Above the Crowd

June 25, 2012:

“Well I was born in a small town
And I live in a small town
Prob’ly die in a small town
Oh, those small – communities”
— Small Town, John Mellencamp

While “Social-Mobile-Local” is certainly an overused buzz phrase, most of the attention has been placed on the “social” and “mobile” parts of the phrase. In social, the spectacular rise of Facebook and Twitter is clearly a disruptive and critical trend. In mobile, the adoption of the smartphone (led by Apple’s iPhone and now catapulted forward by Android) is also a fundamentally important platform transition. Much less attention has been paid to the third concept, “local,” which is ironic since it may be a much larger real business opportunity than either social media or Smartphone application revenue. Over the next five years, this massive opportunity will come into focus as local businesses embrace the Internet and adopt new interactive technologies that increasingly automate the connections between their customers and themselves.

A Huge Opportunity

The attached slide will look familiar to readers in Silicon Valley. It appears to be a disruptive, up-and-to-the-right graph that we normally associate with break-out technology companies. This slide, however, maps the rise of the Yellow Pages industry in North America from 1920 to 2007. As you can see, the Yellow Pages business saw incredible revenue growth as the phone became the key point of connectivity for interaction with local business. At its peak in 2007, the North American Yellow Pages business topped out somewhere between $14-16 billion, depending on the source.

Total local advertising and promotion is much larger than just the Yellow Pages. A separate analysis done by Advertising Age, suggests that in 2007, local U.S. businesses spent around $123 billion annually on local media. However, starting in 2008, this market began to materially erode. Why? Newspapers, magazines, local radio, and Yellow Pages represent about 80% of this spend, and the rise of the Internet is unquestionably undermining the  core structure of these industries. Since 2007, Yellow Pages revenues have fallen in half in five years, after taking 87 years to reach their peak. Many newspapers have closed, and others teeter on the edge of bankruptcy. This is not at all shocking. We  know that consumers are using these products less frequently every day. The Yellow Pages business itself suffers from a terminal disease.

If you think back to five years ago, the small business owner was clearly an Internet skeptic. People would say things like “you should have a web site,” but for most local business owners — like a pet-shop or a locksmith — this didn’t mean anything. They had a phone, it was listed in the Yellow Pages – and people could find them. And if the potential consumer went online, the phone number could be found there as well. No problem. For those that did put up a web site, it was, in many cases, a non-event. Some customers might find it, but only the ones that were already looking for them. What’s the big deal?

An Online Awakening

Two things then happened. The first is the critical success of Yelp. Local merchants were suddenly profiled in an environment where the consumer, not the business owner, controlled the copy and the narrative. At first, it was easy to disregard this thing called Yelp as a passing fad. But the voices  got louder and louder – both the happy and the unhappy ones. Accountability and transparency had arrived at the local level. One has to suspect that Facebook’s pervasiveness played a roll in awakening the small business owner too.  By 2011, Facebook had reached 71% penetration of all 221mm U.S. Internet users. Regardless of  industry, when the small business owner now went home, his or her family was constantly on the Internet – playing games, doing research, connecting with friends. The Internet’s pervasiveness could no longer be denied.

Today, the small business owner’s attitude has shifted from denial to anxiety, and, as a result, these local business owners are rushing to the Internet in droves. In Benchmark’s own portfolio, we have eight companies (OpenTable, Uber, Zillow, Yelp, DemandForce, GrubHub, 1stdibs, and Peixe Urbano, *) that generate the majority of their revenue directly from local businesses. Based on estimates, these companies will represent approximately $735mm in revenue in calendar year 2012. Four of these companies have already seen a liquidity event (OpenTable, Zillow, and Yelp have had successful IPOs, and DemandForce was recently purchased by Intuit for $425 million). As small business owners embrace the Internet, the local Internet is firing on all cylinders. Not bad for a customer segment that was once considered a “do not enter” zone for venture capitalists.

The Smartphone as a Catalyst

If the decay of the Yellow Pages was a catalyst for the local Internet, then the rise of the smartphone is an accelerant. Smartphone adoption is staggering. Today, there are over 1 billion smartphone users worldwide, and in the U.S., smartphone penetration recently passed 50%. Google has announced that Android is activating over 850K new users a day. These mobile devices are frequently the preferred device (vs. a personal computer) when a consumer looks to interact with local businesses. For the eight companies mentioned above, mobile usage already represents between 25-50% of overall customer usage depending on time of day and day of week. And mobile usage looks destined to increase from here: DigitalBuzz predicts that mobile Internet users will pass desktop Internet users within the next 3 years.

