Supported by Greenhaven Road Capital, finding value off the beaten path.
Jeff Jordan’s career includes stints at eBay, The Walt Disney Store, Reel.com, and Paypal and as a GP at a16z, his current role.
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Successful businesses, a friend told me, either sell the same things to new people or sell new things to the same people. That idea leads to two questions:
- Do you have a ‘healthy’ relationship between costs and revenue?
- Do you have the ability to add layers to the cake?
In venture capital, the goal is to stomach the former until you can feast on the latter. Temporary unprofitability is tolerated. Paul Graham wrote, “The slower you burn through your funding, the more time you have to learn.” It’s one of the six things Instagram did right.
A slow cash burn means more time to learn.
Jordan and his colleagues at a16z like Andrew Chen want businesses that can grow gigantically. That tends to mean network effect flywheels and craftsmanship like growth.
Jordan admitted that he can’t code and he’s not a technologist but that’s not a huge disadvantage. “I love product.” Specifically technology products. His first foray was selling DVDs for Reel.com, a company that “lost money on every DVD they sold.” Realizing his mistake he fished around for another opportunity and ended up at eBay, “I went from one of the worst business models on the internet to one of the best.”
Part of the reason a platform business is a great business is that it lacks tangible assets. This was not always obvious. Newspapers knew eBay nipped away classified listings and they investigated investing in the company. But, one executive told, Brian McCullough, “he couldn’t sell it to his c-suite because eBay didn’t have any factories, or trucks and his c-suite would ask, ‘What exactly are we buying?'” That’s a feature, not a bug, replied Ben Horowitz.
Jordan succeeded at eBay and later at Paypal because these platforms allowed consumers to set the direction. His colleague at a16z, Andrew Chen, said, “What’s great about a lot of platforms is that emergent behaviors take place and one of those for the snail mail was the chain letter.”
Twitter introduced the ‘@’ sign after users created it. Netflix introduced shows based on what users watched. Paypal’s breakthrough as an eBay payments company was also an emergent behavior.
“An engineer had the idea (at Paypal) to enter payments on the computer (instead of beaming payments between Palm Pilots). A couple of months later, the business is exploding and they don’t know why. So they call the users and ask, ‘Who are you?’ The repeated response was, ‘I’m an eBay seller.’ They stumbled on the fact that eBay had a huge friction in their payment process.”
And, “The best strategy we had at eBay was to watch what the community was doing and try to make it easier.”
But not always. When Jordan considered ‘adding layers to the cake’ he considered ‘Buy it Now.’ He took this idea to the original eBay users and they hated it. The auction was part of the charm, part of the thrill, part of the esprit de corps of eBay. Jordan tested it anyway. It was a hit.
Internet companies should behave like internet companies said Andrew Ng. Malls with websites aren’t Amazon and streaming radio stations aren’t Spotify. Internet companies have to use a/b testing, bottoms-up innovation, and iteration to make their changes. The oldest users didn’t want to Buy it Now but many of the rest – and the soon to be – did.
Network effect companies enabled by the internet are one of the best business models available. But, “The hardest part is getting the network effect started.”
One option is direct payments to users for referrals, like Paypal. Another is a tool, like the OpenTable reservation system. However an entrepreneur ‘kickstarts the flywheel’ they should lean slightly toward buyers and not sellers on the network. Patrons have more and better alternatives than restaurants. “The sellers were paying us but we were biased to the buyers all day long.”
Jordan elaborated on OpenTable, “The key tactic to build the network effect was that free acquisition of consumers that the more restaurants we had, the more attractive it was to consumers the more consumers who came, the more attractive it was to restaurants. So there is a wicked network effect.”
And yet these businesses aren’t without their challenges. “Large scale marketplaces have tons of strangers doing business with tons of strangers.” It needs to be open (sell whatever you want) but not too open (don’t cheat, lie or steal). This might be best seen in Twitter and Facebook after the 2016 American elections. Some wanted limits to what individuals or businesses could post but limitlessness was what enabled those platforms to grow.
