As you all know, part of a VC’s job is to promote their portfolio companies. And yes, even though Expertcity is no longer a portfolio company since it was bought by Citrix, I would like all of you to know about the new collaboration service that the company is launching, GoToMeeting, which will be FREE until July. At the end of the day, I love the service and product and that is why I thought you would like to try it out. Yes, it will be in a field competing with the likes of WebEx and Placeware. However, the company’s design philosophy since I invested in them 5 years ago is the KISS (Keep It Simple Stupid) method. This means simplicity in terms of usage and pricing. The service is designed to take advantage of the ad-hoc collaboration where an IM or email turns into a working session. Here is an article talking more about the service.
Insights from a recent CIO meeting
This month seems to be my month for CIO meetings. Part of a VC’s job besides helping management with strategy and hiring people is to help with customer introductions and strategic partnerships. In this tough market, my partners and I have been doing our best to help along these fronts. While being in New York can be a disadvantage in terms of finding new companies and hiring great industry people, it is great for our access to customers and the Fortune 500. In New York, we can keep a close ear to the ground and learn about spending priorities and other short and long term problems that CIOs need to solve. This is yet another data point we can use to help us place our bets. I met with another CIO yesterday in the financial services market and thought you would be interested in hearing a few tidbits from the meeting.
1. IT Budgets are loosening up across the board for capital expenditures and people-lots to do, he is looking to hire people for the first time in a couple years, although he does not want to hire too many people if the market collapses in 6 months.
2. IT Priorities-one of the big areas of new spending will be for technology that supports revenue creation instead of cost cutting. For example, this includes making sure that the trading systems can keep pumping out transactions-there is alot more volume today with the market coming back and they have not upgraded their systems in a couple of years when they either overbought or were oversold too much technology. In addtion, his firm wants to upgrade existing applications (many run in old perl scripts and mainframes) and put them on a new application infrastructure like J2EE. Other high priority categories include business continuity/disaster recovery and security, which is not a surprise.
There was nothing earth shattering about this meeting except it does confirm my belief that spending is increasing and that CIOs are starting to look at expenditures that will help generate revenue for the first time in awhile. In addition, it seems that given his priorities, larger IT vendors like Dell, EMC, BEA, and Sun would benefit from his increased spend. As usual I spent some time pitching my companies and the first question he asked after each pitch was, “What other financial service customers do you have?” This is not unlike any other meeting with a CIO and just reminds me how hard it is for a startup to get its first, high-profile, referenceable customer as no one wants to be a guinea pig. Secondly, it shows how important it is to find the early adopters in a particular vertical and make them referenceable so their peers can follow. CIOs spend alot of time these days managing risk not taking on risk.
The increased cost of offshore development in India
In our weekly partner’s meeting yesterday, we ended up in a discussion about the progression of offshore development in a variety of portfolio companies. In the end, the companies that were doing the best job with development were the ones that had their own operations offshore. While a couple of our companies chose to use consulting partners to begin with due to lower upfront costs and better time to market, we found that over time (the last 2 years) that employee churn is becoming a huge problem in these consulting companies and making us less productive in the long run. For example, one portfolio company had 5 consultants from India trained for 3 months on the product. 6 months later only 2 are left. On the other hand, our companies that have their own people on the ground are better able to manage their teams and motivate offshore employees through competitive compensation and a career path. So while we are increasingly going to make sure we create our own teams in India versus use consultants, we will still not be immune to churn and the competitive nature of the economy.
The great aspect of doing business in India is that you have lots of talent. The problem is that offshore development has become so popular that the cost of doing business has increased since wages have been bid up and since employees have many job options. In the past year, SAP and Oracle and a number of other large companies have opened up offices in India or made larger commitments to developing products offshore. What does that mean for us in the future? While it is not as cost effective to do development in India today versus 2-3 years ago due to supply and demand factors, I still believe that having an offshore strategy is important as our portfolio companies still can do alot more with less. However, in the long run, given the competitiveness and cost increase of doing business in India, I am sure that many companies will increasingly look to other locales with strong talent and less competition like Belarus, Romania, Argentina, Russia, and China. I am already seeing that happen.
