I don’t mean to imply that we are in the business of investing in the next generation of . . . quick service restaurants. We are not . . . at least not yet But almost 20 years since the Internet changed everything, in every industry we are seeing, the conversation has changed from a discussion about the “internet” to just a discussion about the industry itself (and the brick and mortar companies within them). In the mid 90’s, the Internet was seen as a platform to build new businesses to disrupt existing markets. What the internet enabled really was, simplistically, a comparatively frictionless method to market, acquire, and service customer and partners. There certainly was an argument to be made (and many have made them) that the “Internet” was not a strategic disruption but an operational innovation which will eventually become a “cost to compete”. Putting that argument aside, what has been increasingly true is that being an online business in of itself no longer translate to an inherent competitive advantage it once did.

The “internet” business is not what it was fifteen years ago. It is now next to impossible to build a brand strictly using online marketing channels. Furthermore, so many middle men and gate keepers have sprout up to charge tolls for directing traffic on the internet that the online cost of customer acquisition has skyrocketed. That almost every business has figured out a way to leverage the internet to optimize their operations also means that the line has continued to blur between online and offline companies. . . . For us. . . it means being an “internet entrepreneur” has increasingly less about “internet” but more about just being an “entrepreneur.”

The ironic part is that there are a whole generation executives and entrepreneurs that are badly equipped for the challenges of taking on incumbents when the internet no longer automatically tilts the playing field in their favor. In the first group are guys and gals who spent the majority of their careers at internet companies – especially at the behemoths like Google, Facebook, Yahoo, eBay – that have so much internal scale that they never learned to compete in the “open” internet for traffic and attention . . . much less offline for branding and sales. In the second group are “internet native” entrepreneurs who are continuously plugged in and never knew a world without iphones, always on internet connections, and facebook pokes . . . the complete unawareness consumer behavioral norms can be really disconcerting. Of course, by no means does it imply we do not want these entrepreneurs to start companies (in or outside of MuckerLab) – we do, because we DO believe that the passion and love of technology is not only important but a prerequisite. It is just that we wish these teams are augmented with more diverse traditional business talents OR that these entrepreneurs would deviate from their strict career paths a bit and acquire some traditional marketing or operational skill sets. Out of the many entrepreneurs we met it appears that some very basic business skills are lacking . . .

Merchandizing – As little as 5 years ago, in the age of Google, recall and precision ruled the Internet. It was all about comprehensiveness, aggregation, and ranking. We didn’t try to tell people what they should like/want – instead of we simply tried to find it for them. Today, words like curation, taste making, maven, fashionista, and social discovery dominates the internet lexicon instead. Offline merchandizing skills honed by offline retailers are increasing important for the web as it was decades ago for businesses from Barneys to Walgreens. Entrepreneurs need to not only be trend setters but also know how to influence tastes and taste makers themselves.

Branding – The fact remains that most of the major internet “brands” were built using PR via some variation of the founding myth playbook. These brands are not nurtured through the highly choreographed product-marketing-advertising-communication tactics employed by offline companies. The life stories of the founders and the origination of their ideas became the basis for building their personalities and brands. This works when the press continues to be fascinated with technology companies but given the noise and the inevitable backlash – technology entrepreneurs needs to stop dismissing some basic (and sometime seemingly hokey) branding strategies and exercises especially in consumer categories. (BTW, there got to be a reason that Apple spends hundreds of millions a year in offline advertising a year – I’m super surprised that not more technology companies has followed suit.)

Retailing – Online customer acquisition tactics has become a never ending search for “cheap” traffic that quickly become tapped out when everyone else piles in . . . rinse repeat. Not enough entrepreneurs understand how to acquire customers profitably through retail channels (end caps, facings, circulars etc). Whether that is because of lack of knowledge, or the inability to think beyond the virtual click stream, I’m not sure. But I do know that for the handful of technology companies that have tried, offline channels constitute the majority of their sales and acquisition volume – and magnitudes cheaper than online.

Direct Response Marketing – It is probably not an exaggeration to say that offline DR marketing is the forefather to adwords. Yet today, I only see so called ‘spammy’ (I call them brilliant instead) internet companies using DR channels such as TV, direct mail, radio, telemarketing, even catalogs/print to acquire customers for their warez and products. This is probably one of the easiest offline marketing techniques to learn for internet entrepreneurs – its just a/b testing and some math. Get on it.

