Disruptions: With No Revenue, an Illusion of Value

http://bits.blogs.nytimes.com/2012/04/29/disruptions-with-no-revenue-an-illusion-of-value/

by rvcamo • 14 years ago

114 43 14 years ago

bits.blogs.nytimes.com

jarek2• 14 years ago

What was left unsaid in that article is that it's also a lot easier to get acquihired or patent-acquired or competitor-extinguish-acquired when you have no concrete commitments to any paying customers and can shut down anytime.

davidu• 14 years ago

It's worth pointing out that some business models only work at scale, which isn't a reason not to try and start those kinds of businesses.

That's one reason to not try and squeeze nickels out of a growing business when you know you'll get quarters or dollars later from greater opportunities that were previously unavailable.

Had Instagram focused on trying to be ramen-profitable early on, it's possible it would have impacted their meteoric growth and successful Android launch. Moreover, at massive scale, their revenue potential and avenues to generate revenue change dramatically compared to what they could do when small.

tomasien3• 14 years ago

I'm sorry, but this is just ridiculous. It seems to completely misunderstand the nature of "venture" capital: (potential value + progress toward that value) x risk = valuation. 40 mm users and growing for Instagram (the example du jour) WITH revenue model would have been worth 2-5 billion, but since they weren't making money, they sold for 1.

Come on NYT!

ontoillogical• 14 years ago

You're saying that if Instagram had a revenue model, each user would be worth on average between $50 and $125?

tomasien3• 14 years ago

Let's pretend they can only monetize per user what Facebook can. With only 40mm users, that'd be $100 million in revenue per year. However, their user count is continuing to explode, and could easily be 100mm in the next 18 months. At $10 per user, $1,000,000,000 revenue per year represents a market cap WELL in excess of 5 billion. No doubt.

dasil003• 14 years ago

Where'd you get that formula?

In all likelihood there is an inverse relationship between revenues and user count.

tomasien3• 14 years ago

Dealing with this stuff on a daily basis, talking to VC's and PE traders. That seems to be how they think about it.

j_baker• 14 years ago

I find it telling that the only data point given in this article is the purchase of instagram and a few other debatable acquisitions. The rest is conspiracy theories against VCs and speculation.

olefoo• 14 years ago

The opacity of the market for shares in speculative ventures is the perfect breeding ground for conspiracy theories of that sort. Remember that most of what even the interested parties knows about any given deal (even the big ones like Instagram) is hearsay. There is no standard reporting format; nor any mandatory disclosure of ownership for startups. So even people who are involved in the process do not have a clear view of what is actually going on across the broader market. Everything that even experts 'know' about the startup funding environment comes mostly from press releases which are not objective in any way. The 'startup bubble', could be entirely the result of inflated numbers and bullish hope.

nutanc• 14 years ago

A million guys walk in to a Silicon Valley bar. None of them buy anything. The bar is declared a rousing success.(Ref:http://www.quora.com/What-are-the-best-_____-walked-into-a-b...)

siavosh• 14 years ago

This made an interesting connection between two discussion threads I've noticed on HN recently: (1) is there a bubble?, and (2) why is there so little innovation in SV?

I think the article made this claim:

Innovation is risky business but hyping a social CRUD app is less so. Hence a disproportionate amount of the money and (VC manufactured) media is focusing on the latter. And these less/non-innovative companies can only match the returns of a successful innovation based business in a bubble/greater-fool environment. So both the lack of innovation and the bubble are being caused by these financial firms.

This seems plausible to me (as an outsider). I would say more that we are seeing this as a direct result of the money looking for returns post real-estate bubble burst. Smart money doesn't seem to chase bubbles, but create them.

The lack of innovation becomes simply the opportunity cost of an investment bubble.

What's unfortunate is that I bet there are 10's maybe 100's of people like Elon Musk looking to get funding for their ideas but are being over looked by these same firms.

noduerme4• 14 years ago

Before I launched my startup with no outside funding, I went looking for $250k on the basis that it did not require large scale to turn a profit, it would turn a small profit immediately, and that there was no sense in asking for more money than we could use at the beginning to acquire a few paying customers and code the next iteration.

Turns out I had it all backwards. Several investors, declining, confirmed to me that the amount I was asking for was frighteningly low. I showed breakdowns of what would go to hiring and equipment, what would go to advertising, and what was the emergency fund - ($100k) - and how we really wouldn't need more because it would start paying for itself quickly. That wasn't satisfying to them.

What I also didn't know was that turning a profit was the last thing on their minds. It took me awhile to piece that together. I have to thank HN for opening my eyes to it.

The problem with speculative investors is that they aren't producing anything of value. They aren't building the software, they aren't in the trenches trying to acquire users or running customer service.

