Decision Making and the Venture Capital Process

I recently read a fascinating scientific paper by Anthony Bastardi and Eldar Shafir titled On the Pursuit and Misuse of Useless Information.

The paper's thesis is that decision makers often delay decisions to pursue additional noninstrumental information - information that a priori will not affect the decision at hand - yet then proceed to make use of the information, thus making it instrumental, once it is obtained.

The key issue for executives and venture capitalists is the following: one needs to determine what information may prove critical to the decision at hand, and, therefore is worth waiting for, and what information is unlikely to affect (and thus need not delay) the decision at hand.

The authors note that "people often arrive at a decision problem not with well-established preferences and clearly ranked preferences, but rather with the need to determine their preference as a result of having to decide, and they often look for additional information in hopes that it may facilitate the choice."

The venture capital process is a class example of this phenomena.

Investors often do not have a priori preferences with respect to an investment decision and need to determine their preference to fund a company and do indeed, as all entrepreneurs know well, seek additional information with which to make their decision.

The central issue is clearly identify which information is instrumental, "information that can alter what decision is made," versus which information is noninstrumental, "information which will not impact the decision at hand if it were available."

Given people like to obtain information and base their decisions on compelling reasons for one option versus another, research finds that, given the option, people will wait for noninstrumental information.

Worse yet, once the noninstrumental information is gathered, people alter their choice based on this noninstrumental information. The cost is not only delayed decision making but also poor decision making as noninstrumental information impacts the final choice.

The key take-away is that all of us, when making a decision, need to carefully think through what we absolutely need to know in order to make a good decision, rather than delaying decision making and leaning on the crutch of more time to gather non-essiential data that may contribute to a poorer decision.

Does Geography Matter?

In a world of high-speed data and voice networks, web-enabled applications, and a global talent pool, does geography matter?

Will technology break down traditional industry clusters and distribute innovation, wealth, and opportunity across an increasingly flat world?

As an investor and resident in the Valley, it is an important question.

Should company founders leverage the benefits of operating in a high-tech cluster and pay the cost premium of doing business here, or should they leverage the benefits of enabling technologies and remain in lower cost geographies?

The work of Michael Porter helps think through the issues. In his HBR article, "Clusters and the New Economics of Competition," he lays out a convincing argument for the long-term viability of clusters.

He defines clusters as,

"geographic concentrations of interconnected companies and institutions in a particular field. Clusters encompass an array of linked industries and other entities important to competition. They include, for example, suppliers of specialized inputs such as components, machinery, and services, and providers of specialized infrastructure."

His core thesis is that advantage in the global economy lies increasingly in local things - knowledge, relationships, and motivation.

Traditionally, competition centered on input-cost advantages - natural and human resources. Today, however, competition rests more on the productive use of inputs, which requires continual innovation. He writes, "modern competition depends on productivity, not on access to inputs or the scale of individual enterprises."

He defines the following characteristics of a cluster that accelerate productivity:

• sourcing of information, technology, talent
• coordinating with related companies
• measuring and motivating improvement
• better access to employees and suppliers
• access to institutions and public goods (venture firms, lawyers, universities)
  
• complimentarities
  
• co-optition, cluster promote both competition and cooperation
  

Clusters also directly support new business formation. Porter argues that working in a cluster allows individuals to more easily identify gaps in the current market offerings, enables efficient access to talent, institutions, partners, etc, and a home-grown exit market (ie established members of the cluster are the likely acquirer).

The most important insight for me is that the modern economy competes on innovation and that operating within a cluster shortens the cycle time to identifying, resourcing, and realizing areas of need and opportunity.

The genesis for this post was a conversation I had with two founders, currently based in Atlanta, about the merits of moving to the Bay Area to start their company. Michael Porter's thoughtful analysis helps me better understand why the Bay Area "cost premium" is well worth it. Market cap is a function of innovation and growth, and innovation is a function of access to ideas, talent, and supporting resources that eliminate frictions and catalyze connections and progress.

Ironically, in an increasingly globalized economy the Valley is gaining not waning in prominence. Boston is now the home to one large public tech company, EMC, and the valley takes close to 40% of total US VC, with CA taking well over 50%.

The key to our magic innovation machine is not to let government policy limit the free flow of talent, energy, and ideas into the cluster. It is incumbent on all beneficiaries of the Bay Area cluster to promote truly free labor markets that serve to fuel our unique productivity and innovation.

Mulesource Raises Series B

Mulesource, the leading open source integration framework, announced today the successful close of a $12.5m Series B. Lightspeed led the deal, with return participation from the Series A leads, Hummer Winblad and Morgenthaler.



The raise reflects five important characteristics of the company:

1. large target market - the integration market is roughly $8bn
2. large pricing umbrella - incumbents' products sell for ~$90k/cpu
3. very active developer community - hundreds of contributors
4. mission critical use cases - high conversion rates from free to paid
5. ramping customer acquisition and bookings

As I wrote in a prior post, the closer to a transaction the higher the open source conversion rates. Enterprise risk controls demand that software that touches critical to revenue/transaction systems be supported.

The attached graphic, forgive my graphics design skills, helps me think through the opportunity

• how large is area A, ie the degree of overlap between a project with an active developer community and a enterprise use case that is mission critical?


• how much headroom is there in area B, ie the pricing umbrella created by the incumbents' price points, TCO, and cost of sale and implementation

I would argue that Mulesource offers a very large overlap, represented by area A, with 10x price umbrella support, represented by area B in the above graphic. The financing, but more importantly the amazing developer, customer, and employee acquisition traction validates the premise.

Congratulations to the team.

Concept to Company Event: Widgets to Riches -- Monetization Strategies for Emerging Web Services Platforms

On Tuesday, May 15th, VLAB and Hummer Winblad are co-hosting the following event:

Concept to Company Event: Widgets to Riches -- Monetization Strategies for Emerging Web Services Platforms

The event is scheduled for 6-8:30 pm at Stanford Business School.

This year's Concept-to-Company will focus on Widgetbox, the leading web widget marketplace and syndication platform. Widgetbox's CEO, Ed Anuff, will present an overview of the market and company.

Other speakers include:

Max Mancini, Senior Director of Platform and Innovation, eBay
Adam Sah, Architect, Google Gadgets, Google
Lance Tokuda, CEO and Founder, RockYou!

The above industry leading experts plan to explore how the widgetization of the web will impact the way we maximize the potential of online communication, efficiency, and revenue generation.

Text from the event host follows:

With the recent proliferation of widgets, widget companies entering the marketplace, and the atomization of content and services, what opportunities do entrepreneurs and VCs see as ways to capitalize on this current trend? Is there a profitable business model for the current trend of decoupling content and services from their source?

Bauer's Second Law

In reading From Airline Reservations to Sonic the Hedgehog, A History Of the Software Industry, I came across a wonderful axiom.

Bauer's Second Law states that:

Talent migrates from areas of well defined and stratified responsibility to areas of expanding activity at a rate proporational to the rate of expansion. Or, stated more simply, talent goes where the action is.

Today, the valley is witnessing an amazing migration of talent from Yahoo!, eBay, AOL, MSN, and other leading web properties to start-ups. The start-up economy is benefiting from Bauer's Second Law in action. The best and brightest Directors and VPs are leaving large cap web companies at a rate proportional to the resurgence of the start-up landscape.

A few years ago, with low rates of start-up expansion, start-ups struggled to attract large company talent. Today, those days are a memory and incredible teams are coming together very early in a company's life cycle. Bauer's axiom helps make sense of the trend and the key driver for the migration of talent towards high-growth vehicles.

Leaders as Weather Vanes

In the 70th anniversary edition of Forbes, I found a wonderful 1915 quote from Charles Mitchell, the President of National City Bank of NY (today's Citibank).

Mitchell said,

"The principal duty of the head of an organization in the formative, developing stage is to pump, pump, pump energy into every fiber of it, to train thoroughly every member of it, and to infuse into every employee white-heat enthusiasm."

Wise words.

A vital lesson for developing leaders is that leadership is a public act. The gestures, facial expressions, and postures of leaders project across the whole organization. Like a weather vane, the comportment of the leader is a viewed as a predictor of the future climate. Leaders must be sensitive that employees will seek answers to the state of the company, health of its prospects, etc in the physical countenance and tone of the leader.

As President Mitchell's quote implies, leaders are also conductors of energy and must be careful to inject vitality, passion, and drive into the culture and not apathy, malaise, and surrender.

90 years later, Mitchell's words of leaders "pump, pump, pumping energy into every fiber" of a business ring as true as ever.

Hubpages: SEO and Dynamic Monetization Innovations

User-generated content is a key secular trend driving consumer behavior, Internet usage, and technology. The legs of the content stool are content creation, search engine optimization, monetization, syndication, and tracking/analytics.

For most small publishers, the process today involves bespoke integration of point solutions to allow for content to be easily created, served, monetized, and tracked. A typical blogger may use Typepad, Ad Sense, Feedburner, and Google Analytics. Not only are solutions stitched together via JavaScript, but also today's solutions fail to provide search engine optimization and dynamic monetization.

Given the Google is a vital source of traffic, it is very important that content appear in natural search results. Given domain aging, link analysis, etc., new sites suffer from very poor natural search placement and limited organic traffic.

Today, content creators need to pick an ad network and STATICALLY bind their content to a single monetization source and format. There is no way to ensure that the most effective ad unit, placement, color, ad network provider, etc. is used for any given piece of content.

Monetization, therefore, is clearly sub-optimized, while natural search results are hard to come by. The net result - very limited traffic and ineffective monetization.

Today, Hubpages, a Humwin company, announced a major upgrade to its self-publishing service. Hubpages provides an integrated content creation, SEO, ad yield optimization, and tracking solution that automatically ensures the best possible natural search results and the most optimal monetization programs.

Since launch in August 2006, Hubpages has enjoyed spectacular growth:

• traffic is growing 150%+ month over month, to 2.4m uniques and 6.2m page views
  
• 90% of the traffic is from organic search - ie SEO in action
• 43% increase in ad yields per page due to Hubpage's Behavioral Formatting Yield Optimization technology
• 20,000 hubs created and 14,000 authors on the system
• $1,800/month/top authors in income

In short, Hubpages delivers not only traffic to authors, but also optimizes the ad yield without any required work from the author to pick an Ad network, ad unit, and ad format.

Abstracting SEO and ad optimization represents a vital breakthrough in freeing authors to focus on content creation and not on bespoke integration of a set of tools with a static tie to a single source of revenue.