venture capital

BuzzFeed: An Open Letter to Ben Horowitz

 

Ben Horowitz, the erudite cofounder of the Andreessen Horowitz (A16z) firm is a respected heavyweight in the Silicon Valley’s venture capital milieu. But A16z’s $50m BuzzFeed funding looks surprisingly ill-advised, to say the least. 

From: frederic.filloux@mondaynote.com
To: Ben Horowitz, Andreessen Horowitz, Menlo Park, California
Re: A16z investment in BuzzFeed
———————————————————
Dear Ben:

May I ask you something? How long did you spend on BuzzFeed before deciding to invest $50m? I’m not talking of Jonah Peretti’s PowerPoint deck or spreadsheets, which, I’m sure, must be quite compelling. But did you sample the real thing, the BuzzFeed site?

And how many times a day do you log in? Please, don’t tell me it’s part of your mandatory media diet, I’ll have to struggle not to express polite disbelief.

Frankly, your investment leaves me bewildered.

Judging by your blog and your remarkable book (I energetically proselytize both), you embody a mixture of vista, courage, combining focus on details with broad systemic vision, all supported by deep hands-on experience.

In addition, you are of the generous type and I was even happier to buy two copies of your book (including a paper version for a friend) knowing all proceeds will go to Women in the Struggle — a noble cause.

In short Ben, I have a great deal of respect for you. You are the type of person our modern economy needs.

Except that I don’t share your vision of the news business. In fact, I’m standing at the polar opposite of it.

Let me be clear: I do not question the goals and means of the VC business you’re in. In fact, I think this extraordinary ecosystem of financing innovation has long been a vital booster to the economy. Whenever I get the opportunity, I preach this in France, only to find out that my plea is beyond the cognitive grasp of the French governing elite (our VC perimeter is 33 times smaller than yours for a GDP only 6 times smaller.) The whole system sounds fine to me:  investors gives you money — $4.15bn for Andreessen Horowitz at my last count –  your mission is to multiply, you create scores of high qualified jobs. Great.

But is BuzzFeed really such a good multiplier?

Obviously, you know more than I do about BuzzFeed’s long term’s prospects: Impressive growth, heavy reliance to technology. From a pure business perspective tough, I would be very careful to put other people’s money in a traffic-machine that depends for 75% on social referrals because not all clicks are born equal. BF’s are myriad, but they are worth a tiny fraction of, say, a click on The New York Times.

I spent some time trying to overcome my reluctance to BuzzFeed’s editorial content. I wanted to to convince myself that I might be wrong, that BuzzFeed could in fact embody some version of journalism’s future. But if that’s the case, I will quickly resettle in a remote place of New Mexico or Provence.

BuzzFeed is to journalism what Geraldo is to Walter Cronkite. It sucks. It is built on meanest of readers’ instincts. These endless stream of crass listicles are an insult to the human intelligence and goodness you personify. Even Business Insider, a champion practitioner of cheap click-bait schemes, looks like The New York Review of Books compared to BuzzFeed. And don’t tell me that, by hiring a couple of “seasoned editors and writers” as the PR spin puts it, BuzzFeed will become a noble and notable contributor of information. We never saw a down/mass market product morphing into a premium media. You can delete as many posts as you wish, it won’t alter BF’s peculiar DNA.

Fact is, quality content does exist in BuzzFeed (an example here), but in the same way as a trash can contains leftovers of good food: you must go deep to find it.  It won’t change the fact that what people enjoy the most on BuzzFeed is unparalleled ability to package, organize and disseminate mediocrity broken down in this promising nomenclature:

334-buzzfeed

Ben, don’t tell me you’re proud of A16z investment in BuzzFeed. By funding it, you are contributing to the intellectual decrepitude of readers, the youngest ones especially — already severely damaged by Facebook and Snapchat sub-cultures. Did it ever cross your mind that these people are going to vote some day?

Two years ago, one of your competitors, the Founders Fund (I believed it held values similar to yours) published an essay titled What Happened to the Future?. Their article outlines the conflict between “funding transformational technologies (like search or mobility)” and supporting “companies that solved incremental problems or even fake problems”. Do you realize that, by funding a company such as BuzzFeed, you fall on the wrong side of the fence?

Look, I’ve no problem to see BuzzFeed or The HuffingtonPost thrive. They’re run by super-smart people (such as this one) who developed audience-building techniques that legacy media should pay more attention to.

What bothers me the most is to see smart money such as A16z’s being diverted to such a shallow product.

Ben: You want to invest in the information business? Consider what the Sandler Family did with ProPublica: they provided the seed money for a fantastic public interest journalism project (which, in passing, snatched two Pulitzers). Technology-driven ProPublica is now financially autonomous. Or consider emulating Pierre Omidyar who supports First Look Media, which promotes the kind of journalism a democracy badly needs.

Of course, these two ventures won’t produce VC-caliber ROI, but you already have plenty of items in A16z portfolio to keep your investors salivating. So, why wallow in BuzzFeed?