So I launched with a couple of friends who threw in some very, very small investments of a few grand, rented the equipment I would have wanted to buy, and ran it myself. And I haven't been able to grow it nearly as fast as I would have wanted to. But y'know what? It's making a profit. I just paid a 12.4% dividend on investments for the first quarter. Average time on the site is 45 minutes. We convert 1.5% of users at an average of $75 each. And I hold 81.5% of the company.

So... are investors looking for massively overhyped, vaporous, disruptive monster-IPOs wrong? No, but it's kind of like going to the track and only betting on the longest-shot horses you can find. The whole game would cease to function if a majority of cooler heads weren't making wiser investments with better chances of pretty-good payouts, in companies that actually turn a profit. Of course, the whole game might cease to function pretty soon; things right now look an awful lot like 1998. But people with good ideas and a shoestring budget will keep finding ways to turn a profit that keeps the lights on; and for that I'm glad I didn't find an investor, and did it my way.

gdilla• 14 years ago

Wow! What is your site?

powertower• 14 years ago

According to his first submits, he's in the online gambling (and maybe porn) industries.

Hence you're not likely to get a URL here.

ScottBurson• 14 years ago

Sounds like you have an excellent lifestyle business there. Which is great for you, but wouldn't necessarily have done that much for an investor who put in $250k. (I'm sure your friends who put in a few grand each will do just fine, relative to the amount they put in.)

I don't think it's irrational on the investors' part. People with larger amounts to invest want to see a potential for larger returns. Larger returns require faster growth which requires more money up front.

I guess "lifestyle business" is a dirty word to investors, but it needn't be to the rest of us. I think we might see a lot more of them in the coming years, now that it has gotten so cheap to build and operate a Web app.

Anyway, kudos on your success. Bootstraps can be quite rewarding, as you see.

angelbob• 14 years ago

It'd be nice if smaller investors (I could probably invest up to $10k or $15k without too much pain) could reasonably be paired up with small percentages of lifestyle businesses.

But nobody is going to get rid of the friction in that market until much, much larger markets have significantly reduced friction. Whoever is de-frictioning needs to make enough money for it to be worth it. And small-to-medium investors willing to tolerate high risk combined with stable, successful businesspeople opening new small businesses has got to be a small total market.

At least, compared with startups, VCs and large tech businesses.

Still, somebody will eventually make some money by making that market work.

noduerme4• 14 years ago

Thanks, I think. Oddly, I never thought of it as a lifestyle business. The main thing it's done to my lifestyle is to prevent me from getting a good night's sleep for the last 3-4 years of coding, beta testing, launching, and finally managing it.

If that's what it is -- ok. But as I understand it, the thing that stops lifestyle businesses from scaling up is that the owner prefers having a business that works around their schedule, suits their lifestyle, and prefers to be hands-on in operation rather than delegating. To the point that it makes little sense to scale, because the person is the business, and vice versa.

So if what stops lifestyle businesses from being good investment vehicles is the founder's unwillingness to scale, then I completely understand why larger investors would shy away from them. But if an owner of one -- I mean, it could be a bakery or a doggy daycare or anything -- builds out a framework for growth, wouldn't it be logical to pick one that was trying to grow at a slow, responsible rate?

Maybe stretching it here, but why would an investor choose someone who makes great at-home pizza and wants to open 50 restaurants next year, over someone who's run a pizza place for awhile and wants to open two or three more, when the investment needed for the latter is half or a quarter that of the former on a per-restaurant basis?

Is it that VCs won't stoop for pennies? Because - I've always thought it was kinda stupid when people said they wouldn't stoop for pennies. That's money. Why would you leave it lying on the ground.

trotsky• 14 years ago

Mark to mystery is a pretty amusing term but I've never once heard it before - is it really something that gets said?

digisth• 14 years ago

This seems like a new sense of the phrase, which has appeared intermittently in the more bearish end of the financial reporting and opinion spectrum. It used to be a synonym of "mark to make-believe", which was one of the popular "methods" during the events leading up to the 2008 bust:

http://www.economonitor.com/blog/2009/09/mark-to-make-believ...

The new usage does seem quite an apt term to describe what's being discussed here (whether it's correct or not is obviously up for discussion.)

rabbitonrails• 14 years ago

Options have value in finance and in life. Instagram possessed the option to turn on advertisements inside the app, and the option to sell virtual goods, and the option to implement any number of other revenue schemes, which would have immediately generated significant free cash flow. The fact that they did not exercise any of these options does not mean that the options themselves are valueless.

georgemcbay• 14 years ago

A very significant open question, IMO, is could they have enabled any of those revenue streams without decimating their user base? I don't think they could have because their product is relatively easy to duplicate.