What needs to be done to make us more secure
I was in a meeting with an executive at a large financial services company today discussing some of his technology problems and how my portfolio companies could address them. One of the big issues he mentioned was spam and stopping worms. Even though his company has spent real dollars in those areas, they are still problems which need to be solved. As Sasser and other worms and blended threats spread rapidly around the Internet, it got me thinking about what needs to be done to make us more secure. Techdirt has a great piece about taking a hyrbid strategy to stopping these threats, an approach I agree with wholeheartedly. I have always been a fan of a defense in depth strategy where you have security devices at the network level and down to the desktop. Have you seen Cisco’s recent advertising campaign about self-defending networks? While it is a broad-based strategy which you can read more about on their site, one aspect I like about the NAC initiative is that it does not allow anyone to access a network wirelessly or wired before a scan is done to make sure the device is virus and worm free and up-to-date with its patches and antivirus software. They currently have an enterprise focus, but the logic behind the initiative makes a ton of sense. Recently, Earthlink launched a deal with Symantec where consumers could get antivirus and firewall software from Symantec on their monthly bill. While I like the direction Earthlink is taking, I think all ISPs should take this a step further and replicate the Cisco NAC initiative where no user can log on to a network until their system is scanned and updated with the latest patch and antivirus software. Charge consumers an extra $1 a month but make it a prerequisite to get on the Internet. On top of that ISPs are and should continue to apply a number of different security devices on the edge of the network to prevent attacks from reaching end users. Vendors sellling home networking equipment like Linksys and D-Link should figure out how to embed and price antivirus and antispam software in their boxes as well. For the most part this will only stop the vulnerabilities and attacks that we know about, but the reality is that many of these attacks take advantage of known vulnerabilities. Helping the naive consumer in a proactive way will help us take one big giant step in making the Internet a more secure place.
Transitioning from a service business to a product-driven company
It has been awhile since my last post as I have been busy with board meetings. In addition, I met a number of interesting companies, a couple of which were service businesses in the process of transitioning their models to become product-driven software companies. It is a familiar formula to many out there. More often than not, the principals of a service business may have developed expertise and a network in a particular industry, developed a solution for a customer, and decided that they could resell it multiple times turning their business from a service one to a more scalable product-driven company. This makes a ton of sense as the entrepreneur gets to understand a particular market and pain point for customers. In addition, the early stage business gets the customer to pay for its initial product development. Having met with a couple of these types of companies this week, it reminds me to issue a few cautionary warnings for entrepreneurs:
1. Just because one customer wants it does not mean you have a big market opportunity-do your homework to make sure the customer’s pain is not unique and that this is not a custom development job
2. Have one version of your product, not one for each customer-I have seen a number of companies that claim they are a product-driven business with 5 customers when in reality they are still a service shop because their customers all have different versions of a product.
There is one company that my team met with a couple of years ago that had a marquee list of customers, all of whom had license deals greater than $300k. However when we did customer reference checks and deeper due dligence on the technology, we learned that all of the customers had different versions of the product. We ultimately passed on the deal as it was quite evident that the business had not made the full transition to a product company. I recently caught up with the former VP Engineering who was looking for a new job. In discussing why the company failed, this is what he basically had to say. While the company had great customers, the support costs associated with supporting 3 different versions of a product killed them. He had to spend too much of his team’s team fixing problems for the installed base rather than devote most of his resources developing the next generation product. Consequently, their product suffered and did not meet the demands of the wider market.
While turning yourself from a service company to a software business may be a good idea, be extremely careful about the customers you sign and remember to make sure that you really have one product not multiple, custom platforms because that can kill you in the long run.
Has the individual investor learned a lesson?