And if you want to put your excess of cash into something even more meaningful, hop on a Netjets plane and go to Africa. I recently bumped into an investment banker from Lazard who gave me the full picture of the economic potential of African countries, in every possible field — including leapfrogging technologies that build on the explosion of the mobile internet. For that matter, I’m personally exploring opportunities and the development of mobile apps for health and education in poor countries (a non-profit project). I started modestly by lending an Android phone and other items to an eye surgeon who runs (pro-bono) surgery campaigns in Sub-Saharian Africa. After her last campaign in Burkina-Faso last spring, we debriefed and the conclusions are staggering in terms of demand and opportunities. And I know the same thing is happening with mobile education. I decided to put €10,000 of my own money, just to see some of the ideas I’m nurturing could fly. If I were you Ben, I’d put a million dollars to explore this. And if I were running A16z, I would invest millions in long-term projects such as the automated large-cargo drones system described at the end of Alexis Madrigal’s recent story in The Atlantic that could change a whole continent economy. Or in mobile phone-based projects in Africa funded by PlaNetFinance Group or others. Tech investment in developing countries is indeed a Next Big Thing — much bigger than listicles. Risks and upsides are both huge. Right up your alley.

Best regards,

—Frederic Filloux

Schibsted’s High Octane Diversification

 

The Norwegian media group Schibsted now aggressively invests in startups. The goal: digital dominance, one market at a time. France is in next in line. Here is a look at their strategy. 

This thought haunts most media executives’ sleepless nights:My legacy business is taking a hit from the internet; my digital conversion is basically on track, but it goes with an massive value destruction. We need both a growth engine and consolidation. How do we achieve this? What are our core assets to build upon? Should we undertake a major diversification that could benefit from our brand and know-how?” (At that moment, the buzzer goes off, it’s time to go to work.) Actually, such nighttime cogitations are a good sign, they are the privilege of people gifted with long term view.

The Scandinavian media power house Schibsted ASA falls into the long-termist category.  Key FY 2012 data follow. Revenue: 15bn Norwegian Kroner (€2bn or $2.6bn.); EBIT: 13.5%. The group currently employs 7800 people spread over 29 countries. 40% of the revenue and 69% of the EBITDA come from online activities. Online classifieds account for 25% of revenue and 52% of the EBITDA; the rest in publishing. (The usual disclosure: I worked for Schibsted between 2007 and 2009, in the international division).

The company went through the delicate transition to digital about five years ahead of other media conglomerates in the Western world. To be fair, Schibsted enjoyed unique conditions: profitable print assets, huge penetration in small Nordic markets immune to foreign players, a solid grasp of all components of the business, from copy sales to subscribers for newspapers and magazines, to advertising and distribution channels. In addition, the group enjoys a stable ownership structure (controlled by a trust), and its board always encourages the management to aim high and take risks. The company is led by a lean team: only 60 people at the Oslo headquarters to oversee the entire operations, largely staffed by McKinsey alumni.

The transition began in 1995 when Schibsted came to realize the media sector’s center of gravity would inevitably shift to digital. The move could be progressive for reading habits but it would definitely be swift and hard for critical revenue streams such as classifieds and consumer services. Hence the unofficial motto that’s still remains at the core of Schibsted’s strategy: Accelerating the inevitable (before the inevitable falls on us). Such view led to speeding up the demise of print classifieds, for instance, in order to free oxygen for emerging digital products. Not exactly popular at the time but, thanks to methodical pedagogy, the transition went well.

One after the other, business units moved to digital. Then, the dot-com crash hit. In Norway and Sweden, Schibsted media properties where largely deployed online with large dedicated newsrooms, emerging consumer services built from scratch or from acquisitions. Management wondered what to do: Should we opt for a quick and massive downsizing to offset a brutal 50% drop in advertising revenue? Schibsted took the opposite tack: Yes business is terrible, but this is mostly the result of the financial crisis; the audience is still here, not only it won’t go away but, eventually, it will experience huge growth. This was the basis for two key decisions: Pursuing investments in digital journalism while finding ways to monetize it; and doing whatever it took in order to dominate the classifieds business.

In Sweden, a bright spot kept blinking on Schibsted’s radar. Blocket was growing like crazy. It was a bare-bone classifieds website, offering a mixture of free and premium ads in the simplest and most efficient way. At first, Schibsted Sweden tried to replicate Blocket’s model with the goal of killing it. After all, the group thought, it had all the media firepower needed to lift any brand… Wrong. After a while, it turned out Schibsted’s copycat  still lagged behind the original. In the kind of pragmatism allowed by deep pockets, Schibsted decided to acquire Blocket (for a hefty price). The clever classifieds website will become the matrix for the group’s foray in global classifieds.

In 2006, Schibsted had acquired and developed a cluster of consumer-oriented websites, from Yellow-Pages-like directories, to price-comparisons sites, or consumer-data services. Until then, the whole assemblage had been built on pure opportunism. It was time to put things in order. Hence, in 2007, the creation of Tillväxmedier, the first iteration of Schibsted Development. (The Norwegian version was launched in 2010 and the French one starts this year).

Last week in Paris, I met Richard Sandenskog, Tillväxmedier’s investment manager and Marc Brandsma, the newly appointed CEO of Schibsted Development France. Sandenskog is a former journalist who also spent eight years in London as a product manager for Yahoo!  Brandsma is a seasoned French entrepreneur and former venture capitalist. Despite local particularisms precluding a dumb replication of Nordic successes, two basics principles remain:

1. Invest in the number one in a niche market, or a potential number one in a larger one. “In the online business, there is no room for number two”, said Richard Sandenskog. “We want to leverage our dominance on a given market to build brands and drive traffic. The goal is to find the best way to expose the new brand in different channels and integrate it in various properties. The keyword is relevant traffic. We don’t care for page views for their sake, but for the value they bring. We see clicks as a currency.”

