Closer To The Ideal

Dan Bezdek posted on LinkedIn, suggesting that it was impossible to launch an online business nowadays due to the hyper-competition on the web. He wrote:

I still think there is a huge difference between an online business and a traditional business. We have this grocery store in the neighborhood which is right next to Safeway. Now, you’d imagine there is no hope for this store; however, not only it is surviving, but in fact has so many customers.

He also wrote:

The main problem is that the culture of internet is free service, and this problem will remain with Internet forever. You might spend a couple of years in development, and provide a great service; but you can’t charge users even a $1 except in very few niche sections.

I wrote a response, but LinkedIn limited me to 4,000 characters, so I was not able to post my whole response. I post it here, instead.

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Dan Bezdek, I’m afraid I’m unable to understand your reasoning. I’m going to try to paraphrase what I think you are saying.

You write “It is so easy for anyone in the world to compete with you even in places that $100 is a week pay.”

I think you are trying to say that because computer programmers can be hired cheaply, it is more difficult for you to build a business? But the opposite is true: cheap computer programmers make it easier to launch a new business. I can not think of a single case in economic history where the falling price of a supply factor made it more difficult to launch a new business. A few examples:

1.) During the late 1600s, in Europe, the dramatic fall in the price of paper allowed for the creation of the first modern newspapers. The Spectator launched on March 4, 1712.

2.) During the mid 1700s, in Europe, the dramatic fall in the price of coffee beans allowed for the first coffee houses to open. Paris had hundreds of small coffee stands at the outbreak of the Revolution.

3.) During the late the 1800s, in America, the dramatic fall in the price of communications (the telegraph and the telephone) allowed for the organization of businesses over a distance, and at a scale, never before seen.

4.) During the late 1900s, all over the world, the dramatic fall in the price of computing power brought several new technologies into the mass market, including cell phones, personal computers, and personal (non-business) software.

As a general rule, the cheaper supplies get, the easier it is to start a business.

You also wrote this:

“In any case, the point of all this is to say that developing even a barely successful online business is probably 10 times more difficult than setting up a grocery shop.”

You didn’t mention which country you are in. If you are in the United States, then your statement is incorrect. The retail sector in the US is overbuilt and is expected to consolidate over the next 10 years. Many grocery chains are expected to go bankrupt. Meanwhile, the Commerce Department projects that the software industry will continue to grow, and much of that growth will be happening on the web.

If you do not live in the US, then I’d have to know what country you are in, to know if there is any truth to what you are saying. Some countries, such as France and Italy, offer strong legal protections to small firms. In those countries, small groceries have some hope of surviving, but that is because of government protection, not economic fundamentals.

I think the concept that you are trying to get at is what economists would call “barriers to entry”. That is, what barriers keep competitors from entering your market and competing with you? And I think what you are thinking is that a local grocery store, because it is grounded in a specific geographical space, has some immunity from competition, whereas a web site has to compete with every other web site on the web.

Again, if you are speaking about the US, you are plainly wrong. The history of post-war economic development in the US is the history of retail consolidation. Mom-n-Pop stores have been relentlessly replaced by big chains such as Wal-Mart. Massive numbers of bankruptcies have happened in every state. The small-scale grocery was once common, and now is nearly extinct. They’ve been hunted to extinction through the relentless competitive pressures of market consolidation.

Consider the graph that the US government has posted here:

In the late 1990s, a number of leading grocery retailers went on a buying spree. Between 1997 and 2000, more than 4,100 stores were acquired, amounting to almost a fifth of all U.S. supermarkets. Mergers and acquisitions by large grocery retailers, including Kroger, Albertson’s, Ahold USA, and Safeway, produced a significant increase in the share of grocery store sales by the largest firms. By 2005, the 20 largest retailers accounted for 61.6 percent of total U.S. grocery store sales, up from 40.6 percent in 1995.

If you look at the facts, you’ll admit that small-scale groceries have mostly been wiped out. And this happened during some of the same decades that saw the explosive growth of the US software market.

Clearly, it is possible to make a lot of money on the web. 37 Signals makes millions of dollars in sales, and Amazon makes billions of dollars in sales. AOL is making a shockingly large gamble on weblogs.

You include this surprising comparison:

Now, compare this store to many 2-3 men operations online trying to make it online offerring some service; there are thousands of such operations which wish they were making as much as that grocery store.

