Andrew Chen Archives

The Silicon Valley machine is still going, for now

Here in Palo Alto, the Silicon Valley machine is still going strong – entrepreneurs are still starting companies, angels and VCs are still investing, and engineers are still coding. In the last 3 months, I’ve had half a dozen friends get their companies financed, which is great. Certainly things are more difficult, but deals are still happening, and there’s still a lot of companies growing.

But I’ll say that I’m still quote worried, because of my belief that the worst has yet to come. There is a large group of 2004-2007 self-described Web 2.0 companies which haven’t hit bottom yet, and I’d like to discuss this possibility in this post. I hope this blog will spawn off useful discussions for entrepreneurs thinking about where we are in the boom-bust cycle.

So first, some thoughts about Web 2.0 and how that category has played out:

Web 2.0 isn’t cool anymore
In the 2004-2007 era, many companies in the “Web 2.0” space received a tremendous amount of funding. You can debate what the term means, but generally I would classify them as companies having some of the following qualities:

• Consumer internet destinations (or widgets!)
• User generated content and activities
• Advertising-based revenue models
• Appealed strongly to the early adopter audience

Yet ultimately, it turned out that most of these startups didn’t work out as real businesses. The reasons hinged primarily on the difficulties of monetizing user-generated content based on ads that I’ve written about. As a result, to be a VC-backable business, you either need to be a top 50 internet property (good luck on that!) or have a well-defined monetization backend that probably wasn’t advertising.

My guess is that the # of companies describing themselves as Web 2.0 has dramatically decreased over the last year, as these business model problems have been rapidly discovered and popularized.

And yet, now the difficulty of course, is that there are dozens of Web 2.0 startups funded in the 2004-2007 timeframe that have a meaningful amount of cost, and not enough revenue. It’s these startups that I’m worried about.

Venture financings as a lagging indicator for the economy
The problem is, VC financings tend to be a lagging indicator for the economy. We haven’t seen the established startups who are trying to raise Series B or C rounds get turned down by the market. The reason is that it’s too early, and these companies failures will lag the downturn in the economy by a year or possibly more.

Lots of smart companies and entrepreneurs did a great job of getting their financings done last year before the economy really fell apart. As a result, these lucky ones have cash in the bank right now and can continue iterating on their model to hopefully figure things out. But if they haven’t figured things out and the economy is still bad, then ruh-roh, that’s no good. But we’re unlikely to see the effects of these sick companies with dysfunctional business models until later this year.

Who are these startups that might be in trouble? Let’s discuss:

Characteristics of startups in danger
I’m not going to call anyone out ;-) But I think that there are several startups out there which are now in the precarious position of either finding their model ASAP, or collapsing.

These companies might include the following characteristics:

• Started in 2004-2007, and self-described as Web 2.0 startups
• Have grown to lots of headcount, let’s say >40 people, which can burn through a $5M Series A in under a year
• Substantial traffic, let’s say >5 million uniques per month, which drives up the cost structure
• Ad-based business models, which rely on big sales teams calling up agencies (whose pockets are now reduced, if not closed)
• Low-context advertising inventory, with low CPM in sectors like communication and entertainment
• Mature internet sectors, where the upside is now established, and acquirers are less likely to pay up as a result
• Not a leader in their category, where they may be #5 or higher, and investors may be unlikely to keep supporting their growth
• Media content hosting, where they allow users to upload, host, and stream content without charging a dime, which also drives down the cost structure

I will leave it as an exercise to the reader to pick out companies that might fit the bill.

The point is, I think this cycle is going to get a lot worse, and a downslide will likely be caused by one or a number of 2004-2007 vintage classically Web 2.0 companies hitting the skids. I am hoping that the slope down will be gentle.

Want more?
If you liked this post, please subscribe or follow me on Twitter.

I wanted to pass this along – I will be moderating a panel at the conference, agenda and conference details below.

Click here for a 10% off of registration for readers of this blog.

More detail:

Conference description

Flash Gaming Summit is a one day conference dedicated to fostering the growth and success of the Flash games community. The conference will bring together leaders in the Flash game space to share industry insights and strategies for monetization, distribution and successful game development. The Mochis, an Flash games award show, will take place at the conference to recognize the best games of 2008.  Flash Gaming Summit sponsors include Adobe, Kongregate and Nonoba and is organized by Mochi Media.

