wave of adoption of mobile apps has benefited strong desktop brands whose services make as much sense or are stronger even on mobile.   Check any smartphone n the US and you’re likely to see some mix of Facebook, Yelp, Google Maps, and Twitter apps to name a few.  Perhaps this shouldn’t be surprising since these are some of the most popular services globally.  And as mobile increases as a percentage of online time spent and as total hours spent online increases because of mobile, you’d expect these services to benefit.   

The next wave of adoption is of mobile-first services.  For some companies like Evernote and Whatsapp, the boat has already sailed in this regard.  For others, there’s huge headroom for adoption.  I’d also argue that there should be a whole slew of services built from the ground up for mobile that we haven’t seen yet.  This is the “third wave opportunity” for mobile apps.  

Gaming and Messaging have been the two killer apps on the smartphone, the former in terms of total time spent and the latter in terms of frequency.  After these, your traditional desktop services like Gmail and Facebook consume a ton of time.  And then you have your set of mobile-first services like Uber that aren’t in the Gaming or Messaging categories.  That last category is growing rapidly and should see many new players emerge.  

There are new ways of re-imagining everything we do on the Web, but for mobile.  For instance, Prezi is re-imagining how you create and view PowerPoint-like presentations on the iPad, and Roambi is reimagining Business Intelligence for mobile. 

In particular, I think there’s a whole host of enterprise applications that can be rebuilt from the ground up for smartphones and/or tablets.  CRM, corporate chat clients, time sheeting, meeting management, conference dial in, and Excel/spreadsheeting are a few examples of generalized apps that need to be rebuilt for smartphones and tablets.  

I also think there’s a whole slew of vertical-specific apps that are ripe for the taking.  Hospital management, big law firms, personal financial advising, hotel management, auto dealers, financial traders, and many other areas have a need for specialized mobile apps.  

In some cases, the incumbent, traditional desktop players will get their act together when it comes to mobile and continue to dominate.  In other areas, these players will either be too late to the opportunity or might lack the ability to, whether because of organization issues, a lack of talent, or something else.  

If I was investing in or looking to start  a company, I’d be looking for these third wave opportunities, especially in areas where the incumbents aren’t equipped to capitalize on the opportunity.  

Wall St’s too short term? Look in the mirror.

11 Aug

A friend sent me a link today to Jeff Bezos’ letter to shareholders from Amazon’s 1997 Annual Report.  It’s a great read.  Bezos lays out his long-term operating principles and basically cautions investors that Amazon will (a) focus on long-term strategy and dominance; and (b) this will mean that it will sacrifice short-term profitability.  Amazon continues to follow this strategy today as it invests heavily in long-term bets (AWS, Kindle, logistics infrastructure, etc.) and runs a low-margin business.  And investors continue to reward the company.  The stock is at an all-time high and it’s market cap is approaching that of traditional software giants like Oracle.  The latter fact is pretty astounding when you realize that Oracle had $5b of operating income quarter, whereas Amazon had <$100m.

I say all of this because one of the big debates in Silicon Valley over the last 4 years has been over the merits of going public versus staying private.  And one of the most often cited reasons for staying private is the ability to “innovate” outside the quarterly earnings pressure of public markets (other reasons are the distraction of the IPO process itself, cost of filings and ongoing SOX compliance, etc.)  In most cases, I don’t think the idea that Wall St is too short-term is a valid reason to stay private, though there may be other reasons.

wall st bull

There are two related arguments people make.  One is that the market is too focused on short-term earnings.  The other is that public companies can’t innovate because of this.  So I ask: what’s the evidence for this?  Some of the most innovative companies in tech – Google, Apple, Amazon, VMWare, eBay, Tesla, Netflix, Linkedin – are public.  These companies don’t have any trouble pursuing new initiatives, speculative ventures, interesting M&A, high R&D spend, etc. under the glare of the public market.  And every company on this list has been richly rewarded by the market.

In fact, some of these companies actively shun Wall St’s supposedly myopic focus on short-term earnings.  Amazon continues to be an incredibly low margin business and continues to invest heavily in growth and new businesses.  Similarly, Google doesn’t even provide quarterly guidance to investors.

The reality is that the public companies that face supposed Wall St “short termism” are the ones that have flawed business models.  Would Zynga and Dell (to name two troubled companies) rather be private right now?  Of course, well at least we know for sure in the latter company’s case.  It would take the heat off.  But the reason there’s heat to begin with is they’re flawed companies.  People don’t want to play expense-to-produce Zynga style social games on their desktop, and PCs are rapidly losing favor to the tablet revolution.  Public markets are very efficient at recognizing this.

If Dell and Zynga laid out a credible, long-term story to investors then I public markets could be receptive.  But they haven’t.  Dell has been trying to transform itself in to an IBM style enterprise software and services company for years.  It has spent billions of dollars in the process, which incidentally it may not have had access to as a private company.  Similarly, Zynga hasn’t laid out a credible story for where it goes from here, for example backtracking on earlier talk of exploring the online gambling market.  Zynga might even be in a worse position right now if private because they wouldn’t have access to the $1.1b of cash they currently have on their balance sheet.  Ditto all of this for other companies like RIM, which is also reportedly thinking of going private to “refocus with less scrutiny.”

Maybe the point of all of this is that a few exceptions withstanding, the best companies go public and they have no problem doing so.  They’re able to think about the long-term and invest in innovation without difficulty.

If you can’t compete effectively under the lights of the public market, don’t blame Wall St.  Look in the mirror instead.

How High Private Valuations are Contributing to the Decline in IPOs

11 Jul

I just read this piece from March written by Scott Kupor, a partner at VC firm Andreessen Horowitz.  I broadly agree with most of his argument (though I think he overstates the importance of the IPO market to strengthening the American middle class).  Taking a company public today is a bigger regulatory and financial burden than it needs to be.  The more onerous parts of Sarbanes-Oxley should be amended and reverting back to a higher minimum tick size should be changed as well.

Also, Kupor doesn’t point this out, but the pressure created by the quarterly earnings cycle is as intense as ever (see declining CEO tenure)  Simply put, with late-stage private financing opportunities abundantly available for the best companies, why should founders/management opt for the IPO route?

Companies are staying private longer in favor of a “private IPO.”  That’s to say that they’re both issuing new shares and offering secondary share sales to large institutional investors to achieve investor, founder, and early employee liquidity.  Only in these “IPOs” there is no public participation.

I think one of the more subtle factors at work here isn’t simply that companies are choosing to stay private longer through late stage financings, but also that these rounds are being done at extremely high valuations.

From a public markets perspective, the current financials of many of these companies wouldn’t support the valuation they’re getting in the private market.  I’m not going to get into whether public market investor are applying a more rigorous standard or are simply naive (i.e., they don’t get the story behind tech), though I tend to think they’re pretty rationale and that investors understand consumer web, SaaS, and other types of businesses than they have in the past.

Late-stage, private investors are clamoring to get into the “hottest” companies – EvernoteUberFab, etc. and once private companies like FacebookZynga, and Groupon.  The excess supply of capital and fear of missing out on the next homerun are driving some valuations above where they would trade if public today.    Some of these companies have to delay an IPO because they don’t have the financials to support the valuation they require to earn an appropriate return for the last round investors.

Twitter is a good example.  It’s only in the last year that its advertising efforts and revenue trajectory have really taken off.  The late stage bets being taken in 2009-10 were being taken on the site’s awesome user growth and assumption that monetization would eventually catch up.  Financials at the time wouldn’t have supported the valuations these rounds were being done at.  As the valuations being to support the valuation, the main beneficiaries will be the private investors, not the public guys.

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