Event/Guerrilla Marketing – For any type of social applications, online communities, and marketplaces – event and guerrilla marketing are crucial for customer retention and virality. The key to success for these companies depend on their ability to attract like-minded users, foster user to user interaction, and generate content. Offline community based marketing tactics does not seem sexy nor scalable but it does do a wonderful job of creating real and tangible connection between the company, its users, and its brand within the target community.

Sales – Many internet entrepreneurs seem to lack old fashion sale management and sales operations experience (“but Will, instagram only has 12 employees!” . . . aargh). Not making money or outsourcing sales to an ad network is never a long term strategy. Furthermore, multi-level marketing direct selling strategies has become a great channel to build a low cost, self propagating, self sustaining sales force to sell products and build a fervent community of evangelists.

Back in October of 2008 (only a few weeks after the world blew up and a few months before the startup I was working at also exploded) I wrote a cryptic note on my personal blog comparing the hype cycle/startup life cycle curve versus the valuation “J-Curve.” By layering the two curves on top of each other, I argued that there are a few optimal points in the lifecycle of a startup to sell equity (raise money but ideally an exit) and conversely a few optimal points to invest. Before the advent of “seed funds” and “bar bell” investment strategies, I cryptically wondered if entrepreneurs needs to learn to sell their companies earlier than what had previously been the norm –when early adopters and the law of small numbers make the founders look like geniuses. VC’s on the other hand should either embrace the small exit or wait out the “long road back” to invest at the cross over stage. (I’ll get into more of it later).

Recently a few influencers in the business started talking about the life cycle curve again which brought me back into my old blog to dig up the post to add to the echo chamber. The Gartner “Hype Cycle” has been around for as long as I could remember. Paul Graham’s Start Up Curve is a colorful and contemporary re-interpretation (Gartner was really focused on the enterprise market). Doug Pepper of Interwest added an important voice on a post @ Techcrunc by providing in depth examples of companies and industries that followed the pattern.

It is generally accepted that startups and entire industries typically achieve significant hype and mind share in its early days due to novelty, and potential. But of course, reality rarely matches the original market assumptions and it takes most companies a long time to actually cross the chasm and achieve mass product – market fit. In a rational market, the valuation of a startup should match exactly to revenue or measurable traction. But of course, venture capital is far from a rational market because we all have to make bets on imperfect amount of information. So sometimes we make smart bets, other times we lose all discipline and push all in when we barely calculate the odds. We make ourselves feel better by muttering to ourselves that we can’t make any money if we don’t put money to work. (or something about the CAPM model if we are even more delusional).

(Image on the left is from Fred Wilson’s blog based on PG’s curve)

Entrepreneurs need to understand where they are on the hype cycle and be realistic about the long term potential of the company. Typically that means raising as much as possible @ seed and A and have the cash hoard to fight your way back when no one will talk to you. Or if you are lucky enough to have achieve early adopter product-market fit and have acquirers beating on your door – think really hard about whether you need to hit that homerun or not – right now .. . at this very moment. The cynic in me says the objective is to maximize the valuation delta between market expectation and actual traction of a business. The optimist in me says it’s the entrepreneur’s obligation to his/her shareholders and employees to try hard to find the right acquirer that will be willing to invest resources into your business when you eventually hit hard times – many times it’s a better path than continue to beg for money from VC’s. By no means is the goal to build companies to flip – no one wants to buy features anymore not even Google. Its just a fact that most of us are not Zuckerberg or Dorsey or Morin – much less Steve, Bill, Jeff, and Michael (Dell) . . . or atleast not now. . . maybe the next startup.

Once in a while, a seminal startup (let’s call them “category busters”) would appear to magically birth a whole new market category while engendering a legion of copycats and derivatives companies across multiple adjacent markets. The category busters often do so with some form of meteoric rise – some do so with incredible adoption metrics or; even better, revenue momentum, some are masters of hype and marketing, and others simply capture our imagination with “why didn’t I think of that” simplicity. We all have heard of these category busting companies. Today there are Airbnb (collaborative consumption), Dropbox (cloud storage), Gilt (flash sales), Groupon (daily deals), Shoedazzle (subscription e-commerce), and the latest, Pinterest (interest graph?). At one time it was Yahoo (portal), ebay (marketplaces), and amazon (e-commerce) and . . . webvan (local commerce) . The derivative companies, on the other hand, do not take on these rocketships directly; but instead, lifts some or all parts of the category busters’ strategy or product and apply it to a different market or segment of customers.