Agenda

Time	Session
8:45	Doors Open – Registration & Breakfast
9:45	Opening Keynote
10:00	Session 1 – Designing and Building Successful Multiplayer Games    Flash game developers are increasingly building more immersive and engaging multiplayer experiences for their users. What makes a multiplayer game successful? Our panel will share their experiences and best practices on designing successful multiplayer games that engage gamers and keep them coming back. Moderator: Ranah Edelin, Raptr Chris Benjaminsen, Nonoba Daniel James, Three Rings Jim Greer, Kongregate Paul Preece, Casual Collective
11:00	Session 2 – Getting Eyeballs – Marketing and Distributing Flash Games    How important is it (or not) to get distributed on game portals? Where are the game plays coming from? Hear from a panel of portals and game developers on the best strategies and tactics to market, distribute and publicize your game to reach gamers. Moderator: Jeremy Liew, Lightspeed Venture Partners Chris Hughes, FlashGameLicense.com John Cooney, Armor Games Richard Fields, MindJolt Games Matt Spall, Gimme5games
12:00	Lunch
1:30	Session 3 – The Future of Flash    Hear from Adobe about the latest developments in Flash 10, CS4, AIR, Flex, Catalyst and more. Adobe Evangelist Ryan Stewart will discuss and answer questions about how these improvements will impact the game development community. Ryan Stewart, Adobe
2:30	Session 4 – Monetization and Business Models for Flash Games    There are multiple models emerging in the industry for monetizing games. How should developers choose which business models to pursue? Our expert panel will share their experiences and thoughts on various business models and their potential. Moderator: Andrew Chen, Futuristic Play Adam Caplan, Super Rewards Kate Connally, AddictingGames Jameson Hsu, Mochi Media Kenny Rosenblatt, Arkadium Games
3:30	The Mochis Flash Game Awards    Recognize the best Flash games of 2008 with The Mochis Award Show!
4:30	Session 5 – What Makes a Flash Game a Hit?    Game developers share insights on how to design and build hit, popular games that appeal to a mass audience. Panelists will discuss topics including game design, game testing/tuning, the effectiveness of creating sequels, and success metrics on succeeding in games. Moderator: Brian Robbins, Fuel Industries Edmund McMillen, creator of Coil (IGF Finalist) Joel Breton, AddictingGames Sean Cooper, SeanTCooper.com Stephen Harris, Ninja Kiwi
5:30 – 6:00	Session 6 – Social Game Design 101: How To Make Flash Games That Social Networkers Want to Play    What are the key elements to designing successful Flash games for reaching gamers on social networks? This talk includes a deep dive into game design and viral mechanisms that you must use to succeed on social networks such as Facebook and MySpace. Bret Terrill, Zynga Games
6:00	Join us for drinks at the Official Flash Gaming Summit After Party: License to Play

 

The Snowball by Alice Schroeder

I <3 Warren Buffett
One of the recent books I read during my blogging vacation was The Snowball, a comprehensive biography of Warren Buffett. I’ve always enjoyed reading the shareholder letters, and have read other books about him, but at nearly 1,000 pages, this book is particularly detailed and goes into a lot of unique stories.

In many ways, Buffett’s world is diametrically opposed to the startup world. He specializes in boring industries, doesn’t worry much about products, and has extremely long timeframes. Yet I took a lot out of reading about his experiences, and thought I’d share some thoughts about the startup world:

1. Enduring businesses take a long time to build
2. Who cares what other people think? Boring businesses can win big 
3. Access to money can be a huge competitive advantage
4. Success begets success

Let’s talk through a couple of these ideas:

1. Enduring businesses take a long time to build
I live in the heart of Silicon Valley, in Palo Alto, and there is an inescapable pull of “get rich quick” in the culture here. Every time there is a new trend, I quickly get calls and emails from people telling me about a new “gold rush” forming, and how I don’t want to miss out. In many ways, getting visibility on these trends is why I’m here, yet at the same time, it demonstrates a real breakdown in the business culture of Silicon Valley to be focused on quick flips.

Right now, the current “gold rush” trend is probably around mobile and social gaming, particularly the amount of revenue that small developer teams are generating on Mob Wars clones. Or iPhone apps. And before that, there was a huge gold rush around Facebook apps, and before that, Web 2.0 anything. The real pinnacle of this is an exit like YouTube, which generated over a billion dollars before it became profitable, and in less than 2 years.