Luckily there are other ways to build businesses. Network effect flywheels are the Simone Biles of the business world; the hardest to pull off but the largest reward if you do. Jeff Jordan and Andrew Chen address specific customer steps for budding businesses; acquisition, engagement, and retention.
From Jordan perspective, “Done right, growth is a scientific discipline because it requires you to understand your business at a micro level.” Don’t think hacks, think strategies that align with a business model.
The earliest customers have to be the shut up and take my money types. Chen explained, “you know, your initially super, super excited core demographic of customers — like they’re gonna convert the best and as you start reaching into different geographies, different kinds of demos, all of a sudden they’re not gonna convert as well.”
Jordan adds, “CAC tends to go up, LTV tends to go down. Because you’re, on the CAC side, you’re acquiring the less interested users over time.”
Unlike baseball caps, CAC and LTV are not one size fits all. Sam Altman advises founders to have their CAC match their business model. If it costs one dollar to acquire a B2B customer whose lifetime value is two and churn is almost zero then pay the dollar to acquire them.
Part of what makes platforms great is the low, zero, (or negative) CAC. It’s no surprise then to see Slack as an a16z investment. Enterprise businesses have higher hit rates but lower ceilings than consumer-focused (which are the opposite). The a16z approach also fits nicely with our Pat Dorsey inspired moats and allocators episode.
Chen said, “What entrepreneurs should think about is what is the unique organic new thing that’s gonna get it in front of people, without spending a bunch of money.” Ways to do that include Lyft’s pink mustache, Lime’s green scooters or even Waffle House’s yellow sign.
Businesses also need to think in terms of sharing. Patrick Doyle of Dominos and Ashley McCollum of Tasty both say that consumers now own the brand. Chen said, “all of these different brick-and-mortar experiences that are making themselves highly Instagrammable”
Businesses should consider cheap (0r zer0) customer acquisition. If that weren’t enough, businesses must then keep and engage their customers. This, said Jordan and Chen, is more about the product. “You can often hack your way into new users. It’s really hard to hack your way into true engagement.”
What should a business do? Talk to users.
Rob Fitzpatrick explains how to do this in his book The Mom Test. It comes down to finding out needs not actions, about requests, not benefits.
One of Steve Jobs’s notable quotes was that the user doesn’t know what they want. That may be true, but they do know what they need. Organizations like IDEO and practitioners like Fitzpatrick and Jan Chipchase have built businesses around this gap.
If someone follows this path they’ll see that Pinterest and eBay are browsing experiences while Amazon is a buying experience.
Ideal investments are in businesses with an economical CAC built on an accelerating flywheel (e.g. mobile, internet).
Ideal, ha! These are clear concepts but hairy tasks.
OpenTable is only an example thanks to fortuitous timing. There were a handful of companies doing similar things and they happened to close a funding round before an investing winter. “If OpenTable was started today I don’t think they’d be as successful because of the emulation that happens.”
Alpha erodes. Daryl Morey said, “it’s a real problem with the draft…and this year again it was straight down our board…the draft is more efficient.”
The next edge, frontier, hummus is something weird. Jordan said, “The best pitches are some combination of analogy, ambition, and that ‘Oh my god that’s so obvious and yet no one has thought of it’.”
That’s good differentiation. If it’s bad, “and you’re highly reliant on paid marketing, the movie typically doesn’t end really great.”
Part of this is telling your story well. Aswath Damodaran says in his valuation class, “Every number in my valuation has to have a story behind it and every story that I tell about a company has to have a number attached to it.”
Terry O’Reilly noted, “When you’re starting out the lack of marketing budget is always an issue but I think the bigger issue how to differentiate your business. Amateurs always think marketing is about selling stuff and the professionals know it’s about differentiating your business.”
And don’t think about it as selling, said Jordan, “You don’t have to be a salesman, you have to be an effective seller.”
Thanks for reading.