Archive | February, 2008

The Luddite Tax

26 Feb

Like most of my peers, I spend a good deal of my time looking for innovative companies that are not only pursuing big, attractive markets, but that also possess those critical, ‘holy grail’  elements that can enable those companies to erect barriers and garner sufficient runway to achieve the scale they need to become dominant, market leading companies. This trail is well-trodden and never-ending.

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In recent weeks, however, I have noticed an interesting trend emerging in the business models of some in my current batch of startup company prospects. As yet, I have not heard anyone on my side of the desk come up with a pithy, clever term for this business model structure, so I am just (temporarily) calling it the Luddite Tax approach. It is by no means a “new” way to generate revenue from customers — heck, the government has been doing this for years — but it is beginning to gain in popularity and acceptance as a bona fide business model strategy. I find it clever, timely and quite powerful when done properly.

Unlike other approaches, the idea is not to “impose” a cost on a consumer or to ever “force” one to convert. Indeed, the notion is very much to give something away for free (or at very little cost) at the initial stages. Like the concept of Network Effects, the point is to build traffic first and foremost. The comeuppance is that eventually that tidal way of traffic creates a self-sustaining and self-fulfilling gravitational pull that brings aboard all users into a pay scheme. Sound familiar? It is. The Luddite Tax is in evidence in a number of everyday situations. You probably do it already in your daily commute if you are a FastTrak customer.

FastTrak is actually a great example. To the uninitiated, FastTrak is a program whereby residents sign up for an account with their local municipality to receive a “transponder”, a plastic device the approximate size of a garage door opener. The transponder is mounted to a vehicle and a signal is transmitted between the transponder and a receiver placed on a toll bridge or other toll-taking infrastructure for the purpose of collecting a toll. The toll is collected by either debiting the customer’s bank account or by having an account set up with the municipality where funds are deposited in advance and periodically replenished. Having a transponder permits the driver to use dedicated FastTrak Only lanes — which are unmanned toll booth lanes where one can drive through at up to 25 miles an hour — thereby saving time during peak commute hours by avoiding the typical manned booth lanes often clogged with drivers handing over their dollar bills the old fashioned way. As an added incentive, municipalities often charge a slightly lower toll fee to a transponder user than for one paying cash. [However, don’t expect this discount to last. See why below.] 

Everybody wins, right? The municipality gets traffic moving faster and saves costs on having to retain toll takers for the toll booths. Transponder users get to fly by toll booths and save commute time. The planet benefits from there being fewer vehicles clogging roadways burning fuel as they sit in long toll booth lines. 

The catch is that the government is careful to never force anyone to become a FastTrak user. Indeed, they do not need to. People who wish to pay tolls in cash can always elect to do that – probably forever as there will always be tourists, etc whose vehicles are not (and needn’t be) transponder equipped. They will need to pay in cash.

The rest of us have a decision to make: We can be one of the “I don’t want Big Brother in my car”contingent and refuse to be joiners. That will guarantee us many hours of sitting in overheating cars each morning (and sometimes each afternoon) rummaging for loose change in our glove boxes. Sure, we can say we are “bucking the system”, but at a cost that soon becomes pretty unbearable, particularly each time a Lexus whizzes by us in the next lane over on its merry way through a FastTrak lane.

Municipalities, therefore, are enforcing a kind of compliance by letting the “old system” become so unbearable that, in time, virtually all drivers with the exception of once-in-a-great-while drivers, tourists, and hard-core “off the grid”-type anti-government activists will yield and get a FastTrak. This is the municipalities’ design all along, but they choose to reach their goal by letting a “reverse Network Effect” do the work for them. That reverse Network Effect is that as users gravitate to a new, pay system, the old system becomes increasingly chaotic, outmoded, inefficient, and downright painful. While it’s not quite the “upgrade or perish” business model of many software applications, it is decidedly a “migrate or wallow” business model of sorts. You won’t perish if you stick with the old system; you’ll just sometimes wish you did.

