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Tag: Amazon

The Four Types of M&A

I’m oftentimes asked what determines the prices that companies get bought for: after all, why does one app company get bought for $19 billion and a similar app get bought at a discount to the amount of investor capital that was raised?

While specific transaction values depend a lot on the specific acquirer (i.e. how much cash on hand they have, how big they are, etc.), I’m going to share a framework that has been very helpful to me in thinking about acquisition valuations and how startups can position themselves to get more attractive offers. The key is understanding that, all things being equal, why you’re being acquired determines the buyer’s willingness to pay. These motivations fall on a spectrum dividing acquisitions into four types:

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  • Talent Acquisitions: These are commonly referred to in the tech press as “acquihires”. In these acquisitions, the buyer has determined that it makes more sense to buy a team than to spend the money, time, and effort needed to recruit a comparable one. In these acquisitions, the size and caliber of the team determine the purchase price.
  • Asset / Capability Acquisitions: In these acquisitions, the buyer is in need of a particular asset or capability of the target: it could be a portfolio of patents, a particular customer relationship, a particular facility, or even a particular product or technology that helps complete the buyer’s product portfolio. In these acquisitions, the uniqueness and potential business value of the assets determine the purchase price.
  • Business Acquisitions: These are acquisitions where the buyer values the target for the success of its business and for the possible synergies that could come about from merging the two. In these acquisitions, the financials of the target (revenues, profitability, growth rate) as well as the benefits that the investment bankers and buyer’s corporate development teams estimate from combining the two businesses (cost savings, ability to easily cross-sell, new business won because of a more complete offering, etc) determine the purchase price.
  • Strategic Gamechangers: These are acquisitions where the buyer believes the target gives them an ability to transform their business and is also a critical threat if acquired by a competitor. These tend to be acquisitions which are priced by the buyer’s full ability to pay as they represent bets on a future.

What’s useful about this framework is that it gives guidance to companies who are contemplating acquisitions as exit opportunities:

  • If your company is being considered for a talent acquisition, then it is your job to convince the acquirer that you have built assets and capabilities above and beyond what your team alone is worth. Emphasize patents, communities, developer ecosystems, corporate relationships, how your product fills a distinct gap in their product portfolio, a sexy domain name, anything that might be valuable beyond just the team that has attracted their interest.
  • If a company is being considered for an asset / capability acquisition, then the key is to emphasize the potential financial trajectory of the business and the synergies that can be realized after a merger. Emphasize how current revenues and contracts will grow and develop, how a combined sales and marketing effort will be more effective than the sum of the parts, and how the current businesses are complementary in a real way that impacts the bottom line, and not just as an interesting “thing” to buy.
  • If a company is being evaluated as a business acquisition, then the key is to emphasize how pivotal a role it can play in defining the future of the acquirer in a way that goes beyond just what the numbers say about the business. This is what drives valuations like GM’s acquisition of Cruise (which was a leader in driverless vehicle technology) for up to $1B, or Facebook’s acquisition of WhatsApp (messenger app with over 600 million users when it was acquired, many in strategic regions for Facebook) for $19B, or Walmart’s acquisition of Jet.com (an innovator in eCommerce that Walmart needs to help in its war for retail marketshare with Amazon.com).

The framework works for two reasons: (1) companies are bought, not sold, and the price is usually determined by the party that is most willing to walk away from a deal (that’s usually the buyer) and (2) it generally reflects how most startups tend to create value over time: they start by hiring a great team, who proceed to build compelling capabilities / assets, which materialize as interesting businesses, which can represent the future direction of an industry.

Hopefully, this framework helps any tech industry onlooker wondering why acquisition valuations end up at a certain level or any startup evaluating how best to court an acquisition offer.

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Henry Ford

This weekend, I paid a visit to The Henry Ford. Its a combination of multiple venues — a museum, an outdoor “innovation village”, a Ford Motors factory tour — which collectively celebrate America’s rich history of innovation and manufacturing and, in particular, the legacy of Henry Ford and the Ford Motors company he built.