2. Picking the right product in the right sector. In Sweden, the Schibsted Developement portfolio evolves around the idea of empowering the consumer. To sum up: people are increasingly lost in a jungle of pricing, plans, offers, deals, for the services they need. It could be cell phones, energy bills, consumer loans… Hence a pattern for acquisitions: a bulk purchase web site for electricity (the Swedish market is largely deregulated with about 100 utilities companies); a helper to find the best cellular carrier plan based on individual usage; a personal finance site that lets consumers shop around for the best loan without degrading their credit rating; a personal factoring service where anyone can auction off invoices, etc.
Most are now #1 on their segment. “We give the power back to the consumer, sums up Richard Sandenskog. We are like Mother Teresa but we make money doing it….” Altogether, Tillväxmedier’s portfolio encompasses about 20 companies that made a billion of Swedish Kröner (€120m, $155m) in 2012 with a 12% EBITDA (several companies are in the growth phase.) All in five years…

France will be a different story. It’s five times bigger than Sweden, a market in which startups can be expensive. But what triggered Schibsted ASA’s decision to create a growth vehicle here is the spectacular performance of the classifieds site LeBoncoin.fr (see a previous Monday Note Schibsted’s extraordinary click machines): €98m in revenue and a cool 68% EBITDA last year. LeBoncoin draws 17m unique viewers (according to Nielsen). Based on this valuable asset, explains Marc Brandsma, the goal is to create the #1 online group in France (besides Facebook and Google). “The typical players we are looking for are B2C companies that already have a proven product — we won’t invest in PowerPoint presentations — driven by a management team aiming to be the leader in their market. Then we acquire it; we buy out all minority shareholders if necessary”. No kolkhoz here; decisions must be made quickly, without interference. “At that point, adds Brandsma we tell managers we’ll take care of growth by providing traffic, brand notoriety, marketing, all based on best practices and proven Schibsted expertise”. Two sectors Marc Brandsma says he won’t touch, though: business-to-business services and news media (ouch…)

frederic.filloux@mondaynote.com

French Entrepreneurs Revolt

 

Not against their VC overlords, mind you. No, calling themselves “Pigeons” (The Fleeced) they staged a highly visible protest  (Google translation) against their government’s latest stroke of the money pump. In a nutshell, the new Socialist administration proposed to tax an entrepreneur’s capital gains as ordinary income. In very rough numbers, the tax rate would go from 19% to 60% or, some say, 80% in extreme cases.

The outcry, obligingly amplified by the media, forced the Minister of Finance to meet with a delegation of the aggrieved and to beat a hasty, muddy, non-retreat retreat with the customary weasel words of caring for entrepreneurship, competitiveness, social justice and the country’s much-needed financial sanity.

This isn’t the first time the French government makes moves that hurt both the facts and the perception of its economy. It is, I believe, yet another manifestation of its perverted, ambivalent relationship with money.

Allow me to explain.

I’m at the Café de Flore, my Parisian neighborhood, what I call the World Centre for the Caviar Left. There, my café-crème drinking companions sometimes question my having left France to go live in the epitome of materialism, Silicon Valley. I point to the double-parked Porsches, the Louis Vuitton, Dior, Armani, Berlutti and Ralph Loren stores nearby. The answer, uttered in utmost sincerity, never varies: ‘It’s not the same…’

In a way, they’re right. Considering sex and money, Americans and French cultures exhibit truly polar opposite behaviors. The French see nothing wrong with a President having a wife, a mistress and a love child, they revel in sexual and often sexist jokes. But, if you ask someone how much they paid for their apartment, they’ll react as if you’d touched them in boundary-breaking ways. Conversely, they perceive us Americans as demonizing sex — think a past President and his “oral” office — while being obscene with money.

If, as I believe, the most honest statement of country’s values is its tax code, the French government has time and again clearly stated where it stands.

One such declaration is the ISF, the Wealth Tax. It’s not a gains tax (on income or capital), or a transaction tax (sales tax or VAT), this is a levy on your assets after you’ve paid all taxes on the path to your owning said assets. I can be seen as  a cultural indictment of the “haves”. The ISF comes with bizarre (or revealing) exclusions: You own a business, that asset is not taxed; the same goes for your expensive art collection; 75% of the forest you own is ISF-free. (I’ll stop there and warn readers the Wikipedia ISF article is woefully out of date on details, but right on the concept.)

The ISF keeps exerting a perverse influence on the country.
First, too many people with substantial assets fled the country, often to nearby Belgium and UK where they were welcomed as they were going to enrich the local economies. I personally know high-tech executives who, after paying good-size income tax bills for decades, decided to protect their savings and moved out. A loss for the French, from grocers to cab drivers and teachers.

Second, companies with European HQs in France moved out, their execs paying income tax on their wages didn’t want to pay additional levies on their assets. Apple is but one such example. Its Euro HQ is now in London. And, of course, no other company will now expose its execs to the ISF by locating a headquarter in France. Another loss in money and, just as important, in reputation, in making France look business-hostile.

Last May, France elected a new President, François Hollande, a leader of the Socialist Party who successfully presented himself as an alternative to the somewhat conservative and definitely abrasive Nicolas Sarkozy. On the stump, Hollande promised more fiscal justice and went for a new low in demagoguery, saying: ‘I hate rich people’.