Yet at the same time that this froth exists, there’s an undeniable fact that enduring, profitable, standalone businesses have still taken 5-8 years to build. Yes, it’s very cheap to get started and run some experiments, but to scale into a huge business, it takes real time and capital. Take a look at Facebook, for example, which clearly still has many years on it before it cracks the code on its business model and scales into something huge. Even Google took from 1996/7 to 2004 to get big – can you really do it faster?

I think the Warren Buffett view of the world is in a decade-or-more type timeframes, not in months. It’d probably be worthwhile for everyone to think about their startups and their eventual businesses that way, rather than just trying to get rich as soon as possible.

2. Who cares what other people think? Boring businesses can win big 
The other striking thing about the Buffett model of investing is that he puts money into a ton of companies which ultimately sell pretty boring things – bricks, chocolates, jewelry, etc. These are evergreen industries that will be around 5 years from now or 50 years from now.

From my personal observation, the startup world doesn’t think like this, and the focus is on the hot new thing. There’s always a lot of excitement about technologies or products, regardless of whether or not they address mainstream consumer needs, and thus a lot of market risk gets injected into every company. From the last couple years, trends like podcasting or RSS or P2P/BitTorrent got white hot, but ultimately didn’t go anywhere. Right now these hot trends might be new platforms (like mobile, SNs, etc.) or data portability, or status messages, or lots of other candidates. Maybe these will all go somewhere, but maybe they won’t.

And woe to the startup which is not working on a sexy problem, but instead working on something boring ;-)

I think there’s a lot of great opportunities in consumer internet that are now considered boring or forgotten. For example, doing things like domaining, ad arbitrage, forum sites, SEO sites, etc. Or similarly, there are now a number of proven consumer interactions, like video sites and toolbar companies, which are not likely to ever get funded now. All of these boring sectors, given the right twist or the right team, might actually lead to big successes, since a significant portion of the model has been proven out, but not as many smart people are working on them. Certainly you won’t have Techcrunch and the geek press banging on your door, but for some, that’s part of the appeal.

Instead of asking “what are the hot areas right now??” instead, the question to ask might be, “what are the overlooked areas right now?” 

3. Access to money can be a huge competitive advantage
One of big competitive advantages of Warren Buffett’s investment model is that he discovered that he could take money out of his cash-rich businesses, particularly in the insurance world, and then use that to invest in more cash-rich companies. This allows him to have a lot more flexibility in reacting to the market, and only jump in when he thinks companies are cheap. (Interestingly enough, the first chapter of the book starts out with everyone writing him off in the late 90s for not investing in tech companies, saying that he’s lost his touch, etc.)

For startups, my interpretation is pretty simple – ultimately, startups get money via two methods:

• Customers give them money
• Or, investors/bankers/VCs give them money

And these two methods are constantly in flux, depending on whether it’s more fashionable to sell stories to investors or whether the focus is more on revenue. And especially right now, the latter holds true. Having access to this capital is huge, for obvious reasons – there’s been a ton of discussion about why it’s a great time to start a company, because it’s easier to hire, office space is cheaper, etc. so I won’t go and repeat all of this.

The important part, I think, is to gear your company into to maximize for bringing cash into the door – you need to make sure that you’re either in a super hot space where investors are willing to throw money at you, and ideally also you’re making a ton of money. Oftentimes it seems like companies end up going either in one direction or the other – either they are going big, growing traffic, and raising money at crazy valuations, or they are boring and make money slowly but surely ;-) Not sure why it seems so mutually exclusive, but either way, have a strategy ;-)

4. Success begets success
Last thought on something that occurred to me while reading The Snowball – in the early years, you could really see that Warren Buffett succeeded just by pure skill alone. He invested in undervalued companies, and made money on them over time. But as his fame grew, it also became clear that there was a secondary impact from him investing – not only did his capital help, but the brand of Warren Buffett investing was enough to drive up the value of his shares. Pretty nice.

In the Silicon Valley startup world, I think it’s unavoidable that many of the successes here also hinge on luck as much as skill. But there’s also some secondary effects of having the right people involved, whether it’s founders or investors or other – you end up seeing that the social proof of having successful people involved has a self-perpetuating angle to it. Success begets success.

No wonder that the best venture capital firms experience serial persistence – the best ones stay at the top, year after year, even though this is typically not the pattern in other investment categories. As an entrepreneur, this tells me that it’s important to get the best people involved with your company, at all levels of the business, from investors to employees – and the more you are kicking ass, the easier it gets.