Another example of this — only now emerging — is around the burgeoning area of “smart” thermostats.  California recently added a regulation, temporarily sidelined, that would have mandated all new construction to have installed a communicating thermostat that could receive messages from the utility companies. The core purpose of this is for the power companies to better manage power usage and requirements in the event of power emergencies like those that afflicted California in the summer of 2001. [Clearly, it is only a matter of time before these communicating thermostats will be remotely adjustable by users — “Honey, I forgot to lower the heat before we left on vacation! Let’s do it from my laptop or cell phone!” — and before they will be able to communicate with other smart devices in your homes.]

Predictably, privacy advocates threw a fit insisting that this was a thinly veiled attempt by the state to take over your thermostat. The dust hasn’t settled on this, but it is already appearing that there will be an element of Luddite Tax in the model that will ultimately emerge in this initiative. Existing structures will be grandfathered. As such, homeowners will not be required to upgrade their thermostats with the the new, smart communicating devices. However, as communicating thermostats become ubiquitous, having an “old school” thermostat that is not remotely adjustable by either the homeowner or the power company will become inefficient, costly, and perhaps dangerous.

Tech companies thinking of pursuing this kind of approach would do well to closely examine some of the ways government agencies are embracing the Luddite Tax model to get apathetic citizens to adopt new ways of interacting with government. Believe it or not, startups can learn a lot from watching government work. Wait a second! – Looking to local government for innovative ideas?? In my years in the technology and venture environment, I truly never thought I would ever find a rationale for saying that…

GPS device sales explode in Q4

20 Feb

NPD data, just released, depict an interesting shift in consumer electronics purchases through the holiday 2007 shopping season. [The chart is courtesy of Infectious Greed’s Paul Kedrosky, who has his own interesting riff on things. Click on it to enlarge.] Predictably, LCD TV sales were a big winner. Nothing terribly surprising there.

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One also sees a curious drop in MP3 player sales (are you listening, Apple?) and digi-cameras. Off the cuff, I’d say the ‘mobilization of everything’ trend is what’s to blame for some of that. Clearly, as photo quality improves on cell phones, and as MP3 player functionality gets embedded into such devices, we are going to see a slow erosion of standalone MP3 players and digi-cam sales due to cannibalization. Pretty soon, such standalone devices will be the exception rather than the rule for the majority of consumers. I can hear the chorus now: “What, it’s ONLY a camera!?!; What, it’s ONLY an MP3 player!?!”I am already weary of “lugging” my cigarette-pack sized camera around when my trusty Treo does a serviceable enough job for quick and dirty snaps. I fear I am not alone.

Granted, this will take some time, but I am a bit surprised to see the turndown so early in the product cycle. If this isn’t evidence of product cycle compression, I don’t know what is. 

But, by far the big surprise is how GPS sales were virtually off the chart in the most recent quarter. I have written extensively on GPS-enabled software solutions, devices, Location-Based Advertising and the like on this forum. So, clearly, I am not an impartial observer here. That said, I was taken aback at these figures. Like most people on the venture side, I see rosy device penetration forecasts in most every funding pitch having to do with GPS-enabled services. However, this data supports a lot of those scenarios in ways that are rare from an investor’s perspective. Seldom does an investor see sales figures that seem to map nicely with PowerPoint figures from an entrepreneur’s presentation.

Yahoo, Microsoft and the Art of Corporate Courtship

13 Feb

Our friends at TechCrunch, WSJ  and elsewhere began reporting earlier today — with some authority, apparently — that Yahoo has now begun full-on courtship with News Corp and, I suspect, several other players to be mentioned later, in its attempt to stymie its impending consumption (and eventual digestion, if I had to guess) by Microsoft — at least at the $31-per-share number inherent in the current bid.

