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the new new venture capital paradigm

I've been doing a lot of work globally setting up big deals lately in my role as managing partner at Avos. It has given me a chance to dig into and improve success factors for the investments we're lining up. 

One client has a half billion dollar capital raise I'm helping with and a key issue there is how the Web fits into their strategy. They had a plan that sounded pretty good, but after some basic analysis, I've moved the conversation closer to what it needs to be: social, low startup cost, SEM compatible, full of experimental mini-value props that help us figure out what engages the target clientele. 

This brings up the evolving criteria used by the venture capitalist in selecting and shaping their portfolio.  I agree with much of Dave McClure's analysis (find it here) about the need for venture capital to move beyond its expectations of use of funds (build a darn expensive product and then find huge customers to buy lots of it). He proposes another angle, much more in line with how businesses succeed in the Web 2.0 world: 

  • Build a product (cheap and fast)
  • Market it (cheaply with SEM)
  • Create revenue (integrating third-party payment systems)

His point is that the huge up-front costs in starting (certain kinds) of businesses are unnecessary and actually counterproductive to VC's needs for returns. This is a good analysis. VC will take too long to pick it up unless, as Dave says, they're innovative.

The reason VCs will be slow to adopt this approach is that they distrust cheap assets. They want their money to buy expensive, protectable things, systems, and markets. The old way? Do patentable stuff, or to build a service ecosystem that's hard to copy just by being very expensive. 

And yet expensive and protectable are two concepts that can be separated. It's far cheaper to start a new company whose brand is strongly differentiated (trademarks, customer behaviors, etc.), and lawyer up on protecting the brand.

Dave - whose street cred is impeccable in understanding the increasing returns generated from socially connected customers - misses the spine that should be throughout his product-market-revenue model.

As I posted on his blog, I would want Dave to look at the root causes of increasing total return to shareholders. This is essentially what gives VC their exit ... it bolsters their argument for the future value of the venture's cash flows.

It's precisely this argument that VC can sell to people whose money will replace theirs (next tranche, IPO). Don't forget, your first product, market, and customer is venture capitalists.

So, the problem to solve is creating a company that measures how to create increasing total return to shareholders (TRS). Drive that, you will please the VC.

What are the drivers for increasing TRS? 

  1. Compelling and engaging value prop - for social media plays, this means solving a problem, engaging the imagination, architecting a user experience that is easy to adopt AND YET NOT GENERIC (god, I hate those 'don't make me think' UI people who make everything so 'web 2.0' that it's all the same vanilla cr*p), lowering barriers to recommendation, allowing co-creation and sharing, and enhancing the customer's reputation. When possible, make vendors/advertisers a legitimate, welcome part of the recommendation, co-creation, and sharing network. This builds into the customer's mental model that the value exchange in the model might, occasionally, and when appropriate, include money. You don't want to introduce the revenue model later, after the customers have gotten used to "free", and even worse, have embedded their own "advertisers suck" values into the brand.
  2. Cognitive sophistication in customer experience management. Most Web 2.0 business are woefully lacking in this. But that's because most business people are woefully lacking in this. 
  3. Well-designed multitouchpoint ecosystem, including partner ecosystems, that is measurable. (Both behaviorally and attitudinally. This innovative voice of the customer systems. Most existing ones are terribly intrusive.)
  4. Hella analytics. You cannot fix what you do not measure.
  5. Lots of experiments, well-designed and targeted to increase customer engagement (see Gallup and Carlson). Got ten features? Six generate 90 percent of your income? Find out why by running more and better experiments. See step 4 above, lather, rinse, repeat.
And you're done.

The rest of Dave's argument can fit with what I outlined.

Remember, the goal is NOT to make it cheaper, or to engage customers sooner, or even to get revenues. Cheap can be bad. Engaging early adopters is not enough. And revenues can be expensive: you have to have profitable revenues that are also early indicators of future customer value. (Whuh? If you don't know about total lifetime customer value, how to measure it, and how to create it, you've got some fun reading - and necessary hiring - to do.)

All that equals ... increasing total returns to shareholders.

THAT you can get funded.

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