Timing is everything

Over the weekend, Apple bought music streaming company Lala for an unspecified price. The most authoritative report comes from blogger/reporter Peter Kafka:

Apple ended up paying around $80 million for the company, according to multiple sources. That’s less than half what investors valued the company at in 2008, but it’s more than the $35 million the company raised throughout its life. Which means that some investors could get their money back and more.

But not all of Lala’s investors. Warner Music Group (WMG), for one, ended up getting back about half the $20 million it put into Lala, I’ve confirmed with people familiar the company.

This account and others make it clear that Lala is being purchased for the knowledge of its staff and its technology. One thing it never did was create a viable revenue model, despite multiple iterations and support from both VCs and record labels.

This seems to be a common problem in Web 2.0 startups. The Dot-Com II era has not been creating viable stand-alone companies, but instead technology sandboxes that have to be bailed out by a good fit to a rich incumbent. In this case, Lala’s service nicely complements the market-leading iTunes. But relying on acquisition for exit has always been a small-numbers problem, particularly when the big boys have gobbled up your competitors (leaving you without a dance partner).

As it was, it sounds like the Lala investors (or founders) got a little greedy. Kafka notes that the investors thought the company was worth $200m at its peak. It‘s not clear if there was a willing buyer that was turned away. But if the owners were holding out for more, they clearly gambled big and lost big. As Charlie Jackson used to tell me, “I’d rather be lucky than good” — an admonishment that timing is everything.

Instead, timing is against the entire categlry. A lot of people thought digital technologies would transform the music industry, and thus garnered piles of VC in hopes of realizing that vision. As Kafka notes, the track record is not great:

The last big exit for a digital music company happened way back in the spring of 2007, when CBS (CBS) paid $280 million for Last.fm. But no one has gotten anything close to that for digital music since then. Imeem is being sold for spare parts, and News Corp. also bought iLike at a steep discount. Spiralfrog filed for Chapter 11 after burning through its cash.

Still, somehow Pandora raised another $35 million. Between the economy, the capital markets, the cratering of its sector and its similar lack of a business model, the wildly popular service with innovative technology has been darn lucky to survive multiple brushes with death. If I were CEO, I’d be looking to negotiate any exit ASAP.

Update Wednesday 9am: Other estimates put Lala's purchase price at $17 million — and a net price of $3m after allowing for cash on hand. Meanwhile, MySpace bought another music service with $24m of VC for “less than $1 million” according to various accounts.

CEO of the decade: never settle for good enough

Apple founder and twice-CEO Steve Jobs was named this week by Fortune magazine to be “CEO of the decade.” Although he’s a liberal arts dropout rather an engineer — and today CEO of a Fortune 100 company rather than a startup — I think Jobs’ career exemplifies the best of what a high-tech startup should be.

Barely removed from his hippie era, the Jobs I era (1976-1985) was clearly about changing the world rather than making a buck. (Until his 1997 return to Apple, Steve made almost all his wealth from Pixar, not Apple).

Reading the Merc summary by John Murrell, it’s clear that the Jobs II era has also succeeded due to Jobs fastidious unwillingness to settle for “good enough.” As Adam Lashinsky wrote in the main Fortune article:

In the past 10 years alone he has radically and lucratively reordered three markets -- music, movies, and mobile telephones -- and his impact on his original industry, computing, has only grown.

Remaking any one business is a career-defining achievement; four is unheard-of. Think about that for a moment. Henry Ford altered the course of the nascent auto industry. PanAm's Juan Trippe invented the global airline. Conrad Hilton internationalized American hospitality.

In all instances, and many more like them, these entrepreneurs turned captains of industry defined a single market that had previously not been dominated by anyone. The industries that Jobs has turned topsy-turvy already existed when he focused on them.

To me, this is what entrepreneurs do, whether Henry Ford and Juan Trippe or Simon Ramo and Irwin Jacobs. Great entrepreneurs — like other change agents — pursue their vision without regard to whether it’s practical.

At the risk of being cliché, this is the epitome of Schumpeter Mark II. As Richard Swedberg said in his introduction to Schumpeter’s Capitalism, Socialism and Democracy:

Schumpeter’s theory was centered around the entrepreneur: he argued that change in economic life always starts with the actions of a forceful individual and then spreads to the rest of the economy.

How did Jobs get where he is? In the Fortune sidebar, fellow IT billionaire Larry Ellison described his friend and former neighbor thus:

"The difference between me and Steve is that I'm willing to live with the best the world can provide. With Steve that's not always good enough." And if you look at how he tackles building a phone, or building a laptop, he really is in pursuit of this technical and aesthetic perfection. And he just won't compromise.

However, as Ellison notes Jobs is proud to have the highest market cap of any Silicon Valley company — ahead of Cisco, Intel, Google and Oracle. Ironically, two years ago Apple’s market cap passed IBM: the same IBM that offered to bail out Apple’s failed management team at $40/share (until they demanded $60) and of course the same IBM that created the PC that bedeviled Apple until Jobs’ return.

Two decades of nanotechnology opportunities

Visiting IBM’s Almaden Research Center Thursday, I was reminded that 20 years ago this week, an IBM ARC researcher made history by being the first person to move a single atom.

Don Eigler is perhaps better known for his November 1989 accomplishment: arranging 35 Xenon atoms to spell out “IBM.” Either way, these were major breakthroughs that enabled the subsequent growth of nanotechnology-related products and startups.

I must confess my limited knowledge of the technological and business aspects of nanotechnology. However, it was clear from my visit with ARC associate director Moidin Mohiuddin that IBM is continuing to invest in developing these technologies, part of decades of materials science basic research. Once this technology had direct application to IBM products (such as disk drive recording heads or coatings), today IBM will also out-license its technology as part of its seminal open innovation strategy.

As it turns out, two of my fellow Anteaters (UCI alumni) are not so ignorant. Jennifer Woolley and Renee Rottner published an article last year on nanotechnology startups in Entrepreneurship Theory & Practice — one of the top entrepreneurship journals.

Their article focused on the geographic distribution of nanotechnology startups. Their conclusion was that states that most aggressively supported nanotechnology research and commercialization had the most activity. (As a cynical ex-politics reporter, I might posit an alternate hypothesis — that the regions with the strongest nanotechnology base lobbied most effectively for state spending — but I haven’t seen their data).

For those trying to understand the phenomenon of nanotechnology-related entrepreneurship, this will be a seminal piece. Jennifer is continuing to do research in this area, so I recommend her work for those interested in the topic (despite her working for arch-rival Santa Clara).

Useful revenue model ambiguity

Michael Arrington of TechCrunch remarks on Twitter’s dilemma for starting its revenue model. To reword his points:

• Many firms are acquired pre-revenue and thus their valuation is made without proof of its revenue model.
• Before a startup has a revenue model, its revenues are anyone’s guess.
• Once a firm has revenues, the range of guesses will be much narrower — and often lower than the most optimistic predictions.

Of course, I’ve long been skeptical of Web 2.0 companies and their ability to create viable business models.

Cross-posted to Open IT Strategies.

A solution that found a problem

Several years ago, one of my students was involved in a business plan concept to use video board graphics processing units to provide extra processing power. The problem was this was a technology — or a solution — without a well-defined problem.

In this morning’s Merc, there was a story about TechniScan, a Salt Lake City company that is using GPU to enhance image processing of medical images (such as CAT scans). This is the targeted solution that my students lacked: a bounded technical problem (in terms of developing code and algorithms) with a well-defined group of customers with similar needs. If ever GPU processing is going to turn into a business, this would be it.

Ironically, the market they’re targeting is not a new one. Back in 1987, when my company was brand new, Peter Marx came down to Vista from Harbor-UCLA Medical Center to tell me how someday all medical imaging would be stored on computers. (At the time, the idea of images being stored on Sun workstations would have been considered technically challenging). He showed me all sorts of cool images that he’d processed on his Macintosh II.

Peter clearly had the right idea, but both the digital image generation and the host-based processing power were decades away.

So here we have examples of some of the factors that distinguish an incipient opportunity from a real one: a well-defined customer with a well-defined problem, and of course technical feasibility to do something about that problem.

The inevitable need for Plan B

Many if not most tech entrepreneurs eventually face a wrenching problem: when do I give up on Plan A and go to Plan B?

In some cases Plan A and B (or A,B,C,D …) co-exist alongside each other in a successful diversified revenue model. In other cases, the company is too small to have more than one plan or the initial plan is such a loser (or another such a winner) that the answer is obvious.

However, in many cases it’s hard for managers to admit the correct decision — either because the data is ambiguous or because of emotional involvement. I suspect that most founders will have a hard time letting go of Plan A, because of the psychic investment and legacy role. Or if Plan C comes from your new CEO — and it bombs — it’s often hard to decide to ditch the plan if it might also mean ditching the CEO.

On Wednesday, I stopped by Pinger, a mobile software startup located walking distance to my SJSU office. CTO Jocelyn Cloutier — who worked for Yahoo, AOL, Bell Labs and as a Montreal C.S. college professor — happens to be married to one of my friends and co-authors.

A venture funded startup that’s not quite 4 years, Pinger spent 2 ½ years trying to get its Pinger voicemail multicast system established. Despite a few high profile wins (like the 2008 presidential campaign of John Edwards), like so many other tech startups it found itself flogging a solution in search of a problem.

Cloutier said that at some point, the management team had to admit that the original company concept wasn’t working: “I just put two years of my life into there, so let’s try something different.”

So when the iPhone App Store launched in the summer of 2008, Pinger carefully evaluated it. On the one hand, ”we didn't know at that time that app store is going to be the thing.” In retrospect, the App Store proved to be a smash success — but as in any startup, it’s tough to make a decision when the future is unknown.

Still, Pinger saw iPhone apps as a big potential opportunity, based on the prior success of the iPhone and its increasing momentum. It jumped in with both feet: in little more than a year, Pinger released four iPhone aps:

• Dec 2008 Pinger Phone: an enhanced souped up IM client (ala Adium) with some other friend features. ad supported
• Feb 2009. Textfree: a freemium SMS client, naturally segmented by the # of messages per day
• July 2009: Doodle Buddy, a kid -oriented drawing program (that allows collaborative color sketching over a network)
• Today (Aug. 20). Free2Call, a new app (approved while I was there at Pinger) that tells consumers which calls are in-network.

While the first application is no longer being sold — the cost structure didn’t work — it paved the way for all the future apps. As Cloutier said: "Pinger phone showed us there's volume there. We can put an application out there and we are going to have a lot of downloads. Now the question is how can we have an application that they're going to use every day and are going to pay for?"

For Pinger, Plan A was a hosted service and Plan B was peddling iPhone apps at $0-$5 each. (Textfree Unlimited has an annual subscription).

It turns out the technology wasn't very similar between Plan A and Plan B, but the technologists were. The founders were veterans of Handspring — and thus understood the whole device-constrained software model — which enables the team to do a good job of designing something for a 320x480 screen with no keyboard and no mouse.

Pursuing Plan B, Pinger has made it so far, but there are lots of uncertainties and no guarantees. International growth is problematic: most of their products are tied to US-specific telecom industry features (Free2Call) which would require data or localization or negotiation for each country. The iPhone/iPT is only a small part of the US market; although ISVs would like to reach other handset owners, it's not clear which app store will catch on next.

More generally, there's also the inerhent problem of package software sales — as opposed to services like If you’re Google or Verizon Wireless, which make ongoing revenue off a customer after acquiring only once.

Software products — like vidoegames, records, movies — are prone to the one hit wonder problem. Once everyone buys your hit, what do you sell them next? If you don’t sell them another product — or an upgrade like Office 2023 or EA’s annual NFL Football update — then once everyone in your segment has bought the product, the income flow stops.

This one-time nature of software product sales nearly killed my own company, as initial strong sales fizzled out as we quickly reached the limits of unexpectedly small niches.

At Palomar we went from Plan A (consumer apps) to Plan B (developer apps) to Plan C (semi-custom OEM utilities) to Plan D (retail OEM utilities). We worked through the 4 business models in the first 4 years. At year 6 dumped all but Plan C (which was cash flow positive and the long run the only one that made any money).

What’s the take home? Entrepreneurs face several tough decisions, including when to look for Plan B (or C or …), when to implement Plan B, when to abandon Plan A. This choice is obscured by the various uncertainties: not knowing what customers will want, what competitors will do, where the industry will go and how effective our execution will be.

There is also the diversification vs. focus problem. Do you hedge your bets, or does spreading your bets guarantee that neither will succeed? Do you put all your eggs in one basket — all the weight behind the arrow? If so, how can you recognize that all-or-nothing bet has become controlled flight into terrain?

Famous lie slightly more true

As is well known in the US, there are three great lies:

1. "I'll respect you in the morning."
2. "The check is in the mail."
3. "I'm from the government, and I'm here to help you."

In a man-bites-dog story, Entrepreneur magazine (which is a lot more pro-free enterprise than Inc.) is praising a government website for actually helping small business owners:

There's something new at business.gov, the official online business link to the U.S. government: community. OK, starting a blog site isn't that new an idea generally. But the business.gov blog, which just got going in July, offers a unique opportunity for small business owners to learn how to do business with the feds.
…
With all the new federal funding floating around from the stimulus bill, this seems like a great place to maybe get a quick answer if you're stymied on how to apply to get stimulus funds, apply for an SBA loan, or about anything else governmental. …

Not enough small businesses even look at trying to snag government contracts if you ask me. Hopefully, this blog will help demystify the process.

I don’t think anyone is going to change the list of lies, but every rule has its exception. It’s good to see sensible, low-cost efforts to disseminate information about existing government programs.