Given that Instagram was free, there was little incentive for anyone else who is serious about getting in front of people to bother duplicating what they had, but had they started in-app ads or anything else that would have irked users, that would have changed very quickly.

tl;dr -- Millions of users can be monetized in a number of ways, but not if your service can be duplicated fairly easily.

jarek2• 14 years ago

Well the usual catch is network effects. For instance Twitter is putting increasing amounts of ads into the feeds, but because everyone's there people will stay on for the time being despite the ad-free alternatives. I've never used Instagram so I'm not sure how strong its 'social' ties are.

kunle• 14 years ago

For something so easy to duplicate (40m users) I see frighteningly few duplications (photo services with 40m users after 18 months.).

Making a camera app that has filters is easy to duplicate. Aggregating an audience of 40m users on no advertising is not. Period.

EDIT: "on no advertising" should read "on no marketing".

DanielBMarkham• 14 years ago

I used to think that SV startups had sort of a rock-band quality to them. It's a beauty contest for the team, eyeballs are all that matters, and they are managed and treated like "talent", not businesses.

That's still mostly true, but looking at it some more, it's more of a Burger King problem.

When Burger King started out, presumably, it made a lot of money and expanded quite a bit. But what they found out (along with other fast food businesses) is that customers are fickle. Unless you mix it up now and then your customer base will slowly melt away to go to Five Guys Burgers, or some other new fast food place that everybody thinks is cool this week.

So what they and other restaurants started doing was launching these short-lived, heavily advertised changes to the menus. Miniature burgers. Mexican burgers. Burgers on a stick. Whatever. They kept a bunch of ideas on the back burner, rigorously A/B tested and used trial markets, then launched something new every now and then. There was always something new and different enough to keep folks from drifting off to the shack down the street.

Startups are now forming a somewhat similar function for these huge tech giants. A startup has some catchy idea, gains millions of addictively faithful users, then sell out to McGoogle (as an example)

Works great for everybody. Google gets new talent with a proven record of coming up with ideas that capture eyeballs, they get an instant boost in eyeballs for their services, and, better still, later on these features can be rolled into the code base. Maybe. Maybe they just buy a startup up to keep the other guy from having it. Works the same way.

I'd also note that this is at a much higher level than the "lifts" restaurants get. It's entirely possible that the next eyeball catcher has no kind of long-term value at all; but is still worth tens of billion in lift to some acquirer over a period of a decade.

So articles like this get it wrong. There's absolutely real innovation and value, but at least to me it doesn't seem like the same kind of innovation and value you get when you cure the common cold. It's more like making a cool new kind of french fry.

nextstep• 14 years ago

I don't think this theory can fully explain the large valuations of these small companies at acquisition. Couldn't the McGoogles get that same publicity and pay a price that better reflects the product they're buying, even of that product is basically advertising as you're describing?

Also, I don't think the McGoogles are having any trouble keeping users (or even attracting new ones).

randomStuff• 14 years ago

I'm not entirely sure if I agree with the author that we are in a bubble. Many of the big companies in the valley such as Google, Apple, Facebook, Amazon, etc ... are flush with cash. The fact that they are buying smaller companies for a lot of money a bubble it does not make. The share prices for Apple and Google at the moment may be very high but the share prices do represent revenue. Look at Facebooks deal with Instagram, it was $300 million cash and $700 million in options. That is a huge difference from an entirely cash deal.

ecocentrik• 14 years ago

The article completely fails to recognize the value of the acquisition of technology, the elimination of competition and any number of other factors that account for the valuation of a business.

If a successful company with massive earning potential decides to pay what seems like too much for another company with no visible revenue and it doesn't make sense to you, it's probably not a great idea to flaunt your ignorance by writing an article for a major publication.

RockyMcNuts• 14 years ago

Bilton is channeling Eduardo Saverin, who pushed for early revenue at Facebook, clashed with Zuckerberg, and got squeezed out with a mere $2 billion or so for his trouble ( http://www.forbes.com/profile/eduardo-saverin/ ).

Look at YouTube. It seems to be doing pretty well for Google now, with more intrusive pre-roll video ads and popups during videos. Google also gets strategic benefits, good placement on iPhones, a better seat at the table for its so far not very successful TV products.

If YouTube had started off with those annoying ads, would it have seen off the competition?

A lot of digital startups are in winner-take-all markets. The conventional wisdom is, push for revenue if it helps you deliver a better product, through revenue relationships that also bring content, users, and lock out competitors.

If the market doesn't value revenue, but values users and the aura of hypergrowth and the next big thing, and it can be fatal to allow space for imitators and competitors, entrepreneurs are being strategic and rational to push for growth at all costs.

