Senior Technology Reporter-Silicon Valley Business Journal
New Enterprise Associates averaged a U.S. funding deal every three days in the first half of this year, the hottest six months for the industry since the end of the dotcom boom in 2001.
Not far behind NEA's 64 first half deals were Kleiner Perkins Caufield & Byers (54), Andreessen Horowitz (52) and Google Ventures (50), according to a report from investment database research firm CB Insights.
An interesting fact from the report is that NEA wasn't involved in any of the huge deals that went down in the most recent quarter, nearly all of which happened here in the Silicon Valley and San Francisco area. That includes Uber ($1.2 billion), AirBnB ($500 million), Lyft ($250 million), Pure Storage ($225 million) Intarcia Therapeutics ($200 million) and Pinterest ($200 million).
CB Insights only tracks deals that include venture firms, so it doesn't factor in any of the big late-stage fundings that came entirely from hedge fund and private equity investors.
The firm said that investors poured 39 percent more capital — nearly $24 billion — into 11 percent more deals than had been recorded in the first three months of the year, the hottest quarter since the second quarter of 2001.
After Q1’14 saw venture capital investment hit its highest quarterly mark since Q2’01, investors deployed 39 percent more capital across 11 percent more deals. In aggregate, H1’14 saw U.S. VC funding leap to $23.87B, a 71 percent increase versus H1’13.
Overall, there were more than 300 funding deals and more than $4 billion invested in each month in Q2.
Among Kleiner Perkins' 54 deals in the second quarter was the $40 million funding of Palo Alto-based Big Data company RelateIQ, which was acquired Friday by Salesforce.com for $350 million.
Here is CB Insights' full list of the most active venture investors in the first six months:
— 1. New Enterprise Associates: 64.
— 2. Kleiner Perkins Caufield & Byers: 54.
— 3. Andreessen Horowitz: 52.
— 4. Google Ventures: 50.
— 5. 500 Startups: 47.
— 6. Khosla Ventures: 40.
— 7. SV Angel: 35.
— 7. Accel Partners: 35.
— 9. Sequoia Capital: 33.
— 10. First Round Capital: 32.
— 11. Greylock Partners: 30.
— 12. Lerer Hippeau Ventures: 28.
— 12. Foundry Group: 28.
— 14. True Ventures: 25.
— 15. General Catalyst Partners: 25.
— 16. Battery Ventures: 24.
— 16. Atlas Venture: 24.
— 18. RRE Ventures: 23.
— 19. Lightspeed Venture Partners: 22.
— 19. Intel Capital: 22.
— 19. InterWest Partners: 22.
— 19. Bessemer Venture Partners: 22.
Director of Client Development
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Here are 10 ways to damage your fast-growing tech startup – and hurt the perception of Silicon Valley in the process. None of these are specific to any one company; they’re general patterns we’ve observed across multiple cycles of tech startups.
#1 Only hiring — or training/motivating/incenting your managers to hire — without focusing on firing. Or on performance management and efficiency optimization.
#2 Selling too much of your own personal stock too quickly, which alienates employees and leads people to question your long-term commitment as a founder. On a related note, letting private stock sales by employees get out of hand creates a “hit-and-run culture” — and forces your company to take on the burdens of being public before actually going public.
#3 Diluting the crap out of the cap table by being sloppy and undisciplined with stock grants to early employees. This also plants hidden “morale landmines” for later employees.
#4 Maximizing absolute valuation of each growth round, which not only makes later rounds harder and harder to achieve but can trigger a disastrous down round.
#5 Letting investors (including, occasionally, private equity firms and hedge funds) suck you into terrible structural terms on growth rounds. You’re guaranteed massive trauma if anything goes even slightly wrong there.
#6 Going public too soon! Going public before you’re a fortress, before you can withstand all assaults leads to a stock-price death spiral and ends up in a train wreck for everyone.
#7 Pouring huge money into overly glorious new headquarters — “The Edifice Complex” — then repeating two years later. There’s also a danger in signaling to employees “we’ve made it, we’re amazing” (and while everyone hates the cramped but collaborative space when they’re in it, they miss it terribly after the move).
#8 Assuming more cash is always available at higher and higher valuations, forever. This one will actually kill your company outright.
#9 Confusing the conference circuit — and especially the party scene — with actual work. This also creates a toxic culture on multiple fronts by encouraging alcohol/drugs and valuing so-called “ballers” over other important, less “loud” contributors.
#10 Refusing to take HR seriously! This issue isn’t specific to just tech-heavy environments; it’s prevalent in any highly creative, highly skilled workplace. At a certain company size, you need both the ability to manage people and an effective HR person. (Even though it is absolutely worth training company leadership in good HR practices, most managers are dangerously amateur at doing actual HR). Without smart, effective HR, terrible internal managerial and employee behavior leads to a toxic culture that can catalyze into a catastrophic ethical — and legal — crisis.
Venture's Q2 surge: Dollars, deals and dominant players
Cromwell Schubarth Senior Technology Reporter-Silicon Valley Business Journal
Valuations on venture-backed companies jumped again in the second quarter as the number of IPOs and the amount VCs invested in startups both hit post-dot-com highs, a new report from PitchBook Data shows.
The total amount invested has climbed steadily each quarter in the past year, jumping from $12.8 billion in Q2 of 2013 to $21.5 billion in the same period this year. The $13.9 billion raised in 76 new venture funds is also a recent high.
Sequoia Capital invested in the most companies in the quarter — participating in 35 deals — and tied with New Enterprise Associates for the most exits with eight.
The big deal for the Menlo Park firm was Facebook's $19 billion acquisition of WhatsApp, which was announced in the first quarter but closed in the second quarter.
That deal also skewed the total amount of capital exited, which jumped from between $16 billion and $19.2 billion in the previous three quarters to $37.9 billion in the second quarter.
The biggest deals Sequoia participated in were the $100 million round for South Korean e-commerce company Coupang, a $100 million round for Chinese content distributor Toutiao and a $75 million round for San Francisco identity management company Okta.