There have been a number of IPO fillings recently, but the one that intrigues me most is the filing by Lindows. As many of you have read, Lindows/Linspire just filed an S-1 to raise $57 million in an IPO. WR Hambrecht is the lead underwriter and will utilize its dutch auction methodology to raise money from individual investors. In my mind, what happens with Lindows will be a barometer of the psyche of the individual investor. It well tell us whether or not the individual investor learned a lesson from the bubble. It will tell us whether or not speculation will run rampant again. As you know, I do find Linux on the desktop intriguing. That does not mean that I believe this is the year and that you should go public now on $2.1 million of revenue in 2003 with a net loss of $4.1 million. On top of that, of the $57 million they are raising, $10 million is going to pay off Michael Robertson, the CEO, for a line of credit he extended the company over the past couple of years. As per the filing,
The approximately $10,400,000 of net proceeds that we intend to use to repay outstanding debt obligations will be paid to Michael L. Robertson, our founder, Chairman and Chief Executive Officer, as payment in full of all remaining outstanding amounts under a revolving line of credit. Mr. Robertson has advanced us funds under the line of credit since July 2002, including advances of $5,600,000 during 2004. Amounts borrowed under this loan are used for our operating expenses. The loan bears interest at the rate of 10% simple interest per year and matures on June 30, 2005.
So not only is this a speculative offering, but also one where the largest shareholder gets paid back $10 million off the top. Michael did pay $4.5 million for the shares that he currently owns but 2/3 of his total capital will be off the table. So how much skin in the game will Michael really have to make this company work? Does this sound like a good investment to you? I am not opposed to the dutch auction and do believe that the methodology has a place in some deals. My big fear is that if this deal does happen, it will only confirm my belief that the individual investor never learned a lesson from the bubble. For the individual investor to forget so quickly about all of the pain and suffering we just went through really scares me.
Founder transition
There are a number of good posts about founder transition in light of the recent changes at Friendster and Plaxo. If you are an entrepreneur, I suggest reading Ross Mayfield’s words of wisdom on this topic. What makes it so interesting is that Ross is a founder, was replaced at a prior company, and is back again as CEO of another company, Socialtext. As Ross says,
Not a day goes by where I don’t brace myself for this change. As a CEO and Founder of an early stage company, I know new stages will come. I constantly question myself if I’m the best person for the job, because the company is more than just me. Its a source of livelihood, investor return and customer bliss — all of which improve over time. I am really darn good at this stage of the company and have proven it in the past. I hope to test my capabilities at latter stages, but also recognize that the day may come where regardless of my ability to lead, manage and deliver — environmental forces may call for the new.
As a VC, we always like to have an open and honest discussion pre-investment about what the entrepreneur expects from us, and what we expect from the founding team. When discussing the idea of transition and building the right team, we learn alot about the founders and what drives them. This does not necessarily mean we will replace the founder with a new CEO, but it is a great way to understand what motivates the founder and how committed they are to creating a successful company, not a one-man show. Some simply want to be CEO come hell or high water-we take a pass on those opportunities. Some tell us what we want to hear, but their body language tells us otherwise-they tense up and there is no positive feeling behind their words. Others like Ross tell us what we want to hear and internalize it. They know the drill and want to be given the opportunity to run the show and prove that they can do the job but at the same time understand that change may happen. These are the founders in which we like to invest.
What aisle/what shelf?
I met with an entrepreneur this week who had a fantastic background and great technology. However, it was a technology in search of a problem to solve. Why? Because he could not readily answer some fundamental questions like what problem are you solving, who is the buyer of the product, and what is the amount of pain the buyer has without your product or solution. This is a problem that I see time and time again. Additionally, many entrepreneurs cannot answer the question, “what aisle, what shelf?” When you go to a supermarket you know that you go to the condiment section to find ketchup, mustard or BBQ sauce. On those shelves, you will find different types of condiments and different brands organized in a way that makes sense. While on any given visit you may see new products on those shelves, they are still condiments. Similarly, your sales prospects need to know where your product fits to determine where you come out of the budget and who is responsible for evaluating new solutions. If you try to create a brand new market category that no one understands simply that will not work. Similarly you do not want to sound like everyone else.
