Zipcar: it's hard to create a stand-alone business

Zipcar sold itself Wednesday to Avis for a half a billion dollars. While that's a hefty premium over final close last week, Dennis Berman of the Wall Street Journal notes that it’s only about half of what the company was worth two years ago at its IPO. The company has $55 million in cumulative losses, but was unable to cost-effectively acquire new customers.

With its greater scale, scope and buying power, Avis hopes to succeed where Zipcar failed. Avis-Budget-Zipcar will be competing with the two other major rental car conglomerates, Hertz-Dollar-Thrifty and Enterprise-National-Alamo-Vanguard-Tilden.

In other words, while Zipcar invented a new business model, it didn’t invent a new industry. It was a failure for public investors and as a stand-alone company. Even several of its venture investors — whether seeking a bigger pop or perhaps having some shred of ethics — hung in with the public investors, hoping for a turnaround that never came.

I think this is symptomatic of a larger problem, which is the difficulty in creating new stand-alone companies that will last. Facebook (and Amazon and Google) will survive, but will LinkedIn and Twitter and Yahoo?

Dan Henninger in the WSJ this morning suggests that the hostile business climate of the past four years is contributing to the problem, but my sense is that it’s hurting low margin businesses — ones that have little margin to spare when faced with higher taxes or regulation. I suspect that the high margin home-run companies work whether the top personal and Subchapter S marginal tax rate is 35% of 2012, 41% in 2013 or 54% now in California).

Instead, I think the issue is whether firms can create new industries, like personal computers, networking, e-commerce, Internet services, social media, biotechnology and the like. The PC and Internet services seemed to catch the incumbents sleeping, and the nature of the e-commerce transformation is overwhelming the incumbent industry more quickly than it could have imagined.

However, Google is meeting the social media challenge more quickly and vigorously than most incumbents. Meanwhile, the long lead times (and huge risks and capital requirements) of the pharma industry have made it difficult for new biotechnology companies to enter without competing with existing biotech or finding Big Pharma is now demanding a high price for access to its channel.

Overall, exit by acquisition rather than IPO is the norm — one more data point that the go-go 1990s were an aberration. Even for companies that do IPO, many of them (like Zipcar) will find their real growth in the bowels of a large, bureaucratic, cash-flow positive enterprise.

When (and whether) to scale?

My friend Tom Eisenmann (@teisenmann) has blogged for his entrepreneurship students on the important question of when (and why) entrepreneurs should ramp up to achieve scale economies. This is an issue that I usually address early when I teach entrepreneurship and also technology strategy.

Of course Tom is a leading scholar of network effects and technological innovation: he knows the material cold. Thus it’s not surprising that his advice is solid — the pros and cons of trying to be a first mover, the benefits of scale, and the obstacles that startups typically face in getting there.

In some ways it’s a more complete explanation than mine would beHe makes the point in a more quantitative way than I have, suggesting that his students are in a program that expects financial analysis throughout the program, not just in a few select classes.

There is only one thing I would add if I were using it in my own course. The posting assumes that the entrepreneur will (or must) scale, and I think it’s a choice that every entrepreneur should consider.

Perhaps it’s Tom’s audience. I can see a scenario where people who plunk down $170K for a Harvard MBA aren’t going to mess around with a mere “lifestyle business” — they’ll take someone else’s money and (ala Babe Ruth) swing for the bleachers rather go for the sure single.

However, in my class I talk to students about what causes scale economies, and how some businesses have them while some don’t — or, more realistically, can achieve minimum efficient scale with fairly modest staff and/or revenues.

Yes, I wanted to create the next HP or Apple, but I didn’t blow my brains out when that didn’t happen — nor did I pull the plug on my business and my customers. (I did cut back to part-time status and get a Ph.D., but that’s another story.)

So what I teach my students is that scale is a choice and a matter of fit to both aspirations and pragmatic realism. If you want to make a rapidly growing business that has a huge exit, 9 times out of 10 you need to attract sizable venture investments and generate the explosive growth those investors demand.

However, if you don’t want to take their money — or don’t have an idea that will generate the growth they expect — you can still start a business. The trick is to find a concept that doesn’t require such scale to create a sustainable competitive advantage.

As with any other aspect of strategy, success is a matter of aligning the goals with the reality, and then executing like hell.

It's not what you know…

The morning papers report the news that Hulu hopes to IPO this fall and raise $2 billion. (The story was first reported in the NY Times on Monday.) As with a lot of tech IPOs, the company is seeking to go public without a lot of revenues.

The company is not a tech startup in the normal sense. Its raison d’être is not its technology, but its connections, specifically its corporate founders — Disney, NBC Universal and News Corp. (who later sold a minority stake to a private equity firm.)

In other words, anyone could have done the technology: what mattered was that it had direct access to three of the four major TV networks: ABC, NBC and Fox. Hulu succeeded — in true Web 2.0 style as measured by traffic rather than profits — not because of its entrepreneurial spunk, but because of its guanxi. (This seems appropriate since supposedly the name was chosen for its Chinese rather than Hawai’ian meaning.)

Because of its connections, Hulu got favorable content deals as the anti-Apple, the distribution channel that Hollywood loves to hate. It is a lot like Orbitz, founded in 2000 by five of the biggest airlines to compete with Travelocity (a venture of the Sabre reservation service) and Expedia (founded by Microsoft).

In these sort of oligopolistic (or oligopsonistic) industries, the opportunities for success are based on industry connections — or in this case, entry by intrapraenurship rather than entrepreneurship.

Still, no alliance is forever. Some wonder if NBC content will remain on Hulu once it’s acquired by Comcast, which would like to destroy the open Internet (at least for video content) and lock everyone into their premium cable TV subscriptions.

Finally, Hulu’s business model has always been hamstrung by the competing goals of the media giants: take market share away from portals they don’t control (iTunes, YouTube) while not cannibalizing the existing TV offerings. As with newspapers, the online per-user revenues are a fraction of the 20th century traditional distribution channel.

So in the end, what will retail shareholders be getting? Is this more or less secure than the IPO of a pure startup like Tesla or Facebook or some solar panel maker? Thanks to its great connections, there is only one Hulu, but that’s no guarantee it will be able to come up with a viable revenue odel.

Flipping is not a business model

I’m getting ready to grade the final projects for my tech strategy MBA class. One of the projects is about a Web 2.0 company seeking a business model — a common problem.

Near the end of the presentation, one slide summarized the revenue model options:

1. keyword advertising
2. promotional services
3. freemium
4. sell the company

With the last point, I hit the roof. (Figuratively — I tried to be patient with students no matter what they say.) This is wrong, wrong, wrong!.

Sure, it’s wrong conceptually, theoretically, legally. Getting an investment is not the same as generating income.

But it’s also wrong from a business standpoint. Yes, the founders and VCs get what they want — but the founders have failed to solve the fundamental problem of their business.

Perhaps someday Google will be able to monetize the $1.7 billion they paid for YouTube; there are certainly going to be cases where the acquiring company has economies of scope (or distribution channels or negotiating leverage) to pull off business models that wouldn’t work for a stand-alone company.

But for every YouTube, there’s a MySpace (bought by Fox), Bebo (AOL), or Skype (eBay).

On the one hand, it’s hard for stand-alone tech companies to get established and compete against diversified and integrated tech giants — whether Apple, Cisco or Nokia. On the other hand, the idea that entrepreneurs should seek an exit prior to creating something of lasting value is part of the “born to flip” mentality that was briefly in vogue during the past decade.

So I think there are a few students in one MBA course at one university who are getting the message. Let’s hope that others do, too.

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.

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?