After Sequoia's 35 deals, Andreessen Horowitz was the second most active with 31 deals, followed by Accel Partners (29) and Kleiner Perkins Caufield & Byers (27).
Pre-money valuations were also up compared to last year's second quarter, ranging from a 34 percent jump to $6.2 million at the seed/angel stage to a 122.2 percent jump in Series D and later rounds.
The length of time between when a startup was founded and when it paid off in an acquisition (the vast majority of exits) was about 6.4 years. PitchBook reported 193 of those deals in the quarter.
The average time to exit for the 47 IPOs in the quarter was 10.8 years. That number has been hovering between about 10 and 11 years since 2009. That's up markedly from prior years when it was typically between seven and eight years between launch and going public.
The average time to exit for the 15 private equity buyouts in the quarter was 11.3 years.
Software companies had by far the most exits, with 107 of the 255 exits reported in the second quarter. That is double the 28 exits each reported in the two sectors that were next — commercial services and biotech/pharmaceuticals.
The software sector also had by far the most fundings in the quarter, accounting for 641 of the 1,590 deals reported.
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Digitization is rewriting the rules of competition, with incumbent companies most at risk of being left behind. Here are six critical decisions CEOs must make to address the strategic challenge posed by the digital revolution.
The board of a large European insurer was pressing management for answers. A company known mostly for its online channel had begun to undercut premiums in a number of markets and was doing so without agents, building on its dazzling brand reputation online and using new technologies to engage buyers. Some of the insurer’s senior managers were sure the threat would abate. Others pointed to serious downtrends in policy renewals among younger customers avidly using new web-based price-comparison tools. The board decided that the company needed to quicken its digital pace.
For many leaders, this story may sound familiar, harkening back to the scary days, 15 years ago, when they encountered the first wave of Internet competitors. Many incumbents responded effectively to these threats, some of which in any event dissipated with the dot-com crash. Today’s challenge is different. Robust attackers are scaling up with incredible speed, inserting themselves artfully between you and your customers and zeroing in on lucrative value-chain segments.
The digital technologies underlying these competitive thrusts may not be new, but they are being used to new effect. Staggering amounts of information are accessible as never before—from proprietary big data to new public sources of open data. Analytical and processing capabilities have made similar leaps with algorithms scattering intelligence across digital networks, themselves often lodged in the cloud. Smart mobile devices make that information and computing power accessible to users around the world.
As these technologies gain momentum, they are profoundly changing the strategic context: altering the structure of competition, the conduct of business, and, ultimately, performance across industries. One banking CEO, for instance, says the industry is in the midst of a transition that occurs once every 100 years. To stay ahead of the unfolding trends and disruptions, leaders across industries will need to challenge their assumptions and pressure-test their strategies.
Opportunities and threats
Digitization often lowers entry barriers, causing long-established boundaries between sectors to tumble. At the same time, the “plug and play” nature of digital assets causes value chains to disaggregate, creating openings for focused, fast-moving competitors. New market entrants often scale up rapidly at lower cost than legacy players can, and returns may grow rapidly as more customers join the network.1
Digital capabilities increasingly will determine which companies create or lose value. Those shifts take place in the context of industry evolution, which isn’t monolithic but can follow a well-worn path: new trends emerge and disruptive entrants appear, their products and services embraced by early adopters (exhibit). Advanced incumbents then begin to adjust to these changes, accelerating the rate of customer adoption until the industry’s level of digitization—among companies but, perhaps more critically, among consumers as well—reaches a tipping point. Eventually, what was once radical is normal, and unprepared incumbents run the risk of becoming the next Blockbuster. Others, which have successfully built new capabilities (as Burberry did in retailing), become powerful digital players. (See the accompanying article, “The seven habits of highly effective digital enterprises.”) The opportunities for the leaders include:
- Enhancing interactions among customers, suppliers, stakeholders, and employees. For many transactions, consumers and businesses increasingly prefer digital channels, which make content universally accessible by mixing media (graphics and video, for example), tailoring messages for context (providing location or demographic information), and adding social connectivity (allowing communities to build around themes and needs, as well as ideas shared among friends). These channels lower the cost of transactions and record them transparently, which can help in resolving disputes.
- Improving management decisions as algorithms crunch big data from social technologies or the Internet of Things. Better decision making helps improve performance across business functions—for example, providing for finer marketing allocations (down to the level of individual consumers) or mitigating operational risks by sensing wear and tear on equipment.
- Enabling new business or operating models, such as peer-to-peer product innovation or customer service. China’s Xiaomi crowdsources features of its new mobile phones rather than investing heavily in R&D, and Telstra crowdsources customer service, so that users support each other to resolve problems without charge. New business or operating models can also disintermediate existing customer–supplier relations—for example, when board-game developers or one-person shops manufacture products using 3-D printers and sell directly to Amazon.
The upshot is that digitization will change industry landscapes as it gives life to new sets of competitors. Some players may consider your capabilities a threat even before you have identified them as competitors. Indeed, the forces at work today will bring immediate challenges, opportunities—or both—to literally all digitally connected businesses.
Seven forces at work
Our research and experience with leading companies point to seven trends that could redefine competition.
1. New pressure on prices and margins
Digital technologies create near-perfect transparency, making it easy to compare prices, service levels, and product performance: consumers can switch among digital retailers, brands, and services with just a few clicks or finger swipes. This dynamic can commoditize products and services as consumers demand comparable features and simple interactions. Some banks, for instance, now find that simplifying products for easy purchase on mobile phones inadvertently contributes to a convergence between their offerings and those of competitors that are also pursuing mobile-friendly simplicity.
Third parties have jumped into this fray, disintermediating relationships between companies and their customers. The rise of price-comparison sites that aggregate information across vendors and allow consumers to compare prices and service offerings easily is a testament to this trend. In Europe, chain retailers, which traditionally dominate fast-moving consumer goods, have seen their revenues fall as customers flock to discounters after comparing prices even for staples like milk and bread. In South Korea, online aggregator OK Cashbag has inserted itself into the consumer’s shopping behavior through a mobile app that pools product promotions and loyalty points for easy use across more than 50,000 merchants.