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While ambitious super-CEOs like Larry Page (Google), Elon Musk (Tesla), and Jeff Bezos (Amazon) with their tentacles in everything sometimes seem like a modern phenomena, The Henry Ford shows that they are just a modern-day reincarnations of the super-CEOs of yesteryear. Except, instead of pioneering software at scale, electric vehicles, and AI assistants, Ford was instrumental in the creation of assembly line mass production, the automotive industry (Ford developed the first car that the middle class could actually afford), the aerospace industry (Ford helped develop some of America’s first successful passenger planes), the forty hour workweek, and even the charcoal briquet (part of a drive to figure out what to do with the lumber waste that came from procuring the wood needed to build Model T’s).

In the same way that the tech giants of today pursue “moonshots” like drone delivery and self-driving cars, Ford pushed the frontier with its own moonshots: creating cars out of bioplastic, developing biofuels, and even an early collaboration with Thomas Edison to build an electric car.

It was a striking parallel, and also an instructional one for any company that believes they can stay on top forever: despite the moonshots and the technology advantages, new technologies, market forces, and global shifts come one after the other and yesterday’s Ford (eventually) gets supplanted by tomorrow’s Tesla.

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What Happens After the Tech Bubble Pops

In recent years, it’s been the opposite of controversial to say that the tech industry is in a bubble. The terrible recent stock market performance of once high-flying startups across virtually every industry (see table below) and the turmoil in the stock market stemming from low oil prices and concerns about the economies of countries like China and Brazil have raised fears that the bubble is beginning to pop.

Company Ticker Industry Stock Price Change Since IPO (Feb 5)
GoPro NASDAQ:GPRO Consumer Hardware -72%
FitBit NYSE:FIT Wearable -47%
Hortonworks NASDAQ:HDP Big Data -68%
Teladoc NYSE:TDOC Telemedicine -50%
Evolent Health NYSE:EVH Healthcare -46%
Square NYSE:SQ Payment & POS -34%
Box NYSE:BOX Cloud Storage -42%
Etsy NASDAQ:ETSY eCommerce -77%
Lending Club NYSE:LC Lending Platform -72%

While history will judge when this bubble “officially” bursts, the purpose of this post is to try to make some predictions about what will happen during/after this “correction” and pull together some advice for people in / wanting to get into the tech industry. Starting with the immediate consequences, one can reasonably expect that:

  • Exit pipeline will dry up: When startup valuations are higher than what the company could reasonably get in the stock market, management teams (who need to keep their investors and employees happy) become less willing to go public. And, if public markets are less excited about startups, the price acquirers need to pay to convince a management team to sell goes down. The result is fewer exits and less cash back to investors and employees for the exits that do happen.
  • VCs become less willing to invest: VCs invest in startups on the promise that future IPOs and acquisitions will make them even more money. When the exit pipeline dries up, VCs get cold feet because the ability to get a nice exit seems to fade away. The result is that VCs become a lot more price-sensitive when it comes to investing in later stage companies (where the dried up exit pipeline hurts the most).
  • Later stage companies start cutting costs: Companies in an environment where they can’t sell themselves or easily raise money have no choice but to cut costs. Since the vast majority of later-stage startups run at a loss to increase growth, they will find themselves in the uncomfortable position of slowing down hiring and potentially laying employees off, cutting back on perks, and focusing a lot more on getting their financials in order.

The result of all of this will be interesting for folks used to a tech industry (and a Bay Area) flush with cash and boundlessly optimistic:

  1. Job hopping should slow: “Easy money” to help companies figure out what works or to get an “acquihire” as a soft landing will be harder to get in a challenged financing and exit environment. The result is that the rapid job hopping endemic in the tech industry should slow as potential founders find it harder to raise money for their ideas and as it becomes harder for new startups to get the capital they need to pay top dollar.
  2. Strong companies are here to stay: While there is broad agreement that there are too many startups with higher valuations than reasonable, what’s also become clear is there are a number of mature tech companies that are doing exceptionally well (i.e. Facebook, Amazon, Netflix, and Google) and a number of “hotshots” which have demonstrated enough growth and strong enough unit economics and market position to survive a challenged environment (i.e. Uber, Airbnb). This will let them continue to hire and invest in ways that weaker peers will be unable to match.
  3. Tech “luxury money” will slow but not disappear: Anyone who lives in the Bay Area has a story of the ridiculousness of “tech money” (sky-high rents, gourmet toast, “its like Uber but for X”, etc). This has been fueled by cash from the startup world as well as free flowing VC money subsidizing many of these new services . However, in a world where companies need to cut costs, where exits are harder to come by, and where VCs are less willing to subsidize random on-demand services, a lot of this will diminish. That some of these services are fundamentally better than what came before (i.e. Uber) and that stronger companies will continue to pay top dollar for top talent will prevent all of this from collapsing (and lets not forget San Francisco’s irrational housing supply policies). As a result, people expecting a reversal of gentrification and the excesses of tech wealth will likely be disappointed, but its reasonable to expect a dramatic rationalization of the price and quantity of many “luxuries” that Bay Area inhabitants have become accustomed to soon.

So, what to do if you’re in / trying to get in to / wanting to invest in the tech industry?

  • Understand the business before you get in: Its a shame that market sentiment drives fundraising and exits, because good financial performance is generally a pretty good indicator of the long-term prospects of a business. In an environment where its harder to exit and raise cash, its absolutely critical to make sure there is a solid business footing so the company can keep going or raise money / exit on good terms.
  • Be concerned about companies which have a lot of startup exposure: Even if a company has solid financial performance, if much of that comes from selling to startups (especially services around accounting, recruiting, or sales), then they’re dependent on VCs opening up their own wallets to make money.
  • Have a much higher bar for large, later-stage companies: The companies that will feel the most “pain” the earliest will be those with with high valuations and high costs. Raising money at unicorn valuations can make a sexy press release but it doesn’t amount to anything if you can’t exit or raise money at an even higher valuation.
  • Rationalize exposure to “luxury”: Don’t expect that “Uber but for X” service that you love to stick around (at least not at current prices)…
  • Early stage companies can still be attractive: Companies that are several years from an exit & raising large amounts of cash will be insulated in the near-term from the pain in the later stage, especially if they are committed to staying frugal and building a disruptive business. Since they are already relatively low in valuation and since investors know they are discounting off a valuation in the future (potentially after any current market softness), the downward pressures on valuation are potentially lighter as well.
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Tomorrow’s Pets.com

petscomToday, it seems perfectly obvious that building an internet business to sell pet food to customers where shipping and logistic costs (let alone advertising costs, etc.) wiped out any chance of profitability was an idea doomed to fail.

But, was it obvious at the time? While some folks will claim they knew all along, the market evidence suggests that most people had no clue: after all, the company raised over $110M in capital from Hummer Winblad, Comcast, Amazon.com, and others. It went on to successfully IPO in 2000 and at one point employed over 300 people. If it was such a terrible idea, it seems that it took quite a while for people to catch on.

This isn’t to specifically pick on Pets.com – quite the opposite: when you work in technology, there is oftentimes so much change and uncertainty around the future that its not obvious that the “emperor has no clothes” until its too late, oftentimes driven by entrepreneurs, career-seekers, and investors willing to pile on to make sure that they “get in on the action before its too late.”

And therein lies a very interesting question: what are the ideas/companies that have generated a ton of traction today which will become “duh, stupid” Pets.com ideas of tomorrow?

Examples of companies that flew high once and “obviously” crashed afterwards (most of the Dot Com bubble companies, many of the Cleantech bubble companies, some prominent consumer internet companies, etc) suggest that ignoring economic realities is a common refrain. Many of the failed Dot Com bubble companies and many of the challenged consumer internet companies relied primarily on drawing eyeballs to their websites/apps without figuring out how to make money enough on them to recoup their costs of marketing & advertising. The cleantech companies, similarly, gambled wrongly on government support and on their ability to make their technologies competitive with conventional systems.

But, the danger of generalizing from this type of thinking is that are plenty of examples of huge companies which succeeded despite bleak economic pictures in the early days. Amazon.com is a particularly noteworthy company that aimed to grow first before worrying about profitability (something it continues to do in a number of new businesses), not generating profit until late 2001, 7 years after founding, and over 4 years after it went public. Considering the company is worth over $100B today, compared with roughly $400M when it went public, it would seem blindly paying attention to the immediate economic picture would’ve cheated you out of a very impressive investment.

The truth is that I don’t have a good answer to this question. Studying what led to the failure of past startup models can be very informative in terms of how to think about other businesses, but the truth is that we aren’t likely to know until it hits us. Who knows, maybe in a few years “Big Data” or “Mobile advertising’ might all be revealed to have been terrible businesses…?

I would love to hear any thoughts on the subject in the comments below.

(image credit – Pets.com sock puppet – RightStartups)

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No Digital Skyscrapers

A colleague of mine shared an interesting article by Sarah Lacy from tech site Pando Daily about the power of technology building the next set of “digital skyscrapers” – Lacy’s term for enduring, 100-year brands in/made possible by technology. On the one hand, I wholeheartedly agree with one of the big takeaways Lacy wants the reader to walk away with: that more entrepreneurs need to strive to make a big impact on the world and not settle for quick-and-easy payouts. That is, after all, why venture capitalists exist: to fund transformative ideas.

But, the premise of the article that I fundamentally disagreed with – and in fact, the very reason I’m interested in technology is that the ability to make transformative ideas means that I don’t think its possible to make “100-year digital skyscrapers”.

In fact, I genuinely hope its not possible. Frankly, if I felt it were, I wouldn’t be in technology, and certainly not in venture capital. To me, technology is exciting and disruptive because you can’t create long-standing skyscrapers. Sure, IBM and Intel have been around a while — but what they as companies do, what their brands mean, and their relative positions in the industry have radically changed. I just don’t believe the products we will care about or the companies we think are shaping the future ten years from now will be the same as the ones we are talking about today, nor were they the ones we talked about ten years ago, and they won’t be the same as the ones we talk about twenty years from now. I’ve done the 10 year comparison before to illustrate the rapid pace of Moore’s Law, but just to be illustrative again: remember, 10 years ago:

  • the iPhone (and Android) did not exist
  • Facebook did not exist (Zuckerberg had just started at Harvard)
  • Amazon had yet to make a single cent of profit
  • Intel thought Itanium was its future (something its basically given up on now)
  • Yahoo had just launched a dialup internet service (seriously)
  • The Human Genome Project had yet to be completed
  • Illumina (posterchild for next-generation DNA sequencing today) had just launched its first system product

And, you know what, I bet 10 years from now, I’ll be able to make a similar list. Technology is a brutal industry and it succeeds by continuously making itself obsolete. It’s why its exciting, and it’s why I don’t think and, in fact, I hope that no long-lasting digital skyscrapers emerge.

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The Cable Show

A few weeks ago, I attended the 2012 Cable Show – the cable television industry’s big trade show – in Boston to get a “on the ground floor” view of how the leading content owners and cable television/cable technology providers saw the future of video delivery, and thought I’d share some pictures and impressions

  • While there is a significant piece of the show that is like a typical technology conference (mainly cable infrastructure/set top box technology vendors like Motorola, Elemental, Azuki, etc showing off their latest and greatest), by far the biggest booths are SXSW-style attempt (flashy booths, gimmicks) by the content owners (NBC, Disney, etc) to get people to notice them. Almost every major content provider booth had a full bar inside, there were lots of gimmicks (see some of the pictures below — Fox and NBC trotted out some of their celebrities, many booths had photo booth games to show off their latest shows – like A&E with its show Duck Dynasty, Turner invited a lollipop maker to create lollipops in the shape of some of their cartoon characters, etc), and a there were a number of networks who used “booth babes” to try to draw more traffic. I guess when your business is dependent on looking sexy & popular for advertisers/cable companies, it should be expected that they would do so during conferences as well.
    2012-05-22 13.16.382012-05-22 14.11.23
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  • The relationship between content owners and cable companies that has built the profits in the industry is being tested by the rise of internet video. Until recently, I had always been confused as to why Hulu and Netflix seemed so restrictive in terms of content availability. It was only upon understanding just how profitable the existing arrangement between the cable/satellite providers (who are the only ones who can sell access to ESPN, HBO, CNN, etc) and the content owners (who can charge the cable/satellite providers for each subscriber, even those who don’t watch their particular networks) that I began to understand why you can’t get ESPN or HBO online (unless you have a cable/satellite subscription) — much to the detriment of the consumer. Thankfully, I saw some promising signs:
    • At the Cable Show, every content provider and cable provider was talking about “TV Everywhere”. Nearly every single booth touted some sort of new, more flexible way to deliver content over the internet and to new devices like tablets and phones. Granted, they were still operating within the existing sandbox (you can’t watch it without a cable subscription), but the increasing competitive overlap between the cable TV-over-internet services (like Xfinity TV online) and the content providers’-over-internet services (like HBO GO), I feel, will come to a breaking point as
      • Networks like HBO realize they could get a ton of standalone users and make a ton of standalone money by going direct to consumers
      • Smaller networks  increasingly feel squeezed as cable companies give a bigger and bigger cut of total content dollars to networks like HBO and Disney/ESPN/ABC, and resort to going direct to consumers.
    • New “TV networks” are getting real traction. One of the most real threats, from my perspective, to the cable-content owner dynamic is the rise of new content networks like Revision3, Blip.TV, College Humor, and YouTube’s new $200M initiative to build original high-quality “shows”. Why? Because it shows that you don’t need to use cable/satellite or to be a major content owner to get massive distribution. Its why Discovery Networks (owners of the Discovery Channel and TLC) bought Revision3. Its why Hulu, Netflix, and Amazon are funding their own content. After all, Hulu has quite a few made-for-Hulu programs (including Spy which I intend to watch as its tangentially related to MI-5 :-)). Netflix has not only created some interesting new shows, they’ve even decided to resurrect the canceled TV series Arrested Development (canceled by who? that’s right, the evil cancelers of Firefly — Fox). And its why Amazon just announced its first four original studio projects. Are these going to give HBO’s Game of Thrones a run for its money? Probably not anytime soon — but traction is traction, and the better off these alternatives do, the more likely the existing content/distributors are forced to adapt to the times.

I think this industry is ripe for change — and while it’ll probably come slower than it should, there’s no doubt that we’re going to see massive changes to how the traditional TV industry works.

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Spooks

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If you haven’t seen it already, go watch British spy show MI5 (or, if you are in the UK, it is called Spooks).

I just finished it this past weekend courtesy of Amazon Instant Video and am at a loss as I can’t imagine another TV series taking its place in my life.

The show is, as its name gives away, about Britain’s MI5 spy agency – an analog to America’s FBI in that it deals primarily with domestic threats — and follows the lives and missions of MI5’s Section D. Now, I know what you’re thinking – this is just James Bond in television form. Well, you couldn’t be further from the truth. This is not your usual spy drama. The first episode is about a pro-life terrorist (can you picture even trying to show this in the US?). There is a later episode where MI5 must run counter-intelligence against a Mossad (Israeli’s secret service agency) operation. There is another episode about all the goings on behind the scenes by the CIA and MI5 when the President of the United States makes a visit to the UK. There is one about a British government hit-job on a retired spy who wants to write a tell-all book to clear his conscience. There is even one about making a deal to help the Venezuelan secret service protect their president on a trip to the UK in return for information about a terrorist plot against a British school. These are not topics your run-of-the-mill spy film covers. Combine that with the writers’ willingness to write or kill off everybody (seriously, if you pick any character in Section D there’s a pretty good chance they’ll be killed or written off at some point), great casting, and a chance to see what people in the UK think of the US, and you have a winner :-).

So, without further ado, five things I learned after watching 10 seasons of MI5:

  • Don’t join a secret service: As I pointed out before, chances are, you’ll be killed or sent away. Even if you are not, the work itself is grueling. You don’t control your own schedule, you can’t have normal relationships with people, you spend a ton of time undercover and at risk of being discovered and killed, and your boss is likely a veteran who has, over the years, accrued enough enemies around the world to make dealing with vendettas and having veterans you don’t even know treat you like a pawn a regular occurrence.
  • If you do join the secret service, cut off all ties with family and friends. Seriously, it never goes well. Ever.
  • Don’t become the asset of anyone at a secret service. Its never worth it and there’s also a pretty good chance you or someone you know will be killed.
  • Whenever someone tells you to abandon an area because of a “gas leak” or a “chemical leak”, there’s probably a terrorist plot nearby. That was the most common way the MI5 agents evacuated regions where a bomb was believed.
  • The US and especially the CIA are nothing but bullies. The number of episodes where the CIA comes across as arrogant and pushy (sometimes to the detriment of itself) is staggering. That is apparently all we Americans are good for…

And there you have it: the life lessons of MI5 🙂

(Image credit)

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Streaming Music Lockers

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I was lucky enough to receive early access to Google’s Music Beta service, the new streaming music service Google announced at their recent Google I/O event. It’s a service that’s fairly similar to Amazon’s Cloud Drive and the streaming service which Apple is rumored to be announcing soon. I’ve used the service for about two weeks, and I have to confess I’m confused as to why everyone is so excited about this.

Let me be clear: I think the service works perfectly fine. I, of course, have some complaints. The web interface, at least not to my knowledge, doesn’t provide a simple way to play or queue individual songs without queuing up the next song in the list. There can also be an awkward buffering pause at the start of playback (although I’ve noticed the software intelligently pre-caches the next song in the list) which can also be a little annoying. And, on my super-slow connection, it took two days to upload my music collection (whereas its been rumored that Apple will simply identify the song and pull it from its own collection). But, overall, I’ve been impressed with the quality. The quality of the playback across all of my devices (including my smartphone even when its not on WiFi) is good, and the ability to easily sync playlists across all of my devices is a nice touch. The free music. The instant playlists and integration with my Android devices are also thoughtful touches.

But my confusion has nothing to do with whether or not the service works: its whether or not this service is actually all that valuable to a large swath of users. While I have a relatively large music collection, I (and I’m willing to bet most people) don’t add to that collection all that often. When you couple that with the fact that storage is pretty cheap (as anyone who bought a USB stick and looked at the prices again 6 months later has noticed), it makes it easy to manage your music collection between your computer and your phone with iTunes or Windows Media Player without Apple or Google or Amazon going through the hassle of setting up an elaborate cloud setup.

For someone like me with four separate devices (a personal laptop, a work laptop, a DROID2 smartphone, and a tablet), this becomes a little more interesting as synching between all four can be a pain, but I don’t know how many people fall into that category. And, even if they did, music services like Mog, Spotify, and Grooveshark offer essentially the same thing – streaming music – except without the limitations of what’s in your own music collection.

Obviously, there are things Amazon, Google, and Apple are doing which are better than good-old-fashioned-manual-synching and what the Mogs/Spotifys/Groovesharks of the world have built. And, if its not clear yet, I do think these services are cool and valuable. But my view here is that they’re not so much better to justify all the hype.

Of course, I have yet to see Steve Jobs’ announcement… maybe his reality distortion field will set me straight :-).

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Heads and tails

I just read a really interesting Economist article which, at first, I thought was very counter-intuitive.

image In the early days of television, there was very little in the way of network selection for the average TV-viewer. There were only a handful of stations and, regardless of how bad the content on a given station was, those stations would stay in business because they were the only stations around. Heck, even if the station’s programming was completely awful, there would still be plenty of people watching it simply because it was one of the only things that was on.

Flash forward a few decades. We now not only have many television stations, not to mention cable, satellite, and internet video. We have enough DVDs to last a lifetime. The web has made it so that anyone with a camera and an internet connection can broadcast to YouTube.

Given all this, what would you expect to happen to what people watch? If you’re anything like me, you would’ve concluded that the power of the internet to connect people with what they want and the abundance of new video content would have encouraged people to “spread out.” Why would you stick to a few “staple” networks, when you can now watch the SyFy channel for science fiction, CNN for the news, and YouTube if you want to keep LonelyGirl company?

imageWell, writer Chris Anderson seemed to agree and he popularized this idea in a book (and “theory”) he called The Long Tail (book cover to the right). In it he describes exactly what I just laid out, that because technology makes it easier for people to find the things which the majority of consumers aren’t interested in, the future of business would be less about selling a few popular items that “sort of” appeal to the “average person” and much more about selling a lot of the “the long tail” (pictured graphically below) of things which really appealed to a few people apiece. Or, to use the TV analogy again, the idea behind the Long Tail is that it makes more sense to create a bunch of small TV stations which focus only on a few niches than it is to have one big station that tries to satisfy everyone at once. This is, after all, one of the big ideas behind eCommerce sites like eBay. Wal-mart or Target can and will stock lamps which sells several millions of units, but because they can’t possibly stock every lamp, they won’t satisfy everyone. The Long Tail theory says that the real money to be made is in selling the millions of things which are only going to sell a few items apiece, but because those items are exactly what those people want, you can probably make a little extra profit off of each.