As a tried-and-true horror movie tagline might suggest, “this time, it’s personal.” You bet it is! I would have to dig deep into the annals of tech M&A deal-making of the past decade to come up with an analogous deal that rose to this level of bilious back channel sniping, posturing, and disinformation. As my friend and former b-school classmate, Revolution Partners investment banker Peter Falvey, first commented on this story, it’s exceedingly hard to tell whether this is a thinly-veiled attempt by Yahoo to drive up the valuation,or it’s just a clear indication that Yahoo really, really does not want to be acquired by Microsoft. Surely, the  blogosphere’s “Anybody But Microsoft” contingent is claiming some kudos are in order.

It goes without saying that it comes as a surprise to no one that Yahoo would be somewhat less than *ahem* enthusiastic about a proposed Microsoft acquisition. Furthermore, it is considered fairly standard M&A gamesmanship to play one suitor off the other in the interest of conveying, well, disinterest about the suitor’s plans along with a sense that there are many options out there for the target. In the vast majority of cases, this all falls under the “dating dance” all companies do; and, more often than not, a deal is ultimately consummated with the original suitor, albeit at a slightly richer valuation and some additional perks thrown in for good measure. The other “interested parties” are usually just being used to gin up the bid price. Sometimes those phantom buyers are complicit in the dance, extracting their own strategic advantages in watching the suitor sweat a little. In keeping with the implied code of M&A modus operandi, the parties typically laugh it off at the closing dinner and everything is smiles and handshakes all around. All in good fun, right? In this case, hardly.

Objectively speaking, a News Corp/Yahoo partnership, investment or other combination does make some sense.  Rupert Murdoch benefited from great timing and foresight in acquiring MySpace for the now-paltry sum of $580mm three years ago. That said, while the MySpace user base has continued to expand exponentially, the same cannot be said for the assumed monetization opportunities inherent in that deal. [Separately, but relevant to this issue, Google has cited disappointing results from its ad partnerships with MySpace and other social networks and appears to be backing away from similar deals in the future, at least as they have been structured to date.] Mr. Murdoch knows this all too well and realizes that the issue needs to be addressed.

A Yahoo deal could alleviate a lot of issues for News Corp but I can’t seem to get past the idea that Messrs Yang and Murdoch will never come to an agreeable figure on how to value MySpace. As such, I think it would be, at best, a long shot that anything substantive comes out of these discussions — and certainly nothing that will materially change the fundamental problems at Yahoo. I have been an outspoken critic of the valuation silliness of social networking companies for some time. Conveniently enough, I was quoted in recent days in two separate San Jose Mercury News pieces (here and here) on the Microsoft/Yahoo drama where I pointed to the problem that Microsoft’s 1.6% investment in Facebook has done to “anchor” a $15 Billion implied valuation in the minds of social networking company management teams (and some investors) and how that has stymied constructive deal-making in this space. I remain equally committed to that position today and will happily go on record as saying I consider a $15 Billion valuation currently for Facebook as absolute folly.

So, back on planet earth, options for Yahoo remain right about where they have been for some time, despite the dust being kicked up by all this supposed courtship talk with AOL, News Corp, Google and the like. Odds are still probably 70/30 that a Microsoft bid will be ultimately accepted (but at a higher figure, natch). The other two scenarios: NewsCorp cuts a deal with Yahoo, Microsoft goes to the mat; or, NewsCorp and Yahoo cut a deal and Microsoft folds its tent, are distant options given the immense complexity and sticky valuation discussions that must be played.

As Dennis Miller might say, ‘anyway, that’s my opinion; then again I could be wrong.’ (But I doubt it.)

Yang to rebuff MSFT bid, but few options for both

11 Feb

Regardless of how one might feel about its trashy image or broadsheet approach to journalism, The New York Post had a way of capturing a dramatic moment in world or business news and boiling it down to its purest essence. Diplomacy, tact, and nuance be damned. In my early school days in NYC — back during the Punic Wars — I remember regularly seeing bold-type New York Post headlines on such weighty matters as US-Russian SALT-II talks summarized in the paper’s unique, inimitable style: “Prez to Gorby: Drop Dead.” 

