Posts from January 2013

MBA Mondays: Revenue Models – Transaction Processing

Transaction Processing is not a "net native" business model. There have been businesses built up around processing transactions for a long time. But the Internet and Mobile present some challenges in processing transactions and therefore there are opportunities to build substantial businesses around helping companies process transactions.

If you look at the Revenue Model Hackpad, you will see that there are a number of different kinds of transaction processing businesses:


View Transaction processing on Hackpad.

The first four examples in the hackpad are related to credit card processing, the next three are related to banking transactions, then there is fulfillment which is physical logistics, then the next three relate to the world of telephony, and the last one is related to internet and mobile platforms.

So you can see that transaction processing is a business model that can be applied to a number of different types of transactions. And certainly our revenue model hackpad is not comprehensive. So I am sure there are many other forms of transaction processing businesses in the online world.

The thing that all of these forms of transaction processing have in common is the processor handles a transaction that was generated by another product or service and provides some form of completion service and charges a fee for doing so. That could be processing a credit card transaction, handling a banking transaction, shipping something to someone, completing a call originated on another network, or distributing a third party app on an internet or mobile platform.

For financial transactions, the fees are generally small, typically in the 2-4% range. For banking transactions, the fees are often much smaller than that because the credit and fraud risks are lower.  For logistics (shipping and handling), the fees vary but relate to the costs of providing the service. For telephony, the fees are generally expressed per minute or per message and are generally low but can be high in certain markets. Platform distribution fees are the outlier as they are often very significant, Apple charges a 30% cut in its app store.

For the most part, the transaction processing business model is all about scale. You process billions of transactions and take a few percent of the total transaction value. PayPal processed $145bn of transactions in 2012 and generated $5.6bn in revenue. Out of that $5.6bn, PayPal has to cover all its costs including processing fees to other transaction processors, customer service, fraud prevention, fraud losses, technology and development, and several others. I am certain that PayPal makes a very nice profit off of that $5.6bn of revenue but it is probably on the order of $1-2bn, which is in the range of 1% of the total transaction volume. This is a business model of pennies on the dollar, literally.

One of the challenges of this business model is that the fixed costs required to process transcations can be significant and you will operate a loss until you can get to scale. You can see that by looking at how much capital Square has raised to date. Crunchbase has it at $341mm. Now Square is one of the most exciting new companies created in the past five years and is executing incredibly well. But it has taken hundreds of millions of dollars to get where it is today. That's what I am talking about. You had better be prepared to fund the costs of ramping to scale if you want to be in this kind of business.

In general, I like these kinds of businesses a lot once they reach scale, but am cognizant of the costs of building them. They are not for the faint of heart.

What Is The Net Native Model?

My partner Brad is fond of reminding us at USV that taking the offline model for something and porting it to the web is not often the best way to build a business online.

John Markoff's piece in the New York Times on online education got me thinking about that this morning. MOOCs are all the rage in the online ed world these days. And most of the MOOCs I have used remind me a lot of the traditional classroom model of teaching. The question I am noodling is if there is a better way to teach when you have tens of thousands of people wanting to learn something that you can teach them.

John contrasts the MOOC model to our portfolio company DuoLingo in his piece. He says:

there are early indications that the high interactivity and personalized feedback of online education might ultimately offer a learning structure that can’t be matched by the traditional classroom.

Although DuoLingo was built by one of the most popular teachers at Carnegie Mellon, there are no teachers in their learning model. It's all software, content, and users. Now maybe language learning is easier to teach this way than other things. I don't have a fully formed opinion on this. I am just thinking outloud.

But what we have seen over and over again is that taking a model that was optimized for the analog world and porting it to the internet is almost always suboptimal. And that the person or team that finds the optimal model for the internet is almost always the one who ends up with the big win.

And I think that will be true in education as well.

Feature Friday: The Explore Page

At USV we invest in a lot of networks and marketplaces. These are messy places where anyone can post most anything and it can be hard to find the good stuff. Enter the explore page. Using data, analytics, social signals, and often some human element, the explore pages are incredible places to discover amazing stuff. Here are some of my favorites:

SoundCloud Explore

Soundcloud explore

Tumblr Explore

Tumblr explore

Kickstarter Discover

Kickstarter discover

Foursquare Explore

Foursquare explore

If you are building a service that empowers people to post all sorts of things, I encourage you to create an explore page where your users can make sense of it all.