These dynamics create downward pressure on returns across consumer-facing industries, and the disruptive currents are now rippling out to B2B businesses.
2. Competitors emerge from unexpected places
Digital dynamics often undermine barriers to entry and long-standing sources of product differentiation. Web-based service providers in telecommunications or insurance, for example, can now tap markets without having to build distribution networks of offices and local agents. They can compete effectively by mining data on risks and on the incomes and preferences of customers.
At the same time, the expense of building brands online and the degree of consumer attention focused on a relatively small number of brands are redrawing battle lines in many markets. Singapore Post is investing in an e-commerce business that benefits from the company’s logistics and warehousing backbone. Japanese web retailer Rakuten is using its network to offer financial services. Web powerhouses like Google and Twitter eagerly test industry boundaries through products such as Google Wallet and Twitter’s retail offerings.
New competitors can often be smaller companies that will never reach scale but still do a lot of damage to incumbents. In the retailing industry, for instance, entrepreneurs are cherry-picking subcategories of products and severely undercutting pricing on small volumes, forcing bigger companies to do the same.
3. Winner-takes-all dynamics
Digital businesses reduce transaction and labor costs, increase returns to scale from aggregated data, and enjoy increases in the quality of digital talent and intellectual property as network effects kick in. The cost advantages can be significant: online retailers may generate three times the level of revenue per employee as even the top-performing discounters. Comparative advantage can materialize rapidly in these information-intensive models—not over the multiyear spans most companies expect.
Scale economies in data and talent often are decisive. In insurance, digital “natives” with large stores of consumer information may navigate risks better than traditional insurers do. Successful start-ups known for digital expertise and engineer-friendly cultures become magnets for the best digital talent, creating a virtuous cycle. These effects will accelerate consolidation in the industries where digital scale weighs most heavily, challenging more capital- and labor-intensive models. In our experience, banking, insurance, media, telecommunications, and travel are particularly vulnerable to these winner-takes-all market dynamics.
In France, for instance, the start-up Free has begun offering mobile service supported by a large and active digital community of “brand fans” and advocates. The company nurtures opinion-leader “alpha fans,” who interact with the rest of the base on the Internet via blogs, social networks, and other channels, building a wave of buzz that quickly spreads across the digital world. Spending only modestly on traditional marketing, Free nonetheless has achieved high levels of customer satisfaction through its social-media efforts—and has gained substantial market share.2
4. Plug-and-play business models
As digital forces reduce transaction costs, value chains disaggregate. Third-party products and services—digital Lego blocks, in effect—can be quickly integrated into the gaps. Amazon, for instance, offers services that let businesses “insource” logistics, IT services, and online retail “storefronts.” For many businesses, it may not pay to build out those functions at competitive levels of performance, so they simply plug an existing offering into their value chains. In the United States, registered investment advisers have been the fastest-growing segment3 of the investment-advisory business, for example. They are expanding so fast largely because the turnkey systems (including record keeping and operating infrastructure) they can purchase from Charles Schwab, Fidelity, and others give them all the capabilities they need. With a license, individuals or small groups can be up and running their own firms.
In the travel industry, new portals are assembling entire trips: flights, hotels, and car rentals. The stand-alone offerings of third parties, sometimes from small companies or even individuals, plug into such portals. These packages are put together in real time, with dynamic pricing that depends on supply and demand. As more niche providers gain access to the new platforms, competition is intensifying.
5. Growing talent mismatches
Software replaces labor in digital businesses. We estimate, for instance, that of the 700 end-to-end processes in banks (opening an account or getting a car loan, for example), about half can be fully automated. Computers increasingly are performing complex tasks as well. “Brilliant machines,” like IBM’s Watson, are poised to take on the work of many call-center workers. Even knowledge-intensive areas, such as oncology diagnostics, are susceptible to challenge by machines: thanks to the ability to scan and store massive amounts of medical research and patients’ MRI results, Watson diagnoses cancers with much higher levels of speed and accuracy than skilled physicians do. Digitization will encroach on a growing number of knowledge roles within companies as they automate many frontline and middle-management jobs based upon synthesizing information for C-level executives.
At the same time, companies are struggling to find the right talent in areas that can’t be automated. Such areas include digital skills like those of artificial-intelligence programmers or data scientists and of people who lead digital strategies and think creatively about new business designs. A key challenge for senior managers will be sensitively reallocating the savings from automation to the talent needed to forge digital businesses. One global company, for example, is simultaneously planning to cut more than 10,000 employees (some through digital economies) while adding 3,000 to its digital business. Moves like these, writ large, could have significant social repercussions, elevating the opportunities and challenges associated with digital advances to a public-policy issue, not just a strategic-business one.
6. Converging global supply and demand
Digital technologies know no borders, and the customer’s demand for a unified experience is raising pressure on global companies to standardize offerings. In the B2C domain, for example, many US consumers are accustomed to e-shopping in the United Kingdom for new fashions (see sidebar, “How digitization is reshaping global flows”). They have come to expect payment systems that work across borders, global distribution, and a uniform customer experience.
7. Relentlessly evolving business models—at higher velocity
In B2B markets from banking to telecommunications, corporate purchasers are raising pressure on their suppliers to offer services that are standardized across borders, integrate with other offerings, and can be plugged into the purchasing companies’ global business processes easily. One global bank has aligned its offerings with the borderless strategies of its major customers by creating a single website, across 20 countries, that integrates what had been an array of separate national or product touch points. A US technology company has given each of its larger customers a customized global portal that allows it to get better insights into their requirements, while giving them an integrated view of global prices and the availability of components.
