The Unsaid Reason VCs May Not Back You: Resource Efficiency

This is really just a long way of saying that services companies get lower multiples (1.5x-2x) than product companies.

Okay, what he says sounds plausible - I guess consulting is an example of a business with linear "resource efficiency". But he doesn't explain the faster than linear resource efficiency case very well. The obvious answer is a case where you get x% more customers per unit time then your effort on your product produces x% more value. Okay, so how do VC's identify businesses that will have X% growth in the number of users? Inform please.

Also, just a pedantic gripe, but someone should really inform this guy of the meaning of exponential growth. His definition that an "exponentially" growing firm the next million nets more value than the previous million would also apply to quadratic growth.

I think VCs in general will be backing less companies in the next year or two. Part of this may be that limited partners who have pledged a certain amount of investment capital will be trying to delay VC funding rounds until the economy stabilizes. Other has to do with the fact that there was a drastic reduction in IPO and M&A activity in 2008. In 2007, there were 86 venture-backed IPOs. In 2008, there were only 6, and 5 of those were in Q1 2008. On the M&A side, there were 360 venture-backed M&As in 2007. In 2008, there were 260. So in other words, VCs aren't getting their money back.

Out of the less number of companies being backed, I guess by this article's argument, these "exponential growth" companies are more likely to be funded. But isn't that obvious? If you were going to invest your money, would you invest in a company that "grows slowly" or a company that "grows really fast"? I guess it's safe to say: don't try to start a venture-backed service company...

Build/Make/Do it once, sell it many times. However, fixed costs (non continuous function) increase as customers increse in numbers. Consumer products have variable costs ($/unit) and a non continuous function for fixed costs too. At full capacity you have to build more physical capacity (investment + fixed costs) in order to supply more customers.

So trying to find out what this Mark is talking about, you can think the value added as a function that is trying to scape toward the infinite (in the y-axis). Web based services has no variable cost (or this is tiny) so value added is pulling down only by fixed cost, which at some point jump to other value (we have to increase capacity to continue serving current and new customers!). It seems that web-based services value added function can reach farther points. This makes sense on a paper but real business is harder.

There a lot of people chasing the kind of opportunities that he advocates: ones that have strongly superlinear scaling. That kind of investment comes with a possibility of an explosive gain, but there are many opportunities out there that are profitable but don't grow quite as dramatically. If investors didn't put money into them, they'd be (i) leaving money on the table and (ii) impoverishing the development of a wide range of goods and services that people want and need.