I struggle with understanding these paired siren songs – did these category busters fundamentally discover a new but permanent change in consumer behavior or business practice? Can the behavioral change they are exploiting spread beyond the user segment or market niche that they are attacking? Or. . . the behavior change is temporary, driven by passing external realities (such as the recession). Or . . . even worse, that the hype has become completely removed from the reality with no real traction beyond fund raising or PR and thus the derivative companies are just chasing ghosts. Even more frustrating, timing has a significant impact on the success of the derivative companies – retail e-commerce across every category eventually did take over the world – but only after going through a complete implosion in the dot-com era. Sometimes, the implosion is permanent. The cautionary tale is the tens of billions dollars of public and private capital that went into “b2b marketplaces” that all but completely disappear into thin air.

We meet with entrepreneurs all the time with derivative concepts of category busters – aka “Airbnb for blah” or “ShoeDazzle for X.” I constantly struggle with their long term potential, but here are some questions I always ask myself to somewhat insulate myself from the echo chamber. (wont know how successful I am till much later!)

1. What is the fundamental consumer behavior modification and what is the problem for the user/customer that the company is alleviating? Only when the “problem” is persistent and chronic can the consumer or enterprise behavior be permanent as well. Taking subscription e-commerce as an example – I want to know if it’s a recurring spend category where the friction of multiple transaction is a large part of the chronic pain. Furthermore that the product that is being offered is chronically “scarce” for whatever reason to the target segment.

2. Is the marketsize atleast comparable, or even better, larger than the original category buster? Call this one an ego issue for me. It’s hard enough to build a successful company. Market and product issue aside – the execution risk alone mean failure is the most likely outcome. In the off chance that I do get lucky, I really don’t want to square up on the ball and still only have it be a line drive single.

3. Is the life time value of customer just as attractive as the category buster? Using the subscription e-commerce business as an example again. Four variables drives your LTVC – average selling price, margin, frequency, and churn. Hitting 4 out of 4 as superior to the original company is a great start. Often it is almost impossible to measure and predict LTVC, BUT by breaking it down to underlying drivers, it is still possible to make intuitive guesses at the comparative attractiveness of these variables to the category buster.

4. Is the business model comparably attractive? This is a bit of a catch-all but many great category busters have some inherent innovation (by chance or design) to its business model (not just pricing model). As an example, the e-commerce business is by definition a low margin business – and as a result return on invested capital will be driven by things like inventory turnover and working capital efficiency. eBay & AirBnB hold no inventory. Amazon (in the beginning) & ShoeDazzle had negative or low working capital requirements. If there is value to be copied, it is in really understanding the cashflow statement and how that helps create a capital efficient yet easily scaling businesses.

5. What are the comparative user acquisition costs and channel strategies? If there is one common defining characteristic of category busting companies is that they often discovered a cheap and scalable source for customer or user acquisition before the rest of the bandwagon. These stories have become almost mythical folklores. Paypal exploited eBay. AirBNB exploited Craigslist. eBay exploited PR. Youtube exploited Myspace, ShoeDazzle exploited Twitter/Social/Celebrity Marketing. Zynga exploited Facebook / Facebook advertising. If there is one thing derivative businesses need to study faithfully is how to find similarily cheap acquisition strategies (of course the hard part is that often those opportunities have already been picked over and no longer cheap).

6. Are the category busters themselves having success (or have ambitions of) moving across adjacent markets? One of the things the entrepreneurs of the derivative companies need to really worry about is whether their market will be quickly encroached by the category buster. (Amazon moving from books to all of e-commerce is a great case study). And if so, understanding if the category buster has some sort of inherent advantage when it enters the market – are the customers similar, are the technology investment fungible, are their partner or distribution relationships the same – will help define the long term competitive picture.

There is no hard and fast rule in the technology industry that first movers are winners or that derivative copycats can never be bigger/greater companies. On the other hand, there are so many inherent risks and unknowns in starting a new venture that for many entrepreneurs chasing after an existing trend can falsely appear to be less daunting (copy product!) and more emotionally comforting (people are already doing it!). Same goes for people like VC’s, investors, and service providers – we are not immune. Dig in, understand the inherent customer value and the business model that the category buster has created and make sure to see the same dynamics exists in the targeted new market – this will help you adjust the playbook or even decide it’s a bad idea in the first place.