Digitization isn’t a one-stop journey. A case in point is music, where the model has shifted from selling tapes and CDs (and then MP3s) to subscription models, like Spotify’s. In transportation, digitization (a combination of mobile apps, sensors in cars, and data in the cloud) has propagated a powerful nonownership model best exemplified by Zipcar, whose service members pay to use vehicles by the hour or day. Google’s ongoing tests of autonomous vehicles indicate even more radical possibilities to shift value. As the digital model expands, auto manufacturers will need to adapt to the swelling demand of car buyers for more automated, safer features. Related businesses, such as trucking and insurance, will be affected, too, as automation lowers the cost of transportation (driverless convoys) and “crash-less” cars rewrite the existing risk profiles of drivers.
Managing the strategic challenges: Six big decisions
Rethinking strategy in the face of these forces involves difficult decisions and trade-offs. Here are six of the thorniest.
Decision 1: Buy or sell businesses in your portfolio?
The growth and profitability of some businesses become less attractive in a digital world, and the capabilities needed to compete change as well. Consequently, the portfolio of businesses within a company may have to be altered if it is to achieve its desired financial profile or to assemble needed talent and systems.
Tesco has made a number of significant digital acquisitions over a two-year span to take on digital competition in consumer electronics. Beauty-product and fragrance retailer Sephora recently acquired Scentsa, a specialist in digital technologies that improve the in-store shopping experience. (Scentsa touch screens access product videos, link to databases on skin care and fragrance types, and make product recommendations.) Sephora officials said they bought the company to keep its technology out of competitors’ reach and to help develop in-store products more rapidly.4
Companies that lack sufficient scale or expect a significant digital downside should consider divesting businesses. Some insurers, for instance, may find themselves outmatched by digital players that can fine-tune risks. In media, DMGT doubled down on an investment in their digital consumer businesses, while making tough structural decisions on their legacy print assets, including the divestment of local publications and increases in their national cover price. Home Depot continues to shift its investment strategy away from new stores to massive new warehouses that serve growing online sales. This year it bought Blinds.com, adding to a string of website acquisitions.5
Decision 2: Lead your customers or follow them?
Incumbents too have opportunities for launching disruptive strategies. One European real-estate brokerage group, with a large, exclusively controlled share of the listings market, decided to act before digital rivals moved into its space. It set up a web-based platform open to all brokers (many of them competitors) and has now become the leading national marketplace, with a growing share. In other situations, the right decision may be to forego digital moves—particularly in industries with high barriers to entry, regulatory complexities, and patents that protect profit streams.
Between these extremes lies the all-too-common reality that digital efforts risk cannibalizing products and services and could erode margins. Yet inaction is equally risky. In-house data on existing buyers can help incumbents with large customer bases develop insights (for example, in pricing and channel management) that are keener than those of small attackers. Brand advantages too can help traditional players outflank digital newbies.
Decision 3: Cooperate or compete with new attackers?
A large incumbent in an industry that’s undergoing digital disruption can feel like a whale attacked by piranhas. While in the past, there may have been one or two new entrants entering your space, there may be dozens now—each causing pain, with none individually fatal. PayPal, for example, is taking slices of payment businesses, and Amazon is eating into small-business lending. Companies can neutralize attacks by rapidly building copycat propositions or even acquiring attackers. However, it’s not feasible to defend all fronts simultaneously, so cooperation with some attackers can make more sense than competing.
Santander, for instance, recently went into partnership with start-up Funding Circle. The bank recognized that a segment of its customer base wanted access to peer-to-peer lending and in effect acknowledged that it would be costly to build a world-class offering from scratch. A group of UK banks formed a consortium to build a mobile-payment utility (Paym) to defend against technology companies entering their markets. British high-end grocer Waitrose collaborated with start-up Ocado to establish a digital channel and home distribution before eventually creating its own digital offering.
Digital technologies themselves are opening pathways to collaborative forms of innovation. Capital One launched Capital One Labs, opening its software interfaces to multiple third parties, which can defend a range of spaces along their value chains by accessing Capital One’s risk- and credit-assessment capabilities without expending their own capital.
Decision 4: Diversify or double down on digital initiatives?
As digital opportunities and challenges proliferate, deciding where to place new bets is a growing headache for leaders. Diversification reduces risks, so many companies are tempted to let a thousand flowers bloom. But often these small initiatives, however innovative, don’t get enough funding to endure or are easily replicated by competitors. One answer is to think like a private-equity fund, seeding multiple initiatives but being disciplined enough to kill off those that don’t quickly gain momentum and to bankroll those with genuinely disruptive potential. Since 2010, Merck’s Global Health Innovation Fund, with $500 million under management, has invested in more than 20 start-ups with positions in health informatics, personalized medicine, and other areas—and it continues to search for new prospects. Other companies, such as BMW and Deutsche Telekom, have set up units to finance digital start-ups.
The alternative is to double down in one area, which may be the right strategy in industries with massive value at stake. A European bank refocused its digital investments on 12 customer decision journeys,6 such as buying a house, that account for less than 5 percent of its processes but nearly half of its cost base. A leading global pharmaceutical company has made significant investments in digital initiatives, pooling data with health insurers to improve rates of adherence to drug regimes. It is also using data to identify the right patients for clinical trials and thus to develop drugs more quickly, while investing in programs that encourage patients to use monitors and wearable devices to track treatment outcomes. Nordstrom has invested heavily to give its customers multichannel experiences. It focused initially on developing first-class shipping and inventory-management facilities and then extended its investments to mobile-shopping apps, kiosks, and capabilities for managing customer relationships across channels.
Decision 5: Keep digital businesses separate or integrate them with current nondigital ones?
Integrating digital operations directly into physical businesses can create additional value—for example, by providing multichannel capabilities for customers or by helping companies share infrastructure, such as supply-chain networks. However, it can be hard to attract and retain digital talent in a traditional culture, and turf wars between the leaders of the digital and the main business are commonplace. Moreover, different businesses may have clashing views on, say, how to design and implement a multichannel strategy.