I assume you meant “people” where you wrote “men”. A 3 person web start-up will cost less than running a grocery store. Even a small grocery store is going to have more than $50,000 worth of inventory in it, then it will have labor costs, rent or real estate taxes plus land cost, licenses for health, fire, safety, etc. If you are going to compare businesses that have different capital requirements, then you might as well write “I tried to run a lemonade stand, but it never made as much money as Toyota.” The comparison is absurd.

Of course, as segments of the web mature, the capital requirements for starting a web site go up for that particular segment. Once upon a time, a long time ago, you could start a successful weblog for free. Nowadays, if you are starting a weblog which you hope will develop a mass audience, then you should probably have $100,000 for marketing and writers. Likewise, if for some crazy reason you decide to launch a competitor to YouTube, you should start with $100 million in the bank. In the future, you may need millions of dollars to get into any established segment. But some segments will remain open to the sudden hit that comes form nowhere. Weblogs, for instance, began to consolidate some time ago, yet new weblogs still occasionally burst forth and become large-scale hits. And one of the great things about the web (so far) has been the speed with which new segments emerge.

I’ve already written extensively about the costs of building a web site. And I’ve helped launched a number of successful sites that cost less than $100,000 to get going. And I continue to work with start-ups that have budgets under $100,000, and I’ve great faith that a number of these will become successful.

If you are thinking of starting a new business, you’d be wise to start it online.

Jory Des Jardins writes with nostalgia about what print media used to be like:

I’m sure if I had stuck it out a bit more and not taken a new media job five years in I might have made more of a go of it. But things discouraged me about traditional media. It had an established power structure that made it nearly impossible to get noticed. I wrote things I was proud of on the side, while editing more established writers in the waking hours and writing uninspired copy as a freelancer. But I hadn’t really established a voice that was worthy of cashing in favors from editor friends of mine.

…I’d only hoped I would be able to pursue this growing interest in a model counter intuitive to the people I used to work for. A model that democratized media, to a large extent, and made possible a notion terrifying to most people like me who hinged their self-worth on “making it” in traditional media: that there’s a whole helluva lot of talent out there and it ain’t all on the Hearst, Conde Nast, or Time Warner payrolls. Traditional media just took in whom they could fit, who matched the pedigree, or who had an uncle who could introduce you to the editor, or who had this random bit of luck and was seen for what she could produce, and sometimes bonafide talent. But so may others could not even make it to the filter, let alone make a living at it.

Back in my print days, there was something so alluring about being one of a few selected, whose name would be committed to print. And there’s a whole community of folks, I’m sure, who still hold print sacred. I’m one of them, even as someone whose name has only made it via her work in new media. I fretted so long about being a part of it that even while it’s suffering I promise to someday return — if it will have me. Many bloggers who are doing just fine building platforms online still look at the book deal as the summit of success. I’ll know I’m fully evolved when I couldn’t care less about hardcover, softcover, or any cover.

Traditional media was hierarchical and often unfair. One’s actual talent was often overlooked due to the personal politics inside each organization. It is hard for me to feel nostalgia for the old model, though possibly I feel a slight nostalgia for the great era of photojournalism, when people like Henri Cartier-Bresson were at work, an era which was funded by the mass circulation magazines.

But all business models die, eventually. In the modern era, we’ve achieved the freedom to constantly re-invent ourselves. While this is occasionally stressful, it is a freedom that people have spent centuries fighting to establish. And this freedom is one of the most exciting aspects of being alive during this era. Karl Marx has a reputation for being critical of market based economies, but few people described our era as perfectly as he did:

Constant revolutionizing of production, uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones. All fixed, fast frozen relations, with their train of ancient and venerable prejudices and opinions, are swept away, all new-formed ones become antiquated before they can ossify. All that is solid melts into the air, all that is holy is profaned, and man is at last compelled to face with sober senses his real condition of life and his relations with his kind.

Sarah Lacy points out that risk aversion and short term thinking are overwhelming the tech industry:

I think there’s also a mindset problem when it comes to venture capital. Investors and many entrepreneurs are no longer focused on building companies and taking real risk. Paul and I did another clip yesterday about Facebook, where he argued it doesn’t make sense for Facebook to stay a stand alone company anymore because the ad markets are going to be locked up for 24 months.

I love P-Ked, but what the hell does a 24 month contraction have to do with building a company? Especially a company that’s still private, growing like mad, has loads of money in the bank and is essentially break even? We’ve got to break ourselves from this quick-fix, quarter-to-quarter mentality of Wall Street– and increasingly Silicon Valley– if any next great tech companies are going to be formed. The very reason great companies are typically started during downturns is they’re started by people who aren’t obsessed with timing a market. They’re started by real entrepreneurs.