Voomly

AVC regular and all around fun and smart guy Andy Swan and his brother Landon have built Voomly. Andy came into USV yesterday to tell me and Andy about it. As you would expect, he also brought a signed bottle of Pappy. As JLM would say, it was well played.

Voomly is a service that folks who have expertise can use to build followings and sell subscriptions to newsletters and Q&A services. I joined the service during our meeting yesterday but I chose not to sell any Q&A services at this time. I did pay and subscribe to Andy and JLM on Voomly and have already asked both of them a question and received a reply.

The service is not (yet) a marketplace. It is really just a utility today. But it can certainly become a marketplace over time if this idea takes off.

I can see this being really useful in high value applications like stock trading (a web native GLG?) and betting (a web native tip sheet?). I also think tech support is an interesting category. I am sure there are many others.

Anyway, I like what they have built and think the AVC community ought to know about it. Check Voomly out.

Guest Post: Startup Business Development 101

Holger Luedorf has been doing business development in the web/tech/mobile sectors for almost 15 years. He currently leads Business Development (BD) for our portfolio company foursquare. Holger has contributed a guest post with a bunch of great advice for startups that are just getting around to BD and what they should do and what they should not do. His views and opinions are his own and not those of foursquare.
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The Beginner’s Guide to Start-up BD: 15 Basic Rules

A lot of the rules below will seem like no-brainers to any seasoned business development manager, but I think it is worth putting them together in one list.  I hope that they will be useful for teams that are building up BD teams from scratch or to those start-ups without a dedicated BD team and in which for example the founders or others take on BD as an additional responsibility.  I don’t think this list is complete and I am planning to add additional rules over time.  If you have any direct feedback, please tweet me at @holger.