One global bank addressed such tensions by creating a groupwide center of excellence populated by digital specialists who advise business units and help them build tools. The digital teams will be integrated with the units eventually, but not until the teams reach critical mass and notch a number of successes. The UK department-store chain John Lewis bought additional digital capabilities with its acquisition of the UK division of Buy.com,7 in 2001, ultimately combining it with the core business. Wal-Mart Stores established its digital business away from corporate headquarters to allow a new culture and new skills to grow. Hybrid approaches involving both stand-alone and well-integrated digital organizations are possible, of course, for companies with diverse business portfolios.
Decision 6: Delegate or own the digital agenda?
Advancing the digital agenda takes lots of senior-management time and attention. Customer behavior and competitive situations are evolving quickly, and an effective digital strategy calls for extensive cross-functional orchestration that may require CEO involvement. One global company, for example, attempted to digitize its processes to compete with a new entrant. The R&D function responsible for product design had little knowledge of how to create offerings that could be distributed effectively over digital channels. Meanwhile, a business unit under pricing pressure was leaning heavily on functional specialists for an outsize investment to redesign the back office. Eventually, the CEO stepped in and ordered a new approach, which organized the digitization effort around the decision journeys of clients.
Faced with the need to sort through functional and regional issues related to digitization, some companies are creating a new role: chief digital officer (or the equivalent), a common way to introduce outside talent with a digital mind-set to provide a focus for the digital agenda. Walgreens, a well-performing US pharmacy and retail chain, hired its president of digital and chief marketing officer (who reports directly to the CEO) from a top technology company six years ago. Her efforts have included leading the acquisition of drugstore.com, which still operates as a pure play. The acquisition upped Walgreens’ skill set, and drugstore.com increasingly shares its digital infrastructure with the company’s existing site: walgreens.com.
Relying on chief digital officers to drive the digital agenda carries some risk of balkanization. Some of them, lacking a CEO’s strategic breadth and depth, may sacrifice the big picture for a narrower focus—say, on marketing or social media. Others may serve as divisional heads, taking full P&L responsibility for businesses that have embarked on robust digital strategies but lacking the influence or authority to get support for execution from the functional units.
Alternatively, CEOs can choose to “own” and direct the digital agenda personally, top down. That may be necessary if digitization is a top-three agenda item for a company or group, if digital businesses need substantial resources from the organization as a whole, or if pursuing new digital priorities requires navigating political minefields in business units or functions.
Regardless of the organizational or leadership model a CEO and board choose, it’s important to keep in mind that digitization is a moving target. The emergent nature of digital forces means that harnessing them is a journey, not a destination—a relentless leadership experience and a rare opportunity to reposition companies for a new era of competition and growth.
Twenty years ago, a 22-year-old Marc Andreessen co-founded Netscape, the company behind the first commercially successful web browser. Netscape went public the next year, making Andreessen wealthy and marking the start of the dot-com boom of the 1990s.
Today, Andreessen is a prominent venture capitalist at the firm Andreessen Horowitz. I asked him to talk about how the stock market has changed over the last two decades. In the 1990s, it was common for small companies to have initial public offerings (IPOs), in which they offer their shares for sale to the general public. But today, companies wait a lot longer to hold their IPOs.
For example, Netscape went public when it was worth a little more than $2 billion, and this wasn't unusual. For comparison, Twitter waited until it was worth about $25 billion before it went public last year. Facebook was worth more than $100 billion when it had its IPO in 2012.
Many companies aren't going public at all. For example, Google bought the home automation company Nest earlier this year for $3.2 billion. Two decades ago, Nest would have been more likely to hold an IPO.
In this interview, conducted on June 12, Andreessen offers his thoughts on why companies are waiting longer to IPO. He argues that the shift is bad for ordinary investors, who no longer have the opportunity to invest in fast-growing technology firms. He also offers his thoughts on the work of Thomas Piketty, a French economist who has studied the growing gap between rich and poor.
The transcript has been edited for length and clarity
Timothy B. Lee: The day you took Netscape public in 1994, it was worth around $2.2 billion ($3.5 billion in today's dollars). Recently, companies have been waiting a lot longer to go public. What do you think has changed?
Marc Andreessen: There's been an absolutely dramatic change. What you say is exactly right. Twenty years ago, IPOs had gotten democratized. You had Microsoft able to go public at less than $1 billion valuation. If you invested in Microsoft's IPO and held you had the prospect in the public market of a 1,000-times gain. There were a whole bunch of other comparable situations over the years. With Oracle, most of the gain was in the public market. In prior eras, the same was true of IBM and Hewlett Packard. These companies primarily grew up in the public market.
Ironically, you just had a much calmer market. You had a much bigger percentage of mutual funds instead of hedge funds, and you actually had more individual participation in the market a lot of the time. It's dramatic how much individual participation has dropped relative to funds. Individuals who wanted to be in growth stocks, institutions like mutual funds that wanted to be in growth stocks who would be longs. [E.g. they were buying assets and holding them in hopes of long-term investment returns.]
You also had a relatively benign regulatory environment, pre-Sarbanes-Oxley [corporate governance legislation enacted in the wake of the Enron scandal] and before all the other kind of corporate reforms that had taken place. In that environment it was actually quite hospitable [to be a public company].
Basically that all started to change after 2000. A whole set of "closing the barn door after the horse had run out" kind of things happened. Sarbanes-Oxley happened. The irony of Sarbanes-Oxley was that it was intended to prevent more Enrons and Worldcoms but it ended up being a gigantic tax on small companies.
Timothy B. Lee: What is it about Sarbanes-Oxley that makes it so burdensome?
Marc Andreessen:The compliance and reporting requirements are extremely burdensome for a small company. It requires fleets of lawyers and accountants who come in and do years of work. It's this idea that if you control everything down to the nth detail, nothing will go wrong. It's this bizarre, bureaucratic, top-down mentality that if only we could make everything predictable, then everything would be magic, everything would be wonderful.
It has the opposite effect. It's biased enormously toward companies that are big enough to hire fleets of lawyers and accountants, biased against companies that are very young and for whom there's still a lot of variability.
The second thing that happened is Regulation Fair Disclosure. The idea is that as a company officer, you are not, under extreme penalties, permitted to give one shareholder information that another does not have. It has really curtailed the ability of companies to communicate with shareholders. It puts everything under more scrutiny with a lot more risk.