The rise of the Smartphone as a new platform is a huge benefit for entrepreneurs. Simply put, large incumbents are typically slow to make shifts to new platforms. This is either because they are overly focused on their current strength, or simply too large and bureaucratic to move quickly. Often, it is a combination of both. Startups on the other hand are eager to find a point of leverage or advantage, and rush to new platforms. New platforms typically have  “hooks” that enable features that never existed on the previous platform, further differentiating the startups offerings. A great example on the Smartphone is using GPS for one button local search. New platforms also require new distribution techniques, and in such a “jump ball” scenario the incumbent’s advantage evaporates. One could argue the incumbents are even at a disadvantage as they are less likely to have the cutting edge technical employees who understand the new platforms.

Changing the Game: Going Deep

But there is an even greater limitation on the power of incumbents than their discomfort with new platforms. As the market moves away from Yellow Pages-like listings and directories as a proxy for advertising, many young companies, taking a page out of the playbook of data-driven software-as-a-service companies, have created deep vertical integration within their spaces in order to drive traffic and enable services. By organizing small business owners, supplementary service providers, and customers on a single canonical set of data, these companies are not only providing new ways for customers to discover local businesses: they are creating new ways for local businesses to interact with customers. They are moving from “listing” services to “automation” services, and they are stitching these Internet services deep into the nervous system of the target industry.

For example, a company like OpenTable provides, on a stand-alone basis, a premises based computer that is an extremely effective tool for restaurants to manage their tables — a digital version of the reservation book on the maitre d’s desk. By connecting that same data on the Internet, and aggregating that data from other restaurants, you have OpenTable’s incredible online reservation system. Along that same data spine, customers can add reviews, limousine services and florists can enhance the dining experience, and a location-aware Smartphone app can tell you what restaurant within walking distance of where you are has a table available right now. The “offering” is the complete network, not just one specific piece, and the pieces alone are less compelling.

Going “deep” like this is a significant challenge for larger incumbents. The playbook requires a deep understanding of the industry, access to all the key content and its structure, a targeted and experienced sales structure, and a willingness to invest in a market that may seem “niche” to the broader service provider. You have to be willing to get your hands dirty. These large companies favor a horizontal, one-size-fits-all approach, offering a widget that all local companies would potentially use (such as virtual loyalty cards). But these lightweight offerings from the incumbents will fall well short of the “automation” features and functionality enabled by the innovators digging deeper into the vertical.

We’ve already seen a couple of recent examples of this with Google. In mortgages, Google launched a product but ultimately retreated, citing prioritization concerns and “taking a hard look at products that haven’t been as successful as we had hoped.” A seemingly simple category like mortgages proved difficult to nail within the overall Google strategic framework. Likewise, in order to gain a foothold in travel — a space where deep verticals thrived for many years —Google ultimately realized they had to pay $700mm for ITA Software in order to acquire the vertical tools they needed to be successful.

The Real Winner: The Customer

If you look closely at many of the leading companies developing these deep verticals, like Zillow or OpenTable or Uber or AirBnB, they are providing far more than just advertising opportunities for local businesses. These companies are using new technologies like mobility and location to improve communication, interaction and overall customer experience.

The amazing thing about these new local Internet companies is how much value the consumer gets from this data-driven, vertically-integrated experience. Watching your Uber driver approaching your location on GPS forever alters your experience of taxis and limos, while at the same time providing total transparency up and down the value chain, from dispatcher to driver to fleet manager.

But the really exciting part is that we are still really early in this process of transformation away from listing/directory advertising to a local Internet.  By way of comparison, in the fourth quarter of 2011, Southwest Airlines reported that 86% of its revenue was booked online.  By comparison, only 12% of US restaurant reservations are booked online. Only 15% of dentists are connected to customers through services like DemandForce.  Only 3% of takeout orders are processed through online offerings like GrubHub. And less than 1% of realtors are premier agents on Zillow.

We all know intuitively where those numbers are headed in the future.

*Benchmark Capital is also super excited about its investment in Nextdoor, the leading social network for local neighborhoods and communities. Join 3,000 other local communities who have revolutionized how neighbors interact online. Check it out at www.nextdoor.com.