After all, how many authors or singers have you absolutely loved, but knew they could never go “mainstream”?

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As appealing as that idea was (especially to the snobs out there, myself included, who just wanted to assure themselves that the real money wasn’t in going mainstream but in going for the nobody’s-ever-heard-of-them CD/book/electronic/movie), reality has not played out quite that way.

While there is no doubt that the internet has expanded choice such that people now have access to the long tail, instead of seeing a diminishing “head”, the size of the biggest hits has increased dramatically. Take books as an example. From the Economist:

A study of the Australian market by Nielsen, a research firm, found that the number of titles bought each year (measured by ISBNs) has risen dramatically, from about 275,000 in 2004 to almost 450,000 in 2007. Niche titles selling fewer than 1,000 copies each accounted for nearly all the growth in variety. Yet their market share fell. In Britain, sales of the ten bestselling books increased from 3.4m to 6m between 1998 and 2008.

So, instead of seeing a migration from the “head” to the Long Tail, we’re seeing Goldilocks’s middle-of-the-road players getting crushed by blockbuster hits on the one side and the long tail on the other. This begs the question: why are hits doing so well when there’s so much else out there? Again, the Economist:

A lot of the people who read a bestselling novel, for example, do not read much other fiction. By contrast, the audience for an obscure novel is largely composed of people who read a lot. That means the least popular books are judged by people who have the highest standards, while the most popular are judged by people who literally do not know any better. An American who read just one book this year was disproportionately likely to have read “The Lost Symbol”, by Dan Brown. He almost certainly liked it.

Ironically, it turns out the technology which makes the long tail more accessible is even better at turning hits into even bigger hits. After all, the internet helps spreads word-of-mouth for hits and long tail products alike. If anything, the fact that technology today makes it so easy to choose between different things is going to drive people to look for hits if only so they have something to talk about with one another.

Unfortunately for content and product people, this makes business very tricky. It means you can take one of two routes to success: make a blockbuster hit or sell a lot of niche products which appeal a great deal to a few people each. The former is tough to do because its hard to know what will be a hit. The latter is tough to do because you’ll need to have a very lean cost structure to be able to profitably make a lot of products which are only selling a few units a piece. But, the worst part is that trying to split the difference between both is especially hard as the former requires a big budget for marketing and for getting the best writers/artists/coders and the latter falls apart because you need to make many different things.

How things will ultimately shape out is anyone’s guess, but my perspective is that the smart companies out there will do three things:

  1. Invest in strong PR and marketing muscle. If people seek hits because they want to be able to talk about things with each other, then the job of the product/content company is not just to make the best product possible, but its also to get people to talk about it. This means the smart companies will invest heavily in either a strong internal public relations/marketing group or a partnership with someone particularly strong in that area. This will be especially critical for the largest product companies/studios as having a strong PR/marketing capability will be an asset they can leverage across all their products, both those that need to be hits and those going for the long tail.
  2. Find ways to cross-sell. The economics of a long tail business are grim, because they involve keeping and developing a wide range of products that are each only going to sell a few items. How do you do well with that type of strategy? The answer is that you do everything possible to turn flops and long tails into hits. One approach is to take a page out of Amazon.com’s playbook: recommendations. Amazon has found a way to encourage buyers to not just buy one thing, but to buy several by using a sophisticated computer algorithm to find products which people tend to buy together. This lets a company use one product to many others: free marketing, in a sense.
  3. Be a lean, mean product-making machine. The only way to survive hits turning into flops is to make sure the hits don’t cost too much to make. The only way to make the long tail profitable is to make sure you have a lean operation in place which quickly and cheaply cranks out high quality ideas. Take some of the large social gaming companies like Zynga, maker of the very popular Facebook game Farmville. Don’t tell me that Fishville, Petville, Yoville, and Cafe World are completely original ideas :-). This is not to bash on Zynga, as I think the idea is brilliant and the quality of the games lies in the execution not necessarily in the originality of the concept, but in a world of hits and long tails, the best strategy is to find some core engine which you can re-hash and improve upon again and again. And few can question Zynga’s winning formula in that arena.

(Image credit – TV) (Image credit – Long Tail book) (Image credit – Long tail diagram)

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