You might say that's a good idea, shareholders should be treated equally. The problem is the shareholder base itself has changed dramatically. You've had a dramatic rise in hedge funds. Very short-term trading and dramatic rise in short-selling [investors betting that a stock's price will fall]. If you're a public company, you become the shuttlecock between warring longs and shorts. They bat your stock around like it's a chew toy.
Most American retirement savings is invested in the public stock market. That raises the societal question of how are we going to pay for retirements.
The shorts will just make stuff up. They will make up rumors and innuendo and stuff you wouldn't believe. I went through this personally myself. Crazy levels of personal rumors, all kinds of just horrendous things. There's this tremendous gaming of the stock price. They use Yahoo message boards and chat rooms.
So then you're the company, and you're dealing with these crazy rumors and all this crazy activity every day. A rumor comes out that your executive is ill. A rumor comes out saying that you lost a big contract. A rumor comes out that you're running short of cash. Normally someone would call you up, [ask if the rumor was true], and you'd say no. But under Regulation FD you can't do that. So the running joke is what you need to start putting out a daily fact sheet saying here's all the things that are said about us that's not true.
It's technically illegal to manipulate the market. But there are hardly ever any cases [enforcing these laws]. Basically the hedge funds run absolutely wild and do whatever they want.
And then there's like 8 more of these things. There are these really abstract, theoretical approaches to corporate governance that wind up being embedded in your business. And the rise of continuous internet journalism, so you're in this continuous 24-hour news cycle about everything involving your company.
Timothy B. Lee: Why is a fluctuating stock price such a big deal? Can't the CEO just ignore it?
Marc Andreessen:This comes across like I'm complaining about how hard it is to be public and of course the answer is that you need to suck it up.
But for young companies, everything is connected: stock price, employee morale, ability to recruit new employees, ability to retain employees, ability to sign customer contracts, ability to raise debt financing, ability to deal with regulators. Every single part of your business ends up being connected and it ends up being tied back to your stock price.
The problem is when your stock price gets hammered by any of this stuff, when your stock price gets hit by a false rumor, that in itself can destabilize your company. These companies that go public too quick are at risk of going into a death spiral at any moment in a way that's super intense and very difficult to get out of it because it becomes self-reinforcing.
And the kicker on all of this is: God help you if you ever need to raise money again. The shorts will drive your stock to zero to prevent you from raising money. So you are in extreme mortal danger if you're public and you need to raise money.
The result of all that is the effective death of the IPO. The number of public companies in the US has dropped dramatically. And then correspondingly, growth companies go public much later. Microsoft went out at under $1 billion, Facebook went out at $80 billion. Gains from the growth accrue to the private investor, not the public investor.
Most American retirement savings is invested in the public stock market. Most Americans can't invest in private companies and most Americans can't invest in venture capital and private equity funds. They're actually prohibited from doing so by the SEC. If you both prohibit them from investing in private growth and wire the market so they can't get into public growth, then you can't be invested in growth. That raises the societal question of how are we going to pay for retirements. That's the question that needs to be asked that nobody asks because it's too scary.
Timothy B. Lee: Do you think this is something that can be reversed?
Marc Andreessen:My belief is that there are a set of market reforms that could happen that would reverse all this. The problem is that all the political momentum is in the other direction. There's a reason for that. When there's a problem, the answer is presumed to be more regulation — even when the regulation was the problem in the first place. This is the central flaw in how the government operates.
This is so powerful in the conventional wisdom right now. I love the Daily Show like everyone else does. But literally [Jon Stewart's] answer to every issue is Congress should pass a law. [People think you can] solve any problem by passing enough laws.
I don't see the world getting less dramatic. I don't see the world calming down.
The loop we're in now is that people are getting upset and disappointed by the stock market. There are no growth stocks, which means there's no growth. Stock market returns have been weak for 15 years, which is exactly what you'd expect if you took all the growth out. Everyone is upset the stock market isn't performing. The worse the results get, the more regulation you get. It's in its own kind of doom loop. Unless something happens to shock the system a lot, our assumption is it gets worse, not better.
This has had a big influence on how we set up our firm. We've set up our firm to basically not have to take companies public. We basically have a 15-year lockup on our money, which is longer than you used to do with private capital. One of the reasons why our funds are so much larger than venture capital funds used to be is because we have to have the firepower to finance companies through the point of time where we take them public. For our investors this is kind of fine. Our investors are these big institutions, university endowments, high net worth family money, private foundations. They're fine. They can invest in us. They can invest in venture capital. Joe retiree, who works hard for 40 years and has his money in the public stock market, he can't do that.
Timothy B. Lee: This relates to another topic I wanted to ask about. You've had some harsh wordsfor Thomas Piketty, the French economist whose new book is trendy in liberal circles right now. Do you think he's right that we're going to see a growing gap between the rich and the poor in the coming years?
Marc Andreessen:The funny thing about Piketty is that he has a lot more faith in returns on invested capital than any professional investor I've ever met. It's actually very interesting about his book. This is exactly what you'd expect form a French socialist economist. He assumes it's really easy to put money in the market for 40 years or 80 years or 100 years and have it compound at these amazing rates. He never explains how that's supposed to happen.
Every investment manager I know is sweating the opposite problem, which is: what do I do? Where do I get the growth? I can't get into the public market, so I have to go into the private market. The problem in the private market is there isn't much growth. Maybe a dozen hedge funds. After that they're not that good. The returns degrade down to S&P 500 levels.
Timothy B. Lee: That's not so bad is it? The S&P 500 has returned 6 or 7 percent real growth for the last few decades.
Marc Andreessen:Yeah, 6 or 7 percent. But if you look at the last 15 years they're much less than that. Jeremy Siegel put out his book about how there's never been a 10-year period where you lose money in the stock market — right at the beginning of a very long period where you lose money for 10-plus years.