  • Create clear BD targets – This goes without saying, but it is worth repeating.  Without clear targets, a BD team will aimlessly chase deals and in the worst case have a distracting effect on the rest of the organization by creating deals that are not core to the company but take up valuable executive, product, and engineering resources.  Ideally, BD targets are a subset of the overall company goals (e.g. grow the user base, expand internationally, outsource a critical technology etc.) but they could also be outside the core company goals, like exploring alternative business opportunities, seeking M&A opportunities etc.
  • Structure your approach – Don’t just run off and randomly approach partners.  Once the goals are set, the first thing the BD team or person should do is set priorities in terms of who your ideal partners are.  This includes market sizing, market and competitive analysis, and a clear timeline.  If you are new to the industry you better start researching yesterday.  There is nothing worse than being pitched by someone who did not make the effort to understand your business and the challenges you are facing.  Secondly, you need to put a lot of work into figuring out how to approach these partners (more to that in point 3). Finally, you have to make sure you have all the necessary contacts to approach your target partners.  If not, work your network.  Cold calls are rarely effective.  Unless you come recommended by a trusted source, chances are very low that you will get someone’s attention.  Ideally, you have built up a ton of what I call “good karma” by helping out others friends in the industry in previous situation so that you can call in some favors and ask for introductions.
  • Solve problems, help partners reach their goals – This is one of the most critical business development tasks.  Partnerships never work when the benefits are one-sided.  In addition to helping you reach your own targets, you really have to figure out how your proposal helps the potential partner reach their goals.  Again, you would think this is a total no-brainer, but this does not seem to be the case judging by the large amounts of proposals that I get that are not really solving any of my company’s problems, or are so obviously mass-emails without any direct relation to myself or my organization.  I consider these proposals to be spam and will refuse even reading those emails once I realize what they are.
  • Be prepared, research the companies you want to partner with – In addition to a well thought out, mutually beneficial proposal, it is important to research your target partners.  To me this is like prepping for an interview.  Nothing worse than realizing that the person you are interviewing knows nothing about your company or the issues you are facing but at the same time tells you how “passionate” s/he is about your business.  Try to figure out what is top of mind for your potential partner. Is it facing a particular competitive thread, has it had a major product launch failure, has the team that you are speaking to experienced a recent change of executives etc. There are so many possible reasons that might make you want to tweak your approach, change your timing, etc.  It is always hard to know for sure what matters most, but I am a firm believer that solid preparation will help you produce better partnerships.  I am literally spending 15-20% of my work time researching the mobile, location, advertising space etc. to understand what our partners are most likely thinking of our product and our company.  This means scanning a lot of industry press and frequently meeting with peers to share information.
  • Understand the partner organization – This is related to the previous point, but focuses on a different aspect.  Especially when trying to partner with a large company, you want to make sure you have as complete of an understanding of the organizational structure as possible.   Who are the decision-makers, which teams or managers are heavily weighing in, who is responsible for the long-term execution of the partnership etc.  This organizational understanding will help you address the right people in the partner organization and help you identify additional contacts you might want to connect or back-channel with.
  • Build a hierarchy of touch points – Ideally, a start-up BD team does not act in a vacuum but is able to tap into various levels of its own managers and executives.  I am fortunate that our CEO and other execs realize the value we can drive via partnerships and that they support the BD efforts in building additional touch points between our company and that of certain partners.  For high-value partnerships, I always try to build a relationship on multiple levels, e.g. between the two day-to-day partnership managers, between the two VP-level managers responsible for those partnership, and ideally also between two or more C-level execs.  Having these multi-level relationships gives you more flexibility in dealing with your partners.  In certain scenarios bottoms-up approaches might work better and you want to convince the ground-level partner managers first but in other cases it might be better to pitch top-down knowing that an executive is passionate about certain topics and will strongly influence the decision making process of her organization.
  • Always be responsive – A pet peeve of mine.  I think it is disrespectful not to respond to companies or people reaching out for various reasons.  The only things I usually do not respond to are blatantly obvious sales pitches.  But if people are reaching out asking for jobs, with a partnership proposal, or some simple user feedback, I will always try to reply within 48 hours, sometimes much faster.  In many cases my answers are a short but polite “No”, but at least I acknowledge their message or request.  This is how I expect to be treated, and that is why I tend to spend a good amount of time responding to incoming email, twitter, and Linkedin messages, etc.  I am pretty sure that there are a lot of people who disagree with me on this, but that is my personal modus operandi, which I think this also creates “good karma”.  (side note: I do not connect with people on Linkedin unless I had at least a few minutes of personal interaction).
  • Don’t rush, don’t annoy – Always remember that you are working in a dynamic start-up while some of the bigger organizations you are trying to partner with have heaps of processes and check-points that decisions have to go through.  I remember from my time at two of those large organizations, in my case Deutsche Telekom and Yahoo!, that people in those organizations could get frustrated with impatient partners banging on their doors all the time.  My mantra: Pitch, have a solid follow-up providing additional data points or whatever else were the action points, but then let it sit for a period of time, before sending a reminder.  There might be legitimate deadlines that you want to be clear about but otherwise give your partners enough time to make their decision, at their own pace. Appearing over-eager never helps from my experience.
  • Can’t close? Regroup, analyze, and adapt if possible – Don’t beat a dead horse.  If a deal cannot get done, and there might be many good reasons, regroup and think why the partnership did not make sense for the potential partner.  Did you have the right partnership concept in the first place, were you talking to the right potential partners, did you talk to the right people in the organization, did the business model make sense for both parties etc.  There can be hundreds of reasons why a deal did not work out and it is important to really try to understand why and come up with an alternative approach.
  • Own your partners, not just deals – There is a fundamental difference between Business Development and Partner Management.  In many large organizations you have a dedicated BD team that flies in to negotiate and close a deal and then moves on to the next deal with another partner. On the other hand you have Partner/Account Management that identifies potential deals, brings in BD for potential negotiations, and then takes over full responsibility for the deal implementation and on-going partnership.   In a start-up with potentially no dedicated BD team or at best a very small one, you have to double-up and take responsibility for both the deal making and on-going partner management.  This can be tricky as in the BD negotiations you want to be able to get the best possible deal for your company and this can create friction with your partners, while as a partner manager you want to be as close to your partner as possible to understand what is going on and in order to smoothly execute the partnership. When BD is a separate function from Partner Management, it is easy to play good cop, bad cop.  The BD guys are the bad cops haggling over the best possible deal while the partner manger is the good cop back-channeling with the partner organization trying to create a positive, productive setting for the partnership.  In a start-up you really have to bridge those attitudes, which takes some experience.  In the end solid knowledge about the partner’s organization and goals will help you find that right balance.
  • Don’t over-commit, internally or externally – With many partnership opportunities, you only have a few potentially only one shot at getting it right, so it is critical that what you commit to towards the partner is actually something that your company can deliver.  This might be in the form of a product feature, launch timeline, support function etc.  Do not over commit as you run the risk of killing the short-term opportunity and long term relationship.  The same is true for internal commitment.  Make sure that deals are signed off by and have commitment from all internal parties involved. This includes the management team, which has to ensure that a deal is in line with the overall company objectives.
  • Build strong relationships with key partners over time – What goes around, comes around.  A strong working relationship with partners will help you build trust over time.  Don’t forget that industries tend to be very small so having a solid reputation for being a trustworthy, proactive interface and partner will help you when partners research you and your company.   Also keep in mind that many times, people will stay involved in a single industry over decades, so how good your relationship with someone 5 or 10 years ago was does matter in a new setting, maybe after that person joined a new company that is a potential partner of yours. Strong relationships with business partners will help getting deals done and in some cases can be the deciding factor that a decision-maker on the partner side chooses your company over another.  Following many of the points above is what creates such strong relationships.
  • Be present as a company – In some cases your start-up is doing so great that you are getting a ton of positive press and interest from companies who want to partner with you.  But these scenarios are rare and can change.  One factor that will support your BD efforts is that your company has a positive image in the market.  In addition to your start-up’s marketing & PR functions, BD can play an important role to represent the company to the outside world.  Participation in conferences or other speaking engagements, hosting university student visits, or providing quotes and insights to journalists are all things that can help your company and your efforts as a BD team.  Of course this should never become a time-suck for you and others on the BD team, but especially when it can be done mainly locally and without much travel involved, it can be a good way to make your company be “part of the conversation”, gain valuable market insights, and network with other people and companies in the industry.
  • Relay partner feedback back into your own organization – The BD team is usually one of the most outward facing teams in a start-up and as such you will be able to collect a ton of valuable feedback for company.  A lot of partner meetings generate a lot of information like product critique, observation of what the competition is doing, insights into what partners would like to see in terms of product innovation etc.  Make it a point to regularly pass this knowledge on to the respective teams in the organization as it will help educating the organization and making more informed decisions.
  • Make sure you have solid legal support – I have been fortunate to have had outstanding, dedicated lawyers to work with on deals in all of my past jobs and as well as in my current role at foursquare.  Having experienced legal support that really understands the big picture and has a good balance of risk-averseness and business acumen will help getting better deals done faster. Weak legal support can kill or create weak deals.
  • Becoming A Boss