Once he got in office, needing more revenue in a sinking economy, he announced he’d raise the ISF percentage, and tax incomes above 1M€ at a new 75% rate. Plus the new tax rate for capital gains discussed at the beginning.

Interestingly, besides the Pigeons’ protest (an example here, so-so translation by Google here), high functionaries in the Ministry of Finance indict their administration’s latest moves. In Le Monde (the semi-official daily) these well-informed technocrats publish a damning opinion piece (translation here) under a nom de plume, Les Arvernes. In it, they remind us that, with the rarest of exceptions, their government bosses never held real jobs. These apparatchiks have no intellectual and, most important, no emotional connection to what building a business is, to putting money and reputation at risk. When you get a wage, you don’t put money at risk. When you build a company, you do. Taxing two different risks at the same rate shows dangerous ignorance of what building a business is — and of the consequences of making France less attractive to business builders.

Here in the Valley, once we’re done slapping our foreheads, we look forward to seeing more talent flow in, looking for a friendlier ecosystem. Paradoxically perhaps, entrepreneurs moving to the Valley shouldn’t worry the money pump operators back in France. As the Israel and India examples uncontrovertibly establish, emigrating entrepreneurs end up doing a lot of good for their country. They send back money, jobs, savoir-faire, technology, culture and optimism. To them, Silicon Valley is a new Villa Medici. This is much better than the Maginot Line French politicians sometime fantasize about in order to prevent individuals to move to better business climates.

JLG@mondaynote.com

 

Francois Hollande’s Start-down Nation

A forgettable election campaign just wrapped up: François Hollande is now the President of the French Republic. Time spent on foreign issues during last week’s one-on-one television debate mirrored the rest of the campaign: less than fifteen minutes in a 2hrs 50 minutes bout, one that left most viewers yawning. This campaign was petty, gallic-centered, oozing with demagoguery and completely devoid of great projects or ambitions for the country.

Mr. Hollande himself epitomizes this political flabbiness. He’s the default candidate. Last year, after Dominique Strauss-Kahn’s sexual implosion, Hollande kept running his tiny electoral diesel engine in low gear, bereft of grand ideas, unable to get into overdrive. He didn’t win because of his track record — he has no such thing. He was both a mediocre party leader and the weak manager of the poorest French department, which he left heavily indebted. Mr. Hollande didn’t win because he embodies any kind of grand aspirations either; other than getting into the Élysée palace, he has none. Instead, he portrays himself as a “normal guy” after — it’s also fair to mention — the hyper-kinetic, agitated, communication-obsessed, Nicolas Sarkozy.

Sure thing: with François Hollande, the country will rest; it will settle into gentle indolence as the rest of the world evolves and interacts. Most likely, the Euro zone crisis will heat up with a worsening situation in Spain where a quarter of the population — and half of the youngest citizens — are unemployed. Most likely also, ratings agencies will further downgrade French debt — since 1973, the country never had a balanced budget. Meanwhile, Mr. Hollande will fulfill his electoral promise of hiring 60,000 additional teachers; this while the country needs less teachers (there are less kids in front of them) but higher paid ones, along with higher respect and better working conditions. He’ll travel to Brussels and renegotiate the European Treaty, pitching the notion of growth (eureka!) against the “austerians“. On this, he might be right somehow (see last week’s Paul Krugman’s column in the New York Times titled Death of a Fairy Tale.)

All this doesn’t mean the Socialist presidency will be as dangerous as too many like to say. People making more than one million euros per year will indeed enter a 75% tax bracket: The new president claimed “[he] doesn’t like rich people” (a few years ago, he assigned a threshold of wealth to the equivalent of $60,000 a year). But vis-à-vis the much-bashed “Finance”, he’s likely to act as a pragmatist. A possible chief of staff for Hollande could  be Jean-Pierre Jouyet, currently chairman of the Financial Markets Authority and former minister of European affairs. There is no shortage of left-leaning talented people, and this middling leader is likely to surround himself wisely — on many counts, he can’t do worse than his predecessor.

France won’t fall from the cliff, nor will it shine brightly under the new regime.

And it won’t innovate either.

What made this campaign so depressing was both sides seemed to willfully ignore one of the most potent engines of the economy, that is innovation and a country’s ability to foster it. Both candidates seemed totally disconnected from critical challenges in which France is failing in every possible way.

Take higher education. The failure is unequivocal, regardless of political leanings. France might have about 80 universities, most of them second or third rate and producing mostly unemployable people. And if you dare a transatlantic comparison, you generate killer statistics. France’s budget for higher education and research is the equivalent of Harvard University’s endowment (€24 billion or $31 billion for French universities and public laboratories and $32 billion of cash reserves for Harvard). Overall, France’s spending per student is less than half of the US — and 15 times less if you compare to the Ivy League colleges. French faculty members, unions and politicians have made their best efforts to disconnect universities from the business world. They’ve been remarkably successful. As a result, Gallic colleges have become poorer, and largely unable to cope with the legions of students that land onto their benches, facing underpaid and unmotivated professors.