Piketty thinks it's really easy to compound capital at scale. There's just a lot of evidence that that's not true. The shining example of that is: where are all the big companies and the big families?
If you look at what's actually happening in the Forbes 400 and the Fortune 500, churn is accelerating. One year it's some real estate family, and then the next year it's like, "There's Larry Page, where did he come from?" Somehow Piketty looks through that to a world where all this change is going to just stop. [He has] this idea that normal is 18th-century feudal France, and we're going to go back to it.
He does this other dodge where the 20th century doesn't conform to his theory, but that's because of the wars and economic dislocations. And so it's like the 21st century is predicted to be much more peaceful and calm. I don't know about you but that's not what I see happening. I look around the world right now and I see exciting things happening that's causing a lot of changes.
It's not an accident that Piketty named his book after Das Capital. It's a very "capitalists are evil, it's all going to roll up to a few rich people" kind of thing.
The other irony in the book is that on the positive side, [people around the world are] rising up from what we would consider destitution, to what we would consider lower-class lifestyles on their way to middle-class lifestyles. Conversely, Iraq is falling again.
So I don't see the world getting less dramatic. I don't see the world calming down. I don't understand why that would be the expectation. At what point is all of this progress and change and disruption going to stop to basically let rich people cement their gains and then earn these great returns in perpetuity. When is that supposed to start?
Maybe that's what happening in France, but it doesn't map to anything I see. What's happening in France is the opposite, which is that all the rich people are leaving, as a consequence of the government he's advising. The irony here is very deep.
Timothy B. Lee: Piketty's argument doesn't require extraordinary returns, does it? He finds the historical return is around 5 percent. The long-run return in the US stock market has been higher than that.
Marc Andreessen:If you actually get regular compounding growth of stocks of that form, then basically what you have is an economic boom — a sustained boom in productivity. If the gains from the market exceed the gains from economic growth, the delta is productivity growth. That's the math. This is why I say he has so much more faith in the progress of capitalism that even the capitalists do.
What all the capitalists are worried about is where's the productivity growth. This is where Piketty's analysis is actually a very optimistic analysis. It suggests you're going to have a gigantic productivity boom. Isn't that the world we want to live in?
Think about what happens in that world, though. Unbelievable progress, unbelievable productivity growth, unbelievable increase in standard of living all across the planet. Somehow as a consequence of that, everything is going to stabilize and we're going to go back to feudal France. At that point it becomes Marxist logic.
There's a missing step in there where everyone but the hereditary elite gets screwed. And he never explains that part. Because if you're having all this economic growth, and everything is getting better, but somehow you're in this dystopian world where there's a few rich people and a lot of poor people, that doesn't add up. It's a really, really Marxist way of looking at the world.
It's not an accident that Piketty named his book after Das Capital. It's a very "capitalists are evil, it's all going to roll up to a few rich people" kind of thing. Marx was wrong. That's literally not what happened. For it to happen now, with the economy being the way it is now, which is so much even more dynamic than it was in Marx's time, [seems unlikely].
If you talk to anyone in the French socialist party, their worldview on how capitalism works is completely backwards from anything you see in the real world. Piketty has taken that and created abstract models and marshaled some data and presented it in book form.
Update: Andreessen originally told me that stock market returns had been "flat" for 15 years. While inflation-adjusted returns have been below average during this period, they have been positive (for example, S&P 500 returns averaged 2.2 percent from January 1999 to December 2013). With Andreessen's approval, I've changed it to say that stock market returns have been "weak" instead of "flat."
Today is Phil Chau's THREE Year anniversary with Growthink. Phil - it has been truly awesome to work with and get to know you these last three years, and to watch you grow into an amazing leader and executive. Thank you for all of the hard work and amazing attitude and the best is yet to come!
The California Network for Manufacturing Innovation (CNMI) held an Advanced Manufacturing Forum on June 24, 2014 at USC Davidson Conference Center. This is the second event organized by CNMI in the past year. CNMI is a California statewide Innovation HUB (iHUB) and a broad-based collaborative that includes: the California Manufacturing Extension Partnership Centers (CMTC andManex), Lawrence Livermore National Laboratory, Lawrence Berkeley National Laboratory , University of California Irvine, El Camino College,Centers for Applied Competitive Technologies, University of Southern California Center for Economic Development, City of Davis and i-Gate.
Our vice president Jeff Jones had the pleasure of moderating the Q&A session in the afternoon. Way to represent Mr. Jeff Jones!
The popular recipe for creating the “next” Silicon Valley goes something like this:
*Build a big, beautiful, fully equipped technology park;
*Mix in R&D labs and university centers;
*Provide incentives to attract scientists, firms, and users;
*Interconnect the industry through consortia and specialized suppliers;
*Protect intellectual property and tech transfer; and
*Establish a favorable business environment and regulations.
Except … this approach to innovation clusters hasn’t really worked. Some have even dismissed these government-driven efforts as “modern-day snake oil.” Yet policymakers are always searching for the next Silicon Valley because of the critical link between tech innovation, economic growth, and social opportunity.
Previous efforts at such clusters failed for a variety of reasons, but one big reason is that government efforts alone simply don’t draw people. That’s why a recent crop of experiments has focused more on building entrepreneurial communities, urban hubs and districts, and hacker spaces. Still, we’re “splitting the logic” on how to create an innovation ecosystem, according to MIT expert Fiona Murray in Technology Review: We’re either going top-down by focusing primarily on infrastructure — plunking down an office park next to a university — or bottom-up by focusing on just the networks. None of these efforts successfully pursue both paths at once, with government, academia and entrepreneurial communities proceeding together in lockstep … as was the case in the development of Silicon Valley.
But policymakers shouldn’t be trying to copy Silicon Valley. Instead, they should be figuring out what domain is (or could be) specific to their region — and then removing the regulatory hurdles for that particular domain. Because we don’t want 50 Silicon Valleys; we want 50 different variations of Silicon Valley, all unique from each other and all focusing on different domains.