News that broke over the weekend — leaks, really — that the Yahoo board would reject Microsoft’s $44.6 Billion offer for the internet company stirred up some of those old memories. How would the media spin this: as an expected and par-for-the-course rejection of a bidder’s initial offer to a target company in an effort to gin up a higher price?…or as one more salvo in a once-simmering, now roiling, war of words between two famed technology CEOs with years of scar tissue built up between them over years clashing in the marketplace? Perhaps both angles would get played; and, were that to be so, would that not be a somewhat accurate description of what is now taking place?

A rumor is just a premature fact, it’s been said. This pending rejection from Yahoo of the Microsoft offer should be a surprise to almost no one. While the formal rejection letter (like the initial letter from Ballmer & Co.) will be parsed and diced and sliced by all manner of market analysts, the effect will be the same: both companies need to get a deal done. What that deal eventually looks like may differ greatly from where it sits today, but both companies have few options, and not terribly attractive ones at that. All the more reason to back off on some of the heated rhetoric and posturing that can only damage both parties and jeopardize a potentially successful combination. A Pyrrhic victory for Microsoft would serve no one’s interest, except perhaps for Google.

In my view, Microsoft may have overplayed its hand here. To be sure, both parties are getting well-paid and competent counsel in the form of Lehman Brothers, Goldman Sachs, Blackstone Group, Morgan Stanley, and others. That said, I have to wonder whether the shot-across-the-bow move on Microsoft’s part of an open offer — thereby, effectively blind-siding Jerry Yang and tying his hands to a certain extent — was particularly well-advised. Ballsy, sure; but just how smart was it?

The $31-per share price — while well over the trading price of Yahoo stock the day before the announcement — is still well under the break-up value of the company, regardless of what banker you want to hire to do a fairness opinion. $35-42 a share is probably where the real value is. So, on that basis alone, the offer is a non-starter.

Second, where is the implied strategic value here for Microsoft in its offer? At $31 a share? Really? This just doesn’t square with Microsoft’s public statements and rosy proclamations about how much they respect and value Yahoo and its team. As Tony Soprano might say, “Paulie, the envelope’s kinda light.” You bet it is. About $12 Billion light. What’s $12 Billion among friends, you say, Mr. Ballmer? About $12 Billion.

Clearly, Microsoft is seeking to acquire Yahoo for strategic purposes, not for an arbitrage play. We are not talking about some buyout shop dismantling a struggling airline and selling off the planes to the Mexicans and the hangers to the Bezzleburg brothers to build condos on. This isn’t Blue Star Airlines, thank goodness.  Yahoo is a powerful brand with — in spite of recent defections — a solid team. Microsoft needs to retain that team in a post-acquisition scenario if this deal is ever going to make sense. Coming in with an offer below break-up value, without any reverse-break-up fee provision to allow for regulatory snafus, and without other sweeteners typical of a deal of this size and this high of a profile is just not terribly constructive.

I trust the conference rooms at Redmond are at this moment filled with bankers and senior executives combing through Jerry Yang’s “Drop Dead” letter to Ballmer & Co that will show up in tomorrow FedEx. and thinking of a more reasoned approach. I also trust they are taking stock of their go-for-the-jugular tactic the first time around and re-adjusting their fire. Truth is, the options on both sides are not terribly appealing. Poison pill provisions in place at Yahoo would make a truly hostile run at the company by Microsoft a very costly and largly losing proposition on Microsoft’s part. Microsoft needs Yahoo intact and as on board, if that is even possible, as can be arranged. Calmer heads will hopefully prevail here. Yang’s rebuttal that Microsoft’s offer “massively” undervalues the company is just shrill, but it speaks to some serious friction here on a personal level between the Yahoo and Microsoft executive teams.