Of course, France has a different way to produce — and to reproduce — its elites. Two highways, actually: l’Ecole Nationale d’Administration (ENA) and l’Ecole Polytechnique. Mr. Hollande is an offspring of the first (so was his former partner, Ségolène Royal, the unlucky but picturesque 2007 presidential candidate.) As someone who grew inside this comfy seraglio and who traveled very little abroad, the new French president can’t envision an alternative to this trusted model for running the country. As for Polytechnique, it produces the top French engineers, a caste in itself, that has little to do with those graduating from top anglo-saxon colleges. The difference between a Polytechnique student and a Stanford one is the former will dream to manage, one day, a large industrial concern such as Thales (defense electronics) or the energy group Total, while the Stanford grad will want to see his/her name on a campus building — after a creating a successful business, needless to say. As the New York Times noted in a recent story about the return of class war,

Just under half of France’s 40 largest companies are run by graduates of just two schools: ENA,(..) and École Polytechnique (…). Together the schools produce only about 600 graduates a year. There are fewer than 6,000 ENA graduates alive today, compared with at least 160,000 Oxford alumni.

This doesn’t constitute the best soil for a start-up culture. And the venture capital activity is not likely to help either. In 2011, French VC funds invested €822 million in start-ups, a 21% drop vs. 2010. Even worse, 64% of these funds went to second or later rounds of financing, initial funding collected a mere 8% of the total. Not exactly a risk-prone attitude.

Again, international comparisons hurt. French VC invested last year about €13 or $16 per company and per inhabitant; that compares to $93 in the United Sates and more than $110 in Israel. Speaking of Israel, if we take into account the money flowing from abroad, the figures are even more staggering as VC funding per capita rose to $280 in 2011 according to IVC-KPMG data:

In 2011, 546 Israeli high-tech companies attracted $2.14billion from local and foreign venture investors, the highest amount in 11 years. This is almost 70 percent above the $1.26 billion raised by 391 companies in 2010 and 91 percent above the $1.12 billion raised in 2009.

In their excellent book Start-up Nation, the story of Israel economic Miracle, authors Dan Senor and Saul Singer also write:

Comparing absolute numbers, Israel — a country of just 7.1 million people –attracted close to $2 billion [in 2008] in venture capital, as much as flowed to the UK, Germany and France combined. (…) In addition to boasting the highest density of start-ups in te world (a total of 3,850, one for every 1,844 Israelis), more Israeli companies are listed on the Nasdaq [list here] than all companies from the entire European continent.

To complete this quote: about 250 companies originating from Israel had an IPO on the Nasdaq. Today 50 companies remain listed vs. 47 European companies including 3 French ones.

None of the above was mentioned, even remotely, during the French election campaign. Nicolas Sarkozy did very little about fostering innovation — he didn’t have a clue. As for François Hollande, the strongest part of its electorate (largely composed of teachers and other public servants) opposes any rapprochement between private sector and public higher education. And let’s not mention the underlying “ideology” of venture capital, carried interest, IPO’s, flexible employment rules, etc. Hollande’s supporters will also oppose any removal of cobwebs from the 102-year-old labor code that greatly complicates the management of companies employing 50 or more people. As a result, France has 2.4 times more companies with 49 employees than with 50, read this story in Bloomberg BusinessWeek.

This makes France a rather start-down nation. Nothing to celebrate.

frederic.filloux@mondaynote.com

Cash is a fact, profit is an opinion

Apologies in advance: If you’re fluent in the language of accounting, please skip to the bonus Verizon iPhone feature at the end. What I’m about to describe will strike you as oversimplified and could bruise your professional sensitivities.

Companies sometimes (often?) manipulate their numbers. Today, we’ll look at a few examples of accounting sophistry and misdirection that may prove useful in fine-tuning your own BS (Bedtime Stories) detector. As always in these Monday Notes, any reference to real people, companies, or accounting principles and practices only have hypothetical connections with reality. Believe anything below at your own risk.

Let’s start with profit. At the most basic level, profit is the difference between what you take in, sales of products or services, and what you spend, salaries, rent, raw materials and the like. So, when that difference is positive, when you spend less than what you take in, you’ve “made money,” right? Profit is money, right?

No. It’s just a number. You can’t put it in your pocket and spend it as you see fit. To start with, you already owe some of that putative money in the form of taxes. The moment you cut an invoice could be a “taxable event.”

We say things like “DC&H is making money” when the company reports a profit, but this is delusional. If customers “buy” but don’t pay, there comes a moment when you run out of actual cash. That’s why some businesses pay a commission to their salespeople on remittances only (in English: only on what customers actually pay). This policy has a strange effect: The more experienced sales people nod sagely when marketing folks tell them what to sell and how, and then they go out and push the products they know customers will actually pay for.

Profit isn’t unimportant, certainly, but it’s not as important as cash. If your business suffers a downturn but has plenty of cash, you live to fight the next battle. If you’re ‘’profitable’’ but run out of cash, you don’t. And you can be profitable and still go bankrupt (and learn another kind of ABCs).

So far, nothing really new or complicated.  The trouble starts with reserves.

I use the word “reserves” to tweak my deceased father, an accountant. I would counter his protest that accounting is a science by uttering the magic word…and the discussion would descend into a lecture on the “accountant’s judgment,” which, in my opinion, makes accounting part of the storytelling category. (As an aside: Wikipedia’s storytelling article misses the excellent Amusing Ourselves To Death in which Neil Postman makes the all-important distinction between science and storytelling. Example: Math vs History.)