Imagine a Bitcoin Valley, for instance, where some country fully legalizes cryptocurrencies for all financial functions. Or a Drone Valley, where a particular region removes all legal barriers to flying unmanned aerial vehicles locally. A Driverless Car Valley in a city that allows experimentation with different autonomous car designs, redesigned roadways and safety laws. A Stem Cell Valley. And so on.
There’s a key difference from the if-you-build-it-they-will-come argument of yore. Here, the focus is more on driving regulatory competition between city, state, and national governments. There are many new categories of innovation out there and entrepreneurs eager to go after opportunities within each of them. Rethinking the regulatory barriers in specific industries would better draw the startups, researchers and divisions of big companies that want to innovate in the vanguard of a particular domain — while also exploring and addressing many of the difficult regulatory issues along the way.
Why this approach? Compared with previous innovation-cluster efforts where governments contrived to do something unnatural, this proposal flows from what governments naturally do best: create, or rather, relax laws.
Another advantage of this approach is that it’s a way for clusters to differentiate from each other and successfully compete for resources. Think of it as a sort of “global arbitrage” around permissionless innovation – the freedom to create new technologies without having to ask the powers that be for their blessing. Entrepreneurs can take advantage of the difference between opportunities in different regions, where innovation in a particular domain of interest may be restricted in one region, allowed and encouraged in another, or completely legal in still another.For example, the laws and guidelines for using drones or taxing bitcoin already vary widely across the globe, just as they do for ride-sharing services across different cities in the U.S.
But the biggest advantage of the 50-different-Silicon Valleys approach isn’t just in what it affords isolated regions or entrepreneurs — it’s in accelerating innovation everywhere. Removing regulations across different regions allows multiple innovation categories to advance together at once, in parallel, without being bottlenecked by time or place.
So what are the risks? Well, there’s a real possibility that advanced regions will essentially outsource or “regulate away” their own risk at the expense of less advanced ones. To get ahead, poorer countries may become more tempted to take on the very things wealthier countries are fencing out of their borders. But as long as the innovations aren’t life-threatening — and many of the restricted domains aren’t (the restrictions are often protecting incumbent interests) — a model like this one provides a much faster and more feasible way for developing regions to catch up. Especially when you consider the advantage that previous innovation clusters didn’t have: mobile.
One way of thinking about economic growth…is that it’s all about the adoption of new technologies of production. We could say that the introduction of electricity was itself economic growth, or that the adoption of smartphones will be. However, they’re both multiplying technologies: electricity allows more work to be done by replacing muscle power and, through light, enables work or study to be done for more hours of the day. The smartphone opens up the books of human knowledge to those who have never had access to it before. And that is seriously going to accelerate economic growth in just about every other field as well. That peasant farmer trying to manage his acre of maize using nothing but a hoe and a machete: sure, he’s not going to be the world’s greatest user of Facebook…but he will benefit massively from information about weather, market prices, and better farming practices.
Because of mobile, removing regulatory hurdles goes from being a potentially vicious cycle to a more virtuous one that can help millions of people climb out of poverty. And the next big companies wouldn’t be built in the U.S., but elsewhere in the world instead. For example, as mobile payment systems like M-Pesa create opportunities in banking, risk-sharing, and more, they’ve expanded to areas outside of Africa as well —including Europe.
Meanwhile, allowing more experimentation in financial services could help those in countries that don’t have stable currencies (let alone banks) to more easily save and move their money across borders; some of these places would leapfrog, innovation-wise, through something like bitcoin. As for other domains, if we think of airspace as the next Internet-like platform, lifting restrictions on drones is one way to give other regions a chance to become the next significant locus of innovation.
In fact, this kind of competition is probably the only way to create successful innovation clusters that can compete with the huge advantage Silicon Valley already has. In the United States, the “death of distance” due to improvements in communications technologies has historically benefited only ideas-producing places like New York, but not goods-producing ones like Detroit. That’s why turning Detroit into a commercial Drone Valley could draw the innovative people who in turn want to be near other innovative people around that domain.
It’s already happening in places like Brazil, which are becoming known for being commercial drone-regulation friendly. It’s also happening in other domains, as genetic reporting companies like 23andme are forced to explore opportunities abroad, athletes go to places like Germany for biologic medicine, and even Japan considers slashing regulatory red tape to attract more drug R&D. But these examples are more reactive than proactive; I’m arguing for cities, states and countries to more systematically consider and create their regulatory competitive advantage. (If you don’t know what that advantage is, the best place to start is with local universities. Have a special competency in materials science? Then begin there.)
This kind of regulatory arbitrage is already happening in the United States, too, through innovations like Google Fiber. Instead of the traditional model where telecoms competed to be in a particular city neighborhood, cities are the ones competing to get Google Fiber. And the ones most willing to relax their oft-arbitrary regulations and fees are the ones getting it.
That’s another advantage of the regulatory arbitrage approach: It helps shake upregulatory capture altogether. The best defense of regulation is its use in protecting consumer interests, but the reality is that agencies and incumbents tend to watch out for their own entrenched interests and extract rents instead.
* * *
But instead of arguing about whether the Silicon Valley mindset cannot or should be copied, we need to shift our attention to an approach that addresses what Silicon Valley alone can’t do, while also creating opportunities for a broader set of people. To do that we need 50 different Silicon Valleys, not 50 failed clones.
LAEDC is hosting a webinar session featuring our president Dave Lavinsky!
June 26, 2014
12:00pm - 1:00pm (PST)
Join us on June 26 for a discussion with Dave Lavinsky, President with Growthink. Guiding Metrics provides real-time business intelligence to help manufacturers move past cost cutting and lean manufacturing methods to become even more efficient, more competitive and more profitable.
The webinar provides a step by step walk through of the major metrics and systems Guiding Metrics has found in most clients and how the dashboard can be relevant to growing manufacturing businesses.The session will then be followed by Q & A.
This webinar is part of LAEDC's new Better Business Webinar Series.
There is no cost to attend this webinar.
Register to attend here.
Learn more about how the LAEDC can assist your company in coming to, expanding in, and staying within Los Angeles County.