    I was watching this Charlie Rose interview with Lena Dunham and I was struck by this line:

    it’s really intense to be thrust into a managerial position before my time

    I have seen this a lot in my business and its always your talent for making things that puts you in this spot. And one of the big challenges is that the "managerial position" (as Lena calls it) is often in conflict with the talent for making things that got your there in the first place.

    I am not saying that folks who are talented at making things aren't talented at managing people. I have come to believe that most people can be talented at managing people if they want to be. What I am saying is the time and energy and passion for making things can be all consuming and managing people can also be all consuming. Doing both well is really hard.

    When we had our USV CEO summit last fall, we kicked it off by asking each founder/CEO to open with the one thing they had learned the hard way during the year. The recurring theme was that they had to let the people they hired do the work even though they wanted to jump in and do it themselves. And as they are all going around the room telling this story over and over, I am thinking "and I want you to jump in and do the work too". Because these are the people who made the thing that got us to invest, the thing that we fell in love with, the thing we believe is big enough to build a business around.

    One of my favorite stories is about an entrepreneur I visited in his office away from the office. That he had one is in and of itself is telling. He was playing his acoustic guitar and singing when I arrived and I said "wow. I didn't realize you were such a talented musician". He said, "I am an artist and the most impactful art that my generation can make is websites but I see myself first and foremost as an artist." And I thought, "well it is a shame that you can't hang a website on a wall and move on to the next one."

    There are a number of ways to handle this conflict that arises between the maker in you and the manager in you.

    Many artists stick to making and hire a manager to focus on their business. Artists that build websites and mobile apps can do that too. In a perfect world, the manager and the maker become partners and operate the enterprise as a duo connected at the hip. The Gotham Gal and I once watched a movie about Valentino and his partner Giancarlo Giammetti and I was struck at how well defined their two roles were in their business endeavors.

    You can devote yourself totally and completely to the manager role and hire people to lead the making effort. That is what many of the founder and CEOs in our portfolio have chosen to do, at least in theory. As our CEO Summit discussion pointed out, that approach is riddled with tension and conflict because makers want to make at their core and being a hired maker working for a founder/CEO maker isn't a party. It can work but it will never work perfectly.

    The third way is to keep your hands in both efforts. To be both the maker and the manager. The challenge with that approach is you have two full time jobs and I have not seen many who can do both as well as they need to be done. Some choose to hire leaders below them to lead the making and managing teams but then keep ultimate responsibility for both. That can work, but defining when you plan to step in and make the calls and when you won't is tricky.