As a prudent businessperson, you have a jaded view of the stack of invoices sent in by the salesforce. You know customers. Even if your salespeople are as realistic as you are, you know some of your buyers won’t pay. As a result, you tell your bookkeeper to make a reserve for bad debts, invoices that won’t be collected. But how much? 1% of sales, 5%? It depends on…name your poison: An unreliable, unproven new product; the economy; a non-financial hurricane; an overly aggressive promotion campaign (a.k.a. “stuffing the channel”). You have to make a judgment call and reduce the number of sales you claim — and the profit you expose to the taxman.

Your sales and profit numbers are now an opinion. And this is what the owners of the company, your shareholders, expect. They don’t want a raw number, they want a good story, they want your best judgment on the state of the business. A small white lie for a greater good.

Now we stretch things — or we become more sophisticated. Reserving for bad debts falls into the broader topic of Revenue Recognition.

Let’s say you ship software. And customers pay for it. Should you report all the revenue (and the 90% profit margin)? Surprisingly, your software has bugs and you, being a forward-looking entrepreneur, decide to issue bug fix releases for free. (This means you’re not Oracle, SAP, or IBM who charge 18% per year for bug fixes.) By some accounting lights, you haven’t fully earned the revenue until you’ve delivered the fully-functional product and so you must put a portion of the dollars you received into a reserve. The real revenue is now less than the receipts.

You do the good deed, you fix enough bugs to declare victory after a few “dot releases” (7.1, 7.2, 7.2.1, …). You can now put the reserve back into the sales number you report and give yourself a momentary bump in profits.

Is this a good idea?

In a literal reading of the words, the question must be answered in the affirmative: Yes, it is a Good Idea. But it’s often abused. In the nineties, Microsoft was well-known — no, celebrated — for its smooth earnings growth, for never surprising Wall Street, for always landing just a penny above “Street consensus” estimates.

How did they perform such a feat? Reserves. As the company shipped humongous volumes of Windows and Office software, it stuffed “suitable” amounts in various reserves cupboards, and then, each quarter, withdrew exactly the right portion to make their earnings look “just so.” I’ll hasten to add that Microsoft wasn’t the worst offender; the company was merely “managing earnings”.

(The Revenue Recognition Wikipedia article is too encyclopedic, this About.com article is less arduous. See the last paragraph on page 2: How Management Can Manipulate the Income Statement Using Revenue Recognition…)

Last week, when discussing Microsoft earnings, I linked to a Gregg Keizer article in Computerworld. There you can find phrases like: “Rob Helm, an analyst with Directions on Microsoft, tried to explain Microsoft’s accounting.” Gregg Keizer proceeds to untangle reserves and, for good measure, makes a judgment call on the revenue spike associated with the release of Windows 7 a year before. He concludes that the “real” Windows business is down 30%, a number that will certainly be disputed.

But what matters, here, isn’t a specific number, it’s the process, the work that must be done to interpret the stories companies tell us through their numbers. One reading of an earnings release could be “Revenue and Profits Are Up, All Is Well.” Another interpretation: “Good Quarter, But Watch This Trend.”

Then there’s the meaning of words. Company X says “We shipped 2 millions gizmos!” It’s a success, gizmos are flying off the shelves. Or not. Does shipped mean sold? Or are the devices sent to a distributor who doesn’t consider the shipment a purchase and can claim return rights if the “sell-through” proves disappointing? Indeed, the Windows Phone 7 “shipment” figures convey little information about the number of phones that have actually been sold by handset makers and carriers. As another example, Samsung executives recently ‘‘clarified’’ their claims of 2 million Galaxy tablets “sold.” They had been shipped to distributors but actual sales were unknown (yet “smooth”).

This introduces the broader and murkier topic of naming, classifying. A fundamental part of accounting is putting things, events, in the proper bin. Or building appropriate bins, or coming up with elaborate language for transferring assets and events from a commonsensical category to a special-purpose bin designed for tax-avoidance…sorry, optimization…or other even darker purposes. And here we enter the hell of off-balance-sheets, synthetic leases, special-purpose entities and memories of the Enron/MCI/Worldcom era.

The complexity of these schemes is mind-numbing, and that’s exactly their purpose: To make people oblivious to reality. But as we know now — and as a few Cassandras had been saying before the fall — negative cash-flow revealed that these fancy entities and vehicles were bad, fraudulent stories.

(This University of Chicago course material, this Brigham Young University presentation and this book abstract will provide legal and inexpensive sleep induction. Don’t ask why fancy accounting got us in trouble again, in 2008 this time, only on a much grander scale.)

To paraphrase a gun lobby slogan: Numbers don’t lie, people lie. And to do so without going to jail, they use obfuscating, misdirecting language. If it’s unclear, it’s probably an attempt to hide something. But cash doesn’t lie.

[Pour mes lecteurs francophones, une traduction libre du titre: le liquide, c’est solide, mais le profit est un gaz…]

And now, the fun bonus feature: The iPhone on Verizon.

Depending on whom you believe, Apple’s partnership with Verizon is either the second coming of the “Jesus Phone” or a non-event. Analyst’s predictions vary wildly, from 11 million to 19 million units for this year. Others, such as Dan Lyons in a Daily Beast column, are more dyspeptic, that the iPhone on Verizon comes too late to avert its pre-ordained destination: a niche.

We’ll see. But, in the meantime, can we make a guess? Will the iPhone enjoy strong sales in Android territory, the Verizon network? (For reasons explained above, we’ll ignore Verizon’s claims of “record first-day pre-order activity” for its iPhone: there are no numbers attached.)