Your thoughts?
If you guys have thoughts on the above and/or on Warren Buffet or the book, please leave me a comment! Thanks. 

Want more?
If you liked this post, please subscribe or follow me on Twitter. 

Blogging vacation was fun
After a good couple months not blogging, I’m going to try to get back in the groove of things ;-) It’ll be hard since the format of writing long essays tends to suck up a lot of time, but I’m going to try to get back to writing something substantive 1-2 times a week. Ideas and suggestions for topics are welcome! Please comments or write me an email

Twitter was a “good enough” replacement for blogging
Of course, even while I was off on blogging vacation, I was still tweeting away on links and other short comments. It was a great way to still publish content but without the constraints of doing something serious in the long-form blog format. If you haven’t followed me on Twitter, please click here to do so! And be sure to email me at voodoo [at] gmail and let me know what you’re working on these days.

Twitter links (lots of them)
I haven’t posted a link dump from Twitter lately, so I’ll do that now. Enjoy!

If you want to stay current, follow me at Twitter here.

• For Obama Girls, There Is No Avoiding Chores http://tinyurl.com/bnbjsx 
• Oscar Halo: Academy Awards and the Matthew Effect http://tinyurl.com/aw7m3z 
• Founder Dilution – How Much Is “Normal”? http://tinyurl.com/basumn 
• Work in small batches http://tinyurl.com/aoflly
• one of my favorite new blogs – TV by the numbers. Lots of data and analysis for old school teevee: http://tvbythenumbers.com
• Japan: No Longer a Miracle http://tinyurl.com/bqplts 
• Allocating Harvard’s Resources http://tinyurl.com/dlbc5e 
• Actively Avoid Insights: 4 Useful KPI Measurement Techniques http://tinyurl.com/cq44bj 
• Jeff Dean keynote at WSDM 2009 http://tinyurl.com/awxbf8 
• Google May Dump MySpace Search Deal http://tinyurl.com/cqv9r3 
• Washington Post profile of 4chan’s moot http://tinyurl.com/aq9qzj 
• Research shows MMOG players mostly play with ppl they know: http://bit.ly/U8gm 
• Lively Languished With 10k Users In Week Before Cancellation http://tinyurl.com/bx3n7x 
• Stop Looking for a WoW Killer http://tinyurl.com/a9p9sr 
• NYT says, don’t blow your nose when you have a cold: http://tinyurl.com/asjrhf 
• michael lewis on stats-driven approaches to basketball: http://tinyurl.com/cagke4 
• Why eBay Should Consider Breaking Itself Up http://tinyurl.com/bepvha 
• The Death Of “Web 2.0″ http://tinyurl.com/cm5vgm
• MySpace Ad Revenues Closing In On AOL’s http://tinyurl.com/cjch88 
• How To Break Up In 64 Easy Steps http://tinyurl.com/czn29c 
• Slate.com on graphs and discussion for Facebook’s 25 random things: http://tinyurl.com/bqz3qx 
• pew internet report on twitter and status updating: http://tinyurl.com/cmlvjb 
• has facebook reached saturation in specific markets? lots of numbers: http://tinyurl.com/ba3y4n 
• rock it out to music composed only of sounds from windows XP and 98: http://tinyurl.com/2m9fwb 
• From wikipedia: A group of crows is called a “murder” http://en.wikipedia.org/wiki/Crow
• another guilty pleasure blog to read… dating a banker anonymous: http://dabagirls.wordpress.com
• kittens riding a roombah! http://tinyurl.com/56v872 
• amazing visualization of openings of Target over the last 50+ years: http://projects.flowingdata.com/target
• pretty great. And totally random. Hamburger bed!! http://tinyurl.com/ckuvkj 
• more on freemium from eric ries of kleiner perkins/IMVU: http://tinyurl.com/aennvv 
• going from freemium to ‘mium: http://tinyurl.com/c4hw5z 
• all good things must come to an end, even search marketing growth: http://bit.ly/5oJs 

This was so good I had to repost it (via pinchmedia).

Here’s some of the great graphs included in the presentation:

• Downloads per unit time versus price
• # of downloads needed to hit Top 25 and Top 100 list
• Retention curves for free apps
• Retention curves for paid apps
• Retention curves per app category
• Engagement for free vs paid and by category
• Advertising revenue tradeoffs for free versus paid
• Cumulative application runs since first use, by decile

Slides below: