The rise of the “successful” unsustainable company
blog.asmartbear.com
blog.asmartbear.com
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[1] http://en.wikipedia.org/wiki/Mark_Pincus
[2] http://www.forbes.com/sites/nathanvardi/2012/10/05/zynga-kee...
If the liquidity from large companies such as FB, Google, AOL, Yahoo, etc. disappears, the value of the above mentioned startups will collapse. A big part of the startup ecosystem is a house of cards, unfortunately many first time entrepreneurs did not experience the .com rise and bust to understand what a downturn really looks like.
Doesn't mean all their money making problems are solved of course, but they're further down the line than turntable.fm are, who continue to confuse me in terms of their lack of business model.
Gasp How could you forget Quora! :)
a) It was the first big success in its space b) at its peak, hired dozens (hundreds?) of actual employees, even copywriters from journalistic institutions. c) Had a huge, huge base of customers
Groupon's leaders should be faulted for the various strategies and actions that have put the company where it is. But Groupon did create a vibrant service out of something that seemed quite pedestrian (can't you just get coupons from the weekend newspaper?)...and a lot if its downfall comes from how easy it is to copycat it.
Color, in contrast, had none of the above.
I probably gave more than $200 to Groupon during the time that I found it useful. I checked into Color over a period of weeks and never stayed on for more than a minute.
So while both are money-losing ventures, I think Groupon should still be ranked higher than Color.
Well I don't think anyone can successfully pitch investors and take millions of dollars of their hard earned (sometimes) money, but agreed on the other points.
Giving discounts may induce the most price sensitive to use your service. They will continue to be price sensitive, and stop using your service once the cost returns to normal.
If the opposite were true, and if business actually did profit from this approach, then it is likely that Groupon would be killing it.
At the end of the day, some types of retailers find ways to profit even off of the price sensitive, but it seems to be the case that the same is not true for most Groupon-trying businesses.
This has been a key part of the mailing list business for many years -- lists that target people who have recently moved, gotten pregnant or had a baby, gotten married, and so on. Special offers with unusually good deals are then offered, because the chance of converting a percentage of the recipients into long-term customers makes it worth it.
If this kind of business model has been translated to online effectively, I'm not familiar with it. Certainly some of that effect can be achieved with the right search keywords or the right websites to advertise on (e.g. baby name sites), but businesses like Groupon and Living Social have brought in many more price sensitive customers than actual long-term business prospects, which is one of the big reasons why they are not more successful.
Really when it comes to coupons there are three options that actually work. You can always have a sale, you can make it a pain to use, or you can limit yourself to 10 to 15% off.
Success that is not sustainable is not success.
>>and a lot if its downfall comes from how easy it is to copycat it.
No, I don't think so. The real (and perhaps the only) reason Groupon is not sustainable is because the fundamental assumption that the business model rests on turned out to be false. Let me explain.
The original idea was that Groupon would team up with a business and provide deep discounts to consumers to encourage them to try out that business. The assumption, which Groupon's sales folks used aggressively to push sales, was that a significant portion of those consumers would like the business so much that they would become repeat customers, thereby (in the long run) offsetting the cost of the original discount. In the end, the business would turn a profit.
Except it didn't work that way.
What ended up happening instead is that the vast majority of consumers never actually went back to the business. The reason is simple: while they could justify paying X dollars for the business's product or service just to try it out, they couldn't justify paying X times three or four. Because of this, most Groupon clients (the businesses) end up losing money, and never offer a second or third discount via GroupOn.
This is why GroupOn has such a huge number of sales reps: they need an ever increasing number of clients in order to postpone the inevitable sinking of the ship.
I guess you think everything ever invented is a failure then?
That's false.
in Q3/2011, 33% of Groupons merchants were people who were doing it for a second time. That number was up to 56% in Q1 of this year.
The deals are getting less lopsided-- $12 for $24 at a restaurant where it's challenging to eat for anything less than $50 is a pretty good buy for a restauranteur. With most of their costs tied up in fixed costs (real estate, etc), they aren't losing much (if any) on this a deal of this size.
You're also somewhat wrong when you say, "The original idea was that Groupon would team up with a business and provide deep discounts to consumers to encourage them to try out that business."
That was part of the original idea, but there are a few other benefits. 1) Filling empty seats for businesses whose costs are largely already incurred 2) It's an effective cash advance for the business- they recognize the revenue quickly (it's like a Kickstarter campaign).
http://venturebeat.com/2012/05/07/groupon-tightens-its-payme...
Another thing to realize is that they get the money REGARDLESS OF WHETHER YOU REDEEM IT. EVER. Depending on the type of Groupon, upwards to 20% of them are never redeemed (this is a dirty secret of gift cards, too).
You're confusing the product and the company. iPod in your definition is not a success, and neither is Sony Walkman.
VCs do due diligence - success for them isn't just funding a real business, but more along the lines of cashing out at the right moment.
They may have grown too fast to do it under the Wall St microscope though.
Growing so fast is not only a problem of expectation, it's a problem of massive overhead that competitors don't have. That's going to harm their competitiveness in anything they do.
The company I was with failed because they bought into the "get big fast" meme that was driving consumer Internet companies. So they went on a acquisition spree, tried launching too many products when they should've just focused on their core, opened several international offices etc.
AND they were already public, so they had to deal with all the BS that comes with that.
The did all of this inside of two years. It was senseless. A company culture rarely scales that well.
And it turns out that in most B2B markets (except for commodities like bandwidth), you don't need to grow that fast. You need to grow in a way that makes your customers happy, yes, but you don't have to worry about everyone suddenly adopting a new competitor (i.e. switching from Yahoo to Google).
But when you have investors throwing money at you, it's easy to think that every decision you make is genius and that you can solve problems simply by throwing money at them.
So to my original point. I think Groupon has multiple strategic options, but it may take them 3-4 years to see them through and in the meantime they have to justify their valuation to angry investors every 90 days. This would not be necessary if they hadn't bought into the "get big fast" mantra.
However, I believe they do have lots of cash in the bank so they may still have time to turn it around. It will be painful and take years.
Even if most companies lose their shirt on that, there are going to be some industries and situations where infinite customers at a temporary loss makes business sense, and once the market for it becomes rational again someone will be able to do it better than they could internally and make a profit on it.
No one can force them to stay. They're already obscenely rich. Think about what their motivations must be.
They're alpha dogs in the absolute worst sense of the word. They thrive off ego, winning, power, greed, narcissism and all those other lovely traits most people pulling similar moves seem to have.
Think Gordon Geko. Remove the pin stripe suit, fast forward 30 years and change the modus operandi from cynical asset stripping to cynical stock hyping and you get...
Edit: a more charitable view, in Pincus' case, is he isn't THAT evil and instead simply made a hugely expensive mistake buying OMGPOP. That wrecked the balance sheet and he's holding in there trying to recover.
As Excutive Chairman in a non-operational role, Lefkofsky is under only a fraction of the unpleasant pressure Mason is under as CEO. If he were guilty of behaving in this way, that would actually jibe pretty well with pg's assertion about people not wanting to run struggling public companies if they can avoid it.
Personally, I am no expert on Groupon. I make no claims that Lefkofsky has behaved in that way, because I don't have any evidence to either validate or invalidate such a hypothesis. It's simply not clear to me that such an accusation is obviously false, as pg claims.
Either way it's not a pump and dump, and their goal is to turn the company around.
Because, at least in Pincus' case, he can't be removed. It would be pretty hard to argue that he wouldn't have been canned under different circumstances.
"Pump and dump" may be a bit much. But I'm glad that it's coming to light that business shadiness doesn't start and stop with the financial industry; it occurs everywhere there are substantial amounts of money changing hands. The Valley has some pretty serious scum-baggery going on. I hope we hold the people who promoted this stuff accountable in the court of public opinion.
My point is that "good vs. evil" style commentary is useless. It automatically lowers the commenters' mean IQ by 15 points.
This, of course, is the reason discussing politics (as opposed to policy) is generally a waste of time.
You implied, Zynga isn't a pump-and-dump scheme because Mark Pincus still runs it, and nobody would inflict the management of a poorly-performing public company on themselves. Well, that's just not true.
There are better arguments against the assertion that Groupon is a pump-and-dump scheme than "it must suck to be Andrew Mason these days" (it does not suck to be Andrew Mason, by the way). For instance, Groupon was open about its liabilities and the enormous risks it faced, and its whole industry sector was very carefully scrutinized.
I'm done arguing this point. My nerdly brain just couldn't handle the idea that being Andrew Mason in Q4'12 is so painful that simply holding his job imputes him credibility.
Agreed. If Pincus and Mason are having a hard time now, I'm sure they can have a good cry in their mansion or on their yacht, weekends in Aspen, luge lessons in Zurich, private Zoroastrian monk mentoring, perhaps a custom birthday song written by the Rolling Stones -- you know, the typical way of handling such hard times as these.
The key point here, I think, is to be very careful to distinguish between a failure to build sustainability, and willful maneuvering for maximum personal gain at the expense of sustainability. The former is a noble failure, the later is deeply unethical (if not illegal) and ne'er the twain shall meet!
I worked in business consulting for a bit. Part of what I learned is that at least some emperors have no clothes. There were really two main types I encountered:
(1) Extremely competent, hard-working executives who try their best to build real value.
(2) Fast talking dominance machines. Sociopaths, really. They make big promises, send a lot of primate dominance gestures, and generally build vapid unsustainable businesses that eventually fail. Yet the failure never sticks to them, and it often never sticks to their initial investors. Usually it's handed off to someone down the line (later investors, the public, employees, etc.).
When I see a resume that consists of a series of a series of unsustainable businesses where the early investors and executives made out well by handing a bag of flaming poo to later investors, I tend to suspect that we're dealing with category (2) players.
I also suspect that when I hear of extremely magnetic reality-distortion-field personality types. There is a certain kind of charisma that I take as a contrarian indicator.
I would openly run a company into the ground if I got hundreds of millions of dollars in the process like they Zynga or Groupon guys did.
VCs fund many promising startups, often flooding them with money that can support the company for a long time, while maintaining a very active public image that perpetuates the sense that the company is successful. Not only is the actual business value hidden, VCs encourage the companies to not try to turn a profit, but to grow very, very quickly. This is, perhaps, what obscures the actual value the most.
Now, why do VCs do that? Because they hope for a good ROI, and some of them do quite well (the entire portfolio taken together, of course). Some say that VC's true desired goal for a company is an IPO, but IPOs are rare, and, I think a good IPO (for anyone who's not Facebook) is only about 10x that of a good acquisition. So I believe, that it is the acquisitions (that outnumber IPOs more than 10x) that really drive the VC investments, and, in turn, the whole industry.
But how can acquisitions be the bread-and-butter of the industry if so many of them fail (for the acquirer, that is)? Because, on the whole, acquisitions are still much cheaper for the acquirers than funding their own technology - or market - research. Instead of throwing a lot of money on large, money-hungry research departments, Big Tech would rather let a ton of entrepreneurs and VCs fight it out, and award the winners handsomely. The price they pay is far less than what they would have had to invest doing independent research.
So, who loses? I'm not sure anyone does. Entrepreneurs get the independence, excitement, and the possibility of huge payoffs of a winner-takes-all market; VCs - well, some of them - do alright, and Big Tech saves a ton of money on thousands of employees they don't need to directly employ and manage. Oh, and bloggers and industry insiders get a lot of juicy gossip and cautionary tales.
The one remaining question is, how come so many companies seem very promising, get good indications from the market, and then slowly (or quickly) declines. I don't have a good answer, but I do have a hypothesis. Web companies mostly compete in a global market. That means that in order for them to succeed, all relevant consumers must learn about them, and must learn about them quickly (fast growth, right?). But this is just not possible, because the average consumer can only keep in mind a bounded (and rather small) set of vendors. So, not only is, say, Groupon competing with uhmm, I dunno, Amazon, maybe for the purchase of some items, it is also competing with Zynga over my time. And not only that, it's even competing with Salesforce because there are only so many products I can even remember to use on a regular basis. And when new startups are funded, they are encouraged to very quickly get global attention, and - out with old, in with the new - novelty seeking consumers forget about yesterday's big thing.
So all of these companies are competing with one another for attention, so the question is, how many fast-growth, global companies can even prosper at the same time?
Well, if you factor in the opportunity costs of the capital and talent allocated to unsustainable companies, then there's a good argument that the US economy loses. Every dollar invested in Zynga or Color is a dollar that could have been invested in something productive over the long haul. Every talented programmer that goes to work at a flash-in-the-pan, overhyped startup creates opportunity costs and economic inefficiencies by not working at more productive enterprises, creating real value. The wage and equity inflation created in the job market by overhyped startups leads to similar inflation across the industry, raising operating costs for everyone in the business.
All that hype-based investing does is swap money around between a relatively tiny cohort of people. It doesn't create real value over the long run, and all the real value that is foregone is opportunity cost.
I think this is an interesting cultural change rather than a loss. Engineers are willing to sacrifice job security for a small chance for a big payoff. The winner-takes-all approach has long been part of the American ethos, only now its working its way down from the capitalists to the workers. I just think it's interesting.
You could say, though, and I think I've written it before, that its the workers (i.e., startup employees) that lose. If the theory is correct, then Big Tech is exploiting the workers' naive preference for promises of big rewards over regular, secure, pay. But, again, I don't know if that desire is naive; most startup folks understand the chances well, and still choose as they do. Maybe the excitement and perceived freedom are worth more than money to them. They sure are to me.
But I do think that there's a major opportunity cost incurred when dollars and talent get shuttled into hypey, bullshit-driven companies instead of legitimate ones. Including legitimate startups.
Of all the risky startups who could potentially get funded and attract talent, it's better for the good ones to get the money and the talent if possible.
To put it another way: the VC system should be selecting for the next Google, not the next Color. But to whatever extent it's selecting for the next Color, it is sub-optimized. That degree of sub-optimization is the opportunity cost / inefficiency inherent to the system.
In other words: it's not simply betting at the track and ending up with the wrong horse. It's actively betting on what it knows to be the wrong horse, because the wrong horse pays off in the short term.
They are one of the most successful internet things and yet they still don't seem to have any really solid way to monetize that. They are now part of culture but are they revenue positive?
The things they are doing lately don't make sense until you take that into account:
Restricting 3rd party apps and APIs? Seems to be driving users away... Except that if all your users are costing you money, then less users is in fact good.
And the only money making thing they seem to have is "paid tweets" that you are forced to see (aka ads) and so yeah, obviously they don't want 3rd party apps and APIs that could filter that one weak still mostly crappy source of money. So if they loose some freeloading users, why would they care.
So yeah. Why has no one else mentioned Twitter in this discussion as the grand-daddy-king of unsustainable companies?
I think their road map to financial success is mainstream media related (second screen etc.).
So long as capital stays productive, from a societal point of view it shouldn't matter whether it stays in one company for 20 years or moves from company to company every three.
Good point though.
Capital is invested because of the potential of growth, and therefore return. You wouldn't buy stock in a company at $10 if you expected it to be worth $10 for the entire time you held the shares.
It's not like the people who bought ZNGA stock at $10 were somehow rewarded with $7 worth of stock in some other company when their shares dipped to $3.
Finance is very much built around the concepts of diversification and risk taking.
And then you go on to provide an example completely opposite of what he was saying.
It is a general principal of how investments work.
The situation you described is a reasonable diversification strategy, but you had the expectation of appreciation with each purchase. You hedged your bet, and lost less, but you still believed that each position would appreciate in value.
If the OP is referring to that cycle, his question seems valid to me. Investors choose companies at various stages because they believe they will “exit” (not just VCs, all investors) at a higher level than today. When a company gets to the end of an industry life cycle, their price/earnings multiple is compressed and “value” investors step in thinking their new strategy will let them enter a new market etc.
Every investor is taking risk and whether the timelines are short 2 to 3 years or long 3 to 10 years before the investor expects the company to go in to decline, every professional investor understands that someday the vast majority of the businesses they invested in will fail. (I’m talking about every type of investor, even stable growth mutual funds). Even if that means it takes 20 years to fail.
I understand my point is highly nuanced and somewhat theoretical, but it is grounded in finance literature and the OP’s question seemed more valid than deserving the response, “that’s not how finance works”. I guess I was hoping someone smarter than I would come along and propose some new framework or possibly add some insight so I rebutted your post.
Yes, you very much would, if you had reason to expect that company to be willing and able to regularly pay out dividends - model for returns that does not depend on growth and is thus sustainable (nothing grows forever).
At its core it's a failure of the investors.
However, I think the problem here is one of time horizons - many people invest in companies expecting them to be longer-term sustainable entities rather than harvest-the-craze entities. But as long as that's a function of lack of investor chops rather than market disinformation, ultimately it's a good thing.
Sustainability is relative. Very few companies "last forever", so the real questions are... What is an acceptable pattern of growth and what is driving the shorter lives of these companies?
For example, Joe's Plumbing shuts down after 2 years because Joe realizes he has to manage his books, do advertising, manage any junior plumbers etc. In the end he spends 50% of his time doing plumbing and 50% of his time doing "business." So he pays off his small business loan (maybe) of $100k and goes to work for Tom's Plumbing where at least he gets to do plumbing all the time.
He had a run of 2 years, but at no point was his company sitting on millions of dollars.
Here is a list of 2012's bankruptcies by assets: http://www.turnaroundletter.com/largest-bankruptcies-this-ye...
There isn't a single "software" company on the list. Now, I also understand that software companies are not as asset intensive, but it is hard to know what companies are "large" after a bankruptcy since their market caps approach zero.
My point was specifically refering to real businesses, not lifestyle businesses.
Startup != Small Business != lifestyle business.
The internet was very different a few years ago - a source for information and creativity, but easy access and growing acceptance (no doubt related to the rise of mobile platforms), have changed all this.
Some startups today are just like pop acts or Hollywood productions: 1 out of 10 makes a killing, the others fail spectacularly. That's the mass media (gambling) busines, not a "bubble".
VCs tend to care principally about how big it could get, to the exclusion of other potentially important principles.
A good counter-example to Color is actually Bingo Card Creator.
It's a great product, very well managed and fine-tuned by patio11, but it has a pretty rigid ceiling on its opportunity.
VCs avoid businesses that seem limited or overly niche so as to create a limited maximal market opportunity.
Another contrast would be anything in the ad business. It's such a huge business that a lot of startups that go into the ad industry end up making a sizeable amount of money fairly early on.
VCs tend to be keen on advertising startups that want to build a large platform or catch-all service that all the buyers/content providers will want to use. Nevertheless, they'll still invest in smaller scope ad startups that have an opportunity to expand.
The start-ups with no revenue don't have that, so they make guesses about what their market can or will be, which is often over inflated and rarely accurate, but nevertheless is the basis for how much people invest. Investors in this scenario take those numbers and then back into what they think the value should be. Or worse, they compare it to other hyper-inflated companies and arrive at a valuation via group-think.
I've got no problems with people exiting like that, but it makes me wonder where all the pressure to sell up and move on comes from.
Not building a company for the long haul isn't necessarily a bad thing, provided the business itself has the ability to grow elsewhere.
The pressure often comes from the VCs who put a lot of money down in an initial investment, and need at least some of their bets to pay off within a short time-frame. Are there any long-term VC funds which accept stock and then wait for dividends?
Companies also aren't obligated to pay a dividend even if they're profitable - see Apple up until about a year ago.
...This guy's a psychopath.
But we do not see this behavior, and hence the mild outrage of this post.
We gnash our teeth and tear our hair because of the irrationality of buyers and investors, because if only they were rational they'd invest in my idea, not his! :)
If you could marry these people with others who have a proven track record of creating sustainable businesses maybe you would have some unstoppable force?
But then again, maybe in order to pump and dump, you have to make certain decisions that are bad for building a company and good for raising funds.
I mean what does Mark Cuban tell his kids? "I built this website and it was shut down, but I'm bloody rich anyways, so..."
I mean I personally would feel like a horrible role model to the children after that. Does this sort of information turn your children into thinking the end justifies the means?
I linked to a completely different blog post in a comment on another story, but someone noticed my blog post and submitted it:
http://news.ycombinator.com/item?id=4692456
Anyhow. It turns out that I'm not alone.
The most relevant trait of a celebrity economy is the importance of visibility (and the vicious politics surrounding who gets to be visible). If everyone (most relevantly, the investor community) knows you're a 5.5, that's better than being a 10 that no one has ever heard of.
This has been my observation. I've met plenty of very successful founders (people that the HN crowd would have heard of) who are just not very impressive.
It also gets under my skin when VCs say, "we don't invest in ideas, we invest in people". To which I say, "then most of you should be fired, because you suck at that." Honestly, VCs are a lot better at picking ideas. Sure, a lot of these "social" apps are lame, but VCs actually do an excellent job of choosing what ideas to fund, given the constraints they face and their objective function (variance-agnostic expectancy maximization, 1-10 year payoffs). That they do well. On the other hand, they seem to be doing a lousy job of picking people (and at that, I would do a better job than 90+ percent of them).