Going back to our earlier analogy, while you want to find a large enough aisle to put yourself into, the struggle is expressing your uniqueness in the 30 second elevator pitch. You do not want to be a “me-too” product lumped in with 30 other companies. If not done correctly, you could end up being thrown into the general data integration, security, or performance management pile. 2 approaches I have seen include defining your own category (aisle) or your own sub-category (shelf). Doing the former is riskier and more expensive (defining a new market is not cheap), while offering the opportunity for outsized returns. More often than not, entrepreneurs with great technology feel like they have to create a distinct new category, and many times they end up creating a market that no one understands or cares about and one in which their dollars come out of the experimental IT budget-not a large bucket or great place to be. It takes time for a new category to become a budget line item. In my opinion, creating a subcategory is easier, gives a company the opportunity to express its uniqueness, allows the sales prospect to understand generally where your product fits in the budget, and still does not prevent you from creating your own category (aisle) in the future. While this may all sound very basic, I would not go pitch a customer or VC without having this nailed down.
Great business model
OK, so times have been tough in the IT market over the last couple of years. Luckily, it is starting to get better. For those of you who understand that selling IT software to enterprises is not easy, I thought you would enjoy this email from one of my portfolio companies regarding differentiation and “secret sauce.”
As X and I have been trekking around Sand Hill Road, and everywhere else venture funds are located, we’ve really paid attention to the issues of differentiation and “secret sauce”. As such, we’ve decided that our company needs a dramatic shift and we have found the answer. We worked on the plan at San Jose airport last night, watching the behavior of customers for this exciting new product. It was reconfirmed this morning as I left Starbucks.
Our company is going to get out of software and information technology completely. No, we are not mad, well, we may be, but that has nothing to do with this discussion. We are going to take the most plentiful resource on the planet, put it in handy plastic bottles and sell it for about $4 per bottle in airports and other convenient locations; but if you choose to buy it from your local grocery store by the case, it will only cost and $4 for a case of either 12 or 24 bottles – purely based on random decision making. This market has been validated by at least 50 other companies, who reap millions of dollars of profit from this market place each month. Our “secret sauce” will be the label – yes, it will be our company name and logo that will differentiate our product from Evian, Vasa, Fiji, San Pelegrino and those many other indistinct brands.
We look for your support at the next board meeting to make this dramatic shift in our company’s strategy!
Please scroll down for some final thoughts!
Can you imagine presenting the idea of bottled water to VC? We of course thought about it after X and I bought two frozen yogurts and 2 bottles of water for $12! Not only wouldn’t we consider drinking airport tap water, we bought bottled water with a name, Vasa, that would make one think it came from Germany – why would I buy water from Germany? I totally cracked up leaving Starbucks (there’s another one!) with my $3.60 non-refillable cup of coffee as I saw a case of water for $3.99 outside a grocery store!
Have a nice weekend everyone!
Linux on the desktop (Continued)
I have written about linux on the desktop in the past (here and here). Today, my partners and I installed the latest version of Xandros 2.0, and I have to admit we were blown away. It installed in about 10-15 minutes with a couple clicks of the mouse, and we had a full working version of a linux desktop which looked and felt like a Windows machine. It partitioned our hard drive so Windows and Linux could run on the same machine (if you really want it to) and allowed the Linux desktop to seamlessly interoperate with my Windows network. The file manager was just like Windows Explorer, and I could easily find, use, and set permissions on my old files. If you have not tried it yet, I encourage you to go to Xandros to buy a copy of the deluxe version ($89). The great news is that we were able to take an old laptop with a P133mhz chip and substantially improve the performance of the machine, extending its useful life. I am definitely going to install this on one of my old laptops at home. What is even more interesting is that with an integrated version of Codeweaver’s Crossover office, you can run many windows-based application seamlessly on your Linux desktop. Unfortunately iTunes does not work yet. Go to the site if you want to learn more about what other applications work. So the Linux desktop is here and much improved, and what is important is that it interoperates with Windows from a networking and management perspective, all very necessary when any enterprise looks at TCO (total cost of ownership). While I do not anticipate huge enterprise adoption this year, I definitely see less barriers to its adoption in the years to come.