There is probably a sizable contingent at Yahoo that would rather commit seppuku on a figurative level than come under the thumb of Microsoft. Microsoft and its advisers would do well to better understand these sensitivies and to think twice about proposing another offer than smacks of an opportunistic land-grab at a company back on its heels. Microsoft should construct a better financial offer promptly. Microsoft has been known to overpay for deals (Facebook, anyone?). The company is again paying a lot of money for good strategic advice here, but in this case, overpaying could be the best advice of all.

Data on the MicroHoo personnel exodus

8 Feb

It seems everyone has an opinion on the Microsoft/Yahoo drama. M&A hasn’t been this edge-of-your-Aeron-chair climactic since AOL/Time Warner. In comparison, it makes the ’08 presidential race look about as exciting as a conference of dental hygienists.

One interesting effect has been some of the secondary concerns, fallouts, and ramifications of this potentially historic combination — what does it mean for venture-backed M&A? what will Google do? what impact will it have on Valley real estate prices? can Miller Lite taste great and be less filling? Indeed, questions for the ages. But, I digress…

A particularly intriguing thought has been that of the impact of an impending exodus of Microsoft and Yahoo personnel in the event this marriage is consummated, posited by First Round Capital’s Josh Kopelman. His well-reasoned argument and supporting data are well worth considering and can be found here.

Getting religion on Location-Based Advertising

7 Feb

What was only spoken about in hushed whispers but a few short years ago has suddenly taken on the dimension of a full-on evangelical rant–and none too soon. I’ve been accused — fairly, at times — of drinking a little bit too much of the Location-Based Services Kool-Aid in recent posts as I waxed poetic about the impact of the intersection of GPS and that of content, advertising and a variety of pushed, targeted services. So be it. If one is too afraid of being wrong (or, more often in this technology venture business of ours, of being early), then one can never be right.

What has been heartening to see in recent months, however, has been the ‘thought migration’ in the punditry about Location-Based Services’ rich, well-dressed cousin — Location-Based Advertising. GigaOM‘s Om Malik has a nice piece on it that bears review. As serendipity would have it, in my return commute from the office this afternoon I heard another piece on this topic on NPR, and a good discussion of the Loopt/CBS Mobile relationship in particular. If that is not indicative that this field is going mainstream, then I do not know what is. As a side note, it is probably also an indicator that if your GPS-meets-content meets advertising business model start-up has not raised capital yet, you’re probably too late.

 Stay tuned. This is starting to get interesting.

Microsoft to acquire Yahoo for $44.6B

1 Feb

The truly pedantic among us will notice that the above headline is loaded with pre-supposition. I intentionally did not write “MSFT offers…” or “MSFT intends..” for the simple reason that this is one of those rare deals that must happen — for both parties. Google continues to grow market share and that growth continues to come directly at the expense of YHOO and MSFT. Furthermore, for Jerry Yang to spurn such an offer (at a 62% premium to the slumping YHOO stock, mind you) would all but guarantee a storming of the Bastille by irate shareholders. Put simply, Yahoo is out of options and must take the Microsoft offer. Yang’s much bally-hooed return last summer as CEO has been less than stellar and the turnaround he put in place has, for all intents and purposes, been a flop. The company is floundering, the stock closed yesterday at a four-year low, and the tech giant’s very own raison d’etre is now clearly being called into question in the shadow of the Google juggernaut.

There will be endless navel gazing in the coming days and weeks on the merits, long-term prospects, and challenges of this acquisition. So, here’s my rundown, in no particular order, of the implications and imperatives of the Microsoft-Yahoo combination:

1. This is good for M&A, (with some caveats): The $44.6B MSFT offer is by far the largest in the Redmond-based company’s 30+year history and dwarfs last year’s $6B aQuantive acquisition. If history is any gauge, this will likely usher in a boomlet in search-related M&A. Watch for a flurry of relatively small acquisitions as Google and others snap up small search players as they wage war in the burgeoning areas of persistant search, vertical search, social search and the old-fashioned ‘my algorithm can beat up your algorithm’ variety.