It's a perfectly valid strategy to build an innovative product that may be a proverbially two-legged horse that doesn't stand on its own, seize a dominant position, and sell to one of the massively cash-generating platform companies, Google, Apple, Facebook, Amazon, Microsoft, that need to maintain their position.

Or if you're in the right place at the right time, that's how Facebook and Amazon became platform companies.

Where would Facebook be today if Zuck had pushed for revenue and organic growth, instead of charging for growth and dominance at all costs?

And that hothouse atmosphere is why the US startup ecosystem is dynamic, and beats competitors around the world flat.

viscanti• 14 years ago

There's a difference between a product and a feature. Both can be valuable, but they don't both make money directly. A product can be sold, and can lead to a profitable business. A feature can be profitable if paired with a currently successful product.

From the perspective of a potential acquirer, a feature might be a more valuable acquisition than a new product (especially one that might compete with it's current product). The problem with building a feature company rather than a product company is that your only real chance for an exit is to get acquired.

There's 2 different routes to the finish line. A product could be acquired or go public, but a feature probably can only be acquired. If a company is building a feature, it probably needs to grab as many eyeballs as possible to increase it's valuation. If a company is looking to go public, it's ability to generate profit is a much more meaningful metric.

tlogan• 14 years ago

One very smart VC once told me that it is bad that startups have profit/revenue before asking for money. Because, if you have profit/revenue they can predict your future growth, while if you are without revenue you can have wild predictions about future growth and convince investors into that.

And also if you have profit/revenue very early you are immediately marked as lifestyle business.

So the entire system is pushed toward wild and big bets without any space for relatively small things.

But I don't think this is bad ...

1527890435• 14 years ago

If you are VC who cares about revenue if investors are willing to give you millions up front? You have made your money. Game over.

The rest is just "try". This is acceptable because outcome is unpredictable and expectations are reasonably low. It's a gamble, and anyone contributing funding knows it.

If you can make money for your clients, great. If not, you are liable for nothing.

It's a good feeling for VC if they can make money for their clients. But VC still make good money either way. That is just how it is.

This is true to some extent in other professions as well. For instance, lawyers, on whom VC closely depend.

If lawyers advising startups can help their clients, it's great. But even if they don't, they still make good money.

And like with VC, clients recognise little is "guaranteed". Often they do not even know what to expect. Expectations are reasonably low.

What matters here is reputation. If someone's reputation is enough to convince others to give them money, with little expectation of "results", then that's abusiness.

There was an op-ed in the NYT a month or so ago called "The Zuckerberg Tax" written by a tax lawyer.

Read it.

Consider that the question it raises may not be how much the kid is "worth" (and his accompanying tax liability), but how much others are willing to give him, with no real expectation of return. Be they Microsoft, Russian investors, advertisers, ..., or his bank.

He no doubt has great "credit". He, through the popularity of Facebook, has a reputation. He may not be able to produce a billion dollars in cash, or even a fraction of it, but he surely can borrow it, the act of which amounts only to a change in a bank's computer database somewhere. We need not see the cash itself. People are willing to give him money. With no expectation of return.

And that my friends - "credit" - is the cause of most of America's economic problems. Spending money we don't have. And assigning large dollar values to things when it's unlikely the physical currency itself could ever be produced. "Show me the money." The real money, that I can hold in my hand. Not the funny stuff that is just the subject of talk... and op-eds.

pg• 14 years ago

I was going to ignore this article as just another piece of nonsense in the same vein, but then it occurred to me that because it's in the NYT, startup founders might actually try to base decisions on it.

So founders and would-be founders, beware. This article is full of mistakes. In particular this one:

  most venture capitalists... are not interested in 
  building viable long-term businesses

If you do the math of VC returns, they are dominated by the big successes-- the companies that go public. Those generate much higher returns than the ones that get acquired, and you can't go public without revenues in at least the tens of millions.

His list of startups that got acquired before they had significant revenues refutes rather than supports his point. It's a short list, and even so, many of the startups on it generated only modest returns for VCs.

YC knows as well as anyone what VCs want, and any founder we've funded can tell you that we tell startups the best thing they can have on Demo Day is a hyperlinear revenue graph.

amirmc• 14 years ago

> "... a hyperlinear revenue graph"

Everything else makes sense but you lost me here. Even googling the term brings me back to this page.

I assume you mean a revenue curve that 'goes up and to the right' (since that appears to be the simplest explanation) but if it means something else, or something more specific, please do clarify.

brlewis• 14 years ago

Simplest explanation is "hyper"=above/beyond and "linear"=straight line. So the revenue should do better than a straight up-and-to-the-right line, i.e. curve up. He could have just said "exponential" except some HNers would pick nits about whether that was the only acceptable curve.

Disruptions: With No Revenue, an Illusion of Value

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