For an answer, we can turn to numbers and a little fable.

The numbers are Android sales at AT&T. In a word: weak. See below, from a New York Times Bits blog post by Nick Bilton:

The only network where the iPhone faced Android was AT&T’s. There, the iPhone won the mano a mano. Why?

I’ll answer with the fable:

My beloved spouse, Brigitte, decides she wants a smartphone. Not because I say so — she’s a normal human and carries a healthy disregard for her tech chauffeur’s views on hardware and software. No. Her friends tell her she needs one.

She enters the AT&T store on El Camino Real and tells the salesman she’s looking for a smartphone. “You’ve come to the right place, Madame. We have Android phones and we have the iPhone.” Inquiring about the difference in price and features, she gets a non-committal answer: “They’re priced about the same and they’re all very good.” She switches gears and plays the poor maiden lost in the high-tech maze and asks again. Suddenly chivalrous, the salesman confides: “Look, this one, the iPhone has an iPod inside, the others don’t.” And the sale is made.

“iPod inside” is symbolic of the difference AT&T customers perceive and pay for. The iPhone doesn’t sell more because it’s less expensive, or because competitors don’t offer incentives to AT&T and “spiffs” (commissions in goods or cash) to sales people on the floor.

We’ll see if the “iPod inside” will also be a factor at Verizon.

JLG@mondaynote.com

Mobile Payments

Last week’s note on Apple licensing generated a good flow of comments, all appreciated. I’ll respond, but not before we get Apple earnings and the putative Jesus Tablet out of the way.

I’ll approach today’s topic, mobile payments, using an Apple Store moment.

Some cables keep disappearing. In particular, the ones that connect MacBooks of various vintages to conference room projectors. As much as some of us admire Apple’s minimalist fixation, the parade of video-out connector generations can grate. The world outside of Cupertino is inelegant, imperfect, we know. But that world features one universal projector connector standard: VGA.
In recent years, Apple moved from mini-VGA to DVI to mini-DVI to micro-DVI to mini-DisplayPort, creating the need for a (dis)array of “to VGA” adapter cables – see the links earlier in the sentence. Elegance at a price. Let’s hope the mini DisplayPort will stay blessed for a while.

So… Entrepreneurs come to our office for a presentation; they forgot the VGA adapter for their MacBook, I lend them one from my private stash. You know what happens next, they’re entrepreneurs. I go back to the Apple store for a replacement.
Adapter in hand, I approach an Apple Store employee with a hip-mounted sales terminal, whip out my credit card; a couple of minutes later, we’re done. No bag, receipt by email, life is good.
But, why use a credit card?
I have an iPhone, the Apple sales terminal is an iPhone as well, why can’t I just touch an icon, enter a PIN and be done? That’s what I do when I buy the Inglorious Basterds movie, a Bo Diddley Blues album or the (very buggy) Kayak application via iTunes on my iPhone.

The iPhone (as well as many other devices) contains a micro-SIM, a Smart Card module similar to what you’ll find in many European payment cards. Insert one of those in the payment terminal, key your PIN and you’re done. Why can’t we do this with a smartphone and get rid of credit cards? Simpler transactions, neatly listed on the device, if desired, and in an on-line account, as it’s done today.

The idea isn’t new. More

Venture Capital Business Model

by Jean-Louis Gassée

As promised last week, let’s dig into a venture fund’s key numbers.

Limited Partners, LP, institutions or individuals put money into the fund. We, the General Partners, GP, make and manage the investments and we split the profits with the LP as the sole compensation for our services.
Over time, the split has varied with the industry’s prosperity and the fund’s reputation, it went as high as 35% of the profits for the GP but, as this WSJ story belatedly explains, is now back to about 20%. In our vernacular, that number is called the Carried Interest or, for short, Carry.
A second number, the Management Fee, needs a bit more elaboration.
As the Carry did, it varied and went up to 2.5% of the fund’s capital; it is now pegged at a fairly standard 2% per year. The Management Fee provides the money needed to run the firm’s operations, pay the rent, associates’ salaries, travel expenses and the like. It also provides fodder for misunderstandings.

The Management Fee is a loan, not a stipend. For the GP to get its 20% of the fund’s profits, both the capital, the money invested by the LP and the Management Fee must be repaid first.
When funds become very large, say a billion dollars or more, the Management Fee gets correspondingly large and can encourage spending habits, thus generating criticism the GP is more interested in the fee than in making money for its investors.
But, you’ll object, the advance must be repaid before profit-sharing kicks in. Yes…, and what happens if the fund doesn’t make money? Are the LP losing money while the VC enjoys a good time, living off the Management Fee? The answer depends upon the way the fund agreement is written. If it contains a Clawback clause, the GP is obligated to return the “unearned” fee. As you can imagine, this leads to interesting exchanges during the fund’s formation and, much later, if it turns out it loses money.

To summarize: profit sharing (Carry) of 20%, a yearly advance of 2% of committed capital (Management Fee), to be repaid before profit sharing kicks in. More

The Other French Paradox (2) – Jobs

Two weeks ago, I discussed what I called The Other French Paradox, that is how French taxpayers and French companies are at a (curable) disadvantage in Silicon Valley. Last week, I “shared” (we’re in California) my own plans to deal with the twin problems: a venture fund whose profits reverse the flow of money back to France and whose role is to help French high-tech start-ups achieve their full potential by becoming real members of the Silicon Valley ecosystem and, from there, by gaining access to Asian markets.