    I cannot and will not recommend one of these approaches over the other. Each founder/CEO has to figure out what will work best for him or her and then build the team around them appropriately. As always, the hires are critical. Some hired leaders can deal with a founder who drops in on the decision making process better than others.  If you are the meddling kind, you should find someone who can handle meddling well. But understand that nobody handles meddling exceptionally well. Pick your battles carefully.

    What I can recommend is that you stare at the elephant in the room, name it, and deal with it. The maker/manager conflict sits at the heart of many of the development challenges that founder/CEOs deal with as they scale their companies and scale themselves. Conquering it is possibly your greatest opportunity and will lead to your biggest success.

    MBA Mondays: Revenue Models – Peer to Peer

    We've covered advertising, commerce, and subscriptions so far in this series on business models. And while they are the big three of Internet business models, they all existed well before the Internet. They are not Internet native business models.

    If there is one thing I have learned investing in Internet businesses over the years it is to pay attention to things you can't do without the Internet. And that describes peer to peer pretty well. Like the Internet, a peer network empowers the edges and devalues the middle. I like peer networks very much.

    If you look at the revenue model hackpad, you will see a list of some interesting peer network businesses, including our portfolio companies Lending Club and Etsy. They all take a similar approach to revenue generation. They connect one or more people together to conduct a transaction and take a fee for doing so. In Etsy's case the transaction fee is 3.5%. In Lending Club's case, the fee is generally 4% to the borrower and 1% to the lender. In Kickstarter's case, the fee is 5% to the project creator if the project is successful.

    But there are ways to generate revenue outside of the transaction fee in peer networks. Etsy is a great example. In addition to the 3.5% transaction fee, they charge a 20cent listing fee, a payment fee for payments processed on their direct checkout service, and they have an advertising marketplace so sellers can promote their items on Etsy. It is possible to sell on Etsy and share less than 5% of your revenue with Etsy. It is also possible to sell on Etsy and share more than 10% of your revenue with Etsy. It all depends on how many of their services you are using to run your business.

    I like this approach very much. I think the basic fee for participating as a seller in a peer network should be as low as possible. This allows the marketplace to develop as much liquidity as possible. Increasing transaction fees will push sellers out of your market into other ones. The better approach to increasing revenues is value added services that sellers can avail themselves of but are not required to. If these services allow sellers to sell more or if they make selling easier, sellers will adopt them and your take rate can ultimately be much larger than your transaction fee.

    The purpose of the revenue model in a peer network should be two fold. First it should incent as many participants in the peer network as possible (ie the lower fees the better). Second, it should produce enough revenue so that the business will produce significant profits at scale.

    The thing about peer networks is most of the value is created by the participants in the network. The business doesn't do that much. It provides the basic infrastructure so that the market can work. It provides trust and safety and governance. And it provides customer service and support. The participants in the network do most everything else. That means these businesses can and should operate very efficiently at scale.

    Craigslist is a good example of a peer network leveraging the power of the model. I have no idea how much revenue Craigslist makes and how many employees they have. But I would not be surprised if it were a $200mm annual revenue business with $150mm or more of annual profits. And yet it is capturing a tiny amount of the economics in its peer network. It should easily be the case that billions of dollars a year are transacted because of Craigslist. So what you see is a huge amount of transactional volume, a relatively small percentage of which is captured in terms of revenue, but a huge percentage of the revenue that is collected drops to the bottom line. That is what a peer network business model should look like.

    And it scales really well. Because so much of what a traditional business would do is being done by the peers on the network instead of the company. Compare an online retailer with Etsy. An online retailer needs to have buyers and merchandisers. It needs to have inventory and warehouses. It needs to ship and track. It needs to spend a large percentage of revenues on marketing, customer acquisition and retention. Etsy doesn't spend much money on those things. Their sellers do. And as a result, their sellers keep more than 90% of the value of the transaction as opposed to giving up 50% as a wholesaler.

    So peer networks are powerful businesses that when constructed well have great defensibility and staying power. The key is keeping the take rate as low as possible and incenting participants to transact with you instead of someone else. If you can do that, you can build a large and sustainable business with this model.

    I am looking for an experienced iOS developer in NYC

    One of our portfolio companies is working on a cool unreleased product and is racing to the finish and needs additional bandwidth. And they have a second version of the product spec’d and need a strong iOS developer to get that out as well.

    This role requires real iOS experience and a willingness to work on a small fast moving team. I can explain a lot more over email. If you are interested, contact me here.