In her BusinessWeek column, she also points out that it’s been a bad decade for tech focused venture capital:

But check your calendar. We’re closing in on 2009. And even if the financial system on which VCs depend for returns averts collapse, it’s still in for a few years of serious wound-licking and stepped-up government regulation. Ask anyone in Silicon Valley whether Sarbanes-Oxley had a chill on IPOs.

This realization hit me like a ton of bricks during a recent trip to Boston, coincidentally the same day Lehman Brothers (LEHMQ) filed for Chapter 11. I was sitting down with Tom Crotty, of the venerable Battery Ventures, which had a unique approach to the tech meltdown. Battery, full as it is with more financial gurus than Valley-style engineers, responded by diversifying from traditional startup investments into so-called Private Investments in Public Stocks (PIPEs). Battery also capitalized on the consolidation of cash-rich but fragmented industries.

Crotty hopes the atypical investment approach will insulate Battery, but he nonetheless sees a reckoning coming—specifically toward the end of 2010. He points to 2000 as the “last really good year” for venture capital. Looking back, “the one-year, three-year, and five-year indexes are all going to be terrible,” Crotty says. “And once 1999 and 2000 fall off, the 10-year will be, too. It’s going to be painful.”

But she also points out that there are new markets out there waiting for investment:

That won’t be such a bad thing. After a painful period of forced reckoning with bad past decisions, VC will emerge stronger. Entrepreneurs and the larger U.S. economy will still need venture capital. Some venture capitalists will engineer a new way to make venture-style returns, like Battery Ventures did eight years ago. Many will turn to emerging markets such as India and China. There will be even fewer Google-like (GOOG) home runs. Then again, a leaner, smarter industry may not need as many.

She puts needed qualifiers around the idea that downturns are good for innovation:

To those of you who say platitudes like: “Downturns are GREAT times for innovation!” yes, that’s true, but you are missing the point. This isn’t just the cause of a downturn. This is a structural change in the industry that needs to occur and has been building for nearly a decade. There is far too much money, tech is maturing, and clean tech isn’t mature enough.

Real innovation can not be done in 90 days. Real innovation does not conform to quarterly profit reports. Real innovation comes from those people who can see a potential business when it is still way out on the horizon, and then find ways to reduce the risk of getting from here to there:

People think entrepreneurs are risk-loving. Really what you find is successful entrepreneurs hate risk, because the founding of the enterprise is already so risky that what they do is take their early resources, the small amounts of capital that they have, whatever assets they have, and they deploy those resources systematically, eliminating the largest risk first, the second-largest risk, and so on, and so on.

Jeff Bezos

In the title of this post I used the word “coward”. That is a strong accusation. It is deserved by those who feel the normal risk minimization of entrepreneurs is no longer enough to allow a business to be trusted with money. It is deserved by those who now only place sure bets, and only short term ones, too.

The tech industry, especially the web portion of it, has been infected with speculative excess. During the South Sea Bubble of 1720 financial manipulators raised money for “a company for carrying out an undertaking of great advantage, but nobody to know what it is” and today we have similar ill dealings: “The company will ‘let its purpose and presence be known’ as soon as they reach their goal of raising a Series A capital round of $10 million”.

For the true entrepreneur, the goal is always MR4MR: minimum risk for maximum reward. But they have bold goals that demand big risks be taken — they then set out to find the least risky way of achieving that goal. This applies to many fields. Shakespeare, Napoleon, Thomas Edison and Bill Gates had this common: they were all successful at minimizing the risks they had to run to achieve their goals, yet their goals were so ambitious that even the least risky path still entailed big gambles. The NASA team that first sent men to the moon was fanatic about reducing risk, yet still the mission was among the riskiest endeavors ever undertaken by the human race.

The driving force of the digital revolution were two fold: the increasing power of computer chips, and the dramatic fall in the price of communications, due to breakthroughs in multiplexing. The pulse of change for both has grown slower. Wal-Mart, Fed-Ex, Google and Twitter were all instances of a creative soul finding that the digital revolution allowed a new way to organize human activity. Such surprising alterations to the existing scene will continue as long as there is still growth in computing power and communicative capacity, though the appearance of such novel businesses can be expected to slow as innovation in the underlying technology does.