This week, as promised, I’ll deal with “mere matters of implementation”, questions and objections.

Sadly, I’ll explain the adjective in a moment, the first objection my compadres and I get is one of jobs outsourcing, or délocalisation: “When you transplant these companies to the Valley, French jobs disappear in the process.”
Understandably, if the company’s management team pulls up stakes and move to Mountain View or Palo Alto, there is a sense of loss, they’re gone, their salaries used to feed the local economy.
But, that’s where the “sadly” comes in, there seems to be little faith in the company’s success and in the resulting job creations back in France. Sometimes, I wonder if this lack of faith can’t be summarized thus, using a metaphoric pizza slice: to get a  bigger share, one can worry about its angle, is it 12 degrees or 15 degrees, or one can work to increase the pizza’s radius. Do we prefer a healthy but smaller company, all located in Brittany, or do we want an even healthier, larger enterprise, creating more jobs, both in France and in the US? Posed like this, the rhetorical question fails the “can you disagree” test, it’s framing.
For a way out of the frame, let’s turn to economic interest; in plainer English: making money.
The way we structure our investments in “transplanted” French startups keeps at least 50% of the engineering work, jobs, in France. We don’t do this because we’re nice guys, we want this because it makes economic sense. Let’s review. More

Resolving The French Other Paradox

Last week, we looked at the two components of the “other” French Paradox.

First, the Valley aura helps a tiny Palo Alto start-up sell its technology in France. But it doesn’t work the other way around: a Lyons high-tech company will get a polite reception but no orders from the likes of HP, Google or Oracle. While the Valley does sell in France, to sell in the Valley you need to be of the Valley.
Second, French taxpayers unwittingly subsidize VC-backed Valley startups. Graduates from public universities or grandes écoles such as Polytechnique, Centrale and many others come to the Valley and contribute their skills and energy to the companies we, American venture capitalists, invest in. (In passing, thanks to a reader who reminded me HEC, one of the leading French business schools is a private institution.)

The French speak of “refaire le monde au Café du Commerce”, the phrase refers to a suitably lubricated theorizing of the World As It Ought To Be. In moderation, a healthy way to pass the time with friends and to keep one’s debating skills sharp. With little risk of dealing with the “mere matter of implementation” – the one I’ve decided to address today.

After a quarter century in the Valley, after meeting countless French entrepreneurs, students, executives, elected officials and high-level civil servants; after indulging in more than a few of the Café du Commerce sessions mentioned above, in the Valley and in Paris; after more than seven years inside a Palo Alto venture firm, I finally had an idea, one of those that come with the pleasant sensation of the retroactively obvious.

Here goes: Resolve the paradox, build a venture firm exclusively focused on helping French high-tech companies become full members of the Valley ecosystem. And open the firm, its first venture fund, solely to French investors.
This isn’t theory, I’m doing it. As we speak, my co-founder and I have assembled a team, we’re polishing our pitch and prepare to go “on the road”. In early 2010, we’ll be meeting with potential Limited Partners, LPs, the accepted term for investors in a fund like ours, called ArèsVentures. More

The Other French Paradox

by Jean-Louis Gassée

Foie gras, crême fraîche, butter, red wine — and lots of it! All these excesses leading to a higher life expectancy, to say nothing of the joys of sinning. That’s the legendary now official French Paradox. Scientists strain to explain the phenomenon: ‘It’s the phenolic compounds in the red wine’, they say. Me, I look at eating habits in my adopted country: restaurant chains like the Cheesecake Factory, “family-style” servings,  food everywhere, everyday, at all times in offices like Google’s.
Methinks there is no paradox just quantity, 360 degrees and 24/7 availability, as the recent but unmistakable widening of French bottoms attests.

No doubt, these must be Thanksgiving hangover-induced thoughts. Let’s turn away from arteries-clogging food and contemplate another set of incongruities.

Silicon Valley VCs (like me) are subsidized by the French taxpayer. Yes, bear with me, no fancy science, no magic involved.
It goes like this: a young kid performs well in high school, s/he is “tagged”, put on the higher education track, prep classes, “grandes écoles”, top-level business, government and engineering schools such as Polytechnique, HEC or ENA and their many local siblings. Such education is essentially free, that is paid by French taxpayers.
The young graduate starts working at one of the big French companies, Thales, France Telecom or Airbus. Soon, an alumnus calls: I’m at Google, or Apple, or Cisco, or this little Silicon Valley VC-funded start-up, come and join the fun. Indeed, graduates from prestigious French higher-education institutions are everywhere in the Valley. VCs have learned long ago to look beyond the “35 hours” and “5 weeks paid holidays” reputation. Actually, we know the “locals” got a little lazy over time, like New York Jewish families wondering why their sons and daughters now lose the Math Prizes to the children of Chines immigrants. First generation immigrants are naturally hungrier than the more prosperous third generation families. The famed Silicon Valley work ethic is too often a pose; new immigrants, in general, and French ones, in particular, are viewed as harder-working than some of the too-cunningly-adapted natives.
Paradoxically, that word again, the constraints, the obstacles of a highly state-regulated culture tend to sharpen creative skills — highly valued ones in our entrepreneurial Valley. In  France, defeating regulations is a national sport, a point of manhood. More