Furthermore, the psychological effect of such a large acquisition will do much towards loosening the purse-strings at several major tech players — particularly those sitting on mountains of cash — and providing political cover to pay up for accretive, high-profile deals.

The negative aspects of this deal for the purposes of M&A is, of course, obvious. Yahoo was a famed member of the GYM (Google-Yahoo-Microsoft) Contingent – a trinity of tech buyers responsible for a lot of exits of venture-backed companies in recent years — particularly important given the sluggish IPO window.  That ready buyer will now be out of the market — hunkered down managing the tremendous merger integration complexities of a Microsoft acquisition.

2. Google continues to lap the field. The naysayers will certainly dredge up the old ‘Barbarians at the Gate’ quote about how putting together two sick puppies will only result in one really big, sick dog–not the show pony everyone hoped for. There are plenty of examples of that in technology M&A annals, to be sure. That said, MSFT has been trying to buy Yahoo for years. As recently as a year ago, Ballmer & Co. made the overture to then-CEO Terry Semel, only to be rebuffed. The situation for both MSFT and YHOO in search has only deteriorated further. Ballmer now realizes, rightfully so, that if MSFT has any real hope of catching up with Google, the time for that is now! According to current search pageview data, the combined MicroHoo would barely account for half of Google’s share. If Google continues to grow at its current rate — and there is everything to suggest that it will — then any more delay and Google would effectively be unstoppable.

3. With YHOO, MSFT continues its needed transformation. Yes, YHOO needs this deal, but so, too, does MSFT…badly. (MSN China anyone?). Cynics will say it has grown a bit lazy and self-satisfied as it has earned mountains of cash from its operating system near-monopoly and premium desktop applications lo these many years. However, as Office has come under increasing attack from Google, Sun and others offering Web-based apps, MSFT is having to pivot quickly to adjust to a rapidly approaching world where operating systems and desktop applications are becoming commoditized and, dare I say it, increasingly redundant. The cloud computing revolution underway only underscores that threat to Microsoft. The Redmond-based giant has been accused of being many things, but one thing it is decidedly not is stupid. MSFT can execute better than almost anyone. Ballmer and Co. see the writing on the wall and have determined that if their core businesses are going to become marginalized and cannibalized in the coming years, they would prefer to be one the ones to do it themselves. 

4. This is good for Google, too. Honest. Forget that GOOG stock fell out of bed this morning. Much of that had to do with a retrenchment beginning last night following earnings that disappointed Wall Street analysts. The MSFT/YHOO deal, even under the best of circumstances, will take at least a year of back-and-forth negotiations, personnel re-assignments and merger integration planning. The consequence for Google will be a huge management distraction for two of its largest chief rivals in the tech world. The world is still Google’s oyster…and now there is no one else at the table with them while they gorge themselves; at least not for the next year or so.

5. No other bidders. Despite the fun drama this would create for all of us who enjoy watching these events unfold, I am not holding out much hope that a Rupert Murdoch will swoop in with a bigger offer to top Microsoft’s. Moreoever, the sheer size of this deal and the creakiness of the debt markets makes a financial buyer-driven deal a relative non-starter. So, don’t expect to see any PE guys throwing their hats in the ring. Furthermore, thoughts that Google might want to play spoiler or muckracker with its own offer for YHOO are likely to be wishful thinking. Infectious Greed’s Paul Kedrosky and others make some good points on this, but I am not persuaded. Hell, Google can’t even sort out what to do about Doubleclick, and don’t get me started on the anti-trust issues a GOOG/YHOO combination would raise. Nope, Microsoft will play this one alone. It’s a very generous offer, it needs to be given the time and consideration it deserves, and — at the end of the day — it needs to get consummated.

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