We should not allow the term “innovation” to be killed by its over-association with the industries that grew during the last few booms. There are other fields desperate for the intervention of  the entrepreneur: green energy, green transport, recycling, lower impact production methods, the education of adults, the teaching of children, child care, environmental clean up. We will soon see a new wave of change in the oldest industry, I mentioned community supported agriculture in the post where I made predictions, in some sense no economic activity is more important than how the human race feeds itself. And at some point in the next 50 years we will see considerable breakthroughs in the way the human race relates to living things on earth, as our understanding of the underlying rules of DNA come into focus.

Downturns are a great time for innovation, but the invitation is only there for those who are thinking long term.

Sam Zell made a terrible mistake when he bought the Tribune Company:

When the Tribune Company announced that it was filing for bankruptcy, last Monday, Sam Zell, the man who bought the company a year ago, for $8.2 billion, said that its problems were the result of a “perfect storm.” You take readers and advertisers who were already migrating away from print, and add a steep recession, and you’ve got serious trouble. What Zell failed to mention was that his acquisition of the company had buried it beneath such a heavy pile of debt that any storm at all would likely have sunk it. But although Zell was making excuses for his own mismanagement, the perfect storm is real enough, and it is threatening to destroy newspapers as we know them. Layoffs and buyouts have become routine. The Miami Herald and the San Diego Union-Tribune are reportedly on the selling block, while lawmakers in Connecticut are trying to keep two newspapers there afloat. Even the New York Times Company has slashed its dividend and announced that it would borrow against its headquarters to avoid cash-flow problems.There’s no mystery as to the source of all the trouble: advertising revenue has dried up. In the third quarter alone, it dropped eighteen per cent, or almost two billion dollars, from last year.

Newspapers are simply a method of delivering ads:

It turns out that subscribers are more expensive, not less expensive, than online readers. Yes, they pay more — but they’re not paying for intensive reporting, experienced editors, and the like. They’re paying for printing presses, mobbed-up newspaper delivery operations, and the whole enormous physical infrastructure involved in getting thousands of tonnes of newsprint delivered to millions of front doors every morning. It’s a hugely expensive operation, and its costs are nowhere near covered by subscription revenues.

There’s an old saying that you’ll never understand newspaper economics until you understand why newspaper vending machines are designed so that you can take as many papers as you like for your quarter. Newspapers are, first and last, devices for delivering ads to readers. It’s the ads which account for all the profits, not the cash coming from subscribers or people who buy their paper at the newsstand. Yes, news itself is free, nowadays. But it always has been. What we’ve been paying for all these years was never news, it was papers.

Lately there have been a lot of articles about the newspaper industry. We are told that this recession is killing off newspapers, everything is moving to the web. There is some mourning, people wonder how journalism will survive once the newspapers are gone. But consider the other side – where will the ad dollars go? When the next boom hits, America will have a lot less newspapers than it has had in the past. And much more of the public will think it natural to get their news online. Doesn’t it seem that at some point quite a bit of ad revenue must become available to online ventures?

I recall somewhere around 1995 there was a lot of talk about the Internet being a disruptive technology that would lead to the bankruptcy of a large number of older, obsolete firms. The bankruptcies did not materialize with the speed that people had expected, so somewhere around 2000 there were a number of articles explaining how the web wasn’t really a disruptive technology, instead, it was an enabling technology.

But in truth, it was a disruptive technology. And the bankruptices are finally beginning to arrive.

Earlier in the month, I was thinking out loud about the future of publishing online, especially where the news was concerned. Others are having a similar conversation:

Internet news is a classic disruptive technology. At its outset, it was simple, dirt cheap, and in many ways inferior to established journalism. But it improved over time, and once it began to rival traditional journalistic outfits in quality around the middle of this decade, the “dirt cheap” part of the equation began to dominate. When your competition can produce a roughly comparable product for a small fraction of the cost, your days are numbered.

But here’s the really important point that Christensen made that is often missed in these kinds of discussions: it’s often close to impossible for an organization built around an older technology to retool for a new, disruptive one because their cost structures just don’t allow it. The New York Times is an expensive place to run. It’s got writers, editors, typesetters, delivery trucks, an ad sales force, a big building, travel budgets, and so forth. In order to recoup those costs, they have to make a certain amount of revenue per unit of output. The institutional structure of the New York Times makes it almost impossible for it to produce news the way TPM Muckraker or Ars Technica do. The need to make payroll and cover their rent makes it almost mandatory for them to focus on their traditional core competencies because even as those markets shrink they still offer better margins than the emerging businesses.