Thursday, June 11, 2009

Google Article in Wired Magazine

Just read a nice article by Steven Levy at Wired about Google’s economic model. None of it is particularly new, but it does a good job of highlighting innovations beyond search.

Key Take-Aways

  • The first major innovation was in auctioning off a slate of ad slots each time a search query was made, and billing advertisers based on clicks on the ad, rather than impressions. Both were major departures for vendors/advertisers, who were familiar with drawn out auctions on eBay, or CPM based ad pricing on Overture.

  • A major innovation in Google’s auction process was the use of “second-price auctions”, where the winner of each keyword auction pays the price of the next highest bidder. The process reassured bidders they wouldn’t be a paying much more than the next guy, and ironically, provided enough comfort to actually result in higher bids over the long-run. Anyone who buys via AdWords knows how this affects their thinking in placing bids.

  • Auction winners and price is also determined by a set of algorithms which determines the quality and relevancy of the ad and associated landing page. This “quality score,” is meant to ensure high click rate and satisfaction for the consumer and advertiser. It also allows Google to predict click-through rates and improve its own business.

  • Google uses a “keyword pricing index”, which similar to the Consumer Price Index in that is measures the relative value of keywords to one another. This is indicative of how much emphasis Google places on data accumulation, trend analysis, and constantly improving its product for advertisers and consumers alike.

The most important I gained from this article is a reminder that Google did not anticipate the intricacies of its business model, let alone the auction model in advance. This is not to say they had no clue how to make money. Early on, they know the value of search provides users, that search implies "intent" and that intent is perfect for monetization. Ultimately, their success came from emphasizing consumer experience, customer experience (advertisers), and harnessing the results to further improve and refine the model and product. Google long ago ceased to be merely search company, and is now an economy unto itself.

Wednesday, June 10, 2009

BVP's David Cowan Gives the IVA Keynote

For those of you who missed it, my partner, David Cowan, gave the keynote address at this year's Israel Venture Association annual conference. I provide this link to his own blog, where you can review his presentation and read most of his thought provoking notes from the speech.

His message was a sober one about the current state of venture market, and how to turn the venture business into asset class that once again yields meaningful returns for our investors. He pointed out the little known fact that only a handful of VCs actually have the attractive returns that warrant continued risk taking on the part of LPs. A recent Kaufman report even claims the venture capital industry must shrink by half for it to survive, and cites stark statisctics from Cambridge Associates that the "venture industry lags the small-cap Russell 2000 Index by 10 percent on a 10-year timeframe, despite the fact that those 10 years include the dot-com period, which materially inflates venture industry performance."
The reality is that while the venture market already experienced an earthquake back in 2000, we are only now coming to grips with the effects post-bubble economics are having on our underlying business. At this point, optimistic scenarios for the return of '90s style venture investing should have been eliminated with the latest financing crisis(which has now undermined the VC's capital base).

In Israel, such optimism over the past decade paved the path for funds to continue backing underperforming companies with the hope that good times were just around the corner. The result is that when looking at the portfolios of Israeli funds, few investments have been written off, and the vast majority are still private many years after the initial investment. David made a compelling argument that most funds would be better off having never invested most of the portfolio, even if it meant accepting a larger write-off(because right now, there aren't enough write-offs to speak of).

We Israelis have an uncanny ability to adhere to the "perseverence of mission," which is one of core principles in the Israel Defense Forces' code of ethics. By this I refer to the ability of both entrepreneurs and their VCs to keep at it as long as it takes to prove even a modicum of success. While this can be an admirable quality in some cases, it can also become a burden that prevents both entrepreneur and VC from stepping back to reassess the rationale of continued investment. As a result, "walking through the dessert" with a portfolio company during a rough patch is not an isolated event reserved for elite crop of companies, but rather the typical route for Israeli VCs and their portfolio companies.

Surprinsingly, there seems to be a difference of opinion on this matter in talking to entrepreneurs and LPs over the past few years. Entrepreneurs in Israel are convinced that Israeli VCs pull the plug too early and don't provide support during tough times. This became clear once again in comments made during the recent Globes survey of venture capital funds. In speaking to LPs from the US, however, they make it very clear that Israeli funds support their portfolio companies in excess, and don't do nearly a good enough job in cleaning their portfolio of underperformers. I for one believe that the LPs are in the better position to point out that Israel is an anomaly in this regard.

From the many compliments David received on this speech, it is clear that many in our industry are also exhausted from the omnipresent cheerleaders, who glorify the Israeli high-tech story ad nauseum. The strength of Israeli high tech is globally renowned for good reason, and its prominance will endure for decades to come. The threat the local industry faces is one of simply being an unattractive place for venture investment due to out-of-date company building models and out-of-date investment models. Despite the somber assessment of our collective performance over the past few years, David made it clear that that there are new and exciting trends, sectors and business models that are clearly attractive for venture investing.
Going forward, David offered advice(given in this blog too) including smaller investment amounts in more capital efficient companies, and not being afraid to fail, admit error and move on to the next opportunity. On the last point, the earlier and faster we do this, the more likely we all have a chance of finding or creating the next success story.

In classic style, he ended the presentation on a literal high note, playing Al-Kol-Eleh (a traditional Jewish song), using his iPhone and an application called Leaf Trombone by Smule (a BVP portfolio company). Thanks for sharing your insight David.